What changed in this filing

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Item 2. Management’s Discussion and Analysis

2022-06-10 compared with 2021-12-13 · 72 added, 108 removed, 19 unchanged (90% of the section changed)

1 unchanged sentence

Results of Operations

The effects of COVID - 19

The results of operations for the three-month and nine-month periods ended October 31, 2021 and the comparable periods ended October 31, 2020 have been significantly impacted by economic conditions driven by the COVID-19 pandemic.

The results of operations for the three-months ended April 30, 2022 and the comparable period ended April 30, 2021 have been significantly impacted by economic conditions driven by the COVID-19 pandemic, global supply chain disruptions and global conflict.

The impact of COVID-19 has been quite different during the current year compared to the prior year.

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Orders received from customers follow a similar cycle, approximately 4-6 weeks preceding the selling season.

During the three and nine-month periods ended October 31, 2020, the majority of our primary customers, the K-12 public school systems, closed school campuses and initiated remote learning on or about March 15, 2020.

Most school districts continued with remote learning for the academic year ended June 2020 and into the year beginning August 2020, with a minority of districts attempting hybrid or on-site learning.

During this period our direct sales force, one of the Company’s distinct competitive advantages, was unable to make in-person sales call.

Our primary customers, educators and district business officials, were typically working remotely which complicated selling activities.

As a result, order rates during our traditionally busy summer season of June 2020 through August 2020 declined, causing a reduction in sales.

During the nine months ended October 31, 2021, many school districts announced hybrid or on-site learning beginning in approximately April 2021.

The Company received a large volume of orders for immediate delivery during this period.

The large majority of schools returned to on-site learning for the academic year beginning in the fall of 2021.

Compared to the same periods in the prior fiscal year, orders received in the first quarter ended April 30, 2021 increased by 26.7%, orders received in the second quarter ended July 31, 2021 increased by 29.9%, and orders received during the traditionally slow third quarter ended October 31, 2021 increased by 59.0%.

Year-to-date 2021 orders increased by 35.1% compared to 2020.

However, due to supply chain issues and a shortage of labor, production and sales levels did not keep up with the increase in orders.

The Company’s order backlog at October 31, 2021 was 195% greater than October 31, 2020, increasing to $50,955,000 compared to $17,249,000.

Due to uncertainty created by COVID-19 during the year ended January 31, 2021, the Company moderated production levels to reflect the reduced order activity and maintained conservative inventory levels going into the current year.

The current year has been characterized by severe supply chain issues, which were exacerbated by our low levels of inventory going into the year.

The Company has significant domestic manufacturing capabilities and manufactures the large majority of finished goods domestically, but the Company imports a number of components from manufacturers in China.

The cost and timely delivery of these components have been adversely affected by difficulties at the ports and by cost increases from China.

The cost and availability of domestically sourced steel, plastic, resin, wood, and a variety of other raw materials has been extremely challenging.

In addition to significant difficulty obtaining adequate supplies of domestically sourced materials, the cost of domestically sourced materials increased significantly, with the cost of steel more than doubling during the year, which has caused our pre-tax profit and gross margin to decline.

The availability of labor, both permanent employees and temporary employees, has also been severely negatively impacted.

In response to a labor shortage in operations, and to reward employees who worked substantial overtime hours during the seasonal summer peak, the Company has announced that for all factory and warehouse hourly employees, all overtime hours would be paid at double time rather than the traditional time and one-half for hours worked between June 1 and continuing through December 31.

This cost the Company an additional $1.5 - $2.0 million during the second and third quarters.

The Company believes that this increased cost was offset in part by the increased efficiency of using experienced Virco employees with a substantial reduction in temporary labor.

In order to improve our ability to hire direct labor, the Company increased the starting wage rate to $15 per hour on October 1, 2021.

Subsequent to October 31, 2021 the Company gave wage increases to hourly workers who did not benefit from the increased entry wage rates, to alleviate compression of wage rates in operations.

These changes enabled the Company to successfully add employees during October.

It is anticipated that the Company may hire as many as 75 permanent employees in operations prior to next year’s second quarter.

Production rates in our factories declined during the first and second quarters due to the material and labor shortages.

Production decreased by 25% in the first quarter compared to the same period last year.

Production decreased by 8% in the second quarter compared to the same period last year.

During the third quarter, production rates typically decline as the summer deliveries conclude.

During the current year, the Company continued to work significant overtime and successfully hire additional workers in October.

Production rates increased by 39% in the third quarter compared to the same period last year.

Production efficiencies during the year declined compared to the prior year.

Manufacturing employees were required to

“job shop” to utilize available materials and to prioritize production to support deliveries with critical due dates.

For the fourth quarter the Company anticipates that production rates will remain greater than the prior year and will continue to operate at increased levels until the Company works down its backlog of sales orders.

Because the first quarter of the year is a seasonally slow period, sales activity during the first fiscal quarter of 2022 was not significantly affected by the supply chain considerations.

Sales volume for the first quarter ended April 30, 2021 increased by 59.2% compared to the same period of the prior year.

During the second quarter, which includes two of the three months that typically account for 50% of our annual sales, the supply chain issues were challenging.

Sales for the second quarter were flat compared to the same period of the prior year despite the strong orders discussed above.

Backlog of orders at July 31, 2021 was approximately $20 million greater than the prior year.

During the third quarter, which includes one of the three months that typically account for 50% of our annual sales, supply chain and labor shortages continued to adversely affect operations.

Sales for the third quarter ended October 31, 2021 were flat compared to the same period last year despite strong orders.

Backlog of orders at October 31, 2021 was $33,700,000 higher than the same date last year.

Inventory levels at October 31, 2021 are greater than the same date last year due to the increased material cost component, but significantly lower than the prior year in terms of unit quantity.

The Company believes that it will make material gains in shipping the order backlog during the fourth quarter ending January 31, 2022.

Raises for entry level employees have already been effective in hiring new employees in operations.

Some of the supply chain issues experienced during the year are starting to improve.

The Company anticipates that sales for the fourth quarter ending January 31, 2022 may be double what they were during the same period last year as long as no unanticipated supply chain or COVID related events occur.

Three Months Ended October 31, 2021

Order rates for the three months ended October 31, 2021 increased significantly compared to the prior year.

Orders for the third quarter, which is traditionally a slower period for orders, increased by 59.2%, but sales were flat, increasing by 0.2% compared to the same period of the prior year.

Backlog of orders at October 31, 2021 is approximately $33.7 million greater than the prior year.

The Company anticipates that a significant portion of the increased backlog will ship during the fourth quarter, with a portion delivered in the first quarter of the next fiscal year.

For the three months ended October 31, 2021, the Company earned a pre-tax profit of $1,620,000 on sales of $57,331,000 compared to a pre-tax profit of $4,864,000 on sales of $57,221,000 in the prior year.

Gross Margin for the third quarter was 35.4% of sales compared to 38.9% in the prior year.

The gross margin was primarily affected by increased cost for raw materials and to a modest amount by costs relating to operating the factories with a reduced and interrupted supply of materials, partially offset by a price increase at the beginning of the year.

Selling, general and administrative expenses for the three months ended October 31, 2021 increased compared to the same period last year.

The increase in selling, general and administrative expenses was attributable to increased variable freight expense and by increased selling expenses as our sales force is now actively calling on customers.

Interest expense decreased by $92,000 for the three months ended October 31, 2021 compared to the same period last year.

The Company has borrowed less money to finance seasonal working capital in the third quarter.

For the three months ended October 31, 2021 and 2020, the effective tax rates were 18.2% and 7.9%, respectively.

Effective tax rates for the three months ended October 31, 2021 and 2020 were primarily due to the change in forecasted mix of income before taxes in various jurisdictions, estimated permanent differences and the recording of a partial valuation allowance on net deferred tax assets.

Nine Months Ended October 31, 2021

Order rates for the nine months ended October 31, 2021 increased by 35.1% compared to the prior year.

For the nine-month period ended October 31, 2021 the Company earned a pre-tax profit of $1,511,000 on sales of $144,720,000 compared to a pre-tax income of $3,570,000 on sales of $134,494,000 in the prior year.

Gross Margin for the first nine months was 34.8% of sales compared to 37.5% in the prior year.

The gross margin was affected by increased cost for raw materials and costs relating to operating the factories with a reduced and interrupted supply of materials, partially offset by a price increase at the beginning of the year.

The Company was required to close the Conway, Arkansas factory for more than one week in February due to severe weather and increased utility bills related to the same severe weather.

Selling, general and administrative expenses for the nine months ended October 31, 2021 increased compared to the same period last year but decreased as a percentage of sales.

The increase in selling, general and administrative expenses was attributable to increased variable freight and installation expenses.

Interest expense decreased by $338,000 for the nine months ended October 31, 2021 compared to the same period last year.

The Company has borrowed less money to finance seasonal working capital during the year.

For the nine months ended October 31, 2021 and 2020, the effective tax rates were 22.2% and 6.6%, respectively.

Effective tax rates for the nine months ended October 31, 2021 and 2020 were primarily due to the change in forecasted mix of income before taxes in various jurisdictions, estimated permanent differences and the recording of a partial valuation allowance on net deferred tax assets.

During the three-month period ended April 30, 2021, the majority of our primary customers had either returned to full time classroom instruction or were planning for an imminent return.

The Company received a large number of orders for immediate delivery in anticipation of the return to classroom instruction.

For the three-month period ended April 30, 2022, management believes that the traditional seasonal cycle has returned.

During the quarter ended April 30, 2022, the Company has experienced a 27.9% increase in orders, most of which are for summer of 2022 delivery.

In addition, the Company started the quarter with an order backlog that was approximately $20 million greater than the prior year.

This caused the Company’s backlog of unshipped orders at April 30, 2022 compared to April 30, 2021 to increase by nearly $36 million to $85.7 million compared to $49.7 million.

During the three-month period ended April 30, 2021 the Company incurred severe price increases in the cost of raw materials.

By example the cost of steel, depending on type, increased by 50% to 100% during the quarter.

In addition to increased costs the Company incurred shortages of domestically supplied materials including steel, plastic, resin, and wood.

During the quarter ended April 30, 2021, the Company incurred labor shortages and had severe difficulty hiring both permanent and temporary labor.

In comparison the quarter ended April 30, 2022 was characterized by continued high and increasing raw material costs, but did not incur the same severe spike in raw material costs incurred in the prior year.

The Company raised factory wages by nearly $3 per hour in the fourth quarter of fiscal year ended January 31, 2022.

This increased factory direct labor and overhead expenses, but allowed the Company to hire and retain adequate quantities of permanent and temporary labor.

Production levels in the quarter ended April 30, 2022 increased by nearly 45% compared to the prior year.

Increased levels of factory production and the related overhead absorption offset the effect of increased material and labor expenses.

Supply chain disruptions from international sources – primarily China – continue to adversely affect operations and the competitive landscape.

In the quarter ended April 30, 2021 obtaining materials from China was adversely affected by sharply increased freight costs and by severe disruptions in ocean freight at domestic ports.

In the current quarter ended April 30, 2022 the port congestion has improved moderately and ocean freight costs have not been as volatile as in the prior year, but China’s severe lockdowns of major cities due to COVID has adversely affected shipments from China to the United States.

Because the Company has maintained its domestic factories, management believes that the Company will be less vulnerable to international supply chain disruption compared to competitors that source finished goods overseas, but the Company will still be affected by these international events.

Supply chain disruptions in the construction industry did not significantly impact the quarter ended April 30, 2022, but may impact the timing of sales during the summer.

Virco does not deliver furniture to new schools until the customer has an occupancy certificate.

Construction delays could have the effect of delaying sales from the second quarter to the third quarter of fiscal year ending January 31, 2023.

The Russian invasion of Ukraine in February 2022 has caused oil and energy prices to spike markedly, which has increased the cost of plastic and freight.

Due to seasonally low first quarter sales activity the impact of freight was not severe, but management believes it may be during the summer delivery season.

In addition, approximately two thirds of the pig iron used in domestic steel production comes from Russia and Ukraine.

During the quarter ended April 30, 2022 steel prices remained high, but did not increase compared to the fourth quarter ended January 31, 2022.

This may have an adverse impact on the availability and cost of steel later in this fiscal year.

As discussed in the Risk Factors section of the Company’s Form 10-K for the fiscal year ended January 31, 2022, the Company utilizes one nationwide contract to price a significant portion of our orders.

This contract/price list determines selling prices for goods and services for periods of one year and occasionally longer.

Due to the current volatile nature of commodity and energy prices in addition to general inflation, the Company has negotiated the ability to increase prices for orders received after July 1 of each contract year in addition to the January 1 price increase.

Three Months Ended April 30, 2022

For the three months ended April 30, 2022, the Company incurred a pre-tax loss of $5,366,000 on sales of $32,084,000 compared to a pre-tax loss of $5,094,000 on sales of $28,367,000 in the prior year.

Gross profit for the first quarter was 30.3% of sales compared to 27.1% in the prior year.

In order to recover the increased cost of materials and labor incurred in the prior year, the Company raised prices for all orders received after January 1, 2022.

The impact of the price increase did not fully impact the first quarter.

The Company started this fiscal year with an order backlog of over $40 million and the majority of this order backlog was received prior to the price increase.

These lower priced orders shipped in the first quarter ended April 30, 2022 adversely affecting the gross margin.

Because the price increase did not substantially impact the quarter, the Company did not fully recover the cost increases in material and labor costs.

Raw material cost increased by more than 5% of sales.

Direct labor increased slightly as a percentage of sales.

These increases were more than offset by increased overhead absorption resulting from increased production levels.

Order rates for the three months ended April 30, 2022 increased by nearly 28% compared to the prior year.

These orders were primarily for summer 2022 delivery and did not ship during the first quarter ended April 30, 2022.

In addition, the Company started the quarter with an order backlog that was approximately $20 million greater than the prior year.

During the first quarter ended April 30, 2022 production levels increased by 45% in anticipation of substantially increased summer deliveries of furniture.

Selling, general and administrative expenses for the three months ended April 30, 2022 increased by approximately $2,468,000 compared to the same period last year.

The increase in selling, general and administrative expenses was attributable in part to increased variable freight and service expense and by increased selling expenses.

In addition, the Company incurred increased legal expenses in the first quarter of 2022 to enforce its intellectual property rights against a competitor in the school furniture market and for outside legal counsel to advise a special committee of the Board of Directors formed in May 2021 and terminated in May 2022.

The special committee was formed to review and advise the Board on an unsolicited acquisition proposal with the assistance of independent legal counsel and an independent financial advisor, which proposal was ultimately rejected as inadequate and not in the best interests of shareholders.

Interest expense increased by $134,000 for the three months ended April 30, 2022 compared to the same period last year.

The increase was primarily attributable to an increase in the amount borrowed in 2022 to finance seasonal working capital in the first quarter and an increase in interest rate.

For the three months ended April 30, 2022 and 2021, the effective tax rates were 5.3% and 23.3%, respectively.

The change in effective tax rates for the three months ended April 30, 2022 was due primarily to the recording of a valuation allowance needed for federal deferred tax assets and certain state net operating loss carryforwards which commenced in the fourth quarter of fiscal year ended January 31, 2022 and continued through the period ended April 30, 2022.

Effective tax rate for the first quarter ended April 30, 2021 was primarily due to the change in forecasted mix of income before taxes in various jurisdictions, estimated permanent differences and the recording of a partial valuation allowance on net deferred tax assets.

Liquidity and Capital Resources

In years not impacted by COVID, approximately 50% of the Company's annual sales volume is shipped in the months of June through August of each year.

The market for education furniture is extremely seasonal and approximately 50% of the Company's annual sales volume is shipped in the months of June through August of each year.

The Company traditionally manufactures large quantities of inventory during the first and second quarters of each fiscal year in anticipation of seasonally high summer shipments.

In addition, the Company finances a large balance of accounts receivable during the peak season.

As discussed above, the current year impact of COVID has moderated the summer peak deliveries, and the Company has operated with reduced levels of inventory when measured by unit quantity.

This has reduced the need for seasonal borrowing under our line of credit.

Accounts receivable increased by $7,947,000 at October 31, 2021 compared to the same date in the prior year.

In the prior year the majority of third quarter sales were in August and had been collected by quarter end.

In the current third quarter, October was the largest month of sales revenue, and the October shipments increased receivables at October 31, 2021.

Inventory increased by $3,611,000 at October 31, 2021 compared to the prior year.

The decrease in units was more than offset by the increase in dollars due to the increased material cost of the inventory.

The net reduction in working capital enabled the Company to reduce its borrowing under its revolving line of credit with PNC Bank as of October 31, 2021.

Outstanding debt at October 31, 2021 includes an equipment loan from PNC in the amount of $278,000 and a seller financed mortgage on a manufacturing facility in Conway, Arkansas.

Interest expense for the nine months ended October 31, 2021 is less than the same period last year due to lower average outstanding borrowings under the Company's revolving line of credit with PNC Bank.

Accrual basis capital expenditures for the nine months ended October 31, 2021 was $2,552,000 compared to $1,768,000 for the same period last year.

Inventory increased by $23,422,000 at April 30, 2022 compared to April 30, 2021.

Approximately 40% of the increase in inventory was valuation related to increased material and labor costs and the other 60% was due to increased quantity.

The increase in inventory was financed by increased borrowing under the Company’s line of credit with PNC Bank and increased vendor credit, which traditionally increases with increased purchases of materials.

Accrual basis capital expenditures for the three months ended April 30, 2022 were $627,000 compared to $428,000 for the same period last year.

Capital expenditures are being financed through the Company's credit facility with PNC Bank and operating cash flow and restricted to not exceed $8,000,000 by covenant.

On September 28, 2021, the Company and Virco Inc., its wholly-owned subsidiary (the “Borrowers”), entered into an Amended and Restated Revolving Credit and Security Agreement (the “Restated Credit Agreement”) with PNC Bank, which amended and restated the prior Revolving Credit and Security Agreement, dated as of December 22, 2011, between the Borrowers and PNC Bank.

The material terms of the Restated Credit Agreement are substantially the same as those of the prior agreement.

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.

The Restated Credit Agreement also requires the Company to maintain a minimum fixed charge coverage ratio, and contains numerous other covenants that limit under certain circumstances the ability of the Borrowers and their subsidiaries to, among other things, merge with or acquire other entities, incur new liens, incur additional indebtedness, sell assets outside of the ordinary course of business, enter into transactions with affiliates, or substantially change the general nature of the business of the Borrowers.

In connection with the Restated Credit Agreement, the Company also agreed to pay to PNC Bank a non-refundable fee of $50,000.

The maturity date of the Restated Credit Agreement is March 19, 2023.

As a result of severe supply chain disruptions and labor shortages, the Borrowers were not in compliance with the fixed-charge coverage ratio requirement under the Restated Credit Agreement as of October 31, 2021.

On December 7, 2021, the Company successfully negotiated and entered into Amendment No.

1 to the Restated Credit Agreement (“Amendment No.

1”) with PNC Bank.

Amendment No.

1 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.

In connection with Amendment No.

1, the Company also agreed to pay to PNC Bank a non-refundable fee of $50,000.

The Company believes that cash flows from operations, together with the Company's unused borrowing capacity with PNC Bank will be sufficient to fund the Company's debt service requirements, capital expenditures and working capital needs for the next twelve months as long as no unanticipated supply chain or COVID related events occur.

The Company was in violation of its financial covenants under the Restated Credit Agreement as of January 31, 2022, due to an increase in the Company’s net loss 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 Revolving Credit and Security Agreement with PNC Bank, which implemented certain changes to the Company’s credit facility with PNC Bank, including the extension of the final

maturity date of the facility to April 15, 2027 and increasing the borrowing limit from $65,000,000 to $70,000,000 in July and August 2022, and from $40,000,000 to $45,000,000 in October 2022.

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 there within, such as raw material costs and supply chain challenges.

The Company was in compliance with its debt covenants as of April 30, 2022.

See Note 7 of Notes to Unaudited Consolidated Financial Statements under Item 1.

Off Balance Sheet Arrangements

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Forward-Looking Statements

From time to time, including in this Quarterly Report on Form 10-Q for the quarterly period ended October 31, 2021, the Company or its representatives have made and may make forward-looking statements, orally or in writing.

From time to time, including in this Quarterly Report on Form 10-Q for the quarterly period ended April 30, 2022, the Company or its representatives have made and may make forward-looking statements, orally or in writing.

Such forward-looking statements may be included in, without limitation, reports to stockholders, press releases, oral statements made with the approval of an authorized executive officer of the Company and filings with the Securities and Exchange Commission ("SEC").

The words or phrases “anticipates,” “expects,” “will continue,” “believes,” “estimates,” “projects,” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.

The results contemplated by the Company's forward-looking statements are subject to certain risks and uncertainties that could cause actual results to vary materially from anticipated results, including without limitation, availability of funding for educational institutions, availability and cost of materials, especially steel, availability and cost of labor, demand for the Company's products, competitive conditions affecting selling prices and margins, capital costs and general economic conditions.

The results contemplated by the Company's forward-looking statements are subject to certain risks and uncertainties that could cause actual results to vary materially from anticipated results, including without limitation, availability of funding for educational institutions, availability and cost of materials, availability and cost of labor, demand for the Company's products, competitive conditions affecting selling prices and margins, capital costs and general economic conditions.

Such risks and uncertainties are discussed in more detail in the Company's Form 10-K for the fiscal year ended January 31, 2022 under the caption "Risk Factors".

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Quantitative and Qualitative Disclosures about Market Risk

The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act as of our third quarter of fiscal 2022 and are not required to provide the information under this item.

The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act, and is therefore not required to provide the information under this item.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis