Great Elm (GEG) - 2022 Q4 - Annual Report

Part I Business Great Elm Group operates through Durable Medical Equipment and Investment Management segments, leveraging $821 million in NOLs for strategic growth and value creation - The company operates through two main business segments: Durable Medical Equipment and Investment Management[14] - The Durable Medical Equipment business was launched in September 2018 and focuses on respiratory care equipment like PAP devices, ventilators, and oxygen equipment[16] - The Investment Management business, through its subsidiary GECM, managed approximately $607.0 million in assets as of June 30, 2022, primarily for GECC and Monomoy REIT[17] - As of June 30, 2022, the company had approximately $821 million of federal Net Operating Loss (NOL) carryforwards, which can be used to offset future taxable income[15] - In June 2021, the company sold its real estate business, which consisted of two office buildings in Fort Myers, Florida, marking a strategic shift[21] Risk Factors The company faces risks including limited operating history, acquisition challenges, economic downturns, cybersecurity threats, NOL utilization uncertainty, Medicare dependency, supply chain disruptions, market volatility, and stock ownership restrictions Risks Related to Our Business General business risks include limited operating history, acquisition competition, key personnel dependency, cybersecurity threats, and uncertainty in utilizing NOL carryforwards - The company has a limited track record in its durable medical equipment (since 2018) and investment management (since 2016) businesses, making future performance uncertain[36] - Growth through acquisitions is a core strategy, but the company faces intense competition from well-financed entities and may not successfully integrate or manage acquired businesses[39][40] - The business is highly dependent on key personnel, and their loss could negatively impact operations and profitability[45] - The ability to fully utilize approximately $821 million in NOL carryforwards is not guaranteed and depends on generating sufficient future taxable income before they expire[48] - The business is subject to operational risks, including cyberattacks, which are becoming more frequent and sophisticated, potentially leading to financial losses and litigation[56] - The COVID-19 pandemic has negatively impacted the business through suppressed demand and significant global supply chain disruptions, particularly for medical devices, which may continue to adversely affect results[60] Risks Related to Our Durable Medical Equipment Business DME business risks include Medicare reimbursement dependency, supply chain disruptions from limited suppliers, and compliance with complex healthcare fraud and abuse laws - A significant portion of the DME business revenue comes from Medicare, making it vulnerable to changes in reimbursement rates and methodologies[64] - The Medicare competitive bidding process, though temporarily suspended, could adversely impact reimbursement rates and financial results once it recommences, with the next round anticipated for January 1, 2024[67][68] - The business is exposed to significant supply chain risk due to reliance on single-source or limited suppliers. A voluntary recall by key supplier Philips Respironics in June 2021 for certain PAP and ventilator devices has created legal, regulatory, and financial risks[70][73] - Global supply chain shortages in semiconductor microchips have further limited the ability to procure sufficient PAP equipment, resulting in lost revenue opportunities[76] - Failure to comply with complex federal and state fraud and abuse laws (Anti-Kickback, Stark Law, False Claims) could result in substantial penalties, fines, and exclusion from government healthcare programs[81][82][83] Risks Related to Our Investment Management Business Investment Management risks include terminable agreements, market volatility impacting AUM and fees, LIBOR transition uncertainty, and potential classification as an investment company - Investment management agreements (IMAs) with key clients like GECC and Monomoy REIT can be terminated, posing a risk to a primary revenue source. The associated intangible asset is being amortized over 15 years despite this cancellable nature[88] - Difficult market conditions can adversely affect the business by reducing the value of managed funds, which in turn lowers management fee revenue and could make it harder to attract or retain capital[89][90] - The transition away from LIBOR to alternative reference rates like SOFR creates uncertainty and could increase interest expenses, reduce investment income, and require renegotiation of existing loans and contracts[91][94] - If the company is deemed an "investment company" under the Investment Company Act of 1940, it would face burdensome compliance requirements and restrictions on its activities, potentially hindering its growth plans[95] Risks Relating to Our Common Stock Common stock risks include ownership restrictions to protect NOLs, potential dilution from future equity issuances, and anti-takeover provisions - To protect its significant NOL carryforwards, the company's certificate of incorporation and a Tax Rights Plan restrict any person or entity from acquiring 4.99% or more of its common stock without board approval[99][100] - The company may issue additional common or preferred stock, which could significantly dilute existing stockholders' equity interests and adversely affect the market price of the common stock[101] - Anti-takeover provisions, including a classified board and limitations on stockholder actions, could discourage or render more difficult a potential acquisition, which might otherwise be beneficial to stockholders[102][104] - The potential conversion of the 5.0% Convertible Senior PIK Notes due 2030 could lead to significant dilution for existing common stockholders[105] Unresolved Staff Comments The company reports no unresolved staff comments - The company reports no unresolved staff comments[106] Properties The company leases all its properties, including executive offices in Waltham, MA, and 22 DME offices and 15 sleep labs across multiple states - The company leases its principal executive offices in Waltham, MA, with the lease running through September 2024[107] - The Durable Medical Equipment business leases 22 offices and 15 sleep labs, primarily in Arizona, Alaska, Iowa, Kansas, Missouri, Nebraska, Oregon, and Washington, with various expiration dates through 2027[109] Legal Proceedings The company reports no legal proceedings - The company reports no legal proceedings[110] Mine Safety Disclosures This item is not applicable to the company - This item is not applicable to the company[111] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities GEG common stock trades on Nasdaq, with no current dividend plans and ownership restrictions to preserve NOLs, with waivers for key shareholders - Common stock is traded on the Nasdaq Global Select Market under the symbol "GEG"[113] - The company does not currently plan to pay dividends on its common stock[115] - Ownership is restricted to 4.99% to preserve tax benefits, with waivers granted to significant investors Northern Right (12.0%) and ICAM (17.6%) as of September 6, 2022[116] Management's Discussion and Analysis of Financial Condition and Results of Operations FY2022 revenue grew 12% to $68.0 million, but pre-tax loss widened to $15.0 million due to increased operating expenses and unrealized investment losses Overview and Critical Accounting Policies The company's performance was impacted by supply chain issues, with critical accounting policies involving significant judgment in areas like goodwill and deferred tax assets - The durable medical equipment business experienced suppressed referral pipelines and was impacted by global supply chain challenges, leading to a patient backlog and missed revenue opportunities for PAP devices[122] - Critical accounting estimates include goodwill impairment, revenue recognition, and valuation of deferred tax assets. The annual goodwill impairment test as of April 1, 2022, indicated no impairment, with the fair value of the DME reporting unit exceeding its carrying value by 34.3%[125][128] - A full valuation allowance of $207.1 million has been established against deferred tax assets as of June 30, 2022, due to historical net operating losses[140] Results of Operations (Consolidated) Consolidated revenue grew 12% to $68.0 million, but a 251% increase in other expenses led to a $15.0 million pre-tax loss Consolidated Results of Operations (in thousands) | | For the years ended June 30, | Percent Change | | :--- | :--- | :--- | :--- | | | 2022 | 2021 | | | Total revenue | $67,974 | $60,853 | 12% | | Total operating expenses | (72,081) | (64,590) | 12% | | Operating loss | (4,107) | (3,737) | 10% | | Total other expense, net | (10,909) | (3,107) | 251% | | Total pre-tax loss from continuing operations | $(15,016) | $(6,844) | 120% | - Revenue growth was driven by contributions from the AMPM and MedOne acquisitions in the DME segment and increased assets under management at GECC and the acquisition of the Monomoy REIT management agreement in the Investment Management segment[144] - The increase in 'Other income (expense)' was primarily due to net realized and unrealized losses on the company's investment in GECC and private funds[147] Durable Medical Equipment Segment Analysis DME segment revenue increased 10% to $63.5 million, but pre-tax loss widened to $3.8 million due to higher other expenses and supply chain issues Durable Medical Equipment Segment Results (in thousands) | | For the years ended June 30, | Percent Change | | :--- | :--- | :--- | :--- | | | 2022 | 2021 | | | Total revenue | $63,458 | $57,643 | 10% | | Operating income | 4,208 | 2,635 | 60% | | Total other expense, net | (8,053) | (5,124) | 57% | | Total pre-tax loss from continuing operations | $(3,845) | $(2,489) | 54% | - Revenue from equipment sales and sleep studies increased to $36.2 million and $5.6 million respectively, driven by the AMPM and MedOne acquisitions[150] - Global supply chain issues significantly restricted the ability to procure CPAP equipment, resulting in lost revenue opportunities during the year[152] - General and administrative expenses included benefits of $2.3 million from Employee Retention Credits (ERCs) in FY2022, compared to $4.6 million in FY2021[155] Investment Management Segment Analysis Investment Management revenue grew 41% to $4.5 million, but a significant swing to $8.6 million pre-tax loss was driven by unrealized investment losses Investment Management Segment Results (in thousands) | | For the years ended June 30, | Percent Change | | :--- | :--- | :--- | :--- | | | 2022 | 2021 | | | Total revenue | $4,516 | $3,210 | 41% | | Operating loss | (2,758) | (830) | 232% | | Other income (expense), net | (5,794) | 3,553 | NM | | Total pre-tax (loss) income from continuing operations | $(8,552) | $2,723 | NM | - Management fee revenue increased to $3.6 million in FY2022 from $2.7 million in FY2021, due to higher AUM at GECC and $0.3 million in fees from the newly acquired Monomoy REIT management agreement[162] - Operating expenses increased primarily due to higher non-cash compensation ($1.1 million increase) and other general & administrative costs ($2.1 million increase) related to payroll, bonuses, and consulting fees[163][164] - The segment recognized net realized and unrealized losses of $7.8 million during FY2022, compared to net gains of $0.7 million in FY2021, primarily from the mark-to-market of its investment in GECC[167] General Corporate Segment Analysis General Corporate segment pre-tax loss improved to $2.6 million, driven by a positive swing in other income from intercompany items General Corporate Segment Results (in thousands) | | For the years ended June 30, | Percent Change | | :--- | :--- | :--- | :--- | | | 2022 | 2021 | | | Operating loss | $(5,557) | $(5,542) | 0% | | Other income (expense), net | 2,938 | (1,536) | NM | | Total pre-tax loss from continuing operations | $(2,619) | $(7,078) | (63)% | - Interest expense increased by $2.1 million, primarily due to a full year of dividends on the Forest Preferred Stock (issued Dec 2020) and interest on the new GEGGL Notes (issued May 2022)[172] - Other income (expense) improved significantly, driven by intercompany interest income and a $2.1 million benefit from the revaluation of an embedded derivative related to HC LLC preferred stock held within the corporate structure[173] Income Taxes Minimal income tax expense was recorded, primarily state and local taxes, with no federal tax due to significant NOL utilization - The company recorded minimal income tax expense of $0.02 million in FY2022 and $1.7 million in FY2021, consisting solely of state and local taxes[174] - No federal income tax is expected for FY2022 or FY2021 due to the utilization of NOLs[174] Summary of Discontinued Operations The company sold its real estate business for $4.6 million in June 2021, reclassifying it as a discontinued operation with $0.6 million net income Discontinued Operations for FY 2021 (in thousands) | | For the year ended June 30, 2021 | | :--- | :--- | | Net revenue | $5,005 | | Operating income from discontinued operations | 2,811 | | Gain on sale of real estate business | 263 | | Pretax income from discontinued operations | 538 | | Net income from discontinued operations | $649 | Liquidity and Capital Resources Working capital was $64.7 million, with operating cash flow at $29.3 million, and the capital structure includes significant debt obligations Selected Financial Position (in thousands) | | As of June 30, 2022 | As of June 30, 2021 | | :--- | :--- | :--- | | Working Capital | $64,746 | $55,529 | | Cash and cash equivalents | $23,595 | $24,382 | | Investments, at fair value | $48,042 | $24,044 | Cash Flow Summary (in thousands) | | For the year ended June 30, 2022 | For the year ended June 30, 2021 | | :--- | :--- | :--- | | Cash provided by (used in) operating activities | $29,280 | $(18,976) | | Cash used in investing activities | (40,047) | (15,482) | | Cash provided by financing activities | 9,980 | 18,340 | - Major borrowings as of June 30, 2022 include: - $26.9 million of 7.25% GEGGL Notes due 2027[186] - $36.1 million of 5.0% Convertible Notes due 2030[187] - $6.3 million Seller Note related to the Monomoy REIT IMA acquisition[189] - $35.0 million in Forest Preferred Stock held by JPM[190] - An undrawn $10 million revolving credit facility (DME Revolver)[193] Quantitative and Qualitative Disclosures About Market Risk This item is not applicable to the company - This item is not applicable to the company[199] Financial Statements and Supplementary Data This section incorporates the company's financial statements from page F-1 and GECC's audited financial statements by reference - The company's financial statements are located starting on page F-1 of the annual report[200] - The audited financial statements of Great Elm Capital Corp. (GECC) are incorporated by reference, as the investment in GECC is significant under SEC rules[201] Changes in and Disagreements With Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants - The company reports no changes in or disagreements with its accountants[202] Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of June 30, 2022 - Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of June 30, 2022[203] - Management concluded that the company's internal control over financial reporting was effective as of June 30, 2022, based on the COSO framework[207] - No material changes were made to the internal control over financial reporting during the fiscal quarter ended June 30, 2022[208] Other Information The company reports no other information - The company reports no other information[209] Disclosure Regarding Foreign Jurisdictions that Prevent Inspections This item is not applicable to the company - This item is not applicable to the company[210] Part III Part III incorporates information on corporate governance, executive compensation, security ownership, related party transactions, and accountant fees by reference from the definitive proxy statement Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance is incorporated by reference from the Proxy Statement - Information required by this item is incorporated by reference from the company's Proxy Statement[212] Executive Compensation Information on executive compensation is incorporated by reference from the Proxy Statement - Information required by this item is incorporated by reference from the company's Proxy Statement[213] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information on security ownership is incorporated by reference from the Proxy Statement - Information required by this item is incorporated by reference from the company's Proxy Statement[214] Certain Relationships and Related Transactions, and Director Independence Information on related party transactions and director independence is incorporated by reference from the Proxy Statement - Information required by this item is incorporated by reference from the company's Proxy Statement[215] Principal Accountant Fees and Services Information on principal accountant fees and services is incorporated by reference from the Proxy Statement - Information required by this item is incorporated by reference from the company's Proxy Statement[216] Part IV Part IV lists exhibits and financial statement schedules, noting financial statements begin on F-1 and schedules are omitted, with no Form 10-K summary provided Exhibits, Financial Statement Schedules Financial statements are included from page F-1, and schedules are omitted as not required or information is elsewhere - The required financial statements are included in the report, beginning on page F-1[218] - Financial statement schedules have been omitted as they are not required or the information is included elsewhere[219] Form 10-K Summary The company elected not to provide a Form 10-K summary - The company elected not to provide a Form 10-K summary[225] Financial Statements and Supplementary Data Report of Independent Registered Public Accounting Firm Grant Thornton LLP issued an unqualified audit opinion, identifying DME revenue recognition as a critical audit matter due to significant judgment - Grant Thornton LLP issued an unqualified audit opinion on the company's consolidated financial statements[236] - The auditor identified Durable Medical Equipment Revenue Recognition, specifically the estimation of variable consideration, as a critical audit matter due to the significant judgment involved[240][242] Consolidated Financial Statements Consolidated financial statements show total assets at $168.1 million, a net loss of $14.9 million, and positive operating cash flow of $29.3 million in FY2022 Consolidated Balance Sheet Highlights (in thousands) | | June 30, 2022 | June 30, 2021 | | :--- | :--- | :--- | | Total Assets | $168,087 | $161,869 | | Cash and cash equivalents | $23,595 | $24,382 | | Goodwill | $52,463 | $50,536 | | Total Liabilities | $125,833 | $106,445 | | Convertible Notes (face value) | $36,085 | $34,346 | | Total Stockholders' Equity | $40,029 | $52,785 | Consolidated Statement of Operations Highlights (in thousands) | | For the year ended June 30, 2022 | For the year ended June 30, 2021 | | :--- | :--- | :--- | | Total revenues | $67,974 | $60,853 | | Operating loss | (4,107) | (3,737) | | Loss from continuing operations | (15,037) | (8,519) | | Income from discontinued operations, net of tax | - | 649 | | Net loss attributable to Great Elm Group, Inc. | $(14,893) | $(7,275) | | Net loss per share | $(0.56) | $(0.28) | Notes to the Consolidated Financial Statements Notes detail accounting policies, segment structure, impact of ASU 2020-06, acquisitions, related-party transactions, debt composition, and $821 million in federal NOL carryforwards - The company adopted ASU 2020-06 for convertible instruments on July 1, 2021, using the full retrospective method. This eliminated the separation of the conversion feature from the debt, resulting in adjustments to the carrying value of convertible notes, additional paid-in capital, and retained earnings in prior periods[311] Revenue by Source (in thousands) | Revenue Source | FY 2022 | FY 2021 | | :--- | :--- | :--- | | Durable Medical Equipment | | | | Equipment Sales | $36,161 | $32,293 | | Service Revenues | $5,559 | $5,167 | | Medical Equipment Rental Income | $21,738 | $20,183 | | Subtotal DME | $63,458 | $57,643 | | Investment Management | | | | Management Fees | $3,612 | $2,652 | | Property Management Fees | $171 | $- | | Administration Fees | $733 | $558 | | Subtotal IM | $4,516 | $3,210 | | Total Revenue | $67,974 | $60,853 | - On May 4, 2022, the company acquired the investment management agreement for Monomoy REIT. The consideration included $2.5 million in GEG stock, $1.25 million in GECC stock, a $6.3 million promissory note, and up to $2.0 million in contingent consideration[350][351] - As of June 30, 2022, the company had $821 million in federal NOL carryforwards. Those generated before fiscal 2018 will expire between 2023 and 2037, while those generated after can be carried forward indefinitely[493] Federal NOL Carryforward Expiration Schedule (in thousands) | Fiscal Year of Expiration | Federal NOL carryforwards | | :--- | :--- | | 2023 | $131,077 | | 2024 | $60,132 | | 2025 | $117,277 | | 2026 through 2037 | $486,542 | | Indefinite | $26,039 | | Total | $821,067 |