Great Elm Group, Inc. (GEG) Q3 2022 Earnings Report, Transcript and Summary

Good morning, and thank you for standing by. Welcome to the Great Elm Group, Inc. Q3 2022 Conference Call and Webcast. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to Adam Yates, Managing Director. Please go ahead.

Thank you, and good morning, everyone. Thank you for joining us for Great Elm Group's Fiscal Third Quarter 2022 Earnings Conference Call. As a reminder, this conference call is being recorded on Friday, May 6, 2022. If you would like to be added to our distribution list, you can e-mail investorrelations@greatelmcap.com or you can sign up for alerts directly on our website, www.greatelmgroup.com. The slide presentation accompanying today's conference call and webcast can be found on our website under Events and Presentations. A link to the webcast is also available on our website as well as in the press release that was disseminated to announce the quarterly results. I would like to call your attention to the customary safe harbor statement regarding forward-looking information. Also, please note that nothing in today's call constitutes an offer to sell or a solicitation of offers to purchase our securities. Today's conference call includes forward-looking statements and projections, and we ask that you refer to Great Elm Group's filings with the SEC for important factors that could cause actual results to differ materially from these projections. Great Elm Group does not undertake to update its forward-looking statements unless required by law. To obtain copies of SEC filings, please visit Great Elm Group's website under Financial Information and select SEC Filings. Great Elm Group is a holding company comprised of 2 verticals: investment management and operating companies. In investment management, we seek to drive sustainable growth in assets under management, both in Great Elm Capital Corp., a publicly traded BDC and across other investment vehicles. In operating companies, we manage Great Elm Durable Medical Equipment, or DME, a distributor of respiratory care equipment and sleep study services. Hosting the call today is Peter Reed, Great Elm Group's Chief Executive Officer. I will now turn the call over to Peter.

Welcome, everyone, and thank you for joining us today. I'm joined this afternoon -- this morning by our President and COO, Adam Kleinman; and our CFO, Brent Pearson. As you may have seen, we announced an important transaction in conjunction with earnings. Yesterday, we entered the private REIT business through our acquisition of the Investment Management agreement for Monomoy Properties REIT, a private real estate investment trust with a 108-property portfolio of diversified net leased industrial assets representing $348 million of real estate. This transaction is exactly what we should be doing to further our strategic objectives and is supported by every Board member. For reference, we added a number of slides to our earnings presentation that are dedicated to the transaction. At a high level, we believe this acquisition represents a transformative transaction for our investment management business and demonstrates significant progress towards our strategy of managing a diversified set of recurring fee generating long-duration capital vehicles. Our AUM more than doubled from $224 million to approximately $572 million. From a financial perspective, GECM will earn an asset management fee equal to 1% of the REIT's NAV in addition to property management fees equal to 4% of gross rents. In the first quarter 2022, asset management fees for the Monomoy REIT were $0.4 million and pro forma for the transaction, property management fees would have been $0.3 million in the quarter. Annualizing this quarterly result, this represents approximately $2.8 million in fees on an annualized basis. We believe the $10 million upfront purchase price is an attractive entry point at approximately 3.6x pro forma first quarter '22 annualized revenues on a growing durable capital vehicle. Taking a step back, I'd like to outline our thesis by speaking to the transaction's 2 key pieces: acquiring the manager and investing into the REIT. Firstly, the manager acquisition adds another leg to our investment management stool and furthers our strategy of acquiring management rights to long-duration capital vehicles that utilize the expertise of our Board, management and GEG's financial resources, including its NOLs. Specifically, the acquisition is compelling, given the platform is backed by a skilled and seasoned management team. The underlying capital is sticky, and therefore, the management fees are durable. We believe there is a path to converting the REIT into a permanent capital vehicle and that GEG's unique tax structure provides it with a competitive advantage in raising additional capital for the Monomoy REIT. Moreover, the growth in fee revenue will allow GEG to leverage fixed overhead. And as outlined earlier, we believe at 3.6x pro forma annualized revenue, this is an attractive purchase price. Secondly, we are making a strategic growth investment into the Monomoy REIT, which provides the GEG access to a diversified portfolio of industrial properties poised for sustainable growth. This investment follows our June 2021 investment of $4.6 million into the REIT, which has grown to $5.6 million as of March 31, 2022. The additional investment into the Monomoy REIT as part of this transaction is based on the strong track record of the management team, a large build-to-suit pipeline and GEG's tax attributes, which offer an advantage to shield both current income and long-term gains. Monomoy Properties is a private real estate investment trust with a 108-property portfolio across 27 states and 41 unique tenants. The REIT holds a diversified portfolio of net leased industrial assets, representing $348 million of gross real estate at fair value as of March 31, 2022 and focuses on single tenant, light industrial properties with small building footprints on significant acreage. The trust targets investments in critical markets with favorable underlying economic trends and demographics, while building mutually beneficial relationships and streamlining the management of tenant's real estate. The terms of the acquisition include multiple components. GEG has agreed to an upfront purchase price of $10 million at closing, financed with a combination of $2.5 million in newly issued shares of GEG stock, $1.25 million in shares of common stock of Great Elm Capital Corp., or GECC, that are owned by GEG; and three, a promissory note issued by GECM in an aggregate principal amount of approximately $6.3 million. In addition, there are 2 earn-out payments subject to meeting revenue growth targets of up to $1 million each following the fiscal years ending June 30, 2023, and June 30, 2024. Also, the transaction includes a targeted equity investment into the Monomoy REIT of up to $30 million to fund growth. GEG has committed to investing $15 million and intends to invest an additional $15 million over the next 12 months, although it is not contractually obligated to do so. In summary, the Monomoy REIT's growth potential represents a substantial value creation opportunity for GEG. We are excited to partner with Chris Macri and his team to accelerate our investment management segment's growth. From a capital perspective, yesterday, we filed a registration statement for a $30 million offering of senior unsecured notes. We expect to use the net proceeds of this offering to make investments in the Monomoy REIT and/or for general corporate purposes, including making opportunistic investments or refinancing subsidiary preferred stock or other indebtedness. Looking ahead, the offering likely serves as a template for future capital raises. Turning to our results for the quarter ended March 31, 2022, we delivered another quarter of solid performance, highlighted by 20% growth in consolidated revenue on a year-over-year basis. Top line growth was broad-based across our DME and Investment Management segments with both businesses poised for growth, reflecting durable demand trends, sustainable competitive advantages and a transformational transaction. Focusing on our Investment Management segment. Revenue for the quarter grew by 36% versus the prior year quarter, driven by rising AUM for GECC and our other investment vehicles. We remain focused on expanding and diversifying the platform by growing GECC through additional equity raises, debt issuances and opportunistic M&A as well as by adding additional clients and relationships through new fund launches and co-investment opportunities. On the Durable Medical Equipment side, we again reported strong revenue growth despite ongoing macro headwinds, including persistent supply chain issues and limited medical device inventories. Looking ahead, demand trends remain strong as evidenced by current backlog, which bodes well for the pace and sustainability of our growth. As is our standard practice, I wanted to reiterate the strong alignment between the Great Elm team and GEG shareholders. Employees and directors, including funds under their management, collectively own or manage approximately 30% of Great Elm's outstanding shares, and we continue to believe a meaningful disconnect exists between the underlying value of the Great Elm platform, particularly following the powerful acquisition of Monomoy properties and the current price of the stock. With that, I'll turn it over to Brent to discuss our financial results for the quarter in more detail. Brent?

Thanks, Pete. I'll provide a brief overview, and of course, I welcome all of you to review our filings in greater detail or to reach out to our team with questions you may have. During the quarter ended March 31, 2022, we reported consolidated revenue of $16.6 million, a net loss of $6.1 million and adjusted EBITDA, a non-GAAP measure, of $1.0 million. For the same period last year, we reported consolidated revenue of $13.8 million, a net loss from continuing operations of $2.8 million and adjusted EBITDA of $2.2 million. Great Elm reports the results of each of our 2 operating segments, including investment management and Durable Medical Equipment as well as unallocated general corporate activity. We'll begin the review with investment management. For the fiscal third quarter, investment management reported total revenue of $1.0 million compared to $0.7 million during the same period in the prior year. Revenue for the quarter was higher due primarily to increases in assets under management at GECC. Adjusted EBITDA was negative $400,000 in the fiscal 2022 third quarter compared to essentially breakeven during the same period in the prior year. We incurred higher payroll and shared service costs in the current period as we focus on growing and optimizing GECC's portfolio of specialty finance companies including the recently acquired Sterling Commercial Credit. These increased costs outpaced the increases in revenue during the quarter. Next, turning to Durable Medical Equipment. For the fiscal third quarter, DME generated $15.6 million in revenue compared to $13.1 million for the same period last year. The increase in revenue was primarily attributable to contributions from previous acquisitions of AMPM in March 2021 and a MedOne in August 2021. In addition, our previous investments into the business have significantly improved the intake and collections process, resulting in lower revenue reserve rates compared to prior year. We improved our gross margin at DME, increasing to 61.2% as compared to 58.4% in the prior year period. The higher margins were driven by improved vendor pricing as compared to the prior period. Great Elm's DME operations reported a net loss of $6.6 million in comparison to a net loss of $5.1 million in the prior year period. Much of the net income volatility can be tied to the recurring valuation adjustment of an embedded derivative on an intercompany instrument, which is eliminated in consolidation and added back for EBITDA purposes. Adjusted EBITDA was $2.5 million for the fiscal third quarter compared to $3.4 million in the prior year period. The prior year period included a $2.3 million benefit related to employee retention payroll tax credits claimed under the CARES Act. Excluding such benefits, segment profitability significantly improved versus the prior year quarter. Moving on to our General Corporate segment. For the fiscal third quarter, Great Elm's General Corporate segment recognized $230,000 in revenue compared to $160,000 during the same period in the prior year. Revenue increased as a result of increased management fees earned on DME. General Corporate adjusted EBITDA for the current quarter was negative $1.2 million, which is consistent with the prior year period. Finally, in terms of our balance sheet, we ended the quarter with a healthy liquidity position of $22.7 million in cash, exclusive of liquid investments. We also delevered our managed fund G Soft during the quarter, subsequently liquidating and distributing approximately 80% of the portfolio in April. This distribution provided an additional $8.2 million in cash subsequent to quarter end, which strengthened our position to execute on fiscal Q4 strategic transactions. This concludes my financial review of the quarter. With that, I'll turn the call over to the operator to open for questions.

[Operator Instructions] There are no questions at this time. I'll turn the call back over to Peter for closing remarks.

Thank you again for joining us today, and we look forward to speaking with you in the future.

This concludes today's conference call. You may now disconnect.