Great Elm Group, Inc.: Form 10-Q for the period ended Sep 30, 2024

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 investment vehicles. The combined assets under management of these entities at September 30, 2024 was approximately $781.6 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 no 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, 2024 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, 2024 as it relates to normal and recurring transactions.

Results of Operations

The following table provides the results of our consolidated operations:

(in thousands)

Revenue

Revenues for the three months ended September 30, 2024 increased $0.7 million as compared to the three months ended September 30, 2023 primarily due to the recognition of $0.6 million of real estate property sales earned in the current quarter whereas there were no corresponding real estate property sales in the prior year period. An additional $0.3 million of management fees were also recognized in the three months ended September 30, 2024 compared to the prior year period due to increased assets under management at GECC, offset by a $0.4 million reduction in Incentive Fees.

Operating Costs and Expenses

Operating costs and expenses for the three months ended September 30, 2024 increased $0.6 million as compared to the prior year period. Investment management expenses for the three months ended September 30, 2024 decreased $0.1 million as compared to the prior year period, which was mainly attributable to a decrease in bonus expense compared to the prior year period. Non-cash compensation for the three months ended September 30, 2024 increased $0.2 million as compared to the prior year period due to additional shares vested in the current period compared to the same prior year period. Other selling, general and administrative expenses for the three months ended September 30, 2024 increased $0.5 million, which was mainly attributable to an increase in professional fees from the prior year period.

Other Income (Expense)

Other income (expense), net includes dividend and interest income and net realized and unrealized gains and losses. For the three months ended September 30, 2024, dividend and interest income was $1.6 million, as compared to $2.0 million for the three months ended September 30, 2023. The $0.4 million decrease in interest income in the current period compared to prior year is due to a reduction in investment in Treasury bills. Net realized and unrealized gains and losses generally consist of unrealized mark-to-market adjustments on investments and the gain or loss realized on the sale of investments. For the three months ended September 30, 2024, realized and unrealized gain increased by $0.5 million from the same prior year period. This increase was primarily due to $3.5 million of unrealized gains recorded in the current period on GESP and PPH due to the valuation technique change for these entities. These were offset by a significant GECC share price increase in the prior year period, which did not occur in the current corresponding period.

Liquidity and Capital Resources

Cash Flows

Cash used in operating activities of our continuing operations for the three months ended September 30, 2024 were $5.8 million. The adjustments to reconcile our net income from continuing operations of $3.0 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, $0.5 million of non-cash interest and amortization of capitalized issuance costs, $0.6 million realized gain on investments and $0.3 million of depreciation and amortization, which was offset by a deduction of $4.4 million of unrealized gain on our investments, and the net negative change in our operating assets and liabilities of $7.2 million, including the impact of changes related to consolidated funds.

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 provided by investing activities of our continuing operations for the three months ended September 30, 2024 were $2.5 million, which includes purchases of investments in held-to-maturity securities of $7.4 million and proceeds from settlement of held-to-maturity investments of $10.0 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 used in financing activities of our continuing operations for the three months ended September 30, 2024 were $2.2 million primarily due to stock repurchases.

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

Financial Condition

As of September 30, 2024, we had an unrestricted cash balance of $44.2 million and $7.5 million in marketable securities. We also held 1,440,722 shares of GECC common stock with an estimated fair value of $14.7 million as of September 30, 2024. 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, 2024, the Company had $26.9 million in outstanding aggregate principal amount of 7.25% notes due on June 30, 2027 (the GEGGL Notes). Interest on the GEGGL Notes 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, 2024, the Company had $35.5 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, 2024.

We evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2024. 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 (the "Exchange Act"), 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, 2024, our disclosure controls and procedures were effective.

There were no changes in our internal control over financial reporting for the quarter ended September 30, 2024, 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, 2024. There have been no material changes from the risk factors previously disclosed.