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-month and six-month periods ended July 31, 2023 and the comparable periods ended July 31, 2022 have been impacted by economic conditions driven by the COVID-19 pandemic and global supply chain disruptions. The impact of COVID-19 has been quite different during the current year compared to the prior years. 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 but less pronounced cycle. The Company typically receives orders for projects several months in advance of delivery, while smaller orders for fill in or replacements are typically received 4-6 weeks prior to delivery. During the months of June, July, and August of 2021, the Company was severely impacted by shortages of labor and materials. The Company delivered less than 40% of annual shipments during the traditional summer season. During the months of June, July, and August of 2022 the Company substantially returned to the traditional seasonal cycle and delivered approximately 47% of sales. For the three months of June, July, and August 2023 the Company believes that there has been a full return to the traditional seasonal summer peak. The Company began the three-month period of June, July, and August of 2023 with a larger backlog of orders for summer delivery, nearly $20 million of increased inventory (as of April 30, 2023) and adequate availability of both full time and temporary labor to service the summer delivery season. During the quarter ended April 30, 2023, the Company had experienced a 10.4% increase in orders, most of which were for summer of 2023 delivery. During the quarter ended July 31, 2023 the Company experienced a 3.3% increase in orders. Year-to-date the Company experienced a 6.7% increase in orders. In addition, the Company started the current fiscal year with an order backlog that was approximately $18 million greater than the prior year. This caused the Company’s backlog of unshipped orders when entering the traditional seasonal period at April 30, 2023 compared to April 30, 2022 to increase by nearly $19 million to $104.6 million compared to $85.7 million. A significant portion of this order backlog is anticipated to be delivered during the months of June, July, and August 2023. The significant increase in sales for the second quarter ended July 31, 2023 was attributable to the increase is order backlog going into the quarter, an $19 million increase in inventory at the beginning of the second quarter, and to the Company’s ability to service the increase in orders during the summer delivery window. The Company’s backlog of unshipped sales orders at July 31, 2023 declined by $7.2 million to $74.0 million compared to $81.2 million in the prior year. Three Months Ended July 31, 2023 For the three months ended July 31, 2023, the Company earned pre-tax income of $20,335,000 on sales of $107,321,000 compared to a pre-tax income of $9,975,000 on sales of $82,797,000 in the prior year. Sales for the second quarter increased by approximately $24,524,000 or 29.6%, compared to the same period in 2022. The increase was attributable to an increase in beginning of year sales backlog, increased first quarter orders, a price increase for orders received after July 1, 2022 and January 1, 2023, and by the Company’s ability to service the traditional seasonal cycle. Gross margin for the second quarter ended July 31, 2023 was 45.3% compared to 38.5% in the prior year. The increase in margin was attributable to the price increases discussed above, relatively stable commodity costs, and an increase in sales which include Virco full service. The increase in full service orders improves gross margin, but does require increased freight and service costs, which are included in selling, general and administrative expenses. Selling, general and administrative expenses for the three months ended July 31, 2023 increased by approximately $6,653,000 and was slightly higher as a percentage of sales 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 attributable to a larger portion of full service orders, increased variable selling expenses, and a provision for a management bonus based upon profitability. Interest expense increased by $385,000 for the three months ended July 31, 2023 compared to the same period last year. The increase was primarily attributable to an increase in the amount borrowed in 2023 to finance seasonal working capital and an increase in interest rates. 20 For the three months ended July 31, 2023 and 2022, the effective income tax rates were 23.6% and 3.0%, respectively. The lower effective tax rate in 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 July 31, 2022. The increase in the effective tax rate for the second quarter ended July 31, 2023 was primarily due to the reversal of the valuation allowance at January 31, 2023. Six Months Ended July 31, 2023 For the six-month period ended July 31, 2023 the Company earned a pre-tax profit of $18,449,000 on sales of $142,264,000 compared to a pre-tax profit of $4,609,000 on sales of $114,881,000 in the prior year. Sales increased by approximately $27,383,000 or 23.8%. The increase was attributable to an increase in beginning of year sales backlog, increased first quarter orders, a price increase for orders received after January 1, 2023 and July 1, 2022, and by the Company’s ability to service the traditional seasonal cycle. Gross Margin for the first six months of fiscal 2024 was 43.4% compared to 36.2% in the prior year. The margin was affected by price increases on July 1, 2022 and January 1, 2023, combined with relatively stable costs for raw materials and labor expenses, and an increase in business which included Virco full service. Selling, general and administrative expenses for the six months ended July 31, 2023 increased compared to the same period last year and decreased as a percentage of sales. The increase in selling, general and administrative expenses was attributable to an increase in orders which include Virco full service, increased variable freight and service expenses, variable selling expenses, and a provision for management bonus based upon profitability. Interest expense increased by $670,000 for the six months ended July 31, 2023 compared to the same period last year. The increase was primarily attributable to an increase in the amount borrowed in 2023 to finance seasonal working capital and an increase in interest rates. For the six months ended July 31, 2023 and 2022, the effective income tax rates were 23.6% and 0.3%, respectively. The lower effective tax rate in 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 July 31, 2022. The increase in the effective tax rate for the six months ended July 31, 2023 was primarily due to the reversal of the valuation allowance at January 31, 2023. 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. As discussed above, due to COVID-19, during fiscal 2021 and 2022 the Company incurred supply chain disruptions and labor shortages which adversely affected the Company’s ability to service the traditional summer delivery window. The Company believes that the Company’s ability to service the traditional seasonal sales cycle has returned and will continue through the remainder of this fiscal year. Accounts Receivable increased by $24,306,000 at July 31, 2023 compared to the same period last year. The increase is attributable to increased sales in the quarter ended July 31, 2023. Inventory increased by $10,625,000 at July 31, 2023 compared to July 31, 2022. The increase is primarily attributable 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 six months ended July 31, 2023 were $3,235,000 compared to $1,839,000 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 per year 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 maturity date of the facility to April 15, 2027. On May 19, 2023, the Company entered into Amendment No. 3 which increased 21 the borrowing limit to $72.5 million during the peak seasonal period from June through August 2023. See Note 7. Debt of Notes to Unaudited Consolidated Financial Statements under Item 1 of this Quarterly Report on Form 10-Q. Based on the Company’s current projections, raw material costs and its ability to introduce price increases, management believes it will maintain compliance with its financial covenants under the Credit Agreement, although risks and uncertainties remain, such as changes in economic conditions, changing raw material costs and supply chain challenges. The Company was in compliance with its debt covenants as of July 31, 2023. 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, 2023. Forward-Looking Statements From time to time, including in this Quarterly Report on Form 10-Q for the quarterly period ended July 31, 2023, 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, 2023, including 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.