Effects of COVID-19 Pandemic
The COVID-19 pandemic had an immediate impact on the Company's operating
activities. In March 2020, most school districts that we serve closed their
doors to students and initiated remote learning. As a result, order rates in
fiscal year 2021 declined by approximately 20% compared to the prior year.
During the first quarter of fiscal 2022, many schools reopened and virtually all
schools were reopened for the beginning of academic year beginning August 2021.
Order rates for fiscal year 2022 increased by nearly 40% compared to the prior
year. The Company experienced severe supply chain issues and dramatically
increased commodity costs during this year. In addition to severe shortages of
materials, the Company incurred a severe shortfall of both temporary and
full-time labor. In October and November of fiscal 2022, the Company
significantly increased the starting wages for production workers followed by
raises for all hourly workers. With these raises the Company was able to attract
and retain additional workers.
In fiscal 2023, the Company was able to substantially resolve supply chain
challenges and labor shortages. Order rates increased by over 13% and sales
increased by 25%, enabling the Company to return to profitable operations.
Executive Overview of Operating Results
The market for school furniture is traditionally seasonal, with approximately
50% of annual sales occurring in the months of June, July, and August. The
Company has traditionally met the seasonal needs with significant overtime and
by hiring seasonal temporary labor. During fiscal 2021, the demand for school
furniture declined primarily due to the COVID-19 pandemic disruption, order
rates declined by 20%, and the Company reduced production levels. Because of the
traditional dependence on temporary seasonal labor, the Company was able to
reduce seasonal hiring to match production to demand. The Company did not sever
any of its full-time employees during the pandemic. During fiscal 2022 order
rates recovered, increasing by nearly 40% compared to fiscal 2021. The Company
was unable to hire adequate new permanent workers or temporary labor to meet the
traditional summer delivery needs and supply chain challenges exacerbated
deliveries of furniture. In fiscal 2023, order rates continued to improve,
increasing by more than 13%. The Company was able to substantially resolve most
supply chain challenges and sales increase by approximately 25%.
The markets that Virco serves include the education market (the Company's
primary market), which is made up of public and private schools (preschool
through 12th grade), junior and community colleges, four-year colleges and
universities and trade, technical and vocational schools. Virco also serves
convention centers and arenas; the hospitality industry, with respect to their
24
--------------------------------------------------------------------------------
banquet and meeting facilities; government facilities at the federal, state,
county and municipal levels; and places of worship. In addition, the Company
sells to wholesalers, distributors, retailers, catalog retailers, and internet
retailers that serve these same markets. These institutions are frequently
characterized by extreme seasonality and/or a bid-based purchasing function. The
Company's business model, which is designed to support this strategy, is highly
integrated. The Company purchases coils of steel, plastic resin, particle board,
and other raw materials and fabricated finished goods for the education market.
The Company markets and sells direct to the schools and provides project
management and logistics. The Company primarily sells to schools FOB
destination, with nearly 80% of sales delivered FOB classroom destination.
As part of this integrated business model, the Company has developed several
competencies to enable superior service to the markets in which Virco competes.
The Company's direct sales force is supported by interior designers, project
managers and field service professionals. An important element of Virco's
business model is the Company's emphasis on developing and maintaining key
manufacturing, warehousing, distribution, delivery, project management and
service capabilities. The Company has developed a comprehensive product offering
for the furniture, fixtures and equipment ("FF&E") needs of the K-12 education
market, enabling a school to procure all of its FF&E requirements from one
source.
Virco's product offering consists primarily of items manufactured by Virco,
complemented with products sourced from other furniture manufacturers to fill
any gaps in product manufactured by the Company. The Company has served the
education industry for over 73 years and over this time developed products to
address a variety of classroom management trends, from collaborative learning to
individual and combination desks facilitating distancing and classroom control.
The pandemic caused a noticeable change in the types of products requested by
educators. In fiscal 2021 we experienced an increase in the demand for
individual desks. In fiscal 2022, demand began to return to products supporting
collaborative learning. This trend continued through fiscal 2023. Our product
offerings are continually enhanced with an ongoing new product development
program that incorporates internally developed products as well as product lines
developed with accomplished designers. Finally, management continues to hone
Virco's ability to forecast, finance, manufacture, warehouse, deliver and
install furniture within the relatively narrow delivery window associated with
the highly seasonal demand for education sales. The educational sales market is
extremely seasonal. Historically, Virco ships approximately 50% of its annual
revenue in the months of June, July, and August. In fiscal 2022, the seasonal
peak was distorted due to severe supply chain interruptions, labor shortages,
and COVID-19 related employee absences and the Company delivered slightly less
than 40% of sales during June, July, and August. In fiscal 2023, approximately
47% of the Company's total sales were delivered in June, July, and August.
During periods of traditional seasonality, average weekly shipments during July
and August can be as great as six times the level of average weekly shipments in
the winter months. Virco's substantial warehouse space allows the Company to
build and ship adequate inventories to service this narrow delivery window for
the education market.
The budgetary pressures directly impact the demand for the Company's products,
as the demand for educational furniture largely depends upon: (1) available
funding in a school's general operating fund and (2) the completion of
bond-funded projects, which is directly impacted by the amount of bond financing
issued to fund new school construction, to renovate older schools, and to fully
equip new and renovated schools.
We believe that a significant majority, approximately 80-85%, of a school's
operating budget is for the salaries and benefits for school teachers and
administrators. Increasing costs for medical insurance, combined with pressures
from unfunded post-retirement medical and pension obligations reduces funds
available for other purposes. In response to these budgetary pressures, schools
typically elect to retain teachers and spend less on repairs, maintenance, and
replacement furniture, which in turn reduces the demand for, and sales of, the
Company's products.
The significant budgetary challenges faced by the education industry have had an
impact on the Company's business model over this time frame and have created
opportunities as well. In response to their budgetary challenges, many school
districts closed warehouses and reduced janitorial and support staff in order to
retain accredited teachers. Selling efforts must now reach school principals and
administrative staff in addition to the district business offices. Sales priced
under national contracts or buying groups are displacing competitive bids
administered by professional purchasing departments. Distribution and service
has become a more meaningful component of our business as most deliveries are to
school sites, and nearly 50% include delivery into the classroom. This evolution
adds to the seasonal challenges of our business, but also creates opportunities
to suppliers that can execute during the short summer delivery window.
The Company's operating results can be impacted significantly by cost and
volatility of commodities, especially steel, plastic, wood, and energy. The
majority of the Company's sales are generated under annual contracts in which
the Company can raise the price of its products once every six months and only
on future orders. If the costs of the Company's raw materials increase suddenly
or unexpectedly, the Company cannot be certain that it will be able to implement
immediate corresponding increases in its sales prices in order to offset such
increased costs. The Company moderates this exposure by building significant
25
--------------------------------------------------------------------------------
quantities of finished goods and component parts during the first and second
quarters. In fiscal 2023, the cost of commodities was volatile but substantially
less volatile compared to fiscal 2022. Increased selling prices covered
increases in commodity prices during fiscal 2023.
Nearly 80% of Virco's sales include freight to the customer facility and the
cost or availability of transportation equipment can adversely impact both
profitability and customer service. Significant cost increases in manufacturing
or distributing products during a given contract period can adversely impact
operating results and have done so during prior years. The Company typically
benefits from any decreases in raw material or distribution costs under the
contracts described above.
For the year ending January 31, 2024 ("fiscal 2024"), the Company anticipates
continued uncertainty and volatility in commodity costs, particularly with
respect to steel, plastic, and other raw materials, transportation, and energy.
The lingering effects of the global pandemic related to COVID-19 and global
sanctions are expected to continue to disrupt global and domestic supply chains.
While the Company anticipates challenging economic conditions to continue to
impact its core customer base in the near term, there are certain underlying
demographics, customer responses and changes in the competitive landscape that
provide opportunities. First, the underlying demographics of the student
population are relatively stable compared to the volatility of school budgets
and the related impact on furniture and equipment purchases. This volatility is
attributable to the financial health of the school systems. Virco management
believes that there is a pent-up demand for quality school furniture (though it
is unclear when and to what extent that pent-up demand will be converted into a
meaningful increase in purchases). Second, management believes that parents and
voters will make quality education an ongoing priority for future government
spending. The disruption related to COVID-19 school closures reinforced the need
for learning in classroom settings. Third, many schools have responded to the
budget strains by reducing their support infrastructure. This change provides
opportunities to provide services to schools, such as project management for new
or renovated schools, delivery to individual school sites rather than truckload
deliveries to central warehouses, and delivery of furniture into classrooms.
Moreover, this change offers opportunities for Virco to promote its complete
product assortment which allows one-stop shopping as opposed to sourcing
furniture needs from a variety of suppliers. Fourth, many suppliers previously
shut down or dramatically curtailed their domestic manufacturing capabilities,
making it difficult for competitors to adapt to dynamic fluctuations in demand
or provide custom colors or finishes during a narrow seasonal summer delivery
window when they are reliant upon a supply chain extending to Asia or elsewhere.
Meanwhile, Virco has continued to invest in automation at its domestic
manufacturing facilities, adding flat metal forming processes to its
manufacturing capabilities and bringing production into its factories of items
formerly sourced from other suppliers (both domestic and international).
Domestic production facilitates our product development process, enabling the
Company to more rapidly develop new products, release extensions of product
families, and offer customized variants of our product offerings. Virco views
its domestic factories as a strategic resource for providing its customers with
timely delivery of a broad selection of colors, finishes, laminates, and product
styles.
Critical Accounting Policies and Estimates
This discussion and analysis of Virco's financial condition and results of
operations is based upon the Company's consolidated financial statements
("financial statements"), which have been prepared in accordance with U.S.
generally accepted accounting principles. The preparation of these financial
statements requires Virco management to make estimates and judgments that affect
the Company's reported assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. Certain of these estimates are
considered critical accounting estimates. On an ongoing basis, management
evaluates such critical estimates, including those related to valuation of
inventory and related excess and obsolescence reserves, self-insured retention
for workers' compensation insurance, liabilities under defined benefit and other
compensation programs, and estimates related to deferred tax assets and
liabilities. Management bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances. This forms the basis of judgments about the carrying value of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions. Factors that could cause or contribute to these differences include
the factors discussed above under "Item 1, Business", and elsewhere in this
Annual Report on Form 10-K. Virco's critical accounting policies and estimates
are as follows:
Inventory Valuation: Inventory is valued at the lower of cost or net realizable
value (determined on a first-in, first-out basis) and includes material, labor,
and factory overhead. The Company records valuation adjustments for the excess
cost of the inventory over its estimated net realizable value. Valuation
adjustments for slow-moving and obsolete inventory are calculated using an
estimated percentage applied to inventories based on a physical inspection of
the product in connection with a physical inventory, a review of slow-moving
products and component stage, inventory category, historical and forecasted
consumption of sales, and consideration of active marketing programs. The market
for education furniture is traditionally driven by value, not style, and the
Company has not typically incurred material obsolescence expenses. If market
conditions are less favorable
26
--------------------------------------------------------------------------------
than those anticipated by management, additional valuation adjustments may be
required. The Company records the cost of excess capacity as a period expense,
not as a component of capitalized inventory valuation.
Self-Insured Retention: For fiscal 2023 and 2022, the Company was self-insured
for product liability losses up to $250,000 per occurrence, workers'
compensation losses up to $250,000 per occurrence, and auto and general
liability losses up to $50,000 per occurrence. The Company obtains quarterly or
semi-annual actuarial valuations for the self-insured retentions. Product
liability, workers' compensation, and auto reserves for known and unknown
incurred but not reported ("IBNR") losses are recorded at the net present value
of the estimated losses using a risk-free discount rate of 4% for fiscal 2023
and fiscal 2022. Given the relatively short term over which the known losses and
IBNR losses are discounted, the sensitivity to the discount rate is not
significant. Estimated workers' compensation and auto losses (including IBNR)
were funded during the insurance year and subject to retroactive loss
adjustments. The Company's exposure to self-insured retentions varies depending
upon the market conditions in the insurance industry and the availability of
cost-effective insurance coverage. Self-insured retentions for fiscal 2024 will
be comparable to the retention levels for fiscal 2023.
Defined Benefit Obligations: The Company has two defined benefit plans, the
Virco Employees Retirement Plan ("Employee Plan") and the Virco Important
Performers Plan ("VIP Plan"), which provide retirement benefits to employees.
Virco discounted the pension obligations for the two plans using the following
discount rates for the fiscal years ended January 31:
2023 2022
Employee Plan 4.85% 3.20%
VIP Plan 4.85% 3.20%
Because new benefit accruals for both plans were frozen by the Company effective
December 31, 2003, the assumed rate of increase in compensation has no effect on
the accounting for the plans. For the Employee Plan, the Company estimated a
6.0% return on plan assets for 2023 and 6.0% for fiscal 2022. The VIP Plan is
unfunded and has no plan assets. These rate assumptions can vary due to changes
in interest rates and expected returns in the stock market. In prior years, the
discount rate has decreased, causing pension expense and pension obligations to
increase.
Because the plans have been frozen for many years, there is no service cost
related to the plans. In the current and prior years, due to a large number of
lump-sum benefits paid to retired and terminated employees, the Company has
incurred settlement costs for the Employee Plan. In effort to "de-risk" the
Employee Plan, the Company intends to continue to reach out to and offer lump
sum benefits to terminated and retired employees, which may result in settlement
costs in the future. The Company incurred settlement costs in the third and
fourth quarters of fiscal 2023 and the second, third, and fourth quarters of
fiscal 2022.
Due to the size of the Company's pension obligations, a one percent change in
discount rates can cause a material change in the pension obligations. A one
percent reduction in discount rates would cause obligations under the Plans to
increase by approximately $4.0 million and increase pension expense by
approximately $750,000. A one percent decrease in return on Plan assets would
increase pension expense by $220,000 and have no impact on retirement
obligations. The retirement obligations would decrease by similar amounts if
discount rate were to increase by a comparable percentage. The Company obtains
annual actuarial valuations for both plans.
Deferred Tax Assets and Liabilities: In assessing the realizability of deferred
tax assets, the Company considers whether it is more-likely-than-not that some
portion or all of its deferred tax assets will be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income or reversal of deferred tax liabilities during the periods in
which those temporary differences become deductible. As a part of this
evaluation, the Company assesses all available positive and negative evidence,
including future reversals of existing taxable temporary differences, projected
future taxable income, the availability of tax carry backs, tax-planning
strategies, and results of recent operations (including cumulative losses in
recent years), to determine whether sufficient future taxable income will be
generated to realize existing deferred tax assets.
During the fiscal year ended January 31, 2022, the Company incurred operating
losses primarily related to COVID-19 and COVID-19 related supply chain
disruptions. During the fourth quarter of the fiscal year ended January 31,
2022, the Company identified objective and verifiable negative evidence in the
form of cumulative losses in the U.S. and in certain state jurisdictions over
the preceding 12 quarters. Based on this evaluation, and after considering
future reversals of existing taxable temporary differences and the effects of
seasonality on the Company's business, the Company determined the realization of
a majority of the net deferred tax assets no longer met the more-likely-than-not
criteria and a valuation allowance was recorded against the majority of the net
deferred tax assets.
During the fiscal year ended January 31, 2023, the Company was profitable and
returned to a cumulative 3-year profit in the fourth quarter. During the fourth
quarter of the fiscal year ended January 31, 2023, the Company concluded a
fiscal year that
27
--------------------------------------------------------------------------------
demonstrated strong growth in order rates, revenue, pricing, and gross margin.
In addition, a very strong level of sales orders received in the fourth quarter
ended January 31, 2023, for shipment in the fiscal year ending January 31, 2024,
resulted in a backlog of unshipped sales orders that was approximately $18
million greater than the prior year ended January 31, 2022 and approximately $40
million more than the average year-end backlog for the prior 5 years. Based on
this evaluation, and after considering future reversals of existing taxable
temporary differences and the effects of seasonality on the Company's business,
the Company determined the realization of a majority of the net deferred tax
assets met the more-likely-than-not criteria and the valuation allowance against
the majority of the net deferred tax assets was reversed.
The amount of the deferred tax asset considered realizable could be adjusted if
the Company's actual results in the future do not generate taxable income that
is sufficient to allow the Company to utilize its deferred tax assets. The
Company's future taxable income projections are subject to a high degree of
uncertainty and could be impacted, both positively and negatively, by changes in
our business or the markets in which we operate. A change in the assessment of
the realizability of our deferred tax assets could materially impact our results
of operations.
Results of Operations (fiscal 2023 vs. 2022)
Financial Highlights
The Company earned a pre-tax profit of $8.0 million on net sales of $231.1
million for fiscal 2023, compared to pre-tax loss of $3.7 million on net sales
of $184.8 million in fiscal 2022, an improvement of $11.8 million. Net income
per diluted share increased to $1.02 for fiscal 2023, compared to a loss of
$0.95 per diluted share in the prior year. Cash flow used in operations was $3.8
million in fiscal 2023, compared to cash used in operations of $0.4 million in
fiscal 2022.
Net Sales
Virco's net sales increased by 25% in fiscal 2023 to $231.1 million compared to
$184.8 million in fiscal 2022. The increase in net sales was primarily
attributable to an increase in selling prices with a minor increase in unit
volume.
Virco's order rates and sales volume were severely impacted by COVID-19. In
fiscal 2021, the Company incurred approximately a 20% reduction in sales orders
and sales volume. This reduction was in large part due to the closure of schools
throughout the nation. In fiscal year 2022, many schools reopened during the
Company's first quarter, and virtually all schools reopened by the beginning of
the Company's third quarter. During fiscal 2022 order rates increased by
approximately 40% compared to the prior year. However, due to severe supply
chain issues and labor shortages, we were not able to increase deliveries at the
same rate and net sales increased by only 21%. The Company ended the fiscal year
with an order backlog that was approximately $18 million higher than the prior
year. In fiscal 2023 the Company continued to benefit from increased order
rates, with sales orders increasing by more than 13%. During the fiscal year
2023, the Company was able to substantially address supply chain issues and
sales of furniture increased by approximately 25%. The Company ended the year
with another increase in year-end backlog of sales orders. This increase was
attributable to a 48% increase sales orders in our traditionally slow fourth
quarter, much of which is planned for delivery in the second quarter of fiscal
2024.
For fiscal 2024, the lingering effect of the COVID-19 pandemic is continuing to
create uncertainty as state and local government budgets may be adversely
impacted. The potential government revenue shortfall may be offset significantly
or in part by a variety of federal government programs. The Company increased
selling prices under its largest contracts to recover volatile commodity,
energy, freight, and labor costs. As we have gone through this economic cycle,
the Company continues to focus on strategies to develop and strengthen its brand
with emphasis on product quality, product selection, and service. We will
continue to use our domestic factories to provide greater flexibility for custom
specifications such as laminates, colors, and on-time delivery. The Company will
continue to emphasize the value, design, variety of its products, the value of
its distribution, delivery, classroom delivery and project management
capabilities, and the importance of timely deliveries during the peak-seasonal
delivery period. To increase or maintain market share during fiscal 2024, when
market conditions warrant, the Company may selectively compete based on direct
prices to build or maintain its market share. Estimates of sales volume for the
next year may continue to be impacted by global events.
Cost of Sales
Cost of sales was 63.1% of net sales in fiscal 2023 and 67.0% of net sales in
fiscal 2022. The decrease in cost of sales as a percentage of sales was
attributable to a variety of factors, but primarily due to increased selling
prices. In fiscal 2022, the Company incurred severe increases in the cost of
steel, plastic, and ocean freight. Other costs increased but not as severely.
These events adversely affected gross margin. At the beginning of fiscal 2023
the Company increased selling prices for orders received after January 1, 2022,
and increased prices again for orders received after July 1, 2022. The
cumulative effect of these
28
--------------------------------------------------------------------------------
price increases allowed margins to recover from the adverse events of fiscal
2022. As the Company's backlog of sales orders at prior year pricing and margins
was delivered, new orders at more favorable pricing raised margins for the
second, third, and fourth quarters.
In fiscal 2022, in addition to increased costs the Company was unable to obtain
desired quantities of many materials on a timely basis. Finally, the Company
experienced labor shortages, both due to COVID-19 related absences and a lack of
available temporary labor. The Company incurred material overtime expenses for
its existing employees in effort to meet demand. At the beginning of the fourth
quarter of fiscal 2022, the Company significantly increased the beginning wage
rate for all hourly workers and gave meaningful raises to all other hourly
workers. During fiscal 2023, the increase in wages substantially resolved
staffing issue and the Company made significant improvements in supply chain
challenges. As the lower margin sales backlog at January 31, 2022 was delivered,
sales orders received after January 1, 2022 enabled the Company to return
margins to more profitable levels.
During fiscal 2024, the Company anticipates continued uncertainty and volatility
in commodity costs, particularly with respect to certain raw materials,
transportation, energy, and tariffs due to potential macroeconomic events,
including global economic sanctions and the lingering effect of the global
pandemic caused by COVID-19. The Company also anticipates continued and possibly
increased supply chain disruptions from both domestic and international
suppliers. Due in part to volatile transportation and energy costs, we may incur
higher commodity costs in fiscal 2024. For more information, please see the
section below entitled "Inflation and Future Change in Prices."
Selling, General and Administrative and Other Expenses
Selling, general and administrative expenses (SG&A) for fiscal 2023 increased by
$13,238,000 to $74,503,000 from $61,265,000 but decreased as a percentage of net
sales to 32.2% in fiscal 2023 from 33.1% in fiscal 2022. The increase in SG&A
was primarily attributable to variable freight expenses, variable classroom
delivery expenses, variable portion of warehousing expense and variable selling
expenses. Pension expense declined due to favorable actuarial changes to AOCI.
An increase in discount rates caused the pension obligation to decline, which
had a favorable impact on settlement expenses. Interest expense was $784,000
higher in fiscal 2023 compared to fiscal 2022 because of increased levels of
borrowing and higher interest rates.
Provision for Income Taxes
Our effective tax rate is based on recurring factors, including the forecasted
mix of income before taxes in various jurisdictions, estimated permanent
differences and the recording of a partial valuation allowance on net deferred
tax asset.
During fiscal 2022, the Company incurred net operating losses, due primary to
adverse economic conditions due to COVID-19 and related business interruptions
while emerging from the effects of the pandemic. During the fourth quarter of
the fiscal year ended January 31, 2022, based on this evaluation, and after
considering future reversals of existing taxable temporary differences and the
effects of seasonality on the Company's business, the Company determined the
realization of a majority of the net deferred tax assets no longer met the
more-likely-than-not criteria and a valuation allowance was recorded against the
majority of the net deferred tax assets.
During fiscal 2023, the Company was profitable and benefited from continued
growth in order rates, growth in sales volume, and improvements in gross margin.
Strong order activity in the fourth quarter indicates the trends experienced in
fiscal 2023 may continue through fiscal 2024. The Company utilized a material
portion of its federal and certain state net operating loss carryforwards
("NOL") in fiscal 2023 and anticipates that all federal NOL may be utilized by
the end of fiscal 2024. During the fourth quarter of the fiscal year ended
January 31, 2023, based on this evaluation, and after considering future
reversals of existing taxable temporary differences and the effects of
seasonality on the Company's business, the Company determined the realization of
a majority of the net deferred tax assets met the more-likely-than-not criteria
and a valuation allowance was reversed against the majority of the net deferred
tax assets, resulting in a net change in valuation allowance of $10.5 million.
Valuation allowances of $864,000 are needed for certain state net operating loss
carryforwards to reduce the carrying amount of deferred tax assets to an amount
that is more-likely-than-not to be realized. At January 31, 2023, the Company
has net operating loss carryforwards of approximately $2,742,000 for U.S.
federal, with no expirations, and $25,074,000 for state income tax purposes,
expiring at various dates through January 31, 2041.
Cash Flows
The following table shows summary cash flows information for the fiscal years
ended January 31, 2023 and 2022:
29
--------------------------------------------------------------------------------
Year ended January 31,
2023 2022
(In thousands)
Net cash used in operating activities $ (3,788) $ (401)
Net cash used in investing activities $ (3,332) $ (2,371)
Net cash provided by financing activities $ 6,818 $ 3,729
Net (decrease) increase in cash $ (302) $ 957Operating activities. Our cash flows from operating activities are primarily
collections from the sale and distribution of furniture to our customers in the
education market. Net cash used in operations increased by $3,387 for the fiscal
year ended January 31, 2023. The increase was substantially due to the timing of
order receipt in the fourth quarter of fiscal 2023. In the fourth quarter of
fiscal 2023 orders increased by more than 48%, resulting in a year-end sales
order backlog that was more than $58 million. This is nearly $20 million greater
than the prior year and more than $40 million more than the average order
backlog for the preceding five years. The Company increased inventory levels at
January 31, 2023 in order to facilitate deliveries of furniture in the first and
seasonally higher second quarters of fiscal 2024.
Investing activities. Investing activities include two distinct categories.
Financial transactions are related to the purchase or sale of investments held
in the Rabbi Trust which funds and secures employee benefits related to the
non-qualified VIP pension and Split Dollar Life Insurance programs. The net
investment activity from these transactions were immaterial. Our net investments
primarily consist of investments in our factories and technology to support our
business activities. Net investment activities were lower than depreciation
expense and lower than typical for the fiscal years ended January 31, 2023 and
January 31, 2022 due to reduced business activity related to the COVID-19
pandemic and the related time lag in receiving new machinery. Capital
expenditures have been financed using borrowings under our line of credit with
PNC Bank. There were no material commitments for capital expenditures as of
January 31, 2023.
Financing activities. Our financing activities primarily consist of the proceeds
and repayments of borrowings under our line of credit with PNC Bank. Due to the
seasonal nature of our business, the Company typically borrows material amounts
under the line to finance seasonal building of inventory and financing of
accounts receivable. The Company typically repays the seasonal borrowings at the
conclusion of the summer busy season.
Inflation and Future Change in Prices
We commit to annual contracts that determine selling prices for goods and
services for periods of six months and occasionally longer. Though the Company
has negotiated flexibility under many of these contracts that may allow the
Company to increase prices on future orders, the Company may not have the
ability to raise prices on orders received prior to any announced price
increase. Due to the intensely seasonal nature of our business, the Company may
receive significant orders during the first and second quarters for delivery in
the second and third quarters. With respect to any of the contracts described
above, if the costs of providing our products or services increase between the
date the orders are received and the shipping date, we may not be able to
implement corresponding increases in our sales prices for such products or
services to offset the related increased costs. In fiscal 2022, the cost of
commodities, especially steel and plastic were extremely volatile, with the cost
of some gauges of steel nearly tripled during the fiscal year. In fiscal 2023,
the cost of commodities continued to be volatile, but not as severe as in fiscal
2022. The cost of steel and plastic declined during the year, but other
commodity and component cost continued to increase.
For fiscal 2024, the Company anticipates continued volatility in costs,
particularly with respect to imported components from China, freight from China,
certain raw materials including steel, transportation, energy, and potential
impacts of escalating labor costs. Anticipated adverse volatility for fiscal
2024 could be severe in light of global supply chain and economic sanctions,
tariffs imposed or threatened on imported commodities and other disruptions
affecting our suppliers. There is continued uncertainty with respect to steel
and other raw material costs, including plastics, that are affected by the price
of oil. Transportation costs may be adversely affected by increased oil prices,
in the form of increased operation costs for our fleet, and surcharges on
freight paid to third-party carriers. Virco depends upon third-party carriers
for more than 90% of customer deliveries. Recent regulation and more stringent
enforcement of federal regulations governing the transportation industry
(especially regarding drivers) have adversely impacted the cost and availability
of freight services. Virco expects to incur continued pressure on employee
compensation and benefit costs. The Company has renewed health insurance
contracts for its employees through December 2023, but costs after that date may
be adversely impacted by current legislation, claim costs and
30
--------------------------------------------------------------------------------
industry consolidation. Virco has aggressively addressed these costs by
controlling headcount and passing on a portion of increased medical costs to
employees.
To recover the cumulative impact of increased costs, the Company has increased
published list prices for fiscal 2024. Due to current economic conditions, the
Company anticipates modestly increased price competition in fiscal 2024 and may
not be able to raise prices further in response to increased commodity costs
without risk of losing market share. As a portion of Virco's business is
obtained through competitive bids, the Company is carefully considering material
and transportation costs as part of the bidding process. The Company is working
to control and reduce costs by improving production and distribution
methodologies, investigating new packaging and shipping materials, and searching
for new sources of purchased components and raw materials.
Liquidity and Capital Resources
Working Capital Requirements
Virco addresses liquidity and working capital requirements in the context of
short-term seasonal requirements and long-term capital requirements of the
business. The Company's core business of selling furniture to publicly-funded
educational institutions is extremely seasonal. The seasonal nature of this
business permeates most of Virco's operational, capital and financing decisions.
The Company's working capital requirements during and in anticipation of the
peak summer season oblige management to make estimates and judgments that affect
Virco's assets, liabilities, revenues and expenses. Management expends a
significant amount of time during the year, and especially in the fourth quarter
of the prior year and first quarter of current year, developing a production
plan and estimating the number of employees, the amount of raw materials and the
types of components and products that will be required during the peak season.
If management underestimates any of these requirements, Virco's ability to fill
customer orders on a timely basis or to provide adequate customer service may be
diminished. If management overestimates any of these requirements, the Company
may be required to absorb higher storage, labor, and related costs, each of
which may affect profitability. On an ongoing basis, management evaluates such
estimates, including those related to market demand, labor costs and inventory
levels, and continually strives to improve Virco's ability to correctly forecast
business requirements during the peak season each year.
As part of Virco's efforts to address seasonality, financial performance, and
quality without sacrificing service or market share, management has been
refining the Company's ATS operating model. ATS is Virco's version of
mass-customization, which assembles standard, stocked components into customized
configurations before shipment. The Company's ATS program reduces the total
amount of inventory and working capital needed to support a given level of
sales. It does this by increasing the inventory's versatility, delaying assembly
until the last moment, and reducing the amount of warehouse space needed to
store finished goods. In order to provide "one-stop shopping" for all FF&E
needs, Virco purchases and re-sells certain finished goods from other furniture
manufacturers. When practical, these furniture items are drop shipped from the
Company's supplier. Where cost effective, the Company will bring the item into
the Virco warehouse, and the third-party products will be shipped along with
product manufactured by Virco. The Company did not carry material amounts of
vendor inventory during the fiscal years ended January 31, 2023 and 2022.
In addition, Virco finances its largest balance of accounts receivable during
the peak season. This occurs for three primary reasons. First, accounts
receivable balances naturally increase during the peak season as shipments of
products increase. Second, many customers during this period are government
institutions, which tend to pay accounts receivable more slowly than commercial
customers. Third, many summer deliveries may be "projects" where the Company
fulfills large orders of furniture for a new school or significant refurbishment
of an existing school. Customers with large projects may require architect sign
off, school board approval prior to payment, or punch list completion, all of
which can delay payment.
Because of the seasonality of our business, our manufacturing and distribution
capacity is dictated by the capacity requirement during the months of June,
July, and August. Because of this seasonality, factory utilization is lower
during the slow season. The Company utilizes a variety of tactics to address the
seasonality of its business. During the summer months, which comprise our second
and third fiscal quarters, our personnel utilization generally is at or close to
full capacity. The Company utilizes temporary labor and significant overtime to
meet the seasonal requirements. During the slow portions of the year, temporary
labor and overtime are eliminated to moderate the off-season costs. Our
manufacturing facility capacity utilization generally remains less than 100%
during these off-season months; because physical structure capacity cannot be
adjusted as readily as personnel capacity, we have secured sufficient physical
structure capacity to accommodate our current needs, as well as for anticipated
future growth. Our physical structure utilization is significantly lower during
the first and fourth quarters of each year than it is during the second and
third quarters.
31
--------------------------------------------------------------------------------
The Company utilizes a comparable strategy to address warehousing and
distribution requirements. During summer months, temporary labor is hired to
supplement experienced warehouse and distribution personnel. More than 90% of
the Company's freight is provided by third-party carriers. The Company has
secured sufficient warehouse capacity to accommodate our current needs as well
as anticipated future growth.
Line of Credit
As the capital required for the summer season generally exceeds cash available
from operations, Virco has historically relied on third-party bank financing to
meet seasonal cash flow requirements. On December 22, 2011, the Company and
Virco Inc., a wholly owned subsidiary of the Company ("Virco" and, together with
the Company, the "Borrowers") entered into a Revolving Credit and Security
Agreement ("Credit Agreement") with PNC Bank, National Association, as
administrative agent and lender ("PNC"). On September 28, 2021, the Borrowers
entered into an Amended and Restated Credit Agreement (the "Restated Credit
Agreement") with PNC that effectively incorporated all of the prior amendments
to the Credit Agreement into an amended and restated form of agreement.
The Restated Credit Agreement provides the Borrowers with a secured revolving
line of credit ("Revolving Credit Facility") of up to $65,000,000, with seasonal
adjustments to the credit limit and subject to borrowing base limitations and
includes a sub-limit of up to $3,000,000 for issuances of letters of credit. In
addition, the Restated Credit Agreement provides an Equipment Line for purchases
of equipment up to $2,000,000. The Revolving Credit Facility is an asset-based
line of credit that is subject to a borrowing base limitation and generally
provides for advances of up to 85% of eligible accounts receivable, plus a
percentage equal to the lesser of 60% of the value of eligible inventory or 85%
of the liquidation value of eligible inventory, plus $15,000,000 for the period
from December to July of each year minus undrawn amounts of letters of credit
and reserves. The Revolving Credit Facility is secured by substantially all of
the Borrowers' personal property and certain of the Borrowers' real property.
The original termination date of the Restated Credit Agreement was March 19,
2023, which date was extended to April 15, 2027, at which point the principal
amount outstanding under the Restated Credit Agreement and any accrued and
unpaid interest is due and payable, subject to certain prepayment penalties upon
earlier termination. Prior to the maturity date, principal amounts outstanding
under the Restated Credit Agreement may be repaid and reborrowed at the option
of the Borrowers without premium or penalty, subject to borrowing base
limitations, seasonal adjustments, and certain other conditions.
The Revolving Credit Facility bears interest, at the Borrowers' option, at
either the Alternate Base Rate (as defined in the Restated Credit Agreement) or
the Eurodollar Currency Rate (as defined in the Restated Credit Agreement), in
each case plus an applicable margin. The applicable margin for Alternate Base
Rate loans is a percentage within a range of 1.25% to 1.75%, and the applicable
margin for Eurodollar Currency Rate loans is a percentage within a range of
2.25% to 2.75%, in each case based on the adjusted EBITDA (as defined in the
Restated Credit Agreement, "EBITDA") of the Borrowers at the end of each fiscal
quarter and may be increased at PNC's option by 2.0% during the continuance of
an event of default. Accrued interest with respect to principal amounts
outstanding under the Restated Credit Agreement is payable in arrears on a
monthly basis for Alternative Base Rate loans, and at the end of the applicable
interest period but at most every three months for Eurodollar Currency Rate
loans. The interest rate at January 31, 2023 was 9.25%.
The Restated Credit Agreement permits the Company to issue dividends or make
payments with respect to the Company's capital stock in an aggregate amount up
to $3,000,000 during any fiscal year, provided that no default shall have
occurred or is continuing or would result from any such payment, and the Company
must demonstrate pro forma compliance with a 12-month trailing fixed charge
coverage ratio of not less than 1.20:1.00 as of the fiscal quarter immediately
preceding the date of any such dividend or payment.
After execution of the Restated Credit Agreement in September 2021, on December
7, 2021 the Company entered into Amendment No. 1 to the Restated Credit
Agreement, which provided a limited waiver of the Company's violation of the
covenant to maintain a fixed charge coverage ratio of at least 1.10 to 1.00 for
the four fiscal quarter periods ended October 31, 2021, and amended the fixed
charge coverage ratio as follows: (i) 1.00 to 1.00 for each of the consecutive
four fiscal quarter periods of Borrowers ending January 31, 2022 and April 30,
2022, and (ii) 1.10 to 1.00 for each consecutive four fiscal quarter periods of
Borrowers ending thereafter.
The Company was in violation of its financial covenants under the Restated
Credit Agreement as of January 31, 2022, due to a decline in the Company's net
income primarily attributable to the effects of supply chain disruptions and
labor shortages. On April 15, 2022, the Company entered into Amendment No. 2 to
the Credit Agreement, which implemented the following changes to the Restated
Credit Agreement and Revolving Credit Facility:
32
--------------------------------------------------------------------------------
i.extended the final maturity date of the Revolving Credit Facility from March
19, 2023 to April 15, 2027;
ii.increased the borrowing limit from $65,000,000 to $70,000,000 in July 2022
and August 2022, and increased the borrowing limit from $40,000,000 to
$45,000,000 in October 2022;
iii.waived the Company's violation of the covenant to maintain a fixed charge
coverage ratio of at least 1.00 for the period ending January 31, 2022;
iv.for the first and second quarters of fiscal 2023, implemented a temporary
year-to-date adjusted EBITDA covenant in lieu of testing the fixed charge
coverage ratio covenant as of such quarters, with quarterly testing of the fixed
charge coverage ratio to resume for the third fiscal quarter and thereafter;
v.permits a sale and leaseback transaction of the Company's property at 1655
Amity Road and release of the lender's pledge on the property, with the net
proceeds to be used for a proposed share repurchase;
vi.retired LIBOR pricing on the Revolving Credit Facility and replace with BSBY
index, with pricing tiers and spreads to remain the same;
vii.extended the P-card, ACH Credit, and ACH debit facilities for an additional
year beyond their current maturities; and
viii. Borrowers to pay a $250,000 extension fee and $75,000 waiver and amendment
fee, with $200,000 due at closing and $125,000 due on the first anniversary of
closing.
The Restated Credit Agreement contains a clean-down provision that requires the
Company to reduce borrowings under the line of credit to less than $10,000,000
for a period of 30 consecutive days during the Company's fourth fiscal quarter
of each fiscal year. The clean-down provision allows the Company to maintain the
minimum outstanding balance of $10,000,000 to be carried on an uninterrupted
period extending beyond one year and ultimately due at the scheduled maturity.
The Company believes that normal operating cash flow will continue to allow it
to meet the clean-down requirement with no adverse impact on the Company's
liquidity.
Events of default (subject to certain cure periods and other limitations) under
the Restated Credit Agreement include, but are not limited to, (i) non-payment
of principal, interest or other amounts due under the Restated Credit Agreement,
(ii) the violation of terms, covenants, representations or warranties in the
Restated Credit Agreement or related loan documents, (iii) any event of default
under agreements governing certain indebtedness of the Borrowers and certain
defaults by the Borrowers under other agreements that would materially adversely
affect the Borrowers, (iv) certain events of bankruptcy, insolvency or
liquidation involving the Borrowers, (v) judgments or judicial actions against
the Borrowers in excess of $250,000, subject to certain conditions, (vi) the
failure of the Company to comply with Pension Benefit Plans (as defined in the
Restated Credit Agreement), (vii) the invalidity of loan documents pertaining to
the Restated Credit Agreement, (viii) a change of control of the Borrowers and
(ix) the interruption of operations of any of the Borrowers' manufacturing
facilities for five consecutive days during the peak season or 15 consecutive
days during any other time, subject to certain conditions.
Pursuant to the Restated Credit Agreement, substantially all of the Borrowers'
accounts receivable are automatically and promptly swept to repay amounts
outstanding under the Revolving Credit Facility upon receipt by the Borrowers.
Due to this automatic liquidating nature of the Revolving Credit Facility, if
the Borrowers breach any covenant, violate any representation or warranty, or
suffer a deterioration in their ability to borrow pursuant to the borrowing base
calculation, the Borrowers may not have access to cash liquidity unless provided
by PNC at its discretion. In addition, certain of the covenants and
representations and warranties set forth in the Restated Credit Agreement
contain limited or no materiality thresholds, and many of the representations
and warranties must be true and correct in all material respects upon each
borrowing, which the Borrowers expect to occur on an ongoing basis. Based on the
Company's current projections, including COVID-19 related costs, raw material
costs and its ability to introduce price increases, management believes it will
maintain compliance with the financial covenants within Amendment No. 2,
although there are uncertainties therewithin, such as raw material costs and
supply chain challenges.
The Company's line of credit with PNC is structured to provide seasonal credit
availability during the Company's peak summer season. Approximately $12,878,000
was available for borrowing as of January 31, 2023.
Long-Term Capital Requirements
33
--------------------------------------------------------------------------------
In addition to short-term liquidity considerations, the Company continually
evaluates long-term capital requirements.
Capital expenditures will continue to focus on automation, both in the factory
and software applications, and new product development along with the tooling
and new processes required to produce new products. The Company has identified
several opportunities for capital expenditures during the next five years. The
Company anticipates capital spending of no more than $5 million for fiscal 2024.
Our Revolving Credit Facility with PNC Bank provides a $2 million line for
equipment and covenants allow for anticipated capital expenditures for fiscal
2024.
Retirement Obligations
The Company provides retirement benefits to employees under two defined benefit
retirement plans; the Employee Plan and the VIP Plan. The Employee Plan is a
qualified retirement plan that is funded through a trust held at PNC Bank
("Trustee"). The other plan is non-qualified retirement plan. Benefits payable
under the VIP Plan are secured by life insurance policies and marketable
securities held in a rabbi trust. The Company obtains annual actuarial
valuations for both retirement plans.
Because the plans have been frozen since 2003, there is no service cost related
to the plans. In past, due to a large number of lump sum benefits paid to
retired and terminated employees, the Company has incurred settlement costs for
the Employee Plan. In effort to "de-risk" the Employee Plan, the Company intends
to continue to reach out to and offer lump sum benefits to terminated and
retired employees, which may result in settlement costs in the future. With the
recent increase in interest rates the Company may purchase annuities from third
parties to further de-risk the Plan. The Company incurred settlement costs in
the third and fourth quarters of fiscal 2023. The Company incurred settlement
costs in the second, third, and fourth quarters of fiscal 2022. It is the
Company's policy to contribute adequate funds to the trust accounts to cover
benefit payments under the VIP Plan and to maintain the funded status of the
Employee Plan at a level which is adequate to avoid significant restrictions to
the Employee Plan under the Pension Protection Act of 2006 and to minimize PBGC
related expenses. Contributions to the Qualified Plan Trust and benefit payments
under the VIP Plan totaled $595,000 in fiscal 2023 and $654,000 in fiscal 2022.
Contributions during fiscal 2024 will depend upon actual investment results and
benefit payments but are anticipated to be approximately $500,000. At January
31, 2023, accumulated other comprehensive loss of approximately $2.4 million,
net of tax, is attributable to the pension plans.
The Company does not anticipate making any significant changes to the pension
assumptions in the near future. If the Company were to have used different
assumptions in the fiscal year ended January 31, 2023, a 1% reduction in
investment return would have increased expense by approximately $221,000, a 1%
change in the rate of compensation increase would have no impact, and a 1%
reduction in discount rates would cause obligations under the Plans to increase
by approximately $4.0 million and increase pension expense by approximately
$744,000.
Stockholders' Equity
Historically it has been the board of directors' policy to periodically review
the payment of cash and stock dividends in light of the Company's earnings and
liquidity. The Company paid four quarterly cash dividends of $0.015 per share in
2018.
Virco issued a 10% stock dividend or 3/2 stock split every year beginning in
1983 through 2003. Although the stock dividend had no cash consequences to the
Company, the accounting methodology required for 10% dividends has affected the
equity section of the balance sheet. When the Company records a 10% stock
dividend, 10% of the market capitalization of the Company on the date of the
declaration is reclassified from retained earnings to additional paid-in
capital. During the period from 1983 through 2003, the cumulative effect of the
stock dividends has been to reclassify over $122 million from retained earnings
to additional paid-in capital. The equity section of the balance sheet on
January 31, 2023 reflects additional paid-in capital of approximately $121
million and accumulated deficit of approximately $51 million. The majority of
the accumulated deficit is a result of the accounting reclassification and is
not the result of accumulated losses.
Environmental and Contingent Liabilities
Environmental Compliance and Government Regulation
Virco is subject to numerous federal, state and local environmental laws and
regulations in the various jurisdictions in which it operates that (a) govern
operations that may have adverse environmental effects, such as the discharge of
materials into the environment, as well as handling, storage, transportation and
disposal practices for solid and hazardous wastes, and (b) impose liability for
response costs and certain damages resulting from past and current spills,
disposals or other releases of hazardous materials. In this context, Virco works
diligently to remain in compliance with all such environmental laws and
regulations as
34
--------------------------------------------------------------------------------
these affect the Company's operations. Moreover, Virco has enacted policies for
recycling and resource recovery that have earned repeated commendations,
including: recognition by the California Department of Resources Recycling and
Recovery ("CalRecycle") in 2012 and 2011 as a Waste Reduction Awards Program
("WRAP") honoree; recognition by the United States Environmental Protection
Agency in 2019 as a WasteWise Winner for reducing waste, in 2004 as a WasteWise
Hall of Fame Charter Member, in 2003 as a WasteWise Partner of the Year, and in
2002 as a WasteWise Program Champion for Large Businesses; and recognition by
the Sanitation Districts of Los Angeles County for compliance with industrial
waste water discharge guidelines in 2008 through 2011. This is only a partial
list of Virco's environmental awards and commendations; for a more complete
list, go to www.virco.com.
In addition to these awards and commendations, Virco's ZUMA and ZUMAfrd product
lines were the first classroom furniture collections to earn indoor air quality
certification through the stringent GREENGUARD® Children & Schools Program, now
known as GREENGUARD Gold certification. As a follow-up to the certification of
ZUMA and ZUMAfrd models in 2006, hundreds of other Virco furniture items -
including Analogy furniture models and Textameter instructor workstations - have
earned GREENGUARD certification. Moreover, all Virco products covered by the
Consumer Product Safety Improvement Act of 2008 are in compliance with this
legislation. All affected Virco models are also in compliance with the
California Air Resources Board rule and Toxic Control Substances Act rule
concerning formaldehyde emissions from composite wood products. Environmental
laws have changed rapidly in recent years, and Virco may be subject to more
stringent environmental laws in the future. The Company has expended, and may be
expected to continue to expend, significant amounts in the future for compliance
with environmental rules and regulations, for the investigation of environmental
conditions, for the installation of environmental control equipment or
remediation of environmental contamination. Normal recurring expenses relating
to operating our factories in a manner that meets or exceeds environmental laws
are matched to the cost of producing inventory. It is possible that the
Company's operations may result in noncompliance with, or liability for
remediation pursuant to, environmental laws. Should such eventualities occur,
the Company records liabilities for remediation costs when remediation costs are
probable and can be reasonably estimated. See "Item 1A. Risk Factors: We could
be required to incur substantial costs to comply with environmental and other
legal requirements." Violations of, and liabilities under, these laws and
regulations may increase our costs or require us to change our business
practices.
Contingent Liabilities
In fiscal 2023 and 2022, the Company was self-insured for product liability
losses of up to $250,000 per occurrence, general liability losses of up to
$50,000 per occurrence, workers' compensation losses up to $250,000 per accident
and auto liability up to $50,000 per accident. In prior years the Company has
been partially self-insured for workers' compensation, automobile, product, and
general liability losses. The Company has purchased insurance to cover losses in
excess of the self-insured retention or deductible up to a limit of $30,000,000.
For the insurance year beginning April 1, 2023, the Company will be self-insured
for product liability losses up to $250,000 per occurrence, general liability
losses up to $50,000 per occurrence, workers' compensation losses up to $250,000
per occurrence, and auto liability up to $50,000 per occurrence. In future
years, the Company's exposure to self-insured retentions will vary depending
upon the market conditions in the insurance industry and the availability of
cost-effective insurance coverage.
The Company has aggressively pursued a program to improve product quality,
reduce product liability claims and losses and to aggressively defend product
liability cases. This program has continued through fiscal 2023 and has resulted
in reductions in product liability claims and litigated product liability cases.
In addition, the Company has active safety programs to improve plant safety and
control workers' compensation losses. As of January 31, 2023, the Company has
incurred no significant workers compensation claims related to COVID-19.
Management does not anticipate that any related settlement, after consideration
of the existing reserves for claims and potential insurance recovery, would have
a material adverse effect on the Company's financial position, results of
operations or cash flows.
Off-Balance Sheet Arrangements
The Company did not enter into any material off-balance sheet arrangements
during fiscal 2023, nor did the Company have any material off-balance sheet
arrangements outstanding at January 31, 2023.
New Accounting Pronouncements
See disclosure of recently adopted and recently issued but not yet adopted
accounting standards in Note 2 to the Consolidated Financial Statements
contained in "Item 8. Financial Statements and Supplementary Data" to this
Annual Report on Form 10-K.
35
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source Glimpses
VIRCO MFG. CORPORATION 
