Item 1A. Risk Factors
Item 1A. Risk Factors.
Our business is subject to a number of risks. You should carefully consider the following risk factors, together with all of the other information included in this report, before you decide whether to invest in our securities. The following risks are not the only risks we face. If any of the following risks occurs or continues to occur, our business, financial condition and results of operations could be materially adversely affected. In such case, the trading price of our common shares could decline, and you may lose all or part of your investment. Although the risks are organized by headings, and each risk is discussed separately, many are interrelated.
Risks Related to Our Business
We have a limited track record in the durable medical equipment and investment management businesses, and provide no assurance as to our acquisition and investment program. We entered the investment management business in November 2016 and we entered the durable medical equipment business in September 2018. Accordingly, there is limited historical information about our performance.
We have plans to make significant investments and will continue to explore opportunities in these and other sectors but cannot provide specificity as to our future investments or financing plans.
These and other factors, including the other risk factors described in this report, make it difficult for you and other market participants to value our company and our prospects. We are unaware of any comparable company that securities analysts can use to benchmark our performance and valuation. We cannot give any assurance that any of the uncertainties or risk factors in this report will be favorably resolved.
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Our growth strategy may not be successful. The process to identify potential investment opportunities and strategic transaction partners , to investigate and evaluate the future returns therefrom and business prospects thereof and negotiate definitive agreements with respect to such transactions on mutually acceptable terms can be time consuming and costly. We are likely to encounter intense competition from other companies with similar business objectives to ours, including private equity and venture capital funds, sovereign wealth funds, special purpose acquisition companies, investment firms with significantly greater financial and other resources and operating businesses competing for acquisitions. Many of these companies are well established, well financed and have extensive experience in identifying and effecting business combinations.
The Company continually evaluates its assets and investments relative to other market opportunities in order to maximize shareholder value. As a result, the Company may purchase new assets or businesses or sell existing assets or businesses at any time. If such a purchase or sale is not successfully completed, integrated or managed effectively, or does not result in the benefits or cost savings we expect, our business, financial condition or results of operations may be adversely affected.
Because we will consider investments in different industries, you have no basis at this time to ascertain the merits or risks of any business that we may ultimately invest in or seek to acquire. We are a holding company seeking to acquire assets and businesses. We are not limited to acquisitions and/or investments in any particular industry or type of business. Accordingly, there is no current basis for you to evaluate the possible merits or risks of the particular industry in which we may ultimately invest or the target businesses in which we may ultimately invest or seek to acquire. We may not properly assess all of the significant risks present in that opportunity. Even if we properly assess those risks, some of them may be outside of our control or ability to affect. For example, as part of our investment management business we will direct investments in a wide variety of industries and vehicles, including special purpose acquisition companies (SPACs), which may decline in value. Except as required under the Nasdaq Stock Market LLC ( Nasdaq ) rules and applicable law, we will not seek stockholder approval of any investment or acquisition that we may pursue, so you will most likely not be provided with an opportunity to evaluate the specific merits or risks of such a transaction before we become committed to the transaction. Our business, financial condition and results of operations are dependent upon our investments. Any material adverse change in one of our investments or in a particular industry in which we invest may cause material adverse changes to our business, financial condition and results of operations. Further, concentration of capital we devote to a particular investment or industry may increase the risk that such investment could significantly impact our financial condition and results of operations, possibly in a material adverse way.
Subsequent to an investment, we may be required to take write-downs or write-offs, restructuring and impairment or other charges that could have a significant negative effect on our financial condition, results of operations and our share price, which could cause you to lose some or all of your investment. Even if we conduct extensive due diligence on a target business that we invest in, we cannot assure you that this diligence will identify all material issues that may be present inside a particular target business, that it would be possible to uncover all material issues through a customary amount of due diligence, or that factors outside of the target business or outside of our control will not later arise. As a result of these factors, we may be forced to later write-down or write-off assets, restructure our operations, or incur impairment or other charges that could result in us reporting losses. Even if our due diligence successfully identifies certain risks, unexpected risks may arise and previously known risks may materialize in a manner not consistent with our preliminary risk analysis. Even though these charges may be non-cash items and not have an immediate impact on our liquidity, the fact that we report charges of this nature could contribute to negative market perceptions about us or our securities. In addition, charges of this nature may cause us to violate covenants under our debt agreements. Accordingly, you could suffer a significant reduction in the value of your shares.
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We may not correctly assess the management teams of the businesses we invest in. The value of the businesses we invest in is driven by the quality of the leaders of those businesses. When evaluating the desirability of a prospective target business, our ability to assess the target business’ management may be limited due to a lack of time, resources or information. Our assessment of the capabilities of the target’s management, therefore, may prove to be incorrect and such management may lack the skills, qualifications or abilities we expected. Should the target’s management not possess the necessary skills, qualifications or abilities, the operations and profitability of that business will be negatively impacted. In addition, we may acquire private, non-public companies, with unsophisticated accounting or compliance operations and personnel.
Our ability to successfully grow our business will be dependent upon the efforts of our key personnel. The loss of key personnel could negatively impact the operations and profitability of our business. Our ability to successfully effect our growth strategy is dependent upon the efforts of our key personnel. The loss of our key personnel could severely negatively impact the operations and profitability of our business.
Increased competition may adversely affect our revenues, profitability and staffing. All aspects of our business are intensely competitive. We will compete directly with a number of BDCs, private equity and venture capital funds, financial investment firms and special purpose acquisition companies. There has been increasing competition from others offering financial services, including services based on technological innovations. Increased competition or an adverse change in our competitive position could lead to a reduction of business and therefore a reduction of revenues and profits.
Competition also extends to the hiring and retention of highly skilled management and employees. A competitor may be successful in hiring away employees, which may result in us losing business formerly serviced by such employees. Competition can also increase our costs of recruiting, hiring and retaining the employees we need to effectively operate our business.
Changing conditions in financial markets and the economy could impact us through decreased revenues, losses or other adverse consequences. Global or regional changes in the financial markets or economic conditions, including supply chain conditions, could adversely affect our business in many ways, including the following:
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Limitations on the availability of credit could affect our ability to borrow on a secured or unsecured basis, which may adversely affect our liquidity and results of operations. Global market and economic conditions have been disrupted and volatile in the last several years and may be in the future. Our cost and availability of funding could be affected by illiquid credit markets and wider credit spreads.
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Should one of our customers, debtors or competitors fail, our business prospects and revenue could be negatively impacted due to negative market sentiment causing customers to cease doing business with us and our lenders to cease extending credit to us, which could adversely affect our business, funding and liquidity.
We may not be able to generate sufficient taxable income to fully realize the tax benefits of our NOL carry forwards, the potential benefits of which would be reduced if U.S. federal income tax rates are lowered. At June 30, 2021, we had NOL carryforwards of approximately $952 million. If we are unable to generate sufficient taxable income prior to the expiration of our U.S. federal NOL carryforwards, the NOL carryforwards would expire unused. Our projections of future taxable income required to fully realize the recorded amount of the gross deferred tax asset reflect numerous assumptions about our operating businesses and investments and are subject to change as conditions change specific to our business units, investments or general economic conditions.
If our tax filing positions were to be challenged by federal, state and local or foreign tax jurisdictions, we may not be wholly successful in defending our tax filing positions. We record reserves for unrecognized tax benefits based on our assessment of the probability of successfully sustaining tax filing positions. Management exercises significant judgment when assessing the probability of successfully sustaining tax filing positions, and in determining whether a contingent tax liability should be recorded and, if so, estimating the amount. If our tax filing positions are successfully challenged, payments could be required that are in excess of reserved amounts or we may be required to reduce the carrying amount of our net deferred tax asset, either of which result could be significant to our financial position, cash balances and results of operations.
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We may issue notes or other debt securities, or otherwise incur substantial debt, which may adversely affect our leverage and financial condition and thus negatively impact the value of our stockholders’ investment in us. We may choose to incur substantial debt to finance our growth plans. For example, in February 2020, we raised $30 million through the issuance of 5.0% Convertible Senior PIK Notes due 2030. The incurrence of additional debt could have a variety of negative effects, including:
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default and foreclosure on our assets if our operating cash flows are insufficient to repay our debt obligations;
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acceleration of our obligations to repay the indebtedness even if we make all principal and interest payments when due if we breach covenants that require the maintenance of financial ratios or reserves without a waiver or renegotiation of that covenant;
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our immediate payment of all principal and accrued interest, if any, if the debt is payable on demand;
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our inability to pay dividends on our common stock;
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using a substantial portion of our cash flow to pay principal and interest on our debt, which will reduce the funds available for dividends on our common stock (if declared), expenses, capital expenditures, acquisitions and other general corporate purposes;
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limitations on our flexibility in planning for and reacting to changes in our business and in the industry in which we operate;
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increased vulnerability to adverse changes in general economic, industry and competitive conditions and adverse changes in government regulation; and
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limitation on our ability to borrow additional amounts for expenses, capital expenditures, acquisitions, debt service requirements, execution of our strategy and other purposes and other disadvantages compared to our competitors who have less debt.
The financial services industry is subject to extensive regulation, including recent legislation and new or pending regulation, which may significantly affect our business. The financial services industry is subject to extensive laws, rules and regulations. In recent years in particular, there has been significant legislation and increased regulation affecting the financial services industry. These legislative and regulatory initiatives affect us, our competitors, our managed investment products and our customers. These changes could have an effect on our revenue and profitability, limit our ability to pursue business opportunities, impact the value of assets that we hold, require us to change certain business practices, impose additional costs on us, and otherwise adversely affect our business. Accordingly, we cannot provide assurance that legislation and regulation will not eventually have an adverse effect on our business, results of operations, cash flows and financial condition.
Firms that engage in securities and derivatives trading and wealth and asset management must comply with the laws, rules and regulations imposed by national and state governments and regulatory and self-regulatory bodies with jurisdiction over such activities. Such laws, rules and regulations cover all aspects of the financial services business, including, but not limited to, sales and trading methods, trade practices, use and safekeeping of customers’ funds and securities, capital structure, anti-money laundering and anti-bribery and corruption efforts, recordkeeping and the conduct of directors, officers and employees. Regulators will supervise our business activities to monitor compliance with laws, rules and regulations of the relevant jurisdiction. In addition, if there are instances in which our regulators question our compliance with laws, rules, and regulations, they may investigate the facts and circumstances to determine whether we have complied.
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Operational risks may disrupt our business, result in regulatory action against us or limit our growth. Our businesses will be highly dependent on our ability to process, on a daily basis, transactions across numerous and diverse markets and the transactions we process have become increasingly complex. If any of our financial, accounting or other data processing systems do not operate properly or are disabled or if there are other shortcomings or failures in our internal processes, people or systems, we could suffer an impairment to our liquidity, a financial loss, a disruption of our businesses, liability to clients, regulatory intervention or reputational damage. These systems may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, including a disruption of electrical or communications services or our inability to occupy one or more of our buildings. The inability of our systems to accommodate an increasing volume of transactions could also constrain our ability to expand our businesses.
Our financial and other data processing systems will rely on access to and the functionality of operating systems maintained by third parties. If the accounting, trading or other data processing systems on which we are dependent are unable to meet increasingly demanding standards for processing and security or if they fail or have other significant shortcomings, we could be adversely affected. Such consequences may include our inability to effect transactions and manage our exposure to risk.
We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us. The increased use of smartphones, tablets and other mobile devices as well as cloud computing may also heighten these and other operational risks. We and our third-party providers are the subject of attempted unauthorized access, computer viruses and malware, and cyber-attacks designed to disrupt or degrade service or cause other damage and denial of service. Cyberattacks and other cyber incidents are occurring more frequently, are constantly evolving in nature, are becoming more sophisticated and are being carried out by groups and individuals (including criminal hackers, hacktivists, state-sponsored actors, criminal and terrorist organizations, individuals or groups participating in organized crime and insiders) with a wide range of expertise and motives (including monetization of corporate, payment or other internal or personal data, theft of computing resources, financial fraud, operational disruption, theft of trade secrets and intellectual property for competitive advantage and leverage for political, social, economic and environmental reasons). Such cyberattacks and cyber incidents can take many forms including cyber extortion, denial of service, social engineering, such as impersonation attempts to fraudulently induce employees or others to disclose information or unwittingly provide access to systems or data, introduction of viruses or malware, such as ransomware through phishing emails, website defacement or theft of passwords and other credentials, unauthorized use of computing resources for digital currency mining and business email compromises. There can be no assurance that such unauthorized access or cyber incidents will not occur in the future, and they could occur more frequently and on a larger scale. Legal liability arising from such risks may harm our business. Many aspects of our business involve substantial risks of liability.
Our financial and operational controls may not be adequate. As we expand our business, there can be no assurance that financial controls, the level and knowledge of personnel, operational abilities, legal and compliance controls and other corporate support systems will be adequate to manage our business and growth. The ineffectiveness of any of these controls or systems could adversely affect our business and prospects. In addition, if we acquire new businesses and introduce new products, we face numerous risks and uncertainties integrating their controls and systems, including financial controls, accounting and data processing systems, management controls and other operations. A failure to integrate these systems and controls, and even an inefficient integration of these systems and controls, could adversely affect our business and prospects.
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Losses not covered by insurance may be large, which could adversely impact our financial performance . We carry various insurance policies on our assets. These policies contain policy specifications, limits and deductibles that may mean that such policies do not provide coverage or sufficient coverage against all potential material losses. There are certain types of risk (generally of a catastrophic nature such as war or environmental contamination) which are either uninsurable or not economically insurable. Further, there are certain types of risk for which insurance coverage is not equal to the full replacement cost of the insured assets. Should any uninsured or underinsured loss occur, we could lose our investment in, and anticipated profits and cash flows from, one or more of our assets or operations.
We also carry directors and officers liability insurance ( D&O insurance ) for losses or advancement of defense costs in the event a legal action is brought against the company’s directors, officers or employees for alleged wrongful acts in their capacity as directors, officers or employees. Our D&O insurance contains certain customary exclusions that may make it unavailable for the company in the event it is needed; and in any case our D&O insurance may not be adequate to fully protect the company against liability for the conduct of its directors, officers or employees.
Our business is subject to risks arising from epidemic diseases, such as the COVID-19 pandemic. The COVID-19 pandemic was designated as a global pandemic by the World Health Organization in March 2020 and continues to impact economic activity in the United States and globally despite robust vaccination rollout efforts by governments and the medical community. Recent surges in virus transmission have caused local, state and federal governments to re-assess their policies and initiatives to mitigate the spread of the virus. The COVID-19 pandemic, or other public health epidemic or pandemic, poses the risk that we or our employees, contractors, suppliers, portfolio companies and other partners may be prevented from conducting business activities for an indefinite period of time, including due to the spread of the disease within these groups or due to shutdowns that may be requested or mandated by governmental authorities. While the ultimate impact of the COVID-19 pandemic on our business remains uncertain, the continued spread of COVID-19 and the measures taken by local governments to date has had a significant impact on our practitioner orders for sleep studies and durable medical equipment set-ups. We have also observed higher cancellation rates for attended sleep studies since March 2020. Although significant disruption to the supply chain has not been observed to date directly related to COVID-19, future disruptions could occur depending on the future duration and magnitude of the pandemic. Such disruptions, were they to occur, could adversely impact our business, financial condition or results of operations, or impact the recoverability of our long-lived assets.
Disruptions in the capital markets have increased the spread between the yields realized on risk-free and higher risk securities, resulting in illiquidity in parts of the capital markets. These and future market disruptions and/or illiquidity would be expected to have an adverse effect on our business, financial condition, results of operations and cash flows. Unfavorable economic conditions also would be expected to increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events have limited and could continue to limit our investment originations, limit our ability to grow and have a material negative impact on our operating results and the fair values of our debt and equity investments. As a result, we may experience additional losses on our investments in GECC stock. Decreases in the market values of investments held within GECC’s portfolio companies could also lead to decreases in asset-based fee revenues within the investment management business.
The COVID-19 pandemic and mitigation measures have and may continue to have an adverse impact on global economic conditions which could have an adverse effect on our business, financial condition, result of operations, and the recovery of our long-lived assets, as well as our ability to obtain third-party financing for potential acquisitions on terms acceptable to us, if at all. The extent to which the COVID-19 pandemic impacts our results and financial condition will depend on future developments that are highly uncertain and cannot be predicted, including the success of continued vaccination rollouts and the potential emergence of new virus strains.
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Risks Related to Our Durable Medical Equipment Business
Adverse trends in the healthcare industry may negatively affect our investment in Great Elm Healthcare, LLC (HC LLC), a supplier of durable medical equipment and services. The healthcare industry is currently experiencing, among other things:
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changes in the demand for and methods of delivering healthcare services;
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competition among healthcare providers;
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consolidation of large health insurers;
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regulatory and government reimbursement uncertainty resulting from the Patient Protection and Affordable Care Act (the ACA ) and other healthcare reform and transparency laws;
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federal court decisions on cases challenging the legality of certain aspects of the ACA;
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federal and state government plans to reduce budget deficits and address debt ceiling limits by lowering healthcare provider Medicare and Medicaid reimbursement rates;
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expanded patient enrollment in federal and state health care programs;
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federal and state regulatory reform related to pricing practices and disclosures for health care services and supplies;
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changes in third-party reimbursement methods and policies; and
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increased scrutiny of billing, referral and other practices by U.S. federal and state authorities.
These factors may negatively impact the economic performance of HC LLC, which may have a material adverse effect on our business and financial condition.
A significant portion of HC LLC’s patients who rent and use its products have health coverage under the Medicare program, and future changes in the reimbursement rates or payment methodologies under Medicare and other government programs may adversely affect the financial condition of HC LLC, which could materially and adversely affect our business and operating results. As a provider of respiratory-related product rentals, a portion of HC LLC’s revenue comes from Medicare reimbursement, due in part to a higher proportion of elderly persons suffering from chronic respiratory conditions than in the general population. There are increasing pressures on Medicare to control healthcare costs and to reduce or limit reimbursement rates for home medical products.
Legislation, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, the Deficit Reduction Act of 2005, the Medicare Improvements for Patients and Providers Act of 2008, the ACA, the 21 st Century Cures Act and the Coronavirus Aid, Relief and Economic Securities ( CARES ) Act contain provisions that directly impact reimbursement for the durable medical equipment products supplied by HC LLC. These legislative provisions as currently in effect and any changes to such provisions in the future will continue to have a material effect on HC LLC’s business, financial condition and operating results.
Further, due to budgetary shortfalls, many states are considering, or have enacted, cuts to their Medicaid programs. These cuts have included, or may include, elimination or reduction of coverage for HC LLC’s products, amounts eligible for payment under co-insurance arrangements, or reimbursement rates for covered items. Continued state budgetary pressures could lead to further reductions in funding for the reimbursement for HC LLC’s products which, in turn, would adversely affect its, and ultimately our, business, financial condition and results of operations.
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The competitive bidding process under Medicare could adversely impact the business and financial condition of HC LLC. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 requires the Secretary of Health and Human Services to establish and implement programs under which competitive bid areas ( CBAs ) are established throughout the U.S. for purposes of awarding contracts for the furnishing of competitively priced items of durable medical equipment. The Centers for Medicare and Medicaid Services ( CMS ), the agency responsible for administering this Medicare program, conducts a competition for each competitive acquisition area under which suppliers submit bids to supply certain covered items of durable medical equipment. Successful bidders must meet certain program quality standards in order to be awarded a contract and only successful bidders can supply the covered items to Medicare beneficiaries in the CBAs . There are, however, regulations in place that allow non-contracted suppliers to continue to provide products and services to their existing customers at the new competitive bidding payment amounts. The contracts are generally expected to be re-bid every three years.
CMS suspended its competitive bidding process last year and existing contracts expired on December 31, 2018. As of January 1, 2019, there is a temporary gap in the competitive bidding program. The Company submitted bids for the 2021 competitive bidding program in September 2019. However, in October 2020 CMS announced that relevant product categories had been removed from the 2021 competitive bidding program as resulting prices did not achieve expected savings. According to guidance from CMS, the next competitive bidding round is anticipated to begin on January 1, 2024.
We continue to monitor developments regarding the implementation of this competitive bidding program, but we are currently unable to predict the future outcome of the competitive bidding program on HC LLC once it recommences. It is likely that reimbursement rates will continue to fluctuate, thus resulting in payment adjustments which could adversely affect the financial conditions and results of operations of HC LLC.
HC LLC obtains some of the components, subassemblies and completed products included in its sleep and respiratory-focused durable medical equipment from a single source or a limited group of manufacturers or suppliers, and the partial or complete loss of one of these manufacturers or suppliers could cause significant production delays, an inability to meet customer demand and a substantial loss in revenue. HC LLC utilizes single-source suppliers for some of the components and subassemblies it uses in its sleep and respiratory-focused durable medical equipment. HC LLC’s use of single-source suppliers for some components of its durable medical equipment may expose it to several risks, including, among other things:
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HC LLC’s suppliers may encounter financial hardships as a result of unfavorable economic and market conditions unrelated to its demand for components, which could inhibit their ability to fulfill orders and meet HC LLC’s requirements;
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HC LLC suppliers may fail to comply with regulatory requirements, be subject to lengthy compliance, validation or qualification periods, or make errors in manufacturing components that could negatively affect the performance or safety of HC LLC’s products or cause delays in the supplying of HC LLC’s products to its customers;
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suppliers that are newly identified by HC LLC may not qualify under the stringent quality or regulatory standards to which HC LLC’s business is subject;
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HC LLC or its suppliers may not be able to respond to unanticipated changes in customer orders, and if orders do not match forecasts, HC LLC or its suppliers may have excess or inadequate inventory of materials and components;
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HC LLC may be subject to price fluctuations due to a lack of long-term supply arrangements for key components;
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HC LLC may experience delays in delivery by its suppliers due to customs clearing delays, shipping delays, scarcity of raw materials or changes in demand from HC LLC or its other customers;
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HC LLC or its suppliers may lose access to critical services and components, resulting in an interruption in the manufacture, assembly and shipment of its systems;
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HC LLC ’s suppliers may be subject to allegations by other parties of misappropriation of proprietary information in connection with their supply of products to HC LLC , which could inhibit their ability to fulfill HC LLC ’s orders and meet its requirements;
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fluctuations in demand for products that HC LLC’s suppliers manufacture for others may affect their ability or willingness to deliver components to HC LLC in a timely manner;
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HC LLC’s suppliers may wish to discontinue supplying components or services to HC LLC; and
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HC LLC may not be able to find new or alternative components or reconfigure its system and manufacturing processes in a timely manner if the necessary components become unavailable.
HC LLC may experience problems with some of its suppliers in the future. It may not be able to quickly establish additional or replacement suppliers, particularly for single source components or subassemblies. Any interruption or delay in the supply of components or subassemblies, or HC LLC’s inability to obtain components or subassemblies from alternate sources at acceptable prices in a timely manner, could impair its ability to meet the demand of its customers and cause them to cancel orders or switch to competitive products, potentially resulting in a loss of revenues.
On June 14, 2021 the Company received notice from Philips Respironics, a key supplier, that certain positive air pressure equipment and ventilator devices that we distribute and sell would be included in a voluntary recall. The recall was initiated by Philips Respironics due to potential health risks to patients involving the polyester-based polyurethane sound abatement foam used in the recalled devices. Based on testing performed by Philips Respironics, this foam may degrade into particles which may enter the device’s air pathway and be ingested or inhaled by the user, and the foam may off-gas certain chemicals leading to potential health risks. Patients using these devices have been instructed to talk with their health care provider regarding the most appropriate options for treatment for their condition in light of this recall.
Since June 14, 2021, the Company has worked with affected patients to register their device on the Philips Respironics’ recall website.
Currently, it is not possible to purchase these positive air pressure equipment and ventilator devices from Philips Respironics. As a significant supplier in the space, this has led to observed supply chain constraints for such devices. While the Company regularly maintains certain on-hand inventory stores of such equipment, a prolonged shortage could significantly affect the Company’s ability to service all patient demand for these devices and materially and adversely affect the Company’s business and results of operations.
The Company cannot predict the potential legal, regulatory, and financial risks that may arise out of the recall. It is possible that some patients will discontinue use of their device, which could affect the Company’s ability to continue billing for service. Furthermore, the Company may be subject to future litigation related to the recall, including but not limited to claims related to personal injury for devices affected by the recall. The Company cannot predict what additional actions will be required of the Company by the Food and Drug Administration or other state or federal agencies related to the recall.
HC LLC depends upon reimbursement from Medicare, private payors, Medicaid and patients for a significant portion of its revenue, and if it fails to manage the complex and lengthy reimbursement process, its business and operating results could suffer. A significant portion of HC LLC’s rental revenue is derived from reimbursement by third-party payors. HC LLC accepts assignment of insurance benefits from customers and, in a majority of cases, invoices and collects payments directly from Medicare, private insurance companies and Medicaid, as well as direct from patients under co-insurance provisions.
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HC LLC ’s financial condition and results of operations may be affected by the healthcare industry’s reimbursement process, which is complex and can involve lengthy delays between the time that a product is delivered to the consumer and the time that the reimbursement amounts are settled. Depending on the payor, HC LLC may be required to obtain certain payor-specific documentation from physicians and other healthcare providers before submitting claims for reimbursement. Certain payors have filing deadlines and they will not pay claims submitted after such time. HC LLC is also subject to extensive pre-payment and post-payment audits by governmental and private payors that could result in material delays, underpayments of negotiated amounts, refunds of monies received or denials of claims submitted for payment under such third-party payor programs and contracts. We cannot ensure that HC LLC will be able to continue to effectively manage the reimbursement process and collect payments for its products promptly. If it fails to manage the complex and lengthy reimbursement process, it could adversely affect HC LLC ’s business, financial conditions and results of operations.
During the year ended June 30, 2020, we applied for and received $4.4 million in advanced payments from the CMS under their Accelerated and Advance Payment Program, which was expanded to increase cash flow to providers of services and suppliers impacted by the COVID-19 pandemic through disruption in claims submission and claims processing. This CMS program has been modified through the CARES Act to provide additional flexibilities, including extending repayment timeframes and repayment amounts. During the year ended June 30, 2021, $0.9 million of these advanced payments were recouped by CMS, leaving a remaining balance of $3.5 million. On October 1, 2020, the Continuing Appropriations Act, 2021 and Other Extensions Act further amended the repayment terms for all providers and suppliers who requested and received accelerated and advance payment(s) during the COVID-19 pandemic by further extending the repayment deadlines and reducing the amount of Medicare payments subject to recoupment. If HC LLS is unable to repay the total amount of the accelerated or advance payment during this extended time-period, CMS may issue demand letters requiring repayment of any outstanding balance, subject to an interest rate of four percent consistent with the terms of the Continuing Appropriations Act, 2021.
If HC LLC fails to comply with state and federal fraud and abuse laws, including anti-kickback, physician self-referral (Stark), false claims and anti-inducement laws, it, and we, could face substantial penalties and HC LLC’s business, operations, and financial condition could be adversely affected. The federal anti-kickback statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce or in return for purchasing, leasing, ordering, or arranging for the purchase, lease or order of any healthcare item or service reimbursable under Medicare, Medicaid, or other federal healthcare programs. Although there are a number of statutory exceptions and regulatory safe harbors protecting certain common activities from prosecution, the exceptions and safe harbors are drawn narrowly, and any remuneration to or from a prescriber or purchaser of healthcare products or services may be subject to scrutiny if it does not qualify for an exception or safe harbor. HC LLC’s practices may not in all cases meet all of the criteria for safe harbor protection from anti-kickback liability. Failure to meet all requirements of a safe harbor is not determinative of a kickback issue but could subject the practice to increased scrutiny by the government.
The “Stark Law” prohibits a physician from referring Medicare or Medicaid patients to an entity providing “designated health services,” which includes durable medical equipment, if the physician or immediate family member of the physician has an ownership or investment interest in or compensation arrangement with such entity that does not comply with the requirements of a Stark exception. Violation of the Stark Law could result in denial of payment, disgorgement of reimbursements received under a non-compliant arrangement, civil penalties, and exclusion from Medicare, Medicaid or other governmental programs. Although we believe that HC LLC has structured its provider arrangements to comply with current Stark Law requirements, these arrangements may not expressly meet the requirements for applicable exceptions from the law.
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Federal false claims laws prohibit any person from knowingly presenting or causing to be presented a false claim for payment to the federal government, or knowingly making or causing to be made a false statement to get a false claim paid. The majority of states also have statutes or regulations similar to the federal anti-kickback and self-referral laws and false claims laws, which apply to items or services, reimbursed under Medicaid and other state programs, or, in several states, apply regardless of payor. These false claims statutes allow any person to bring suit in the name of the government alleging false and fraudulent claims presented to or paid by the government (or other violations of the statutes) and to share in any amounts paid by the entity to the government in fines or settlement. Such suits, known as qui tam actions, have increased significantly in the healthcare industry in recent years. Sanctions under these federal and state laws may include civil monetary penalties, damages, exclusion of a manufacturer’s products from reimbursement under government programs, criminal fines and imprisonment. In addition, the recently enacted ACA, among other things, amends the intent requirement of the federal anti-kickback and criminal healthcare fraud statutes. A person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it. In addition, the ACA provides that the government may assert that a claim including items or services resulting from a violation of the federal anti-kickback statute constitutes a false or fraudulent claim for purposes of the false claims statutes. Because of the breadth of these laws and the narrowness of the safe harbors and exceptions, it is possible that some of HC LLC ’s business activities could be subject to challenge under one or more of such laws. Such a challenge, regardless of the outcome, could have a material adverse effect on its business, business relationships, reputation, financial condition and results of operations.
In addition, there has been a recent trend of increased federal and state regulation of payments made to physicians. Certain states mandate implementation of compliance programs and/or the tracking and reporting of gifts, compensation and other remuneration to physicians. The shifting compliance environment and the need to build and maintain robust and expandable systems to comply with different compliance and/or reporting requirements in multiple jurisdictions increase the possibility that a healthcare company may violate one or more of the requirements.
The federal Civil Monetary Penalties Law prohibits the offering or giving of remuneration to a Medicare or Medicaid beneficiary that the person knows or should know is likely to influence the beneficiary’s selection of a particular supplier of items or services reimbursable by a federal or state governmental healthcare program. While it is HC LLC’s intent to comply with all applicable laws, the government may find that HC LLC’s marketing activities violate the Civil Monetary Penalties Law. If it is found to be in non-compliance, HC LLC could be subject to civil money penalties of up to $0.01 million for each wrongful act, assessment of three times the amount claimed for each item or service and exclusion from the federal or state healthcare programs.
The scope and enforcement of each of these laws is uncertain and subject to rapid change in the current environment of healthcare reform, especially in light of the lack of applicable precedent and regulations. If HC LLC’s operations are found to be in violation of any of the laws described above or any other government regulations that apply to us, it, and potentially we, may be subject to penalties, including civil and criminal penalties, damages, fines and the curtailment or restricting of HC LLC’s operations. Any penalties, damages, fines, curtailment or restructuring of HC LLC’s operations could harm its ability to operate its business, and ultimately our financial results. Any action against HC LLC for violation of these laws, even if successfully defended against, could cause HC LLC to incur significant legal expenses and divert its management’s attention from operation of its business. Moreover, achieving and sustaining compliance with applicable federal and state fraud and abuse laws may prove costly.
Risks Related to Our Investment Management Business
Our investment management agreements may be terminated. The investment management agreements ( IMAs ) we have through GECM with various pooled investment vehicles, such as GECC, may be cancelled at the applicable counterparty’s discretion upon certain notice or upon the occurrence of certain events. We do not control the boards of directors of such pooled investment vehicles, and they may cancel our respective IMAs at their discretion without making any termination payment to us. GECM’s investment performance is a key element of retaining this business. We have recorded an intangible asset attributable to the IMAs that is being amortized over a 15-year economic life even though the IMAs are cancellable by the respective counterparties.
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Difficult or changing market conditions can adversely affect our investment management business in many ways, by reducing the value or performance of our funds (including our invested funds and funds invested by third parties) or by reducing the ability of our funds to raise or deploy capital, each of which could negatively impact our income and cash flow and adversely affect our financial condition. The build-out of our investment management business is affected by conditions in the financial markets and economic conditions and events throughout the world, such as interest rates, availability of credit, inflation rates, economic uncertainty, changes in laws and regulations, market perceptions and other factors.
Adverse changes could lead to a reduction in investment income, losses on our own capital invested and lower revenues from investment management fees. Such adverse changes may also lead to a decrease in new capital raised and may cause investors to withdraw their investments and commitments. Even in the absence of a market downturn, below-market investment performance by our funds and portfolio managers could reduce investment management revenues and assets under management and result in reputational damage that may make it more difficult to attract new investors or retain existing investors.
In July 2017, the Financial Conduct Authority ( FCA ) of the United Kingdom, which regulates the London Interbank Offered Rate ( LIBOR ), announced that it intends to stop compelling banks to submit rates for the calculation of LIBOR after December 31, 2021. On March 5, 2021, however, the FCA and ICE Benchmark Administration Limited ( IBA ), which is the administrator that publishes LIBOR, announced that IBA intends to cease the publication of all settings of non-U.S. dollar LIBOR and the one-week and two-month U.S. dollar LIBOR settings on December 31, 2021, with the publication of the remaining U.S. dollar LIBOR settings being discontinued after June 30, 2023, subject to any rights of the FCA to compel the IBA to continue publication of something called “LIBOR” that would likely be based on a different methodology and information (the March 5 Announcements ). In light of the expected permanent cessation of LIBOR, the Federal Reserve Board of Governors has advised regulated financial institutions to cease using LIBOR in new transactions as soon as practicable but in all events by December 31, 2021.
We may pay interest under credit facilities, and may receive interest payments on certain investments, based on various LIBOR settings. There can be no assurance that the relevant LIBOR settings will continue to be published through December 31, 2021 or June 30, 2023, as applicable. Conversely, there can be no assurance that LIBOR will not continue to be published after those dates, or that the FCA will not cause so-called “synthetic LIBOR” to be published after those dates. There also can be no assurance that LIBOR is or will remain reliable and representative of the market or economic reality that it was intended to measure, particularly should the market’s use of LIBOR decline in response to public sector guidance, market changes and industry practices. In that regard, on June 13, 2021, the Market Risk Advisory Committee ( MRAC ) of the Commodity Futures Trading Commission (the Commission ) adopted a market “best practice” now being considered by the full Commission known as the “SOFR First” initiative, which is intended to hasten the market’s transition from its use and dependence on LIBOR to alternative reference rates like the Secured Overnight Financing Rate ( SOFR ). The Alternative Reference Rates Committee ( ARRC ) convened by the Federal Reserve Board and Federal Reserve Bank of New York has announced the SOFR as its recommended alternative to LIBOR for U.S. dollar obligations. However, because the SOFR is a broad U.S. Treasury repo financing rate that represents overnight secured funding transactions, it differs fundamentally from LIBOR.
Regulators, industry groups and certain committees (e.g., the ARRC) have published recommended fallback language for LIBOR-linked financial instruments, identified recommended alternatives for certain LIBOR rates (e.g., SOFR as the recommended alternative to U.S. dollar LIBOR), and proposed implementations of the recommended alternatives in floating rate instruments. However, at this time, it is not possible to predict whether these recommendations and proposals will be broadly accepted, whether they will continue to evolve and what the effect of their implementation may be on the markets for floating-rate financial instruments.
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Funds managed by GECM, our wholly-owned subsidiary, are party to, and derive income from, other agreements that expressly provide for alternative reference rates and spread adjustments to be used in the event that LIBOR ceases to be published. Despite those provisions, the impact on such agreements of LIBOR no longer being available cannot be entirely predicted at this time. Nor can a seamless transition of such agreements from LIBOR to those alternative reference rates be guaranteed. For example, no assurance can be given that the relevant parties to such agreements will satisfy their contractual obligations to transition to alternative reference rates once LIBOR is no longer available. In addition, the alternative reference rates and spread adjustments used in such agreements could result in a net-effective interest rate that is higher or lower than that which would result from the parties’ use of LIBOR. The alternative reference rates also may be more or less volatile than LIBOR is prior to its discontinuance, which could result in an increase in the cost of our indebtedness, impact our ability to refinance some or all of our existing indebtedness, reduce income generated from assets currently referencing LIBOR, or otherwise have a material adverse impact on our business, financial condition and operations. There also can be no assurance that LIBOR transition-related legislation in the United States or abroad will not adversely impact us by, for example, materially altering, disrupting, impairing, modifying or changing the terms of any LIBOR-linked agreements to which we are a party or beneficiary.
As a result of the foregoing, we may need to renegotiate outstanding loans to our funds and their portfolio companies which extend beyond 2021, and that utilize LIBOR as a factor in determining the interest rate, to replace LIBOR with the new standard that is established. The situation continues to evolve and currently there is no definitive information regarding any particular replacement rate. As such, the potential effect of any such event on our cost of capital and net investment income cannot yet be determined. The effect on our investments will vary depending, among other things, on (1) whether fallback or termination provisions in individual contracts currently exist, and if so, the terms of such provisions and (2) whether, how, and when industry participants develop and adopt new reference rates and fallbacks for both legacy and new investments. We may have discretion to determine a successor or substitute reference rate, including any price or other adjustments to account for differences between the successor or substitute reference rate and previous rate. Such successor or substitute reference rate and any adjustments selected may negatively impact the income of our investments and may expose such investments to additional tax, accounting and regulatory risks. The elimination of LIBOR may affect the value, liquidity or return on our investments and may result in costs incurred in connection with closing out positions and entering into new investments, adversely impacting our overall financial condition or results of operations. Accordingly, it is difficult to predict the full impact of the transition away from LIBOR on our businesses and investments until new reference rates and fallbacks for both legacy and new products, instruments and contracts are commercially accepted.
If we are deemed to be an investment company under the Investment Company Act, we may be required to institute burdensome compliance requirements and our activities may be restricted, which may make it difficult for us to execute our growth plans . If we are deemed to be an investment company under the Investment Company Act, we will be subject to additional regulatory requirements and our activities may be restricted, including:
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restrictions on the nature of our investments;
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limitations on our ability to borrow;
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prohibitions on transactions with affiliates; and
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restrictions on the issuance of securities.
Each of these may make it difficult for us to run our business. In addition, the law may impose upon us burdensome requirements, including:
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registration as an investment company and subsequent regulation as an investment company;
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adoption of a specific form of corporate structure; and
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reporting, record keeping, voting, proxy and disclosure requirements and other rules and regulations.
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In order not to be regulated as an investment company under the Investment Company Act, unless we can qualify for an exclusion, we must ensure that we are engaged primarily in a business other than investing, reinvesting or trading of securities and that our activities do not include investing, reinvesting, owning, holding or trading “investment securities” constituting more than 40% of our total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. Though we do not believe that our principal activities will subject us to the Investment Company Act, if we were deemed to be subject to the Investment Company Act, compliance with these additional regulatory burdens would require additional expense and attention from management for which we have not accounted.
Our officers and directors may become aware of business opportunities which may be appropriate for presentation to us and the other entities to which they owe certain fiduciary or contractual duties. Accordingly, they may have conflicts of interest in determining to which entity a particular business opportunity should be presented. These conflicts may not be resolved in our favor and a potential target business may be presented to another entity prior to its presentation to us, subject to their fiduciary duties under applicable law.
We may engage in a business combination with one or more target businesses that have relationships with our executive officers, directors or existing holders which may raise potential conflicts of interest. In light of the involvement of our executive officers and directors with other entities in the investment management business and otherwise, we may decide to acquire or do business with one or more businesses affiliated with our executive officers, directors or existing shareholders.
Our directors also serve as officers and board members for other entities. Such entities may compete with us. We could pursue an affiliate transaction if we determined that such affiliated entity met our criteria for a business combination and such transaction was approved by a majority of our disinterested directors. Potential conflicts of interest may exist, and, as a result, the terms of the business combination may not be as advantageous to our public stockholders as they would be absent any conflicts of interest.
Risks Relating to Our Common Stock
Our common stock is subject to transfer restrictions. We have significant NOL carryforwards and other tax attributes, the amount and availability of which are subject to certain qualifications, limitations and uncertainties. In order to reduce the possibility that certain changes in ownership could result in limitations on the use of the tax attributes, our amended and restated certificate of incorporation (our certificate of incorporation ) contains provisions that generally restrict the ability of a person or entity from acquiring ownership (including through attribution under the tax law) of 4.99% or more of our common stock and the ability of persons or entities now owning 5% or more of our common shares from acquiring additional common shares. The restriction will remain until the earliest of (1) the repeal of Section 382 of the Internal Revenue Code of 1986, as amended or any successor statute if our Board determines that the restriction on transfer is no longer necessary or desirable for the preservation of tax benefits, (2) the close of business on the first day of a taxable year as to which our Board determines that no tax benefits may be carried forward, (3) such date as our Board may fix for expiration of transfer restrictions and (4) January 29, 2028. The restriction may be waived by our Board on a case-by-case basis. You are advised to carefully monitor your ownership of our common shares and consult your own legal advisors to determine whether your ownership of our common shares approaches the proscribed level.
We also have a Tax Rights Plan that would be triggered if any person acquires 4.99% or more of our common stock without prior approval by our Board. Holders of more than 4.99% of our common stock on the day the rights plan was adopted were exempted from this limitation as to the number shares they held at the time of adoption of the rights plan.
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We may issue additional shares of common stock or shares of our preferred stock to obtain additional financial resources, as acquisition currency or under employee incentive plans . Any such issuances would dilute the interest of our stockholders and likely present other risks. Our certificate of incorporation authorizes our Board to issue shares of our common stock or preferred stock from time to time in their business judgement up to the amount of our then authorized capitalization. We may issue a substantial number of additional shares of our common stock and may issue shares of our preferred stock. These issuances:
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may significantly dilute your equity interests;
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may require you to make an additional investment in us or suffer dilution of your equity interest;
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may subordinate the rights of holders of shares of our common stock if shares of preferred stock are issued with rights senior to those afforded to our common stock;
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could cause a change in control if a substantial number of shares of our common stock are issued;
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may affect, among other things, our ability to use our NOL carry forwards; and
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may adversely affect prevailing market prices for our common stock.
Anti-takeover provisions contained in our certificate of incorporation and amended and restated bylaws (our bylaws), as well as provisions of Delaware law, could impair a takeover attempt. Our certificate of incorporation, bylaws and Delaware law contain provisions that could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our Board. Our corporate governance documents include provisions:
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authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock;
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limiting the liability of, and providing indemnification to, our Board and officers;
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limiting the ability of our stockholders to call and bring business before special meetings and to take action by written consent in lieu of a meeting;
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requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our Board;
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controlling the procedures for the conduct and scheduling of Board and stockholder meetings;
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limiting the ability for persons to acquire 4.99% or more of our common stock;
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providing our Board with the express power to postpone previously scheduled annual meetings and to cancel previously scheduled special meetings;
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limiting the determination of the number of directors on our Board and the filling of vacancies or newly created seats on the board to our Board then in office; and
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providing that directors may be removed by stockholders only for cause.
These provisions, alone or together, could delay hostile takeovers and changes in control of our company or changes in our management.
As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation Law, which prevents some stockholders holding more than 15% of our outstanding common stock from engaging in certain business combinations without approval of the holders of substantially all of our outstanding common stock. Any provision of our certificate of incorporation or bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock and could also affect the price that some investors are willing to pay for our common stock.
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Our common stockholders may experience significant dilution upon the issuance of common stock upon conversion of 5.0% Convertible Senior PIK Notes due 2030 (The Convertible Notes) . The issuance of common stock upon conversion of some or all of the C onvertible N otes will dilute the ownership interests of existing holders of shares of our common stock, which could cause the price of our common stock to decline. Furthermore, the number of shares of common stock to be issued upon conversion of the C onvertible N otes may be substantially greater if the conversion rate is adjusted in accordance with the terms of the C onvertible N otes. Holders of the C onvertible N otes have the right to convert all or any portion of such notes at any time prior to February 22, 2030 into shares of our common stock at a conversion price of $3.4722 per share . Upon conversion of any note, the Company will pay or deliver, as the case may be, to the noteholder, in respect of each $1,000 principal amount of notes being converted, shares of common stock equal to the conversion rate in effect on the conversion date, together with cash, if applicable, in lieu of delivering any fractional share of common stock. We cannot predict or accurately forecast the total amount of shares of common stock that ultimately may be issued under the C onvertible N otes. Further, the perception of these sales or issuances, or the conversion of the C onvertible N otes, could impair our ability to raise additional capital through the sale of our equity securities.
Item 1B. Unresolved Staff Comments.
None.