VIRCO MFG CORPORATION 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Executive Overview of Operating Results Virco Mfg. Corporation is the nation’s largest domestic manufacturer and distributor of Furniture, Fixtures, and Equipment ("FF&E") for the education (K-12) market. The Company’s operating model and unique market differs in several ways from the traditional furniture industry model. The furniture industry is traditionally structured around furniture manufacturers that sell to end customers through dealership networks. These dealership networks can be aligned with one manufacturer or open to multiple manufacturers. Virco is one of the few domestic manufacturers of school furniture that call on and sell direct to school customers, with approximately 70% to 80% of sales being direct to customers. 26 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 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 markets and sells direct to the schools and provides project management and logistics. Approximately 75% of sales are delivered FOB 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. Virco's sales force is supported by a project management team which includes field-based project specialists, in-house interior designers, project management specialists, purchasing specialists, and field service supervisors. The project management team and the sales force utilize the Company's proprietary PlanSCAPE® software in conjunction with Building Information Modeling when preparing complete package solutions for the FF&E segment of bond-funded public school construction projects. The PlanSCAPE® software supports classroom by classroom product selection, product specification, pricing, and furniture delivery including delivery to and turnkey classroom setup. PlanSCAPE® software also enables the entire Virco sales force to prepare quotations for less complicated projects. 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 FF&E needs of the K-12 education market, enabling a school to procure all of its FF&E requirements from one source. China’s entry into the World Trade Organization in 2001 had a severe impact on the industry, with most furniture manufacturers closing their domestic fabrication facilities and importing components or finished goods from China. This also enabled dealers and resellers to bypass domestic sources and purchase direct from China for domestic distribution. During this time Virco retained its domestic fabrication facilities. Today these facilities are substantially depreciated on our books but extremely well maintained, automated where cost effective, and fully operational. Recent economic events, in some cases accelerated by COVID, tariffs, volatility in both cost and availability of ocean freight, and other extended supply chain challenges have made our domestic manufacturing footprint a significant competitive advantage compared to companies which import finished products. Furniture sold into the educational market is characteristically heavy, bulky, and logistically challenging compared to other markets significantly impacted by imports. 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. In the current fiscal year, the Company has benefited from a large series of disaster recovery orders that were received at the end of the prior fiscal year and the first quarter of the current year. During fiscal 2025, the Company shipped and recognized revenue related to these orders of approximately $9 million in the first quarter, $4 million in the second quarter, $6 million in the third quarter and $4 million in the fourth quarter. These shipments positively affected the Company’s traditional seasonal cycle this fiscal year, with positive impacts on production, overhead absorption, accounts receivable, collections, as well as lower borrowings to support that inventory. The Company believes that this project was substantially completed at the end of fiscal year 2025. The Company further believes that the timing and related positive impacts of this project are unusual and that more typical seasonal and financial patterns are likely to return after this project concludes. Following a downturn during the COVID pandemic, order rates recovered during fiscal 2022, 2023, and 2024. Initially, the Company had difficulty sourcing adequate new permanent and temporary workers. The Company remedied this by providing significant raises to its hourly work force, and for fiscal years 2023, 2024, and 2025 our ability to support the seasonal business model returned to pre-COVID capabilities, with the Company delivering 47% - 49% of annual revenue during June, July, and August. 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 75 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 27 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, 2024, and 2025. 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. In fiscal 2024 and 2025, approximately 47% - 49% 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 typical 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 over 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 quantities of finished goods and component parts during the first and second quarters. In fiscal 2023, the cost of commodities was volatile, but not as severe as experienced in 2022. Increased selling prices covered increases in commodity prices during fiscal 2023. In 2024 and 2025, the Company increased selling prices in anticipation of additional cost increases. The cost of materials in 2024 and 2025 were reasonably stable compared to the volatility in prior years – especially the years impacted by COVID. Approximately 75% 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. In early 2025, there have been significant changes and proposed changes to U.S. trade policies. On April 2, 2025, President Trump announced new tariffs on foreign imported goods, including a baseline duty of 10% on foreign imports and additional tariffs on imports from China of an additional 34%. The U.S. also reinstated the steel import tariff to 25% effective March 12, 2025. These tariffs are likely to result in increased prices for imported components and materials supplied locally. For the year ending January 31, 2026 ("fiscal 2026"), the Company anticipates continued uncertainty and volatility in commodity costs, particularly with respect to steel, plastic, and other raw materials, transportation, and energy. The Company may be challenged in effectively increasing the prices of its products, and its business and results of operations may be adversely affected. 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. 28 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. Finally, many of our domestic competitors, especially small dealerships, may be undercapitalized and less capable of supporting the significant seasonal nature of our business. We believe that our financial strength, which allows us to build material quantities of inventory in advance of the summer delivery season, is a significant competitive advantage. 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 estimates, including those related to valuation of inventory and related excess and obsolete inventories, 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 1A. Risk Factors” , and elsewhere in this Annual Report on Form 10-K. Virco's critical accounting policies and estimates are as follows: Slow-Moving and Obsolete Inventories : Inventory is valued at the lower of cost or net realizable value (determined on a first-in, first-out basis (“FIFO”)) 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 involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the Company's financial condition or results of operations. 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 educational furniture is traditionally driven by value, not style, and the Company has not typically incurred material obsolescence expenses. If market conditions are less favorable 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. While we believe that adequate adjustments for inventory obsolescence have been made in the consolidated financial statements, our obsolescence adjustments calculations contain estimates that require management to make assumptions based on several factors, including market conditions, the selling environment, historical results, supply-chain environment, current inventory trends and customer behavior. There have been no changes to our policies for establishing adjustments throughout the year, and we do not expect significant changes to our historical obsolescence levels. A 10% increase in our year-end inventory adjustments would decrease our net income by approximately $0.4 million, on an after-tax basis. The net income would increase by similar amounts if the inventory adjustments was to decrease by a comparable percentage. As of January 31, 2025 and January 31, 2024, our inventory obsolescence adjustments were $5.6 million and $6.0 million, respectively, representing 9.1% and 10.8%, respectively, of our inventories on a FIFO basis. Self-Insured Retention : For fiscal 2025 and 2024, 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 4.0% for fiscal 2025 and fiscal 2024. Given the relatively short term over which the known losses and IBNR losses are discounted, the sensitivity to the discount rate 29 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 2026 will be comparable to the retention levels for fiscal 2025. 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: 2025 2024 Employee Plan 5.55% 5.15% VIP Plan 5.60% 5.20% 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 fiscal 2025 and 2024. 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. During fiscal year 2024, the Plan purchased approximately $5.0 million of annuities for retired employees. The Company did not incur settlement costs in fiscal 2025. In fiscal 2024, the Company has incurred settlement costs for the Employee Plan due to a large number of lump-sum benefits paid to retired and terminated employees. 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. 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 $2.7 million and increase pension expense by approximately $190,000. A one percent decrease in return on Plan assets would increase pension expense by $180,000 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 income (losses) in recent years), to determine whether sufficient future taxable income will be generated to realize existing deferred tax assets. At January 31, 2025, the Company recorded a partial valuation allowances of $236,000 on certain state NOL to reduce the carrying amount of deferred tax assets to an amount that is more-likely-than-not to be realized. The net change in the valuation allowance for the year ended January 31, 2025, was a decrease of $15,000. At January 31, 2025, the Company has no NOL for U.S. federal tax purposes and $6.3 million for state income tax purposes, expiring at various dates through January 31, 2041. 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 2025 vs. 2024) Financial Highlights The Company earned a pre-tax profit of $28.4 million on net sales of $266.2 million for fiscal 2025, compared to pre-tax profit of $29.2 million on net sales of $269.1 million in fiscal 2024. Net income per diluted share was $1.32 for fiscal 2025, compared to $1.34 per diluted share in the prior year. Cash flow provided by operations was $33.1 million in fiscal 2025, compared to cash provided by operations of $27.0 million in fiscal 2024. 30 Net Sales Virco's net sales decreased by 1.1% in fiscal 2025 to $266.2 million compared to $269.1 million in fiscal 2024. The small decrease in net sales was attributable to a slight increase in selling prices offset by a minimal decrease in unit volume. In fiscal 2025, order rates increased by approximately 3.3% compared to 2024. The Company believes that order rates have now substantially recovered from the impact of COVID and related supply chain disruptions. The Company has effectively increased selling prices under its largest contracts to recover volatile commodity, energy, freight, and labor costs incurred in recent years. The Company does not anticipate material margin growth as recent price increases have restored profitability. 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 2026, 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 56.9% of net sales in both fiscal 2025 and fiscal 2024. In the current year, the composition of orders moderated slightly with a slight decrease in orders delivered with full service. Full service orders typically generate greater margins, but also result in increased service costs which are included in selling, general, and administrative expenses. The material portion of our costs as a percentage of sales was 33.2% of net sales in fiscal 2025 and 34.7% of net sales in fiscal 2024. This was primarily due to relatively stable commodity costs in 2025 and 2024. Direct labor costs increased slightly as a percentage of sales. Overhead costs as a percentage of sales increased slightly. The net result of all activity was no change in COS as a percentage of sales. During fiscal 2025, 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. 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 2026. 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 2025 increased by $2.6 million to $86.8 million from $84.2 million. The increase in SG&A was primarily attributable to an increase in variable selling and other compensation expenses. Pension expense decreased due to increased discount rates and because prior year included plan settlement expenses. Interest expense was $2.3 million lower in fiscal 2025 compared to fiscal 2024 because of decreased levels of borrowing. Provision for Income Taxes Our effective tax rate was 23.9% for fiscal 2025, and 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 2024 the Company utilized all of its federal NOL’s and a significant portion of its state NOL’s. The effective tax rate for 2025 is more representative of rates that will affect fiscal 2026. Valuation allowances of $236,000 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, 2025, the Company has no operating loss carryforwards for U.S. federal, and $6.3 million 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, 2025 and 2024: 31 Year ended January 31, 2025 2024 (In thousands) Net cash provided by operating activities $ 33,128 $ 26,960 Net cash used in investing activities (5,563) (4,759) Net cash used in financing activities (5,984) (17,972) Net increase in cash $ 21,581 $ 4,229 Operating 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 provided in operations was $33.1 million in 2025 and $27.0 million in 2024. The increase in cash provided was primarily attributable to decrease in accounts receivable offset by an increase in income tax payments. 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 investing activity from these transactions were immaterial. Our net investments primarily consist of investments in our factories and technology to support our business activities. 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, 2025. Financing activities. Our financing activities primarily consist of the proceeds and repayments of borrowings under our line of credit with PNC Bank, payment of cash dividends, and repurchases of Company stock. 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. In fiscal years 2025 and 2024 the Company materially reduced its year end borrowings under the line of credit, primarily due to cash flows from operations. 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 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. During fiscal 2025 and 2024 the cost of commodities was reasonably stable. For fiscal 2026, 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 2026 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 2025, but costs after that date may be adversely impacted by current legislation, claim costs and industry consolidation. To recover the cumulative impact of increased costs, the Company has increased published list prices for fiscal 2026. Due to current economic conditions, the Company anticipates increased price competition in fiscal 2026 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. 32 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, 2025 and 2024. 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, and 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. 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. Additionally, the Company may elect to opportunistically purchase shares based on excess cash generation and share price considerations. In fiscal 2025, the Company spent $3.8 million to repurchase 342,026 shares of its common stock. As of January 31, 2025, $11.2 million was authorized and available for repurchase of shares by the Company. 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 33 wholly owned subsidiary of the Company (“Virco” and, together with the Company, the “Borrowers”) entered into a Revolving Credit and Security Agreement (“Restated Credit Agreement”) with PNC Bank, National Association, as administrative agent and lender (“PNC”). The Restated Credit Agreement as currently in effect provides the Borrowers with a secured revolving line of credit (“Revolving Credit Facility”) of up to $65.0 million, with seasonal adjustments to the credit limit (up to $70.0 million during the months of June, July and August 2024) and subject to borrowing base limitations and includes a sub-limit of up to $3.0 million for issuances of letters of credit. In addition, the Restated Credit Agreement provides an inventory sublimit of $35.0 million and Assemble-to-ship (“ATS”) inventory sublimit of $15.0 million during the months of May through August 2024, and an Equipment Line for purchases of equipment of up to $2.0 million. 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 $15.0 million 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 scheduled maturity date of the Restated Credit Agreement is 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, 2025 was 9.5%. 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 $3.0 million 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 contains a clean-down provision that requires the Company to reduce borrowings under the line of credit to less than $10.0 million 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 $10.0 million 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, raw material costs and its ability 34 to introduce price increases, management believes it will maintain compliance with these financial covenants, although there are uncertainties therewithin, such as raw material costs and supply chain challenges. The Company's revolving line of credit with PNC is structured to provide seasonal credit availability during the Company's peak summer season. Approximately $30.0 million was available for borrowing as of January 31, 2025 and 2024. Long-Term Capital Requirements 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 approximately $5.0 million for fiscal 2026. Our Revolving Credit Facility with PNC Bank provides a $2.0 million line for equipment and covenants allow for anticipated capital expenditures for fiscal 2026. 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 was able to purchase approximately $5.0 million of annuities in the third quarter ended October 31, 2023, resulting in a settlement charge in that quarter. In the future, the Company may purchase additional annuities from third parties to further de-risk the Plan. The Company did not incur settlement costs in fiscal 2025. The Company incurred settlement costs in the third and fourth quarters of fiscal 2024. 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 $623,000 and $676,000 in fiscal 2025 and 2024, respectively. Contributions during fiscal 2026 will depend upon actual investment results and benefit payments but are anticipated to be less than $500,000. At January 31, 2025, accumulated other comprehensive income of $422,000, 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, 2025, a 1% reduction in investment return would have increased pension expense by approximately $180,000, 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 $2.7 million and increase pension expense by approximately $190,000. 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 declared a cash dividend in the fourth quarter of 2024 and in each quarter of 2025. 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 $122.0 million from retained earnings to additional paid-in capital. The equity section of the balance sheet on January 31, 2025 reflects additional paid-in capital of approximately $117.5 million and accumulated deficit of approximately $8.9 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 35 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 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 2025 and 2024, 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 $30.0 million. For the insurance year beginning April 1, 2025, 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 2025 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. 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 2025, nor did the Company have any material off-balance sheet arrangements outstanding at January 31, 2025. New Accounting Pronouncements 36 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.