10-Q 1 f10q0918_flatrockcapital.htm QUARTERLY REPORT

 

 

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 September 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   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 November 9, 2018, the registrant had 1,832,036 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 September 30, 2018 (Unaudited) and December 31, 2017 1
  Statements of Operations for the Three and Nine Months Ended September 30, 2018, for the Three Months Ended September 30, 2017 and for the Period May 3, 2017 (commencement of operations) through September 30, 2017 (Unaudited) 2
 

Statements of Changes in Net Assets for the Nine Months Ended September 30, 2018 and for the Period May 3, 2017 (commencement of operations) through September 30, 2017 (Unaudited)

3
  Statements of Cash Flows for the Nine Months Ended September 30, 2018 and for the Period May 3, 2017 (commencement of operations) through September 30, 2017 (Unaudited) 4
  Schedules of Investments as of September 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 22-30
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 34
Item 4. Mine Safety Disclosures 34
Item 5. Other Information 34
Item 6. Exhibits 34
     
Signatures   35

 

i

 

 

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

Flat Rock Capital Corp.

Statements of Assets and Liabilities

 

  

September 30, 2018

(Unaudited)

  

December 31, 2017

 
Assets:        
Non-controlled investments, at fair value (amortized cost $46,720,844 and $27,416,962, respectively)  $46,984,753   $27,717,744 
Cash and cash equivalents   7,678,893    1,244,044 
Unrealized appreciation on forward foreign currency contracts   93,172    - 
Receivables:          
Investment securities sold   4,508,125    1,486,885 
Paydowns receivable   -    12,658 
Subscriptions receivable   -    100,000 
Due from investment adviser   12,090    520,033 
Interest   84,398    60,792 
Prepaid expenses and other assets   75,000    - 
Total Assets  $59,436,431   $31,142,156 
           
Liabilities:          
Payables:          
Investment securities purchased  $23,967,764   $9,735,166 
Distributions payable   148,212    110,965 
Unrealized depreciation on forward foreign currency contracts   -    38,141 
Incentive fee payable   39,255    - 
Accrued other general and administrative expenses   572,730    588,235 
Total Liabilities  $24,727,961   $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; 1,732,435 and 1,032,445 issued and outstanding, respectively   1,732    1,032 
Additional paid-in capital   34,508,543    20,488,843 
Accumulated undistributed net investment income (loss)   (329,024)   (83,641)
Net realized gains (losses) on investments and foreign currency transactions   168,645    - 
Net unrealized gains (losses) on investments, foreign currency translations, and foreign currency contracts   358,574    263,415 
Total Net Assets  $34,708,470   $20,669,649 
Total Liabilities and Net Assets  $59,436,431   $31,142,156 
Net Asset Value Per Share  $20.03   $20.02 

 

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

 

1

 

  

Flat Rock Capital Corp.

Statements of Operations

(Unaudited)

 

   For the Three Months Ended   For the Nine Months Ended  

For the Period May 3, 2017 (commencement of operations)

through

 
   September 30, 2018   September 30, 2017   September 30, 2018  

September 30, 2017

 
Income:                
Investment income from non-controlled, non-affiliated investments:                
Interest income  $611,020   $113,255   $1,461,848   $113,940 
Other income   2,682    -    6,396    - 
Total investment income from non-controlled, non-affiliated investments   613,702    113,255    1,468,244    113,940 
Total Investment Income   613,702    113,255    1,468,244    113,940 
                     
Expenses:                    
Management fees   162,160    96,535    386,696    121,127 
Professional fees   143,722    138,170    327,407    163,650 
Incentive fees   12,328    -    39,255    - 
Interest expense from security borrowings   -    9,778    -    9,778 
Other general and administrative expenses   119,996    54,644    244,708    64,644 
Total Expenses   438,206    299,127    998,066    359,199 
Less: Management fee waiver (Note 3)   (162,160)   (96,535)   (386,696)   (121,127)
Less: Expense reimbursement (Note 3)   -    (165,839)   (12,090)   (200,839)
Net expenses   276,046    36,753    599,280    37,233 
Net Investment Income (Loss)   337,656    76,502    868,964    76,707 
                     
Realized and unrealized gains (losses) on investments                    
Net realized gains (losses):                    
Non-controlled, non-affiliated investments   87,341    (687)   168,887    (687)
Net realized gains (losses) on foreign currency transactions   164    (265,971)   (242)   (265,971)
Total net realized gains (losses)   87,505    (266,658)   168,645    (266,658)
Net change in unrealized gains (losses):                    
Non-controlled, non-affiliated investments   2,666    62,806    95,156    63,168 
Foreign currency translation   89,574    301,901    (131,310)   301,901 
Forward foreign currency contracts (Note 2)   (95,455)   (75,326)   131,313    (75,326)
Total net unrealized gains (losses)   (3,215)   289,381    95,159    289,743 
Total realized and unrealized gains (losses)   84,290    22,723    263,804    23,085 
Net Increase in Net Assets Resulting from Operations  $421,946   $99,225   $1,132,768   $99,792 
Earnings Per Share - Basic and Diluted  $0.32   $0.26   $0.98   $0.42 
Weighted Average Shares Outstanding - Basic and Diluted   1,305,073    380,567    1,151,840    237,349 

  

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

 

2

 

 

Flat Rock Capital Corp.

Statements of Changes in Net Assets

(Unaudited)

  

   For the Nine Months Ended September 30, 2018   For the Period May 3, 2017 (commencement of operations) through September 30, 2017 
Increase in Net Assets Resulting from Operations:        
Net investment income  $868,964   $76,707 
Net realized gains (losses) on investments and foreign currency transactions   168,645    (266,658)
Net unrealized gains (losses) on investments, foreign currency translations, and foreign currency contracts   95,159    289,743 
Net Increase in Net Assets Resulting from Operations   1,132,768    99,792 
           
Decrease in Net Assets Resulting from Stockholder Distributions          
Distributions declared from net investment income    (1,114,347)   (99,792)
Net Decrease in Net Assets Resulting from Stockholder Distributions   (1,114,347)   (99,792)
           
Increase in Net Assets Resulting from Capital Share Transactions          
Issuance of common shares   14,421,000    19,284,000 
Repurchase of common shares   (400,600)   - 
Net Increase in Net Assets Resulting from Capital Share Transactions   14,020,400    19,284,000 
Total Increase in Net Assets   14,038,821    19,284,000 
Net Assets, Beginning of Period   20,669,649    - 
Net Assets, End of Period  $34,708,470   $19,284,000 
Undistributed net investment income (loss)  $(329,024)  $(23,085)

 

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

  

3

 

 

Flat Rock Capital Corp.

Statements of Cash Flows

(Unaudited)

 

   For the Nine Months Ended   For the Period May 3, 2017 (commencement of operations) through 
   September 30, 2018   September 30, 2017 
         
Cash Flows from Operating Activities:        
Net increase in net assets resulting from operations  $1,132,768   $99,792 
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   (168,645)   266,658 
Net change in unrealized gains/losses on investments and foreign currency translations   36,154    (289,743)
Net amortization of discount on investments   (16,950)   (5,347)
Purchases of investments   (72,145,684)   (38,307,397)
Proceeds from sale of investments   53,028,116    12,999,094 
Changes in operating assets and liabilities:          
Investment securities sold   (3,021,240)   - 
Dividends and interest receivable   (23,606)   (9,402)
Receivable due from investment adviser   507,943    (140,477)
Receivable for paydowns   12,658    - 
Prepaid expenses and other assets   (75,000)   - 
Payable for investments purchased   14,232,598    6,131,918 
Dividends Payable   -    63,585 
Payable for incentive fee   39,255    - 
Payable due to broker   -    7,734,932 
Unrealized depreciation on forward foreign currency contracts   (131,313)   - 
Accrued other general and administrative expenses   (15,505)   167,932 
Net cash used in operating activities   (6,608,451)   (11,288,455)
Cash Flows from Financing Activities:          
Distributions paid in cash   (1,077,100)   (36,207)
Subscription receivable   100,000    - 
Proceeds from issuance of common shares   14,421,000    19,284,000 
Repurchase of common shares   (400,600)   - 
Net cash provided by financing activities   13,043,300    19,247,793 
Net increase in cash and cash equivalents   6,434,849    7,959,338 
Cash and cash equivalents, beginning of period   1,244,044    - 
Cash and cash equivalents, end of period  $7,678,893   $7,959,338 
           
Non-cash financing activities:          
Dividend reinvestments  $-   $- 
           
Supplemental Information:          
Interest paid during the period  $-   $9,778 

 

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

 

4

 

 

Flat Rock Capital Corp.

Schedule of Investments

As of September 30, 2018

(Unaudited)

 

         Acquisition  Maturity   Principal /   Amortized   Fair   Percentage 
Company(3)  Industry  Interest  Date  Date   Par   Cost(1)(6)   Value   of Net Assets 
Debt Investments                             
First Lien Senior Secured(2)                             
AIS HoldCo, LLC(5)  Insurance Services  3M USD L + 5.00% (1% Floor)  9/5/2018  8/15/2025   $3,992,179   $3,992,168   $4,012,140    11.6%
Bomgar Corporation  Computers & Electronics  3M USD L + 4.00% (1% Floor)  4/17/2018  4/17/2025    2,743,125    2,753,229    2,760,270    8.0%
Deliver Buyer, Inc.  Capital Equipment  3M USD L + 5.00% (1% Floor)  6/14/2018  5/1/2024    498,737    497,593    502,478    1.4%
Financial & Risk US Holdings, Inc.(5)  Financial Services  1M USD L + 3.75% (1% Floor)  9/18/2018  9/18/2025    1,000,000    997,500    997,500    2.9%
GI Revelation Acquisition LLC  Business Services  1M USD L + 5.00% (1% Floor)  4/11/2018  4/11/2025    498,750    496,386    499,373    1.4%
Hill International, Inc.  Business Services  3M USD L + 5.75% (1% Floor)  9/22/2017  6/21/2023    1,481,250    1,474,509    1,477,547    4.3%
Idera, Inc.(5)  Computers & Electronics  1M USD L + 4.50% (1% Floor)  6/27/2017  6/27/2024    1,334,886    1,332,214    1,337,811    3.9%
Isagenix International LLC(5)  Direct Selling  3M USD L + 5.75% (1% Floor)  4/26/2018  4/25/2025    2,962,500    2,972,692    2,992,125    8.6%
Kettle Cuisine, LLC(5)  Food & Beverage  1M USD L + 3.75% (1% Floor)  8/22/2018  8/25/2025    1,000,000    995,000    995,000    2.9%
Logibec Inc.(4)  Healthcare IT  1M CDOR + 6.00% (1% Floor)  6/14/2017  1/15/2020    4,990,166    4,837,448    4,990,166    14.4%
MHVC Acquisition Corp (Magnolia/Peraton)(5)  Aerospace and Defense  3M USD L + 5.25% (1% Floor)  9/21/2018  4/25/2024    997,475    992,487    992,487    2.9%
MRO Holdings, Inc.  Transportation  3M USD L + 5.25% (1% Floor)  10/20/2017  10/25/2023    992,500    983,986    1,002,425    2.9%
Next Level Apparel, Inc.  Consumer goods  1M USD L + 6.00% (1% Floor)  7/27/2018  7/26/2024    2,000,000    1,980,025    1,980,000    5.7%
NM Z Parent Inc (Zep Inc)  Chemicals & Allied Products  3M USD L+ 4.00% (1% Floor)  5/25/2018  8/9/2024    994,975    983,145    945,226    2.7%
Octave Music Group, Inc.  Broadcasting & Subscription  1M USD L + 4.75% (1% Floor)  10/17/2017  5/28/2021    989,770    995,240    989,770    2.9%
Radiology Partners, Inc. Term Loan  Healthcare Services  3M USD L+ 4.25% (1% Floor)  6/28/2018  7/4/2025    2,000,000    1,980,480    2,017,500    5.8%
ThreeBridge Solutions Term Loan  IT Implementation  1M USD L+ 9.00% (1% Floor)  12/4/2017  12/1/2022    3,950,000    3,913,588    3,950,000    11.4%
Web.com (Siris Parker Private Merger Sub, Inc)(5)  Internet Services  1M USD L + 3.75% (1% Floor)  9/17/2018  9/17/2025    2,000,000    1,995,000    1,995,000    5.7%
World Insurance Associates, LLC Delayed Draw(5)(7)  Insurance Brokerage  1M USD L + 4.75% (1% Floor)  8/29/2018  7/18/2024    -    -    -    0.0%
World Insurance Associates, LLC(5)  Insurance Brokerage  1M USD L + 4.75% (1% Floor)  8/29/2018  7/18/2024    2,515,599    2,549,787    2,549,635    7.3%
Total First Lien Senior Secured               $36,941,912   $36,722,477   $36,986,453    106.7%
                                  
Total Debt Investments                $36,941,912   $36,722,477   $36,986,453    106.7%

 

      Maturity   Acquisition   Number of   Principal /   Amortized   Fair   Percentage 
Company(3)  Yield to Maturity  Date   Date   Shares   Par   Cost(6)   Value   of Net Assets 
U.S. Government Securities                               
U.S. Treasury Bill(5)  0.01%   10/1/2018    9/28/2018    10,000,000    10,000,000    9,998,367    9,998,300    28.8%
Total U.S. Government Securities                     10,000,000    9,998,367    9,998,300    28.8%
                                       
Total Investments                    $46,941,912   $46,720,844   $46,984,753    135.5%
Liabilities in Excess of Other Assets                               (12,276,283)   (35.5)%
Net assets                              $34,708,470    100.0%

 

5

 

 

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

 

Currency   Currency      Expiration   Unrealized Appreciation 
Purchased   Sold   Counterparty  Date   (Depreciation) 
USD5,090,981   CAD6,435,000   Bannockburn Global Forex, LLC   1/31/2019    93,172

 

CADCanadian Dollar
USDUnited 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 September 30, 2018, the 1 month (1M), 2 month (2M), and 3 month (3M) USD LIBOR rates were 2.26%, 2.31%, and 2.40%, respectively. As of September 30, 2018, CDOR was 2.03%.
   
(3) As of September 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. As of September 30, 2018, 8.40% of the Company’s total assets were in non-qualifying investments.
   
(5) Investments or a portion of investments are unsettled as of September 30, 2018.
   
(6) As of September 30, 2018, the tax cost of the Company’s investments approximates their amortized cost.
   
(7)

The entire $1,546,797 commitment to World Insurance Associates, LLC Delayed Draw was unfunded as of September 30, 2018. As such, no interest is being earned on this investment. The investment is subject to a 0.50% commitment fee (see Note 7 to the financial statements).

 

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

 

6

 

 

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  1M USD L + 5.50% (1% Floor)  6/6/2017  2/15/2024  $249,373   $249,373   $249,373    1.2%
Hill International, Inc.  Business Services  3M USD 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  1M USD 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  3M USD L + 6.00% (1% Floor)  8/24/2017  4/30/2022   974,684    965,465    972,247    4.7%
Logibec Inc.(4)  Healthcare IT  1M 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  3M USD 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  1M USD 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  3M USD 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  3M USD 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  1M USD 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  1M USD 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  1M USD 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%

 

7

 

 

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)

 

CADCanadian Dollar
USDUnited 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 (1M), 2 month (2M), and 3 month (3M) USD 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.

 

8

 

 

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 has elected to 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 to be taxed 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”, as such term is defined in Section 2(a)(19) of the 1940 Act, of the Company or Flat Rock Global.

 

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 has elected to be treated for U.S. federal income tax purposes as a RIC under the Code beginning with 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.

 

9

 

 

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.

 

10

 

 

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.

 

11

 

 

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 nine months ended September 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 nine months ended September 30, 2018, grouped by contract type and risk exposure category.

 

Derivatives

 

Forward Contracts 

Unrealized appreciation (depreciation) on forward foreign currency contracts

  $93,172 
Derivative Assets     $93,172 

 

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 nine months ended September 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  $131,313   $131,313 
      $131,313   $131,313 

 

During the nine months ended September 30, 2018, the Company’s quarterly average volume of derivatives is as follows:

 

Forward Foreign Currency

Contracts - Payable (Value at Trade Date)

 
$(5,090,981)

 

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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 Accounting Standards Update (“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 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 financial statements and disclosures.

 

In August 2017, the FASB issued ASU 2017-12, which amends the hedge accounting recognition and presentation requirements in ASC 815. The FASB’s objectives in issuing the ASU are to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. ASU 2017-12 is effective on fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Management is considering the impact of ASU 2017-12 on the Company's financial statements.

 

In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2018-03”), which makes minor changes to certain aspects of recognition, measurement, presentation and disclosure of financial instruments. ASU 2018-03 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. Adoption of this standard has no impact on the Company’s financial statements and disclosures.

 

In May 2018, the FASB issued ASU 2018-06, which supersedes the guidance in Subtopic 942-740, Financial Services—Depository and Lending—Income Taxes, that is related to Circular 202 because that guidance has been rescinded by the Office of the Comptroller of the Currency (OCC) and no longer is relevant.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). The primary focus of ASU 2018-13 is to improve the effectiveness of the disclosure requirements for fair value measurements. The changes affect all companies that are required to include fair value measurement disclosures. In general, the amendments in ASU 2018-13 are effective for all entities for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019. An entity is permitted to early adopt the removed or modified disclosures upon the issuance of ASU 2018-13 and may delay adoption of the additional disclosures, which are required for public companies only, until their effective date. Management is currently evaluating the impact these changes will have on the Company’s financial statements and disclosures.

 

In August 2018, the Securities and Exchange Commission issued Final Rule Release No. 33-10532, Disclosure Update and Simplification, which in part amends certain disclosure requirements of Regulation S-X that have become redundant, duplicative, overlapping, outdated, or superseded, in light of other Commission disclosure requirements, U.S. Generally Accepted Accounting Principles, or changes in the information environment. The amendments are intended to facilitate the disclosure of information to investors and simplify compliance without significantly altering the total mix of information provided to investors. The effective date for these disclosures is November 5, 2018. Management is currently evaluating the impact of the changes to the Company’s financial statements.

13

 

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 September 28, 2018, acquired $10,000,000 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 nine months ended September 30, 2018, the Company incurred management fees of $162,160 and $386,696, respectively, all of which were waived by Flat Rock Global. For the three months ended September 30, 2017 and the period May 3, 2017 (commencement of operations) through September 30, 2017, the Company incurred management fees of $96,535 and $121,127, respectively, 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 nine-month periods ended September 30, 2018 and for the period May 3, 2017 (commencement of operations) through September 2017, 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 nine-month periods ended September 30, 2018, the Company accrued capital gains incentive fees of $12,328 and $39,255, respectively. For the period May 3, 2017 (commencement of operations) through September 30, 2017, no capital gain incentive fees were accrued. 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 nine months ended September 30, 2018, the reimbursement totaled $0 and $12,090, respectively, which consisted of audit, fund accounting, fund administration, insurance, legal, valuation and other fees. For the three months ended September 30, 2017 and period May 3, 2017 (commencement of operations) through September 30, 2017, the reimbursement totaled $165,839 and $200,839, respectively. 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.

14

 

 

Note 4. Investments

 

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

 

   September 30, 2018   December 31, 2017 
   Amortized   Fair   Amortized   Fair 
   Cost   Value   Cost   Value 
First-lien senior secured debt  $36,722,477   $36,986,453   $19,417,419   $19,718,232 
U.S. Government Securities   9,998,367    9,998,300    7,999,543    7,999,512 
    46,720,844    46,984,753    27,416,962    27,717,744 
Forward foreign currency contracts   -    93,172    -    (38,141)
Total Investments  $46,720,844   $47,077,925   $27,416,962   $27,679,603 

 

As of September 30, 2018, approximately 10.4% of the investment portfolio at amortized cost and 10.6% 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 September 30, 2018 and December 31, 2017 was as follows:

 

   September 30, 2018   December 31, 2017 
         
U.S. Government Securities   21.3%   28.9%
Healthcare IT   10.6%   18.5%
Computers & Electronics   8.7%   3.0%
Insurance Services   8.5%   1.8%
IT Implementation   8.4%   14.3%
Direct Selling   6.4%   0.0%
Insurance Brokerage   5.4%   0.0%
Healthcare Services   4.3%   13.0%
Internet Services   4.3%   0.0%
Business Services   4.2%   5.3%
Consumer Goods   4.2%   0.0%
Transportation   2.1%   3.6%
Broadcasting & Subscription   2.1%   3.6%
Aerospace and Defense   2.1%   0.0%
Financial Services   2.1%   0.0%
Food & Beverage   2.1%   0.0%
Chemicals & Allied Products   2.0%   0.0%
Capital Equipment   1.2%   0.0%
Entertainment & Leisure   0.0%   0.9%
Forward Foreign Currency Contracts   0.0%*   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 September 30, 2018 and December 31, 2017 was as follows:

 

   September 30, 2018   December 31, 2017 
         
United States:        
Northeast   24.5%   12.5%
Government Securities   21.3%   28.9%
West   14.9%   17.4%
South   11.8%   3.0%
Southeast   8.5%   3.6%
Midwest   8.4%   16.1%
Canada   10.6%   18.5%
Total   100.0%   100.0%

15

 

 

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 September 30, 2018 and December 31, 2017:

 

   Fair Value Hierarchy as of September 30, 2018 
   Level 1   Level 2   Level 3   Total 
First-lien senior secured debt  $-   $-   $36,986,453   $36,986,453 
U.S. Government Securities   9,998,300    -    -    9,998,300 
Forward foreign currency contracts   -    93,172    -    93,172 
Total Investments  $9,998,300   $93,172   $36,986,453   $47,077,925 

 

   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 

 

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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 nine months ended September 30, 2018, for the three months ended September 30, 2017 and for the period May 3, 2017 (commencement of operations) through September 30, 2017:

 

   For the Three Months Ended 
First-lien senior secured debt  September 30, 2018   September 30, 2017 
Fair value, beginning of period  $27,153,149   $6,954,895 
Purchases of investments, net   29,852,709    10,025,747 
Proceeds from investments, net   (20,114,933)   - 
Net change in unrealized gain (loss)   92,291    366,858 
Net amortization of discount on investments   3,237    3,560 
Transfers into (out of) Level 3   -    - 
Fair value, end of period  $36,986,453   $17,351,060 

 

First-lien senior secured debt  For the Nine Months Ended September 30, 2018   For the Period May 3, 2017 (commencement of operations) through September 30, 2017 
Fair value, beginning of period  $19,718,232   $- 
Purchases of investments, net   51,649,163    16,980,642 
Proceeds from investments, net   (34,361,774)   - 
Net change in unrealized gain (loss)   (36,118)   366,858 
Net amortization of discount on investments   16,950    3,560 
Transfers into (out of) Level 3   -    - 
Fair value, end of period  $36,986,453   $17,351,060 

 

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 three and nine months ended September 30, 2018, for the three months ended September 30, 2017 and for the period May 3, 2017 (commencement of operations) through September 30, 2017:

 

   For the Three Months Ended 
Net Change in Unrealized Gain (Loss)  September 30, 2018   September 30, 2017 
           
First-lien senior secured debt  $92,291   $366,858 

 

Net Change in Unrealized Gain (Loss)  For the Nine Months Ended September 30, 2018   For the Period May 3, 2017 (commencement of operations) through September 30, 2017 
           
First-lien senior secured debt  $(36,118)  $366,858 

 

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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 September 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 September 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 September 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 September 30, 2018
       Valuation  Unobservable  Range
   Fair Value   Technique  Input  (Weighted Average)
First-lien senior secured debt  $15,429,556   Recent transaction   Transaction price   99.00-100.25 (99.58)
First-lien senior secured debt   21,556,897   Market & income approach  EBITDA multiple  6.5x - 12.5x (8.90x)
   $36,986,453      Revenue multiple  2.9x
           Discount rate  6.50% - 8.25% (8.75%)

 

   As of December 31, 2017
       Valuation  Unobservable  Range
   Fair Value   Technique  Input  (Weighted 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 nine months ended September 30, 2018, the Company issued and sold 719,990 shares of its common stock at an aggregate purchase price of $14,421,000.

 

Distributions

 

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

 

      Distribution        
Declaration  Record  Per   Payment  Distribution 
Date  Date  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 
7/26/2018  7/26/2018   0.108   8/6/2018   135,436 
8/26/2018  8/26/2018   0.108   9/6/2018   136,430 
9/26/2018  9/26/2018   0.108   10/6/2018   148,212 
              $1,114,347 

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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 represented 25% of the total issued and outstanding shares of our common stock as of July 31, 2018.

 

The second tender offer expired at 11:59 P.M., Central Time, on September 6, 2018 (the “Second Offer Expiration Date”). As of the Second Offer Expiration Date, no shares of the Company’s common stock were validly tendered and not withdrawn pursuant to the second tender offer. In accordance with the terms of the second tender offer, the Company did not purchase any shares of its common stock pursuant to the second tender offer.

 

On September 12, 2018, following approval from the Board, the Company filed a third tender offer to repurchase up to 343,089 shares of the Company’s issued and outstanding common stock, which represented 25% of the issued and outstanding shares of our common stock as of September 11, 2018.

 

Note 7. Commitments and Contingencies

 

The Company had an aggregate of $1,546,797 of unfunded commitments to provide debt financing to its portfolio companies or to fund limited partnership interests as of September 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 September 30, 2018 is shown in the table below:

 

   As of 
   September 30, 2018 
     
World Insurance Associates, LLC   1,546,797 
   $1,546,797 

 

A summary of the composition of the unfunded commitments as of December 31, 2017 is shown in the table below:

 

   As of December 31, 2017 
Radiology Partners, Inc.  $351,133 
ThreeBridge Solutions   500,000 
Total unfunded  $851,133 

 

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

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Note 8. Earnings Per Share

 

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

 

   For the Three Months Ended   For the Nine Months Ended   For the Period
May 3, 2017 (commencement of operations) through
 
   September 30, 2018   September 30, 2017   September 30, 2018   September 30, 2017 
                 
Increase in net assets resulting from operations  $421,946   $99,225   $1,132,768   $99,792 
Weighted average shares of common stock outstanding - basic and diluted   1,305,073    380,567    1,151,840    237,349 
Earnings per common share - basic and diluted  $0.32   $0.26   $0.98   $0.42 

 

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 nine months ended September 30, 2018 and for the period May 3, 2017 (commencement of operations) through September 30, 2017:

 

   For the Nine Months Ended September 30, 2018   For the Period
May 3, 2017 (commencement of operations) through September 30, 2017
 
Per Common Share Operating Performance        
Net Asset Value, Beginning of Period  $20.02   $- 
           
Results of Operations:          
Net Investment Income(1)   0.75    0.32 
Net Realized and Unrealized Gain (Loss) on Investments(1)   0.23    (0.10)
Net Increase (Decrease) in Net Assets Resulting from Operations   0.98    0.22 
           
Distributions to Common Stockholders          
Distributions from Net Investment Income   (0.97)   (0.22)
Distributions from Realized Gains   -    - 
Net Decrease in Net Assets Resulting from Distributions   (0.97)   (0.22)
           
Capital Share Transactions          
Issuance of Common Stock   -    20.00 
Repurchase of Common Stock   -    - 
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   1,732,435    964,200 
           
Ratio/Supplemental Data          
Net assets, end of period  $34,708,470   $19,284,000 
Weighted-average shares outstanding   1,151,840    237,349 
Total Return(3)   4.91%   1.08%
Portfolio turnover   131.8%   0.0%
Ratio of operating expenses to average net assets without waiver and reimbursement(2)(4)   5.28%   9.01%
Ratio of operating expenses to average net assets with waiver and reimbursement(2)(4)   3.17%   0.93%
Ratio of net investment income (loss) to average net assets without waiver and reimbursement(2)(4)   2.49%   (6.15%)
Ratio of net investment income (loss) to average net assets with waiver and reimbursement(2)(4)   4.60%   1.92%

 

(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.

20

 

 

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:

 

Credit Facility

 

On October 12, 2018, the Company, through a special purpose wholly-owned subsidiary, FRC Funding I, LLC (“FRC Funding” and together with the Company, the “Borrowers”) entered into a Loan and Security Agreement (the “Loan Agreement”) with certain financial institutions as lenders (“Lenders”), State Bank and Trust Company as the administrative agent (“State Bank”) and Alostar Capital Finance (“Alostar”), as Lead Arranger and Bookrunner, pursuant to which Lenders will provide the Company with a revolving line of credit. The Loan Agreement is effective as of October 12, 2018.

 

The Loan Agreement provides for an initial $20.0 million in Revolver Commitments (as defined in the Loan Agreement) to be available at closing that the Company can draw down and repay for three years, subject to borrowing base eligibility. The Loan Agreement matures at the earliest of (a) the date that is four (4) years from closing, (b) the date on which FRC Funding terminates the Revolver Commitments pursuant to the Loan Agreement; or (c) the date on which the Revolver Commitments are terminated pursuant to certain events of default under the Loan Agreement; and the Scheduled Revolving Period End Date (as defined in the Loan Agreement) is three years from closing.

 

The Loan Agreement accrues interest at the Daily LIBOR Rate, plus a 2.88% margin, and principal is repayable in full at maturity. Interest is generally required to be paid monthly in arrears. The Loan Agreement requires the payment of an unused line fee of between 0.50% and 1.0%, commencing on the date that is two months from closing, based on the amount by which the Revolver Commitments exceed the average daily balance of the Revolver Loans (as defined in the Loan Agreement) during any month. Such fee is payable monthly in arrears. The Loan Agreement has an advance rate against FRC Funding’s Eligible Portfolio Investment (as defined in the Loan Agreement). The advance rate, as to any Eligible Portfolio Investment, is 75.0% when the Company’s asset coverage ratio is equal or greater than 200.0% or 70.0% when the Company’s asset coverage ratio is less than 200.0%, subject to certain eligibility requirements.

 

Pursuant to the terms of the Loan Agreement, the Borrowers grant to State Bank for the benefit of State Bank, Lenders, Alostar and its affiliates, a security interest and a lien in substantially all of FRC Funding’s assets. The Loan Agreement contains certain affirmative and negative covenants, including a minimum Company asset coverage ratio, a minimum fixed charge ratio, and a minimum Company tangible net worth. Under the Loan Agreement, the Borrowers are required to make certain customary representations and warranties and are required to comply with various covenants, reporting requirements and other requirements that are customary for similar credit facilities. The obligations under the Loan Agreement may be accelerated upon the occurrence of an event of default under the Loan Agreement or in the event of a change of control of the Company or FRC Funding.

 

Repurchases of Shares

 

As stated in Note 8, the Company filed a third tender offer on September 12, 2018. The third tender offer expired at 11:59 P.M., Central Time, on October 12, 2018 (the “Third Offer Expiration Date”). As of the Third Offer Expiration Date, no shares of the Company’s common stock were validly tendered and not withdrawn pursuant to the third tender offer. In accordance with the terms of the third tender offer, the Company did not purchase any shares of Common Stock pursuant to the third tender offer.

 

On October 24, 2018, following approval from the Board, in order to continue to comply with such 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 fourth tender offer to repurchase up to 433,109 shares of the Company’s issued and outstanding common stock. The fourth offer represented 25% of the Company’s total issued and outstanding shares of common stock as of October 23, 2018. Upon completion of the fourth tender offer, the Company will have fully complied with the provisions of the SBCAA, described herein, and will be eligible to take advantage of the reduced asset coverage ratio of 150% beginning May 30, 2019. The fourth tender offer is scheduled to expire on December 4, 2018.

 

Issuance of Common Stock

 

On October 29, 2018, the Company issued and sold 99,601 shares of its common stock at an aggregate purchase price of $1,995,000. 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.

 

Distributions

 

On October 26, 2018, the Company declared a distribution of $0.108 per share, or $187,103, payable on November 6, 2018.

 

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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 has elected 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.

 

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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 nine months ended September 30, 2018, the reimbursement totaled $0 and $12,090, respectively, which consisted of audit, fund accounting, fund administration, insurance, legal, valuation and other fees. For the three months ended September 30, 2017 and for the period May 3, 2017 (commencement of operations) through September 30, 2017, the reimbursement totaled $165,839 and $200,839, respectively. 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.

 

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Portfolio and Investment Activity

 

As of September 30, 2018, our weighted average total yield of debt and income producing securities at fair value was 7.56%, and our weighted average total yield of debt and income producing securities at amortized cost was 7.74%.

 

As of September 30, 2018, we had 22 investments in 19 portfolio companies with an aggregate fair value of approximately $37.0 million.

 

Our investment activity for the three months ended September 30, 2018 and September 30, 2017 is presented below (information presented herein is at amortized cost unless otherwise indicated).

 

   For the Three Months Ended 
   September 30, 2018   September 30, 2017 
         
New investments:        
Gross investments  $29,852,709   $9,789,023 
Less: sold investments   (20,111,697)   - 
Total new investments   9,741,012    9,789,023 
           
Principal amount of investments funded:          
First-lien senior secured debt investments  $29,852,709   $343,341 
Second-lien senior secured debt investments   -    - 
Total principal amount of investments funded   29,852,709    343,341 
           
Principal amount of investments sold:          
First-lien senior secured debt investments   (20,111,697)   - 
Second-lien senior secured debt investments   -    - 
Total principal amount of investments sold or repaid  $(20,111,697)   $- 
           
Number of new investment commitments   11    8 
Average new investment commitment amount  $885,547   $1,223,628 
Weighted average maturity for new investment commitments   5.3 years    4.5 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   7.13%   6.83%
Weighted average spread LIBOR of new floating rate investment commitments   4.83%   5.54%
Weighted average interest rate on investment sold or paid down   7.41%   N/A 

 

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

 

   September 30, 2018   December 31, 2017 
   Amortized   Fair   Amortized   Fair 
   Cost   Value   Cost   Value 
First-lien senior secured debt  $36,722,477   $36,986,453   $19,417,419   $19,718,232 
U.S. Government Securities   9,998,367    9,998,300    7,999,543    7,999,512 
Forward foreign currency contracts   -    93,172    -    (38,141)
Total Investments  $46,720,844   $47,077,925   $27,416,962   $27,679,603 

 

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

 

   September 30, 2018   December 31, 2017 
         
U.S. Government Securities   21.3%   28.9%
Healthcare IT   10.6%   18.5%
Computers & Electronics   8.7%   3.0%
Insurance Services   8.5%   1.8%
IT Implementation   8.4%   14.3%
Direct Selling   6.4%   0.0%
Insurance Brokerage   5.4%   0.0%
Healthcare Services   4.3%   13.0%
Internet Services   4.3%   0.0%
Business Services   4.2%   5.3%
Consumer Goods   4.2%   0.0%
Transportation   2.1%   3.6%
Broadcasting & Subscription   2.1%   3.6%
Aerospace and Defense   2.1%   0.0%
Financial Services   2.1%   0.0%
Food & Beverage   2.1%   0.0%
Chemicals & Allied Products   2.0%   0.0%
Capital Equipment   1.2%   0.0%
Entertainment & Leisure   0.0%   0.9%
Forward Foreign Currency Contracts   0.0%*   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 September 30, 2018 and December 31, 2017:

 

   September 30, 2018   December 31, 2017 
         
United States:        
Northeast   24.5%   12.5%
Government Securities   21.3%   28.9%
West   14.9%   17.4%
South   11.8%   3.0%
Southeast   8.5%   3.6%
Midwest   8.4%   16.1%
Canada   10.6%   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 September 30, 2018 and December 31, 2017:

 

   September 30, 2018   December 31, 2017 
Weighted average total yield of debt and income producing securities   7.79%   7.99%
Weighted average interest rate of debt and income producing securities   7.64%   7.82%
Weighted average spread over LIBOR of all floating rate investments   5.47%   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.

 

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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 September 30, 2018 and December 31, 2017.

 

   September 30, 2018   December 31, 2017 
       Percentage       Percentage 
   Investments at   of Total   Investments at   of Total 
Investment Rating  Fair Value   Portfolio   Fair Value   Portfolio 
2   47,077,925    100.0%   27,679,603    100.0%
Total  $47,077,925    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 do not have a full nine month period with which to compare our operating results.

 

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

 

   For the Three Months Ended   For the Nine Months Ended     For the Period
May 3, 2017
(commencement of operations) through
 
   September 30, 2018   September 30, 2017   September 30, 2018   September 30, 2017 
Total Investment Income  $613,702   $113,255   $1,468,244   $113,940 
Less: Net Expenses   276,046    36,753    599,280    37,233 
Net Investment Income (Loss) before income taxes   337,656    76,502    868,964    76,707 
Less: Income taxes, including excise taxes   -    -    -    - 
Net Investment Income   337,656    76,502    868,964    76,707 
Net realized gains (losses) on investments   87,505    (266,658)   168,645    (266,658)
Net unrealized gains (losses) on investments   (3,215)   289,381    95,159    289,743 
Net increase in net assets resulting from operations  $421,946   $99,225   $1,132,768   $99,792 

 

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Investment Income

 

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

 

    For the Three Months Ended   For the Nine Months Ended   For the Period
May 3, 2017 (commencement of operations) through
 
   September 30, 2018   September 30, 2017   September 30, 2018   September 30, 2017 
Interest from investments  $611,020   $113,255   $1,461,848   $113,940 
Other income   2,682    -    6,396    - 
Total investment income  $613,702   $113,255   $1,468,244   $113,940 

 

Expenses

 

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

 

   For the Three Months Ended   For the Nine Months Ended     For the Period May 3, 2017 (commencement of operations) through 
   September 30, 2018   September 30, 2017   September 30, 2018   September 30, 2017 
Management fees  $162,160   $96,535   $386,696   $121,127 
Incentive fees   12,328    -    39,255    - 
Other operating expenses   263,718    202,592    572,115    238,072 
Management fee waiver   (162,160)   (96,535)   (386,696)   (121,127)
Expense Reimbursement   -    (165,839)   (12,090)   (200,839)
Net Expenses  $276,046   $36,753   $599,280   $37,233 

 

Net expenses for the three months ended September 30, 2018 were $276,046, which consisted of $162,160 in management fees, $12,328 in incentive fees, $143,722 in professional fees, and $119,996 in general and administrative expenses, offset by $162,160 in management fee waiver and $0 in expense reimbursement from the Adviser.

 

Net expenses for the nine months ended September 30, 2018 were $599,280, which consisted of $386,696 in management fees, $39,255 in incentive fees, $327,407 in professional fees, and $244,708 in general and administrative expenses, offset by $386,696 in management fee waiver and $12,090 in expense reimbursement from the Adviser.

 

In order to meet the diversification tests required to qualify as a RIC, the Company, on September 28, 2018, acquired $10,000,000 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 nine months ended September 30, 2018, the Company incurred management fees of $386,696, all of which were waived by Flat Rock Global.


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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 nine months ended September 30, 2018, for the three months ended September 30, 2017 and for the period May 3, 2017 (commencement of operations) through September 30, 2017, net unrealized gains (losses) on our investment portfolio were comprised of the following:

 

   For the Three Months Ended   For the Nine Months Ended     For the Period
May 3, 2017 (commencement of operations) through
 
   September 30, 2018   September 30, 2017   September 30, 2018   September 30, 2017 
Net unrealized gains (losses) on investments  $(3,215)  $289,381   $95,159   $289,743 

 

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 September 30, 2018, we sold 1,752,435 shares of common stock for gross proceeds of approximately $35.1 million. As of September 30, 2018, we had cash and cash equivalents of $7,678,893.

 

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. 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. 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 nine months ended September 30, 2018, we issued and sold 719,990 shares of our common stock at an aggregate purchase price of $14,421,000.

 

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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 elected 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 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 nine months ended September 30, 2018:

 

        Distribution         
Declaration   Record   Per   Payment   Distribution 
Date   Date   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 
7/26/2018   7/26/2018    0.108   8/6/2018    135,436 
8/26/2018   8/26/2018    0.108   9/6/2018    136,430 
9/26/2018   9/26/2018    0.108   10/6/2018    148,212 
                 $1,114,347 

 

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.

 

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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.

 

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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 September 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 including our credit facility, 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 September 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 September 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 September 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 September 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 September 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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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 September 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. On September 12, 2018, we filed our third tender offer (the “Third Tender Offer”) to each of our shareholders as of September 11, 2018, to purchase up to 343,089 shares of our common stock. The Initial Tender Offer, the Second Tender Offer and Third 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 are conducting a fourth tender offer, which offers 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.

 

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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.

 

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.

 

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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 29, 2018, the Company issued and sold 109,086 shares of its common stock at an aggregate purchase price of $2,185,000. 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 September 29, 2018, the Company issued and sold 360,110 shares of its common stock at an aggregate purchase price of $7,213,000. 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.)
   
10.5 Loan and Security Agreement among FRC Funding I, LLC as borrower, Flat Rock Capital Corp. as servicer, the Lenders party thereto, and State Bank and Trust Company as agent for the Lenders, dated October 12, 2018 (Incorporated by reference to the Registrant’s Current Report on Form 8-K, filed with the SEC on October 18, 2018.)
   
10.6 Sale, Contribution and Master Participation Agreement between Flat Rock Capital Corp. as seller and FRC Funding I, LLC as purchaser dated October 12, 2018 (Incorporated by reference to the Registrant’s Current Report on Form 8-K, filed with the SEC on October 18, 2018.)
   
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.

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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.

 

Date: November 13,2018 Flat Rock Capital Corp.
     
    /s/ Robert K. Grunewald
  Name: Robert K. Grunewald
  Title: President and Chief Executive Officer
Date: November 13, 2018   (Principal Executive Officer)
     
    /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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