Virco Mfg. Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended October 31, 2018. Virco manufactures and distributes school and office furniture. Results are highly seasonal: about half of annual sales typically occur from June through August, and the company builds inventory and finances receivables ahead of that peak. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Three months 2018 | Three months 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $76.809 | $68.794 | $174.180 | $164.665 |
| Gross profit / margin | $26.430 / 34.4% | $24.467 / 35.6% | $61.247 / 35.2% | $59.577 / 36.2% |
| Operating income | $4.665 | $4.684 | $8.492 | $9.825 |
| Net income | $2.932 | $2.524 | $4.835 | $5.341 |
| Diluted EPS | $0.19 | $0.16 | $0.31 | $0.35 |
Quarterly sales increased 11.7%, while nine-month sales rose 5.8%. Quarterly net income improved, but nine-month net income declined 9.5%. Gross margin fell in both comparisons; nine-month operating income also declined despite higher sales. The filing attributes margin pressure to raw-material and compensation cost increases not fully covered by price increases, more complex project orders and a greater share of lower-margin third-party-sourced products. Interest expense rose with borrowing levels and rates. Nine-month income tax expense was lower, in part reflecting the federal tax-rate reduction under the Tax Cuts and Jobs Act; management cautions that tax expense is not comparable with the prior year.
Cash flow, balance sheet and liquidity
- Nine-month operating cash flow was $2.819 million, versus $4.004 million a year earlier. Investing cash use was $3.316 million; financing cash provided was $2.444 million. Cash increased $1.947 million to $2.481 million.
- At October 31, cash was $2.481 million, receivables $24.281 million, inventory $42.670 million and current assets $71.476 million. Current liabilities were $34.361 million.
- Total debt was $20.212 million, compared with $14.588 million a year earlier and $16.681 million at January 31, 2018. The revolving-credit balance was $13.245 million. The PNC facility’s stated interest rate was 6.25%; about $9.930 million was available to borrow at quarter-end.
- The PNC facility matures March 19, 2023, has a $60 million maximum revolving advance amount subject to borrowing-base and seasonal limits, and includes financial covenants and a seasonal clean-down requirement. Virco reported compliance with its financial covenants for the quarter. Management said cash flows and unused capacity should fund the next 12 months of debt service, capital spending, dividends and working capital.
- Capital expenditures were $3.319 million, down from $12.521 million, which included the prior-year purchase of the Conway, Arkansas manufacturing facility. Cash dividends paid during the nine months were $0.697 million; a further $0.015-per-share dividend was approved after quarter-end.
Business trends, outlook and risks
Management said quarterly sales growth reflected higher prices and a small volume increase. Orders had grown robustly in the first six months, more influenced by bond-funded projects, but third-quarter orders declined approximately $6.5 million as orders increasingly depended on school operating budgets. Backlog was $16.2 million at October 31, versus $16.9 million a year earlier. Nine-month order rates increased approximately 3.7% year over year. No specific earnings or sales guidance was provided.
Key risks cited include school funding and product demand, competition and selling prices, availability and cost of materials—especially steel—and labor costs. Seasonal working-capital needs are substantial; rising variable borrowing rates also pose risk. A 100-basis-point increase in PNC’s base rate would have increased interest expense by approximately $85,000 for the quarter and $261,000 for the nine months.
Other notable items: pension-plan settlements resulted in $341,000 of nine-month expense, while a pension remeasurement generated $1.376 million of after-tax other comprehensive income in the quarter. Virco expects the new lease standard to materially increase balance-sheet assets and liabilities when adopted. The company reported ordinary-course legal proceedings that management considers not material, and stated that risk factors had not materially changed. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether the recent decline in third-quarter orders and lower backlog persist, particularly as demand shifts between bond-funded and school-budget-funded projects.
- Whether pricing and manufacturing efficiency can offset materials, labor, freight and project-order costs and stabilize gross margins.
- Seasonal borrowing availability, covenant compliance, the clean-down requirement and sensitivity to variable interest rates.
- Inventory valuation and receivables collection, given the seasonal build and higher year-over-year inventory and receivables.
- The balance-sheet impact of lease-standard adoption and the treatment of pension and tax-related items in future periods.