Home Short payment terms STEEL CONNECT, INC. MANAGEMENT REPORT AND ANALYSIS OF FINANCIAL POSITION AND OPERATING RESULTS (Form 10-K)

STEEL CONNECT, INC. MANAGEMENT REPORT AND ANALYSIS OF FINANCIAL POSITION AND OPERATING RESULTS (Form 10-K)

0
This Annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 21E of the Exchange Act and Section 27A of the Securities
Act. For this purpose, any statements contained herein that are not statements
of historical fact may be deemed to be forward-looking statements. Without
limiting the foregoing, the words "believes," "anticipates," "plans," "expects"
and similar expressions are intended to identify forward-looking statements.
Factors that could cause actual results to differ materially from those
reflected in the forward-looking statements include, but are not limited to,
those discussed in Item 1A. Risk Factors and elsewhere in this Report. For more
information, see "Forward Looking Statements." Readers are cautioned not to
place undue reliance on these forward-looking statements, which reflect
management's analysis, judgment, belief or expectation only as of the date
hereof. We do not undertake any obligation to update forward-looking statements
whether as a result of new information, future events or otherwise.

The following discussion and analysis of our financial condition and results of
operations should be read together with our consolidated financial statements
and related notes included in Part II, Item 8 of this Annual Report on Form
10-K, which recasts the financial information in the Company's Annual Report on
Form 10-K for the year ended July 31, 2021 to present IWCO Direct (formerly our
Direct Marketing segment) as a discontinued operation.

Insight

SteelConnect, Inc. (the “Company”) is a holding company which operates through its wholly owned subsidiary, ModusLink Corporation (“ModusLink” or “Supply Chain”), which serves the supply chain management market.

ModusLink provides digital and physical supply chain solutions to many of the
world's leading brands across a diverse range of industries, including consumer
electronics, telecommunications, computing and storage, software and content,
consumer packaged goods, medical devices, retail and luxury and connected
devices. These solutions are delivered through a combination of industry
expertise, innovative service solutions, and integrated operations, proven
business processes, an expansive global footprint and world-class technology.
With a global footprint spanning North America, Europe and the Asia Pacific
region, the Company's solutions and services are designed to improve end-to-end
supply chains in order to drive growth, lower costs, and improve profitability.

Provision of IWCO Direct Holdings, Inc. (“IWCO Direct” or “Direct Marketing”)

Beginning in the second quarter of 2020, with the shutdown of the U.S. economy
due to the COVID-19 pandemic, IWCO Direct's business was significantly and
adversely affected by a material reduction in customer mailing activities.
Against this backdrop, the Company held, on behalf of IWCO Direct, extensive
discussions with Cerberus about amending and extending IWCO Direct's credit
facility with Cerberus under which there was approximately $361 million
outstanding as of January 31, 2022 that was to mature in December 2022. In
addition, the Company's Board of Directors considered a range of
                                       22
--------------------------------------------------------------------------------
  Table of Contents
strategic options to address the impending maturity. In mid-January 2022, it
became apparent that it would not be possible to extend or refinance the credit
facility prior to its maturity. In addition, short-term funding under the
revolving credit facility became unavailable. IWCO Direct was in the process of
implementing the previously disclosed competitive improvement plan ("CIP")
intended to address the changing requirements of its customers and markets.
Despite initial favorable outcomes and improving prospects from the CIP, the
Company was unable to amend IWCO Direct's credit facility or identify
alternatives to refinance IWCO Direct's indebtedness given the magnitude of that
indebtedness relative to the performance of IWCO Direct's business.

In light of these developments, the Board of Directors determined that it was in
the best interests of the Company's stockholders to pursue an orderly and
consensual disposition of IWCO Direct to the Cerberus-led investor group.
Although the Board of Directors considered other alternatives for IWCO Direct,
the Board of Directors concluded that such alternatives would not be viable and
on February 25, 2022, the Company completed the disposition of IWCO Direct to
the Cerberus-led investor group (the entire transaction being referred to as the
"IWCO Direct Disposal"). The Company did not receive any cash consideration from
the Cerberus-led investor group in exchange for the disposition of IWCO Direct.

The Company deconsolidated IWCO Direct as of February 25, 2022 as it no longer
held a controlling financial interest as of that date. The results of IWCO
Direct are presented as a discontinued operation in all periods reported. Refer
to Notes 1 and 3 to the consolidated financial statements in Part II, Item 8 of
this Annual Report on Form 10-K for further information on the IWCO Direct
Disposal.

Clients

Historically, a limited number of key clients have accounted for a significant
percentage of the Company's revenue. For the fiscal years ended July 31, 2022
and 2021, the Company's 10 largest clients accounted for approximately 78% and
81% of consolidated net revenue from continuing operations, respectively. Two
customers accounted for approximately 31% and 12% of the Company's consolidated
net revenue from continuing operations for the fiscal year ended July 31, 2022,
and one customer accounted for 42% of the Company's consolidated net revenue
from continuing operations for the fiscal year ended July 31, 2021. No other
clients accounted for greater than 10% of the Company's consolidated net revenue
from continuing operations for the fiscal year ended July 31, 2022 and 2021.

In general, the Company does not have any agreements that obligate any client to
buy a minimum amount of services from it or designate it as an exclusive service
provider. Consequently, the Company's net revenue is subject to demand
variability by our clients. The level and timing of orders placed by the
Company's clients vary for a variety of reasons, including seasonal buying by
end-users, the introduction of new technologies and general economic conditions.
By diversifying into new markets and improving the operational support structure
for its clients, the Company expects to offset the adverse financial impact such
factors may bring about.

Impact of COVID-19

The ongoing COVID-19 pandemic (in particular, the emergence of new variants of
the virus across the globe) has caused, and continues to cause, significant
disruptions in the U.S. and global economies. For example, national and local
governments in the United States and around the world continue to implement
measures to prevent the spread of COVID-19 and its variants, including travel
bans, prohibitions on group events and gatherings, shutdowns of certain
businesses, quarantines, curfews, and recommendations to practice physical
distancing. Such measures have restricted and continue to restrict individuals'
daily activities and curtail or cease many businesses' normal operations. The
COVID-19 pandemic has adversely impacted, and is likely to further adversely
impact, nearly all aspects of our business and markets, including our workforce
and the operations of our clients, suppliers, and business partners. Beginning
in March 2020, when the World Health Organization categorized COVID-19 as a
pandemic and the President of the United States declared the COVID-19 outbreak a
national emergency, we experienced impacts to our customers' demand, facility
operations, supply chain, availability and productivity of personnel, while also
working to comply with rapidly evolving international, federal, state and local
restrictions and recommendations on travel and workplace health and safety. We
experienced disruptions to our business continuity as a result of temporary
closures of certain of ModusLink's facilities in the third and fourth quarters
of fiscal year 2020, as well as the four quarters of fiscal year 2021. However,
these temporary closures did not have a significant impact on ModusLink's
operations.

An outbreak in Mainland China forced temporary lockdown orders from March 14,
2022 to March 20, 2022 in several cities in which ModusLink operates. In April
and May 2022, there were further temporary lockdown orders which impacted
several ModusLink facilities in China; however, ModusLink was able to resume
operations on May 5, 2022 at one site and at another site on May 31, 2022. In
July 2022, there were further temporary lockdown orders which impacted one
ModusLink facility in China. In September and October 2022, there were further
temporary lockdown order which impacted several ModusLink facilities in China.
The lockdowns in China have not had a significant impact to ModusLink's
operations
                                       23
--------------------------------------------------------------------------------
  Table of Contents
through the filing of this Annual Report on Form 10-K. If the situation
continues at this level or worsens, however, it could result in a potential
adverse impact on our business, results of operations and financial condition.
We will evaluate further actions if circumstances warrant.

Beginning in the second quarter of 2020, with the shutdown of the U.S. economy
due to the COVID-19 pandemic, IWCO Direct's business was also significantly and
adversely affected by a material reduction in customer mailing activities.
Additionally, although IWCO Direct operated as an essential business, it had
reduced operating levels and labor shifts due to lower sales volume during the
third quarter of fiscal year 2020.

To help combat these impacts and mitigate the financial impact of the COVID-19
pandemic on our business, during fiscal year 2020 we took proactive measures by
initiating cost reduction actions, including the waiver of board fees, hiring
freezes, staffing and force reductions, company-wide salary reductions, bonus
payment deferrals and temporary 401(k) match suspension. The temporary waiver of
board fees and company-wide salary reduction actions taken in the prior fiscal
year were fully restored prior to the beginning of fiscal year 2021, and the
majority of salary reductions were repaid prior to the fiscal quarter ended
January 31, 2021.

Additionally, against the backdrop of the reduction in IWCO Direct's business,
the Company held extensive discussions with Cerberus about amending and
extending IWCO Direct's credit facility with Cerberus under which there was
approximately $361.3 million outstanding as of January 31, 2022 that was to
mature in December 2022. These discussions ultimately resulted in the
disposition of IWCO Direct. For more information, see "Disposition of IWCO
Direct" above and
Note 3 below. We continue our focus on cash management and liquidity, which
includes aggressive working capital management.

We continue to closely monitor the impact of COVID-19 on all aspects of our
business and geographies, including its impact on our clients, employees,
suppliers, vendors, business partners and distribution channels. We believe that
such impacts could include, the continued disruption to the demand for our
businesses' products and services; disruptions in or closures of our business
operations or those of our customers or suppliers; the impact of the global
business and economic environment on liquidity and the availability of capital;
increased costs and delays in payments of outstanding receivables beyond normal
payment terms; supply chain disruptions; uncertain demand; and the effect of any
initiatives or programs that we may undertake to address financial and
operational challenges faced by our customers. Despite indications of economic
recovery, the severity of the impact of the COVID-19 pandemic on the Company's
business in the fiscal year ending July 31, 2022 and beyond is difficult to
predict and will depend on a number of uncertain factors and trends. Such
factors and trends include, but are not limited to: the duration and severity of
the virus and its current variants; the emergence of new variant strains; the
availability and widespread use of vaccines; the impact of the global business
and economic environment on liquidity and the availability of capital; the
extent and severity of the impact on our customers and suppliers; and U.S. and
foreign government actions that have been taken, or may be taken in the future,
to mitigate adverse economic or other impacts or to mitigate the spread of the
virus and its variants. The Company continues to monitor for any developments or
updates to COVID-19 guidelines from public health and governmental authorities,
as well as the protection of the health and safety of its personnel, and is
continuously working to ensure that its health and safety protocols, business
continuity plans and crisis management protocols are in place to help mitigate
any negative impacts of the COVID-19 pandemic on the Company's employees,
business or operations.

RECENT DEVELOPMENTS

Merger project with Steel assets

On June 12, 2022, the Company, Steel Partners Holdings L.P. ("Steel Holdings")
and SP Merger Sub, Inc., a wholly-owned subsidiary of Steel Holdings ("Merger
Sub"), entered into an agreement and plan of merger (the "Merger Agreement"),
pursuant to which Merger Sub will merge with and into the Company (the
"Merger"), with the Company surviving the Merger as a wholly-owned subsidiary of
Steel Holdings. The Merger Agreement provides that each share of the Company's
common stock issued and outstanding immediately prior to the effective time of
the Merger (other than dissenting shares and shares owned by the Company, Steel
Holdings or any of their respective subsidiaries) will, subject to the terms and
conditions set forth in the Merger Agreement, be converted into the right to
receive (i) $1.35 in cash, without interest and (ii) one contingent value right
to receive a pro rata share of the proceeds received by the Company, Steel
Holdings or any of their affiliates with respect to the sale, transfer or other
disposition of all or any portion of the assets currently owned by ModusLink
within two years of the Merger's closing date, to the extent such proceeds
exceed $80 million plus certain related costs and expenses. Steel Holdings and
certain of its affiliates have also entered into a Voting and Support Agreement
pursuant to which, among other things, they have agreed to vote all shares of
common stock and Series C Preferred Stock beneficially owned by them in favor of
the adoption of the Merger Agreement and the Merger and any alternative
acquisition agreement approved by the Company's Board of Directors (acting on
the recommendation of the special committee (the "Special Committee") of
independent and disinterested directors formed to consider and negotiate the
terms and conditions of the Merger and to make a recommendation to our Board of
Directors).
                                       24

————————————————– ——————————

Contents

The Merger Agreement includes a "go-shop" period that expired at 11:59 p.m.
Eastern time on July 12, 2022, during which the Company was authorized to
actively solicit and consider alternative acquisition proposals. Although the
Company's financial advisor contacted or held discussions with numerous parties,
no offers were received during the go shop period.

The closing of the Merger is conditioned upon receipt of approval of the Merger
from (i) the holders of a majority in voting power of the outstanding shares of
common stock and Series C Preferred Stock of the Company (voting on an as
converted to shares of common stock basis), voting together as a single class,
(ii) a majority of the outstanding shares of common stock of the Company not
owned, directly or indirectly, by Steel Holdings and its affiliates and related
parties, and any other officers or directors of the Company, and (iii) the
holders of a majority of the outstanding shares of Series C Preferred Stock of
the Company, voting as a separate class, as well as other customary closing
conditions. Accordingly, there can be no assurance that the Company will be able
to complete the Merger on the expected timeline or at all. See "Part I, Item 1A.
Risk Factors" included in this Annual Report on Form 10-K.

Our Board of Directors, acting on the unanimous recommendation of the Special
Committee, and the Board of Directors of Steel Partner Holdings GP Inc., the
general partner of Steel Holdings, approved the Merger Agreement and the
transactions contemplated by the Merger Agreement (such transactions,
collectively, the "Transactions") and resolved to recommend the stockholders
adopt the Merger Agreement and approve the Transactions. The Special Committee,
which is comprised solely of independent and disinterested directors of the
Company who are unaffiliated with Steel Holdings, exclusively negotiated the
terms of the Merger Agreement with Steel Holdings, with the assistance of its
independent financial and legal advisors.

Subject to the satisfaction of all of the conditions to closing, including the
receipt of the requisite stockholder approvals, the Merger is expected to close
in the last quarter of calendar 2022.

Operating results

Unless otherwise stated, this analysis of operating results relates to our continuing operations.

Fiscal 2022 vs. Fiscal 2021

                                               Fiscal Year Ended        Fiscal Year Ended
                                                 July 31, 2022            July 31, 2021           $ Change1             % Change1
                                                                                   (In thousands)
Net revenue                                    $    203,272             $    226,256             $ (22,984)                   (10.2) %
Cost of revenue                                    (161,736)                (178,552)               16,816                      9.4  %
Gross profit                                         41,536                   47,704                (6,168)                   (12.9) %
Gross margin percentage                                20.4     %               21.1     %
Selling, general and administrative                 (40,373)                 (49,274)                8,901                     18.1  %
Interest expense                                     (3,120)                  (2,615)                 (505)                   (19.3) %
Other gains, net                                      4,089                    1,187                 2,902                    244.5  %
Income (loss) from continuing operations
before income taxes                                   2,132                   (2,998)                5,130                    171.1  %
Income tax expense                                  (11,388)                  (8,837)               (2,551)                   (28.9) %
Net loss from continuing operations                  (9,256)                 (11,835)                2,579                     21.8  %
Net loss from discontinued operations                (1,712)                 (32,556)               30,844                     94.7  %


1 favorable (unfavourable) change

Net revenue:

Consolidated net revenue from continuing operations, for the fiscal year ended
July 31, 2022, decreased by approximately $23.0 million, as compared to the
fiscal year ended July 31, 2021. This decrease in net revenue was primarily
driven by lower volume associated with clients in the computing and consumer
electronics markets which have been negatively impacted by global market
shortage of semiconductor and other electrical component supplies. Fluctuations
in foreign currency exchange rates had an insignificant impact on the net
revenue for the fiscal year ended July 31, 2022, as compared to the same period
in the prior year.

                                       25
--------------------------------------------------------------------------------
  Table of Contents
Cost of Revenue:

Consolidated cost of revenue from continuing operations consists primarily of
expenses related to the cost of materials purchased in connection with the
provision of supply chain management services as well as costs for salaries and
benefits, contract labor, consulting, fulfillment and shipping, and applicable
facilities costs. Supply Chain's cost of revenue decreased by $16.8 million for
the fiscal year ended July 31, 2022, as compared to the prior year, primarily
due to a $17.0 million decrease in materials procured on behalf of clients.
Supply Chain's gross margin percentage for the fiscal year ended July 31, 2022
decreased 70 basis points to 20.4% from 21.1% in the fiscal year ended July 31,
2021, primarily due to lower revenues and higher labor costs. Fluctuations in
foreign currency exchange rates had an insignificant impact on Supply Chain's
gross margin for the fiscal year ended July 31, 2022, as compared to the same
period in the prior year.

Selling, general and administrative expenses:

Consolidated selling, general and administrative expenses ("SG&A") from
continuing operations consist primarily of compensation and employee-related
costs, sales commissions and incentive plans, information technology expenses,
travel expenses, facilities costs, consulting fees, fees for professional
services, depreciation expense, marketing expenses, share-based compensation
expense, transaction costs, restructuring and public reporting costs. SG&A
expenses for the fiscal year ended July 31, 2022 decreased by approximately $8.9
million, as compared to the same period in the prior year. Supply Chain's SG&A
expenses decreased by $10.7 million primarily due to lower costs associated with
the information technology function for the Supply Chain segment.
Corporate-level activity increased by $1.8 million, primarily due to an increase
in professional fees. Fluctuations in foreign currency exchange rates had an
insignificant impact on SG&A expenses for the fiscal year ended July 31, 2022.

Interest charges:

Total interest expense, net, for the year ended July 31, 2022 increased by about $0.5 million mainly due to the higher interest expense related to the increase in the discount on the SPHG note.

Other earnings, net:

Other gains, net for the fiscal year ended July 31, 2022 were approximately $4.1
million. Other gains, net included gains of $0.9 million from the derecognition
of accrued pricing liabilities in the Supply Chain segment, net realized and
unrealized foreign exchange gains of $2.4 million, and $0.7 million of sublease
income in the Supply Chain segment.

Other gains, net for the fiscal year ended July 31, 2021 were approximately $1.2
million. Other gains, net included gains of $3.2 million from the derecognition
of accrued pricing liabilities in the Supply Chain segment, partially offset by
net realized and unrealized foreign exchange losses of $1.9 million in the
Supply Chain segment.

The income tax charge:

Company recorded income tax expense of approximately $11.4 million and $8.8
million for the fiscal years ended July 31, 2022 and 2021, respectively. The
increase in income tax expenses for the year ended July 31, 2022 is primarily
due to the income tax expense associated with an increase in the valuation
allowance recorded on deferred tax assets as a result of the IWCO Direct
disposal.

Net loss from continuing operations:

Net loss from continuing operations for the year ended July 31, 2022 decreased
$2.6 million, as compared to the same period in the prior year. The decrease in
net loss from continuing operations is primarily due an increase in foreign
exchange gains and an increase in operating income, partially offset by an
increase in income taxes.

Net loss from discontinued operations:

Net loss from discontinued operations for the year ended July 31, 2022 and 2021
were $1.7 million and $32.6 million, respectively, and reflects the net loss for
IWCO Direct. See Note 3 to the Consolidated Financial Statements in "Part II,
Item 8. Financial Statements and Supplementary Data" included in this Annual
Report on Form 10-K.

Cash and capital resources

                                       26
--------------------------------------------------------------------------------
  Table of Contents
Anticipated Sources and Uses of Cash Flow

Historically, the Company has financed its operations and met its capital
requirements primarily through funds generated from operations, the sale of its
securities, borrowings from lending institutions and sale of facilities that
were not fully utilized. The Company believes it has access to adequate
resources to meet its needs for normal operating costs, debt obligations and
working capital for at least the next twelve months. The following table
summarizes our liquidity:

                                                                   July 31,
                                                                     2022
                                                                (In thousands)
Cash and cash equivalents                                      $        53,142
Readily available borrowing capacity under Umpqua Revolver              11,890
                                                               $        65,032



Due to the changes reflected in the U.S. Tax Cuts and Jobs Act in December 2017
("U.S. Tax Reform"), there is no U.S. tax payable upon repatriating the
undistributed earnings of foreign subsidiaries considered not subject to
permanent investment. Foreign withholding taxes would range from 0% to 10% on
any repatriated funds. For the Company, earnings and profits have been
calculated at each subsidiary. The Company's foreign subsidiaries are in an
overall net deficit for earnings and profits purposes. As such, no adjustment
was made to U.S. taxable income in the fiscal year ended July 31, 2022 relating
to this aspect of the U.S. Tax Reform. In future years, the Company believes
that it will be able to repatriate its foreign earnings without incurring
additional U.S. tax as a result of a 100% dividends received deduction. The
Company believes that any future withholding taxes or state taxes associated
with such a repatriation would be minor. However, foreign laws may delay or add
cost to any repatriation of cash from outside the U.S., which costs or delays
may be significant.

Disposal of IWCO Direct

As a result of the IWCO Direct Disposal, the Company has no debt outstanding
under the Cerberus Credit Facility (as defined below) as of July 31, 2022.
Additionally, the CIP, which had estimated future cash outflows remaining of
approximately $44 million, is no longer a future cash outflow of the Company.

Consolidated net working capital was $26.0 million at July 31, 2022, compared
with $22.3 million at July 31, 2021. Included in net working capital were cash
and cash equivalents of $53.1 million at July 31, 2022 and $58.1 million at
July 31, 2021. The improvement in net working capital was primarily related to
an increase in accounts receivable of $3.5 million from the fiscal year ended
July 31, 2021.

Sources and uses of cash for the year ended July 31, 2022compared to the year ended July 31, 2021are the following:

                                                    Fiscal Year Ended
                                                        July 31,
                                             2022          2021        Change
                                                     (In thousands)
Net cash used in operating activities     $ (3,134)     $ (8,110)     $ 4,976
Net cash used in investing activities       (1,485)       (1,035)        (450)
Net cash used in financing activities       (2,297)       (2,195)        (102)



Operating Activities: Net cash used in operating activities was $3.1 million for
the fiscal year ended July 31, 2022, compared to $8.1 million for the fiscal
year ended July 31, 2021. The Company's future cash flows related to operating
activities are dependent on several factors, including profitability, accounts
receivable collections, effective inventory management practices and
optimization of the credit terms of certain vendors of the Company, and overall
performance of the technology sector impacting the Supply Chain segment. The
decrease in cash used as compared to the prior fiscal year was primarily due to
an increase in working capital of $3.8 million.

Investing Activities: Net cash used in investing activities was $1.5 million and
$1.0 million for the fiscal year ended July 31, 2022 and 2021, respectively, and
was primarily comprised of capital expenditures. The increase in capital
expenditures in the fiscal year ended July 31, 2022 is primarily due to reduced
capital spending in the prior year as a result of the COVID-19 pandemic.

                                       27

————————————————– ——————————

Table of Contents Fundraising Activities: The $2.3 million and $2.2 million cash used in financing activities during the year ended July 31, 2022 and 2021, respectively, was mainly due to $2.1 million in payment of preferential dividends during each period.

Below is a summary of the Company’s outstanding debt and financing arrangements and preferred stock. Refer to notes 7 and 19 of our consolidated financial statements for more information.

7.50% Convertible Senior Note

On February 28, 2019, the Company entered into that certain 7.50% Convertible
Senior Note Due 2024 Purchase Agreement with SPHG Holdings whereby SPHG Holdings
loaned the Company $14.9 million in exchange for a 7.50% Convertible Senior Note
due 2024 (the "SPHG Note"). The SPHG Note bears interest at the fixed rate of
7.50% per year, payable semi-annually in arrears on March 1 and September 1 of
each year, beginning on September 1, 2019. The SPHG Note will mature on March 1,
2024 (the "SPHG Note Maturity Date"), unless earlier repurchased by the Company
or converted by the holder in accordance with its terms prior to such maturity
date.

At its election, the Company may pay some or all of the interest due on each
interest payment date by increasing the principal amount of the SPHG Note in the
amount of such interest due or any portion thereof (such payment of interest by
increasing the principal amount of the SPHG Note referred to as "PIK Interest"),
with the remaining portion of the interest due on such interest payment date
(or, at the Company's election, the entire amount of interest then due) to be
paid in cash by the Company. Following an increase in the principal amount of
the SPHG Note as a result of a payment of PIK Interest, the SPHG Note will bear
interest on such increased principal amount from and after the date of such
payment of PIK Interest. SPHG Holdings has the right to require the Company to
repurchase the SPHG Note upon the occurrence of certain fundamental changes,
subject to certain conditions, at a repurchase price equal to 100% of the
principal amount of the SPHG Note plus accrued and unpaid interest. The Company
will have the right to elect to cause the mandatory conversion of the SPHG Note
in whole, and not in part, at any time on or after March 6, 2022, subject to
certain conditions including that the stock price of the Company exceeds a
certain threshold. SPHG Holdings has the right, at its option, prior to the
close of business on the business day immediately preceding the SPHG Note
Maturity Date, to convert the SPHG Note or a portion thereof that is $1,000 or
an integral multiple thereof, into shares of common stock (if the Company has
not received a required stockholder approval) or cash, shares of common stock or
a combination of cash and shares of common stock, as applicable (if the Company
has received a required stockholder approval), at an initial conversion rate of
421.2655 shares of common stock, which is equivalent to an initial conversion
price of approximately $2.37 per share (subject to adjustment as provided in the
SPHG Note) per $1,000 principal amount of the SPHG Note (the "Conversion Rate"),
subject to, and in accordance with, the settlement provisions of the SPHG Note.
For any conversion of the SPHG Note, if the Company is required to obtain and
has not received approval from its stockholders in accordance with Nasdaq Stock
Market Rule 5635 to issue 20% or more of the total shares of common stock
outstanding upon conversion (including upon any mandatory conversion) of the
SPHG Note prior to the relevant conversion date (or, if earlier, the 45th
scheduled trading day immediately preceding the SPHG Note Maturity Date), the
Company shall deliver to the converting holder, in respect of each $1,000
principal amount of the SPHG Note being converted, a number of shares of common
stock determined by reference to the Conversion Rate, together with a cash
payment, if applicable, in lieu of delivering any fractional share of common
stock based on the volume weighted average price (VWAP) of its common stock on
the relevant conversion date, on the third business day immediately following
the relevant conversion date. As of July 31, 2022 and 2021, outstanding debt in
both periods consisted of the $14.9 million 7.50% Convertible Senior Note due
March 1, 2024. As of July 31, 2022 and July 31, 2021, the net carrying value of
the SPHG Note was $11.0 million, and $9.3 million, respectively.

Umpqua Revolver

On March 16, 2022, ModusLink, as borrower, submitted a notice of termination to
MidCap Financial Trust for its $12.5
million revolving credit facility (the "MidCap Credit Facility"), and entered
into a new credit agreement with Umpqua Bank (the "Umpqua Revolver"), as lender
and as agent. There was no balance outstanding on the Midcap Credit Facility of
at the time of its termination. The Umpqua Revolver provides for a maximum
credit commitment of $12.5 million and a sublimit of $5.0 million for letters of
credit and expires on March 16, 2024. Steel Connect, Inc. ("Parent") is not a
borrower or a guarantor under the Umpqua Revolver. Under the Umpqua Revolver,
ModusLink is permitted to make distributions to the Parent, in an aggregate
amount not to exceed $10.0 million in any fiscal year.

From July 31, 2022, Modus Link was in compliance with Umpqua Revolver’s covenants, and believes that it will remain in compliance with Umpqua Revolver’s covenants for the next twelve months. From July 31, 2022, Modus Link had a borrowing capacity of $11.9 million and there was $0.6 million
outstanding for letters of credit.

Cerberus Credit Facility

                                       28
--------------------------------------------------------------------------------
  Table of Contents
The Cerberus Credit Facility consisted of a term loan facility (the "Cerberus
Term Loan") and a $25 million revolving credit facility (the "Revolving
Facility") (together the "Cerberus Credit Facility") which was to mature on
December 15, 2022. On February 25, 2022, the Company transferred all of its
interests in IWCO Direct and the financial obligations of the Cerberus Credit
Facility as part of the IWCO Direct Disposal. As a result, the Company has no
debt or access to future borrowings under the Cerberus Credit Facility.

Favorite stock

On December 15, 2017, the Company entered into a Preferred Stock Purchase
Agreement (the "Purchase Agreement") with SPHG Holdings, pursuant to which the
Company issued 35,000 shares of the Company's newly created Series C Convertible
Preferred Stock, par value $0.01 per shares, or the Preferred Stock, to SPHG
Holdings at a price of $1,000 per share, for an aggregate purchase consideration
of $35.0 million (the "Preferred Stock Transaction"). The terms, rights,
obligations and preferences of the Preferred Stock are set forth in a
Certificate of Designations, Preferences and Rights of Series C Convertible
Preferred Stock of the Company (the "Series C Certificate of Designations"),
which has been filed with the Secretary of State of the State of Delaware.

Under the Series C Certificate of Designations, each share of Preferred Stock
can be converted into shares of the Company's Common Stock at an initial
conversion price equal to $1.96 per share, subject to appropriate adjustments
for any stock dividend, stock split, stock combination, reclassification or
similar transaction. Holders of the Preferred Stock will also receive dividends
at 6% per annum payable, at the Company's option, in cash or Common Stock. If at
any time the closing bid price of the Company's Common Stock exceeds 170% of the
conversion price for at least five consecutive trading days (subject to
appropriate adjustments for any stock dividend, stock split, stock combination,
reclassification or similar transaction), the Company has the right to require
each holder of Preferred Stock to convert all, or any whole number, of shares of
the Preferred Stock into Common Stock.

Upon the occurrence of certain triggering events such as a liquidation,
dissolution or winding up of the Company, either voluntary or involuntary, or
the merger or consolidation of the Company or significant subsidiary, or the
sale of substantially all of the assets or capital stock of the Company or a
significant subsidiary, the holders of the Preferred Stock are entitled to
receive, prior and in preference to any distribution of any of the assets or
funds of the Company to the holders of other equity or equity equivalent
securities of the Company other than the Preferred Stock by reason of their
ownership thereof, an amount per share in cash equal to the sum of (i) 100% of
the stated value per share of Preferred Stock (initially $1,000 per share) then
held by them (as adjusted for any stock dividend, stock split, stock
combination, reclassification or other similar transactions with respect to the
Preferred Stock), plus (ii) 100% of all declared but unpaid dividends, and all
accrued but unpaid dividends on each such share of Preferred Stock, in each case
as the date of the triggering event.

On or after December 15, 2022, each holder of Preferred Stock can also require
the Company to redeem its Preferred Stock in cash at a price equal to the
Liquidation Preference (as defined in the Series C Certificate of Designations),
or approximately $35.2 million. If holders of the Preferred Stock exercise this
right to require the Company to redeem all the Preferred Stock, the Company may
have insufficient liquidity to pay the redemption price, or the Company's
payment of the redemption price would likely adversely impact the Company's
liquidity and ability to finance its operations.

SteelConnect, Inc.(as parent company, the “Mother”)

The Parent believes it has access to adequate resources to meet its needs for
normal operating costs, debt obligations and working capital for at least the
next twelve months. Upon a redemption request of the Preferred Stock (as
discussed above), the Parent believes it is probable that it has access to
adequate resources, including cash on hand and potential dividends from
ModusLink, to pay the redemption price and continue its operations.

ModusLink believes that if dividends to the Parent are required, it would have
access to adequate resources to meet its operating needs while remaining in
compliance with the Umpqua Revolver's covenants over the next twelve months.
However, there can be no assurances that ModusLink will continue to have access
to its line of credit if its financial performance does not satisfy the
financial covenants set forth in its financing agreement, which could also
result in the acceleration of its debt obligations by its lender, adversely
affecting liquidity.

Contractual obligations

Our principal uses of cash will be to provide working capital, meet debt service
requirements, fund capital expenditures and execute management's strategic plans
including the IWCO Direct CIP. As of July 31, 2022, we had contractual cash
                                       29

————————————————– ——————————

Table of Contents obligations to repay debt, make payments under operating and capital leases and pay dividends. From July 31, 2022the payments due under these long-term obligations are as follows:

                                             Less than 1
                                                 year            2-3 years           4-5 years           More than 5 years            Total
                                                                                      (In thousands)
Debt(1)                                      $       -          $  14,940          $        -          $                -          $ 14,940
Interest payments(2)                             1,136              1,139                   -                           -             2,275
Operating lease liabilities                      7,151              7,941               4,819                           -            19,911
Financing lease liabilities                         38                  -                   -                           -                38
Preferred dividend payments                      2,100              4,200               4,200                              †         10,500
                                             $  10,425          $  28,220          $    9,019          $                -          $ 47,664



(1) Represents principal amount of debt and only includes scheduled principal
payments.
(2) Represents expected interest payments on debt. Interest payments based on
variable interest rates were determined using the interest rate in effect as of
July 31, 2022.
† Holders of the Preferred Stock receive dividends at 6% per annum. In addition,
beginning December 15, 2022, each holder of the Preferred Stock can require the
Company to redeem its Preferred Stock in cash at a price equal to the
Liquidation Preference (as defined in Series C Certificate of Designations).

Critical accounting policies

Our significant accounting policies are discussed in Note 2 to our audited
consolidated financial statements. The discussion and analysis of our financial
condition and results of operations are based on 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 management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenue and expenses during the reporting
period. The most significant of these estimates and assumptions relate to: (1)
revenue recognition; (2) valuation allowances for trade and other receivables
and inventories; (3) the valuation of long-lived assets; (4) contingencies,
including litigation reserves; (5) restructuring charges and related severance
expenses; (6) litigation reserves; (7) pension obligations; (8) going concern
assumptions; (9) accrued pricing and tax related liabilities and; (10)
incremental borrowing rate to determine present value of lease payments. Of the
accounting estimates we routinely make relating to our critical accounting
policies, those estimates made in the process of: recognition of revenue;
determining the valuation of inventory and related reserves; accounting for
impairment of long-lived assets; and establishing income tax valuation
allowances and liabilities are the estimates most likely to have a material
impact on our financial position and results of operations. The Company bases
its estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances. Changes in estimates are
reflected in the periods in which they become known. However, because these
estimates inherently involve judgments and uncertainties, there can be no
assurance that actual results will not differ materially from those estimates.

We believe that our critical accounting estimates have the following attributes:
(1) we are required to make assumptions about matters that are uncertain and
require judgment at the time of the estimate; (2) use of reasonably different
assumptions could have changed our estimates, particularly with respect to
recoverability of assets; and (3) changes in the estimate could have a material
effect on our financial condition or results of operations. We believe the
critical accounting policies below contain the more significant judgments and
estimates used in the preparation of our financial statements:

•Revenue recognition
•Accounting for impairment of long-lived assets
•Income taxes
•Leases

Revenue Recognition

The Company recognizes revenue from its contracts with customers primarily from
the sale of supply chain management services. Revenue is recognized when control
of the promised goods or services is transferred to a customer, in an amount
that reflects the consideration the Company expects to be entitled to in
exchange for those goods or services. For ModusLink's supply chain management
services arrangements, the services are considered to be transferred over time
as they are performed. Taxes assessed by a governmental authority that are both
imposed on and concurrent with a specific revenue-producing transaction, that
are collected by the Company from a customer, are excluded from revenue.
                                       30

————————————————– ——————————

Contents

Supply chain management services.

ModusLink's revenue primarily comes from the sale of supply chain management
services to its clients. Amounts billed to customers under these arrangements
include revenue attributable to the services performed as well as for materials
procured on the customer's behalf as part of its service to them. The majority
of these arrangements consist of two distinct performance obligations (i.e,
warehousing/inventory management service and a separate
kitting/packaging/assembly service), revenue related to each of which is
recognized over time as services are performed using an input method based on
the level of efforts expended.

Other.

Other revenue consists of cloud-based software subscriptions, software
maintenance and support service contracts, fees for professional services and
fees for the sale of perpetual software licenses in ModusLink's e-Business
operations. Except for perpetual software licenses, revenue related to these
arrangements is recognized on a straight-line basis over the term of the
agreement or over the term of the agreement in proportion to the costs incurred
in satisfying the obligations under the contract. Revenue from the sale of
perpetual licenses is recognized at a point in time upon execution of the
relevant license agreement and when delivery has taken place.

Performance obligations and autonomous selling price

The Company's contracts with customers may include promises to transfer multiple
products and services to a customer. Determining whether products and services
are considered distinct performance obligations that should be accounted for
separately versus together may require certain judgment. For arrangements with
multiple performance obligations, the Company allocates revenue to each
performance obligation based on its relative standalone selling price. Judgment
is required to determine the standalone selling price for each distinct
performance obligation. The Company generally determines standalone selling
prices based on the prices charged to customers and uses a range of amounts to
estimate standalone selling prices when we sell each of the products and
services separately and need to determine whether there is a discount that needs
to be allocated based on the relative standalone selling prices of the various
products and services. The Company typically has more than one range of
standalone selling prices for individual products and services due to the
stratification of those products and services by customers and circumstances. In
these instances, the Company may use information such as the type of customer
and geographic region in determining the range of standalone selling prices.

Variable Consideration

The Company may provide credits or incentives to customers, which are accounted
for as variable consideration when estimating the transaction price of the
contract and amounts of revenue to recognize. The amount of variable
consideration to include in the transaction price is estimated at contract
inception using either the estimated value method or the most likely amount
method based on the nature of the variable consideration. These estimates are
updated at the end of each reporting period as additional information becomes
available and revenue is recognized only to the extent that it is probable that
a significant reversal of any amounts of variable consideration included in the
transaction price will not occur.

Recognition of Principal vs. Agent Revenue

For revenue generated from contracts with customers involving another party, the
Company considers whether it maintains control of the specified goods or
services before they are transferred to the customer, as well as other
indicators such as the party primarily responsible for fulfillment and
discretion in establishing price. Revenues are recognized on a gross basis if
the Company is acting in the capacity of a principal and on a net basis if it's
acting in the capacity of an agent.

Accounting for impairment of long-lived assets

Our long-lived assets include property, plant and equipment, capitalized software development costs for software to be sold, leased or otherwise marketed, and certain long-term investments. From July 31, 2022the consolidated book values ​​of our property, plant and equipment have been $3.5 million, which represented 2.6% of total assets. We examine the valuation of our

                                       31
--------------------------------------------------------------------------------
  Table of Contents
long-lived assets whenever events or changes in circumstances indicate that the
carrying amount of these assets may not be recoverable. An impairment loss is
recognized when the carrying amount of a long-lived asset exceeds its fair value
or net realizable value expected to result from the asset's use and eventual
disposition. We use a variety of factors to assess valuation, depending upon the
asset. Long-lived assets are evaluated based upon the expected period the asset
will be utilized and other factors depending on the asset, including estimated
future sales, profits and related cash flows. Changes in estimates and judgments
on any of these factors could have a material impact on our results of
operations and financial position.

Income taxes

The Company has net operating loss carryforwards for federal and state tax
purposes of approximately $2.2 billion and $153.7 million, respectively, as of
July 31, 2022. Income taxes are accounted for under the provisions of ASC 740,
Income Taxes, using the asset and liability method whereby deferred tax assets
and liabilities are recognized for the estimated future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates in effect for the
year in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Deferred tax assets are reduced by a valuation allowance, if based on the weight
of available evidence, it is more likely than not that some portion or all of
the recorded deferred tax assets will not be realized in future periods. This
methodology is subjective and requires significant estimates and judgments in
the determination of the recoverability of deferred tax assets and in the
calculation of certain tax liabilities. As of July 31, 2022 and 2021, a
valuation allowance has been recorded against the deferred tax asset in the U.S.
and certain of its foreign subsidiaries since management believes that after
considering all the available objective evidence, both positive and negative,
historical and prospective, with greater weight given to historical evidence, it
is more likely than not that these assets will not be realized. In each
reporting period, we evaluate the adequacy of our valuation allowance on our
deferred tax assets. In the future, if the Company is able to demonstrate a
consistent trend of pre-tax income, then at that time management may reduce its
valuation allowance accordingly. The Company also performs a valuation allowance
scheduling exercise based on the deferred tax assets and liabilities as of July
31, 2022.

In addition, the calculation of the Company's tax liabilities involves dealing
with uncertainties in the application of complex tax regulations in several tax
jurisdictions. The Company is periodically reviewed by domestic and foreign tax
authorities regarding the amount of taxes due. These reviews include questions
regarding the timing and amount of deductions and the allocation of income among
various tax jurisdictions. In evaluating the exposure associated with various
filing positions, we record estimated reserves for exposures. Based on our
evaluation of current tax positions, the Company believes it has appropriately
accrued for exposures as of July 31, 2022.

Leases

In order to calculate the operating ROU asset and operating lease liability for
a lease, a lessee is required to apply a discount rate equal to the rate
implicit in the lease whenever that rate is readily determinable. The Company's
lease agreements generally do not provide a readily determinable implicit rate,
nor is the rate available to the Company from its lessors and, therefore, the
Company determines an incremental borrowing rate to determine the present value
of the lease payments. The incremental borrowing rate represents the rate of
interest the Company would have to pay to borrow on a collateralized basis over
a similar lease term to obtain an asset of similar value.

Recent accounting pronouncements

For a discussion of new or recently adopted accounting pronouncements by the Company, see Note 2 to the consolidated financial statements found elsewhere in this Form 10-K.

Tax Benefit Preservation Plan

Our past operations generated significant net operating losses, or NOLs. On
March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act was
enacted in response to the COVID-19 pandemic which among, other things, amends
the treatment of NOLs. Under federal tax laws, for NOLs arising in tax years
beginning before January 1, 2018, we generally can use any such NOLs and certain
related tax credits to reduce ordinary income tax paid in our prior two tax
years or on our future taxable income for up to 20 years, at which point they
"expire" for such purposes. Until they expire, we can "carry forward" NOLs and
certain related tax credits that we do not use in any particular year to offset
taxable income in future years. For NOLs arising in tax years beginning after
December 31, 2017 and before January 1, 2021, we are allowed to carryback such
NOLs to each of the five taxable years preceding the taxable year of such losses
and generally can use any such NOLs and certain related tax credits to reduce
ordinary income tax paid on our future taxable income indefinitely; however,
except for NOLs generated
                                       32
--------------------------------------------------------------------------------
  Table of Contents
in tax years beginning after December 31, 2017 and prior to January 1, 2021
(which can be carried back to reduce taxable income for the prior five tax
years), any such NOLs cannot be used to reduce ordinary income tax paid in prior
tax years. In addition, the deduction for NOLs arising in tax years beginning
after December 31, 2020 is limited to 80% of our taxable income for any tax year
(computed without regard to the NOL deduction). NOLs arising in tax years
beginning before January 1, 2018, are referred to herein as "Current NOLs." The
Company had net NOL carryforwards for federal and state tax purposes of
approximately $2.2 billion and $153..7 million, respectively, at July 31, 2022,
$2.02 billion of the federal NOL arose in tax years ending before January 1,
2018 and $138 million arose post January 1, 2018. We cannot estimate the exact
amount of NOLs that we will be able use to reduce future income tax liability
because we cannot predict the amount and timing of our future taxable income.
For more information, see "Part I, Item 1A. Risk Factors-Risks Related to
Taxation-We may be unable to realize the benefits of our net operating loss
carry-forwards and other tax benefits (collectively, the 'NOLs' or 'Tax
Benefits')."

In early 2018, Company's board of directors adopted the Protective Amendment and
Tax Plan, each designed to preserve the Company's ability to utilize its NOLs,
by preventing an "ownership change" within the meaning of Section 382 of the
Internal Revenue Code that would impair the Company's ability to utilize its
NOLs. Later that year, the stockholders of Steel Connect approved the Protective
Amendment and Tax Plan.

The federal net operating losses will expire from fiscal year 2023 through 2038,
and the state net operating losses will expire from fiscal year 2023 through
2041. The Company's ability to use its Tax Benefits would be substantially
limited if the Company undergoes an Ownership Change. The Protective Amendment
and Tax Plan are intended to prevent an Ownership Change of the Company that
would impair the Company's ability to utilize its Tax Benefits.

The Protective Amendment generally restricts any direct or indirect transfer if
the effect would be to (i) increase the direct, indirect or constructive
ownership of any stockholder from less than 4.99% to 4.99% or more of the shares
of common stock then outstanding or (ii) increase the direct, indirect or
constructive ownership of any stockholder owning or deemed to own 4.99% or more
of the shares of common stock then outstanding. Pursuant to the Protective
Amendment, any direct or indirect transfer attempted in violation of the
Protective Amendment would be void as of the date of the prohibited transfer as
to the purported transferee (or, in the case of an indirect transfer, the
ownership of the direct owner of the shares would terminate simultaneously with
the transfer), and the purported transferee (or in the case of any indirect
transfer, the direct owner) would not be recognized as the owner of the shares
owned in violation of the Protective Amendment (the "excess stock") for any
purpose, including for purposes of voting and receiving dividends or other
distributions in respect of such shares, or in the case of options, receiving
shares in respect of their exercise. In addition to a prohibited transfer being
void as of the date it is attempted, upon demand, the purported transferee must
transfer the excess stock to an agent of the Company along with any dividends or
other distributions paid with respect to such excess stock. The agent is
required to sell such excess stock in an arm's-length transaction (or series of
transactions) that would not constitute a violation under the Protective
Amendment.

As part of the Tax Plan, the Board declared a dividend of one right (a "Right")
for each share of common stock then outstanding. The dividend was payable to
holders of record as of the close of business on January 29, 2018. Any shares of
common stock issued after January 29, 2018, will be issued together with the
Rights. Each Right initially represents the right to purchase one one-thousandth
of a share of newly created Series D Junior Participating Preferred Stock.

Initially, the Rights will be attached to all certificates representing shares
of common stock then outstanding, and no separate rights certificates will be
distributed. In the case of book entry shares, the Rights will be evidenced by
notations in the book entry accounts. Subject to certain exceptions specified in
the Tax Plan, the Rights will separate from the common stock and a distribution
date (the "Distribution Date") will occur upon the earlier of (i) ten (10)
business days following a public announcement that a stockholder (or group) has
become a beneficial owner of 4.99% or more of the shares of common stock then
outstanding or (ii) ten (10) business days (or such later date as the Board
determines) following the commencement of a tender offer or exchange offer that
would result in a person or group becoming a 4.99% stockholder.

Pursuant to the Tax Plan and subject to certain exceptions, if a stockholder (or
group) becomes a new 4.99% stockholder after adoption of the Tax Plan, the
Rights would generally become exercisable and entitle stockholders (other than
the new 4.99% stockholder or group) to purchase additional shares of the Company
at a significant discount, resulting in substantial dilution in the economic
interest and voting power of the 4.99% stockholder (or group). In addition,
under certain circumstances in which the Company is acquired in a merger or
other business combination after a non-exempt stockholder (or group) becomes a
4.99% stockholder, each holder of the Right (other than the 4.99% stockholder or
group) would then be entitled to purchase shares of the acquiring company's
common stock at a discount.

                                       33

————————————————– ——————————

  Table of Contents
The Protective Amendment does not expire. The Rights are not exercisable until
the Distribution Date and will expire at 11:59 p.m., on January 18, 2024, unless
the Rights are earlier redeemed or exchanged as provided in the Tax Plan or the
Board of Directors earlier determines that the Tax Plan is no longer necessary
or desirable for the preservation of the Tax Benefits. For more information, see
"Part I, Item 1A. Risk Factors-Risks Related to Taxation-We may be unable to
realize the benefits of our net operating loss carry-forwards and other tax
benefits (collectively, the 'NOLs' or 'Tax Benefits')."

© Edgar Online, source Previews