03-Jun-2021

Steel Connect Reports Third Quarter Financial Results

Third Quarter 2021 Results

Net revenue totaled $151.8 million, as compared to $177.4 million in the prior year
Net loss was $27.6 million, as compared to net loss of $6.2 million in the prior year
Net loss attributable to common stockholders was $28.1 million, as compared to net loss of $6.7 million in the prior year
Adjusted EBITDA^* was $16.5 million, as compared to $16.7 million in the prior year
Net cash provided by operating activities was $15.8 million
Free Cash Flow^* totaled $15.2 million
Total debt, net of unamortized discounts and issuance costs, was $374.2 million; Net Debt^* totaled $283.2 million

Nine-Month Financial Results

Net revenue totaled $477.8 million, as compared to $618.0 million in the prior year
Net loss was $33.4 million, as compared to net loss of $4.9 million in the prior year
Net loss attributable to common stockholders was $35.0 million, as compared to net loss of $6.5 million in the prior year
Adjusted EBITDA^* was $60.2 million, as compared to $62.1 million in the prior year
Net cash provided by operating activities was $21.0 million
Free Cash Flow^* totaled $18.2 million

SMYRNA, Tenn.--(BUSINESS WIRE)--Steel Connect, Inc. (the "Company") (NASDAQ: STCN) today announced financial results for its third quarter ended April 30, 2021.

“As we emerge from the pandemic, we remain focused on our highest-return priorities to generate long-term value for all stakeholders,” said Interim Chief Executive Officer and Executive Chairman Warren Lichtenstein. “The Special Committee of the Board of Directors is still evaluating Steel Partners’ proposal to purchase all outstanding shares of Steel Connect not currently owned by Steel Partners or its affiliates. In the Direct Marketing segment, the Board of Directors approved a Competitive Improvement Plan aimed at expanding services, improving production, and reducing overall production costs. Also, in the Supply Chain business, we continue to reduce costs as we right size the business.”

The Company's acquisition proposal special committee, comprised of independent directors, is still evaluating the proposed transaction contemplated in the expression of interest from Steel Partners Holdings L.P., ("Steel Partners") to acquire all of the outstanding shares of the Company's common stock not already owned by Steel Partners or its affiliates.

	Three Months Ended April 30,						Nine Months Ended April 30,
	2021			2020			2021			2020
	(in thousands)
Net revenue	$	151,785		$	177,351		$	477,766		$	617,956
Net loss	(27,629)			(6,159)			(33,376)			(4,924)
Net loss attributable to common stockholders	(28,148)			(6,684)			(34,962)			(6,516)
Adjusted EBITDA^*	16,472			16,694			60,219			62,059
Adjusted EBITDA margin^*	10.9		%	9.4		%	12.6		%	10.0		%
Net cash provided by operating activities	15,826			45,178			21,012			60,051
Additions to property and equipment	659			1,107			2,819			11,477
Free cash flow^*	15,167			44,071			18,193			48,574

* See reconciliations of these non-GAAP measurements to the most directly comparable GAAP measures included in the financial tables. See also "Note Regarding Use of Non-GAAP Financial Measurements" below for the definitions of these non-GAAP measures.

Results of Operations

Comparison of the Third Quarter and Nine Months Ended April 30, 2021 and 2020

	Three Months Ended April 30,						Nine Months Ended April 30,
	2021			2020			2021			2020
	(unaudited, $ in thousands)
Net revenue:
Direct Marketing	$	102,351		$	98,284		$	299,214		$	354,404
Supply Chain	49,434			79,067			178,552			263,552
Total net revenue	151,785			177,351			477,766			617,956
Cost of revenue	119,538			143,881			369,201			494,991
Gross profit margin	21.2		%	18.9		%	22.7		%	19.9		%
Selling, general and administrative	21,405			25,872			70,073			79,264
Goodwill impairment charge	25,658			—			25,658			—
Amortization of intangible assets	4,182			6,531			16,076			20,719
Interest expense	7,764			8,523			23,412			26,425
All other (income) expense, net	(153)			(2,782)			4,007			(2,547)
Total costs and expenses	58,856			38,144			139,226			123,861
Loss before income taxes	(26,609)			(4,674)			(30,661)			(896)
Income tax expense	1,020			1,485			2,715			4,028
Net loss	$	(27,629)		$	(6,159)		$	(33,376)		$	(4,924)

Net Revenue

Total net revenue for the third quarter decreased $25.6 million, or 14.4%, as compared to the same period in the prior year. Net revenue for the Direct Marketing segment increased by approximately $4.1 million, primarily driven by higher volume, partially offset by a slightly lower average price per package mailed. The increase in net revenue was primarily associated with customers in the financial industry. Within the Supply Chain segment, net revenues decreased by $29.6 million. This decrease in net revenue was primarily driven by lower volume associated with clients in the computing and consumer electronics markets.

Total net revenue for the nine months ended April 30, 2021 decreased $140.2 million, or 22.7%, as compared to the same period in the prior year. Net revenue for the Direct Marketing segment decreased by $55.2 million, primarily driven by lower sales volume. The decrease in net revenue was primarily associated with customers in the financial and multiple-system operator industries. Within the Supply Chain segment, net revenues decreased by $85.0 million. This decrease in net revenue was primarily driven by lower volume associated with clients in the computing and consumer electronics markets.

Cost of Revenue

Cost of revenue for the third quarter decreased $24.3 million, or 16.9%, as compared to the same period in the prior year, primarily due to decreased material and labor costs in both the Direct Marketing and Supply Chain segments. The Direct Marketing segment's gross margin percentage increased by 270 basis points to 21.8% for the three months ended April 30, 2021, as compared to 19.1% for the same period in the prior year. The increase in the Direct Marketing segment’s gross margin percentage was primarily due to favorable changes in customer sales mix and Direct Marketing’s cost management initiatives. The Supply Chain segment's gross margin percentage increased by 150 basis points to 20.0% for the three months ended April 30, 2021, as compared to 18.5% for the same period in the prior year, primarily due to improved customer mix and decreased materials and labor costs.

Cost of revenue for the nine months ended April 30, 2021 decreased $125.8 million, or 25.4%, as compared to the same period in the prior year, primarily due to decreased material and labor costs. The Direct Marketing segment's gross margin percentage increased by 180 basis points to 23.2% for the nine months ended April 30, 2021, as compared to 21.4% for the same period in the prior year, primarily due to favorable changes in customer sales mix and the Company's aggressive measures to manage labor and reduce discretionary spend. The Supply Chain segment's gross margin percentage increased by 410 basis points to 22.0% for the nine months ended April 30, 2021, as compared to 17.9% for the same period in the prior year, primarily due to improved sales mix towards higher margin services.

Selling, General and Administrative

Selling, general and administrative expenses for the third quarter decreased $4.5 million, or 17.3%, as compared to the same period in the prior year, comprised of a decrease in the Direct Marketing segment of $6.3 million related to a net decrease of certain tax liabilities of $5.0 million as well as decreases in most other expense categories as a result of the COVID-19 pandemic cost saving actions.

Selling, general and administrative expenses for the Supply Chain segment increased primarily due to increased information technology costs due to one-time contract termination costs.

Selling, general and administrative expenses for the nine months ended April 30, 2021 decreased $9.2 million, or 11.6%, as compared to the same period in the prior year. Selling, general and administrative expenses for the Direct Marketing segment decreased $9.3 million, as compared to the same period in the prior year, primarily in the areas of employee-related costs, sales and marketing, and other discretionary expenses. Selling, general and administrative expenses for the Supply Chain segment increased $1.3 million, as compared to the same period in the prior year, primarily due to increased information technology costs due to one-time contract termination costs.

Goodwill Impairment Charge

During the three and nine months ended April 30, 2021, the Company recorded a non-cash pre-tax goodwill impairment charge of $25.7 million for the Direct Marketing segment. The Company did not record any impairment charge during the same periods in the prior fiscal year.

Amortization of Intangible Assets

Amortization of intangibles assets for the third quarter decreased $2.3 million, or 36.0%, as compared to the same period in the prior year. Amortization of intangibles assets for the nine months ended April 30, 2021 decreased $4.6 million, or 22.4%, as compared to the same period in the prior year. Amortization expense decreased in both periods as our trademarks and tradenames were fully amortized in December 2020, and our customer relationships are amortized using an accelerated method, which reflects the pattern in which we receive the economic benefit of the asset.

Interest Expense

Interest expense for the third quarter decreased $0.8 million, or 8.9%, as compared to the same period in the prior year. Interest expense for the nine months ended April 30, 2021 decreased $3.0 million, or 11.4%, as compared to the same period in the prior year. The lower interest expense in both periods is primarily due to lower average outstanding debt balances.

All Other Expenses, Net

All other expenses, net are primarily composed of foreign exchange gains and losses. The Company recorded $0.2 million and $2.7 million of foreign exchange gains during the three months ended April 30, 2021 and 2020, respectively. The Company recorded $3.6 million of foreign exchange losses during the nine months ended April 30, 2021, as compared to $2.4 million of foreign exchange gains in the same period in the prior year.

Income Tax Expense

Income tax expense for the third quarter decreased $0.5 million, 31.3%, as compared to the same period in the prior year. Income tax expense for the nine months ended April 30, 2021 decreased $1.3 million, 32.6%, as compared to the same period in the prior year. The decrease in income tax expense for both periods was primarily due to lower taxable income in foreign jurisdictions.

Additions to Property and Equipment (Capital Expenditures)

Capital expenditures for the third quarter totaled $0.7 million, or 0.4% of net revenue, as compared to $1.1 million, or 0.6% of net revenue, for the same period in the prior year. Capital expenditures for the nine months ended April 30, 2021 totaled $2.8 million, or 0.6% of net revenue, as compared to $11.5 million, or 1.9% of net revenue, for the same period in the prior year. The decrease in capital expenditures for both periods in the current fiscal year was primarily due to reduced discretionary spending in response to the COVID-19 pandemic.

Adjusted EBITDA

Adjusted EBITDA decreased $0.2 million, or 1.3%, for the third quarter and decreased $1.8 million, or 3.0%, for the nine months ended April 30, 2021, each as compared to the same period in the prior year, primarily due to reduced gross profit, offset partially by a reduction in certain operating expenses.

Liquidity and Capital Resources

As of April 30, 2021, the Company had cash and cash equivalents of $97.6 million. As of April 30, 2021, IWCO Direct and ModusLink had readily available borrowing capacities of $25.0 million and $5.2 million, respectively, under their credit facilities.

As of April 30, 2021, total debt outstanding, net of unamortized discounts and issuance costs, was $374.2 million, which was comprised of a $365.8 million term loan due December 15, 2022 and $14.9 million outstanding on the 7.50% Convertible Senior Note due March 1, 2024, less associated unamortized discounts and issuance costs.

On June 2, 2021, ModusLink entered into a Second Amendment to the MidCap credit agreement (“Amendment No. 2”) by and among ModusLink, certain of ModusLink’s subsidiaries, and MidCap as lender and agent. Amendment No. 2 amends the MidCap credit agreement to extend the time period for payment from ModusLink to the Company of special distributions to July 31, 2022. In addition, the unused line fee was increased to 0.65% in Amendment No. 2 and certain other technical amendments were incorporated.

Subsequent Event

IWCO Direct's Competitive Improvement Plan

On June 2, 2021, the Board of Directors of Steel Connect, Inc. approved a Competitive Improvement Plan (“CIP”) for its subsidiary IWCO Direct. This plan addresses the changing requirements of the customers and markets IWCO serves and the current competitive landscape. The CIP seeks to expand IWCO’s marketing services capabilities, and upgrade its production platform to new digital and inserting technology, while reducing its overall production costs to enhance its competitive pricing capabilities.

The CIP contemplates a total investment of approximately $50 million over a 24-month period. The Company estimates the CIP cost will consist of approximately $36 million for digital press and insertion equipment and approximately $14 million for severance, employee retention, facilities optimization, and other implementation costs. The cost estimate does not include amounts for potential non-cash accelerated depreciation or asset impairment charges relating to facilities and equipment optimization. The timing and amount of the costs will depend on a number of factors.

About Steel Connect, Inc.

Steel Connect, Inc. is a diversified holding company with two wholly-owned subsidiaries, IWCO Direct Holdings, Inc. and ModusLink Corporation, that serve the direct marketing and supply chain management markets, respectively.

IWCO Direct delivers highly effective data-driven marketing solutions for its customers, which represent some of the largest and most respected brands in the world in markets such as insurance, financial services, and multiple system operators (cable or direct broadcasting satellite TV systems). Its full range of services includes strategy, creative and execution for omnichannel marketing campaigns, along with one of the industry's most sophisticated postal logistics programs for direct mail. Through its Mail-Gard® division, IWCO Direct also offers business continuity and disaster recovery services to protect against unexpected business interruptions, along with providing print and mail outsourcing services. IWCO Direct was named one of the largest direct mail production providers in North America, with the largest platform of continuous digital print technology and a growing direct marketing agency service. IWCO Direct's solutions enable customers to improve customer lifetime value, which, in turn, has led to longer customer relationships. The company is ISO/IEC 27001 Information Security Management System (ISMS) certified through BSI, reflecting its commitment to data security.

ModusLink is a leader in global supply chain business process management, serving clients in markets such as consumer electronics, communications, computing, medical devices, software, and retail. ModusLink designs and executes critical elements in its clients' global supply chains to improve speed to market, product customization, flexibility, cost, quality, and service. These benefits 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. ModusLink also produces and licenses an entitlement management solution powered by its enterprise-class Poetic software, which offers a complete solution for activation, provisioning, entitlement subscription, and data collection from physical goods (connected products) and digital products. ModusLink has an integrated network of strategically located facilities with sites in various countries, including numerous sites throughout North America, Europe, and Asia.

– Financial Tables Follow –

Steel Connect, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in thousands)

	April 30, 2021		July 31, 2020
	(unaudited)
Assets:
Cash and cash equivalents	$	97,582	$	75,887
Accounts receivable, trade, net	72,048		93,072
Inventories, net	15,673		15,354
Funds held for clients	8,397		18,755
Prepaid expenses and other current assets	24,765		20,475
Total current assets	218,465		223,543
Property and equipment, net	66,619		79,678
Goodwill	231,470		257,128
Other intangible assets, net	119,187		135,263
Operating lease right-of-use assets	51,052		56,140
Other assets	7,062		7,420
Total assets	$	693,855	$	759,172

Liabilities:
Accounts payable	$	56,757	$	70,002
Accrued expenses	107,581		111,380
Funds held for clients	8,397		18,755
Current portion of long-term debt	5,612		5,527
Current lease obligations	13,177		14,318
Other current liabilities	28,319		29,950
Total current liabilities	219,843		249,932
Convertible note payable	8,984		8,054
Long-term debt, excluding current portion	359,604		365,468
Long-term lease obligations	39,457		43,211
Other long-term liabilities	11,203		8,509
Total liabilities	639,091		675,174

Contingently redeemable preferred stock	35,180		35,180

Total stockholders' equity	19,584		48,818

Total liabilities, contingently redeemable preferred stock and stockholders' equity	$	693,855	$	759,172

Steel Connect, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts)
(unaudited)

	Three Months Ended April 30,								Nine Months Ended April 30,
	2021			2020			Fav (Unfav)		2021			2020			Fav (Unfav)
Net revenue:
Direct Marketing	$	102,351		$	98,284		4.1	%	$	299,214		$	354,404		(15.6)	%
Supply Chain	49,434			79,067			(37.5)	%	178,552			263,552			(32.3)	%
Total net revenue	151,785			177,351			(14.4)	%	477,766			617,956			(22.7)	%
Cost of revenue	119,538			143,881			16.9	%	369,201			494,991			25.4	%
Gross profit	32,247			33,470			(3.7)	%	108,565			122,965			(11.7)	%
Gross profit margin	21.2		%	18.9		%			22.7		%	19.9		%
Operating expenses:
Selling, general and administrative	21,405			25,872			17.3	%	70,073			79,264			11.6	%
Goodwill impairment charge	25,658			—			—	%	25,658			—			—	%
Amortization of intangible assets	4,182			6,531			36.0	%	16,076			20,719			22.4	%
Total operating expenses	51,245			32,403			(58.1)	%	111,807			99,983			(11.8)	%
Operating (loss) income	(18,998)			1,067			(1,880.5)	%	(3,242)			22,982			(114.1)	%
Total other expense	(7,611)			(5,741)			(32.6)	%	(27,419)			(23,878)			(14.8)	%
Loss before income taxes	(26,609)			(4,674)			(469.3)	%	(30,661)			(896)			3,322.0	%
Income tax expense	1,020			1,485			31.3	%	2,715			4,028			32.6	%
Net loss	(27,629)			(6,159)			(348.6)	%	(33,376)			(4,924)			577.8	%
Less: Preferred dividends on redeemable preferred stock	(519)			(525)			1.1	%	(1,586)			(1,592)			0.4	%
Net loss attributable to common stockholders	$	(28,148)		$	(6,684)		(321.1)	%	$	(34,962)		$	(6,516)		436.6	%

Basic net loss per share attributable to common stockholders	$	(0.45)		$	(0.11)				$	(0.56)		$	(0.11)
Diluted net loss per share attributable to common stockholders	$	(0.45)		$	(0.11)				$	(0.56)		$	(0.11)
Weighted average common shares used in:
Basic loss per share	62,263			61,815					61,898			61,583
Diluted loss per share	62,263			61,815					61,898			61,583

Steel Connect, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

	Nine Months Ended April 30,
	2021		2020
Cash flows from operating activities:
Net loss	$	(33,376)	$	(4,924)
Adjustments to reconcile net loss to cash flows from operating activities:
Depreciation	15,622		17,240
Amortization of intangible assets	16,076		20,719
Amortization of deferred financing costs	467		285
Accretion of debt discount	930		1,240
Impairment of goodwill	25,658		—
Share-based compensation	443		581
Other losses (gains), net	5,686		(2,509)
Changes in operating assets and liabilities:
Accounts receivable, net	21,243		28,492
Inventories, net	(80)		3,847
Prepaid expenses and other current assets	(4,179)		7,538
Accounts payable and accrued expenses	(18,592)		(14,547)
Refundable and accrued income taxes, net	(378)		(793)
Other assets and liabilities	(8,508)		2,882
Net cash provided by operating activities	21,012		60,051
Cash flows from investing activities:
Additions of property and equipment	(2,819)		(11,477)
Proceeds from the disposition of property and equipment	174		12
Proceeds from the sale of available-for-sale securities	—		163
Net cash used in investing activities	(2,645)		(11,302)
Cash flows from financing activities:
Proceeds from revolving lines of credit, net	—		19,000
Long-term debt repayments	(6,142)		(3,076)
Preferred dividend payments	(1,586)		(1,563)
Payment of debt financing costs	—		(914)
Repayments on capital lease obligations	(52)		(83)
Proceeds from issuance of common stock	4		8
Net cash (used in) provided by financing activities	(7,776)		13,372
Net effect of exchange rate changes on cash, cash equivalents and restricted cash	746		(798)
Net increase in cash, cash equivalents and restricted cash	11,337		61,323
Cash, cash equivalents and restricted cash, beginning of period	94,642		46,064
Cash, cash equivalents and restricted cash, end of period	$	105,979	$	107,387

Steel Connect, Inc. and Subsidiaries
Segment Data
(in thousands)
(unaudited)

	Three Months Ended April 30,				Nine Months Ended April 30,
	2021		2020		2021		2020
Net revenue:
Direct Marketing	$	102,351	$	98,284	$	299,214	$	354,404
Supply Chain	49,434		79,067		178,552		263,552
	$	151,785	$	177,351	$	477,766	$	617,956
Operating (loss) income:
Direct Marketing	$	(16,484)	$	(3,041)	$	(5,778)	$	12,379
Supply Chain	(534)		6,535		9,574		18,808
Total segment operating (loss) income	(17,018)		3,494		3,796		31,187
Corporate-level activity	(1,980)		(2,427)		(7,038)		(8,205)
Total operating (loss) income	(18,998)		1,067		(3,242)		22,982
Total other expense	(7,611)		(5,741)		(27,419)		(23,878)
Loss before income taxes	$	(26,609)	$	(4,674)	$	(30,661)	$	(896)

Steel Connect, Inc. and Subsidiaries
Reconciliation of Non-GAAP Measures to GAAP Measures
(in thousands)
(unaudited)

EBITDA and Adjusted EBITDA Reconciliations:
	Three Months Ended April 30,						Nine Months Ended April 30,
	2021			2020			2021			2020
Net loss	$	(27,629)		$	(6,159)		$	(33,376)		$	(4,924)

Interest income	(1)			(8)			(21)			(38)
Interest expense	7,764			8,523			23,412			26,425
Income tax expense	1,020			1,485			2,715			4,028
Depreciation	4,505			5,866			15,622			17,240
Amortization of intangible assets	4,182			6,531			16,076			20,719
EBITDA	(10,159)			16,238			24,428			63,450

Strategic consulting and other related professional fees	1,019			—			1,184			—
Executive severance and employee retention	—			162			—			534
Restructuring and restructuring-related expense	(300)			2			918			924
Share-based compensation	97			209			443			581
Loss on sale of long-lived assets	39			7			79			45
Goodwill impairment charge	25,658			—			25,658			—
Unrealized foreign exchange losses, net	410			(1,833)			5,183			(1,272)
Other non-cash (gains) losses, net	(28)			(113)			(38)			(171)
Adjustments related to certain tax liabilities	(264)			2,022			2,364			(2,032)
Adjusted EBITDA	$	16,472		$	16,694		$	60,219		$	62,059

Net revenue	$	151,785		$	177,351		$	477,766		$	617,956
Adjusted EBITDA margin	10.9		%	9.4		%	12.6		%	10.0		%

Contacts

Investor Relations Contact
Jennifer Golembeske
914-461-1276
investorrelations@steelconnectinc.com

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Last Updated: 03-Jun-2021