Virco MFG Corporation: Form 10-Q for the period ended Apr 30, 2021

Results of Operations

The effects of COVID -19

The results of operations for the three-months ended April 30, 2021 have been significantly impacted by economic conditions driven by the COVID-19 pandemic. The majority of our primary customers, the K-12 public school systems, closed school campuses and initiated remote learning on or about March 15, 2020. Most school districts continued with remote learning for the academic year beginning August 2020, with a minority of districts attempting hybrid or on-site learning.

During the first quarter ended April 30, 2021, many school districts announced hybrid or on-site learning beginning approximately April 2021. The Company received a large volume of orders for immediate delivery during the first quarter ended April 30, 2021. Orders received for the quarter increased by 26.7% compared to the same period of the prior year. Sales volume for the quarter increased by 59.2% compared to the same period of the prior year. Backlog of orders at April 30, 2021 were approximately $2.1 million greater than the prior year.

The market for educational furniture is extremely seasonal, but there has traditionally been stability to this seasonal cycle. In the prior year, the timing of orders did not follow the traditional seasonal trends. Orders of educational furniture are traditionally very strong in May and June. In the fiscal 2021, these months were uncharacteristically slow. This reduction adversely impacted both second and third quarter sales revenue in fiscal 2021. In the current year, the Company experienced strong orders in the first quarter. Subsequent to April 30, 2021, the Company continued to experience strong order rates through May 2021. Nevertheless, management is not able to predict whether and to what extent the return to full time classroom learning will result in a return to the traditional seasonal sales cycle for educational furniture.

Due to uncertainty created by COVID-19 during fiscal 2021 the Company moderated production levels to reflect the reduced order activity and maintained conservative inventory levels going into the first quarter ended April 30, 2021. Because the first quarter of the year is a seasonally slow period, sales activity during the first quarter was not significantly affected by supply chain considerations that have impacted the economy.

The Company imports a number of key components from manufacturers in China. The cost and timely delivery of these components has been adversely affected by difficulties at the ports and by cost increases from China. The cost of steel and a variety of other raw materials has been extremely volatile, and the supply chain considerations have been challenging. The severe weather experienced in significant portions of the United States in February 2021 has also interrupted the supply and increased cost for plastic and utilities. The availability of labor, both permanent employees and temporary employees, has been adversely impacted. In response to the labor shortage, and to reward employees who will be working substantial overtime hours during the seasonal summer peak, the Company has announced that for all factory and warehouse hourly employees, all overtime hours will be paid at double time rather than the traditional time and one-half for hours worked between June 1 and Labor Day. This is anticipated to cost the Company an additional $1.5 million during the second and third quarters. The Company anticipates that this increased cost will be offset, in whole or in part, by the increased efficiency of using experienced Virco employees with a substantial reduction in temporary labor. Inventory levels at April 30, 2021 are significantly lower than the prior year, and the Company may incur additional costs for expediting to satisfy customer orders. While these challenges are substantial, the Company believes that the benefits of domestic manufacturing compared to an import model will be realized during the current fiscal year.

Three Months Ended April 30, 2021

Order rates and sales for the first three months of 2021 increased significantly compared to the prior year, as schools reopen and effects of COVID-19 are moderating. Orders for the first quarter increased by 26.7%, and sales increased by 59.2% compared to the same period of the prior year. Backlog of orders at April 30, 2021 is approximately $2.1 million greater than the prior year.

For the three months ended April 30, 2021, the Company incurred a pre-tax loss of $5,094,000 on sales of $28,367,000 compared to a pre-tax loss of $7,973,000 on sales of $17,817,000 in the prior year.

Gross Margin for the first quarter was 27.1% of sales compared to 27.5% in the prior year. The gross margin was favorably affected by a modest price increase at the beginning of the year, a favorable change in product mix, and an increase in the proportion of product sold with full service relative to sold FOB factory. These improvements were offset by an increase in the cost of commodities used to manufacture product and reduced levels of production. The Company was required to close the Conway, Arkansas factory for more than one week in February due to severe weather and increased utility bills related to the same severe weather.

Selling, general and administrative expenses for the three months ended April 30, 2021 increased by less than 1% compared to the same period last year and decreased as a percentage of sales to 42.2% from 67.0%. The increase in selling, general and administrative expenses was primarily attributable to increased variable freight expense.

Interest expense decreased by $111,000 for the three months ended April 30, 2021 compared to the same period last year. The Company has borrowed less money to finance seasonal working capital in the first quarter.

Income Taxes for the three-months ended April 30, 2021

Income tax benefit for the first quarter ended April 30, 2021 is less than the prior year, primarily due to the decrease in pre-tax loss.

Liquidity and Capital Resources

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.

Accounts receivable increased by $6,770,000 at April 30, 2021 compared to the same date in the prior year. A portion of the increase was attributable to increased volume of sales, and a portion due to the timing of sales. Sales in the month of April 2021 were more than double sales in April 2020 due to the timing of school closures. Inventory decreased by $15,315,000 at April 30, 2021 compared to the prior year. The reduction was due to cautious inventory management combined with a significant increase in first quarter sales activity. The net reduction in working capital enabled the Company to reduce its borrowing under its revolving line of credit with PNC Bank as of April 30, 2021. Outstanding debt at April 30, 2021 includes an equipment loan from PNC in the amount of $611,000 and a seller financed mortgage on a manufacturing facility in Conway, Arkansas.

Interest expense for the three months ended April 30, 2021 is less than the same period last year due to lower average outstanding borrowings under the Company's revolving line of credit with PNC Bank.

Accrual basis capital expenditures for the three months ended April 30, 2021 was $428,000 compared to $922,000 for the same period last year. The reduction in capital spending was a direct result of management controlling the expenditures to preserve cash due to the adverse impact that the COVID-19 pandemic had on the Company’s operations. 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 by covenant.

Due to the adverse impact of the COVID-19 pandemic upon the Company’s operations, the Company violated its fixed-charge coverage ratio contained in the credit agreement with PNC Bank for the quarterly periods ended July 31, 2020 and October 31, 2020. The Company obtained limited waivers and amendments from PNC Bank for both events of default, Amendment No. 21 and 22 (see Note 7 to the condensed consolidated financial statements). Amendment No. 22 amended the ongoing fixed-charge coverage calculation to allow for the add back of certain COVID-19 related costs incurred from May 1, 2020 through April 30, 2021, not to exceed $2,000,000, to adjusted EBITDA and retained the minimum fixed-charge coverage ratio of 1.10:1.00 beginning with the four quarter period ending January 31, 2021. Based on the add back allowance for certain COVID-19 related costs, and the current forecasts through April 30, 2022, management believes the Company will maintain compliance with its financial covenants.

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, 2021.

Forward-Looking Statements

From time to time, including in this Quarterly Report on Form 10-Q for the quarterly period ended April 30, 2021, 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, 2021 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 a smaller reporting company as defined by Rule 12b-2 of the Exchange Act as of our second quarter of fiscal 2021 and are not required to provide the information under this item.

Evaluation of 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 April 30, 2021. 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, 2021 (the “Form 10-K”), which was filed with the SEC on April 28, 2021. The risk factors associated with our business have not materially changed compared to the risk factors disclosed in the Form 10-K.