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 nine-month periods ended October 31, 2023 and the comparable periods ended October 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 compared to the same quarter in 2022, 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 compared to the same quarter in 2022. During a seasonally light third quarter ended October 31, 2023 the Company experienced a 25.0% increase in orders compared to the same quarter in 2022. During the first nine months of fiscal 2023, the Company experienced a 10.3% increase in orders compared to the same period in 2022. 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. The largest portion of this increased backlog was delivered during the second quarter ended July 31, 2023 with the balance delivered during the third quarter ended October 31, 2023. The increase in sales for the third quarter ended October 31, 2023 was attributable to improved on time delivery of orders and increased order rates during the third quarter. The Company’s backlog of unshipped sales orders at October 31, 2023 declined by $2.3 million to $42.5 million compared to $44.8 million in the prior year. Three Months Ended October 31, 2023 For the three months ended October 31, 2023, the Company earned pre-tax income of $13.5 million on sales of $84.2 million compared to a pre-tax income of $8.2 million on sales of $77.4 million in the prior year. Net sales for the third quarter increased by approximately $6.9 million or 8.9%, compared to the same period in 2022. The increase was attributable to an improvement in on-time deliveries during the traditional summer season and increased order rates during the third quarter. Gross margin for the third quarter ended October 31, 2023 was 45.4% compared to 39.8% in the prior year. The increase in margin was attributable to the price increases, 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 October 31, 2023 increased by approximately $1.5 million but was slightly lower 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, and increased variable selling expenses. 20 Interest expense increased by $0.2 million for the three months ended October 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 three months ended October 31, 2023 and 2022, the effective income tax rates were 24.5% and 3.9%, 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 October 31, 2022. The increase in the effective tax rate for the third quarter ended October 31, 2023 was primarily due to the reversal of the valuation allowance at January 31, 2023. Nine Months Ended October 31, 2023 For the nine months ended October 31, 2023 the Company earned a pre-tax profit of $31.9 million on sales of $226.5 million compared to a pre-tax profit of $12.8 million on sales of $192.3 million in the prior year. Net sales increased by approximately $34.2 million or 17.8%. The increase was attributable to an increase in beginning of year sales backlog, increased order rates, 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 nine months of fiscal 2024 was 44.1% compared to 37.6% 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 nine months ended October 31, 2023 increased by $8.2 million 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 an increase in orders which include Virco full service, increased variable freight and service expenses, and variable selling expenses. Interest expense increased by $0.9 million for the nine months ended October 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 nine months ended October 31, 2023 and 2022, the effective income tax rates were 24.0% and 2.6%, 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 October 31, 2022. The increase in the effective tax rate for the nine months ended October 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 $5.0 million at October 31, 2023 compared to the same period last year. The increase is attributable to increased sales in the quarter ended October 31, 2023. Inventory increased by $1.5 million at October 31, 2023 compared to October 31, 2022. The increase is primarily attributable to increased cost, not increased quantity. The increase in inventory was financed by cash flow from operations. Traditional sources of financing, including borrowing under the Company’s line of credit with PNC Bank and vendor credit declined. Accrual basis capital expenditures for the nine months ended October 31, 2023 were $4.1 million compared to $2.7 million 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 million per year by covenant. 21 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 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 October 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 October 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.