VIRC

Business Context and Reporting Period

Company: Virco Mfg. Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: July 31, 2008
Business Overview: Virco manufactures educational furniture and equipment. The business is highly seasonal, with over 50% of annual sales typically occurring between June and September. The company relies on third-party bank financing to fund inventory build-ups prior to the peak season.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 9.8% ($8.7M) for the quarter and 8.9% ($10.6M) for the six-month period compared to the prior year. Management attributes this to reduced school budgets in states with declining real estate values (specifically California and Florida) and delayed order timing.
• Margin Compression: Gross margin percentage dropped from 37.9% to 32.3% for the quarter. This was driven by significant increases in raw material costs (steel, plastic), energy costs, and a 26% reduction in production hours which adversely affected overhead absorption.
• Profitability: Net income for the quarter fell from $11.6M to $3.5M. For the six-month period, net income dropped from $8.6M to $0.7M.
• Working Capital: Accounts receivable increased by approximately $27.6M compared to the prior fiscal year-end due to seasonal shipment volumes. Inventory levels also increased, primarily due to higher raw material stockpiles.
• Debt Structure: The company amended its credit agreement with Wells Fargo Bank in July 2008 to modify covenants (including the leverage ratio) and implement a borrowing base formula. Total debt increased significantly from the prior year-end to fund working capital needs.

Outlook, Risks, and Management Commentary

• Contract Renewal: Subsequent to the reporting period, Virco was awarded a new three-year nationwide contract with a major purchasing alliance (Jan 2009–Dec 2011), including mid-year price adjustments to recover commodity costs.
• Price Adjustments: The company has instituted mid-year price adjustments for virtually all dealers and resellers to offset rising input costs.
• Liquidity: Management believes cash flows from operations and the $21.95M available under the credit facility are sufficient to fund debt service, capital expenditures, and working capital for the next 12 months.
• Dividends and Buybacks: The company declared a quarterly dividend of $0.025 per share. A $3M stock repurchase program was authorized; $63,000 worth of shares were repurchased in the second quarter.
• Risks: Key risks include the inability to pass on increased costs of steel, plastic, and fuel due to fixed-price contracts, and continued pressure on government school budgets. The company is currently under IRS audit for the fiscal year ended January 31, 2007.
• Subsequent Events: The company entered into a five-year lease extension for its Torrance facility and agreed to sell a former facility in Conway, AR, for an anticipated gain of nearly $1M.

Investor Verification Checklist

• Commodity Cost Pass-Through: Verify the effectiveness of recent price adjustments in restoring gross margins given the fixed-price nature of many contracts.
• Working Capital Efficiency: Monitor the collection of the $43M+ accounts receivable balance and the drawdown of elevated inventory levels in the third quarter.
• Credit Facility Compliance: Confirm continued compliance with the amended Wells Fargo credit agreement covenants, specifically the borrowing base formula.
• State Budget Impact: Assess the specific impact of California and Florida school funding cuts on future order volumes.
• IRS Audit Outcome: Track the resolution of the IRS audit for the fiscal year ended January 31, 2007, and potential tax liability adjustments.