Virco Mfg. Corporation — Q2 FY2018 Form 10-Q
Reporting period: Quarter and six months ended July 31, 2017. Virco manufactures and sells furniture primarily to educational customers. The business is highly seasonal: about half of annual sales typically occur from June through August, requiring substantial pre-season inventory and working-capital financing.
Financial performance
| Metric | Three months ended July 31, 2017 | Six months ended July 31, 2017 |
|---|---|---|
| Net sales | $72.6 million, up 18.4% | $95.9 million, up 16.7% |
| Gross profit / margin | $26.7 million / 36.7%; prior-year margin 38.7% | $35.1 million / 36.6%; prior-year margin 38.7% |
| Operating income | $8.4 million, versus $7.5 million | $5.1 million, versus $4.7 million |
| Income before taxes | $7.9 million, versus $7.0 million | $4.3 million, versus $3.9 million |
| Net income | $5.0 million, versus $6.9 million | $2.8 million, versus $3.7 million |
| Diluted EPS | $0.33, versus $0.45 | $0.18, versus $0.25 |
Despite higher sales and operating income, net income declined because income tax expense rose substantially from unusually low prior-year expense. The filing attributes the prior-year tax comparison to a valuation allowance against deferred tax assets at July 31, 2016, substantially reversed in the following quarter. FY2018 tax expense reflected a more normalized rate: 36.2% for Q2 and 34.7% for the six-month period.
Cash flow, debt and liquidity
- For the six months, operating cash flow was negative $24.8 million, compared with negative $26.6 million a year earlier. Seasonal increases in receivables and inventory were the main working-capital demands.
- Capital expenditures were $3.9 million, up from $1.9 million, as the company increased investment in factory automation and technology. Financing activities provided $30.6 million; cash rose to $2.7 million from $0.8 million at January 31, 2017.
- At July 31, cash was $2.7 million, net receivables $40.2 million, and inventory $50.9 million. Total debt was $36.0 million, including $35.9 million drawn on the revolving credit line; debt was $5.0 million at January 31 and $37.0 million a year earlier.
- The PNC facility had a $49.5 million maximum availability, with approximately $31.9 million available to borrow at quarter-end. The July 31 interest rate was 4.75%. The company reported compliance with credit covenants and said cash flows and unused borrowing capacity should meet requirements for at least the next 12 months.
Changes, outlook and risks
- Sales growth reflected higher volume and modest price increases. Orders for the quarter rose about 14%, and July 31 backlog was $47.3 million versus $39.5 million a year earlier. Management said order rates were volatile; more August-delivery orders shifted some revenue from Q2 to Q3.
- Gross margin fell as growth came entirely from complex, service-intensive project business, including lower-margin products sourced from manufacturing partners. Partner-product sales rose 78% in Q2 and represented more than one-third of quarterly sales growth. Steel costs, employee compensation and workers’ compensation costs also increased; price increases did not fully offset cost inflation.
- Management reported no formal earnings guidance. It expected elevated capital spending to continue during the year and stated that liquidity was adequate for the next 12 months. Key sensitivities include educational-institution funding and demand, steel and other material costs, labor availability and costs, competition, selling prices, and general economic conditions.
- After quarter-end, Virco purchased its Conway, Arkansas manufacturing building for $7.2 million, paying 20% down with seller financing over 20 years at 4%. Management estimated annual depreciation and debt-service costs each to be about $300,000 below current rent expense. PNC amended its facility to consent to the acquisition and additional debt.
- Other items: the company adopted share-based payment accounting changes, recording approximately $172,000 of previously unrecognized excess tax benefits to retained earnings. It received notice after quarter-end of an IRS examination of its fiscal 2016 federal return. Ordinary-course legal proceedings were described as not expected to be material; risk factors were reported as not materially changed.
Important facts for investors to verify
- Whether the elevated backlog converts to shipments and revenue, particularly given August delivery timing and volatile order rates.
- Whether pricing, product mix and sourcing can offset steel, labor and workers’ compensation cost increases and restore gross margin.
- Seasonal working-capital needs, receivable collections, revolving borrowings, covenant compliance and remaining credit availability.
- Actual capital spending and the building purchase’s financing, operating-cost savings and effect on liquidity.
- The normalized tax rate and outcome of the IRS examination of the fiscal 2016 return.