Attached files

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EX-32.2 - EX-32.2 - Great Elm Capital Group, Inc.gec-ex322_12.htm
EX-32.1 - EX-32.1 - Great Elm Capital Group, Inc.gec-ex321_11.htm
EX-31.2 - EX-31.2 - Great Elm Capital Group, Inc.gec-ex312_13.htm
EX-31.1 - EX-31.1 - Great Elm Capital Group, Inc.gec-ex311_8.htm
EX-23.3 - EX-23.3 - Great Elm Capital Group, Inc.gec-ex233_551.htm
EX-23.2 - EX-23.2 - Great Elm Capital Group, Inc.gec-ex232_552.htm
EX-23.1 - EX-23.1 - Great Elm Capital Group, Inc.gec-ex231_550.htm
EX-21.1 - EX-21.1 - Great Elm Capital Group, Inc.gec-ex211_10.htm
EX-4.6 - EX-4.6 - Great Elm Capital Group, Inc.gec-ex46_9.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

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

For the fiscal year ended June 30, 2020

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM                      TO                     

Commission File Number 001-16073

 

GREAT ELM CAPITAL GROUP, INC.

(Exact name of Registrant as specified in its charter)

 

 

Delaware

94-3219054

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

800 South Street, Suite 230, Waltham, MA

02453

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (617) 375-3006

 

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

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

Common stock, par value $0.001 per share

 

gec

 

The Nasdaq Stock Market LLC

(Nasdaq Global Select Market)

Preferred Stock Purchase Rights

 

 

 

Nasdaq Global Select Market

Units, par value $0.001 per share

 

 

 

Nasdaq Global Select Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES  No

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES  No

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, a smaller reporting company, or an emerging growth 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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES  NO

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based on the closing price of the shares of common stock on The Nasdaq Global Select Market on December 31, 2019, was $75,768,274.  This number does not include shares of common stock held by our investor, Northern Right Capital Management, L.P. and persons who are directors or executive officers.

The number of shares of the Registrant’s common stock outstanding as of September 1, 2020 was 25,560,160.

DOCUMENTS INCORPORATED BY REFERENCE

 

 


TABLE OF CONTENTS

 

 

 

 

Page

 

 

 

 

 

PART I

 

 

 

 

 

 

 

 

 

Item 1.

 

Business

 

2

Item 1A.

 

Risk Factors

 

4

Item 1B.

 

Unresolved Staff Comments

 

18

Item 2.

 

Properties

 

19

Item 3.

 

Legal Proceedings

 

19

Item 4.

 

Mine Safety Disclosures

 

19

 

 

 

 

 

PART II

 

 

 

 

 

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

20

Item 6.

 

Selected Financial Data

 

20

Item 7.

 

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

 

20

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

35

Item 8.

 

Financial Statements and Supplementary Data

 

35

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

36

Item 9A.

 

Controls and Procedures

 

36

Item 9B.

 

Other Information

 

37

 

 

 

 

 

PART III

 

 

 

 

 

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

38

Item 11.

 

Executive Compensation

 

48

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

51

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

54

Item 14.

 

Principal Accountant Fees and Services

 

55

 

 

 

 

 

PART IV

 

 

 

 

 

 

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

 

55

Item 16

 

Form 10-K Summary

 

55

 

 

 

 

 

Exhibit Index

 

56

Signatures

 

59

Index to Financial Statements

 

F-1

 

 

 

 

 

 

i


Unless the context otherwise requires, “we,” “us,” “our,” the “Company,” “Great Elm” and terms of similar import refer to Great Elm Capital Group, Inc. and/or its subsidiaries.

Cautionary Statement Regarding Forward-Looking Information

This report and certain information incorporated herein by reference contain forward-looking statements under the Private Securities Litigation Reform Act of 1995.  Such statements often include words such as “may,” “will,” “should,” “believe,” “expect,” “seek,” “anticipate,” “intend,” “estimate,” “plan,” “target,” “project,” “forecast,” “envision” and other similar phrases.  Although we believe the assumptions and expectations reflected in these forward-looking statements are reasonable, these assumptions and expectations may not prove to be correct, and we may not achieve the financial results or benefits anticipated.  These forward-looking statements are not guarantees of actual results.  Our actual results may differ materially from those suggested in the forward-looking statements.  These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, including, without limitation:

 

our ability to profitably manage Great Elm Capital Corp. (NASDAQ: GECC), a business development company (BDC) that we manage through our investment management business;

 

the dividend rate that GECC will pay;

 

our ability to continue to develop and grow our durable medical equipment, investment management and real estate businesses;

 

our ability to raise capital to fund our business plan;

 

our ability to make acquisitions and manage any businesses we acquire;

 

conditions in the equity capital markets and debt capital markets as well as the economy generally;

 

our ability to maintain the security of electronic and other confidential information;

 

serious disruptions and catastrophic events, including the impact of Coronavirus Disease 2019 (COVID‑19) on the global economy;

 

competition, mostly from larger, well-financed organizations (both domestic and foreign), including operating companies, global asset managers, investment banks, commercial banks, and private equity funds;

 

outcomes of litigation and proceedings and the availability of insurance, indemnification and other third-party coverage of any losses suffered in connection therewith;

 

maintaining our contractual arrangements and relationships with third parties;

 

our ability to attract, assimilate and retain key personnel;

 

compliance with laws, regulations and orders;

 

changes in laws and regulations governing our operations; and

 

other factors described under “Item 1A. Risk Factors” or as set forth from time to time in our Securities and Exchange Commission (SEC) filings.

These forward-looking statements speak only as of the time of filing of this report and we do not undertake to update or revise them as more information becomes available.  You are cautioned not to place undue reliance on these forward-looking statements.  We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect future events or circumstances or to reflect the occurrence of unanticipated events.

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PART I

Item 1.  Business.

Overview

We are a holding company seeking to acquire assets and businesses, where our people and other assets provide a competitive advantage.  We currently have three business operating segments: durable medical equipment, investment management and real estate with general corporate representing unallocated costs and activity to arrive at consolidated operations.

Our goal is to build a diversified holding company focused on generating attractive, risk-adjusted returns on investment and long-term value creation.  We intend to accomplish this principally through:

 

continuous review of acquisitions of businesses, securities and assets that generate attractive risk-adjusted returns and exhibit the potential for significant long-term value creation;

 

effective use of the skills of our team and our financial resources, including our tax assets, our willingness to create bespoke solutions and our ability to prudently assume risks; and

 

constant evaluation of the retention and disposition of our operations and holdings.

In recent years, we have made a number of changes in our business:

 

During the year ended June 30, 2018, we:

 

commenced our real estate business and determined that it was a separate business operating segment; and

 

expanded our investment management business with agreements to provide investment management services to separate accounts for an institutional investor.

 

 

During the year ended June 30, 2019, we:

 

launched a new credit focused fund, Great Elm Opportunities Fund I, LP (GEOF), with a mandate to invest across the capital structure in niche, small and middle market opportunities with a catalyst for value-realization;

 

commenced our durable medical equipment business and determined that it was a separate business operating segment; and

 

subsequently, expanded our durable medical equipment business through the acquisition of certain operations of Midwest Respiratory Care, Inc.

 

During the year ended June 30, 2020, we:

 

raised $30 million through the issuance of convertible notes to be used for future acquisitions and general corporate purposes, bolstering the Company’s overall financial health and providing the means to pursue strategic acquisitions; and

 

invested in the employees, systems and processes of the durable medical equipment business to enhance scalability and remediate previously identified material weaknesses in internal controls over financial reporting.

As of June 30, 2020, we had approximately $1.5 billion of net operating loss (NOL) carryforwards for Federal income tax purposes.

Our Durable Medical Equipment Business

In September 2018, we launched our durable medical equipment segment by acquiring two durable medical equipment businesses that specialize in the distribution of respiratory care equipment, including positive air pressure equipment and supplies, ventilators and oxygen equipment, and provide sleep study services.

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Our Investment Management Business

We decided to invest in the asset management business because of our assessment of its ability to generate recurring free cash flows, its growth prospects and our Board of Directors’ (our Board) and employees’ industry expertise.  GECM, our wholly-owned registered investment adviser subsidiary, is an investment adviser providing investment management services to GECC, our largest investment vehicle, as well as GEOF and separate accounts for an institutional investor.  The combined assets under management for these entities as of June 30, 2020 was approximately $190.5 million.

Our BDC, GECC, was established in 2016.  At this time, GECC elected to be treated as a BDC under the Investment Company Act of 1940, as amended (the Investment Company Act).  We own approximately 19.6% of GECC’s shares that we may hold to generate dividends or sell to redeploy our capital in higher yielding opportunities.

GECM earns revenue through investment management agreements with each investment vehicle which provide for management fees, incentive fees and/or administrative fees.  These fees are generally based on assets under management, investment performance and allocable expenses incurred in the administration of these investment vehicles.

Our Real Estate Business

We launched our real estate business in March 2018 with an investment in a majority-interest in two Class A office buildings totaling 257,000 square feet situated on 17 acres of land in Fort Myers, Florida (collectively, the Property).  The Property is fully-leased, on a triple-net basis, to a single tenant through March 31, 2030.

For additional information see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Acquisition Program

GEC’s team continues to monitor and identify opportunities in the durable medical equipment, investment management, real estate and other sectors through the acquisition of operating businesses.  In the fiscal year ended June 30, 2020, we evaluated a number of opportunities in these areas.

Competition

We face competition from larger, well financed organizations (both domestic and foreign), including operating companies, global asset managers, investment banks, commercial banks, private equity funds, sovereign wealth funds and state-owned enterprises.  Government regulation is a key competitive factor for certain industries.

Employees

We had 349 employees as of June 30, 2020, including the 337 employees of our durable medical equipment subsidiaries.

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Information about Great Elm on the Internet

The following documents and reports are available on or through our website as soon as reasonably practicable after we electronically file such materials with, or furnish to, the SEC:

 

Code of Conduct;

 

Reportable waivers, if any, from our Code of Conduct by our executive officers;

 

Charter of the audit committee of our Board;

 

Charter of the nominating and corporate governance committee of our Board;

 

Charter of the compensation committee of our Board;

 

Annual reports on Form 10-K;

 

Quarterly reports on Form 10-Q;

 

Current reports on Form 8-K;

 

Proxy or information statements we send to our stockholders; and

 

Any amendments to the above-mentioned documents and reports.

The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov. Our stockholders may also obtain a printed copy of any of the above documents or reports free of charge by sending a request to Great Elm Capital Group, Inc., 800 South Street, Suite 230, Waltham, MA 02453; Attention: Investor Relations, or by calling (617) 375-3006.

Our corporate headquarters is located at 800 South Street, Suite 230, Waltham, Massachusetts 02453.  Our corporate website address is www.greatelmcap.com.  We are a Delaware corporation that was incorporated in 1994 and completed our initial public offering in 1999.

The contents of the websites referred to above are not incorporated into this filing.  

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.  

Risks Related to Our Business

We have a limited track record in the investment management, durable medical equipment and real estate businesses, and provide no assurance as to our acquisition and investment program.  We entered the investment management business in November 2016, we entered the real estate business in March 2018, 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 acquisition targets, to investigate and evaluate the future returns therefrom and business prospects thereof and to 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.  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.

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 operations and personnel.

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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 could adversely affect our business in many ways, including the following:

 

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.

 

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, 2020, we had NOL carryforwards of approximately $1.5 billion.  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.

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:

 

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;

 

our immediate payment of all principal and accrued interest, if any, if the debt is payable on demand;

 

our inability to pay dividends on our common stock;

 

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;

 

limitations on our flexibility in planning for and reacting to changes in our business and in the industry in which we operate;

 

increased vulnerability to adverse changes in general economic, industry and competitive conditions and adverse changes in government regulation; and

 

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.

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.

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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.

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.

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Our business is subject to risks arising from epidemic diseases, such as the COVID-19 pandemic.  The COVID-19 pandemic has spread across the globe and is impacting worldwide economic activity. 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 has temporarily had an adverse impact on our referral pipeline 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, 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 new information that may emerge concerning the severity of the virus and the actions to contain its impact.

Risks Related to Our Durable Medical Equipment Business

Adverse trends in the healthcare industry may negatively affect our investment in Great Elm DME, Inc. (DME Inc.), a supplier of durable medical equipment and services.  The healthcare industry is currently experiencing, among other things:

 

changes in the demand for and methods of delivering healthcare services;

 

competition among healthcare providers;

 

consolidation of large health insurers;

 

regulatory and government reimbursement uncertainty resulting from the Patient Protection and Affordable Care Act (the ACA) and other healthcare reform laws;

 

federal court decisions on cases challenging the legality of certain aspects of the ACA;

 

federal and state government plans to reduce budget deficits and address debt ceiling limits by lowering healthcare provider Medicare and Medicaid reimbursement rates;

 

changes in third-party reimbursement methods and policies; and

 

increased scrutiny of billing, referral and other practices by U.S. federal and state authorities.

These factors may negatively impact the economic performance of DME Inc., which may have a material adverse effect on our business and financial condition.

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A significant portion of DME Inc.’s rental patients who 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 DME Inc., which could materially and adversely affect our business and operating results.  As a provider of respiratory-related product rentals, a portion of DME Inc.’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, and the 21st Century Cures Act contain provisions that directly impact reimbursement for the durable medical equipment products supplied by DME Inc. These legislative provisions as currently in effect and any changes to such provisions in the future will continue to have a material effect on DME Inc.’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 DME Inc.’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 DME Inc.’s products which, in turn, would adversely affect its, and ultimately our, business, financial condition and results of operations.

The competitive bidding process under Medicare could adversely impact the business and financial condition of DME Inc.  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 expected to be re-bid every three years.

We continue to monitor developments regarding the implementation of this competitive bidding program, but we are currently unable to predict the outcome of the competitive bidding program on DME Inc. once fully implemented. 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 DME Inc.

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 that is expected to last until December 31, 2020.  The bids for the 2021 competitive bidding program were due on September 18, 2019 and our bids are currently being evaluated by CMS.

Since 2011, the competitive bidding program has undergone several rounds, awarding contracts to program winners to supply durable medical equipment in competitive bid areas. Certain operating subsidiaries of DME Inc. currently have contracts in Phoenix and Tucson, AZ, as well as Omaha, NE, where it anticipates new competition as a result of the expiration of contracts that could adversely affect the financial conditions and results of operations of DME Inc.

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DME Inc. 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.  DME Inc. utilizes single-source suppliers for some of the components and subassemblies it uses in its sleep and respiratory-focused durable medical equipment. DME Inc.’s use of single-source suppliers for some components of its durable medical equipment may expose it to several risks, including, among other things:

 

its 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 DME Inc.’s requirements;

 

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 DME Inc.’s products or cause delays in the supplying of DME Inc.’s products to its customers;

 

newly identified suppliers may not qualify under the stringent quality regulatory standards to which DME Inc.’s business is subject;

 

DME Inc. or its suppliers may not be able to respond to unanticipated changes in customer orders, and if orders do not match forecasts, DME Inc. or its suppliers may have excess or inadequate inventory of materials and components;

 

DME Inc. may be subject to price fluctuations due to a lack of long-term supply arrangements for key components;

 

DME Inc. may experience delays in delivery by its suppliers due to customs clearing delays, shipping delays, scarcity of raw materials or changes in demand from DME Inc. or their other customers;

 

DME Inc. or its suppliers may lose access to critical services and components, resulting in an interruption in the manufacture, assembly and shipment of its systems;

 

DME Inc.’s suppliers may be subject to allegations by other parties of misappropriation of proprietary information in connection with their supply of products to DME Inc., which could inhibit their ability to fulfill DME Inc.’s orders and meet its requirements;

 

fluctuations in demand for products that DME Inc.’s suppliers manufacture for others may affect their ability or willingness to deliver components to DME Inc. in a timely manner;

 

DME Inc.’s suppliers may wish to discontinue supplying components or services to DME Inc.; and

 

DME Inc. 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.

DME Inc. 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 DME Inc.’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.

DME Inc. 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 DME Inc.’s rental revenue is derived from reimbursement by third-party payors. DME Inc. 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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DME Inc.’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, DME Inc. 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. DME Inc. is also subject to extensive pre-payment and post-payment audits by governmental and private payors that could result in material delays, refunds of monies received or denials of claims submitted for payment under such third-party payor programs and contracts. We cannot ensure that DME Inc. 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 DME Inc.’s business, financial conditions and results of operations.

Furthermore, 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.  These advanced payments will be recouped against our future Medicare and Medicaid claims, expected during fiscal year 2021.  Our cash flows will be negatively impacted in the future as these recoupments occur.

If DME Inc. fails to comply with state and federal fraud and abuse laws, including anti-kickback, Stark, false claims and anti-inducement laws, it, and we, could face substantial penalties and DME Inc.’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. DME Inc.’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 DME Inc. 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 DME Inc.’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 DME Inc.’s intent to comply with all applicable laws, the government may find that DME Inc.’s marketing activities violate the Civil Monetary Penalties Law. If it is found to be in non-compliance, DME Inc. 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 DME Inc.’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 DME Inc.’s operations. Any penalties, damages, fines, curtailment or restructuring of DME Inc.’s operations could harm its ability to operate its business, and ultimately our financial results. Any action against DME Inc. for violation of these laws, even if successfully defended against, could cause DME Inc. 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.

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DME Inc. and its subsidiaries received economic stimulus during the year ended June 30, 2020 under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).  If such funding was required to be repaid pursuant to the terms of the CARES Act or related guidance, our financial condition would be adversely affected.  Section 1102 of the CARES Act established the Paycheck Protection Program (PPP), which provided additional funding for small businesses, as defined by the Small Business Act, to keep workers employed during through the COVID-19 crisis.  In April 2020, our 80.1% owned subsidiary Great Elm DME, Inc. applied for and received $3.6 million in PPP funding.  Proceeds can only be used for specified covered purposes including payroll, rent and utilities in accordance with the CARES Act.  The PPP loan has a two-year term and bears interest at a rate of 1.0% per annum.  To the extent proceeds are used for these covered purposes, some or all of the related principal balances may be forgiven. Between funding and June 30, 2020, the Company spent these proceeds on covered purposes and has recognized the proceeds as a reduction to operating expenses.  Subsequent to June 30, 2020, the Company submitted a forgiveness application to the lender seeking full forgiveness of the PPP Loan.  The eligibility requirement of the PPP loan is subjective, and if determined that we were ineligible to receive the PPP loan we could be required to repay the PPP loan in its entirety.

Additionally, pursuant to the CARES Act, Congress appropriated $100 billion in relief funds for hospitals and healthcare providers through grants administered by the U.S. Department of Health and Human Services (HHS).  Qualified providers of healthcare, services and support may receive HHS grants for healthcare-related expenses or lost revenue due to the COVID-19 pandemic.  Retention and use of the HHS grants are subject to certain terms and conditions including that such grant funds may only be used to prevent, prepare for, and respond to COVID-19 and such grant funds will reimburse only healthcare-related expenses or lost revenue that are attributable to the COVID-19 pandemic.  If these terms and conditions are met, HHS grants do not need to be repaid.  In April 2020 subsidiaries of Great Elm DME Inc. received $1.4 million in HHS grants to continue providing health care treatment to patients during the COVID-19 pandemic.  Between the date of funding and June 30, 2020, the Company used these funds as authorized by the HHS grant and has recognized the proceeds as a reduction to operating expenses.  We will continue to monitor our compliance with the terms and conditions of the HHS grant and any additional requirements if and when they become applicable.

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.

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.

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In July 2017, the head of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced the desire to phase out the use of LIBOR by the end of 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S. dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities, called the Secured Overnight Financing Rate. If LIBOR ceases to exist, GECC may need to renegotiate outstanding loans to its 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. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate.  As such, the potential effect of any such event on our cost of capital and investment income cannot yet be determined.

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:

 

restrictions on the nature of our investments;

 

limitations on our ability to borrow;

 

prohibitions on transactions with affiliates; and

 

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:

 

registration as an investment company and subsequent regulation as an investment company;

 

adoption of a specific form of corporate structure; and

 

reporting, record keeping, voting, proxy and disclosure requirements and other rules and regulations.

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.

15


Risks Related to Our Real Estate Business

Our initial investment through our real estate business includes the Property leased pursuant to a long-term triple net lease and the failure of the tenant to satisfy its obligations under the lease may adversely affect the condition of the Property or the results of our real estate business segment.  Because the Property is leased pursuant to a long-term triple net lease, we depend on the tenant to pay all insurance, taxes, utilities, common area maintenance charges, maintenance and repair expenses and to indemnify, defend and hold us harmless from and against various claims, litigation and liabilities arising in connection with its business, including any environmental liabilities resulting from the tenant’s failure to comply with applicable environmental laws.  There are no assurances that the tenant will have sufficient assets and income to enable it to satisfy its payment obligations to us under the lease.  The inability or unwillingness of the tenant to meet its rent obligations could materially adversely affect the business, financial position or results of operations of our real estate business segment.  Furthermore, the inability or unwillingness of the tenant to satisfy its other obligations under the lease, such as the payment of insurance, taxes and utilities, could materially and adversely affect the condition of the Property.  Our triple net lease agreement requires that the tenant maintains comprehensive liability and all risk property insurance.  However, there are certain types of losses (including losses arising from environmental conditions or of a catastrophic nature, such as earthquakes, hurricanes and floods) that may be uninsurable or not economically insurable.  Insurance coverage may not be sufficient to pay the full current market value or current replacement cost of a loss.  Inflation, changes in building codes and ordinances, environmental considerations, and other factors also might make it infeasible to use insurance proceeds to replace the Property after such property has been damaged or destroyed.  In addition, if we experience a loss that is uninsured or that exceeds policy coverage limits, we could lose the capital invested in the Property as well as the anticipated future cash flows from the Property.

We are subject to risks inherent in ownership of real estate.  Cash flows from our real estate business segment and real estate values are affected by a number of factors, including competition from other available properties and the ability to provide adequate property maintenance and insurance and to control operating costs.  Cash flows from our real estate business segment and real estate values are also affected by such factors as governmental regulations (including zoning, usage and tax laws), property tax rates, utility expenses, potential liability under environmental and other laws and changes in environmental and other laws.

We may incur significant liabilities from environmental contamination.  Existing or future laws impose or may impose liability on us to clean up environmental contamination on or around the property that we currently own, or may in the future own, even if we were not responsible for or aware of the environmental contamination or even if such environmental contamination occurred prior to our involvement with such property.  From time to time, we may conduct environmental assessments, commonly referred to as “Phase 1 Environmental Reports,” on properties in which we are considering an investment.  These assessments typically include an investigation (excluding soil or groundwater sampling or analysis) and a review of publicly available information regarding the site and other nearby properties.  However, such environmental assessments may not identify all potential environmental liabilities.

We may face potential difficulties or delays renewing leases or re-letting space.  We currently derive all of our real estate business income from rent received from a single tenant in connection with our initial investment in two Class A office buildings in Fort Myers, FL. If the tenant experiences a downturn in its business or other types of financial distress, it may be unable to make timely rental payments.  Also, in the event that the tenant does not renew the lease, we may not be able to re-let the space or there could be a substantial delay in re-letting the space.  Even if the tenant decides to renew or lease new space, the terms of renewals or new leases, including the cost of required renovations or concessions, may be less favorable to us than the current lease term.

We face potential adverse effects from a tenant’s bankruptcy or insolvency.  The bankruptcy or insolvency of a tenant may adversely affect the income produced by our property, or by any properties we may own in the future.  Our tenant could file for bankruptcy protection or become insolvent in the future.  A bankrupt tenant may reject and terminate its lease with us.  In such case, our claim against the bankrupt tenant for unpaid and future rent would be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease.  This shortfall could adversely affect our cash flow and results of operations.

16


We face possible risks associated with the physical effects of climate change.  The physical effects of climate change could have a material adverse effect on our properties, and consequently on our operations and business.  For example, we have two Class A office buildings located in southern Florida; to the extent climate change causes changes in weather patterns, that geographic area could experience increases in storm intensity and rising sea-levels.  Over time, these conditions could result in declining demand for office space in our office buildings or our inability to operate the buildings at all.  Climate change may also have indirect effects on our business by increasing the cost of (or making unavailable) property insurance on terms we find acceptable, or by increasing the cost of energy at our properties.  There can be no assurance that climate change will not have a material adverse effect on our property, operations or business.

We depend upon personnel of our property managers.  We do not have any internal real estate management capacity.  We depend, and will depend in the future, on our property managers and their personnel to efficiently manage the day-to-day operations at certain of our properties; any difficulties our property managers encounter in hiring, training and retaining skilled personnel may adversely affect the income produced by our properties.

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.

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:

 

may significantly dilute your equity interests;

 

may require you to make an additional investment in us or suffer dilution of your equity interest;

 

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;

 

could cause a change in control if a substantial number of shares of our common stock are issued;

 

may affect, among other things, our ability to use our NOL carry forwards; and

 

may adversely affect prevailing market prices for our common stock.

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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:

 

authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock;

 

limiting the liability of, and providing indemnification to, our Board and officers;

 

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;

 

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;

 

controlling the procedures for the conduct and scheduling of Board and stockholder meetings;

 

limiting the ability for persons to acquire 4.99% or more of our common stock;

 

providing our Board with the express power to postpone previously scheduled annual meetings and to cancel previously scheduled special meetings;

 

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

 

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.

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 Convertible Notes 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 Convertible Notes may be substantially greater if the conversion rate is adjusted in accordance with the terms of the Convertible Notes. Holders of the Convertible Notes 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 Convertible Notes.  Further, the perception of these sales or issuances, or the conversion of the Convertible Notes, could impair our ability to raise additional capital through the sale of our equity securities.

Item 1B.  Unresolved Staff Comments.

None.

18


Item 2.  Properties.

We currently lease office space for our principal executive offices in Waltham, Massachusetts where our general corporate, investment management and real estate businesses operate.  Our lease is non-cancellable through September 2024.

Durable Medical Equipment Business

We lease 20 offices and nine sleep labs for our durable medical equipment businesses.  These facilities have various expiration dates between 2020 and 2027.  Certain office locations may also include warehouse and retail sales space.  The facilities are primarily located in Arizona, Alaska, Iowa, Kansas, Nebraska, Oregon and Washington.

Real Estate Business

Through our real estate business we own a majority-interest in two Class A office buildings totaling 257,000 square feet situated on 17 acres of land in Fort Myers, Florida (collectively, the Property).  The Property is fully-leased, on a triple-net basis, to a single tenant through March 31, 2030.  The Company does not have any operations at this location.

Item 3.  Legal Proceedings.

None.

Item 4.  Mine Safety Disclosures.

Not applicable.

19


PART II

Item 5.  Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our common stock is traded on the Nasdaq Global Select Market under the trading symbol “GEC”.

Record Holders

As of September 1, 2020, there were 58 record holders of our common stock.

Dividends

We do not currently intend to pay dividends on our common stock.  The payment of dividends in the future is subject to the discretion of our Board and will depend upon general business conditions, legal and contractual restrictions on the payment of dividends and other factors that our Board may deem to be relevant.

Restrictions on Ownership

We have significant NOL carryforwards and other tax attributes, the amount and availability of which are subject to qualifications, limitations and uncertainties.  In order to reduce the possibility that certain changes in ownership could result in limitations on the use of our tax attributes, our certificate of incorporation contains provisions which generally restrict the ability of a person or entity from acquiring ownership (including through attribution under the tax law) of 5% or more of the outstanding shares of common stock and the ability of persons or entities now owning 5% or more of the outstanding shares of common stock from acquiring additional common shares.  We also have a tax benefits preservation rights plan that restricts ownership of 4.99% or more of our outstanding shares of common stock.  Persons that owned more than 4.99% of our common stock when the rights plan was adopted were grandfathered as to their then-current holdings of our common stock.  Our Board has granted limited waivers to certain investors to own more than 4.9% of our common stock, including the MAST Funds, Northern Right Capital Management, L.P. (Northern Right) and Imperial Capital Asset Management, LLC (ICAM).  As of September 1, 2020, the MAST Funds and their affiliates, Northern Right and its affiliates, and ICAM and its affiliates own approximately 7.8%, 9.7% and 9.3%, respectively, of the outstanding shares of our common stock.  Ownership information is based on information in publicly available filings.

Stock Purchases

None.

Item 6.  Selected Financial Data.

Not applicable.

Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations is a supplement to, and should be read in conjunction with, and is qualified entirely by, our consolidated financial statements (including Notes to the Consolidated Financial Statements) and the other consolidated financial information appearing elsewhere in this report.  Some of the information in this discussion and analysis includes forward-looking statements that involve risk and uncertainties.  Actual results and timing of events could differ from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

20


Overview

We are a holding company seeking to acquire assets and businesses, where our people and other assets provide a competitive advantage.  We currently have three business operating segments: durable medical equipment, investment management and real estate with general corporate representing unallocated costs and activity to arrive at consolidated operations.

For additional information see “Item 1. Business.”

COVID-19

In the six months ended June 30, 2020, the Company’s revenues declined relative to its prior expectations in part due to the impact of the Coronavirus Disease 2019 (COVID-19) pandemic.  During the six months ended June 30, 2020, the Company experienced a decrease in assets under management in our managed portfolios within the investment management business and observed higher patient cancellation rates for attended sleep studies at DME Inc.  The impact of COVID-19 continues to evolve and its duration and ultimate disruption to the Company’s customers and to its operations cannot be estimated at this time. However, the Company has experienced and expects to continue to experience decreased patient referrals in our medical equipment business in the near future due to these factors.  Should the disruption continue for an extended period of time, the impact could have a more severe adverse effect on our business and operations.

In addition, COVID-19 may impact our ability to act on new acquisitions or other business opportunities.

The Company prioritizes the health and safety of employees and customers.  Beginning in early March 2020, all employees at our GEC headquarters as well as certain employees of DME Inc. moved to a remote-working model.  In addition, the officers of GEC have maintained regular communications with key service providers, including legal and accounting professionals, other consultants and vendors, noting that those firms have similarly moved to remote-working models to the extent possible.  Such employees and key service providers have been able to effectively transition to working remotely while maintaining a consistent level of capabilities and service, however, we will continue to monitor and make adjustments as necessary.  

At DME Inc. we invested in virtual patient set-ups which allow our respiratory therapists to interact with patients by video to maintain social distance.  Certain other employees whose responsibilities have been impacted by social distancing have been temporarily redeployed within the organization.

We cannot predict the full impact of the COVID-19 pandemic, including its duration in the United States and worldwide and the magnitude of the economic impact of the outbreak, particularly with respect to the travel restrictions, business closures and other quarantine measures imposed on our employees, suppliers and service providers by various local, state, and federal governmental authorities, as well as non-U.S. governmental authorities.  As such, we are unable to predict the duration of any business and supply-chain disruptions, the extent to which the COVID-19 pandemic will negatively affect our operating companies’ operating results or the impact that such disruptions may have on our results of operations and financial condition.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with US GAAP.  The preparation of these financial statements requires our management to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  These items are monitored and analyzed by our management for changes in facts and circumstances, and material changes in these estimates could occur in the future.

21


Business Combinations, Acquired Intangible Assets and Goodwill

Business combinations are accounted for at fair value. The accounting for business combinations requires estimates and judgment as to expectations for future cash flows of the acquired business, and the allocation of those cash flows to identifiable intangible assets, in determining the estimated fair value for assets and liabilities acquired.  Goodwill represents the excess of fair value over identifiable tangible and intangible net assets acquired in business combinations.  Goodwill is not amortized. Instead goodwill is reviewed for impairment at least annually, or on an interim basis between annual tests when events or circumstances indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying value.

The fair values assigned to tangible and intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions, as well as other information compiled by management, including projected financial information, effective income tax rates, present value discount factors, and long-term growth expectations. The Company utilizes third-party specialists to assist management with the identification and valuation of intangible assets using customary valuation procedures and techniques.

We perform our annual impairment test of goodwill on the first day of the fiscal fourth quarter.  The Company tests long-lived assets, including intangible assets, for impairment if conditions exist that indicate the carrying value may not be recoverable.

All of the Company’s goodwill was acquired in conjunction with the acquisitions of the durable medical equipment businesses during the fiscal year ended June 30, 2019 and has been recorded within our durable medical equipment reporting unit.  Based on our annual impairment test as of April 1, 2020 the fair value of the durable medical equipment reporting unit exceeded the carrying value by 12.0% and no impairment occurred.  The fair value of this reporting unit was derived using a combination of present value of estimated cash flows and the valuations and prices of comparable businesses.  The discount rate used in this analysis was 15.0%.

In addition, due to identified potential impairment triggering events as of March 31, 2020 related to the asset groups at our durable medical equipment and investment management businesses, the Company performed quantitative impairment testing over such asset groups.  This analysis considered the estimated cash flows during the remaining useful life of each asset group, and no impairments were identified.  

Although neither the durable medical equipment reporting unit nor long-lived asset groups were deemed at risk of impairment as of June 30, 2020, there exists the potential for future impairment should actual results deteriorate versus our current expectations. As of June 30, 2020, the Company had approximately $65.1 million on its consolidated balance sheet related to acquired goodwill and intangible assets.

Accounts Receivable

Substantially all of the accounts receivable balance relates to the durable medical equipment business.  Accounts receivable are customer obligations due under normal sales and rental terms and represent the amount estimated to be collected from the patient customers and, if applicable, the third-party private insurance provider or government program (collectively, Payors), based on the contractual agreements.  The Company does not require collateral in connection with its customer transactions and aside from verifying insurance coverage, does not perform credit checks on patient customers.  Revenue and accounts receivable have been constrained to the extent that billed amounts exceed the amounts estimated to be collected.  The constrained transaction price relates primarily to expected billing adjustments with the Payors and patient customers.  Management’s evaluation of variable consideration takes into account such factors as past experience, information about specific receivables, Payors and patient customers.

The assessment of variable consideration to be constrained is based on estimates, and ultimate losses may vary from current estimates. As adjustments to these estimates become necessary, they are reported in earnings in the periods in which they become known.  Changes in constraints on variable consideration are recorded as a component of net revenues.  To the extent historical experience is not indicative of future performance, actual collections experience could differ significantly from management’s judgments and expectations, resulting in either increases or decreases to future revenues, as applicable.

22


The Company generally does not allow returns from providers for reasons not covered under the manufacturer’s standard warranty. Therefore, there is no provision for sales return reserves.  The Company does not have significant bad debt experience with Payors, and therefore does not maintain an allowance for doubtful accounts.

Durable Medical Equipment Revenue

Durable medical equipment revenue from a customer consists of any combination of the sale and rental of durable medical equipment and/or the provision of sleep study services. For durable medical equipment sales and services, the Company recognizes revenue in accordance with FASB Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers.  For revenue associated with durable medical equipment rentals, the Company recognizes revenue in accordance with ASC Topic 842, Leases.

The Company sells durable medical equipment, replacement parts and supplies to customers and recognizes revenue at the point control is transferred through delivery to the customer.  Each piece of equipment, part or supply is distinct and separately priced thus they each represent a single performance obligation.  The revenue is allocated amongst the performance obligations based upon the relative standalone selling price method, however, items are typically all delivered or supplied together.  The customer and, if applicable, the Payors are generally charged at the time that the product is sold, although separate layers of insurance coverage may need to be invoiced before final billings may occur.

The Company also provides sleep study services to customers and recognizes revenue when the results of the sleep study are complete as that is when the performance obligation is met.

The Company leases durable medical equipment to customers for a fixed monthly amount on a month-to-month basis.  The customer has the right to cancel the lease at any time during the rental period and payments are generally billed in advance on a month-to-month basis.  

Due to the nature of the durable medical equipment business, billing adjustments customarily occur during the collections process when explanations of benefits are received by Payors, and as amounts are deferred to secondary Payors or to patient responsibility.  For durable medical equipment sales and services revenue, the Company includes in the transaction price only the amount that the Company expects to be entitled.  Durable medical equipment rental revenue is recognized for amounts where collection from Payors and patients are reasonably assured.  As such, revenue recognized upon satisfaction of the Company’s performance obligations consist of substantially all of the Payor billings at contractual rates as well as estimates of patient co-payments that will ultimately be collected.

Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available. Specifically, the complexity of many third-party billing arrangements and the uncertainty of reimbursement amounts for certain services from certain Payors may result in adjustments to amounts originally recorded. Such adjustments are typically identified and recorded at the point of cash application or claim denial.  To the extent historical experience is not indicative of future performance, actual collections experience could differ significantly from management’s judgments and expectations, resulting in either increases or decreases to future durable medical equipment sales and services revenues or durable medical equipment rental income, as applicable.

Investment Management Revenue

The Company recognizes revenue from its investment management business at amounts that reflect the consideration to which it expects to be entitled in exchange for providing services to its customer.  Investment management revenue primarily consists of fees based on a percentage of assets under management; fees based on the performance of managed assets; and administrative fees.

23


Because of the uncertainty of when incentive fees will be collected due to market conditions and investment performance, incentive fees are fully constrained and not recorded until received and the probability of significant reversal of the fees is eliminated in accordance with the respective investment management agreements.  As of June 30, 2020, the Company had $8.5 million in cumulative earned but constrained incentive fee revenue.  To the extent such constrained incentive fees are collected in the future, they could result in significant increases to future investment management revenue.

Real Estate Revenue

Consistent with the leases of durable medical equipment, the Company recognizes rental revenue on a straight-line basis over the non-cancelable term of the lease.  Based on management’s assessment, we expect to receive all contractual amounts owed.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards.  Valuation allowances are established when necessary in order to reduce deferred tax assets to the amounts expected to be recovered.

The Company has established a full valuation allowance for its deferred tax assets that are not recoverable from taxable temporary differences due to historical net operating losses.  To the extent that the Company generates taxable income in the future, the reversal of valuation allowances could generate significant tax benefits to future operations.  As of June 30, 2020, the Company has a valuation allowance of $325.9 million.

The calculation of the Company’s tax positions involves dealing with uncertainties in the application of complex tax regulations in several different state tax jurisdictions.  The Company is periodically reviewed by tax authorities regarding the amount of taxes due.  These reviews include inquiries regarding the timing and amount of deductions and the allocation of income among various tax jurisdictions.  The Company records estimated reserves for exposures associated with positions that it takes on its income tax returns that do not meet the more likely than not standards.

Results of Operations

The following discussion is reflective of our three business operating segments: durable medical equipment, investment management and real estate.  General corporate represents unallocated costs and activity to arrive at consolidated operations.  Activity not allocated to the segments include, but are not limited to, certain investment and financing activities, professional fees, costs associated with being a public company, acquisition costs and costs associated with executive and corporate management departments, including compensation, benefits, rent and insurance.  Durable medical equipment commenced operations in September 2018.  Correspondingly, the results of operations for the period ended June 30, 2020 for that segment is not comparable to the corresponding periods ended June 30, 2019.

The following table provides the results of our consolidated operations for the years ended June 30, 2020 and 2019:

24


 

 

For the years ended June 30,

 

 

 

2020

 

 

Percent Change

 

 

2019

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

64,098

 

 

 

25

%

 

$

51,180

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

 

(15,055

)

 

 

31

%

 

 

(11,463

)

Cost of rentals

 

 

(9,105

)

 

 

57

%

 

 

(5,798

)

Other selling, general and administrative

 

 

(35,034

)

 

 

1

%

 

 

(34,540

)

Depreciation and amortization

 

 

(4,237

)

 

 

15

%

 

 

(3,683

)

Total operating expenses

 

 

(63,431

)

 

 

 

 

 

 

(55,484

)

Operating income (loss)

 

 

667

 

 

 

 

 

 

 

(4,304

)

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(7,195

)

 

 

15

%

 

 

(6,250

)

Other income (expense)

 

 

(6,555

)

 

 

(536

)%

 

 

1,504

 

Total other expense, net

 

 

(13,750

)

 

 

 

 

 

 

(4,746

)

Total pre-tax income (loss) from continuing operations

 

$

(13,083

)

 

 

 

 

 

$

(9,050

)

Revenues

Revenues for the year ended June 30, 2020 included $55.7 million from the durable medical equipment business, $3.3 million from the investment management business and $5.1 million from the real estate business, while revenues for the year ended June 30, 2019 included $41.9 million from the durable medical equipment business, $3.8 million from the investment management business and $5.5 million from the real estate business.  The increase in total revenue for the year ended June 30, 2020 as compared to the year ended June 30, 2019 is primarily attributable to the prior period not including a full year of durable medical equipment segment operations due to acquisition of the business in the first quarter of fiscal year 2019.

Operating costs and expenses

The increase in operating expenses for the year ended June 30, 2020 as compared to the year ended June 30, 2019 is primarily attributable to the additional costs associated with the durable medical equipment business, including cost of goods sold and cost of rentals, as well as the general and administrative costs of the durable medical equipment business, depreciation on fixed assets and amortization of the intangible assets associated with the durable medical equipment business.  The increased costs are consistent with increases in topline sales, along with additional expenses incurred to enhance the scalability of the durable medical equipment business.

Other income (expense)

Interest expense increased for the year ended June 30, 2020 as compared to the year ended June 30, 2019 due to increased borrowings related to our acquisition of the durable medical equipment businesses in the first quarter of fiscal year 2019 and the issuance of the 5.0% Convertible Senior PIK Notes due 2030 (the Convertible Notes) which were issued in February 2020.  These increases were partially offset by the redemption of the 10% preferred stock of DME Holdings, Inc. in June 2019 resulting in no related interest expensed in the current year.

Other income (expense) consists of dividend income and net unrealized loss on our investment in GECC.  The year over year net expense is primarily attributable to the net realized loss on our investment in GECC which is discussed under “—General Corporate” below.

25


Durable Medical Equipment

The key metrics of our durable medical equipment business include:

 

Patients and setup growth – which drives revenue growth and takes advantage of scalable operations

 

Earnings before interest, taxes, depreciation and amortization (EBITDA)

The following table provides the results of our durable medical equipment business for the year ended June 30, 2020 and the period from its inception in September 2018 to June 30, 2019 (the DME inception period).

(in thousands)

 

For the year ended June 30, 2020

 

 

Percent Change

 

 

For the period September 7, 2018 to June 30, 2019

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

55,662

 

 

 

33

%

 

$

41,880

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

 

(15,055

)

 

 

31

%

 

 

(11,463

)

Cost of rentals

 

 

(9,105

)

 

 

57

%

 

 

(5,798

)

Transaction costs

 

 

-

 

 

 

(100

)%

 

 

(551

)

Other selling, general and administrative

 

 

(26,080

)

 

 

29

%

 

 

(20,260

)

Depreciation and amortization

 

 

(1,878

)

 

 

42

%

 

 

(1,323

)

Total operating expenses

 

 

(52,118

)

 

 

 

 

 

 

(39,395

)

Operating income (loss)

 

 

3,544

 

 

 

 

 

 

 

2,485

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(3,655

)

 

 

7

%

 

 

(3,415

)

Other income (expense)

 

 

5

 

 

 

(103

)%

 

 

(177

)

Total other expense, net

 

 

(3,650

)

 

 

 

 

 

 

(3,592

)

Total pre-tax income (loss) from continuing operations

 

$

(106

)

 

 

 

 

 

$

(1,107

)

Durable Medical Equipment Revenue

Durable medical equipment revenues include revenue from the sale of medical equipment, sleep study services and medical equipment rentals.  For the year ended June 30, 2020, revenues from the sale of medical equipment and sleep study services were $28.9 million and $5.3 million, respectively, compared to $22.4 million and $4.9 million, respectively during the DME inception period.  The increases are primarily attributable to the acquisition of the durable medical equipment businesses in September 2018 resulting in a shorter comparable period in the DME inception period.

Revenue from medical equipment rentals was $21.5 million for the year ended June 30, 2020 as compared to $14.6 million during the DME inception period.  The increase is primarily attributable to the shorter comparable DME inception period, as well as incremental revenue from increases in patient setups and the acquisition of Midwest Respiratory Care, Inc. (Midwest) on June 12, 2019.

Due to the COVID-19 pandemic, we have seen a decline in our sleep study services related to increased patient cancellations of attended sleep studies beginning in March 2020.  Though this did not have a material impact on total revenues for the year ended June 30, 2020, we expect this decline in patient referrals to continue into future periods as some local governments have issued advisories or regulations limiting certain non-essential business operations.

In addition, a portion of our equipment sales and rentals are dependent on the availability and accessibility of primary physicians to patients.  If patients are unable to access their physicians, it may negatively impact our referrals for new patient set-ups.

26


Durable Medical Equipment Costs and Expenses

Cost of goods sold includes inventory costs for medical equipment sold and direct costs associated with running sleep study services, including staff compensation to perform the studies and the purchase of supplies used in the studies.  Cost of rentals includes depreciation on medical equipment held for lease and costs related to maintenance expenses.  The increases in these costs for the year ended June 30, 2020 as compared to the DME inception period are primarily due to the increases in the related revenues and sales volumes.

General and administrative expenses primarily consist of payroll related costs, facility expenses, including lease costs, and professional fees.  For the year ended June 30, 2020 and for the DME inception period, payroll related costs were $20.2 million and $14.4 million, respectively, facility expenses were $2.0 million and $1.5 million, respectively, and professional fees were $2.0 million and $0.1 million, respectively.  In addition to the shorter comparable DME inception period, the increases in payroll related costs is due to growth in the business and additional employee hires.  The increase in professional fees is largely attributable to consulting costs and investments in technology to integrate the durable medical equipment business into the Company and prepare for future growth and scalability.  The increase is offset by $5.1 million of government stimulus received for purposes of keeping workers employed during the COVID-19 crisis and covering the incremental costs of serving patients during the pandemic.

Transaction costs decreased for the year ended June 30, 2020 as compared to the DME inception period as they primarily relate to one-time expenses incurred in the period of acquisition.

Depreciation and amortization includes the depreciation of fixed assets, excluding depreciation on the equipment held for rental, which is included in the cost of rentals, and amortization of the intangible assets resulting from the acquisition of the durable medical equipment businesses.  In addition to the shorter comparable DME inception period, the increase in depreciation and amortization was primarily driven by increases in leasehold improvements and sleep study equipment in existing locations as well as the acquisition of Midwest.

In addition to the operating costs and expenses, we recognized interest expense of $3.7 million and 3.4 million for the year ended June 30, 2020 and for the DME inception period, respectively.  The increase is primarily related to the shorter comparable DME inception period.  

Other income (expense) for the DME inception period ended June 30, 2019 includes dividend income of $0.7 million and realized loss of $0.9 million for the portion of the investment in GECC which had been restricted in connection with the Great Elm DME Holdings, Inc. (DME Holdings) preferred stock issued at inception of the durable medical equipment business in September 2018 (see Note 15 - Non-Controlling Interests and Preferred Stock of Subsidiary in the accompanying Notes to the Consolidated Financial Statements).  This preferred stock was redeemed in June 2019 and the restricted investments in GECC held by DME Holdings were returned to the parent, Great Elm Capital Group, Inc.  As such, no related activity occurred during the year ended June 30, 2020.

27


Investment Management

The key metrics of our investment management business include:

 

Assets under management ― which provides the basis on which our management fees and performance milestones for vesting of certain equity awards are based

 

Investment performance ― on which our incentive fees (if any) are based and on which we are measured against our competition

The following table provides the results of our investment management business:

 

 

For the years ended June 30,

 

 

(in thousands)

 

2020

 

 

Percent Change

 

 

2019

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

3,332

 

 

 

(13

)%

 

$

3,841

 

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

34

 

 

 

(107

)%

 

 

(521

)

 

Consulting agreement

 

 

(283

)

 

 

(63

)%

 

 

(763

)

 

Other general and administrative

 

 

(1,855

)

 

 

(32

)%

 

 

(2,741

)

 

Depreciation and amortization

 

 

(636

)

 

 

1

%

 

 

(631

)

 

Total operating expenses

 

 

(2,740

)

 

 

 

 

 

 

(4,656

)

 

Operating income (loss)

 

 

592

 

 

 

 

 

 

 

(815

)

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(157

)

 

 

(13

)%

 

 

(180

)

 

Other income (expense)

 

 

-

 

 

 

-

%

 

 

-

 

 

Total other expense, net

 

 

(157

)

 

 

 

 

 

 

(180

)

 

Total pre-tax income (loss) from continuing operations

 

$

435

 

 

 

 

 

 

$

(995

)

 

Investment Management Revenue

Investment management revenues include management fees and administration fees related to the management of GECC.

For the years ended June 30, 2020 and 2019, we recognized $2.8 million and $3.0 million, respectively, of management fee revenue and $0.5 million and $0.9 million, respectively, of administration fee revenue.  The decrease in management fee revenue for the year ended June 30, 2020 as compared to the year ended June 30, 2019 is attributable to decreases in the average assets on which such fees are calculated, most notably during the fourth quarter of fiscal year 2020 as a result of the impact of COVID-19 on the portfolio managed.  Administration fees decreased for the year ended June 30, 2020 as compared to the year ended June 30, 2019 primarily due to lower allocations of overhead costs as a result of internal restructuring in January 2019.

Investment Management Costs and Expenses

Stock-based compensation costs decreased for the year ended June 30, 2020 as compared to the year ended June 30, 2019 in connection with updated estimates related to performance-based awards.

GECM had a consulting agreement with a third party to provide services in exchange for 26% of the fees earned from the management of GECC, excluding incentive fees. The consulting agreement expired in November 2019 resulting in decreased fees for year ended June 30, 2020 as compared to the fees for the year ended June 30, 2019.

28


Other general and administrative costs consist primarily of professional fees, facilities and other overhead costs, and payroll and related costs, excluding stock-based compensation.  The decrease in general and administrative costs for the year ended June 30, 2020 as compared to the year ended June 30, 2019 is primarily attributable to the decreased allocation of overhead costs, including payroll-related costs.  These decreases were the result of efficiencies gained through restructuring in the prior year resulting in lower costs overall, as well as the increased allocation of such overhead costs to the general corporate segment in connection with the acquisition of the durable medical equipment business during the year ended June 30, 2019.

Real Estate

The key metrics of our real estate business include rental revenues, depreciation on rental properties and interest expense on the related debt.

The following table provides the results of our real estate business:

 

 

For the years ended June 30,

 

(in thousands)

 

2020

 

 

Percent Change

 

 

2019

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

5,104

 

 

 

(7

)%

 

$

5,459

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative

 

 

(544

)

 

 

(38

)%

 

 

(884

)

Depreciation and amortization

 

 

(1,722

)

 

 

(0

)%

 

 

(1,729

)

Total operating expenses

 

 

(2,266

)

 

 

 

 

 

 

(2,613

)

Operating income (loss)

 

 

2,838

 

 

 

 

 

 

 

2,846

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(2,619

)

 

 

(1

)%

 

 

(2,655

)

Other income (expense)

 

 

-

 

 

 

-

%

 

 

-

 

Total other expense, net

 

 

(2,619

)

 

 

 

 

 

 

(2,655

)

Total pre-tax income (loss) from continuing operations

 

$

219

 

 

 

 

 

 

$

191

 

Real Estate Revenue

For the years ended June 30, 2020 and 2019, we recognized $5.1 million and $5.5 million of rental revenue in connection with our recently acquired Class A office buildings in Fort Myers, Florida.  The decrease in revenue is attributable to the adoption of updated lease accounting guidance, which excludes from revenue and the corresponding real estate expenses and lessor costs paid directly to third parties by the lessee.

Real Estate Costs and Expenses

Our real estate business’ costs primarily consist of management fees, insurance and state sales tax, depreciation of real estate assets and the amortization of the in-place lease intangible assets.  Our costs and expenses have generally remained consistent year over year with the exception of the impact of adopting the updated lease accounting guidance which resulted in excluding certain expenses paid directly to third parties by the lessee.

29


General Corporate

The following table provides the results of our general corporate business:

 

 

For the years ended June 30,

 

 

(in thousands)

 

2020

 

 

Percent Change

 

 

2019

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

159

 

 

 

100

%

 

$

123

 

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

(582

)

 

 

27

%

 

 

(457

)

 

Transaction costs

 

 

(863

)

 

 

(45

)%

 

 

(1,582

)

 

Other general and administrative

 

 

(5,020

)

 

 

(27

)%

 

 

(6,904

)

 

Depreciation and amortization

 

 

(1

)

 

 

-

%

 

 

-

 

 

Total operating expenses

 

 

(6,466

)

 

 

 

 

 

 

(8,943

)

 

Operating income (loss)

 

 

(6,307

)

 

 

 

 

 

 

(8,820

)

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(764

)

 

 

-

%

 

 

-

 

 

Other income (expense)

 

 

(6,560

)

 

 

(490

)%

 

 

1,682

 

 

Total other income (expense), net

 

 

(7,324

)

 

 

 

 

 

 

1,682

 

 

Total pre-tax income (loss) from continuing operations

 

$

(13,631

)

 

 

 

 

 

$

(7,138

)

 

 

General Corporate Revenue

For the years ended June 30, 2020 and 2019, all revenue was derived from fees earned by DME Manager, a subsidiary in our general corporate segment, which provides consulting services to DME Inc., a subsidiary in our durable medical equipment segment.  Both DME Manager and DME Inc. were formed in connection with the acquisition of the durable medical equipment businesses in September 2018 and there was no corresponding activity prior to this acquisition.

General Corporate Costs and Expenses

Our general and administrative costs primarily consisted of professional fees, payroll and facility costs for our finance, legal and other administrative functions as well as professional fees and payroll costs in connection with our diligence efforts towards identifying asset and business acquisition opportunities.  For the years ended June 30, 2020 and 2019, professional fees in relation to the diligence of such opportunities were $0.9 million and $1.6 million, respectively.  Such professional fees for the year ended June 30, 2019 were higher than the current year due to the significant acquisition of our durable medical equipment business in September 2018.

The decrease in other general and administrative costs for the year ended June 30, 2020 as compared to the prior year was primarily driven by the change in fair value of contingent consideration related to the acquisition of the durable medical equipment business.  The fair value of contingent consideration decreased by $1.1 million for the year ended June 30, 2020, whereas the fair value of contingent consideration increased by $0.5 million for the year ended June 30, 2019, resulting in a year over year net change of $1.6 million.  Other key drivers of the decrease in other general and administrative costs for the year ended June 30, 2020 as compared to the prior year include reductions in professional fees of approximately $0.1 million and overhead costs of $0.1 million as a result of efficiencies gained through restructuring in the prior year.

30


Other Income (Expense)

Other income and expense primarily consisted of dividend income and unrealized gains or losses on the Company’s investment in GECC and interest income earned on cash balances.  Dividend income for the years ended June 30, 2020 and 2019 was $2.1 million and $1.7 million, respectively.  During the year ended June 30, 2019, a portion of the Company’s investment in GECC had been allocated to the durable medical equipment segment due to collateral requirements of the related party qualified preferred stock issued by DME Holdings in connection with the acquisition of the durable medical equipment businesses resulting in dividend income on those shares allocated to the durable medical equipment segment for that period.  The preferred stock were fully redeemed during the year ended June 30, 2019, and all shares allocated to the durable medical equipment were reallocated back to the general corporate segment.  As a result, all dividend income earned during the year ended June 30, 2020 has been allocated to the general corporate segment.

We recognized unrealized losses of $8.7 million and $0.2 million, respectively, for the years ended June 30, 2020 and 2019.  We mark-to-market our investment in GECC by reference to the closing price of GECC common stock on Nasdaq as of each period end.

Income Taxes

We do not expect that we will owe any federal taxes for the year ended June 30, 2020.  In the aggregate, we did not owe any federal taxes for the year ended June 30, 2019, however, we are required to provide intra period taxes allocated between continuing operations and discontinued operations.  During 2019, the Company recognized an income tax benefit with respect to discontinued operations of $1.3 million related to intra period allocations.  In addition, the Company recognized an income tax benefit with respect to deferred tax liabilities of $0.9 million acquired in the durable medical equipment acquisition. State and local taxes were approximately $0.1 and $0.1 million for the year ended June 30, 2020 and 2019, respectively.

Summary of Discontinued Operations

On June 30, 2016, the Company sold two of its previously wholly-owned subsidiaries (the Divestiture) engaged in the patent licensing business for an aggregate purchase price of up to $40 million.  The purchaser paid the Company $30 million, plus certain adjustments, upon the closing of the Divestiture, and had made claims that it had incurred indemnifiable losses in excess of the remaining $10 million due under the purchase and sale agreement.  

On January 21, 2019, we entered into a mutual release and settlement agreement with the purchaser resulting in the release of any indemnifiable liabilities and an incremental cash receipt of $1.5 million.  Prior to the execution of this settlement, the Company had determined that a loss related to final settlement with the purchaser was not realizable or estimable, and therefore had not accrued for any losses; however, the recognition of a portion of proceeds received associated with the former patent licensing business had been deferred pending finalization of all contingencies.  The settlement resulted in a $5.0 million gain in discontinued operations during the year ended June 30, 2019, consisting of the extinguishment of related liabilities of $3.6 million and the receipt of cash of $1.5 million from the purchaser, partially offset by legal fees of $0.1 million.  The net income from discontinued operations includes these gains, offset by a tax provision of $1.3 million for the year ended June 30, 2019.

The following table provides a reconciliation of the Company’s discontinued operations:

 

 

For the years ended June 30,

 

(in thousands)

 

2020

 

 

2019

 

Discontinued operations:

 

 

 

 

 

 

 

 

Net revenue

 

$

-

 

 

$

1,500

 

Extinguishment of liabilities related to discontinued operations

 

 

-

 

 

 

3,608

 

General and administrative expenses

 

 

-

 

 

 

(87

)

Pretax gain (loss) from discontinued operations

 

 

-

 

 

 

5,021

 

Income tax benefit (expense)

 

 

-

 

 

 

(1,285

)

Net gain (loss) from discontinued operations

 

$

-

 

 

$

3,736

 

31


Net Revenues

As a result of the settlement during the year ended June 30, 2019, we recognized $1.5 million in net revenues for the period.  There were no revenues related to discontinued operations for the year ended June 30, 2020.

Extinguishment of Liabilities

As a result of the settlement during the year ended June 30, 2019, $3.6 million of liabilities related to the discontinued operations were extinguished.

General and Administrative Expenses

During the year ended June 30, 2019 the general and administrative expenses of our discontinued operations related primarily to the work associated with settling claims on the representations and warranties in connection with the Divestiture.  There were no expenses related to discontinued operations for the year ended June 30, 2020.

Liquidity and Capital Resources

The following table presents selected financial information and statistics:

 

 

As of June 30,

(in thousands)

 

2020

 

 

2019

 

 

Current Assets

 

$

61,328

 

 

$

42,400

 

 

Current Liabilities

 

 

25,514

 

 

 

18,068

 

 

Working Capital

 

$

35,814

 

 

$

24,332

 

 

Long Term Liabilities

 

$

101,361

 

 

$

95,664

 

 

 

 

 

For the years ended June 30,

(in thousands)

 

2020

 

 

2019

 

 

Cash provided by (used in) operating activities

 

$

13,391

 

 

$

2,691

 

 

Cash provided by (used in) investing activities

 

 

(6,632

)

 

 

(54,903

)

 

Cash provided by (used in) financing activities

 

 

21,776

 

 

 

21,502

 

 

Net increase (decrease) in cash and cash equivalents

 

$

28,535

 

 

$

(30,710

)

 

 

Working Capital and Cash Flows

As of June 30, 2020, we had a cash balance of $41.4 million, including restricted cash of $0.8 million.  We also owned 2,043,434 shares of GECC common stock with an estimated fair value of $8.7 million as of June 30, 2020.

We intend to make acquisitions that will likely result in our investment of all of our liquid financial resources, the issuance of equity securities and the incurrence of indebtedness.  If we are unsuccessful at raising additional capital resources, through either debt or equity, it is unlikely we will be able execute our strategic growth plan.  See “Item 1A. Risk Factors.”

Cash Provided by or Used in Operating Activities. Cash flows provided by operating activities totaled $13.4 million and $2.7 million for the years ended June 30, 2020 and 2019, respectively.  For the year ended June 30, 2020, net cash provided by operating activities consisted primarily of the net loss of $13.1 million offset by non-cash activity, including $12.5 million in depreciation and amortization and $8.7 million in unrealized loss on our investment in GECC.  The net loss of $13.1 million is net of $5.1 million of CARES Act stimulus income.  Changes in operating assets and liabilities resulted in net cash provided by operating activities of $3.9 million which was primarily driven by increases in deferred revenue.  The increase in deferred revenue is primarily related to the receipt of $4.4 million in CMS payments.

32


For the year ended June 30, 2019, net cash provided by operating activities for continuing operations consisted primarily of the net loss of $3.1 million and gain on discontinued operations of $3.7 million offset by non-cash activity, including $9.2 million of depreciation and amortization.  Changes in operating assets and liabilities resulted in net cash used in operating activities of $3.0 million, primarily consisting of an increase in accounts receivable of $2.8 million and decrease in operating leases of $1.1 million offset by increases in related party payables of $0.8 million.  These changes in operating assets and liabilities are primarily related to operational changes as a result of the acquisition of our durable medical equipment businesses during the year.

Cash Used in Investing Activities. Cash flows used in investing activities totaled $6.6 million and $54.9 million for the years ended June 30, 2020 and 2019, respectively.  For the year ended June 30, 2020, net cash used in investing activities primarily consists of $8.1 million in purchases of equipment held for rental which was partially offset by proceeds from the sale of equipment held for rental.

For the year ended June 30, 2019 investing activities primarily consist of $48.1 million spent in the acquisitions of our durable medical equipment businesses in September 2018 and June 2019, as well as the purchase of $6.8 million in equipment held for rental and another $0.8 million in fixed assets related to the durable medical equipment business.

Cash Provided by Financing Activities. Cash flows provided by financing activities totaled $21.8 million and $21.5 million for the years ended June 30, 2020 and 2019, respectively. For the year ended June 30, 2020, cash inflows of $30.0 million were provided by the issuance of Convertible Notes with additional inflows related to proceeds from equipment financing and our revolving line of credit.  These inflows partially offset by principal payments on our long term debt, related party notes payable, revolving line of credit and equipment financing.

For the year ended June 30, 2019, cash inflows of approximately $19.9 million and $6.6 million were provided by net proceeds on the note payable from a seller and a revolving line of credit, respectively, established with the acquisition of the durable medical equipment business, including additional draws made during the year. Additionally, $1.6 million was provided by proceeds from equipment financing arrangements and $1.4 million was provided by the exercise of warrants in July 2018.  These inflows were partially offset by principal payments of $2.8 million on our long term debt and related party notes payable, as well as $5.1 million paid to redeem the preferred stock of a subsidiary during the year ended June 30, 2019.

Borrowings

As of June 30, 2020, the Company had $30.5 million face value in Convertible Notes outstanding.  The Convertible Notes are held by a consortium of investors, including related parties.  The Convertible Notes accrue interest at 5.0% per annum, payable semiannually in arrears on June 30 and December 31, in cash or in-kind at the option of the Company.

The Convertible Notes are due on February 26, 2030 but are convertible at the option of the holders at a conversion price of $3.4722 per share, subject to the terms therein, prior to maturity into shares of our common stock.  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.

As of June 30, 2020, we had a note due to a non-controlling interest holder of DME Inc., Corbel Capital Partners SBIC, L.P., totaling $25.1 million that accrues interest at a rate of three-month LIBOR plus 10.0% (at June 30, 2020, the effective interest rate was 10.30%) through maturity on August 31, 2023 (the Corbel Facility).  The Corbel Facility requires quarterly interest payments along with principal payments of $0.3 million plus an additional amount based on excess cash flows, if any, generated by the durable medical equipment business operations.  The Corbel Facility is secured by all of the assets of the durable medical equipment business and the Company is required to meet certain financial covenants.

33


The Company has the option to prepay the borrowings outstanding under the Corbel Facility in whole or in part subject to certain prepayment penalties ranging from 1.0% - 5.0% of the early payment of the principal, based on the time that the Corbel Facility has been outstanding through the first five years of the loan.

DME Inc. is required to pay to Corbel, as agent of the Corbel Facility, a quarterly monitoring fee of $25,000 per quarter while the borrowings remain outstanding.  In addition, if the borrowing is repaid with proceeds of debt in full or in part at any time within the first three years from the date of issuance, the borrower shall pay an additional fee to the agent, ranging from 2.10% to 3.50% depending on the date of repayment based on the period outstanding, of the aggregate repaid principal amount.

As of June 30, 2020, we had a credit facility due to Pacific Mercantile Bank totaling $3.9 million that accrues interest at the prime rate plus 0.40% (at June 30, 2020, the effective rate was 3.65%) through maturity on August 30, 2020 (the DME Revolver).  The DME Revolver allows for borrowings up to $10 million.  The DME Revolver requires monthly interest payments.  The DME Revolver is secured by all of the assets of the durable medical equipment business and the Company is required to meet certain financial covenants.

The Corbel Facility and DME Revolver each include covenants that restrict DME Inc. business operations to its current business, limit additional indebtedness, liens, asset dispositions and investments, require compliance and maintenance of licenses and government approvals and other customary conditions.  Events of default include the failure to pay amounts when due, bankruptcy, or violation of covenants, including a change in control of DME Inc.  DME Inc. must also comply with a fixed-charge coverage and leverage ratio financial covenants, which are based in part on the DME Inc. EBITDA levels. The Company was in compliance with all material covenants and restrictions at June 30, 2020.

As of June 30, 2020, we had a related party note due to MAST Capital (the GP Corp. Note) totaling $3.1 million that accrues interest at a variable rate of three-month LIBOR plus 3.0%, as adjusted for each 90-day period (at June 30, 2020, the effective rate was 3.30%) through maturity on November 3, 2026.  The GP Corp. Note requires minimum annual principal payments of $0.08 million and quarterly interest-only payments.  The GP Corp. Note is secured by the profit sharing agreement between GECM and GECC GP Corp. (the Profit Sharing Agreement) that transfers profits generated by our management of GECC, with no recourse to any of our other assets, entities or operations.

The GP Corp. Note is non-recourse to any of the Company’s operations or net assets not related to GECM’s management services to GECC.  The GP Corp. Note may be prepaid at par value at any time with prior written notice to the holders of the GP Corp. Note.  Additionally, GECC GP Corp. is required to prepay the GP Corp. Note upon certain material liquidation transactions including any termination of the Profit Sharing Agreement.

As of June 30, 2020, we had a senior note due to Wells Fargo Bank Northwest, National totaling $50.0 million that accrues interest at a rate of 3.49% through maturity on March 15, 2030 (the Senior Note).  The Senior Note requires monthly principal and interest payments through the maturity date.  The Senior Note is secured by a first lien mortgage on the Property and an Assignment of Leases and Rents, with no recourse to any of our assets, entities or operations.

The principal and interest due on the Senior Note may be prepaid at the option of the borrower, based on an amount determined by discounting the remaining principal and interest payments at a rate equal to an applicable premium in excess of a rate corresponding to the specified U.S. Treasury security over the remaining average life of the Senior Note.

As of June 30, 2020, we had a subordinated note due to Wells Fargo Bank Northwest, National totaling $3.8 million that accrues interest at a rate of 15.00% through maturity on March 15, 2030 (the Subordinated Note).  The Subordinated Note is a capital appreciation note, whereby the monthly interest is capitalized to the principal balance and due at maturity.  The Subordinated Note is secured by a second lien mortgage on the Property, and an Assignment of Leases and Rents, with no recourse to any of our assets, entities or operations.

The principal and interest due on the Subordinated Note may be prepaid at the option of the borrower, based on an amount determined by discounting the remaining principal and interest payments at a rate equal to an applicable premium in excess of a rate corresponding to the specified U.S. Treasury security over the remaining average life of the Subordinated Note.

34


The note agreements for both the Senior Note and the Subordinated Note include negative covenants that restrict the Company’s majority-owned subsidiary, CRIC IT Fort Myers LLC’s (the Property Owner) business operations to ownership and lease of the Property, limit additional indebtedness, require maintenance of insurance and other customary requirements related to the Property.  Events of default include non-payment of amounts when due, inability to pay indebtedness or material change in the business operations or financial condition of the Property Owner or the lease tenant that in the lender’s reasonable determination would reasonably be expected to materially impair the value of the Property, prevent timely repayment of the notes or performance of any material obligations under the note and related agreements.  The payments under the notes are also guaranteed on a full and several basis by the non-controlling interest holder of the Property Owner.  Both the Senior Note and Subordinated Note are non-recourse to the Company, but are secured by the Property, the rights associated with the leases and the stock owned by the Company in the Property Owner.

Beginning in April 2019, DME Inc’s operating subsidiaries also utilize equipment financing debt to fund certain inventory and equipment purchases from suppliers.  These equipment financing debt agreements are entered into with 3rd party banks and are generally payable in equal installments over terms of one to three years, depending on the nature of the underlying purchases being financed.  The debt is secured by the inventory and equipment, as applicable, of the operating subsidiaries entering into the agreements, and the long-term agreements have implicit interest rates between 7 – 8%.  During the years ended June 30, 2020 and 2019, the Company financed $3.6 million and $1.6 million, respectively, in inventory and equipment through such financing agreements.

Restrictions on Subsidiary Dividends

In the GP Corp. Note agreement, GECC GP Corp. agreed not to declare any dividends until the GP Corp. Note is satisfied.  In the Senior Note and Subordinated Note, the Property Owner is restricted from paying any dividends until such notes are satisfied.  The ability of DME Inc. to pay dividends is subject to compliance with the restricted payment covenants under the Corbel Facility and DME Revolver.

Off-Balance Sheet Obligations

As of June 30, 2020, we did not invest in any off-balance sheet vehicles that provide financing, liquidity, market or credit risk support or engage in any leasing activities that expose us to any liability that is not reflected in our consolidated financial statements.

New Accounting Pronouncements

See Note 2 – Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 8.  Financial Statements and Supplementary Data.

The information required by this Item appears beginning on page F-1 of this Annual Report on Form 10-K and is incorporated in this Item 8 by reference.

Per Rule 3-09 of Regulation S-X, the audited financial statements of GECC for the years ended December 31, 2019 and 2018 included in GECC’s registration statement on Form N-2 (File No.  333-239839), as amended, filed with the SEC on August 27, 2020 are incorporated herein by reference.  We include the financial statements of GECC because our investment in GECC met the test of significance under Rule 3-09 in Regulation S-X.  The management of GECC is responsible for the form and content of GECC’s financial statements.  Certain officers of GECC are also officers of GEC.  Mr. Reed is our Chief Executive Officer as well as the Chief Executive Officer of GECC and Mr. Kleinman is our President and Chief Operating Officer as well as the Chief Compliance Officer of GECC.  GECM serves as the investment advisor to GECC.

35


Item 9.  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

Not applicable.

Item 9A.  Controls and Procedures.

Disclosure Controls and Procedures

The Company’s management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports filed or submitted under the Securities Exchange Act of 1934, as amended (the Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective as of June 30, 2020.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for preparation of the accompanying consolidated financial statements in accordance with US GAAP.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13(a)-15(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Our internal control over financial reporting is supported by written policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2020 as required by the Exchange Act. In making this assessment, we used the criteria set forth in the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  Based on management’s evaluation under the framework, management concluded that Great Elm Capital Group, Inc.’s internal control over financial reporting was effective as of June 30, 2020.

Changes in Internal Control Over Financial Reporting

Remediation of Previously Reported Material Weaknesses

36


As disclosed in our Annual Report on Form 10-K, Item 9A. for the fiscal year ended June 30, 2019, our management concluded that our internal controls over financial reporting were not effective at June 30, 2019.  As of that date, material weaknesses were identified in the principals associated with each component of the COSO framework.

Over the course of fiscal year 2020, we have completed remediation actions to address the material weaknesses in internal control over financial reporting, including:

 

Control Environment – We evaluated the sufficiency, experience, and training of our internal personnel at our durable medical equipment subsidiaries and hired additional qualified personnel or used external resources to address identified needs.  In addition, we enhanced the oversight controls performed by Corporate management over the durable medical equipment business.

 

Risk Assessment – We engaged a new outside firm to assist management in performing a comprehensive risk assessment, including: (i) identifying, assessing, and communicating appropriate objectives, (ii) identifying and analyzing risks to achieve these objectives, and (iii) identifying and assessing changes in the business that could impact our system of internal controls.

 

Control Activities – This outside firm also assisted management in assessing control activities, including identifying control gaps impacting the Company’s businesses, enhancing the design and implementation of internal controls, and testing the operating effectiveness of these controls.

 

Information and Communication – We integrated information systems within the durable medical equipment business and implemented technology solutions to reduce manual processes and facilitate the design and implementation of an effective system of controls.  These improvements also enhanced the quality and accuracy of financial information provided pursuant to objectives, responsibilities and functions of internal control.

 

Monitoring Activities – We implemented additional corporate monitoring activities over the Company’s internal controls over financial reporting to determine whether the components of internal control were present and functioning appropriately.  

Based upon the actions taken during fiscal year 2020, of which testing of design, implementation and operating effectiveness were completed in the fourth fiscal quarter of 2020, we have concluded that the material weaknesses have been remediated as of June 30, 2020.

Other than the changes discussed above, there has been no change in our internal control over financial reporting during the fiscal quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B.  Other Information.

None.

37


PART III

Item 10.  Directors, Executive Officers and Corporate Governance.

Our Board currently has eight members. Directors are typically elected at each Annual Stockholders’ Meeting for terms expiring at the next Annual Stockholders’ Meeting. The following table sets forth information with respect to persons who are currently serving as directors of the Company.

Director

Age

Audit Committee

Nominating & Corporate Governance Committee

Compensation Committee

Thomas S. Harbin III

46

 

 

James H. Hugar

74

Chair

 

Peter A. Reed

40

 

 

 

Jason W. Reese

54

 

 

 

Eric J. Scheyer

55

 

Jeffrey S. Serota

54

 

 

 

 

We entered into agreements (the MAST Fund Agreements) with private investment funds (the MAST Funds) pursuant to which the MAST Funds have the right to nominate two directors in accordance with the terms of such MAST Fund Agreements. The MAST Funds have nominated the following two individuals as directors, both of whom currently are directors:

Director

Age

Audit Committee

Nominating & Corporate Governance Committee

Compensation Committee

Matthew A. Drapkin

47

 

Chair

James P. Parmelee

54

 

Chair

 

Our Board determined that each non-employee director, except Messrs. Reese and Serota, is an independent director. Our Board determines the independence of our directors by applying independence principles and standards established by Nasdaq. Based on these standards, our Board has determined that Messrs. Reese and Serota are not independent, Mr. Reese due to his position as our Executive Co-Chairman and Mr. Serota due to his position with Corbel Capital Partners.

Information about the Directors

Biographical information regarding each director and his qualifications to serve as a director is set forth on the succeeding pages. The year shown as election as a director is the year that the director was first elected as one of our directors. Unless otherwise indicated, each director has held his principal occupation or other positions with the same or predecessor organizations for at least the last five years. There are currently no family relationships among any directors or executive officers.

Thomas S. Harbin III is 46 years old and has been a member of our Board since October 2017. Mr. Harbin co-founded Source Capital, LLC (Source Capital) in 2002 and currently serves as its Managing Partner. Source Capital, through its affiliates and several committed funds, invests in both private equity and private debt transactions primarily in support of growing US-based companies in the lower-middle market. Mr. Harbin worked previously with J.H. Whitney & Co., a Connecticut-based private equity firm with over $5 billion in assets under management. He was the Head of Business Development for PowerBand Communications, a Whitney portfolio company located in Tokyo, Japan. Mr. Harbin also spent time in the Leveraged Finance group of Goldman, Sachs & Co. in New York.  Mr. Harbin received a BA with distinction in Economics from the University of Virginia.  Mr. Harbin is also a member of the Board of Trustees for the Nature Conservancy of Georgia and the Piedmont Healthcare Foundation.

Mr. Harbin brings to our Board investment expertise and extensive experience, including in leadership roles, in the private capital markets.

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James H. Hugar is 74 years old and has been a member of our Board since March 2020. Mr. Hugar was previously a member of the board of directors of Vitesse Semiconductor Corporation from 2009 until its acquisition in April 2015. Mr. Hugar was also on the board of advisors of American Relocation & Logistics, Inc., a privately-held company, until its sale in December, 2017. Mr. Hugar retired from Deloitte & Touche LLP where he was an audit partner from 1982 to 2008, specializing in the financial service industry. Prior to his retirement, he served as the partner-in-charge of the Southern California Investment Company and Broker/Dealer Practice Unit. Mr. Hugar holds a BS degree in Accounting from Pennsylvania State University and a MSBA degree from the University of California, Los Angeles and is a Certified Public Accountant.

Mr. Hugar brings to our Board extensive financial and accounting experience.

Peter A. Reed is 40 years old and since September 2017 has been our Chief Executive Officer. Mr. Reed has been a member of our Board since May 2015. Mr. Reed is Chief Investment Officer of GECM, and President, Chief Executive Officer, and Chairman of the board of directors of GECC. Mr. Reed is also currently a member of the board of directors of GECM, GECC GP Corp., Great Elm FM Acquisition, Inc., Great Elm FM Holdings, Inc., DME Holdings and DME Inc. From 2017 through 2019, Mr. Reed served on the board of directors of Avanti Communications Group PLC, a UK-based satellite provider.  Until September 2017, Mr. Reed was Portfolio Manager and Partner at MAST Capital Management, LLC (MAST Capital), a Boston-based registered investment advisor. Prior to joining MAST Capital in 2004, Mr. Reed was an investment banking analyst at Brown, Gibbons, Lang & Company where he worked on mergers and acquisitions, in-court and out-of-court financial restructurings, and debt and equity private placements for middle market companies.

Mr. Reed brings to our Board knowledge of the investment management business, capital markets and corporate restructuring.

Jason W. Reese is 54 years old and has been Executive Co-Chairman of our Board since February 2020. Mr. Reese is the Co-Founder, Chairman and Chief Executive Officer of Imperial Capital Asset Management, LLC (ICAM) and the Co-Founder and Executive Committee Member of Imperial Capital, LLC, both founded in 1997. ICAM is a registered investment advisor which has managed various hedge funds, investment partnerships, a private REIT and a private equity fund. Imperial Capital, LLC is a registered broker-dealer, headquartered in Los Angeles. Prior to co-founding ICAM and Imperial Capital, LLC, Mr. Reese was a principal with Gordon Investment Corporation, a merchant banking firm in New York and Dallas, where he focused on investing in distressed real estate transactions, high yield securities and leveraged buyouts. Prior to his time with Gordon, Mr. Reese worked in the Corporate Finance Group at PaineWebber in New York. Mr. Reese is currently on the board of directors of City Ventures, LLC, a California-based private home builder. Mr. Reese graduated with honors from Yale University with a B.S. in Electrical Engineering.

Mr. Reese brings to our Board investment expertise and extensive experience in capital markets.

Eric J. Scheyer is 55 years old and has been a member of our Board since February 2020. Mr. Scheyer is currently the chief executive officer and on the board of directors of Star Peak Energy Transition Corp., a special purpose acquisition company. Mr. Scheyer is a partner at Magnetar Capital, member of the Magnetar Management Committee and Magnetar Investment Committee and head of the Energy and Infrastructure group. Prior to joining Magnetar in 2005, Mr. Scheyer spent two years as a consultant at Caxton Associates. Prior to Caxton, Mr. Scheyer was a principal of Decorel Incorporated where he served as President of Decorel S.A. de C.V. and Executive Vice President of Decorel Inc. until the sale of the company to Newell Rubbermaid. Mr. Scheyer began his career at Donaldson, Lufkin & Jenrette focusing on the oil and gas sector. Previously, Mr. Scheyer served on the board of managers of Lightfoot Capital Partners GP LLC and the board of directors of Arc Logistics Partners LP. Mr. Scheyer holds a Bachelor of Arts in History from Trinity College in Hartford, Connecticut.

Mr. Scheyer brings to our Board investment expertise and extensive experience in capital markets.

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Jeffrey S. Serota is 54 years old, has been a member of our Board since November 2016 and currently serves as Co-Chairman of the Board. Mr. Serota is currently a Vice Chairman at Corbel Capital Partners, an alternative lower middle-market debt manager. Mr. Serota served as a Senior Partner and Senior Advisor at Ares Management LLC (Ares) from 1997 to 2013. While at Ares, Mr. Serota led investments in an array of security types and industries. Transaction structures included buyouts, recapitalizations, structured equity, minority interest, and distressed-for-control, among others. As part of his role as a Senior Partner at Ares, Mr. Serota acted as an interim Chief Executive Officer for certain portfolio company investments of Ares, led fundraising efforts for private equity investment funds, participated in numerous private and public companies as a member of the board of directors, and assisted in the management of the private equity efforts at Ares. Before Ares, Mr. Serota served as a Vice President in the investment banking department at Bear, Stearns & Co. Inc. Prior to Bear Stearns, Mr. Serota was employed at Dabney/Resnick, Inc., where he specialized in merchant banking and capital raising activities for middle-market companies and had primary responsibility for Dabney/Resnick’s bridge financing activities. Mr. Serota was also employed at Salomon Brothers Inc., where he focused on mergers and acquisitions and merchant banking transactions.

Mr. Serota is currently a director of Goodrich Petroleum Corporation. Mr. Serota was previously Chairman of the Board of CIFC Corp., a $15 billion asset management firm specializing in non-investment grade credit products. Mr. Serota also served as the Chairman of SandRidge Energy, Inc. from June 2013 until October 2016 and as one of its independent director from March 2007 to October 2016. Mr. Serota has also served on numerous public and private company boards over his career. Public company boards included: Exco Resources, Lyondell Basell Inc., WCA Waste Corp. and Douglas Dynamics, Inc.

Mr. Serota brings to our Board over 30 years of experience as a principal investor, financial services professional, and operating executive.

Matthew A. Drapkin is 47 years old and has been a member of our Board since April 2017. Mr. Drapkin is Chief Executive Officer & Portfolio Manager of Northern Right, a value-oriented, alternative asset manager focused on constructive activist investing in small-to-mid cap, public companies.

Mr. Drapkin is currently on the board of directors of PRGX Global, a global provider of recovery audit services to retail and commercial clients and serves as Executive Chairman of Boardroom Alpha, Inc., an analytics company. Mr. Drapkin previously served on the board of directors of Intevac, a publicly-traded provider of equipment solutions to the hard-disk drive industry and high-sensitivity imaging products, primarily for the defense market, as Chairman of the Board of Ruby Tuesday, a restaurant operator, Lead Independent Director of Hot Topic, a specialty retailer, and a director of Xura (formerly known as Comverse), a provider of telecommunications businesses solutions, Glu Mobile, a mobile gaming company, Plato Learning, a provider of curriculum management, and Alloy, a diversified media company.

Before joining Northern Right in December 2009, Mr. Drapkin had extensive investment experience, including his work as Head of Research, Special Situations, and Private Equity at ENSO Capital, a New York-based hedge fund, and Senior VP of Corporate Development at MacAndrews & Forbes, where he participated in more than $3 billion of transactions, including Scientific Games, Deluxe Entertainment Services, AM General, and Scantron. Prior to MacAndrews & Forbes, Mr. Drapkin served as General Manager of two of Condé Nast publications’ wholly-owned Internet sites, Epicurious.com and Concierge.com, and headed Conde Nast’s Internet venture investment effort. Mr. Drapkin began his career as an investment banker at Goldman, Sachs and Co where he advised companies on corporate finance and M&A matters. He holds a J.D. from Columbia Law School, an M.B.A. from Columbia Business School, and a B.A. in American History from Princeton University.

Mr. Drapkin was elected to our Board as a result of the MAST Funds’ exercise of their rights to appoint two members of our Board under the MAST Fund Agreements.

James P. Parmelee is 54 years old and has been a member of our Board since June 2017. Mr. Parmelee is a managing director of Hamilton Robinson Capital Partners, a private equity firm that invests in middle-market specialty manufacturing, industrial technology and business services companies in the U.S. and Canada. Mr. Parmelee currently serves on the board of directors of PNE LLC based in Longview, WA, GrayMatter Systems based in Pittsburgh, PA and Tanknology, based in Austin, TX.

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Mr. Parmelee is a former member of the board of directors of The Meet Group based in New Hope, PA. Previously, Mr. Parmelee was a Partner in Peak Ten Management, a long/short equity fund backed by Tiger Management LLC focused on investing in the global information technology sector. Mr. Parmelee was responsible for the firm’s investments in the software, IT infrastructure and Internet verticals. Prior to joining Peak Ten Management, Mr. Parmelee was a partner in Union Square Advisors LLC, a strategic advisory firm. Mr. Parmelee led the firm’s global IT infrastructure practice providing strategic M&A advisory services to the firm’s clients. From 1992 to 2004, Mr. Parmelee was a senior equity research analyst responsible for coverage of the data networking and telecommunications equipment sectors, primarily at Credit Suisse First Boston where he was most recently a Managing Director and served as the Global Coordinator of Technology Research for the firm.

Mr. Parmelee was elected to our Board as a result of the MAST Funds’ exercise of their rights to appoint two members of our Board under the MAST Fund Agreements.

Executive Officers

Name

Age

Position

Peter A. Reed

40

Chief Executive Officer

Brent J. Pearson

39

Chief Financial Officer & Chief Accounting Officer

Adam M. Kleinman

45

President and Chief Operating Officer

 

Peter A. Reed. For biographical information for Mr. Reed, see the section above titled “Information about the Directors.

Brent J. Pearson has been our Chief Financial Officer since September 2019, and previously served as our interim Chief Financial Officer from February 2019 to September 2019. Mr. Pearson has also served as our Chief Accounting Officer since October 2018. Prior to joining GEC, Mr. Pearson was a Senior Manager in the audit practice at Deloitte & Touche LLP where he held various positions of increasing responsibility from 2005-2018. Mr. Pearson received a Masters in Accounting and a Bachelor of Science from Boston College and is a Certified Public Accountant.

Adam M. Kleinman has been our President and Chief Operating Officer since March 21, 2018. Mr. Kleinman is GECC’s Chief Compliance Officer and GECM’s Chief Operating Officer, Chief Compliance Officer and General Counsel. Mr. Kleinman is also currently a member of the board of directors of GECM, GECC GP Corp., Great Elm FM Acquisition, Inc., Great Elm FM Holdings, Inc., DME Holdings and Avanti Communications Group PLC, a UK-based satellite provider. Mr. Kleinman was a Partner, Chief Operating Officer and General Counsel of MAST Capital from 2009 to September 2017. Prior to joining MAST Capital, Mr. Kleinman was an associate in the Banking and Leverage Finance group at Bingham McCutchen LLP, where he represented financial institutions, hedge funds and corporate borrowers in a broad range of commercial finance transactions, including syndicated debt financings, asset-based credit facilities and domestic and international debt workouts and restructurings. Mr. Kleinman graduated Phi Beta Kappa form Haverford College in 1997 with a BA in History and received his JD from the University of Virginia School of Law in 2004.

Delinquent Section 16(a) Reports

Section 16(a) of the Exchange Act requires our directors, executive officers and persons who own more than 10% of a registered class of our equity securities to file reports of ownership and changes in ownership with the SEC. Directors, executive officers and greater than 10% shareholders are required by regulations of the SEC to furnish us with copies of all Section 16(a) reports that they file. Such reports are filed on Forms 3, 4 and 5 under the Exchange Act. Based solely on our review of the copies of such forms received by us, we believe that, during the fiscal year ended June 30, 2020, all such persons complied on a timely basis with the filing requirements of Section 16(a) with the exception of the following inadvertent late filings: one Form 4 filing on December 12, 2019 by each of Matthew A. Drapkin, Thomas S. Harbin, James P. Parmelee and Jeffrey S. Serota, each with respect to one award of restricted shares and one Form 4 filing on April 28, 2020 by each of James H. Hugar, Eric Scheyer, and jointly by Jason W. Reese, ICAM and Long Ball, each with respect to one award of restricted shares.

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Code of Conduct

Our Code of Conduct applies to our directors and employees (including our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer).  Our Code of Conduct provides our written policies and procedures for the review of any activities by a director, executive officer or employee or members of their immediate families which create or appear to create an actual or potential conflict between the individual’s interests and our interests. Our Audit Committee is responsible for interpreting our Code of Conduct, reviewing reports of alleged breaches of such Code of Conduct and granting waivers of or approving amendments of such Code of Conduct. Our Audit Committee is responsible for reviewing past or proposed transactions between us and related persons. We expect that any amendment to the code, or any waivers of its requirements, will be disclosed on our website. The identification of our website does not include or incorporate by reference the information on our website into this report.

Our Code of Conduct requires all of our employees, executive officers and directors to avoid any activity or personal interest that creates or appears to create a conflict of interest with us, and requires all of our personnel to disclose any such activity or interest to management. Our directors and executive officers are required to obtain the prior written approval of our Audit Committee, or its designated member, following the full disclosure of all facts and circumstances before making any investment, accepting any position or benefits, or participating in any transaction or business arrangement that creates or appears to create a conflict of interest.  All of our other employees are required to make such disclosure to, and receive the prior written approval of, those individuals who are delegated such responsibility through policies and procedures adopted by us.

CORPORATE GOVERNANCE

Our business and affairs are managed and all corporate powers are exercised under the direction of our Board. Our Board establishes fundamental corporate policies and oversees our performance and our Chief Executive Officer and the other officers to whom our Board has delegated authority to manage day-to-day business operations.

Our Board has committees assist our Board in carrying out its responsibilities. Each operates under a written charter adopted by our Board.

Our standing committee charters, including our Audit, Compensation, and Nominating and Corporate Governance Committee charters, and Code of Conduct are posted on our website at www.greatelmcap.com. Paper copies may be obtained upon request by writing to: Corporate Secretary, Great Elm Capital Group, Inc., 800 South Street, Suite 230, Waltham, MA 02453.

Board of Directors

Functions

In addition to its general oversight role, our Board performs a number of specific functions, including:

 

Hiring and firing our Chief Executive Officer and overseeing his or her performance and that of other senior management in the operation of the Corporation;

 

Planning for management succession;

 

Guiding corporate strategy;

 

Reviewing and monitoring strategic, financial and operating plans and budgets and their development and implementation by management;

 

Assessing and monitoring risks and risk-management strategies;

 

Suggesting, reviewing and approving significant corporate actions;

 

Reviewing and monitoring processes designed to maintain our integrity, including financial reporting, compliance with legal and regulatory obligations, and relationships with stockholders, employees, customers, suppliers and others; and

42


 

Selecting director nominees, appointing board committee members, forming board committees and overseeing effective corporate governance.

Leadership Structure

Our Board retains the flexibility to determine on a case-by-case basis whether the positions of Chief Executive Officer and Chairman of the Board (or Co-Chairman of the Board) should be combined or separated and whether an independent director should serve as Chairman or Co-Chairman. This flexibility permits our Board to organize its functions and conduct its business in a manner it deems most effective in then prevailing circumstances. Our Board has determined that its leadership structure is appropriate in light of our current management framework.

Currently, we have two non-independent Co-Chairmen, whose roles include:

 

To act as the principal liaison between the independent directors and the Chief Executive Officer;

 

To review and approve all board and committee agendas and approve information sent to our Board, providing input to management on the scope and quality of such information;

 

To consult with the Chief Executive Officer and committee chairs regarding the topics and schedules of the meetings of our Board and its committees and approve such schedules to assure that there is sufficient time for discussion of all agenda items;

 

To call a special meeting of our Board or the independent directors at any time, at any place and for any purpose;

 

To be available for consultation and direct communication with GEC’s major stockholders;

 

To consult with the Nominating and Corporate Governance Committee as part of the committee’s review of director nominations and recommendations of director candidates;

 

To consult with directors regarding acceptance of memberships on other boards to assure that multiple board service does not conflict or otherwise interfere with such directors’ service to GEC;

 

Led by the Compensation Committee and together with the Chief Executive Officer, to report annually to our Board on succession planning, including policies and principles for executive officer selection;

 

To organize, convene and preside over executive sessions of the independent directors and promptly communicate approved messages and directives to the Chief Executive Officer; and

 

To perform such other duties as may be assigned from time-to-time by the independent directors.

The position and role of Chairman (or Co-Chairman) is intended to provide board leadership. It is also intended to expand lines of communication between our Board and members of management. It is not intended to reduce the free and open access and communications that each independent board member has with other board members and members of management.

Messrs. Reese and Serota currently serve as Co-Chairmen of the Board.

Our Board believes that its independence and oversight of management is maintained effectively through this flexible leadership structure, our Board composition and sound corporate governance policies and practices.

Director Share Ownership Guidelines

Our Board has not established director share ownership guidelines. We prohibit shorting our stock by our directors and executive officers.

Board and Committee Meetings; Executive Sessions; Annual Stockholders’ Meetings

At regularly scheduled board and committee meetings, directors review and discuss management reports regarding our performance, prospects and plans, as well as significant opportunities and immediate issues facing us. At least once a year, our Board also reviews management’s long-term strategic and financial plans.

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The Chief Executive Officer proposes the agenda and schedule for each board meeting to the Co-Chairmen of the Board, who then review and modify or approve it. Committee agendas and schedules are set by or in consultation with the committee chair and with the approval of the Co-Chairmen of the Board. Directors are encouraged to propose agenda items, and any director also may raise at any meeting subjects that are not on the agenda. Information and other materials important to understanding the business to be conducted at Board and its committee meetings, to the extent available, are distributed in writing to the directors in advance of the meeting. Additional information may be presented at the meeting. An executive session of independent members of the Board is held at each regular board meeting, and any director may call for an executive session at any Board meeting. The Co-Chairmen of the Board preside over executive sessions.

During the fiscal year ended June 30, 2020, our Board held 4 meetings and committees of our Board held 7 meetings. Directors, on an aggregate basis, attended 94% of the combined number of these meetings.

Evaluation of Board and Director Performance

The Nominating and Corporate Governance Committee annually reviews and evaluates the performance of our Board. The committee assesses our Board’s contribution as a whole and identifies areas in which our Board or senior management believes a better contribution may be made. The purpose of the review is to increase the effectiveness of our Board, and the results are reviewed with our Board and its committees.

Our Board annually reviews the individual performance and qualifications of each director who may wish to be considered for nomination to an additional term. The evaluations are reviewed by the Nominating and Corporate Governance Committee, which makes recommendations to our Board regarding nominees for election as directors.

Risk Oversight

Our Board is responsible for the general oversight of risks that affect us. Our Board receives regular reports on our operations from our Chief Executive Officer, as well as other members of management. Our Board reviews these reports and makes inquiries in their business judgment.

Our Board also fulfills its oversight role through the operations of its various committees, including our Audit Committee. Our Board receives periodic reports on each committee’s activities. Our Audit Committee has responsibility for risk oversight in connection with its review of our financial reports filed with the SEC. Our Audit Committee receives reports from our Chief Financial Officer and our independent auditors in connection with the review of our quarterly and annual financial statements regarding significant financial transactions, accounting and reporting matters, critical accounting estimates and management’s exercise of judgment in accounting matters. When reporting on such matters, our independent auditors also provide their assessment of management’s report and conclusions.

Succession Planning and Management Development

Our Compensation Committee oversees and regularly evaluates leadership succession planning practices and results. Our Compensation Committee reports annually to our Board on succession planning, including policies and principles for executive officer selection.

Board Access to Senior Management, Independent Accountants and Counsel

Directors have complete access to our independent registered public accounting firm, senior management and other employees. They also have complete access to counsel, advisors and experts of their choice with respect to any issues relating to our Board’s discharge of its duties.

Retirement Policy

We have not established a board retirement policy.

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Committees of our Board of Directors

Audit Committee

Our Audit Committee reviews our internal accounting procedures and considers and reports to our Board with respect to other auditing and accounting matters, including the selection of our independent auditors, the scope of annual audits, fees to be paid to our independent auditors and the performance of our independent auditors. Our Audit Committee relies on the expertise and knowledge of management and the independent auditors in carrying out its oversight responsibilities. On a routine basis, our Audit Committee meets separately with our independent auditors and invites select employees who work under the Chief Financial Officer to participate in its meetings. Our Audit Committee charter requires that each of the members of our Audit Committee is independent, as defined under SEC rules and Nasdaq listing standards, and that at least one member of our Audit Committee has past employment experience in finance or accounting, requisite professional certification in accounting, or other comparable experience or background which results in the individual’s financial sophistication, including having been a chief executive officer, chief financial officer, or other senior officer with financial oversight responsibilities. The responsibilities and activities of our Audit Committee are described in greater detail in our Audit Committee charter.

Our Board determined that each member of our Audit Committee met the independence and financial knowledge requirements under the Audit Committee charter, the SEC rules, and the Nasdaq listing standards. Our Board of Directors also determined that Mr. Hugar qualifies as an “audit committee financial expert” in accordance with SEC rules, based upon his experience and understanding with respect to accounting and auditing matters. Our Audit Committee held 4 meetings during the fiscal year ended June 30, 2020.

Compensation Committee

The Compensation Committee of our Board acts on behalf of our Board to review, adopt and oversee our compensation and employee benefit programs and practices, including, but not limited to:

 

establishment of corporate goals and objectives relevant to the compensation of our named executive officers (as defined below) and our other executive officers and evaluation of performance in light of these stated objectives;

 

evaluation of the performance of the named executive officers and determination and approval of, and, in the case of our Chief Executive Officer, recommendation to our Board for approval, the compensation and other terms of employment, including long-term incentive compensation, severance and change-in-control arrangements, of our named executive officers;

 

appointment, retention, compensation, termination and oversight of the work of any independent experts, consultants and other advisers, review and approval of the fees and retention terms for such experts, consultants and other advisers and consideration at least annually of the independence of such consultants;

 

review and administration of our general compensation plans and other employee benefit plans, including incentive-based compensation and equity compensation plans and other similar plans and programs; and

 

review with management the Compensation Discussion and Analysis (or other applicable executive compensation disclosure), including the determination of whether to recommend that it be included in the proxy statement. In fulfilling its responsibilities, our Compensation Committee is entitled to delegate to a subcommittee for any purpose it deems appropriate, including delegation to a subcommittee of our Board consisting of one or more members of our Board the authority to make awards to non-executive officers under the equity-based plans, in accordance with guidelines and policies set by our Compensation Committee.

For executive officers other than our Chief Executive Officer, our Compensation Committee considers evaluations and recommendations submitted to our Compensation Committee by our Chief Executive Officer on which compensation determinations are then made. In the case of our Chief Executive Officer, the evaluation of his or her performance is conducted by our Compensation Committee, which determines whether, and if so in what manner, to recommend to the full Board any adjustments to his or her compensation as well as awards to be granted. Our Compensation Committee does not determine non-employee director compensation.

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Our Board has determined that each of the members of our Compensation Committee is independent as defined by the Nasdaq rules. In addition, each member of our Compensation Committee is an “outside director” as defined in Section 162(m) of the Code and is a “non-employee” director as defined under Section 16 of the Exchange Act. The Compensation Committee met 2 times during the fiscal year ended June 30, 2020. Our Compensation Committee operates under a written charter adopted by our Board.

The charter of our Compensation Committee provides that any independent compensation consultant engaged by our Compensation Committee works for our Compensation Committee, not our management, with respect to executive and director compensation matters.

Nominating and Corporate Governance Committee

Our Nominating and Corporate Governance Committee is responsible for identifying, reviewing and evaluating individuals to serve as our directors, advising our Board with respect to its composition, procedures and committees, evaluating incumbent directors, and assessing the performance of management. Our Nominating and Corporate Governance Committee also oversees the development of our corporate governance matters. The responsibilities and activities of our Nominating and Corporate Governance Committee are described in greater detail in the Nominating and Corporate Governance Committee charter.

Our Nominating and Corporate Governance Committee is committed to a diversified board, seeking members from various professional backgrounds who combine a broad spectrum of experience and expertise with a reputation for the highest personal and professional integrity. However, our Nominating and Corporate Governance Committee does not have a policy with respect to diversity considerations in the selection of director nominees. Our Nominating and Corporate Governance Committee evaluates nominees to our Board, which evaluation applies to both new director candidates as well as incumbent directors, in the context of the current composition of our Board, the operating requirements of the Corporation and the long-term interests of stockholders. In conducting this assessment, the Nominating and Corporate Governance Committee considers the criteria for director qualifications set by our Board, as well as diversity, age, skills, and such other factors as it deems appropriate to maintain a balance of knowledge, experience, effectiveness and capability. In the case of incumbent directors whose terms of office are set to expire, our Nominating and Corporate Governance Committee typically reviews such directors’ overall service during their term, including:

 

the number of meetings attended;

 

the level of participation;

 

the quality of performance; and

 

any other relationships and transactions that might impair such directors’ independence.

In the case of new director candidates, our Nominating and Corporate Governance Committee also determines whether the nominee must be independent for Nasdaq purposes, which determination is based upon applicable Nasdaq listing standards, applicable SEC rules and regulations and the advice of counsel, if necessary. Our Nominating and Corporate Governance Committee then uses its network of contacts to compile a list of potential candidates, but may also engage, if it deems appropriate, a professional search firm. Our Nominating and Corporate Governance Committee conducts any appropriate and necessary inquiries into the backgrounds and qualifications of possible candidates after considering the function and needs of our Board. Our Nominating and Corporate Governance Committee arranges for as many members of the Nominating and Corporate Governance Committee as it determines advisable to interview each potential candidate it is considering recommending to our Board. Our Nominating and Corporate Governance Committee meets to discuss and consider such candidates’ qualifications and then selects a nominee for recommendation to our Board by majority vote.

Our Nominating and Corporate Governance Committee believes that a candidate for director should have certain minimum qualifications. Our Nominating and Corporate Governance Committee will generally consider such factors as:

 

possessing relevant expertise upon which to be able to offer advice and guidance to management, including public company board experience and international business experience;

 

the ability to read and understand basic financial statements;

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having sufficient time to devote to our affairs;

 

a reputation for personal integrity and ethics;

 

demonstrated excellence in his or her field;

 

the ability to work effectively with the other members of our Board;

 

having the ability to exercise sound business judgment; and

 

the commitment to rigorously represent the long-term interests of the stockholders.

Notwithstanding the foregoing, our Nominating and Corporate Governance Committee reserves the right to modify these factors from time to time, taking into account the then current needs of our Board in an effort to maintain a balance of knowledge, experience and capability.

Our Nominating and Corporate Governance Committee considers and evaluates any candidate who is properly recommended by stockholders, identified by members of our Board or our executive officers, or, at the discretion of our Nominating and Corporate Governance Committee, an independent search firm.

Our Nominating and Corporate Governance Committee held 1 meeting during the fiscal year ended June 30, 2020.

Communications with the Board

Stockholders and other interested parties may contact any member (or all members) of our Board (including, without limitation, the non-management directors as a group), any committee of our Board or the Chair of any such committee by mail. All such correspondence may be sent addressed to our Board, any committee or any individual director, c/o Corporate Secretary, Great Elm Capital Group, Inc., 800 South Street, Suite 230, Waltham, MA 02453.

All stockholder communications will be opened and reviewed by the Corporate Secretary for the sole purpose of determining whether the contents represent a message to the directors. Any contents that are not in the nature of advertising, promotions of a product or service, or patently offensive material will be forwarded promptly to the addressee. In the case of communications to our Board or any group or committee of directors, the Corporate Secretary will make sufficient copies and send one copy to each director who is a member of the group or committee to which the envelope is addressed.

Insider Trading Policy — Hedging

Our insider trading policy provides that all directors, officers and employees of the Company and GECM and the executive officers and certain employees with access to financial information of Great Elm DME, Inc. (Covered Persons) and certain of their related persons may not engage in any hedging or monetization transactions, such as zero-cost collars and forward sale contracts, with respect to Company securities, including those granted to, or held directly or indirectly by, such Covered Persons. Further, such persons may not trade in options, warrants, puts and calls or similar instruments on Company securities or sell Company securities “short.”

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Item 11.  Executive Compensation.

Summary Compensation Table

Name and Principal Position

 

Fiscal Year

 

Salary

($)

 

 

Bonus

($)(4)

 

 

Stock Awards

($)

 

 

Option Awards

($)(5)

 

 

Non-Equity Incentive Plan Compensation

($)(6)

 

 

All Other Compensation ($)(7)

 

 

Total ($)

 

Peter A. Reed(1)

 

2020

 

 

250,000

 

 

 

 

 

 

 

100,255

 

 

 

81,080

 

 

 

 

 

 

 

8,400