Results of Operations
Overview
The results of operations for the three-month and six-month periods ended July
31, 2022 and the comparable periods ended July 31, 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 and six-month periods ended July 31, 2021, the majority
of our primary customers had either returned to full time classroom instruction
or were planning for an imminent return. During this period, the Company
received a large number of orders for immediate delivery in anticipation of the
return to classroom instruction. Due to shortages of labor and raw materials,
the Company was not able to deliver the ordered furniture during the traditional
three months seasonal window in 2021, and both production and shipping activity
extended through the fourth quarter ended January 31, 2022.
For the three-month and six-month periods ended July 31, 2022, management
believes that the traditional seasonal cycle and the Company's ability to
service that seasonal cycle has substantially returned to normal. During the
quarter ended April 30, 2022, the Company has experienced a 27.9% increase in
orders, most of which were for summer of 2022 delivery. During the quarter ended
July 31, 2022 the Company experienced a 4.1% increase in orders. Year to date
the Company experienced a 14.3% increase in orders. In addition, the Company
started the current fiscal year with an order backlog that was approximately $20
million greater than the prior year. This caused the Company's backlog of
unshipped orders when entering the traditional seasonal period 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 and six-month periods ended July 31, 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. These cost
increases continued through the end of the fiscal year ended January 31, 2022.
During the three-month and six-month periods ended July 31, 2021, the Company
incurred labor shortages and had severe difficulty hiring both permanent and
temporary labor. The Company paid significant amounts of double-time wages to
both factory and warehouse employees, which adversely affected financial
results. In comparison, the three-month and six-month periods ended July 31,
2022 were characterized by continued high and moderately 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 for the
six months ended July 31, 2022 increased by nearly 30% compared to the prior
year. Increased levels of factory production and the related overhead absorption
partially offset the effect of increased labor expenses.
Supply chain disruptions from international sources - primarily China - continue
to adversely affect operations and the competitive landscape. In the six-month
period ended July 31, 2021, obtaining materials from China was adversely
affected by sharply increased freight costs and by severe disruptions in ocean
freight at domestic ports. The Company experienced supply chain disruptions from
domestic suppliers in addition to imported components. In the current six-month
period ended July 31, 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.
Virco does not deliver furniture to new schools until the customer has an
occupancy certificate. Supply chain disruptions in the construction industry
which may delay the completion of new schools did not significantly impact sales
volume during the quarter ended July 31, 2022, but may impact the timing of
sales during the balance of the summer
The Russian invasion of Ukraine in February 2022 has caused oil and energy
prices to spike, which can increase the cost of plastic and freight. The Company
incurred increased freight rates, but because the Company increased selling
prices at the
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beginning of the year, freight costs as a percentage of sales have been stable.
In addition, approximately two thirds of the pig iron used in domestic steel
production comes from Russia and Ukraine. During the quarter ended July 31, 2022
steel prices declined slightly, but remain high in comparison to the beginning
of 2021.
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. There is typically several months'
time lag between raising prices on orders and realizing the increase in sales
revenue. Sales for the first quarter ended April 30, 2022 consisted
substantially of orders received prior to the January 1, 2022 price increase.
Sales for the second quarter ended July 31, 2022 and third quarter ending
October 31, 2022 will substantially consist of orders received prior to the July
1, 2022 price increase.
Three Months Ended July 31, 2022
For the three months ended July 31, 2022, the Company earned pre-tax income of
$9,975,000 on sales of $82,797,000 compared to a pre-tax income of $4,985,000 on
sales of $59,022,000 in the prior year.
Sales increased by approximately $23,775,000 or 40.3%, compared to the same
period in 2021. 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, and by the Company's ability to service the
traditional seasonal cycle.
Gross margin for the second quarter ended July 31, 2022 was 38.5% of sales
compared to 37.8% 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 affect sales for the first quarter, but was substantially realized for
sales during the second quarter ended July 31, 2022.
Selling, general and administrative expenses for the three months ended July 31,
2022 increased by approximately $4,420,000 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 variable selling expenses. In addition, the Company incurred increased
legal expenses in the second quarter ended July 31, 2022 to enforce its
intellectual property rights against a competitor in the school furniture
market.
Interest expense increased by $339,000 for the three months ended July 31, 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 and an increase in interest rate.
For the three months ended July 31, 2022 and 2021, the effective income tax
rates were 3.0% and 24.6%, 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 July 31, 2022. Effective tax rate for the
second quarter ended July 31, 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.
Six Months Ended July 31, 2022
For the six-month period ended July 31, 2022 the Company earned a pre-tax profit
of $4,609,000 on sales of $114,881,000 compared to a pre-tax loss of $109,000 on
sales of $87,389,000 in the prior year. Sales increased by approximately
$27,492,000 or 31.5%. 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, and by the Company's ability to service the
traditional seasonal cycle.
Gross Margin for the first six months of fiscal 2023 was 36.2% of sales compared
to 34.3% in the prior year. The margin was affected by a price increase at the
beginning of fiscal 2023, offset in part by increased costs for raw materials
and labor expenses.
Selling, general and administrative expenses for the six months ended July 31,
2022 increased compared to the same period last year but decreased as a
percentage of sales. The increase in selling, general and administrative
expenses was attributable to increased variable freight and service expenses,
variable selling expenses, and by legal expenses to enforce its intellectual
property rights against a competitor in the school furniture market.
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Interest expense increased by $473,000 for the six months ended July 31, 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 and an increase in interest rate.
For the six months ended July 31, 2022 and 2021, the effective income tax rates
were 0.3% and (36.7)%, 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. Effective tax rate for the
second quarter ended July 31, 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. As
discussed above, in during the fiscal year ended January 31, 2022 the Company
experienced severe supply chain disruptions and labor availability and delivered
orders later in the year. In the current quarter ended July 31, 2022 the Company
continued to experience supply chain challenges, but not to the same degree as
in the prior year. The Company believes that traditional seasonal sales cycle
has returned for the quarter ended July 31, 2022 and will continue through the
third quarter ending October 31, 2022.
Inventory increased by $18,835,000 at July 31, 2022 compared to July 31, 2021.
Approximately 30% of the increase in inventory was valuation related to
increased material and labor costs and the other 70% 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 six months ended July 31, 2022 were
$1,839,000 compared to $1,210,000 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 and increase in 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. 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, including COVID-19 related costs,
raw material costs and its ability to introduce price increases, management
believes it will maintain compliance with its financial covenants under
Amendment No. 2, although risks and uncertainties remain, such as changing raw
material costs and supply chain challenges. The Company was in compliance with
its debt covenants as of July 31, 2022.
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.
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Forward-Looking Statements
From time to time, including in this Quarterly Report on Form 10-Q for the
quarterly period ended July 31, 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, 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.
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VIRCO MFG. CORPORATION 
