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MarketScreener Homepage  >  Equities  >  Nasdaq  >  Steel Connect, Inc.    STCN

STEEL CONNECT, INC.

(STCN)
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STEEL CONNECT : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-K)

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09/30/2020 | 05:37pm EDT
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 of this report, "Risk Factors," and elsewhere in this
report. 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.

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Overview

Steel Connect, Inc. is a diversified holding company with two, wholly-owned
subsidiaries, IWCO and ModusLink, that serve the direct marketing and supply
chain management markets, respectively. For a more complete description of the
Company's segments, see Part I, Item 1, "Business" found elsewhere in this Form
10-K.

Impact of COVID-19

In March 2020, 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. The spread of the outbreak has caused significant disruptions in the
U.S. and global economies, and economists expect the impact will be significant
during the next year. The Company is subject to risks and uncertainties as a
result of the COVID-19 pandemic. The Company continues to evaluate the global
risks and the slowdown in business activity related to COVID-19, including the
potential impacts on its employees, customers, suppliers and financial results.
For the fiscal year 2020, COVID-19 required temporary closures of certain of
ModusLink's facilities. Additionally, although IWCO operated as an essential
business, it had reduced operating levels and labor shifts due to lower sales
volume. As of the filing of this Form 10-K, all of the Company's facilities were
open and able to operate at normal capacities. Additionally, to help mitigate
the financial impact of the COVID-19 pandemic, the Company initiated 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 Company continues its focus on cash
management and liquidity, which includes elimination of discretionary spending,
aggressive working capital management, strict approvals for capital expenditures
and borrowing from its revolving credit facilities, if needed, as a
precautionary measure to preserve financial flexibility. The Company will
evaluate further actions if circumstances warrant.

Currently, the Company anticipates that the impact of the rapid deterioration of
the U.S and global economies will most likely continue and have an adverse
impact on the Company's business. However, as the situation surrounding COVID-19
remains fluid, it is difficult to predict the duration of the pandemic and the
impact on the Company's business, operations, financial condition and cash
flows. The severity of the impact on the Company's business beyond fiscal year
2020 will depend on a number of factors, including, but not limited to, the
duration and severity of the pandemic, the extent and severity of the impact on
the Company's customers and suppliers, the continued disruption to the demand
for our businesses' products and services, and the impact of the global business
and economic environment on liquidity and the availability of capital, all of
which are uncertain and cannot be predicted. The Company's future results of
operations and liquidity could also be adversely impacted by delays in payments
of outstanding receivables beyond normal payment terms, supply chain
disruptions, and uncertain demand, and the effect of any initiatives or programs
that the Company may undertake to address financial and operational challenges
faced by its customers. There is also no certainty that federal, state or local
regulations regarding safety measures to address the spread of COVID-19 will not
adversely impact the Company's operations.

Results of Operations

Fiscal Year 2020 compared to Fiscal Year 2019


Net Revenue:
                                       As a %                         As a %
                       Fiscal            of           Fiscal            of
                     Year Ended        Total        Year Ended        Total
                      July  31,         Net          July  31,         Net
                        2020          Revenue          2019          Revenue       $ Change      % Change
                                                        (In thousands)
Direct Marketing   $     444,360         56.8 %   $     486,902         59.4 %   $  (42,542 )       (8.7 )%
Supply Chain             338,453         43.2 %         332,928         40.6 %        5,525          1.7  %
Total              $     782,813        100.0 %   $     819,830        100.0 %   $  (37,017 )       (4.5 )%



Consolidated net revenue, for the fiscal year ended July 31, 2020, decreased by
approximately $37.0 million, as compared to the fiscal year ended July 31, 2019.
Direct Marketing segment net revenue for the fiscal year ended July 31, 2020
decreased by approximately $42.5 million primarily driven by lower volumes due
to the COVID-19 pandemic, partially offset by a higher average price per package
mailed. The decrease in net revenue was primarily associated with customers in
the financial services and MSO industries, partially offset by increases in the
subscription services and healthcare industries. Supply Chain net revenue for
the fiscal year ended July 31, 2020 increased by approximately $5.5 million
primarily driven by increased revenues from a client computing market, partially
offset by decreased revenues from clients in the consumer electronics and
consumer products industries. Fluctuations in foreign currency exchange rates
had an insignificant impact on the Supply Chain segment's net revenues for the
fiscal year ended July 31, 2020, as compared to the same period in the prior
year.

Cost of Revenue:

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                                       As a %                         As a %
                       Fiscal            of           Fiscal            of
                     Year Ended       Segment       Year Ended       Segment
                      July  31,         Net          July  31,         Net
                        2020          Revenue          2019          Revenue       $ Change      % Change
                                                        (In thousands)
Direct Marketing   $     345,173         77.7 %   $     372,683         76.5 %   $  (27,510 )       (7.4 )%
Supply Chain             274,681         81.2 %         297,417         89.3 %      (22,736 )       (7.6 )%
Total              $     619,854         79.2 %   $     670,100         81.7 %   $  (50,246 )       (7.5 )%



Consolidated cost of revenue consists primarily of expenses related to the cost
of materials purchased in connection with the provision of direct marketing and
supply chain management services as well as costs for salaries and benefits,
contract labor, consulting, paper for direct mailing, fulfillment and shipping,
and applicable facilities costs. Cost of revenue for the fiscal year ended
July 31, 2020 included materials procured on behalf of our Supply Chain clients
of $190.3 million, as compared to $191.4 million for the same period in the
prior year, a decrease of $1.1 million. Total cost of revenue decreased by $50.2
million for the fiscal year ended July 31, 2020, as compared to the same period
in the prior year, primarily due to a decline in labor and material costs.

Gross margin percentage for the fiscal year ended July 31, 2020 increased to
20.8% from 18.3% in the fiscal year ended July 31, 2019, primarily due to
improved customer mix and lower labor costs, partially offset by an increase in
material costs as a percentage of net revenue. The Direct Marketing segment's
gross margin percentage decreased by 120 basis points to 22.3% for the fiscal
year ended July 31, 2020, as compared to 23.5% for the fiscal year ended
July 31, 2019 primarily due to changes in sales mix, higher material costs as a
percentage of net revenue and lower overhead absorption caused by a decline in
sales volume due to the COVID-19 pandemic. The Supply Chain segment's gross
margin percentage increased by 810 basis points to 18.8% for the fiscal year
ended July 31, 2020, as compared to 10.7% for the fiscal year ended July 31,
2019 primarily due to improved customer mix and decreased labor costs.
Fluctuations in foreign currency exchange rates had an insignificant impact on
the Supply Chain segment's gross margin for the fiscal year ended July 31, 2020.

Selling, General and Administrative:

                                       As a %                         As a %
                       Fiscal            of           Fiscal            of
                     Year Ended       Segment       Year Ended       Segment
                      July  31,         Net          July  31,         Net
                        2020          Revenue          2019          Revenue       $ Change      % Change
                                                        (In thousands)
Direct Marketing   $      58,992         13.3 %   $      92,927         19.1 %   $  (33,935 )      (36.5 )%
Supply Chain              35,820         10.6 %          38,848         11.7 %       (3,028 )       (7.8 )%
Sub-total                 94,812         12.1 %         131,775         16.1 %      (36,963 )      (28.1 )%
Corporate-level
activity                   8,449                         12,303                      (3,854 )      (31.3 )%
Total              $     103,261         13.2 %   $     144,078

17.6 % $ (40,817 ) (28.3 )%




During the three months ended October 31, 2019, the Company recorded a $6.4
million adjustment to correct an out-of-period misstatement related to the
Company's estimate for certain tax related liabilities. Had this correction been
recorded for the fiscal year ended July 31, 2019, the Company's selling, general
and administrative expenses and net loss for that period would have been reduced
to $137.7 million and $60.3 million, respectively. The Company's accrued
expenses as of July 31, 2019 would have been reduced to $106.3 million.

Selling, general and administrative expenses during the fiscal year ended
July 31, 2020 decreased by approximately $40.8 million, as compared to the same
period in the prior year. Direct Marketing's selling, general and administrative
expenses for the fiscal year ended July 31, 2020 decreased approximately $33.9
million primarily due to a $32.1 million charge in the prior fiscal year for
accrued taxes that did not recur. Supply Chain's selling, general and
administrative expenses for the fiscal year ended July 31, 2020 decreased
approximately $3.0 million primarily to due to a decrease in professional
services and employee-related costs. Corporate-level activity decreased
primarily due to a reduction in employee-related costs. Fluctuations in foreign
currency exchange rates had an insignificant impact on the Supply Chain
segment's selling, general and administrative expenses for the fiscal year ended
July 31, 2020.

Amortization of Intangible Assets:

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The intangible asset amortization of $27.3 million and $30.4 million during the
fiscal years ended July 31, 2020 and 2019, respectively, relates to amortizable
intangible assets acquired by the Company in connection with its acquisition of
IWCO on December 15, 2017. The decrease is due to lower amortization expense
with respect to our customer relationship intangible assets. Our customer
relationship intangible assets are amortized using an accelerated method, which
reflects the pattern in which we receive the economic benefit of the asset.

Interest Income/Expense:

Interest income totaled approximately $0.1 million and $0.5 million for the fiscal years ended July 31, 2020 and 2019, respectively. The decrease in interest income is primarily due to the sale of marketable securities during the fiscal year 2019.

Interest expense totaled approximately $34.0 million and $42.0 million for the fiscal years ended July 31, 2020 and 2019, respectively. The decrease in interest expense is primarily due to the maturity and settlement of the Company's 5.25% Convertible Senior Notes on March 1, 2019.

Other Gains, Net:


Other gains, net for the fiscal year ended July 31, 2020 were approximately $2.1
million. Other gains, net included gains of $0.8 million from the derecognition
of accrued pricing liabilities in the Supply Chain segment and $0.9 million in
net realized and unrealized foreign exchange gains in the Supply Chain segment.

Other gains, net for the fiscal year ended July 31, 2019 were approximately $4.6
million. Other gains, net included gains of $4.6 million from the derecognition
of accrued pricing liabilities in the Supply Chain segment and $0.3 million in
net realized foreign exchange gains in the Supply Chain segment, partially
offset by $0.3 million in other losses, net.

Income Tax Expense:

During the fiscal year ended July 31, 2020, the Company recorded income tax expense of approximately $5.9 million. During the fiscal year ended July 31, 2019, the Company recorded income tax expense of approximately $4.7 million.

The Company provides for income tax expense related to federal, state and foreign income taxes. The Company continues to maintain a full valuation allowance against its deferred tax assets in the U.S. and certain of its foreign subsidiaries due to the uncertainty of realizing such benefits.

Liquidity and Capital Resources


Historically, the Company has financed its operations and met its capital
requirements primarily through funds generated from operations, the sale of it
securities, borrowings from lending institutions and sale of facilities that
were not fully utilized. As of July 31, 2020, the Company's primary sources of
liquidity consisted of cash and cash equivalents of $75.9 million, which include
balances held in certain foreign jurisdictions, and borrowing availability under
its subsidiaries credit facilities.

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, 2019 relating
to this aspect of the U.S. Tax Reform. In future years, under the U.S. Tax
Reform, the Company 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.

Cerberus Credit Facility


On December 15, 2017, the Company entered into a Financing Agreement (the
"Financing Agreement"), by and among the Company, Instant Web, LLC, a Delaware
corporation and wholly-owned subsidiary of IWCO (as "Borrower"), IWCO, and
certain of IWCO's subsidiaries (together with IWCO, the "Guarantors"), the
lenders from time to time party thereto and Cerberus Business Finance, LLC, as
collateral agent and administrative agent for the lenders. Steel Connect, Inc.
is not a borrower or a guarantor under the Financing Agreement.


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The Financing Agreement provides for a $393.0 million term loan facility (the
"Term Loan") and a $25.0 million revolving credit facility (the "Revolving
Facility") (together, the "Cerberus Credit Facility"). Proceeds of the Cerberus
Credit Facility were used (i) to finance a portion of the Company's acquisition
of IWCO (the "IWCO Acquisition"), (ii) to repay certain existing indebtedness of
the Borrower and its subsidiaries, (iii) for working capital and general
corporate purposes and (iv) to pay fees and expenses related to the Financing
Agreement and the IWCO Acquisition. The Cerberus Credit Facility has a maturity
of five years. Borrowings under the Cerberus Credit Facility bear interest, at
the Borrower's option, at a Reference Rate plus 3.75% or a LIBOR Rate plus 6.5%,
each as defined the Financing Agreement. The initial interest rate under the
Cerberus Credit Facility is at the LIBOR Rate option. The Term Loan under the
Cerberus Credit Facility is repayable in consecutive quarterly installments,
each of which will be in an amount equal per quarter of $1.5 million and each
such installment to be due and payable, in arrears, on the last day of each
calendar quarter commencing on March 31, 2018 and ending on the earlier of
(a) December 15, 2022 and (b) upon the payment in full of all obligations under
the Financing Agreement and the termination of all commitments under the
Financing Agreement. Further, the Term Loan would be permanently reduced
pursuant to certain mandatory prepayment events including an annual "excess cash
flow sweep" of 50% of the consolidated excess cash flow, with a step-down to 25%
when the Leverage Ratio (as defined in the Financing Agreement) is below
3.50:1.00; provided that, in any calendar year, any voluntary prepayments of the
Term Loan shall be credited against the Borrower's "excess cash flow" prepayment
obligations on a dollar-for-dollar basis for such calendar year. Borrowings
under the Financing Agreement are fully guaranteed by the Guarantors and are
collateralized by substantially all the assets of the Borrower and the
Guarantors and a pledge of all of the issued and outstanding equity interests of
each of IWCO's subsidiaries.

On March 30, 2020, IWCO entered into Amendment No. 2 to the Financing Agreement
("Amendment No. 2"). Amendment No. 2 amends the Financing Agreement to permit
Borrower to defer approximately $3.0 million in principal payments, due between
March 31, 2020 and June 30, 2020, until loan maturity and to forgo the payment
of approximately $4.3 million in principal payments pursuant to the excess cash
flow sweep in the Financing Agreement. In addition, while Amendment No. 2 limits
the total amount Borrower may distribute to the Company for management fees and
tax sharing to $5.0 million during the calendar year ending December 31, 2020,
Amendment No. 2 also amends the calculation of the excess cash flow defined in
the Financing Agreement, for the same period, to eliminate any adverse impact to
Borrower from the distribution limit or from the deferral of principal payments.
Borrower is required to continue to make all interest payments. In addition,
Amendment No. 2 amends the liquidity requirement from $15.0 million to $14.5
million. Amendment No. 2 was part of a comprehensive precautionary approach to
increase the Company's cash position and maximize its financial flexibility in
light of the current volatility in the global markets resulting from the
COVID-19 outbreak.

The Financing Agreement contains certain representations, warranties, events of
default, mandatory prepayment requirements, as well as certain affirmative and
negative covenants customary for financing agreements of this type. These
covenants include restrictions on borrowings, investments and dispositions, as
well as limitations on the ability of the Borrower and the Guarantors to make
certain capital expenditures and pay dividends. Upon the occurrence and during
the continuation of an event of default under the Financing Agreement, the
lenders under the Financing Agreement may, among other things, terminate all
commitments and declare all or a portion of the loans under the Financing
Agreement immediately due and payable and increase the interest rate at which
loans and obligations under the Financing Agreement bear interest. During the
fiscal year ended July 31, 2020, the Company did not trigger any of these
covenants. At July 31, 2020, IWCO had a readily available borrowing capacity
under its Revolving Facility of $25.0 million. As of July 31, 2020, IWCO did not
have any balance outstanding on the Revolving Facility. As of July 31, 2019,
IWCO had $6.0 million outstanding on the Revolving Facility. As of July 31,
2020, the principal amount outstanding on the Term Loan was $372.0 million, and
the current and long-term net carrying value of the Term Loan was $371.0
million.

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 agreed to loan 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 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

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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, 2020, the net carrying value of the
SPHG Note was $8.1 million.

MidCap Credit Facility

On December 31, 2019, ModusLink, as borrower, and certain of its subsidiaries as
guarantors (the "MidCap Guarantors"), entered into a revolving credit and
security agreement (the "MidCap Credit Agreement"), with MidCap Financial Trust,
as lender and as agent ("MidCap"). The MidCap Credit Agreement, which has a
three year term, provides for a maximum credit commitment of $12.5 million and a
sublimit of $5.0 million for letters of credit. The actual maximum credit
available under the MidCap Credit Agreement varies from time to time and is
determined by calculating the applicable borrowing base, which is based upon
applicable percentages of the values of (a) eligible accounts receivable; plus
(b) the least of (i) the orderly liquidation value of eligible inventory, (ii)
the value of eligible inventory based on first-in-first-out cost or market cost
and other adjustments, and (iii) $4.5 million; minus (c) reserves; all as
specified in the MidCap Credit Agreement. Amounts borrowed under the MidCap
Credit Agreement are due and payable, together with all unpaid interest, fees
and other obligations, on December 31, 2022. Generally, borrowings under the
MidCap Credit Agreement bear interest at a rate per annum equal to the LIBOR
Rate (as defined in the MidCap Credit Agreement), which is subject to adjustment
by MidCap, plus a margin of 4% per annum. In addition to paying interest on
outstanding principal under the MidCap Credit Agreement, ModusLink is required
to pay an unused line fee of 0.50% per annum. ModusLink is also required to pay
a customary letter of credit fee equal to the applicable margin on loans bearing
interest at the LIBOR Rate.

Obligations under the MidCap Credit Agreement are guaranteed by the MidCap
Guarantors, and the MidCap Credit Agreement is secured by security interests in
substantially all of the assets of ModusLink and the MidCap Guarantors,
including a pledge of all of the equity interests of each subsidiary of
ModusLink that is a domestic entity (subject to certain limited exceptions).
Steel Connect, Inc. is not a borrower or a guarantor under the MidCap Credit
Agreement. The MidCap Credit Agreement includes certain representations and
warranties of ModusLink, as well as events of default and certain affirmative
and negative covenants that are customary for credit agreements of this type.
These covenants include restrictions on borrowings, investments and dispositions
by ModusLink, as well as limitations on ModusLink's ability to make certain
distributions and to enter into transactions with affiliates. The MidCap Credit
Agreement requires compliance with certain financial covenants providing for the
maintenance of a minimum fixed charge coverage ratio, all as more fully
described in the MidCap Credit Agreement. Upon the occurrence and during the
continuation of an event of default under the MidCap Credit Agreement, MidCap
may, among other things, declare all obligations under the MidCap Credit
Agreement immediately due and payable and increase the interest rate at which
loans and other obligations under the MidCap Credit Agreement bear interest. At
July 31, 2020, the Company had a readily available borrowing capacity under its
MidCap Credit Facility of $4.4 million. At July 31, 2020, the Company did not
have any balance outstanding on the MidCap Credit Facility.

Steel Connect, Inc., the Parent


As indicated above, Steel Connect, Inc. (excluding its operating subsidiaries,
the "Parent") is not a borrower or a guarantor under its subsidiaries' credit
facilities, and these credit facilities place limits on distributions to the
Parent. Under the Financing Agreement, IWCO is permitted to make distributions
to the Parent, in an aggregate amount not to exceed $5.0

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million in any fiscal year. The Parent is entitled to receive additional cash
remittances under a tax sharing agreement from IWCO; however, the total amount
that IWCO may distribute to the Parent for management fees and tax sharing
during the calendar year ending December 31, 2020, is limited to $5.0 million.
Distributions by ModusLink to the Parent are limited to $2.0 million in any
fiscal year under the terms of the MidCap Credit Agreement.

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; however, there can be no assurances that the Parent and its
operating businesses will continue to have access to their lines of credit if
their financial performance does not satisfy the financial covenants set forth
in their respective financing agreements, which could also result in the
acceleration of their debt obligations by their respective lenders, adversely
affecting liquidity.

Cash Flows Information

Consolidated working capital deficit was $26.4 million at July 31, 2020,
compared with $43.5 million at July 31, 2019. Included in working capital were
cash and cash equivalents of $75.9 million at July 31, 2020 and $32.5 million at
July 31, 2019. The improvement in the working capital deficit was primarily
driven by higher cash and cash equivalents and lower accounts payable, partially
offset by lower accounts receivable due to earlier customer cash receipts,
reflecting our focus on cash collection, and reduced sales levels at IWCO, as
well as increased lease liabilities recognized due to the adoption of new
accounting standards.

Net cash provided by operating activities was $71.6 million for the fiscal year
ended July 31, 2020, as compared to net cash provided by operating activities of
$20.8 million in the prior year period. The $50.8 million improvement in cash
provided by operating activities reflects improvement in operating income.
During the year ended July 31, 2020, non-cash items within net cash provided by
operating activities included depreciation expense of $23.1 million,
amortization of intangible assets of $27.3 million, amortization of deferred
financing costs of $0.4 million, accretion of debt discount of $0.6 million,
share-based compensation of $0.7 million and other gains, net of $2.1 million.
During the fiscal year ended July 31, 2019, non-cash items within net cash
provided by operating activities included depreciation expense of $22.1 million,
amortization of intangible assets of $30.4 million, amortization of deferred
financing costs of $0.8 million, accretion of debt discount of $3.4 million,
impairment of long-lived assets of $3.0 million, share-based compensation of
$1.3 million, other gains, net of $4.6 million and gains on investments in
affiliates of $42.0 thousand.

The Company believes that its 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. Our cash flows from operations
are also dependent on several factors including the overall performance of the
technology sector, the market for outsourcing services and the continued
positive operations of IWCO.

Net cash used in investing activities was $11.9 million for the fiscal year
ended July 31, 2020, as compared to net cash used in investing activities of
$14.5 million in the prior year period. The $11.9 million of cash used in
investing activities during the fiscal year ended July 31, 2020 was primarily
comprised of $12.1 million in capital expenditures. The $14.5 million of cash
used in investing activities during the year ended July 31, 2019 was primarily
comprised of $14.5 million in capital expenditures.

Net cash used in financing activities was $12.3 million for the year ended
July 31, 2020, as compared to net cash used in financing activities of $63.8
million in the prior year period. The $12.3 million of cash used in financing
activities during the fiscal year ended July 31, 2020 was primarily due to $6.0
million of net payments under revolving credit facilities, $3.2 million in
payments of long-term debt, $2.1 million in payment of preferred dividends and
$0.9 million in payments for financing the MidCap Credit Agreement and amending
the Cerberus Credit Facility. The $63.8 million of cash used in financing
activities during the year ended July 31, 2019 was primarily comprised of
proceeds from issuance of the SPHG Note of $14.9 million, proceeds from
revolving line of credit, net of $6.0 million, payments on maturity of the
Company's 5.25% convertible senior notes of $63.9 million, payments of long-term
debt of $14.9 million, payments of preferred dividends of $2.1 million,
purchases of the Company's convertible senior notes of $3.7 million.

The Company believes it will generate sufficient cash to meet its debt
obligations and covenants under its credit facilities to which certain of its
subsidiaries are a party and that it will be able to obtain cash through its
current and future credit facilities, if needed.

Off-Balance Sheet Financing Arrangements

The Company does not have any off-balance sheet financing arrangements.

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Contractual Obligations

Consistent with the rules applicable to "Smaller Reporting Companies" we have omitted information required by this Item.

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 goodwill, other intangible assets and
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, and (9) accrued pricing
and tax related liabilities. 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 goodwill, other intangible assets
and 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


• Inventory valuation

• Accounting for goodwill, other intangible assets and long-lived assets


• Income taxes



Revenue Recognition

The Company recognizes revenue from its contracts with customers primarily from
the sale of marketing solutions offerings and 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
IWCO's marketing solutions offerings and ModusLink's supply chain management
services arrangements, the goods and 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.

Marketing solutions offerings.


IWCO's revenue is generated through the provision of data-driven marketing
solutions, primarily through providing direct mail products to customers.
Revenue related to the majority of IWCO's marketing solutions contracts, which
typically consist of a single integrated performance obligation, is recognized
over time as the Company performs because the products have no alternative use
to the Company.

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

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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.

Significant Judgments


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 significant 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.

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.

Inventory Valuation


We value inventory at the lower of cost or net realizable value. Cost is
determined by both moving averages and the first-in, first-out methods. We
monitor inventory balances and record inventory provisions for any excess of the
cost of the inventory over its estimated net realizable value. We also monitor
inventory balances for obsolescence and excess quantities as compared to
projected demands. Our inventory methodology is based on assumptions about
average shelf life of inventory, forecasted volumes, forecasted selling prices,
contractual provisions with our clients, write-down history of inventory and
market conditions. While such assumptions may change from period to period, in
determining the net realizable value of our inventories, we use the best
information available as of the balance sheet date. If actual market conditions
are less favorable than those projected, or we experience a higher incidence of
inventory obsolescence because of rapidly changing technology or client
requirements, additional inventory provisions may be required. Once established,
write-downs of inventory are considered permanent adjustments to the cost basis
of inventory and cannot be reversed due to subsequent increases in demand
forecasts.

IWCO's inventory consists primarily of raw material (paper) used to produce
direct mail packages and work-in-process. Finished goods are generally not a
significant element of IWCO's inventory as they are generally mailed after the
production and sorting process.

Accounting for Impairment of Long-Lived Assets, Goodwill and Other Intangible Assets



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Goodwill, which is not amortized, represents the difference between the purchase
price and the fair value of identifiable net assets acquired in a business
combination. The Company's goodwill of $257.1 million as of July 31, 2020
relates to the Company's Direct Marketing reporting unit, which is the only
reporting unit in the Direct Marketing reportable segment. We review goodwill
for impairment annually in the fourth quarter and test for impairment during the
year if an event occurs or circumstances change that would indicate the carrying
amount may be impaired. An entity can choose between using the qualitative or
Step 0 approach, or perform a quantitative test for impairment.

For the Step 0 approach, an entity may assess qualitative factors to determine
whether it is more likely than not that the fair value of a reporting unit is
less than its carrying amount. An entity has an unconditional option to bypass
the Step 0 assessment for any reporting unit in any period and proceed directly
to performing the quantitative goodwill impairment test. An entity may resume
performing the Step 0 assessment in any subsequent period.

For the quantitative test, the Company will calculate the fair value of a
reporting unit and compare it to its carrying amount. There are several methods
that may be used to estimate a reporting unit's fair value, including the income
approach, the market approach and/or the cost approach. The Company generally
determines the fair value of its reporting unit using a discounted cash flow
valuation approach. If a potential impairment is identified, the Company will
determine the amount of goodwill impairment by comparing the fair value of a
reporting unit with its carrying amount. To the extent the carrying value of a
reporting unit exceeds its fair value, a goodwill impairment charge is
recognized.

In our latest annual impairment evaluation that occurred as of June 30, 2020, we
used the qualitative method of assessing goodwill for the Direct Marketing
reporting unit, and we determined that it was not more likely than not that the
fair value was less than its carrying value. In making this determination, we
considered several factors, including but not limited to the following:

• the amount by which the fair value of the reporting unit exceeded its

carrying values as of the date of the most recent quantitative impairment

        analysis (April 30, 2020), which was greater than $30 million and which
        indicated there would need to be substantial negative developments in the
        markets in which the Direct Marketing reporting unit operates in order
        for there to be potential impairment;

• the carrying value of the reporting unit as of June 30, 2020 compared to

        the previously calculated fair value as of the date of the most recent
        quantitative impairment analysis;

• the current forecasts as compared to the forecasts included in the most

recent quantitative impairment analysis;

• public information from competitors and other industry information to

determine if there were any significant adverse trends in our

competitors' businesses, such as significant declines in market

capitalization or significant goodwill impairment charges that could be

an indication that the goodwill of our reporting units was potentially

impaired;

• changes in our market capitalization and overall enterprise valuation to

determine if there were any significant decreases that could be an

indication that the valuation of the reporting unit had significantly

decreased; and

• whether there had been any significant increases to the weighted average

        cost of capital (WACC) rate for the reporting unit, which could
        materially lower our prior valuation conclusions under a discounted cash
        flow approach.



As discussed previously, in addition to the annual goodwill impairment
assessment, we review goodwill for impairment whenever events or changes in
circumstances indicate that the carrying amount of a reporting unit's goodwill
may not be recoverable. As a result of the COVID-19 pandemic, it is possible in
future periods that further declines in market conditions, customer demand or
other potential changes in operations may increase the risk that goodwill and
other intangible assets may become impaired.

Other intangible assets, net, as of July 31, 2020, include trademarks and
tradenames with a gross balance of $20.5 million and carrying balance of $2.6
million, and customer relationships with a gross balance of $192.7 million and
carrying balance of $132.7 million. The trademarks and tradenames intangible
assets are being amortized on a straight-line basis over a 3 years estimated
useful life. The customer relationship intangible assets are being amortized on
a double-declining basis over an estimated useful life of 15 years. Intangible
assets are reviewed for impairment on an interim basis when certain events or
circumstances exist. If the carrying amount of other intangible assets, net is
not recoverable, the carrying amount of such assets is reduced to fair value.
The Company did not identify indicators of impairment as of July 31, 2020.

In addition to goodwill and identifiable intangible assets recognized in
connection with our business acquisitions, our long-lived assets also include
property, plant and equipment, capitalized software development costs for
software to be sold, leased or otherwise marketed, and certain long-term
investments. As July 31, 2020, the consolidated carrying values of our property,
plant and equipment were $79.7 million, which represented 10.5% of total assets.
We review the valuation of our long-lived assets whenever events or changes in
circumstances indicate that the carrying amount of these assets may not be

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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 $2.1 billion and $117.0 million, respectively, at
July 31, 2020. A 5% reduction in the Company's current valuation allowance on
these federal and state net operating loss carryforwards would result in an
income tax benefit of approximately $23.4 million. 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, 2020 and 2019, 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, 2020. From a state
perspective, the Company does not have enough deferred tax assets in certain
state jurisdictions to offset future income from the reversal of its deferred
tax liabilities, and therefore a state deferred tax liability was recorded in
the period ending July 31, 2020.

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, 2020.

Recent Accounting Pronouncements

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

Tax Benefits Preservation Plan


In early 2018, Company's Board of Directors adopted an amendment to its Restated
Certificate of Incorporation (the referred to as the "Protective Amendment") and
a tax benefit preservation plan (referred to as the "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. On April 12,
2018, at the 2017 Annual Meeting, the stockholders of Steel Connect approved the
Protective Amendment and Tax Plan, and Steel Connect filed the Protective
Amendment with the Delaware Secretary of State.

The federal net operating losses will expire from fiscal year 2022 through 2038,
and the state net operating losses will expire from fiscal year 2019 through
2039. 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

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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 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 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-percent 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 percent stockholder.

Pursuant to the Tax Plan and subject to certain exceptions, if a stockholder (or
group) becomes a 4.99-percent stockholder after adoption of the Tax Plan, the
Rights would generally become exercisable and entitle stockholders (other than
the 4.99-percent 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-percent 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-percent stockholder, each holder of the Right (other than the
4.99-percent stockholder or group) would then be entitled to purchase shares of
the acquiring company's common stock at a discount.

The Protective Amendment does not expire. The Rights are not exercisable until
the Distribution Date and will expire at the earliest of (i) 11:59 p.m., on
January 18, 2021; (ii) the time at which the Rights are redeemed or exchanged as
provided in the Tax Plan; and (iii) the time at which the Board determines that
the Tax Plan is no longer necessary or desirable for the preservation of the Tax
Benefits. The Company's Board of Directors is currently considering whether to
adopt another tax benefit preservation plan in light of the upcoming expiration
of the Rights under the Tax Plan.

© Edgar Online, source Glimpses


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