VIRCO MFG CORPORATION - Quarter Report: 2003 October (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Quarterly Report under Section 13 or 15(d)
of the Securities Exchange Act of 1934

FORM 10-Q

For Quarter Ended      October 31, 2003           Commission File Number     1-8777

VIRCO MFG. CORPORATION

Registrant’s telephone number, including area code:      (310) 533-0474

No change

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   [X]     No [   ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes   [X]     No [   ]

     The number of shares outstanding of each of the issuer’s classes of common stock, as of November 18, 2003.

Common Stock                13,095,801 Shares

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VIRCO MFG. CORPORATION

INDEX

Part I. Financial Information

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PART I

Item 1. Financial Statements

VIRCO MFG. CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands, except per share data)

See Notes to Condensed Consolidated Financial Statements.

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VIRCO MFG. CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands, except per share data)

See Notes to Condensed Consolidated Financial Statements.

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VIRCO MFG. CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited (Note 1)

(Dollar amounts in thousands, except per share data)

See Notes to Condensed Consolidated Financial Statements.

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VIRCO MFG. CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited (Note 1)

(Dollar amounts in thousands, except per share data)

See Notes to Condensed Consolidated Financial Statements.

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VIRCO MFG. CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited (Note 1)

See Notes to Condensed Consolidated Financial Statements.

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VIRCO MFG. CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

October 31, 2003

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For the quarter ended October 31, 2003, net loss per share was calculated based on basic shares outstanding at October 31, 2003 due to the anti-dilutive effect on the inclusion of common stock equivalent shares. The following table sets forth the computation of basic loss per share:

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SFAS No. 123, as amended by SFAS No. 148, requires pro forma information regarding net income and net income per share to be disclosed for new options granted after fiscal year 1996. The fair value of these options was determined at the date of grant using the Black-Scholes option-pricing model. The estimated fair value of the options is amortized to expense over the options’ vesting period for pro forma disclosures. The per share “pro forma” for the effects of SFAS No. 123, as amended by SFAS 148, is not indicative of the effects on reported net income/loss for future years. The Company’s “reported” and “pro forma” information for the three and nine-month periods ended October 31, 2003 and October 31, 2002 are as follows:

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VIRCO MFG. CORPORATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Results of Operations:

For the third quarter of 2003, the Company incurred a net loss of $7,675,000 on sales of $65,802,000 compared to a net income of $3,244,000 on sales of $85,022,000 in the same period last year. Net loss per share was $0.59 compared to net income per share of $0.24 in the same period last year. For the nine months ended October 31, 2003, the Company incurred a net loss of $19,974,000 on sales of $162,843,000 compared to net income of $5,367,000 on sales of $209,354,000 in the same period last year. Net loss per share was $1.51 compared to net income per share of $0.40 in the same period last year.

Sales for the third quarter decreased by $19,220,000, a 23% decrease compared to the same period last year. For the first nine months of 2003 sales decreased by $46,511,000, a 22% decrease compared to the prior year. Backlog at quarter end increased by 4% compared to the prior year third quarter.

The decrease in sales is primarily attributable to budgetary pressures on state and local governments. As more fully discussed in the President’s Letter included with our 2002 annual report (page 21), schools obtain funding for educational furniture from two primary sources. The first source is from bonds that fund development of new schools and significant refurbishment of older schools. The availability of funds from bonds is relatively stable compared to the prior year. The second source of funds is typically provided from a state’s general funds. Many of the state governments are facing severe funding shortages and school officials will curtail expenditures on maintenance, furniture, and supplies in order to avoid laying off teachers and administrators. With approximately 80-85% of school budgets spent on teachers and administrators, the impact on funds available for furniture can be dramatic when school funding is reduced. In addition to the weakness in the education market, the market for commercial furniture, which suffered a severe decline in 2001 and 2002, continues to be very weak.

Gross profit for the third quarter, as a percentage of sales, decreased approximately 8% compared to the same period last year. For the first nine months, gross profit as a percentage of sales decreased by nearly 6% compared to the prior year. The reduction in gross margin is attributable to increased material costs and reduced production hours. In the prior year, the Company benefited from favorable raw material costs, especially steel. During the second half of 2002, the Company incurred higher steel costs, and has had difficulty passing these costs on to our customers. Material costs, as a percentage of sales were 2% higher in the third quarter and 3% higher for the first nine months as compared to the same periods last year. In addition to increased material costs, the Company substantially reduced factory production in order to control inventory levels. This reduction in production caused the Company to incur unfavorable manufacturing variances. These manufacturing variances caused the balance of the reduced gross margin. In the third quarter, production hours decreased by 51% compared to the prior year. This was accomplished using four tactics. First, the Company implemented a hiring freeze. Second, the Company has traditionally hired temporary labor in its factories during the summer months, and did not hire these temporary workers in the current year. Third, the Company has traditionally hired temporary workers to perform installations at customer locations. In the current year, the Company created installation teams from its factory and warehouse locations. These installation teams performed a significant number of the installations, allowing the Company to reduce production hours, reduce money spent on temporary labor services, and improve customer service at installed jobs. Finally, as more fully discussed below, the Company implemented a voluntary reduction in force at the end of the second quarter, followed by a mandatory reduction in force during the third quarter.

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Selling, general and administrative expense, excluding separation costs of $4,589,000, decreased by $3,741,000 for the quarter ended October 31, 2003 as compared to the same period last year, but increased by approximately 3% as a percentage of sales. Approximately 1% of the increase was related to freight expenses and the balance attributable to costs that were not impacted by the reduction in volume. Selling, general and administrative expense, excluding separation costs of $12,377,000, decreased by $5,933,000 for the nine months ended October 31, 2003 as compared to the same period last year but increased by approximately 5% as a percentage of sales. Approximately 1% of the increase was related to freight expenses and the balance attributable to costs that were not impacted by the reduction in volume.

Interest expense for the quarter ended October 31, 2003 decreased by approximately $207,000 compared to the same period last year. Interest expense for the nine months ended October 31, 2003 decreased by approximately $989,000 compared to the same period last year. Average borrowings for the year increased due to increased inventories for the first 5 months of the year and the loss from operations. The increased interest expense is offset by lower interest rates resulted in an overall net reduction in interest expense.

Income taxes for the nine-month period ended October 31, 2003, were computed using the effective tax rate estimated to be applicable for the full fiscal year and the determination of a valuation allowance for deferred income tax assets. For the nine months ended October 31, 2003, the Company established a $6 million deferred tax valuation allowance. The allowance was recognized based on the weight of available evidence that it is more likely than not that this portion of the Company’s deferred tax asset will not be realized within the next three years, notwithstanding that some of those assets may have longer lives under applicable tax laws. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes. The Company believes, based on its history of prior operating earnings, its actions to reduce costs (see Note 8), and its expectations of future earnings, that operating income of the Company will more likely than not be sufficient to realize the future benefits of the amount classified as a net deferred tax asset. Future adverse changes in market conditions, poor operating results or a decline in our projections about future profitability may affect the Company assessment of the adequacy of the reserve and, consequently, the net carrying value of net deferred tax assets. In the event that the Company determines that it is more likely than not that it would be unable to realize an additional portion of the net deferred tax asset, an additional adjustment to the deferred tax asset valuation allowance would be charged to income in the period such determination was made.

During the second and third quarters, the Company determined that the reduced level of orders received in the first quarter would likely continue for the rest of the year and possibly through 2004 as well. In the second quarter the Company announced a Voluntary Severance Program in addition to other measures that include voluntary part-time work and voluntary sabbaticals. Under the program, employees who voluntarily terminated their employment with the Company were paid six months of severance pay. During the second quarter, nearly 500 employees accepted this offer. Approximately 25% of the workforce severed their employment in June and July. Including employer taxes, the Company incurred approximately $7.8 million in severance costs during the second quarter.

During the third quarter, the Company elected to further reduce expenses and head count through a non-voluntary reduction in force. In September, the Company laid off an additional 160 employees. These employees were given six months of severance pay in addition to a variety of outplacement service benefits to help them locate new employment. The Company incurred approximately $2.6 million of severance costs in the

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third quarter related to this reduction in force. In addition to the severance costs, the Company incurred additional pension settlement costs of approximately $2 million and is anticipated to record another $1 million during the fourth quarter.

As a result of the hiring freeze and the voluntary and involuntary severance programs, the Company anticipates spending on salaries and wages in 2004 to decrease by approximately $22 million compared to 2002, with 2003 being a transition year. In addition to the reduction in salaries, the Company anticipates it will save the related costs for retirement, health, and welfare benefits.

Financial Condition:

Net cash (used in) provided by operating activities for the nine months ended October 31, 2003 was ($2,926,000) compared to $13,332,000 for the same period last year. The increase in cash used in operating activities was primarily due to a large operating loss combined with an increase in accounts and income tax receivable, offset by a reduction in inventory.

As a result of seasonally higher sales in the third quarter, accounts receivable increased by $7,384,000 compared to the year-ended January 31, 2003. In the prior year, accounts receivable increased by $8,072,000 in the same period. In response to the reduction in orders, the Company substantially reduced levels of production in the third quarter by 51% compared to the prior year. Although the reduced production caused the Company to incur unfavorable manufacturing variances, the inventory levels were reduced by nearly $17 million compared to January 31, 2003 and by more that $10 million compared to October 31, 2002.

The Company has established a goal of limiting capital spending to approximately $5,000,000 to $7,000,000 for 2003, which is approximately one-half of anticipated depreciation expense. Capital spending for the nine-month period ended October 31, 2003, was $943,000 compared to $2,700,000 for the same period last year. Capital expenditures were financed through the credit facility established with Wells Fargo Bank and operating cash flow.

Subsequent to the end of the quarter, the Company sold its former manufacturing facility in Gardena, California, which had been held as rental property. Rental revenue for the 9 months ended October 31, 2003 was approximately $425,000. The sale generated approximately $5.8 million of cash and a $5.5 million pre-tax gain.

To facilitate the Company’s seasonal working capital requirements, beginning June 1, 2003, the credit facility with Wells Fargo Bank increased from $60,000,000 to $70,000,000. This line of credit decreases to $60,000,000 on September 1, 2003 and to $40,000,000 effective November 1, 2003.

As of October 31, 2003, the Company violated certain debt covenants relating to its revolving line of credit with Wells Fargo Bank. In December 2003 Wells Fargo provided the Company with a waiver of these covenants. However, based on management’s forecast for operating results for the remainder of the year, it is considered to be more likely than not that the Company will violate the loan covenants in the fourth quarter ending January 31, 2004. Accordingly, the debt has been classified as a current liability on the October 31, 2003 balance sheet. The Company is currently negotiating with Wells Fargo to restructure the credit facility so that the Company will comply with the quarterly debt covenants and have adequate liquidity for the next twelve months. No assurance can be given that such negotiations will be successful. If they are not, the Company would be in default with the bank, which could significantly affect its liquidity. If additional sources of financing are not available, the Company plans to continue to implement measures to conserve cash or reduce costs.

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In April 1998, the Board of Directors approved a stock buyback program. As of October 31, 2003, the Company has repurchased approximately 1,454,000 shares at a cost of approximately $18,788,000 since the inception of this program. The Company intends to continue buying back shares of common stock as long as the Company believes the shares are undervalued and operating cashflows and borrowing capacity under the Wells Fargo line allow. Under the current Wells Fargo line, the Company must limit stock buyback activity to $250,000 for the period between June 4, 2003 and December 1, 2003.

The Company believes that upon the successful completion of the refinancing or restructuring of the Wells Fargo line of credit, funds available under the restructured or refinanced line, together with cashflows from operations, will be sufficient to fund the Company’s debt service requirements, capital expenditures and working capital needs.

Critical Accounting Policies and Estimates:

The Company’s critical accounting policies are outlined in its Form 10-K for fiscal year ended January 31, 2003.

Forward-Looking Statements:

From time to time, the Company or its representatives have made and may make forward-looking statements, orally or in writing, including those contained herein. 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. 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, risks and uncertainties relating to the Company’s ability to refinance or restructure its credit line with Wells Fargo Bank; material availability and cost of materials, especially steel; the 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 Annual Report on Form 10-K for the fiscal year ended January 31, 2003.

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.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

On February 22, 2000, the Company entered into an interest rate swap agreement with Wells Fargo Bank. The initial notional swap amount was $30,000,000 for the period February 22, 2000 through February 28, 2001. The

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notional swap amount then decreased to $20,000,000 until the end of the swap agreement, March 3, 2003. The swap agreement was in consideration for a fixed rate at 7.23% plus a fluctuating margin of 1.50% to 2.50%. The swap agreement was not renewed at expiration.

As of October 31, 2003, the Company had borrowed $32,925,000 under its Wells Fargo credit facility. The revolving credit facility with Wells Fargo Bank is a two-year non-amortizing line with interest payable monthly at a fluctuating rate equal to the Bank’s prime rate, plus a fluctuating margin of 0.25% - 0.50%. The line also allows the Company the option to borrow under 30- 60- and 90-day fixed term rates at LIBOR plus a fluctuating margin of 1.50% to 2.50%. Accordingly, a 100 basis point upward fluctuation in the lender’s base rate would cause the Company to incur additional interest charges of approximately $117,000 and $383,000 for the fiscal quarter and nine months ended October 31, 2003, respectively. The Company would benefit from a similar interest savings if the base rate were to fluctuate downward by a like amount.

Item 4. Controls and Procedures

     (a)  Evaluation of Disclosure Controls and Procedures

Our Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed with the Securities and Exchange Commission (the “SEC”) pursuant to the Securities Exchange Act of 1934 (the “Exchange Act”) 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 our company’s management, including its President and Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Assessing the costs and benefits of such controls and procedures necessarily involves the exercise of judgment by management, and such controls and procedures, by their nature, can provide only reasonable assurance that management’s objectives in establishing them will be achieved.

We carried out an evaluation, under the supervision and with the participation of our company’s management, including the Company’s President and Chief Executive Officer along with the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this Quarterly Report pursuant to Exchange Act Rule 13a-15. Based upon the foregoing, the Company’s President and Chief Executive Officer along with the Company’s Chief Financial Officer and other members of management concluded that our Company’s disclosure controls and procedures are effective in alerting them in a timely fashion to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic filings with the Securities Exchange Commission.

     (b)  Changes In Internal Control Over Financial Reporting

No changes in our internal control over financial reporting have come to management’s attention during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II

VIRCO MFG. CORPORATION

OTHER INFORMATION

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VIRCO MFG. CORPORATION

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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