Great Elm Group, Inc.: Form 10-Q for the period ended Sep 30, 2023

Overview

GEG is a publicly-traded alternative asset management company focused on growing a scalable and diversified portfolio of long-duration and permanent capital vehicles across credit, real estate, specialty finance, and other alternative strategies. GEG and its subsidiaries currently manage GECC, a publicly-traded business development company, and Monomoy UpREIT, an industrial-focused real estate investment trust, in addition to other investments. The combined assets under management of these entities at September 30, 2023 was approximately $640.6 million.

GEG continues to explore other investment management opportunities, as well as opportunities in other areas that it believes provide attractive risk-adjusted returns on invested capital. As of the date of this report, GEG had $2.3 million of unfunded binding commitments to make additional investments.

Critical Accounting Policies

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 accounting principles generally accepted in the United States of America. 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. During the three months ended September 30, 2023 we did not make material changes in our critical accounting policies or underlying assumptions as disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2023 as it relates to normal and recurring transactions.

The historical results of the Durable Medical Equipment (DME) business, primarily consisting of HC LLC and its subsidiaries, sold on January 3, 2023 and related activity have been presented in the accompanying unaudited condensed consolidated statements of operations and cash flows for the three months ended September 30, 2022 as discontinued operations. Further, the historical segment information was recast to reflect our ongoing business as a single reportable segment and to remove the activity of discontinued operations. Unless otherwise specified, disclosures in these condensed consolidated financial statements reflect continuing operations only.

Results of Operations

The following table provides the results of our consolidated operations:

(in thousands)

*NM - not meaningful

Revenue

Revenues for the three months ended September 30, 2023 increased $1.5 million as compared to the corresponding period in the prior year. The increase is primarily attributable to the incentive fees due from GECC.

Operating Costs and Expenses

Operating costs and expenses for the three months ended September 30, 2023 increased $0.9 million as compared to the corresponding period in the prior year. Investment management expenses, excluding non-cash compensation, increased $0.8 million and other selling, general and administrative expenses increased $0.2 million, which was mainly attributable to compensation-related costs. Depreciation and amortization and non-cash compensation remained relatively flat.

Other Income (Expense)

Interest expense for the three months ended September 30, 2023 decreased by $0.9 million, compared to the corresponding period in the prior year, as there was no interest expense related to the 35,010 shares of preferred stock issued by Forest Investments, Inc. (Forest) to J.P. Morgan Broker-Dealer Holdings Inc. on December 29, 2020 after the sale of controlling interest in Forest on December 30, 2022, which was partially offset by interest expense on the $6.3 million promissory note issued to Imperial Capital Asset Management, LLC in May 2022 (fully repaid in February 2023).

During the three months ended September 30, 2023, the Company recognized $5.3 million of other income (net), comprised of net realized and unrealized gain on investments of $3.3 million and dividends and interest income of $2.0 million. During the three months ended September 30, 2022, the Company recognized $5.3 million of other expense (net) mainly attributed to net realized and unrealized loss on investments of $6.8 million, partially offset by dividends and interest income of $1.5 million.

Liquidity and Capital Resources

Cash Flows

Cash flows used in operating activities of our continuing operations for the three months ended September 30, 2023 were $6.1 million. The adjustments to reconcile our net income from continuing operations of $2.8 million to net cash used in operating activities included add-backs for various non-cash charges, such as $0.7 million of stock-based compensation expense, $0.6 million of non-cash interest and amortization of capitalized issuance costs, $0.3 million of depreciation and amortization, and $0.1 million of realized loss on our investments, which was offset by deduction of $3.4 million of unrealized gain on our investments, and the net negative change in our operating assets and liabilities of $7.0 million.

Cash flows used in operating activities of our continuing operations for the three months ended September 30, 2022 were $0.8 million. The adjustments to reconcile our net loss of $9.5 million to net cash used in operating activities included add-backs for various non-cash charges, such as $5.6 million of realized loss on our investments, $1.2 million of unrealized loss on our investments, $0.8 million of stock-based compensation expense, and $0.3 million of depreciation and amortization, which was partially offset by the net negative change in our operating assets and liabilities of $1.0 million. Further, we received $1.6 million attributed to sales of investments by Great Elm SPAC Opportunity Fund, LLC (GESOF). Cash flows used in operating activities of our discontinued operations for the three months ended September 30, 2022 were $2.8 million.

Cash flows used in investing activities of our continuing operations for the three months ended September 30, 2023 were $12.6 million which is attributed to purchases on investments of $14.3 million, partially offset by the proceeds from sale of investments of $1.8 million. Cash flows used in investing activities of our discontinued operations for the three months ended September 30, 2023 were $0.4 million, which represents the payment made to the buyer of our DME business in September 2023 following finalization of the working capital adjustment.

Cash flows used in investing activities of our continuing operations for the three months ended September 30, 2022 were $11 thousand and cash flows used in investing activities of our discontinued operations for the three months ended September 30, 2022 were $2.3 million.

We did not have any cash flows within financing activities of our continuing or discontinued operations for the three months ended September 30, 2023.

Cash flows used in financing activities of our continuing operations for the three months ended September 30, 2022 were $0.6 million representing distributions to non-controlling interests in GESOF, while cash flows provided by financing activities of our discontinued operations for the same period were $0.6 million.

Financial Condition

As of September 30, 2023, we had an unrestricted cash balance of $41.1 million. We also held 1,493,560 shares of GECC common stock with an estimated fair value of $14.7 million as of September 30, 2023.

We believe we have sufficient liquidity available to meet our short-term and long-term obligations for at least the next 12 months.

Borrowings

As of September 30, 2023, the Company had $26.9 million in outstanding aggregate principal of the GEGGL Notes. The GEGGL Notes are due on June 30, 2027, and interest is paid quarterly. The GEGGL Notes include covenants that limit additional indebtedness or the payment of dividends in the event that our net consolidated debt to equity ratio is, or would be on a pro forma basis, greater than 2 to 1. In addition, if our net consolidated debt to equity ratio is greater than 2 to 1 at the end of any calendar quarter, we must retain no less than 10% of our excess cash flow as cash and cash equivalents until such time as our net consolidated debt to equity ratio is less than 2 to 1 at the end of a calendar quarter.

As of September 30, 2023, the Company had $37.9 million principal balance in convertible notes outstanding (including cumulative interest paid in-kind). 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, 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. To date, all interest on these instruments has been paid in-kind.

There have been no material changes in the market risks discussed in Item 7A. of our Annual Report on Form 10-K for the fiscal year ended June 30, 2023.

We evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2023. Disclosure controls and procedures include, without limitation, controls and procedures that are designed to ensure that the information we are required to disclose in reports that we file under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), to allow timely decisions regarding required disclosure. Our CEO and CFO participated in this evaluation and concluded that, as of September 30, 2023, our disclosure controls and procedures were effective.

There were no changes in our internal control over financial reporting for the quarter ended September 30, 2023, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

We have disclosed the risk factors affecting our business, financial condition and operating results in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2023. There have been no material changes from the risk factors previously disclosed.