Virco MFG Corporation: Form 10-Q for the period ended Jul 31, 2018

Results of Operations

Three Months Ended July 31, 2018

For the three months ended July 31, 2018, the Company earned a pre-tax profit of $7,593,000 on sales of $74,802,000 compared to a pre-tax profit of $7,877,000 on sales of $72,636,000 in the prior year.

Net sales for the three months ended July 31, 2018 increased by $2,166,000 or 3%. This increase was primarily due to an increase in price partially offset by a slight decrease in volume. The Company began the second quarter with a backlog of orders that was approximately $10.6 million greater than the prior year. Orders for the second quarter increased by approximately 7.6% compared to the prior year. Ending backlog at July 31, 2018 was $60.1 million compared to $47.3 million at the same date last year.

The second quarter results reflected continued increase in seasonality of the Company’s business. School districts in many parts of the Country have accelerated the beginning of back to school to mid-August, impacting the summer delivery window. Although this would suggest that shipments would be pushed forward into July, the Company experienced an increase in orders that specified delivery in August, effectively moving revenue from the second quarter to the third quarter.

Gross margin as a percentage of sales decreased to 36.3% for the three months ended July 31, 2018 compared to 36.7% in the same period last year. The slight deterioration of the margin in the second quarter is attributable to several components, which may also impact our gross margins in future periods. In response to increased material costs incurred in the prior fiscal year, the Company increased selling prices at the beginning of the fiscal year. The increase in prices attained by the Company was not adequate to cover the significant increases in costs incurred in the prior year when combined with certain unanticipated increased costs incurred during the current year. Tariffs on steel, threatened tariffs on imported furniture from China, and increased prices for oil and the related impact on plastic have significantly increased the material cost component of our product. Also impacting margins was the composition of business in the quarter. The entire growth in sales was driven by full service business, consisting of a mix of our manufactured products accompanied by re-sale products. As discussed in prior year’s Form 10K, the Company provides “one-stop-shopping” to schools where a new school can furnish an entire campus with one purchase order to Virco. To facilitate this product offering, the Company purchases and re-sells certain products from third-party furniture manufacturing partners. The gross margin on products purchased for resale are lower than on products manufactured by Virco, but are instrumental to successfully winning projects that include the more profitable Virco manufactured product.

Selling, general and administrative expenses for the three months ended July 31, 2018 increased by $439,000 compared to the same period last year, but decreased very slightly as a percentage of sales to 25.0% from 25.2%. The increase in selling, general and administrative expenses was attributable to variable service expenses driven by the increased sales volume, and by a pension settlement charge.

Interest expense was more for the three months ended July 31, 2018 compared to the same period last year. There are three components of the increase. First, the three months ended July 31, 2018 includes interest expense on a mortgage related to the purchase of a building in Conway, Arkansas that was completed in the third quarter last year. Second, the Company has borrowed more money to finance production of inventory in anticipation of increased summer shipping activity. Finally, expense increased as a result of higher interest rates.

Six Months Ended July 31, 2018

For the six months ended July 31, 2018, the Company earned a pre-tax profit of $2,559,000 on net sales of $97,371,000 compared to a pre-tax profit of $4,317,000 on net sales of $95,871,000 in the same period last year. Net sales for the six months ended July 31, 2018 increased by $1,500,000 compared to the same period last year. This increase was primarily the result of an increase in selling prices partially offset by a reduction in volume. The Company began the year with a backlog of orders that was approximately $3.6 million greater than the prior year. Order rates for the first six months increased by approximately 9.5% compared to the prior year.

Gross margin as a percentage of sales declined to 35.8% for the six months ended July 31, 2018 compared to 36.6% in the same period last year. Due to the extreme seasonality of our business, second quarter sales represent more than 75% of sales for the first six months. The events articulated above that caused gross margins to decline for the second quarter are consistent with events that impacted the first six months. Such events may continue to have an ongoing impact upon our gross margins in future periods.

Selling, general and administrative expenses for the six months ended July 31, 2018 increased by approximately $1,021,000 compared to the same period last year and increased as a percentage of sales by 0.5%. The increase in selling, general and administrative expenses was attributable to variable service expense driven by increased revenue combined with a pension settlement charge.

Interest expense was more for the six months ended July 31, 2018 compared to the same period last year. The events articulated above that caused interest expense to rise for the second quarter are consistent with events that impacted the first six months.

Income Taxes for the three- and six-months ended July 31, 2018

Income tax expense for the second quarter and six months ended July 31, 2018 is less than the prior year, primarily due to the reduction in federal income tax rates for fiscal 2018.

Liquidity and Capital Resources

As discussed in the Company's Form 10-K, approximately 50% of the Company's annual sales volume is shipped in June through August. 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. Accounts receivable increased by $32,724,000 from January 31, 2018 to July 31, 2018. This compares to prior year when accounts receivable grew by $30,286,000 during the same period. The accounts receivable balance was $3,908,000 higher at July 31, 2018 than at July 31, 2017 due to increased sales.

For the first six months, the Company increased inventory by approximately $18,239,000 at July 31, 2018 compared to January 31, 2018. This compares to an increase of $15,172,000 during the same period last year. Inventory at July 31, 2018 was $9,435,000 more than the prior year. The increase in inventory compared to the prior year is primarily increased unit volume to fill the increase in order backlog at July 31, 2018 combined with an increase in valuation due to higher commodity costs. The increase in accounts receivable and inventory at July 31, 2018 compared to the January 31, 2018, was financed in part by vendor credit, which naturally increases with increased second quarter business activity, and through the Company's credit facility with PNC Bank.

Interest expense for the six months ended July 31, 2018 is slightly higher the same period last year. Borrowings under the Company's revolving line of credit with PNC Bank at July 31, 2018 is higher than the borrowings at July 31, 2017. In addition, the Company purchased a manufacturing facility in the third quarter of 2018, and has an outstanding mortgage that the Company did not have at July 31, 2017.

Capital spending for the six months ended July 31, 2018 was $1,686,000 compared to $3,891,000 for the same period last year. The decrease is not anticipated to continue for the year as the Company is investing more in factory automation and technology. Capital expenditures are being financed through the Company's credit facility with PNC Bank and operating cash flow.

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, 2018. There have been no significant changes in the quarter ended July 31, 2018, except as disclosed in “Recently Adopted Accounting Updates” in Note 3. New Accounting Pronouncements in the Notes to unaudited Condensed Consolidated Financial Statements in Item 1 to this Quarterly Report on Form 10-Q.

Forward-Looking Statements

From time to time, including in this Quarterly Report on Form 10-Q for the quarterly period ended April 30, 2018, 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, especially steel, 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, 2018 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.

The Company is subject to interest rate risk related to its seasonal borrowings used to finance additional inventory and receivables. Rising interest rates may adversely affect the Company's results of operations and cash flows related to its variable-rate bank borrowings under its credit line with PNC. Accordingly, a 100-basis point upward fluctuation in PNC's base rate would have caused the Company to incur additional interest charges of approximately $114,000 and $175,000 for the three months and six months ended July 31, 2018, respectively. The Company would have benefited from a similar interest savings if the base rate were to have fluctuated downward by a like amount.

Disclosure Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including its Principal Executive Officer along with its Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”) as of July 31, 2018. Based upon the foregoing, the Company's Principal Executive Officer along with the Company's Principal Financial Officer concluded that the Company's disclosure controls and procedures as of such date were effective to ensure that the information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to Company management, including its Principal Executive Officer and Principal Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, Company management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Changes in Internal Control Over Financial Reporting

The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including its Principal Executive Officer along with its Principal Financial Officer, of the effectiveness of the design and operation of disclosure controls and procedures. Based upon the foregoing, the Company's Principal Executive Officer along with the Company's Principal Financial Officer concluded that the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were effective as of the end of the period covered by this Quarterly Report on Form 10-Q.

There have been no changes in the Company's internal control over financial reporting during the fiscal quarter covered by this quarterly report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.

You should carefully consider and evaluate the information in this Quarterly Report and the risk factors set forth under the caption “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 31, 2018 (the “Form 10-K”), which was filed with the SEC on April 27, 2018. The risk factors associated with our business have not materially changed compared to the risk factors disclosed in the Form 10-K.