VIRCO MFG CORPORATION 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations Overview 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. Typically, the Company has an exceptionally seasonal annual cycle where approximately 50% of sales occur in the months of June, July and August. Orders received from customers follow a similar cycle, approximately 4-6 weeks preceding the selling season. 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 17 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 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. 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. 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 18 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. 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. Off Balance Sheet Arrangements None. Critical Accounting Policies and Estimates The Company's critical accounting policies are outlined in its Annual Report on Form 10-K for the fiscal year ended January 31, 2022. Forward-Looking Statements 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, 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". The Company's forward-looking statements represent its judgment only on the dates such statements were made. By making any forward-looking statements, the Company assumes no duty to update them to reflect new, changed or unanticipated events or circumstances. Item 3. Quantitative and Qualitative Disclosures about Market Risk 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.