Virco Mfg. Corporation — Q3 FY2018 Form 10-Q
Reporting period: Quarter and nine months ended October 31, 2017. Virco manufactures and sells educational furniture. Its business is highly seasonal, with approximately half of annual sales typically shipped from June through August. Financial statements are unaudited.
Financial results
| Metric | Three months ended Oct. 31, 2017 | Prior-year quarter | Nine months ended Oct. 31, 2017 | Prior-year nine months |
|---|---|---|---|---|
| Net sales | $68.8m | $67.8m | $164.7m | $150.0m |
| Gross profit / margin | $24.5m / 35.6% | $24.3m / 35.9% | $59.6m / 36.2% | $56.1m / 37.4% |
| Operating income | $4.7m | $6.5m | $9.8m | $11.2m |
| Net income | $2.5m | $24.0m | $5.3m | $27.7m |
| Diluted earnings per share | $0.16 | $1.57 | $0.35 | $1.83 |
- Margins and expenses: Gross margin fell year over year in both periods. Management cited a greater share of service-intensive projects and lower-margin third-party products, selling-price increases that did not fully offset cost inflation, higher steel and compensation costs, and reduced manufacturing efficiencies on complex orders. SG&A rose $2.0m in the quarter and $4.9m year to date, mainly due to freight, service, selling, and compensation costs associated with higher-volume and project business.
- Cash flow: Nine-month operating cash flow was $4.0m, versus $7.0m a year earlier. Capital expenditures were $12.5m versus $3.2m, including the Conway, Arkansas facility purchase. Financing provided $9.2m; cash increased $0.7m to $1.5m.
- Liquidity and debt: At October 31, cash was $1.5m, current assets $60.8m, and current liabilities $28.1m. Total debt was $14.6m, compared with $4.6m at October 31, 2016; it included $8.8m drawn on the revolving credit line and $5.8m of other debt, principally seller financing for the Conway building. The PNC facility had approximately $12.0m available and a 4.75% interest rate at quarter-end. The company reported covenant compliance and believes operating cash flow and unused borrowing capacity will cover needs for at least 12 months.
- Other balance-sheet items: Trade receivables were $21.1m and inventory $36.4m. Deferred tax assets, net, were $13.8m, down from $18.4m at October 31, 2016.
Changes versus the prior comparable period
Quarterly sales increased 1.5%, while nine-month sales grew 9.8%. Management attributed year-to-date growth to higher volume and pricing; order rates for the first nine months rose approximately 13%. Despite higher sales, operating income declined in both comparisons as gross margin weakened and SG&A increased. Year-to-date results were also affected by much higher capital spending and borrowing. The prior-year net income comparisons are not representative of underlying tax rates: a substantial deferred-tax valuation allowance reversal generated a $17.8m tax benefit in the 2016 quarter and a $17.6m benefit for the 2016 nine-month period. 2017 reflects more normalized tax expense.
Quarter-end backlog was $16.9m, up from $10.7m a year earlier; third-quarter orders were less than 1% above the prior year. Accounts receivable increased $11.2m from January 31, 2017, reflecting seasonal activity. Inventory was $4.7m higher than a year earlier to support the larger backlog.
Outlook, risks, and notable items
- Management expects higher capital expenditures to continue during the year, including factory automation and technology investment. It gave no specific earnings or revenue guidance.
- Virco purchased its Conway manufacturing building for $7.2m in August, with 20% down and $5.76m seller financing for 20 years at 4%. Management expects annual depreciation and debt service each to be about $0.3m below prior rent expense.
- On November 1, 2017, the company signed a five-year nationwide contract/price list, through December 31, 2022, with two two-year renewal options. Approximately 50% of sales are priced through one exclusive-supplier contract, making contract economics and renewal important.
- After quarter-end, Virco extended its Torrance facility lease through April 30, 2025, with monthly base rent varying by period from approximately $396,890 to $446,703. The board also declared a $0.015-per-share dividend, payable January 10, 2018.
- Key risks include seasonality and school funding, demand and competition, steel and labor costs, pricing and margins, and reliance on borrowing to fund seasonal working capital and investment. The company warned that proposed federal tax reform could reduce the value of its $13.8m deferred tax assets, particularly if the corporate tax rate falls. Its revolving credit agreement includes financial covenants and limits annual dividends or capital-stock payments to $1.3m.
- Management said ordinary-course legal proceedings are not expected to materially affect results or financial position. The company was under IRS examination for its fiscal 2016 federal return. Disclosure controls were deemed effective; no material internal-control changes were reported.
Important facts for investors to verify
- Whether the higher backlog converts to shipments and cash, given seasonal shipment timing and customer payment patterns.
- Whether pricing, product mix, steel and labor costs, and project-related freight and service costs allow gross margins to recover.
- Actual capital spending, borrowing needs, revolver availability, interest costs, and ongoing compliance with credit-facility covenants.
- The economics and renewal terms of the nationwide contract and the effect of tax reform on deferred tax assets.
- The full-year outcome: management cautioned that nine-month operating results are not necessarily indicative of the fiscal year.