UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 10-Q
________________________
(Mark One)
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the quarterly period ended April 30, 2024
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the transition period from to
Commission File Number 001-35319
_______________________
Steel Connect, Inc.
(Exact name of registrant as specified in its charter)
_______________________
Delaware (State or other jurisdiction of incorporation or organization) | 04-2921333 (I.R.S. Employer Identification No.) | |||||||
590 Madison Avenue New York, New York (Address of principal executive offices) | 10022 (Zip Code) | |||||||
(914) 461-1276
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
_______________________
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
| Common Stock, $0.01 par value | STCN | Nasdaq Capital Market | ||||||
| Rights to Purchase Series D Junior Participating Preferred Stock | -- | Nasdaq Capital Market | ||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | Accelerated filer | ☐ | |||||||||||
| Non-accelerated filer | ☒ | Smaller reporting company | ☒ | |||||||||||
| Emerging growth company | ☐ | |||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of May 30, 2024, there were 6,304,750 shares issued and outstanding of the registrant's Common Stock, $0.01 par value per share.
STEEL CONNECT, INC.
FORM 10-Q
TABLE OF CONTENTS
| Page Number | ||||||||
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements.
3
STEEL CONNECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
| Successor | |||||||||||
| April 30, 2024 | July 31, 2023 | ||||||||||
| (unaudited) | |||||||||||
| ASSETS | |||||||||||
| Cash and cash equivalents | $ | 269,237 | $ | 121,372 | |||||||
Accounts receivable, trade, net of allowance for credit losses of $169 and $219 at April 30, 2024 and July 31, 2023, respectively | 31,873 | 28,616 | |||||||||
| Inventories, net | 7,474 | 8,569 | |||||||||
| Funds held for clients | 3,139 | 2,031 | |||||||||
| Prepaid expenses and other current assets | 2,727 | 158,686 | |||||||||
| Total current assets | 314,450 | 319,274 | |||||||||
| Property and equipment, net | 5,153 | 3,698 | |||||||||
| Operating lease right-of-use assets | 22,907 | 27,098 | |||||||||
| Investments | 14,293 | — | |||||||||
| Other intangible assets, net | 31,929 | 34,589 | |||||||||
| Goodwill | 22,785 | 22,785 | |||||||||
| Deferred tax assets | 71,065 | 317 | |||||||||
| Other assets | 2,880 | 3,420 | |||||||||
| Total assets | $ | 485,462 | $ | 411,181 | |||||||
| LIABILITIES, CONTINGENTLY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY | |||||||||||
| Accounts payable | $ | 27,494 | $ | 26,514 | |||||||
| Accrued expenses | 23,057 | 26,774 | |||||||||
| Funds held for clients | 3,031 | 1,949 | |||||||||
| Current lease obligations | 8,890 | 7,973 | |||||||||
| Convertible note payable | 12,903 | — | |||||||||
| Other current liabilities | 4,333 | 4,544 | |||||||||
| Total current liabilities | 79,708 | 67,754 | |||||||||
| Convertible note payable | — | 12,461 | |||||||||
| Long-term lease obligations | 14,444 | 19,161 | |||||||||
| Other long-term liabilities | 4,997 | 5,442 | |||||||||
| Total long-term liabilities | 19,441 | 37,064 | |||||||||
| Total liabilities | 99,149 | 104,818 | |||||||||
Series C contingently redeemable preferred stock, $0.01 par value per share. 35,000 shares authorized, issued and outstanding at April 30, 2024 and July 31, 2023 | 35,000 | 35,006 | |||||||||
Series E contingently redeemable preferred stock, $0.01 par value per share. 3,500,000 shares authorized, issued and outstanding at April 30, 2024 and July 31, 2023 | 202,733 | 202,733 | |||||||||
| Total contingently redeemable preferred stock | 237,733 | 237,739 | |||||||||
| Stockholders' equity: | |||||||||||
Preferred stock, $0.01 par value per share. 4,965,000 shares authorized at April 30, 2024 and July 31, 2023; zero shares issued and outstanding at April 30, 2024 and July 31, 2023 | — | — | |||||||||
Common stock, $0.01 par value per share. Authorized 1,400,000,000 shares; 6,304,750 issued and outstanding shares at April 30, 2024; 6,250,493 issued and outstanding shares at July 31, 2023 | 65 | 65 | |||||||||
| Additional paid-in capital | 61,993 | 61,534 | |||||||||
| Accumulated earnings | 87,450 | 7,612 | |||||||||
| Accumulated other comprehensive loss | (928) | (587) | |||||||||
| Total stockholders' equity | 148,580 | 68,624 | |||||||||
| Total liabilities, contingently redeemable preferred stock and stockholders' equity | $ | 485,462 | $ | 411,181 | |||||||
See accompanying notes to unaudited condensed consolidated financial statements
4
STEEL CONNECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
| Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||||||||||||
| Three Months Ended April 30, | Three Months Ended April 30, | Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | 2024 | 2023 | ||||||||||||||||||||||||||||||||
| Net revenue | $ | 43,855 | $ | 46,142 | $ | 128,240 | $ | 148,283 | |||||||||||||||||||||||||||
| Cost of revenue | 30,838 | 33,218 | 92,402 | 108,031 | |||||||||||||||||||||||||||||||
| Gross profit | 13,017 | 12,924 | 35,838 | 40,252 | |||||||||||||||||||||||||||||||
| Operating expenses: | |||||||||||||||||||||||||||||||||||
| Selling, general and administrative | 9,144 | 12,619 | 26,670 | 33,463 | |||||||||||||||||||||||||||||||
| Amortization | 893 | — | 2,661 | — | |||||||||||||||||||||||||||||||
| Total operating expenses | 10,037 | 12,619 | 29,331 | 33,463 | |||||||||||||||||||||||||||||||
| Operating income | 2,980 | 305 | 6,507 | 6,789 | |||||||||||||||||||||||||||||||
| Other income (expense): | |||||||||||||||||||||||||||||||||||
| Interest income | 3,656 | 452 | 10,374 | 928 | |||||||||||||||||||||||||||||||
| Interest expense | (243) | (914) | (739) | (2,588) | |||||||||||||||||||||||||||||||
| Other (losses) gains, net | (2,533) | 4,037 | (1,635) | 3,961 | |||||||||||||||||||||||||||||||
| Total other income, net | 880 | 3,575 | 8,000 | 2,301 | |||||||||||||||||||||||||||||||
| Income before income taxes | 3,860 | 3,880 | 14,507 | 9,090 | |||||||||||||||||||||||||||||||
| Income tax (benefit) expense | (67,800) | 851 | (66,935) | 1,630 | |||||||||||||||||||||||||||||||
| Net income | 71,660 | 3,029 | 81,442 | 7,460 | |||||||||||||||||||||||||||||||
| Less: Preferred dividends on Series C redeemable preferred stock | (531) | (519) | (1,604) | (1,593) | |||||||||||||||||||||||||||||||
| Net income available to common stockholders | $ | 71,129 | $ | 2,510 | $ | 79,838 | $ | 5,867 | |||||||||||||||||||||||||||
| Net income per common shares - basic | $ | 2.73 | $ | 0.39 | $ | 3.07 | $ | 0.91 | |||||||||||||||||||||||||||
| Net income per common shares - diluted | $ | 2.51 | $ | 0.36 | $ | 2.88 | $ | 0.89 | |||||||||||||||||||||||||||
| Weighted-average number of common shares outstanding - basic | 6,224 | 6,461 | 6,211 | 6,449 | |||||||||||||||||||||||||||||||
| Weighted-average number of common shares outstanding - diluted | 28,599 | 8,431 | 28,580 | 8,417 | |||||||||||||||||||||||||||||||
See accompanying notes to unaudited condensed consolidated financial statements
5
STEEL CONNECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
| Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||||||||||||
| Three Months Ended April 30, | Three Months Ended April 30, | Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | 2024 | 2023 | ||||||||||||||||||||||||||||||||
| Net income | $ | 71,660 | $ | 3,029 | $ | 81,442 | $ | 7,460 | |||||||||||||||||||||||||||
| Other comprehensive income (loss): | |||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustment | (68) | (819) | (341) | 999 | |||||||||||||||||||||||||||||||
| Pension liability adjustments, net of tax | — | — | — | (1,078) | |||||||||||||||||||||||||||||||
| Other comprehensive loss | (68) | (819) | (341) | (79) | |||||||||||||||||||||||||||||||
| Comprehensive income | $ | 71,592 | $ | 2,210 | $ | 81,101 | $ | 7,381 | |||||||||||||||||||||||||||
See accompanying notes to unaudited condensed consolidated financial statements
6
STEEL CONNECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share amounts)
(unaudited)
| Number of Shares | Common Stock | Additional Paid-in Capital | Accumulated Earnings | Accumulated Other Comprehensive Loss | Total Stockholders' Equity | ||||||||||||||||||||||||||||||
| Balance at January 31, 2024 (Successor) | 6,285,591 | $ | 65 | $ | 61,831 | $ | 16,321 | $ | (860) | $ | 77,357 | ||||||||||||||||||||||||
| Net income | — | — | — | 71,660 | — | 71,660 | |||||||||||||||||||||||||||||
| Preferred dividends | — | — | — | (531) | — | (531) | |||||||||||||||||||||||||||||
| Restricted stock grants | 19,159 | — | — | — | — | — | |||||||||||||||||||||||||||||
| Share-based compensation | — | — | 162 | — | — | 162 | |||||||||||||||||||||||||||||
| Other comprehensive items | — | — | — | — | (68) | (68) | |||||||||||||||||||||||||||||
| Balance at April 30, 2024 (Successor) | 6,304,750 | $ | 65 | $ | 61,993 | $ | 87,450 | $ | (928) | $ | 148,580 | ||||||||||||||||||||||||
| Number of Shares | Common Stock | Additional Paid-in Capital | Accumulated Deficit | Accumulated Other Comprehensive Income | Total Stockholders' Deficit | ||||||||||||||||||||||||||||||
| Balance at January 31, 2023 (Predecessor) | 6,512,633 | $ | 65 | $ | 7,480,261 | $ | (7,489,960) | $ | 4,880 | $ | (4,754) | ||||||||||||||||||||||||
| Net income | — | — | — | 3,029 | — | 3,029 | |||||||||||||||||||||||||||||
| Preferred dividends | — | — | — | (519) | — | (519) | |||||||||||||||||||||||||||||
| Restricted stock grants | 16,916 | — | — | — | — | — | |||||||||||||||||||||||||||||
| Share-based compensation | — | — | 174 | — | — | 174 | |||||||||||||||||||||||||||||
| Other comprehensive items | — | — | — | — | (819) | (819) | |||||||||||||||||||||||||||||
| Balance at April 30, 2023 (Predecessor) | 6,529,549 | $ | 65 | $ | 7,480,435 | $ | (7,487,450) | $ | 4,061 | $ | (2,889) | ||||||||||||||||||||||||
7
| Number of Shares | Common Stock | Additional Paid-in Capital | Accumulated Earnings | Accumulated Other Comprehensive Loss | Total Stockholders' Equity | ||||||||||||||||||||||||||||||
| Balance at July 31, 2023 (Successor) | 6,250,493 | $ | 65 | $ | 61,534 | $ | 7,612 | $ | (587) | $ | 68,624 | ||||||||||||||||||||||||
| Net income | — | — | — | 81,442 | — | 81,442 | |||||||||||||||||||||||||||||
| Preferred dividends | — | — | — | (1,604) | — | (1,604) | |||||||||||||||||||||||||||||
| Restricted stock grants | 54,257 | — | — | — | — | — | |||||||||||||||||||||||||||||
| Share-based compensation | — | — | 459 | — | — | 459 | |||||||||||||||||||||||||||||
| Other comprehensive items | — | — | — | — | (341) | (341) | |||||||||||||||||||||||||||||
| Balance at April 30, 2024 (Successor) | 6,304,750 | $ | 65 | $ | 61,993 | $ | 87,450 | $ | (928) | $ | 148,580 | ||||||||||||||||||||||||
| Number of Shares | Common Stock | Additional Paid-in Capital | Accumulated Deficit | Accumulated Other Comprehensive Income | Total Stockholders' Deficit | ||||||||||||||||||||||||||||||
| Balance at July 31, 2022 (Predecessor) | 6,485,309 | $ | 65 | $ | 7,479,906 | $ | (7,493,317) | $ | 4,140 | $ | (9,206) | ||||||||||||||||||||||||
| Net income | — | — | — | 7,460 | — | 7,460 | |||||||||||||||||||||||||||||
| Preferred dividends | — | — | — | (1,593) | — | (1,593) | |||||||||||||||||||||||||||||
| Restricted stock grants | 44,240 | — | — | — | — | — | |||||||||||||||||||||||||||||
| Share-based compensation | — | — | 529 | — | — | 529 | |||||||||||||||||||||||||||||
| Other comprehensive items | — | — | — | — | (79) | (79) | |||||||||||||||||||||||||||||
| Balance at April 30, 2023 (Predecessor) | 6,529,549 | $ | 65 | $ | 7,480,435 | $ | (7,487,450) | $ | 4,061 | $ | (2,889) | ||||||||||||||||||||||||
See accompanying notes to unaudited condensed consolidated financial statements
8
STEEL CONNECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
| Successor | Predecessor | ||||||||||||||||
| Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||
| 2024 | 2023 | ||||||||||||||||
| Cash flows from operating activities: | |||||||||||||||||
| Net income | $ | 81,442 | $ | 7,460 | |||||||||||||
| Adjustments to reconcile net income to cash flows from operating activities: | |||||||||||||||||
| Depreciation | 1,324 | 1,427 | |||||||||||||||
| Amortization of finite-lived intangible assets | 2,661 | — | |||||||||||||||
| Amortization of deferred financing costs | — | 36 | |||||||||||||||
| Accretion of debt discount | — | 1,688 | |||||||||||||||
| Share-based compensation | 459 | 529 | |||||||||||||||
| Deferred taxes | (71,550) | — | |||||||||||||||
| Non-cash lease expense | 6,838 | 6,760 | |||||||||||||||
| Bad debt expense | — | 1,136 | |||||||||||||||
| Other losses (gains), net | 1,635 | (3,962) | |||||||||||||||
| Changes in operating assets and liabilities: | |||||||||||||||||
| Accounts receivable, net | (3,632) | 2,933 | |||||||||||||||
| Inventories, net | 808 | 1,440 | |||||||||||||||
| Prepaid expenses and other current assets | 1,363 | (1,237) | |||||||||||||||
| Accounts payable and accrued expenses | (1,725) | (3,886) | |||||||||||||||
| Refundable and accrued income taxes, net | (117) | (829) | |||||||||||||||
| Other assets and liabilities | (4,078) | (4,495) | |||||||||||||||
| Net cash provided by operating activities | 15,428 | 9,000 | |||||||||||||||
| Cash flows from investing activities: | |||||||||||||||||
| Purchases of investments | (18,869) | — | |||||||||||||||
| Proceeds from sales of investments | 157,599 | 1,881 | |||||||||||||||
| Additions of property and equipment | (2,911) | (1,311) | |||||||||||||||
| Proceeds from the disposition of property and equipment | — | 166 | |||||||||||||||
| Net cash provided by investing activities | 135,819 | 736 | |||||||||||||||
| Cash flows from financing activities: | |||||||||||||||||
| Preferred dividend payments | (1,604) | (1,593) | |||||||||||||||
| Payment of deferred financing costs | — | (149) | |||||||||||||||
| Repayments on debt | — | (1,000) | |||||||||||||||
| Repayments on capital lease obligations | — | (38) | |||||||||||||||
| Net cash used in financing activities | (1,604) | (2,780) | |||||||||||||||
| Net effect of exchange rate changes on cash, cash equivalents and restricted cash | (670) | 895 | |||||||||||||||
| Net increase in cash, cash equivalents and restricted cash | 148,973 | 7,851 | |||||||||||||||
| Cash, cash equivalents and restricted cash, beginning of period | 123,403 | 58,045 | |||||||||||||||
| Cash, cash equivalents and restricted cash, end of period | $ | 272,376 | $ | 65,896 | |||||||||||||
| Cash and cash equivalents, end of period | $ | 269,237 | $ | 62,738 | |||||||||||||
| Restricted cash for funds held for clients, end of period | 3,139 | 3,158 | |||||||||||||||
| Cash, cash equivalents and restricted cash, end of period | $ | 272,376 | $ | 65,896 | |||||||||||||
9
See accompanying notes to unaudited condensed consolidated financial statements
10
STEEL CONNECT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1)NATURE OF OPERATIONS
Steel Connect, Inc. (the "Company" or "Steel Connect"), is a holding company which operates through its wholly-owned subsidiary ModusLink Corporation ("ModusLink" or "Supply Chain").
ModusLink is a supply chain business process management company serving clients in markets such as consumer electronics, communications, computing, medical devices, software and retail. ModusLink designs and executes elements in its clients' global supply chains to improve speed to market, product customization, flexibility, cost, quality and service. The Company also produces and licenses an entitlement management solution for activation, provisioning, entitlement subscription and data collection from physical goods (connected products) and digital products.
Steel Partners and Steel Connect Exchange Transaction
On April 30, 2023, Steel Partners Holdings L.P., (“Steel Holdings”) and the Company executed a series of agreements in which Steel Holdings and certain of its affiliates (the “Steel Partners Group”) agreed to transfer certain marketable securities held by the Steel Partners Group to the Company in exchange for 3.5 million shares of Series E Convertible Preferred Stock of the Company (the “Series E Convertible Preferred Stock”, and, such transfer and related transactions, the “Exchange Transaction”). The Exchange Transaction closed on May 1, 2023, which is the date that the consideration was exchanged between Steel Holdings and the Company. See Note 4 - "Exchange Transaction" for further information regarding the Exchange Transaction.
(2)BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of a normal recurring nature) considered necessary for fair presentation have been included. These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and related notes for the year ended July 31, 2023 (Fiscal Year 2023), which are contained in the Company's Fiscal Year 2023 Form 10-K filed on November 8, 2023, as amended on November 28, 2023. Certain prior year amounts have been reclassified to conform to current year presentation. The results for the nine months ended April 30, 2024 are not necessarily indicative of the results to be expected for the full fiscal year. The year-end condensed consolidated balance sheet data was derived from audited consolidated financial statements, but does not include all disclosures required by U.S. GAAP.
Predecessor/Successor Reporting
On May 1, 2023, the Exchange Transaction resulted in Steel Holdings obtaining control of the Company for financial statement consolidation purposes. Steel Holdings does not consolidate the Company for Federal income tax purposes because the ownership in the Company is dispersed between different federal tax consolidation groups within Steel Holdings. As of May 1, 2023, the Company elected pushdown accounting in which it used Steel Holdings' basis of accounting, which reflected the fair market value of the Company’s assets and liabilities at the date of the Exchange Transaction. As a result, the Company has reflected the required pushdown accounting adjustments in its consolidated financial statements. Due to the application of pushdown accounting, the Company’s consolidated financial statements and certain footnote disclosures include a black line division between the two distinct periods to indicate the application of two different bases of accounting, which may not be comparable, between the periods presented. The pre-exchange period through April 30, 2023 is referred to as the "Predecessor" period. The post-exchange period, May 1, 2023 and onward, includes the impact of pushdown accounting and is referred to as the "Successor" period. As such for purposes of this quarterly report, all references to the three and nine months ended April 30, 2024 are for the Successor period, and all references to the three and nine months ended April 30, 2023 are for the Predecessor period. See Note 4 - "Exchange Transaction" for further information regarding the Exchange Transaction and the application of pushdown accounting.
Reverse/Forward Stock Split
At the special stockholders meeting held on June 6, 2023, the stockholders approved proposals to amend the Company’s restated certificate of incorporation (the “Charter”), to effect a 1-for-3,500 reverse stock split of the common stock (the “Reverse Stock Split”), followed immediately by a 375-for-1 forward stock split of the common stock (the “Forward Stock Split,” and, together with the Reverse Stock Split, the “Reverse/Forward Stock Split”). On June 7, 2023, Steel Connect's Board of Directors ("the Board") approved the Reverse/Forward Stock Split, and as such, the Board directed the Company to file with the State of
11
Delaware certificates of amendment to our Charter to effectuate the Reverse/Forward Stock Split. The Reverse/Forward Stock Split was effective on June 21, 2023 (the “Effective Date”). The Company’s common stock began trading on a Reverse/Forward Stock Split-adjusted basis on the Nasdaq Capital Market when the market opened on June 22, 2023. The trading symbol for the Company’s common stock remains “STCN.” Accordingly, all share and per-share amounts for the current period and prior periods have been adjusted to reflect the Reverse/Forward Stock Split.
Summary of Significant Accounting Policies
Interest income is recognized when earned.
All intercompany transactions and balances have been eliminated in consolidation.
The Company considers events or transactions that occur after the balance sheet date but before the issuance of financial statements to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. For the nine months ended April 30, 2024, the Company evaluated subsequent events for potential recognition and disclosure through the date these financial statements were filed.
The following significant accounting policy has been added from the policies described in the Fiscal Year 2023 Form 10-K:
Investments
Long-term investments consist of debt and equity securities. The Company determines the appropriate classifications of its investments at the acquisition date and re-evaluates the classifications at each balance sheet date.
Equity securities that do not result in consolidation and are not accounted for under the equity method are measured at fair value, with any changes recognized in Other (losses) gains, net in the consolidated statements of operations in accordance with Accounting Standards Codification ("ASC") Topic 321, Investments - Equity Securities. The Company uses quoted market prices to determine the fair value of equity securities with readily determinable fair value.
Available-for-sale debt securities are reported at fair value, with unrealized gains and losses recognized in accumulated other comprehensive income or loss as a separate component of the Company's stockholders' equity in accordance with ASC Topic 320, Investments - Debt Securities. To the extent that debt securities meet the definition of a hybrid security under ASC 815, Derivatives and Hedging, the Company may elect the fair value option under ASC 825, Financial Instruments to measure the entire hybrid instrument, with changes in fair value recorded in the Company's consolidated statements of operations.
(3)RECENT ACCOUNTING PRONOUNCEMENTS
Accounting Standards Issued and Not Yet Implemented
In December 2023, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures, which is intended to enhance the transparency, decision usefulness and effectiveness of income tax disclosures. The new guidance requires disaggregated information about the effective tax rate reconciliation and additional information on taxes paid that meet a quantitative threshold. The new guidance is effective for annual reporting periods beginning after December 15, 2024, with early adoption and retrospective application permitted. This guidance will be effective for the Company beginning in the fourth quarter in the fiscal year ending July 31, 2026. The Company is currently evaluating this guidance to determine the impact it may have on its consolidated financial statement disclosures; however, adoption is not expected to impact its consolidated balance sheets or statement of operations.
In November 2023, the FASB issued ASU No. 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures, which is intended to improve reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses, allowing financial statement users to better understand the components of a segment's profit or loss to assess potential future cash flows for each reportable segment and the entity as a whole. The new guidance requires a public entity to disclose significant expenses and other segment items that are regularly reported to the chief operating decision maker ("CODM") and the nature of segment expense information used to manage operations. Additionally, it requires a public entity to disclose the title and position of the CODM. The ASU does not change how a public entity identifies its operating segments, aggregates them, or applies the quantitative thresholds to determine its reportable segments. The new guidance is effective for annual reporting periods beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. This guidance will be effective for the Company beginning in the fourth quarter in the fiscal year ending July 31, 2025. The Company is currently evaluating this guidance to determine the impact it may have on its consolidated financial statement disclosures; however, adoption is not expected to impact its consolidated balance sheets or statements of operations.
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In August 2020, the FASB issued ASU 2020-06, Debt-Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging-Contracts in Entity's Own Equity (Subtopic 815-40). The amendment in this update simplifies the accounting for convertible instruments by reducing the number of accounting models available for convertible debt instruments and convertible preferred stock. This update also amends the guidance for the derivatives scope exception for contracts in an entity's own equity to reduce form-over-substance-based accounting conclusions and requires the application of the if-converted method for calculating diluted earnings per share. The update also requires entities to provide expanded disclosures about the terms and features of convertible instruments, how the instruments have been reported in the entity's financial statements and information about events, conditions and circumstances that can affect how to assess the amount or timing of an entity's future cash flows related to those instruments. The guidance is effective beginning in the first quarter of our fiscal year ending July 31, 2025, with early adoption permitted. The Company is currently evaluating this guidance to determine the impact it may have on its consolidated financial statements; however, adoption is not expected to impact its consolidated balance sheets or statements of operations.
Other new pronouncements issued but not effective until after April 30, 2024 are not expected to have a material impact on our financial condition, results of operations or liquidity.
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(4)EXCHANGE TRANSACTION
Steel Partners and Steel Connect Exchange Transaction
On April 30, 2023, the Company and Steel Holdings executed a series of agreements, in which the Steel Partners Group transferred an aggregate of 3,597,744 shares of common stock, par value $0.10 per share, of Aerojet Rocketdyne Holdings, Inc. ("Aerojet") held by the Steel Partners Group to the Company in exchange for 3.5 million shares of the Company's newly created Series E Convertible Preferred Stock (the “Series E Convertible Preferred Stock” and such transfer and related transactions, the "Exchange Transaction"). Following the approval by the Company's stockholders on June 6, 2023, pursuant to the rules of the Nasdaq Capital Market, the Series E Convertible Preferred Stock is convertible into an aggregate of 19.8 million shares of the Company's common stock, par value $0.01 per share (the “common stock” or “Common Stock”), and votes together with the Company's common stock and participates in any dividends paid on the Company's common stock, in each case on an as-converted basis. Upon conversion of the Series E Convertible Preferred Stock, when combined with the Steel Connect common stock, the 7.50% Convertible Senior Note, if converted, and the Steel Connect Series C Convertible Preferred Stock, also if converted, owned by Steel Holdings, would result in Steel Holdings holding approximately 84.0% of the outstanding equity interests of the Company as of May 1, 2023.
The Exchange Transaction closed on May 1, 2023, the date that the consideration was exchanged between the Company and Steel Holdings, and as of that date the Company became a consolidated subsidiary of Steel Holdings for financial statement purposes. The Company is not consolidated by Steel Holdings for Federal income tax purposes because Steel Holdings' ownership in the Company is dispersed between different federal tax consolidation groups. The Company's assets and liabilities have been included in Steel Holdings' consolidated balance sheet, with a related noncontrolling interest of 16.0% of the Company's common stock. Prior to May 1, 2023, when including the if-converted value of the 7.50% Convertible Senior Note and the Steel Connect Series C Convertible Preferred Stock, Steel Holdings held a 49.6% ownership interest in the Company and accounted for its investment in the Company in accordance with the equity method of accounting. As of the date of the Exchange Transaction, Steel Holdings remeasured the previously held equity method investment to its fair value based upon a valuation of the Company.
The Exchange Transaction was accounted for in accordance with ASC Topic 805, Business Combinations, and, accordingly, the Company's results of operations were consolidated in Steel Holdings' financial statements on the date of the Exchange Transaction. Steel Holdings recorded a preliminary allocation of the Exchange Transaction to assets acquired and liabilities assumed based on their estimated fair values as of May 1, 2023. Steel Holdings' final Exchange Transaction allocation was finalized as of December 31, 2023, with no significant changes to preliminary amounts. As discussed in Note 2 - "Basis of Presentation", the Company elected pushdown accounting in which it uses Steel Holdings' basis of accounting, which reflects the fair market value of the Company’s assets and liabilities at the date of the Exchange Transaction.
The following table summarizes the total Exchange Transaction consideration:
| (in thousands) | May 1, 2023 | ||||
| Fair value of Aerojet common stock | $ | 202,733 | |||
| Fair value of previously held interest in Steel Connect and noncontrolling interest | 111,816 | ||||
| Less: cash acquired from Steel Connect | (65,896) | ||||
| Total estimated consideration, less cash acquired | $ | 248,653 | |||
The following represents the final calculation of goodwill and fair value amounts recognized. The Company notes that there were no measurement period adjustments made in the current period that would result in an updated preliminary fair value allocation.
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| (in thousands) | May 1, 2023 | ||||
| Assets | |||||
| Accounts receivable, trade | $ | 36,900 | |||
| Inventories, net | 6,900 | ||||
| Prepaid expenses and other current assets | 4,957 | ||||
| Other intangible assets | 35,500 | ||||
| Other assets | 3,900 | ||||
| Property and equipment, net | 3,400 | ||||
| Operating lease right-of-use assets | 29,250 | ||||
| Investments | 202,733 | ||||
| Estimated fair value of total assets acquired by Steel Holdings | 323,540 | ||||
| Liabilities | |||||
| Accounts payable | 26,300 | ||||
| Accrued expenses | 29,100 | ||||
| Current lease obligations | 7,994 | ||||
| Other current liabilities | 7,236 | ||||
| Long-term lease obligations | 21,300 | ||||
| Other long-term liabilities | 5,742 | ||||
| Estimated fair value of total liabilities assumed by Steel Holdings | 97,672 | ||||
| Fair value of identifiable net assets | 225,868 | ||||
| Goodwill attributable to Steel Connect | $ | 22,785 | |||
In connection with the application of pushdown accounting, the Company calculated the amount of goodwill recognized based on the excess of the Exchange Transaction consideration over the fair value of net identifiable assets acquired and liabilities assumed. Goodwill is primarily attributable to expected synergies and the assembled workforce of the Company. The goodwill recognized will not be deductible for income tax purposes.
Identifiable intangible assets were recognized at their estimated fair value as of the date of the Exchange Transaction. The fair value of the trade name asset was determined using the relief-from-royalty method and the fair value of the customer relationships asset was determined using the excess earnings method. These income-based approaches included assumptions such as the amount and timing of projected cash flows, growth rates, customer attrition rates, discount rates, and the assessment of the asset’s life cycle. The estimated fair value and estimated remaining useful lives of identifiable intangible assets as of the Exchange Transaction date were as follows:
| (in thousands) | Useful Life (Years) | Amount | ||||||||||||
| Customer relationships | 7 | $ | 25,000 | |||||||||||
| Trade name | Indefinite | 10,500 | ||||||||||||
| Estimated fair value of identifiable intangible assets | $ | 35,500 | ||||||||||||
(5)GOODWILL AND OTHER INTANGIBLE ASSETS, NET
In connection with the application of pushdown accounting, the Company recorded intangible assets for goodwill, customer relationships and tradenames. A reconciliation of the change in the carrying amount of goodwill by reportable segment is as follows:
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| (in thousands) | Supply Chain | ||||
| Balance at July 31, 2023 (Successor) | |||||
| Gross goodwill | $ | 22,785 | |||
| Accumulated impairments | — | ||||
| Net goodwill | $ | 22,785 | |||
| Balance at April 30, 2024 (Successor) | |||||
| Gross goodwill | $ | 22,785 | |||
| Accumulated impairments | — | ||||
| Net goodwill | $ | 22,785 | |||
A summary of Other intangible assets, net is as follows:
| Successor | |||||||||||||||||||||||||||||||||||
| April 30, 2024 | July 31, 2023 | ||||||||||||||||||||||||||||||||||
| (in thousands) | Gross Carrying Amount | Accumulated Amortization | Net | Gross Carrying Amount | Accumulated Amortization | Net | |||||||||||||||||||||||||||||
| Customer relationships | $ | 25,000 | $ | 3,571 | $ | 21,429 | $ | 25,000 | $ | 911 | $ | 24,089 | |||||||||||||||||||||||
| Trade name | 10,500 | — | 10,500 | 10,500 | — | 10,500 | |||||||||||||||||||||||||||||
| Total | $ | 35,500 | $ | 3,571 | $ | 31,929 | $ | 35,500 | $ | 911 | $ | 34,589 | |||||||||||||||||||||||
The trade name intangible asset has an indefinite useful life. Customer relationships are amortized on a straight-line basis. Amortization expense related to intangible assets was $0.9 million and $2.7 million for the three and nine months ended April 30, 2024, respectively. The Exchange Transaction closed on May 1, 2023, and as such, there was no intangible assets or related amortization expense for the three and nine months ended April 30, 2023.
Based on gross carrying amounts at April 30, 2024, the Company's projection of amortization expense for identifiable intangible assets for the remainder of the fiscal year ending July 31, 2024, and fiscal years 2025 through 2028 and thereafter is presented in the table below:
| Fiscal Year Ending July 31, | |||||||||||||||||||||||||||||||||||
| (in thousands) | 2024 | 2025 | 2026 | 2027 | 2028 | Thereafter | |||||||||||||||||||||||||||||
| Projected amortization expense | $ | 893 | $ | 3,571 | $ | 3,571 | $ | 3,571 | $ | 3,571 | $ | 6,252 | |||||||||||||||||||||||
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(6)INVENTORIES, NET
The table below presents the components of Inventories, net:
| Successor | |||||||||||
| April 30, 2024 | July 31, 2023 | ||||||||||
| (in thousands) | |||||||||||
| Raw materials | $ | 6,271 | $ | 4,805 | |||||||
| Work-in-process | 258 | 239 | |||||||||
| Finished goods | 945 | 3,525 | |||||||||
| $ | 7,474 | $ | 8,569 | ||||||||
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(7)INVESTMENTS
The following table summarizes the Company's investments as of April 30, 2024. There were no investments as of July 31, 2023.
| Successor | ||||||||
| (in thousands) | April 30, 2024 | |||||||
Convertible loan note investment(a) | $ | — | ||||||
Other investments(b) | 14,293 | |||||||
| Total | $ | 14,293 | ||||||
(a) The Company entered into a new convertible loan note on October 13, 2023, which matures on March 31, 2025. The Company paid 1.0 million GBP (approximately $1.2 million) to subscribe for an amount of £1.0 million (the "loan principal") of 11.0% 2025 unsecured convertible loan notes issued by the investee (the "CLN Instrument Agreement"). Contemporaneous with the execution of the CLN Instrument Agreement, the Company executed the Equity Warrant Instrument Agreement (“Warrant Agreement”), which provides the Company with the option to convert the outstanding balance into equity shares of the investee at any time before repayment of the outstanding loan principal balance. The Company’s £1.0 million investment in the £20.0 million GBP 11.0% unsecured convertible loan notes provides it with an approximate 5.0% ownership interest on an if-converted basis. Changes in fair value will be recorded in the Company's condensed consolidated statements of operations as the Company elected the fair value option under ASC 825 to account for this investment. Changes in fair value are recorded in the Company's condensed consolidated statements of operations as the Company elected the fair value option under ASC 825 to account for this investment. In April 2024, the Company became aware that the investee had halted its operations while it undergoes a restructuring process. As a result, the Company determined that the fair value of the investment was zero. The Company recorded a loss of $1.2 million to Other (losses) gains, net on the condensed consolidated statements of operations during the three and nine months ended April 30, 2024, which was the fair value of the investment as of January 31, 2024.
(b) The balance consists of multiple common stock investments in public companies which are measured at fair value.
The amount of unrealized net losses for the three and nine months ended April 30, 2024 that relate to equity securities still held as of April 30, 2024 are as follows:
| Successor | ||||||||||||||
| Three months ended April 30, | Nine months ended April 30, | |||||||||||||
| (in thousands) | 2024 | 2024 | ||||||||||||
| Net losses recognized during the period on equity securities | $ | (872) | $ | (276) | ||||||||||
| Less: Net (losses) gains recognized during the period on equity securities sold during the period | (21) | 372 | ||||||||||||
| Unrealized net losses recognized during the period on equity securities still held at the end of the period | $ | (851) | $ | (648) | ||||||||||
Unrealized net losses are recorded in Other (losses) gains, net on the condensed consolidated statements of operations. There was no investment activity for the three and nine months ended April 30, 2023.
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(8)ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
The following tables reflect the components of "Accrued expenses" and "Other current liabilities".
| Successor | |||||||||||
| April 30, 2024 | July 31, 2023 | ||||||||||
| Accrued Expenses | (in thousands) | ||||||||||
| Accrued compensation | $ | 6,311 | $ | 6,891 | |||||||
| Accrued audit, tax and legal | 4,027 | 5,696 | |||||||||
| Accrued price concessions | 2,587 | 2,981 | |||||||||
| Accrued taxes | 1,796 | 2,811 | |||||||||
| Accrued occupancy costs | 1,611 | 1,412 | |||||||||
| Accrued IT costs | 648 | 831 | |||||||||
| Accrued travel | 535 | — | |||||||||
| Accrued freight | 447 | 502 | |||||||||
| Accrued contract labor | 372 | 517 | |||||||||
| Accrued other | 4,723 | 5,133 | |||||||||
| Total accrued expenses | $ | 23,057 | $ | 26,774 | |||||||
| Successor | |||||||||||
| April 30, 2024 | July 31, 2023 | ||||||||||
| Other Current Liabilities | (in thousands) | ||||||||||
| Deferred revenue - current | 2,762 | 2,574 | |||||||||
| Other | 1,571 | 1,970 | |||||||||
| Total other current liabilities | $ | 4,333 | $ | 4,544 | |||||||
(9)LEASES
The table below presents the components of the Company's lease expense:
| Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||||||||||||
| Three Months Ended April 30, | Three Months Ended April 30, | Nine Months Ended April 30, 2024 | Nine Months Ended April 30, 2023 | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | 2024 | 2023 | ||||||||||||||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||||||||||||||
| Operating lease cost | $ | 2,672 | $ | 2,636 | $ | 7,830 | $ | 7,538 | |||||||||||||||||||||||||||
| Short-term lease expense | 337 | 394 | 1,215 | 1,269 | |||||||||||||||||||||||||||||||
| Variable lease cost | — | — | — | 7 | |||||||||||||||||||||||||||||||
| Sublease income | $ | (61) | $ | (222) | $ | (352) | $ | (786) | |||||||||||||||||||||||||||
| Total lease expense | $ | 2,948 | $ | 2,808 | $ | 8,693 | $ | 8,028 | |||||||||||||||||||||||||||
Supplemental Cash Flow Information
Supplemental cash flow information related to the Company's leases was as follows:
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| Successor | Predecessor | ||||||||||||||||
| Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||
| 2024 | 2023 | ||||||||||||||||
| (in thousands) | |||||||||||||||||
| Cash paid for amounts included in measurement of lease liabilities: | |||||||||||||||||
| Operating cash flows from operating leases | $ | 7,641 | $ | 7,224 | |||||||||||||
| Financing cash flows from finance leases | $ | — | $ | 38 | |||||||||||||
(10)DEBT
The components of debt are presented in the table below:
| Successor | |||||||||||
| April 30, 2024 | July 31, 2023 | ||||||||||
| (in thousands) | |||||||||||
| Unsecured | |||||||||||
7.50% Convertible Senior Note due September 1, 2024 | $ | 12,903 | $ | 12,461 | |||||||
| Credit Facility | |||||||||||
| Umpqua Revolver | — | — | |||||||||
| Total debt, net | $ | 12,903 | $ | 12,461 | |||||||
7.50% Convertible Senior Note
On February 28, 2019, the Company entered into a 7.50% Convertible Senior Note Due 2024 Purchase Agreement (the "SPHG Note Purchase Agreement") with SPH Group Holdings LLC ("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 was amended on March 9, 2023 (the "Amendment Date"), to extend the maturity date to September 1, 2024. In addition, the Company repaid $2.0 million in principal amount of the SPHG Note during Fiscal Year 2023. Refer to Note 18 - "Fair Value Measurements" for further information.
As of both April 30, 2024 and July 31, 2023, the principal amount of the note was $12.9 million. As of May 1, 2023, or the date of the Exchange Transaction, the Company accounts for the SPHG Note under the fair value option in order to conform with Steel Holdings' basis of accounting, with changes in fair value recognized in earnings. Refer to Note 18 - "Fair Value Measurements" for further information. The fair value of the SPHG Note was reported as a current liability on the condensed consolidated balance sheets beginning in the first quarter of fiscal year 2024, as its maturity is less than twelve months.
Below is a reconciliation of interest expense related to the SPHG Note to total interest expense:
| Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||||||||||||
| Three Months Ended April 30, | Three Months Ended April 30, | Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | 2024 | 2023 | ||||||||||||||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||||||||||||||
| Interest expense related to contractual interest coupon on the SPHG Note | $ | 243 | $ | 271 | $ | 739 | $ | 844 | |||||||||||||||||||||||||||
Interest expense related to accretion of the discount on the SPHG Note(a) | — | 632 | — | 1,688 | |||||||||||||||||||||||||||||||
| Interest expense related to revolving credit facilities (see below) | — | 11 | — | 36 | |||||||||||||||||||||||||||||||
| Other | — | — | — | 20 | |||||||||||||||||||||||||||||||
| Total interest expense | $ | 243 | $ | 914 | $ | 739 | $ | 2,588 | |||||||||||||||||||||||||||
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(a) Prior to the date of the Exchange Transaction, the discount on the SPHG Note was accreted using the effective interest rate method. The effective interest rate on the SPHG Note was 27.8% prior to the SPHG Note Amendment, and was 23.0% subsequent to the SPHG Note Amendment.
Umpqua Revolver
ModusLink, as borrower, is party to a revolving credit agreement with Umpqua Bank as lender and as agent, which provides for a maximum credit commitment of $12.5 million and a sublimit of $5.0 million for letters of credit (collectively, the "Umpqua Revolver"). On May 1, 2024, ModusLink, entered into a Second Amendment to the Umpqua Revolver (the “Second Amendment”). Among other things, the Second Amendment (i) extended the maturity date with respect to revolving loans from March 31, 2025 to March 31, 2026, (ii) removed certain adjustments in the definition of “Adjusted EBITDA” as set forth in the Umpqua Revolver, (iii) increased the minimum Adjusted Tangible Net Worth (as defined in the credit agreement) and (iv) removed certain caps and conditions on ModusLink’s ability to pay dividends.
As of April 30, 2024, ModusLink was in compliance with the Umpqua Revolver's covenants, and believes it will remain in compliance with the Umpqua Revolver’s covenants for the next twelve months from the filing of this Form 10-Q. As of April 30, 2024, ModusLink had available borrowing capacity of $11.9 million and there was $0.6 million outstanding letters of credit.
(11)CONTINGENCIES
Donald Reith v. Warren G. Lichtenstein, et al.
On April 13, 2018, a purported shareholder, Donald Reith, filed a verified complaint, Reith v. Lichtenstein, et al., 2018-277 (Del. Ch.) in the Delaware Court of Chancery (the “Reith litigation”). The complaint alleges class and derivative claims for breach of fiduciary duty and/or aiding and abetting breach of fiduciary duty and unjust enrichment against certain current and former directors of the Company, Warren G. Lichtenstein, Glen M. Kassan, William T. Fejes, Jack L. Howard, Jeffrey J. Fenton, Philip E. Lengyel and Jeffrey S. Wald; and stockholders Steel Holdings and several of its affiliated companies (collectively, the "Steel Parties") in connection with the acquisition of $35.0 million of the Series C Convertible Preferred Stock by SPHG Holdings and equity grants made to Messrs. Lichtenstein, Howard and Fejes on December 15, 2017 (collectively, the "Challenged Transactions"). The Company is named as a nominal defendant. The complaint alleges that although the Challenged Transactions were approved by a Special Committee consisting of the independent members of the Board of Directors (Messrs. Fenton, Lengyel and Wald), the Steel Parties dominated and controlled the Special Committee, who approved the Challenged Transactions in breach of their fiduciary duty. Plaintiff alleges that the Challenged Transactions unfairly diluted stockholders and therefore unjustly enriched Steel Holdings, SPHG Holdings and Messrs. Lichtenstein, Howard and Fejes. The complaint also alleges that the Board of Directors made misleading disclosures in the Company's proxy statement for the 2017 Annual Meeting of Stockholders in connection with seeking approval to amend the 2010 Incentive Award Plan to authorize the issuance of additional shares to accommodate certain shares underlying the equity grants. Remedies requested include rescission of the Series C Convertible Preferred Stock and equity grants, disgorgement of any unjustly obtained property or compensation and monetary damages.
On August 13, 2021, the Company, together with certain of its current and former directors of the Board, Warren Lichtenstein, Glen Kassan, William Fejes, Jr., Jack Howard, Jeffrey Fenton and Jeffrey Wald, as well as other named defendants (collectively, the “Defendants”), entered into a memorandum of understanding (the “MOU”) with Donald Reith (the “Plaintiff”) in connection with the settlement of the Reith v. Lichtenstein, et al., C.A. No. 2018-0277-MTZ (Del. Ch. 2018) class and derivative action. A definitive Stipulation of Settlement (the “Stipulation”) incorporating the terms of the MOU was filed with the Court on February 18, 2022. Pursuant to the MOU and Stipulation, and contingent on approval of the terms by the court, the Defendants agreed to cause their directors’ and officers’ liability insurance carriers to pay to the Company $2.8 million in cash. The Company's insurance carrier agreed to pay $1.7 million and Steel Holdings' insurance carrier agreed to pay $1.1 million of the settlement.
Additionally, under the MOU and separate letter agreements between the Company and such individuals (the “Surrender Agreements”), Messrs. Lichtenstein, Howard and Fejes agreed to surrender to the Company an aggregate 353,571 shares that they had initially received in December 2017 in consideration for services to the Company. The surrenders and cancellations are in the following amounts: for Mr. Lichtenstein, 196,429 vested shares and 32,143 unvested shares; for Mr. Howard, 98,214 vested shares and 16,071 unvested shares; and for Mr. Fejes, 10,714 vested shares. On August 17, 2021, Mr. Lichtenstein and Mr. Howard surrendered the shares required under the MOU, the Stipulation and their respective Surrender Agreements, and in December 2021 Mr. Fejes did the same. All such shares were subsequently cancelled. Pursuant to the MOU and Stipulation, the Company also agreed to pay the Plaintiff’s counsel legal fees for this matter in an amount up to $2.05 million, if approved by the court.
On September 23, 2022, the court ruled that it was denying approval of the settlement. On September 12, 2023, the court approved a stipulated pretrial and trial schedule culminating in a trial scheduled for September 2024.
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On June 6, 2023, the Company received a books and records demand from Reith under Delaware General Corporation Law Section 220 which requests an array of documents for the purported purposes of investigating potential wrongdoing in connection with the April 30, 2023 transaction between Steel Holdings and Steel Connect.
On April 8, 2024, the Company, the Defendants and Mr. Reith entered into a new memorandum of understanding (the "New MOU") contemplating the settlement of the Reith litigation (the "2024 Settlement"). If the 2024 Settlement is approved by the Court, (i) the Defendants shall cause their insurers to make a cash payment of $6.0 million to the Company and, after deducting any Court-approved award of attorneys’ fees to Plaintiff's counsel and certain litigation expenses, the Company shall distribute the balance of the cash payment, by way of a special divided or other distribution, to the holders of the Company’s common stock pursuant to the allocation provisions set forth in the previously disclosed Stockholders Agreement dated April 20, 2023 by and among the Company, Steel Partners Holdings L.P., and other stockholders signatory thereto (the “Stockholders’ Agreement”) as amended by the 2024 Settlement; (ii) the Company will adopt certain amendments to the Stockholders’ Agreement; and (iii) the Company will adopt certain corporate governance policies and practices, including a formal review process for compensation clawbacks, enhancing the process for granting equity awards and keeping records of equity awards granted under the Company’s stock plans, further enhancing board committee independence, and reducing the materiality threshold for review of related party transactions under the Stockholders Agreement, in exchange for which all parties will be released from all claims in the Reith litigation. The 2024 Settlement requires Court approval, and there can be no assurances that such approval will be granted.
On December 12, 2023, the Company received books and records demand, similar to the demand from Reith, from another purported shareholder. The possible liability, if any, with respect to this matter cannot be determined.
Mohammad Ladjevardian v. Warren G. Lichtenstein, et al.
On September 1, 2023, a purported stockholder, Mohammad Ladjevardian, filed a verified complaint alleging a single direct claim for breach of fiduciary duty against members of Steel Connect’s Board of Directors and Steel Holdings and certain of its affiliates in connection with the Exchange Transaction. Directors named in the complaint are Warren Lichtenstein, Glen Kassan, and Jack Howard. The complaint alleges that although the challenged transaction was approved by the independent Strategic Planning Committee, the committee failed to obtain a “control premium” or to consider the dilutive effect that the Series E Convertible Preferred Stock issuance had on the plaintiff’s holdings. Remedies requested in the complaint include rescission of the Series E Convertible Preferred Stock and a judicially imposed requirement that all future transactions involving Steel Holdings and its affiliates be subject to minority stockholder approval. On September 27, 2023, the entity defendants moved to dismiss the complaint. On October 5, 2023, the individual defendants moved to dismiss the complaint.
On April 18, 2024, in order to avoid the cost and uncertainty of litigation, Messrs. Lichtenstein and Howard, Steel Holdings, Steel Excel and WebFinancial, without admitting any wrongdoing, entered into a Settlement Agreement and Securities Purchase Agreements (the "SPAs") with the Estate of Mohammad Ladjevardian and certain parties related to Mohammad Ladjevardian (the "Ladjevardian Parties"). Pursuant to the SPAs, a Steel Holdings subsidiary purchased an aggregate of 701,246 shares of the Company’s common stock held by the Ladjevardian Parties at a price of $9.83 per share, which represented the closing market price of the shares on April 17, 2024 and made an aggregate cash settlement payment of $1.5 million to the Ladjevardian Parties.
(12)REVENUE RECOGNITION
Disaggregation of Revenue
The following table presents the Company's revenues from contracts with customers disaggregated by major good or service line and timing of revenue recognition. The table also includes a reconciliation of the disaggregated revenue with the reportable segments.
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| Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||||||||||||
| Three Months Ended April 30, | Three Months Ended April 30, | Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | 2024 | 2023 | ||||||||||||||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||||||||||||||
| Major Goods/Service Lines | |||||||||||||||||||||||||||||||||||
| Supply chain management services | $ | 43,456 | $ | 45,826 | $ | 127,157 | $ | 147,185 | |||||||||||||||||||||||||||
| Other | 399 | 316 | 1,083 | 1,098 | |||||||||||||||||||||||||||||||
| $ | 43,855 | $ | 46,142 | $ | 128,240 | $ | 148,283 | ||||||||||||||||||||||||||||
| Timing of Revenue Recognition | |||||||||||||||||||||||||||||||||||
| Services transferred over time | $ | 43,855 | $ | 46,142 | $ | 128,240 | $ | 148,283 | |||||||||||||||||||||||||||
| $ | 43,855 | $ | 46,142 | $ | 128,240 | $ | 148,283 | ||||||||||||||||||||||||||||
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, and fees for professional services. 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.
Contract Balances
Timing of revenue recognition may differ from timing of invoicing to customers. The Company records contract assets and liabilities related to its contracts with customers as follows:
•Accounts receivable when revenue is recognized prior to receipt of cash payments and if the right to such amounts is unconditional and solely based on the passage of time.
•Contract asset when the Company recognizes revenue based on efforts expended but the right to such amount is conditional upon satisfaction of another performance obligation. Contract assets are primarily comprised of fees related to supply chain management services. The Company's contract assets are all short-term in nature and are included in prepaid expenses and other current assets in the condensed consolidated balance sheets.
•Deferred revenue when cash payments are received or due in advance of performance. Deferred revenue is primarily comprised of fees related to supply chain management services, cloud-based software subscriptions and software maintenance and support service contracts, which are generally billed in advance. Deferred revenue also includes other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. The deferred revenue balance is classified as a component of other current liabilities and other long-term liabilities on the Company's condensed consolidated balance sheets.
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The table below presents information for the Company's contract balances:
| Successor | Predecessor | ||||||||||||||||||||||
| April 30, 2024 | July 31, 2023 | August 1, 2022 | |||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||
| Accounts receivable, trade, net | $ | 31,873 | $ | 28,616 | $ | 40,083 | |||||||||||||||||
| Contract assets | 283 | 439 | 369 | ||||||||||||||||||||
| Deferred revenue - current | $ | 2,762 | $ | 2,574 | $ | 2,705 | |||||||||||||||||
| Deferred revenue - long-term | 68 | 144 | 134 | ||||||||||||||||||||
| Total deferred revenue | $ | 2,830 | $ | 2,718 | $ | 2,839 | |||||||||||||||||
Remaining Performance Obligations
Remaining performance obligations are comprised of deferred revenue. Changes in deferred revenue during the nine months ended April 30, 2024 and April 30, 2023, were as follows:
| Successor | Predecessor | ||||||||||||||||
| Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||
| 2024 | 2023 | ||||||||||||||||
| (in thousands) | |||||||||||||||||
| Balance at beginning of period | $ | 2,718 | $ | 2,839 | |||||||||||||
| Deferral of revenue | 1,456 | 1,595 | |||||||||||||||
| Recognition of deferred amounts upon satisfaction of performance obligation | (1,344) | (1,361) | |||||||||||||||
| Balance at end of period | $ | 2,830 | $ | 3,073 | |||||||||||||
The Company expects to recognize approximately $2.8 million of deferred revenue over the next twelve months and the remaining $0.1 million beyond that time period.
The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.
(13)INCOME TAXES
The Company operates in multiple taxing jurisdictions, both within and outside of the United States. For the nine months ended April 30, 2024, the Company was profitable in certain jurisdictions, resulting in an income tax expense using enacted rates in those jurisdictions. As of both April 30, 2024 and July 31, 2023, the total amount of the liability for unrecognized tax benefits related to federal, state and foreign taxes was approximately $0.4 million.
Deferred Income Taxes
As of April 30, 2024, the Company reassessed the need for a valuation allowance against its deferred tax assets. After considering historical and projected future taxable income and existing taxable temporary differences, the Company determined that it is more likely than not that the deferred tax assets will be realized. As a result, the Company released substantially all of its valuation allowance except the valuation allowance relating to approximately $31.0 million of NOLs that will expire as of July 31, 2024, and approximately $0.9 million of state NOLs that the Company anticipates will expire unutilized. This release of the valuation allowance resulted in a one-time non-cash income tax benefit of $71.5 million for the quarter ended April 30, 2024.
Uncertain Tax Positions
In accordance with the Company's accounting policy, interest related to unrecognized tax benefits is included in the income tax expense line of the condensed consolidated statements of operations. As of both April 30, 2024 and July 31, 2023, the liabilities for interest expense related to uncertain tax positions was less than $0.1 million. The Company expects $0.3 million of unrecognized tax benefits and related interest to reverse in the next twelve months.
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Management's judgment is required in determining our provision for income taxes, including any valuation allowance recorded against the Company’s deferred tax assets due to uncertainties related to our ability to utilize these assets. The valuation allowance is based on our estimates of taxable income and the period over which the Company’s deferred tax assets will be recoverable. The evolution of facts and circumstances in future periods may result in adjustments to our valuation allowance, which could materially impact our financial position and results of operation.
The Company is subject to U.S. federal income tax and various state, local and international income taxes in numerous jurisdictions. The federal and state tax returns are generally subject to tax examinations for the tax years ended July 31, 2020 through July 31, 2023. To the extent the Company has tax attribute carryforwards, the tax year in which the attribute was generated may still be adjusted upon examination by the Internal Revenue Service or state tax authorities to the extent utilized in a future period. In addition, a number of tax years remain subject to examination by the appropriate government agencies for certain countries in the Europe and Asia regions. In Europe, the Company's 2015 through 2022 tax years remain subject to examination in most locations, while the Company's 2010 through 2021 tax years remain subject to examination in most Asia locations.
(14)EARNINGS PER SHARE
As discussed in Note 2 - "Basis of Presentation", the Reverse/Forward Stock Split was effective on June 21, 2023. The Company’s shares of outstanding common stock and earnings per share amounts have been retroactively restated for all periods
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presented for the Reverse/Forward Stock Split. The following table reconciles net earnings per share for the three and nine months ended April 30, 2024 and 2023:
| Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||||||||||||
| Three Months Ended April 30, | Three Months Ended April 30, | Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | 2024 | 2023 | ||||||||||||||||||||||||||||||||
| (in thousands, except per share data) | |||||||||||||||||||||||||||||||||||
| Reconciliation of net income to net income attributable to common stockholders after assumed conversions: | |||||||||||||||||||||||||||||||||||
| Net income | $ | 71,660 | $ | 3,029 | $ | 81,442 | $ | 7,460 | |||||||||||||||||||||||||||
| Less: Preferred dividends on Series C redeemable preferred stock | (531) | (519) | (1,604) | (1,593) | |||||||||||||||||||||||||||||||
| Net income available to common stockholders | 71,129 | 2,510 | 79,838 | 5,867 | |||||||||||||||||||||||||||||||
| Less: Undistributed earnings allocated to participating securities | (54,125) | — | (60,780) | — | |||||||||||||||||||||||||||||||
| Net income attributable to common stockholders | $ | 17,004 | $ | 2,510 | $ | 19,058 | $ | 5,867 | |||||||||||||||||||||||||||
| Effect of dilutive securities: | |||||||||||||||||||||||||||||||||||
| Interest and debt amortization costs on convertible debt | 243 | — | 739 | — | |||||||||||||||||||||||||||||||
| Dividends on Series C preferred stock | 531 | 519 | 1,604 | 1,593 | |||||||||||||||||||||||||||||||
| Undistributed earnings allocated to Series E preferred stock | 54,125 | — | 60,780 | — | |||||||||||||||||||||||||||||||
| Net income attributable to common stockholders - assuming dilution | $ | 71,903 | $ | 3,029 | $ | 82,181 | $ | 7,460 | |||||||||||||||||||||||||||
| Net income per common share - basic | $ | 2.73 | $ | 0.39 | $ | 3.07 | $ | 0.91 | |||||||||||||||||||||||||||
| Net income per common share - diluted | $ | 2.51 | $ | 0.36 | $ | 2.88 | $ | 0.89 | |||||||||||||||||||||||||||
| Weighted average common shares outstanding - basic | 6,224 | 6,461 | 6,211 | 6,449 | |||||||||||||||||||||||||||||||
| Effect of dilutive securities: | |||||||||||||||||||||||||||||||||||
| Common stock equivalents - Restricted stock and restricted stock shares | 68 | 57 | 62 | 55 | |||||||||||||||||||||||||||||||
| Common stock equivalents - Convertible debt | 584 | — | 584 | — | |||||||||||||||||||||||||||||||
| Common stock equivalents - Series C Preferred stock | 1,913 | 1,913 | 1,913 | 1,913 | |||||||||||||||||||||||||||||||
| Common stock equivalents - Series E Preferred stock | 19,810 | — | 19,810 | — | |||||||||||||||||||||||||||||||
| Weighted average common shares outstanding - diluted | 28,599 | 8,431 | 28,580 | 8,417 | |||||||||||||||||||||||||||||||
For the three and nine months ended April 30, 2024, the Company calculated basic and diluted net income per common share using the two-class method, as the Series E Convertible Preferred Stock meets the definition of a participating security. The two-class method is an allocation formula that determines net income per common share for each share of common stock and Series E Convertible Preferred Stock, a participating security, according to dividends declared and participation rights in undistributed earnings. Under this method, all earnings (distributed and undistributed) are allocated to common shares and Series E Convertible Preferred Stock based on their respective rights to receive dividends. The holders of Series E Convertible Preferred Stock are entitled to participate equally and ratably with the holders of shares of Common Stock in all dividends or other distributions on the shares of Common Stock as if, immediately prior to each record date for payment of dividends or other distributions on the Common Stock, shares of Series E Preferred Stock then outstanding were converted into shares of Common Stock. Basic net income per common share is computed by dividing net income attributable to common stockholders for the period by the weighted average number of common shares outstanding for the period. Net income attributable to common stockholders for the period includes any dividends paid to common stockholders during the period plus a proportionate share of undistributed net income allocable to common stockholders for the period; the proportionate share of undistributed net income allocable to common stockholders for the period is based on the proportionate share of total weighted-average common shares and participating securities outstanding during the period. Diluted net income per common share is computed based on the weighted
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average number of shares of common stock outstanding during each period, plus potential common shares considered outstanding during the period, as long as the inclusion of such awards is not antidilutive. Potential common shares consist of restricted common stock (calculated based on the treasury stock method) and shares issuable upon debt or preferred stock conversion (calculated using an as-if converted method), using the more dilutive of either the two-class method or as-converted stock method.
The Company was not required to apply the two-class method during the Predecessor Period as there were no participating securities, and as such, there were no changes to the Predecessor Period other than the retrospective restatement for the Reverse/Forward Stock Split discussed previously.
The below details certain exclusions from the calculation of diluted net income per share, as their inclusion would have been antidilutive:
For the three months ended April 30, 2023, $0.7 million of interest expense, net of tax related to the SPHG Note was excluded from the numerator in the calculation of diluted net income per share as its inclusion would have been antidilutive. For the three months ended April 30, 2023, 0.6 million common stock equivalent shares (including those related to the SPHG Note) were excluded from the denominator in the calculation of diluted net income per share as their inclusion would have been antidilutive.
For the nine months ended April 30, 2023, $2.3 million of interest expense, net of tax impact related to the SPHG Note was excluded from the numerator in the calculation of diluted net income per share as its inclusion would have been antidilutive. For the nine months ended April 30, 2023, 0.6 million common stock equivalent shares (including those related to the SPHG Note) were excluded from the denominator in the calculation of diluted net income per share as their inclusion would have been antidilutive.
No exclusions were required from the calculation of diluted net income per share for the three and nine months ended April 30, 2024, as all securities were considered dilutive.
(15)COMPREHENSIVE (LOSS) INCOME
Comprehensive (loss) income combines net income and other comprehensive items. Other comprehensive items represent certain amounts that are reported as components of stockholders' equity in the accompanying condensed consolidated balance sheets. Accumulated other comprehensive items consist of the following:
| Foreign Currency Items | Pension Items | Total | |||||||||||||||
| (in thousands) | |||||||||||||||||
| Accumulated other comprehensive (loss) income as of July 31, 2023 (Successor) | $ | (623) | $ | 36 | $ | (587) | |||||||||||
| Foreign currency translation adjustment | (341) | — | (341) | ||||||||||||||
| Net current-period other comprehensive loss | (341) | — | (341) | ||||||||||||||
| Accumulated other comprehensive (loss) income as of April 30, 2024 (Successor) | $ | (964) | $ | 36 | $ | (928) | |||||||||||
| Foreign Currency Items | Pension Items | Total | |||||||||||||||
| (in thousands) | |||||||||||||||||
| Accumulated other comprehensive income (loss) as of July 31, 2022 (Predecessor) | $ | 6,063 | $ | (1,923) | $ | 4,140 | |||||||||||
| Foreign currency translation adjustment | 999 | — | 999 | ||||||||||||||
| Pension liability adjustments, net of tax | — | (1,078) | (1,078) | ||||||||||||||
| Net current-period other comprehensive income (loss) | 999 | (1,078) | (79) | ||||||||||||||
| Accumulated other comprehensive income (loss) as of April 30, 2023 (Predecessor) | $ | 7,062 | $ | (3,001) | $ | 4,061 | |||||||||||
During the year ended July 31, 2020, a Netherlands defined benefit pension plan was amended, so that active participants no longer accrued benefits as of January 1, 2020, which resulted in a pre-tax curtailment gain of $2.4 million recognized in accumulated other comprehensive income (loss). At that time, the active plan participants were moved into a new defined benefit contribution pension plan. During the nine months ended April 30, 2023, the Company recorded an increase of approximately $1.1 million to accrued pension liabilities for the defined benefit pension plan as it was determined plan participants are entitled to unconditional indexation of benefits for as long as they remain in active service with the Company.
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(16)SEGMENT INFORMATION
The Company has one reportable segment: Supply Chain. The Company also has Corporate-level activity, which consists primarily of costs associated with certain corporate administrative functions such as legal, finance and share-based compensation, which are not allocated to the Company's reportable segment. The Corporate-level balance sheet information includes cash and cash equivalents, debt and other assets and liabilities which are not allocated to the operations of the Company's operating segment. All significant intra-segment amounts have been eliminated. Management evaluates segment performance based on segment net revenue and operating income (loss).
Summarized financial information of the Company's continuing operations by operating segment is as follows:
| Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||||||||||||
| Three Months Ended April 30, | Three Months Ended April 30, | Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | 2024 | 2023 | ||||||||||||||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||||||||||||||
| Net revenue: | |||||||||||||||||||||||||||||||||||
| Supply Chain | $ | 43,855 | $ | 46,142 | $ | 128,240 | $ | 148,283 | |||||||||||||||||||||||||||
| Total segment net revenue | $ | 43,855 | $ | 46,142 | $ | 128,240 | $ | 148,283 | |||||||||||||||||||||||||||
| Operating income: | |||||||||||||||||||||||||||||||||||
| Supply Chain | $ | 4,448 | $ | 5,249 | $ | 10,187 | $ | 16,488 | |||||||||||||||||||||||||||
| Total segment operating income | 4,448 | 5,249 | 10,187 | 16,488 | |||||||||||||||||||||||||||||||
| Corporate-level activity | (1,468) | (4,944) | (3,680) | (9,699) | |||||||||||||||||||||||||||||||
| Total operating income | 2,980 | 305 | 6,507 | 6,789 | |||||||||||||||||||||||||||||||
| Total other income, net | 880 | 3,575 | 8,000 | 2,301 | |||||||||||||||||||||||||||||||
| Income before income taxes | $ | 3,860 | $ | 3,880 | $ | 14,507 | $ | 9,090 | |||||||||||||||||||||||||||
| Successor | |||||||||||
| April 30, 2024 | July 31, 2023 | ||||||||||
| (in thousands) | |||||||||||
| Total assets: | |||||||||||
| Supply Chain | $ | 160,565 | $ | 146,614 | |||||||
| Corporate | 324,897 | 264,567 | |||||||||
| Total assets | $ | 485,462 | $ | 411,181 | |||||||
Summarized financial information of the Company's capital expenditures and depreciation expense for the Supply Chain reportable segment is as follows:
| Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||||||||||||
| Three Months Ended April 30, | Three Months Ended April 30, | Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | 2024 | 2023 | ||||||||||||||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||||||||||||||
| Capital expenditures | $ | 1,211 | $ | 445 | $ | 2,911 | $ | 1,311 | |||||||||||||||||||||||||||
| Depreciation expense | $ | 439 | $ | 503 | $ | 1,324 | $ | 1,427 | |||||||||||||||||||||||||||
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Summarized financial information of the Company's net revenue by geographic location is as follows:
| Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||||||||||||
| Three Months Ended April 30, | Three Months Ended April 30, | Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | 2024 | 2023 | ||||||||||||||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||||||||||||||
| Mainland China | $ | 15,822 | $ | 13,852 | $ | 45,577 | $ | 48,049 | |||||||||||||||||||||||||||
| United States | 9,776 | 12,917 | 31,593 | 38,262 | |||||||||||||||||||||||||||||||
| Netherlands | 5,035 | 4,872 | 16,121 | 15,149 | |||||||||||||||||||||||||||||||
| Singapore | 4,413 | 4,705 | 12,332 | 14,940 | |||||||||||||||||||||||||||||||
| Czech Republic | 4,241 | 6,202 | 9,436 | 19,497 | |||||||||||||||||||||||||||||||
| Other | 4,568 | 3,594 | 13,181 | 12,386 | |||||||||||||||||||||||||||||||
| Total consolidated net revenue | $ | 43,855 | $ | 46,142 | $ | 128,240 | $ | 148,283 | |||||||||||||||||||||||||||
(17)RELATED PARTY TRANSACTIONS
As of April 30, 2024, SPHG Holdings and its affiliates, including Steel Holdings, Handy & Harman Ltd. and Steel Partners Ltd., beneficially owned approximately 89.6% of our outstanding capital stock, including the if-converted value of the SPHG Note and shares of Series C Convertible Preferred Stock and Series E Convertible Preferred Stock that vote on an as-converted basis together with our common stock. Warren G. Lichtenstein, our Interim Chief Executive Officer and the Executive Chairman of our Board, is also the Executive Chairman of Steel Holdings GP. Glen Kassan, our Vice Chairman of the Board of Directors and former Chief Administrative Officer, is an employee of Steel Services. Jack L. Howard, the President and a director of Steel Holdings GP, is also a director. Joseph Martin, one of our directors, is the Chief Administrative Officer and Chief Legal Officer of Steel Holdings. Ryan O'Herrin, our Chief Financial Officer, is the Chief Financial Officer of Steel Holdings.
Upon closing of the Exchange Transaction on May 1, 2023, the Company became a consolidated subsidiary of Steel Holdings as described in Note 1 - "Nature of Operations", Note 2 - "Basis of Presentation", and Note 4 - "Exchange Transaction". After May 1, 2023, transactions between Steel Holdings and the Company are eliminated in consolidation by Steel Holdings.
SPHG Note Transaction
On February 28, 2019, the Company entered into the SPHG Note Purchase Agreement with SPHG Holdings, whereby SPHG Holdings agreed to loan the Company $14.9 million in exchange for the SPHG Note.
On March 9, 2023 (the "Amendment Date"), the Company and SPHG Holdings entered into an amendment to the SPHG Note. Pursuant to the SPHG Note Amendment, the maturity date of the SPHG Note was extended six months from March 1, 2024 to September 1, 2024. The Company repaid $1.0 million in principal amount of the SPHG Note on the Amendment Date, and repaid an additional $1.0 million principal amount of the note on June 9, 2023. In connection with the SPHG Note Amendment, the Company also paid SPHG Holdings a cash amendment fee of $0.1 million, and derecognized $0.2 million of the debt discount in proportion to the reduction of the principal balance on the Amendment Date in the third quarter of Fiscal Year 2023. No other changes were made to the terms of the SPHG Note besides the items discussed.
SPHG Holdings has the right, at its option, prior to the close of business on the business day immediately preceding the maturity date of the SPHG Note, 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 45.1356 shares of common stock, which is equivalent to an initial conversion price of approximately $22.16 per share (subject to adjustment as provided in the SPHG Note) per $1,000 principal amount of the SPHG Note, subject to, and in accordance with, the settlement provisions of the SPHG Note. As of April 30, 2024, the if-converted value of the SPHG Note did not exceed the principal value of the SPHG Note. Refer to Note 10 - "Debt" for further information.
Series C Preferred Stock Transaction
On December 15, 2017, the Company entered into a Preferred Stock 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 to SPHG Holdings at a price of $1,000 per share, for an aggregate purchase consideration of $35.0 million. The terms, rights, obligations and preferences of the Series C Convertible Preferred Stock are set forth in the Series C Certificate of Designations, which has
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been filed with the Secretary of State of the State of Delaware. During each of the three months ended April 30, 2024 and 2023, the Company paid dividends of $0.5 million associated with the Series C Convertible Preferred Stock. During each of the nine months ended April 30, 2024 and 2023, the Company paid dividends of $1.6 million associated with the Series C Convertible Preferred Stock.
On or after December 15, 2022, each holder of Series C Convertible Preferred Stock can also require the Company to redeem its Series C Convertible Preferred Stock in cash at a price equal to the Liquidation Preference (as defined in Series C Certificate of Designations).
Series E Preferred Stock Transaction
On May 1, 2023, the Company and Steel Holdings executed a series of agreements in which the Steel Partners Group agreed to transfer certain marketable securities held by the Steel Partners Group to Steel Connect in exchange for 3.5 million shares of Series E Convertible Preferred Stock of Steel Connect (the “Series E Convertible Preferred Stock”, and, such transfer, the “Transfer and Exchange Agreement”). Pursuant to the Transfer and Exchange Agreement, the Company held a special stockholders’ meeting on June 6, 2023 (the “Special Meeting”) to consider and vote upon the rights of the Series E Preferred Stock to vote and receive dividends together with the Common Stock on an as-converted basis and the issuance of the Company's common stock (the "Common Stock") upon conversion of the Series E Preferred Stock by the holders at their option, pursuant to the rules and regulations of Nasdaq (the “Nasdaq Proposal”). Following approval of the Nasdaq Proposal by the Steel Connect stockholders (the “Stockholder Approval”), the Series E Convertible Preferred Stock became convertible into an aggregate of 19.8 million shares of Common Stock, and votes together with holders of Company Common Stock and participates in any dividends paid on the Common Stock, in each case on an as-converted basis.
The terms, rights, obligations and preferences of the Series E Convertible Preferred Stock are set forth in a Certificate of Designations, Preferences and Rights of Series E Convertible Preferred Stock of the Company (the “Series E Certificate of Designations”).
Stockholders' Agreement
Concurrently with the execution of the Transfer and Exchange Agreement, the Company, Steel Holdings, Steel Excel, WebFinancial, WHX CS, LLC, WF Asset Corp., Steel Partners Ltd., Warren G. Lichtenstein and Jack L. Howard (together, the "SP Investors") entered into a Stockholders' Agreement dated as of April 30, 2023 (the "Stockholders' Agreement"). Pursuant to the Stockholders' Agreement, the parties agreed to certain aspects of the Company's governance, including the maintenance of the Board size at seven directors and the creation of an audit committee consisting of at least three independent directors under SEC and applicable stock exchange rules (an "Independent Audit Committee") or one consisting of at least three directors, at least one of whom qualifies as independent under SEC and applicable stock exchange rules and the remainder of whom are not affiliated, as described in the Stockholders’ Agreement, with the Company or the SP Investors or their subsidiaries or affiliates (the “Disinterested Audit Committee”).
The Stockholders' Agreement further provides that (a) prior to September 1, 2025 the prior approval of the Independent Audit Committee or the Disinterested Audit Committee, as applicable, is required for the following: (i) a voluntary delisting of the common stock from the applicable stock exchange or a transaction (including a merger, recapitalization, stock split or otherwise) which results in the delisting of the common stock, Steel Connect ceasing to be an SEC reporting company, or Steel Connect filing a Form 25 or Form 15 or any similar form with the SEC; (ii) an amendment to the terms of the STCN Management Services Agreement (the "Services Agreement") dated June 14, 2019, by and between Steel Connect and Steel Services Ltd.; and (iii) any related party transaction between Steel Connect and the SP Investors and their subsidiaries and affiliates; (b) prior to September 1, 2028, the prior approval of the Independent Audit Committee or the Disinterested Audit Committee, as applicable, is required for the Board to approve a going private transaction pursuant to which Steel Holdings or its subsidiaries or affiliates acquires the outstanding shares of common stock they do not own (or any alternative transaction that would have the same impact); and (c) until the Final Sunset Date (as defined in the Stockholders' Agreement), the prior approval of the Independent Audit Committee or the Disinterested Audit Committee, as applicable, is required (i) for the Board to approve a short-form or squeeze-out merger between Steel Connect and the SP Investors; or (ii) prior to any transfer of equity interests in Steel Connect by the members of the SP Group (as defined in the Stockholders' Agreement) if such transfers would result in 80% of the voting power and value of the equity interests in Steel Connect that are held by the members of the SP Group being held by one corporate entity.
Currently, the Stockholders' Agreement also provides that 70% of the net proceeds received by the Company upon resolution of the Reith litigation will be distributed to the Company’s stockholders with the SP Investors agreeing to waive their portion of any such distribution to the extent of any shares of common stock held as of the date of the Stockholders’ Agreement or issuable upon conversion of the Series E Convertible Preferred Stock held by the SP Investors and the Series C Convertible Preferred Stock of Steel Connect, and the SPHG Note. Any amendment to the Stockholders’ Agreement by the Company prior to the date that any person or group of related persons owns 100% of the equity securities of the Company requires the prior
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approval of the Independent Audit Committee or the Disinterested Audit Committee, as applicable. As described in the notes to the financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, if the 2024 Settlement is approved, the Company will make certain changes to the Stockholders’ Agreement as described above.
Steel Connect Management Services Agreement
On June 14, 2019, the Company entered into an agreement (the "STCN Management Services Agreement") with Steel Services Ltd. ("Steel Services"), an indirect wholly-owned subsidiary of Steel Holdings. The STCN Management Services Agreement was effective as of June 1, 2019. Pursuant to the STCN Management Services Agreement, Steel Services provides the Company and its subsidiaries with the non-exclusive services of certain employees, including certain executive officers (including chief financial officer and general counsel services) and other corporate services. The STCN Management Services Agreement also provides for reimbursements to Steel Services and its representatives for all reasonable expenses incurred in providing the non-exclusive services and automatically renews for successive one year periods unless and until terminated by the Company or Steel Services. On February 25, 2022, in connection with the Company's disposal of its ownership in IWCO Direct Holdings, Inc., the management fee was reduced from $282.8 thousand per month to $101.9 thousand per month.
On October 25, 2023, the Company and Steel Services entered into Amendment No. 2 to the STCN Management Services Agreement, pursuant to which the parties agreed to increase the monthly fee to $131.0 thousand effective as of January 1, 2024, primarily to increase the business development and mergers and acquisition staffing needed to originate, analyze and pursue strategic acquisitions and investments.
Prior to the effective date of Amendment No. 2 to the STCN Management Services Agreement, expenses incurred by ModusLink were paid to Steel Services under the STCN Management Services Agreement.
ModusLink Management Services Agreement
On October 25, 2023, ModusLink entered into a management services agreement (the “ModusLink Management Services Agreement”) with Steel Services, effective as of January 1, 2024. Pursuant to the ModusLink Management Services Agreement, Steel Services will provide ModusLink with certain non-exclusive services of certain employees and executive officers to serve in various positions or functions and to perform duties normally associated with those specific to, or substantially equivalent, positions or functions for ModusLink based on its particular needs. Such services include, but are not limited to, services related to legal and environmental, health and safety, finance, tax and treasury, human resources, “lean,” internal audit, mergers and acquisitions, and information technology. Previously, the terms regarding such non-exclusive services were governed by the STCN Management Services Agreement.
The ModusLink Management Services Agreement provides that ModusLink will pay Steel Services a fixed monthly fee of $80.0 thousand in consideration of the non-exclusive services and will reimburse Steel Services and its representatives for all reasonable expenses incurred in providing the services. The ModusLink Management Services Agreement will automatically renew for successive one-year periods unless and until terminated by ModusLink or Steel Services.
Total expenses incurred related to the management services agreements for the three months ended April 30, 2024 and 2023 were $0.9 million and $0.6 million, respectively. Total expenses incurred related to the management services agreements for the nine months ended April 30, 2024 and 2023 were $2.2 million and $1.7 million, respectively. As of April 30, 2024 and July 31, 2023, amounts due to Steel Services were $0.6 million and $0.7 million, respectively, and are recorded within the condensed consolidated balance sheets as a component of Accounts payable.
Air Travel
The Company reimburses SP General Services, LLC (an affiliate of Steel Holdings), rather than Steel Services, for expenses for business-related air travel, which relates to services provided to the Company by Warren G. Lichtenstein as Interim Chief Executive Officer as well as certain of the Company’s executive officers whose services are provided to the Company under the STCN Management Services Agreement or the ModusLink Management Services Agreement. During the three and nine months ended April 30, 2024, SP General Services, LLC incurred $0.4 million and $0.5 million in expenses for business-related air travel. During the three and nine months ended April 30, 2023, SP General Services, LLC did not incur any reportable expenses for such business-related air travel. As of April 30, 2024, amounts due to SP General Services, LLC were $0.5 million. There was no balance due to SP General Services, LLC as of July 31, 2023.
(18)FAIR VALUE MEASUREMENTS
Assets and Liabilities that are Measured at Fair Value on a Recurring Basis
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The following tables present the Company's financial assets and liabilities measured at fair value on a recurring basis as of April 30, 2024 and July 31, 2023, classified by fair value hierarchy:
| Successor | Fair Value Measurements at Reporting Date Using | ||||||||||||||||||||||
| (in thousands) | April 30, 2024 | Level 1 | Level 2 | Level 3 | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Money market funds | $ | 254,118 | $ | 254,118 | $ | — | $ | — | |||||||||||||||
| Convertible loan note investment | $ | — | $ | — | $ | — | $ | — | |||||||||||||||
| Other investments | $ | 14,293 | $ | 14,293 | $ | — | $ | — | |||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| SPHG Note | $ | 12,903 | $ | — | $ | — | $ | 12,903 | |||||||||||||||
| Successor | Fair Value Measurements at Reporting Date Using | ||||||||||||||||||||||
| (in thousands) | July 31, 2023 | Level 1 | Level 2 | Level 3 | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Money market funds | $ | 85,269 | $ | 85,269 | $ | — | $ | — | |||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| SPHG Note | $ | 12,461 | $ | — | $ | — | $ | 12,461 | |||||||||||||||
There were no transfers between Levels 1, 2 or 3 during any of the periods presented.
ASC 820, Fair Value Measurement, provides that fair value is an exit price, representing the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants based on the highest and best use of the asset or liability. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. ASC 820 requires the Company to use valuation techniques to measure fair value that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs are prioritized as follows:
Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets
Level 2: Other inputs that are observable directly or indirectly, such as quoted prices for similar assets or liabilities or market-corroborated inputs
Level 3: Unobservable inputs for which there is little or no market data and which require the Company to develop its own assumptions about how market participants would price the assets or liabilities
When available, quoted prices are used to determine fair value. When quoted prices in active markets are available, investments are classified within Level 1 of the fair value hierarchy. When quoted prices in active markets are not available, fair values are determined using pricing models, and the inputs to those pricing models are based on observable market inputs. The inputs to the pricing models are typically benchmark yields, reported trades, broker-dealer quotes, issuer spreads and benchmark securities, among others.
Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis
The Company reviews the carrying amounts of these assets whenever certain events or changes in circumstances indicate that the carrying amounts may not be recoverable. An impairment loss is recognized when the carrying amount of the asset group or reporting unit is not recoverable and exceeds its fair value. The Company estimates the fair values of assets subject to impairment based on the Company's own judgments about the assumptions that market participants would use in pricing the assets and on observable market data, when available.
Fair Value of Financial Instruments
The Company's financial instruments not measured at fair value on a recurring basis include cash and cash equivalents, accounts receivable, customer deposits, accounts payable, and restricted cash, and are reflected in the consolidated financial
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statements at carrying value. Carrying value approximates fair value for these items due to their short-term nature. Included in cash and cash equivalents in the accompanying condensed consolidated balance sheets are money market funds. These are valued at quoted market prices in active markets.
Subsequent to the issuance of Fiscal Year 2023 financial statements, the Company determined that the money market funds balance as of July 31, 2023 in the above table, was understated by $54.2 million. The Company corrected this immaterial error in the table above as of July 31, 2023. This disclosure change did not have any impact to amounts recognized in the condensed consolidated balance sheets.
Following is a summary of changes in financial assets and liabilities measured using Level 3 inputs:
| (in thousands) | SPHG Note (a) | Convertible Loan Note Investment (a) | ||||||||||||
| Balance as of July 31, 2023 (Successor) | $ | 12,461 | $ | — | ||||||||||
| Purchases | — | 1,227 | ||||||||||||
| Change in fair value | 442 | (1,227) | ||||||||||||
| Balance as of April 30, 2024 (Successor) | $ | 12,903 | $ | — | ||||||||||
(a) Unrealized losses are recorded in Other (losses) gains, net within the condensed consolidated statements of operations.
Valuation Techniques
Prior to the date of the Exchange Transaction, the Company did not measure the fair value of the SPHG Note on a recurring basis, as the assumption was that the carrying value of the liability component of the SPHG Note approximated fair value because the stated interest rate of this debt was consistent with current market rates. In conjunction with the application of pushdown accounting, the Company now measures the fair value of the SPHG Note on a recurring basis. Refer to Note 10 - "Debt" for further details. The Company estimates the value of the SPHG Note using a Binomial Lattice Model. Key inputs in the valuation include the trading price and volatility of Steel Connect's common stock, the risk-free rate of return, as well as the dividend rate, conversion price, and maturity date. The Company recognized $0.4 million in unrealized losses in Other (losses) gains, net within the condensed consolidated statements of operations for the nine months ended April 30, 2024 as a result of the fair value measurement performed. The Company determined that there have been no changes to the fair value of the SPHG Note from the prior quarter, given that the fair value remeasurement performed as of January 31, 2024 yielded $12.9 million, which equates to the principal balance remaining on the SPHG Note, and the SPHG Note is due on September 1, 2024.
As discussed in Note 7 - "Investments", the Company elected the fair value option to account for their convertible loan note investment. As of April 30, 2024, the Company believes the fair value of the investment is zero. As such, the Company recorded a loss of $1.2 million to the condensed consolidated statement of operations for the three and nine months ended April 30, 2024. There were no unrealized gains or losses recorded to the condensed consolidated statement of operations for the Predecessor Period, as the convertible loan note investment was a new investment in October 2023.
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(19)SUPPLEMENTAL CASH FLOW INFORMATION
A summary of supplemental cash flow information for the nine months ended April 30, 2024 and 2023 is presented in the following table:
| Successor | Predecessor | |||||||||||||||||||
| Nine Months Ended April 30, | Nine Months Ended April 30, | |||||||||||||||||||
| 2024 | 2023 | |||||||||||||||||||
| (in thousands) | ||||||||||||||||||||
| Cash paid during the period for: | ||||||||||||||||||||
| Interest | $ | 1,009 | $ | 1,145 | ||||||||||||||||
| Income taxes | $ | 215 | $ | 35 | ||||||||||||||||
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Cautionary Note Regarding Forward-Looking Statements
The matters discussed in this Quarterly Report on Form 10-Q contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Section 27A of the Securities Act of 1933, as amended, that involve risks and uncertainties. All statements other than statements of historical information provided herein 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 risks discussed elsewhere in this Quarterly Report on Form 10-Q and the risks discussed in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC") on November 8, 2023, and other subsequent reports filed with or furnished to the SEC. Please see “Risk Factors” located in Part I, Item 1A in our Annual Report on Form 10-K for the year ended July 31, 2023. 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. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof, except as required by law.
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 I, Item 1 of this Quarterly Report on Form 10-Q.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Overview
Steel Connect, Inc. (the "Company" or "Steel Connect") 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.
Steel Partners and Steel Connect Exchange Transaction
On April 30, 2023, Steel Partners Holdings L.P., (“Steel Holdings”) and the Company executed a series of agreements in which Steel Holdings and certain of its affiliates (the “Steel Partners Group”) agreed to transfer certain marketable securities held by the Steel Partners Group to the Company in exchange for 3.5 million shares of Series E Convertible Preferred Stock of the Company (the “Series E Convertible Preferred Stock”, and, such transfer and related transactions, the “Exchange Transaction”). The Series E Convertible Preferred Stock is convertible into an aggregate of 19.8 million shares of the Company's common stock, par value $0.01 per share (the “common stock” or “Common Stock”), and votes together with the Company's common stock and participates in any dividends paid on the Company's common stock, in each case on an as-converted basis. Upon conversion of the Series E Convertible Preferred Stock, when combined with the Steel Connect common stock, the 7.50% Convertible Senior Note, if converted, and the Steel Connect Series C Convertible Preferred Stock, also if converted, owned by Steel Holdings, would result in Steel Holdings holding approximately 84.0% of the outstanding equity interests of the Company as of May 1, 2023. The Exchange Transaction closed on May 1, 2023, which is the date that the consideration was exchanged between Steel Holdings and the Company. Refer to Note 1 - "Nature of Operations" and Note 4 - "Exchange Transaction" to the consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further information.
Predecessor/Successor Reporting
On May 1, 2023, the Exchange Transaction resulted in Steel Holdings obtaining control of the Company for financial statement purposes. Steel Holdings does not consolidate the Company for Federal income tax purposes because the ownership in the Company is dispersed between different federal tax consolidation groups within Steel Holdings. The Company elected pushdown accounting in which it uses Steel Holdings' basis of accounting, which reflects the fair market value of the Company’s assets and liabilities at the date of the Exchange Transaction. As a result, the Company has reflected the required pushdown accounting adjustments in its consolidated financial statements. Due to the application of pushdown accounting, the Company’s consolidated financial statements and certain footnote disclosures include a black line division between the two distinct periods to indicate the application of two different bases of accounting, which may not be comparable, between the periods presented. The pre-exchange period through April 30, 2023 is referred to as the "Predecessor" period. The post-exchange period, May 1, 2023
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and onward, includes the impact of pushdown accounting and is referred to as the "Successor" period. As such for purposes of this quarterly report, all references to the three and nine months ended April 30, 2024 are for the Successor period, and all references to the three and nine months ended April 30, 2023 are for the Predecessor period. Refer to Note 2 - "Basis of Presentation" and Note 4 - "Exchange Transaction" to the consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further information.
As it relates to the results of operations, while the 2024 Successor period and the 2023 Predecessor period are distinct reporting periods, the effects of the change of control for financial statement purposes did not have a material impact on the comparability of our results of operations between the periods, unless otherwise noted related to the impact from pushdown accounting.
Reverse/Forward Stock Split
At the special stockholders meeting held on June 6, 2023, the stockholders approved proposals to amend the Company’s restated certificate of incorporation (the “Charter”), to effect a 1-for-3,500 reverse stock split of the common stock (the “Reverse Stock Split”), followed immediately by a 375-for-1 forward stock split of the common stock (the “Forward Stock Split,” and, together with the Reverse Stock Split, the “Reverse/Forward Stock Split”). On June 7, 2023, the Board approved the Reverse/Forward Stock Split, and as such, the Board directed the Company to file with the State of Delaware certificates of amendment to our Charter to effectuate the Reverse/Forward Stock Split. The Reverse/Forward Stock Split was effective on June 21, 2023 (the “Effective Date”). The Company’s common stock began trading on a Reverse/Forward Stock Split-adjusted basis on the Nasdaq Capital Market when the market opened on June 22, 2023. The trading symbol for the Company’s common stock remains “STCN.”
No fractional shares were issued in connection with the Reverse/Forward Stock Split. Shares held by stockholders who held fewer than 3,500 shares of the Company’s common stock immediately prior to the Reverse Stock Split were converted into the right to receive a payment in cash (without interest) equal to the fair value of such shares as of the time when those entitled to receive such payments were determined, which shall be an amount equal to such number of shares of the Company’s common stock held multiplied by the average of the closing sales prices of the Company’s common stock on Nasdaq for the five consecutive trading days immediately preceding the effective date of the Reverse Stock Split, and each share of the Company’s common stock held by a stockholder of record owning 3,500 shares or more immediately prior to the effective time of the Reverse Stock Split were converted into a new number of shares of Company’s common stock based on a ratio of 375 shares of the Company’s common stock for each share of the Company’s common stock owned immediately following the Reverse Stock Split, including any fractional shares owned following the Reverse Stock Split; however, with respect to any fractions of a share of Company common stock that may be held as a result of the Forward Stock Split, stockholders received a payment in cash (without interest) equal to the fair value of such fractions as of the time when those entitled to receive such fractions are determined, which was an amount equal to such fractions multiplied by the average of the closing sales prices of the Company’s common stock on Nasdaq for the five consecutive trading days immediately preceding the effective date of the Reverse/Forward Stock Split (with such average closing sales prices being adjusted to give effect to the Reverse/Forward Stock Split).
The number of shares of authorized Company common stock did not change as a result of the Reverse/Forward Stock Split; however, the number of shares of outstanding Company common stock decreased as a result of the Reverse/Forward Stock Split.
Accordingly, all share and per-share amounts for the current period and prior periods have been adjusted to reflect the Reverse/Forward Stock Split.
The number of shares of Company’s common stock issuable upon the exercise of Series C Preferred Stock and the Series E Preferred Stock immediately prior to the Reverse/Forward Stock Split were proportionately decreased and the conversion price of the Series C Preferred Stock and the Series E Preferred Stock were proportionately increased, effective as of June 21, 2023, the close of business on the date of such Reverse/Forward Stock Split. Our issued and outstanding preferred stock was not affected by the reverse stock split and continues to be 3,535,000 shares of preferred stock, with a par value of $0.01 per share. Refer to Note 2 - "Basis of Presentation" to the consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further information.
Disposition of Interest in Aerojet Shares
As a result of the Exchange Transaction, the Company recorded $202.7 million to investments, which represents the fair value of the Aerojet common stock transferred to Steel Connect. As of July 31, 2023, the Company had disposed of all its interest in Aerojet common stock. The majority of Aerojet common stock was disposed of when L3 Harris closed its merger with Aerojet. As of July 31, 2023, the Company received $53.3 million in cash out of the total net proceeds of $207.8 million. The Company received the remaining $154.5 million proceeds in cash in the first quarter of fiscal year 2024, and there was a corresponding decrease in prepaid expenses and other current assets within the condensed consolidated balance sheet at the time of this cash
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receipt. Refer to Note 1 - "Nature of Operations" to the consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further information.
Customers
Historically, a limited number of key clients have accounted for a significant percentage of the Company's revenue. For the three months ended April 30, 2024 and 2023, the Company's ten largest clients accounted for approximately 82.6% and 85.0%, respectively, of consolidated net revenue. Two clients accounted for 41.6% and 13.8%, respectively, of the Company's consolidated net revenue for the three months ended April 30, 2024. Two clients accounted for 45.0% and 11.0%, respectively, of the Company's consolidated net revenue for three months ended April 30, 2023. No other clients accounted for more than 10.0% of the Company's consolidated net revenue for the three months ended April 30, 2024 or 2023.
For the nine months ended April 30, 2024 and 2023, the Company's ten largest clients accounted for approximately 80.0% and 84.0%, respectively, of consolidated net revenue. Two clients accounted for 36.8% and 15.6%, respectively, of the Company's consolidated net revenue for the nine months ended April 30, 2024. Two clients accounted for 43.0% and 12.0%, respectively, of the Company's consolidated net revenue for nine months ended April 30, 2023. No other clients accounted for more than 10.0% of the Company's consolidated net revenue for the nine months ended April 30, 2024 or 2023.
Two clients accounted for greater than 10.0% of the Company's consolidated net accounts receivables as of April 30, 2024. The clients accounted for approximately 40.0% and 12.2%, respectively, of the Company's consolidated net accounts receivable balance as of April 30, 2024. Four clients accounted for greater than 10% of the Company's consolidated net accounts receivables as of July 31, 2023. The clients accounted for approximately 28.0%, 14.0%, 12.0%, and 10.0%, respectively, of the Company's consolidated net accounts receivable balance as of July 31, 2023.
In general, the Company does not have any agreements which 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.
Basis of Presentation
The Company has one operating segment which is the same as its reportable segment: Supply Chain. The Company also has Corporate-level activity, which consists primarily of costs associated with certain corporate administrative functions such as legal, finance and share-based compensation, which are not allocated to the Company's reportable segment. The Corporate-level balance sheet information includes cash and cash equivalents, investments, debt and other assets and liabilities which are not allocated to the operations of the Company's operating segment. All significant intra-segment amounts have been eliminated.
The Company elected pushdown accounting in which it uses Steel Holdings' basis of accounting, which reflects the fair market value of the Company’s assets and liabilities at the date of the Exchange Transaction. As a result, the Company has reflected the required pushdown accounting adjustments in its consolidated financial statements. Due to the application of pushdown accounting, the Company’s consolidated financial statements and certain footnote disclosures include a black line division between the two distinct periods to indicate the application of two different bases of accounting, which may not be comparable, between the periods presented. The pre-exchange period through April 30, 2023 is referred to as the "Predecessor" period. The post-exchange period, May 1, 2023 and onward, includes the impact of pushdown accounting and is referred to as the "Successor" period. As such for purposes of this Quarterly Report, all references to the three and nine months ended April 30, 2024 are for the Successor period, and all references to the three and nine months ended April 30, 2023, or the prior fiscal year, are for the Predecessor period.
All share and per-share amounts for the current period and prior periods have been adjusted to reflect the Reverse/Forward Stock Split.
Results of Operations
The following summarizes the condensed consolidated results of operations for the Successor and Predecessor periods, which relate to the period succeeding and period preceding the Exchange Transaction with Steel Holdings, respectively. The results of operations for the Successor and Predecessor periods are comparable unless otherwise noted that as a result of pushdown accounting the periods are not comparable.
Three months ended April 30, 2024 compared to the three months ended April 30, 2023
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| Successor | Predecessor | |||||||||||||||||||||||||||||||
| Three Months Ended April 30, | Three Months Ended April 30, | |||||||||||||||||||||||||||||||
| (unaudited in thousands) | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | $ Change1 | % Change1 | |||||||||||||||||||||||||||||
| Net revenue | $43,855 | $46,142 | $(2,287) | (5.0) | % | |||||||||||||||||||||||||||
| Cost of revenue | (30,838) | (33,218) | 2,380 | 7.2 | % | |||||||||||||||||||||||||||
| Gross profit | 13,017 | 12,924 | 93 | 0.7 | % | |||||||||||||||||||||||||||
| Gross profit percentage | 29.7% | 28.0% | — | 170 | bpts | |||||||||||||||||||||||||||
| Selling, general and administrative | (9,144) | (12,619) | 3,475 | 27.5 | % | |||||||||||||||||||||||||||
| Amortization | (893) | — | (893) | (100.0) | % | |||||||||||||||||||||||||||
| Interest expense | (243) | (914) | 671 | 73.4 | % | |||||||||||||||||||||||||||
| Other gains, net | 1,123 | 4,489 | (3,366) | (75.0) | % | |||||||||||||||||||||||||||
| Income before income taxes | 3,860 | 3,880 | (20) | (0.5) | % | |||||||||||||||||||||||||||
| Income tax benefit (expense) | 67,800 | (851) | 68,651 | 8067.1 | % | |||||||||||||||||||||||||||
| Net income | $71,660 | $3,029 | $68,631 | 2,265.8 | % | |||||||||||||||||||||||||||
1 Favorable (unfavorable) change
Net Revenue:
During the three months ended April 30, 2024, net revenue decreased by approximately $2.3 million as compared to the same period in the prior fiscal year. This decrease in net revenue was primarily driven by lower volumes and loss of programs associated with existing clients in the computing and consumer electronics markets, offset partially by new business revenue with a client in the consumer electronics market. Fluctuations in foreign currency exchange rates had an insignificant impact on net revenues for the three months ended April 30, 2024, as compared to the same period in the prior fiscal year.
Cost of Revenue:
Cost of revenue 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, depreciation expense, severance, contract labor, consulting, fulfillment and shipping, and applicable facilities costs. Total cost of revenue decreased by $2.4 million for the three months ended April 30, 2024, as compared to the same period in the prior fiscal year. This was primarily driven by a decrease in cost of materials procured on behalf of our clients of $2.3 million as a result of lower sales volumes associated with existing clients in the computing and consumer electronics markets. Fluctuations in foreign currency exchange rates had an insignificant impact on cost of revenues for the three months ended April 30, 2024, as compared to the same period in the prior fiscal year.
Gross Profit:
Gross profit percentage increased 170 basis points to 29.7% from 28.0% in the three months ended April 30, 2024 as compared to the same period in the prior fiscal year, primarily due to a decrease in material costs as discussed above. Fluctuations in foreign currency exchange rates had an insignificant impact on the Company's gross margin for the three months ended April 30, 2024, as compared to the same period in the prior fiscal year.
Selling, General and Administrative Expenses:
Selling, general and administrative expenses 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 costs and public reporting costs. Selling, general and administrative expenses during the three months ended April 30, 2024 decreased by approximately $3.5 million as compared to the same period in the prior fiscal year, primarily due to $3.5 million lower Corporate-level activity driven by a decrease in legal fees and board fees, offset partially by an increase in expenses related to mergers and acquisitions activity. Fluctuations in foreign currency exchange rates did not have a significant
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impact on selling, general and administrative expenses for the three months ended April 30, 2024, as compared to the same period in the prior fiscal year.
Amortization Expense:
Amortization expense for the three months ended April 30, 2024 was $0.9 million and was driven by the recognition of intangible assets in connection with the application of pushdown accounting as a result of the Exchange Transaction. The Exchange Transaction closed on May 1, 2023, and as such, there was no activity for the three months ended April 30, 2023.
Interest Expense:
Total interest expense during the three months ended April 30, 2024 decreased $0.7 million as compared to the same period in the prior year, primarily due to the cessation of the amortization of the discount on the SPHG Note as of May 1, 2023, the date of the Exchange Transaction.
Other Gains, Net:
Other gains, net are primarily composed of investment gains (losses), fair value remeasurement gains (losses), foreign exchange gains (losses), interest income, and sublease income.
The Company recorded $1.1 million to Other gains, net for the three months ended April 30, 2024, driven by $3.7 million interest income, primarily due to interest earned on money market funds, offset by $2.1 million of net realized and unrealized losses recognized on investments, and $0.6 million in foreign exchange losses.
The Company recorded $4.5 million to Other gains, net, for the three months ended April 30, 2023 primarily due to: (1) $1.9 million gain from proceeds received from the sale of an investment, (2) $1.4 million gain due to settlement with a client; (3) $0.5 million interest income; and (4) $0.3 million foreign exchange gains.
Income Tax Benefit (Expense):
During the three months ended April 30, 2024, the Company recorded an income tax benefit of approximately $67.8 million as compared to income tax expense of $0.9 million for the same period in the prior fiscal year. The favorable change in income tax is due to the Company's release of a portion of its valuation allowance for certain pre-existing Company deferred tax assets. The release resulted in a one-time non-cash adjustment to income tax benefit of $71.5 million for the three months ended April 30, 2024.
Net Income:
Net income for the three months ended April 30, 2024 increased $68.6 million as compared to the same period in the prior fiscal year due to the one-time non-cash, significant income tax benefit accounting adjustment booked during the three months ended April 30, 2024.
Nine months ended April 30, 2024 compared to the nine months ended April 30, 2023
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| Successor | Predecessor | |||||||||||||||||||||||||||||||
| Nine Months Ended April 30, | Nine Months Ended April 30, | |||||||||||||||||||||||||||||||
| (unaudited in thousands) | ||||||||||||||||||||||||||||||||
| 2024 | 2023 | $ Change1 | % Change1 | |||||||||||||||||||||||||||||
| Net revenue | $128,240 | $148,283 | $(20,043) | (13.5) | % | |||||||||||||||||||||||||||
| Cost of revenue | (92,402) | (108,031) | 15,629 | 14.5 | % | |||||||||||||||||||||||||||
| Gross profit | 35,838 | 40,252 | (4,414) | (11.0) | % | |||||||||||||||||||||||||||
| Gross profit percentage | 27.9% | 27.1% | — | 80 | bpts | |||||||||||||||||||||||||||
| Selling, general and administrative | (26,670) | (33,463) | 6,793 | 20.3 | % | |||||||||||||||||||||||||||
| Amortization | (2,661) | — | (2,661) | (100.0) | % | |||||||||||||||||||||||||||
| Interest expense | (739) | (2,588) | 1,849 | 71.4 | % | |||||||||||||||||||||||||||
| Other gains, net | 8,739 | 4,889 | 3,850 | 78.7 | % | |||||||||||||||||||||||||||
| Income before income taxes | 14,507 | 9,090 | 5,417 | 59.6 | % | |||||||||||||||||||||||||||
| Income tax benefit (expense) | 66,935 | (1,630) | 68,565 | 4206.4 | % | |||||||||||||||||||||||||||
| Net income | $81,442 | $7,460 | $73,982 | 991.7 | % | |||||||||||||||||||||||||||
1 Favorable (unfavorable) change
Net Revenue:
During the nine months ended April 30, 2024, net revenue decreased by approximately $20.0 million as compared to the same period in the prior fiscal year. This decrease in net revenue was primarily driven by lower volumes associated with existing clients in the computing and consumer electronics markets, partially offset by new business revenue with a client in the consumer electronics market. Fluctuations in foreign currency exchange rates had an insignificant impact on net revenues for the nine months ended April 30, 2024, as compared to the same period in the prior fiscal year.
Cost of Revenue:
Total cost of revenue decreased by $15.6 million for the nine months ended April 30, 2024, as compared to the same period in the prior fiscal year. This was primarily driven by a decrease in cost of materials procured on behalf of our clients of $15.1 million as a result of lower sales volumes associated with existing clients in the computing and consumer electronics markets, along with a decrease in payroll, benefits and labor in support of customers in the consumer electronics market. Fluctuations in foreign currency exchange rates had an insignificant impact on cost of revenues for the nine months ended April 30, 2024, as compared to the same period in the prior fiscal year.
Gross Profit:
Gross profit decreased $4.4 million in the nine months ended April 30, 2024 as compared to the same period in the prior fiscal year, primarily driven by the lower sales volume discussed above. The gross profit percentage increased 80 basis points to 27.9% from 27.1%, primarily due to changes in customer sales mix. Fluctuations in foreign currency exchange rates had an insignificant impact on the Company's gross margin for the nine months ended April 30, 2024, as compared to the same period in the prior fiscal year.
Selling, General and Administrative Expenses:
Selling, general and administrative expenses during the nine months ended April 30, 2024 decreased by approximately $6.8 million as compared to the same period in the prior fiscal year.
Selling, general and administrative expenses for the Supply Chain segment decreased by $0.8 million primarily due to bad debt expense recorded for a client in the consumer products industry in the prior fiscal year period that did not reoccur in the current year period. Corporate-level activity decreased by $6.0 million, primarily due to a decrease in legal fees, board fees, and other professional fees, offset partially by an increase in expenses related to mergers and acquisitions activity. Fluctuations in foreign currency exchange rates did not have a significant impact on selling, general and administrative expenses for the nine
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months ended April 30, 2024 as compared to the same period in the prior fiscal year.
Amortization Expense:
Amortization expense of $2.7 million for the nine months ended April 30, 2024 was driven by the recognition of intangible assets in connection with the application of pushdown accounting as a result of the Exchange Transaction. The Exchange Transaction closed on May 1, 2023, and as such, there was no activity for the nine months ended April 30, 2023.
Interest Expense:
Total interest expense during the nine months ended April 30, 2024 decreased $1.8 million as compared to the same period in the prior year, primarily due to the cessation of the amortization of the discount on the SPHG Note as of May 1, 2023, the date of the Exchange Transaction.
Other Gains, Net:
The Company recorded $8.7 million to Other gains, net for the nine months ended April 30, 2024, due to $10.4 million interest income primarily earned on money market funds. This activity was partially offset by $1.5 million of net realized and unrealized losses recognized on investments, and $0.4 million unrealized losses recognized as a result of the fair value remeasurement of the SPHG Note.
The Company recorded $4.9 million to Other gains, net, for the nine months ended April 30, 2023, primarily due to (1) $1.9 million gain from proceeds received from the sale of an investment, (2) $1.4 million gain due to settlement with a client, (3) $0.9 million interest income; and (4) $0.8 million sublease income. These gains were partially offset by $0.5 million foreign exchange losses.
Income Tax Benefit (Expense):
During the nine months ended April 30, 2024, the Company recorded an income tax benefit of approximately $66.9 million as compared to income tax expense of $1.6 million for the same period in the prior fiscal year. The favorable change in income tax is due to the Company's release of a portion of its valuation allowance for certain pre-existing Company deferred tax assets. The release resulted in a one-time non-cash adjustment to income tax benefit of $71.5 million for the nine months ended April 30, 2024.
Net Income:
Net income for the nine months ended April 30, 2024 increased $74.0 million, as compared to the same period in the prior fiscal year due to the one-time non-cash, significant income tax benefit accounting adjustment booked during the nine months ended April 30, 2024.
Liquidity and Capital Resources
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.
As a result of the Exchange Transaction, the Company recorded $202.7 million to investments, which represents the fair value of the Aerojet common stock transferred to Steel Connect. As of July 31, 2023, the Company had disposed of all its interest in Aerojet common stock. The majority of Aerojet common stock was disposed of when L3 Harris closed its merger with Aerojet. As of July 31, 2023, the Company received $53.3 million in cash out of the total net proceeds of $207.8 million. During the first quarter of fiscal year 2024, the Company received the remaining $154.5 million proceeds in cash. The Company believes it has access to adequate resources to meet its needs for normal operating costs, capital expenditures, debt obligations and working capital for at least the next twelve months from the date of this Form 10-Q. As of April 30, 2024, these resources include cash and cash equivalents and ModusLink's borrowing capacity under its credit agreement with Umpqua Bank (the “Umpqua Revolver”), as lender and as agent. 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 31, 2026 and removed certain adjustments in the definition of “Adjusted EBITDA” as set forth in the Umpqua Facility, and certain caps and conditions on ModusLink’s ability to pay dividends. There was no balance outstanding on the Umpqua Revolver as of April 30, 2024. See Note 10 - "Debt" for further details regarding the Umpqua Revolver.
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Upon a redemption request by a holder of the Preferred Stock (as discussed in Note 17 - "Related Party Transactions" and in the Company's Annual Report on Form 10-K for the Fiscal Year ended July 31, 2023), Steel Connect believes 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 for the next twelve months from the date of this Form 10-Q.
The following table summarizes our liquidity:
| Successor | |||||
| April 30, 2024 | |||||
| (in thousands) | |||||
| Cash and cash equivalents | $ | 269,237 | |||
| Readily available borrowing capacity under Umpqua Revolver | 11,890 | ||||
| $ | 281,127 | ||||
There is no U.S. tax payable upon repatriating the undistributed earnings of foreign subsidiaries considered not subject to indefinite 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 nine months ended April 30, 2024. In future years, 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 not be material.
Consolidated working capital was $234.7 million as of April 30, 2024, as compared to $251.5 million at July 31, 2023. Included in working capital were cash and cash equivalents of $269.2 million as of April 30, 2024 and $121.4 million at July 31, 2023. Sources and uses of cash for the nine months ended April 30, 2024, as compared to the same period in the prior year, are as follows:
| Successor | Predecessor | ||||||||||||||||
| Nine Months Ended April 30, | Nine Months Ended April 30, | ||||||||||||||||
| 2024 | 2023 | ||||||||||||||||
| (in thousands) | |||||||||||||||||
| Net cash provided by operating activities | $ | 15,428 | $ | 9,000 | |||||||||||||
| Net cash provided by investing activities | $ | 135,819 | $ | 736 | |||||||||||||
| Net cash used in financing activities | $ | (1,604) | $ | (2,780) | |||||||||||||
Operating Activities: We generated cash of $15.4 million from operating activities during the nine months ended April 30, 2024, an increase of $6.4 million compared to $9.0 million provided by operating activities during the nine months ended April 30, 2023. 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.
Investing Activities: Net cash provided by investing activities was $135.8 million during the nine months ended April 30, 2024 as compared to $0.7 million during the nine months ended April 30, 2023. The increase was driven primarily by the $154.5 million cash receipt in August 2023 for the remaining proceeds receivable from the disposition of the Aerojet shares in the prior fiscal year. Also contributing to the increase was $3.1 million in proceeds from the sale of equity securities. This activity was partially offset by the purchase of investments totaling $18.9 million and $2.9 million spend on capital expenditures during the nine months ended April 30, 2024. Net cash provided by investing activities during the nine months ended April 30, 2023 was related to $1.9 million in proceeds received from the sale of an investment, offset by $1.3 million from spend on capital expenditures.
Financing Activities: Net cash used in financing activities was $1.6 million and $2.8 million during the nine months ended April 30, 2024 and 2023, respectively, which primarily consisted of $1.6 million payments of dividends on the Series C Convertible Preferred Stock in both periods, as well as $1.1 million of convertible debt repayments related to the SPHG Note during the nine months ended April 30, 2023.
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Debt and Financing Arrangements
The following is a summary of the Company’s outstanding debt and financing agreements and Preferred Stock. Refer to Note 10 – “Debt” and Note 17 – “Related Party Transactions” to the consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further 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 September 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.
On March 9, 2023 (the "Amendment Date"), the Company and SPHG Holdings entered into an amendment to the SPHG Note (the “SPHG Note Amendment”). Pursuant to the SPHG Note Amendment, the maturity date of the SPHG Note was extended to its current maturity date of September 1, 2024 from its original maturity date of March 1, 2024. In addition, the Company repaid $1.0 million in principal amount of the SPHG Note on the Amendment Date, and repaid an additional $1.0 million principal amount of the note on June 9, 2023. In connection with the SPHG Note Amendment, the Company paid SPHG Holdings a cash amendment fee of $0.1 million, and derecognized $0.2 million of the debt discount in proportion to the reduction of the principal balance during Fiscal Year 2023. No other changes were made to the terms of the SPHG Note besides the items discussed.
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 the required stockholder approval), at an initial conversion rate of 45.1356 shares of common stock, which is equivalent to an initial conversion price of approximately $22.16 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.
As of April 30, 2024 and July 31, 2023, outstanding debt in both periods consisted of the $12.9 million 7.50% Convertible Senior Note due September 1, 2024. As of April 30, 2024 and July 31, 2023, the fair value of the SPHG Note was $12.9 million and $12.5 million, respectively.
Umpqua Revolver
ModusLink, as borrower, is party to a revolving credit agreement with Umpqua Bank as lender and as agent. The Umpqua Revolver provides for a maximum credit commitment of $12.5 million and a sublimit of $5.0 million for letters of credit. On May 1, 2024, ModusLink, entered into a Second Amendment to Umpqua Revolver (the “Second Amendment”). Among other things, the Second Amendment (i) extended the maturity date with respect to revolving loans from March 31, 2025 to March 31, 2026, (ii) removed certain adjustments in the definition of “Adjusted EBITDA” as set forth in the Umpqua Revolver, (iii) increased the minimum Adjusted Tangible Net Worth (as defined in the credit agreement) and (iv) removed certain caps and conditions on ModusLink’s ability to pay dividends. Steel Connect is not a borrower or a guarantor under the Umpqua Revolver.
As of April 30, 2024, ModusLink was in compliance with the Umpqua Revolver's covenants, and believes it will remain in compliance with the Umpqua Revolver’s covenants for the next twelve months from the date of filing this Form 10-Q. As of April 30, 2024, ModusLink had available borrowing capacity of $11.9 million and there was $0.6 million outstanding letters of credit.
ModusLink believes that if dividends to the Company 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 under the Umpqua Revolver 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.
Series C Preferred Stock
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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 Series C 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 Series C 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 Series C Preferred Stock can be converted into shares of the Company's common stock at an initial conversion price equal to $18.29 per share, subject to appropriate adjustments for any stock dividend, stock split, stock combination, reclassification or similar transaction. Holders of the Series C 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 Series C Preferred Stock to convert all, or any whole number, of shares of the Series C 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 Series C 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 Series C 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 Series C 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 Series C Preferred Stock), plus (ii) 100% of all declared but unpaid dividends, and all accrued but unpaid dividends on each such share of Series C Preferred Stock, in each case as of the date of the triggering event.
On or after December 15, 2022, each holder of Series C Preferred Stock can also require the Company to redeem its Series C Preferred Stock in cash at a price equal to the Liquidation Preference (as defined in the Series C Certificate of Designations), or approximately $35.0 million. If holders of the Series C Preferred Stock exercise this right to require the Company to redeem all the Series C 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.
Series E Preferred Stock
On May 1, 2023, the Company and Steel Holdings executed a series of agreements in which the Steel Partners Group agreed to transfer certain marketable securities held by the Steel Partners Group to Steel Connect in exchange for 3.5 million shares of Series E Convertible Preferred Stock of Steel Connect (the “Series E Convertible Preferred Stock”, and, such transfer the “Transfer and Exchange Agreement”). Following the approval by the Company's stockholders at the special stockholders' meeting held on June 6, 2023 pursuant to the rules of the Nasdaq Capital Market (the “Stockholder Approval”), the Series E Convertible Preferred Stock is convertible into an aggregate of 19.8 million shares of the Company’s common stock (the “Common Stock”), and will vote together with the Common Stock and participate in any dividends paid on the Common Stock, in each case on an as-converted basis.
The terms, rights, obligations and preferences of the Series E Convertible Preferred Stock are set forth in a Certificate of Designations, Preferences and Rights of Series E Convertible Preferred Stock of the Company (the “Series E Certificate of Designations”), which are summarized below:
Any holder of the Series E Convertible Preferred Stock (“Holder”), may, at its option, convert all or any shares of Series E Convertible Preferred Stock held by such Holder into Common Stock based on a conversion price of $10.27 (the “Conversion Price”) per share, subject to appropriate adjustments for any stock dividend, stock split, stock combination, or similar transaction by delivering to the Company a conversion notice.
Holders are entitled to participate equally and ratably with the holders of shares of Common Stock in all dividends or other distributions on the shares of Common Stock as if, immediately prior to each record date for payment of dividends or other distributions on the Common Stock, shares of the Series E Convertible Preferred Stock then outstanding were converted into shares of Common Stock. Dividends or other distributions payable will be payable on the same date that such dividends or other distributions are payable to holders of shares of Common Stock, and no dividends or other distributions will be payable to holders
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of shares of Common Stock unless dividends or such other distributions are also paid at the same time in respect of the Series E Convertible Preferred Stock.
Upon the occurrence of certain triggering events such as a liquidation, dissolution or winding up of the Company, either voluntary or involuntary, any merger or consolidation in which the Company is a constituent party or a significant subsidiary is a constituent party and the Company issues shares of its capital stock pursuant to such merger or consolidation such that the stockholders of the Company prior to such merger or consolidation hold less than 50.0% of the aggregate voting securities of the Company following such merger or consolidation, or the sale of substantially all of the assets or capital stock of the Company or a significant subsidiary (collectively, or any of these, a “Liquidation Event(s)”), the holders of the Series E Convertible 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 Common Stock by reason of their ownership thereof, an amount per share in cash equal to $58.1087 (as adjusted for any stock split, stock dividend, stock combination or other similar transactions with respect to the Series E Convertible Preferred Stock (“the Series E Convertible Preferred Stock Liquidation Preference”). In the event that the Series E Convertible Preferred Stock Liquidation Preference is not paid with respect to any shares of Series E Convertible Preferred Stock as required to be paid, such shares shall continue to be entitled to dividends and all such shares shall remain outstanding and entitled to all the rights and preferences provided within the Series E Certificate of Designations.
Neither the Company nor the Holder has any rights to redeem the Series E Convertible Preferred Stock.
Each Holder of the Series E Convertible Preferred Stock is entitled to vote with holders of outstanding shares of Common Stock, voting together as a single class, with respect to any and all matters presented to the stockholders of the Company for their action or consideration (whether at a meeting of stockholders of the Company, by written action of stockholders in lieu of a meeting or otherwise), except as provided by law. In any such vote, each holder shall be entitled to a number of votes equal to the largest number of whole shares of Common Stock into which all shares of Series E Convertible Preferred Stock held of record by such holder is convertible as of the record date for such vote or written consent or, if there is no specified record date, as of the date of such vote or written consent.
Off-Balance Sheet Arrangements
The Company does not have any material off-balance sheet financing arrangements.
Critical Accounting Estimates Update
The Company's consolidated financial statements are prepared in conformity with U.S. GAAP, which require us to make estimates and assumptions that affect the amounts reported in the financial statements. The critical accounting policies and estimates that we believe are most critical to the portrayal of our financial condition and results of operations are reported in the "Critical Accounting Policies" section of Part II. Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Fiscal Year 2023 Form 10-K filed. During the nine months ended April 30, 2024, the Company added the following critical accounting estimates:
Goodwill and Other Intangible Assets, Net
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. Goodwill is tested for impairment at a reporting unit level, and all of the Company’s goodwill is assigned to its reporting units. Reporting units are determined based upon the Company’s organizational structure in place at the date of the goodwill impairment testing and are generally one level below the operating segment level. The Company tests goodwill annually for impairment, and additionally on an interim basis, if events occur or circumstances change that would indicate the carrying amount may be impaired. Examples of such events would include pertinent macroeconomic conditions, industry and market considerations, overall financial performance and other factors. An entity can choose between using a qualitative impairment test often referred to as “Step 0” or a quantitative impairment test often referred to as “Step 1”.
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 a Step 1 of the goodwill impairment test. An entity may resume performing the Step 0 assessment in any subsequent period. For the Step 1 approach, which is a quantitative approach, 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 amount of impairment, if any, is determined by comparing the fair value of a reporting unit with its carrying amount and recognizing an impairment charge based on the amount that the carrying amount exceeds the reporting unit's fair value. The loss recognized should not exceed the total goodwill allocated to the reporting unit.
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For finite-lived intangible assets, the Company evaluates the carrying amount of such assets when circumstances indicate the carrying amount may not be recoverable. Conditions that could have an adverse impact on the cash flows and fair value of the long-lived assets are deteriorating business climate, condition of the asset or plans to dispose of the asset before the end of its useful life. If the assets' carrying amounts exceed the sum of the undiscounted cash flows, an impairment charge is recognized in the amount by which the carrying amounts exceeds their fair values. The Company performs such assessments at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities, which is generally at the plant level, operating company level or the reporting unit level, depending on the level of interdependencies in the Company's operations.
Indefinite-lived intangible assets are tested for impairment at least annually, or when events or changes in circumstances indicate that it is more likely than not that the asset is impaired. Companies can use the same two testing approaches for indefinite-lived intangibles as for goodwill. There were no impairments of goodwill or other intangible assets for the three and nine months ended April 30, 2024 or for the fiscal year ended July 31, 2023. The Company’s annual impairment test date is June 30th each year. No indicators of impairment for goodwill and other indefinite-lived intangible assets were identified as of April 30, 2024.
Income Taxes
The Company has net operating loss carryforwards for federal and state tax purposes of approximately $369.9 million and $138.8 million, respectively, as of July 31, 2023. As of July 31, 2023, approximately $1.6 billion of net operating loss carryforwards for federal and state tax purposes expired. 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, 2023, a valuation allowance had been recorded against the Company’s deferred tax assets in the U.S. and certain of its foreign subsidiaries as management believed that after considering all the available objective evidence, both positive and negative, historical and prospective, with greater weight given to historical evidence, it was more likely than not that these assets would not be realized. As of April 30, 2024, the Company reassessed the need for a valuation allowance against its deferred tax assets. After considering historical and projected future taxable income and existing taxable temporary differences, the Company determined that it is more likely than not that the deferred tax assets will be realized at a point in the future prior to their expiration. As a result, the Company released substantially all of its valuation allowance except the valuation allowance relating to approximately $31.0 million of NOLs that will expire as of July 31, 2024, and approximately $0.9 million of state NOLs that the Company anticipates will expire unutilized. This release of the valuation allowance resulted in a one-time non-cash income tax benefit of $71.5 million for the quarter ended April 30, 2024.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Consistent with the rules applicable to "Smaller Reporting Companies," we have omitted information required by this item.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation of our management, including the Interim Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such terms are defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. "Disclosure controls and procedures" means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives. Based upon that
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evaluation, management, including the Interim Chief Executive Officer and Chief Financial Officer, concluded that the Company's disclosure controls were effective as of April 30, 2024.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during the quarter ended April 30, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The information set forth under Note 11 - "Contingencies" to Condensed Consolidated Financial Statements, included in Part I, Item 1 of this Quarterly Report on Form 10-Q, is incorporated herein by reference. For an additional discussion of certain risks associated with legal proceedings, also see Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the Fiscal Year ended July 31, 2023.
Item 1A. Risk Factors.
There have been no material changes from the risk factors previously disclosed under the heading "Risk Factors" in the Company's Annual Report on Form 10-K for the Fiscal Year ended July 31, 2023.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
a.None.
b.Not applicable.
c.None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Insider trading arrangements and policies
During the three months ended April 30, 2024, no director or officer of the Company adopted or terminated a "Rule 10b5-1 trading arrangement" or "non-Rule 10b5-1 trading arrangement," as each term is defined in Item 408(a) of Regulation S-K.
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Item 6. Exhibits.
| Exhibit Number | Description | |||||||
| 10.23 | ||||||||
| 10.24*+ | ||||||||
| 31.1* | ||||||||
| 31.2* | ||||||||
| 32.1± | ||||||||
| 32.2± | ||||||||
| 101* | The following financial information from Steel Connect, Inc.'s Quarterly Report Form 10-Q for the quarter ended April 30, 2024 formatted in Inline XBRL: (i) Unaudited Condensed Consolidated Balance Sheets as of April 30, 2024 and July 31, 2023, (ii) Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended April 30, 2024 and 2023, (iii) Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended April 30, 2024 and 2023, (iv) Unaudited Condensed Consolidated Statements of Stockholders' Equity (Deficit) for the three and nine months ended April 30, 2024 and 2023, (v) Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended April 30, 2024 and 2023 and (vi) Notes to Unaudited Condensed Consolidated Financial Statements. | |||||||
| 104* | Cover Page Interactive Data File (embedded within the Inline XBRL document) | |||||||
*Filed herewith.
+ Management contract or compensatory plan or arrangement.
± Furnished herewith.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| STEEL CONNECT, INC. | ||||||||
Date: June 6, 2024 | By: | /S/ RYAN O'HERRIN | ||||||
| Ryan O'Herrin | ||||||||
| Chief Financial Officer | ||||||||
| (Principal Financial Officer and Authorized Signatory) | ||||||||
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