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

Virco Mfg.Corporation Form 10-Q
Table of Contents

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


(Exact Name of Registrant as Specified in its Charter)
     
Delaware   95-1613718

 
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
 
2027 Harpers Way, Torrance, CA   90501

 
(Address of principal executive offices)   (Zip Code)

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

No change


Former name, former address and former fiscal year, if changed since last report.

     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

 


TABLE OF CONTENTS

PART I
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Item 4. Controls and Procedures
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1


Table of Contents

VIRCO MFG. CORPORATION

INDEX

Part I. Financial Information

     
Item 1.   Financial Statements (unaudited)
 
    Condensed consolidated balance sheets — October 31, 2003, and January 31, 2003
 
    Condensed consolidated statements of operations — Three months ended October 31, 2003 and 2002
 
    Condensed consolidated statements of operations — Nine months ended October 31, 2003 and 2002
 
    Condensed consolidated statements of cash flows — Nine months ended October 31, 2003 and 2002
 
    Notes to condensed consolidated financial statements — October 31, 2003
 
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Item 3.   Quantitative and Qualitative Disclosures about Market Risk.
 
Item 4.   Controls and Procedures
 
Part II. Other Information
 
Item 1.   Legal Proceedings
 
Item 2.   Changes in Securities and Use of Proceeds
 
Item 3.   Defaults upon Senior Securities
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
Item 5.   Other Information
 
Item 6.   Exhibits and Reports on Form 8-K
 
    Exhibit 31.1
 
    Exhibit 31.2
 
    Exhibit 32.1
 
Signatures

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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)

                     
        10/31/2003   1/31/2003
       
 
        Unaudited (Note 1)        
ASSETS
               
Current assets
               
 
Cash
  $ 2,284     $ 1,639  
 
Accounts and notes receivable
    25,003       17,601  
   
Less allowance for doubtful accounts
    320       200  
 
 
   
     
 
   
Net accounts and notes receivable
    24,683       17,401  
 
Income tax receivable
    853        
 
Inventories (Note 2)
               
   
Finished goods
    10,873       16,510  
   
Work in process
    8,615       18,233  
   
Raw materials and supplies
    6,916       8,296  
 
 
   
     
 
   
Total inventories
    26,404       43,039  
 
Deferred income taxes
    2,416       2,494  
 
Prepaid expenses and other current assets
    589       1,495  
 
 
   
     
 
Total current assets
    57,229       66,068  
Property, plant & equipment
               
   
Cost
    156,978       156,863  
   
Less accumulated depreciation
    91,949       83,827  
 
 
   
     
 
   
Net property, plant & equipment
    65,029       73,036  
Other assets
    15,692       15,692  
 
 
   
     
 
Total assets
  $ 137,950     $ 154,796  
 
 
   
     
 

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)

                     
        10/31/2003   1/31/2003
       
 
        Unaudited (Note 1)        
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities
               
 
Checks released but not yet cleared bank
  $ 2,229     $ 2,506  
 
Accounts payable
    5,917       8,395  
 
Income tax payable
          3,538  
 
Accrued compensation and employee benefits
    6,617       7,109  
 
Current maturities on long-term debt
    34,012       1,087  
 
Other current liabilities
    4,754       4,685  
 
 
   
     
 
Total current liabilities
    53,529       27,320  
Non-current liabilities
               
 
Long term debt (less current portion)
          27,905  
 
Other non-current liabilities
    22,354       16,797  
 
 
   
     
 
Total non-current liabilities
    22,354       44,702  
Stockholders’ equity
               
 
Preferred stock:
               
   
Authorized 3,000,000 shares, $.01 par value; none issued or outstanding
           
 
Common stock:
               
   
Authorized 25,000,000 shares, $.01 par value; 14,583,331 and 14,527,074 issued at 10/31/2003 and 1/31/2003
    145       145  
 
Additional paid-in capital
    126,728       126,284  
 
Retained deficit
    (39,424 )     (18,927 )
 
Less treasury stock at cost (1,487,530 shares at 10/31/2003 and 1,416,472 shares at 1/31/2003)
    (19,406 )     (18,634 )
 
Less accumulated comprehensive loss
    (5,976 )     (6,094 )
 
 
   
     
 
Total stockholders’ equity
    62,067       82,774  
 
 
   
     
 
Total liabilities and stockholders’ equity
  $ 137,950     $ 154,796  
 
 
   
     
 

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)

                 
    Three Months Ended
   
    10/31/2003   10/31/2002
   
 
Net sales
  $ 65,802     $ 85,022  
Cost of goods sold
    46,937       53,805  
 
   
     
 
Gross profit
    18,865       31,217  
Operating expense
               
Selling, general and administrative expense
    21,450       25,191  
Separation charges
    4,589        
Interest expense
    501       708  
 
   
     
 
 
    26,540       25,899  
(Loss)/income before income taxes
    (7,675 )     5,318  
Income tax expense
          2,074  
 
   
     
 
Net (loss)/income
  $ (7,675 )   $ 3,244  
 
   
     
 
Amounts per common share (a)
               
Net (loss)/income
  $ (0.59 )   $ 0.24  
 
   
     
 
Weighted average shares outstanding (a)
    13,099,000       13,457,000  
Dividend per common share (a)
               
Cash
  $     $ 0.02  


(a) For fiscal year 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.

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)

                 
    Nine Months Ended
   
    10/31/2003   10/31/2002
   
 
Net sales
  $ 162,843     $ 209,354  
Cost of goods sold
    112,601       132,849  
 
   
     
 
Gross profit
    50,242       76,505  
Operating expense
               
Selling, general and administrative expense
    59,472       65,405  
Separation charges
    12,377        
Interest expense
    1,313       2,302  
 
   
     
 
 
    73,162       67,707  
(Loss)/income before income taxes
    (22,920 )     8,798  
Income tax (benefit)/expense
    (2,946 )     3,431  
 
   
     
 
Net (loss)/income
  $ (19,974 )   $ 5,367  
 
   
     
 
Amounts per common share (a)
               
Net (loss)/income
  $ (1.52 )   $ 0.40  
 
   
     
 
Weighted average shares outstanding (a)
    13,107,000       13,493,000  
Dividend per common share (a)
               
Cash
  $     $ 0.02  


(a) For fiscal year 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.

See Notes to Condensed Consolidated Financial Statements.

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VIRCO MFG. CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited (Note 1)

                     
        Nine Months Ended
       
(Dollar amounts in thousands)   10/31/2003   10/31/2002
   
 
Operating activities
               
 
Net (loss)/income
  $ (19,974 )   $ 5,367  
 
Adjustments to reconcile net (loss)/income to net cash (used in) provided by operating activities:
               
 
Depreciation
    8,901       10,223  
 
Provision for doubtful accounts
    102       319  
 
Loss on sale of fixed assets
    49        
 
Changes in assets and liabilities:
               
   
Accounts and notes receivable
    (7,384 )     (8,072 )
   
Inventories
    16,635       1,878  
   
Prepaid expenses and other current assets
    906       361  
   
Income taxes receivable/payable
    (4,391 )     3,530  
   
Accounts payable and accrued expenses
    2,230       (274 )
 
 
   
     
 
Net cash (used in) provided by operating activities
    (2,926 )     13,332  
Investing activities
               
 
Capital expenditures
    (943 )     (2,700 )
 
Acquisition
          (4,550 )
 
Proceeds from sale of assets
          2  
 
 
   
     
 
Net cash used in investing activities
    (943 )     (7,248 )
Financing activities
               
 
Issuance of debt
    5,365       5,586  
 
Repayment of long-term debt
          (2,705 )
 
Purchase of treasury stock
    (446 )     (754 )
 
Payment of cash dividend
    (525 )     (2,250 )
 
Issuance of common stock
    120       178  
 
 
   
     
 
Net cash provided by financing activities
    4,514       55  
Net change in cash
    645       6,139  
Cash at beginning of period
    1,639       1,704  
 
 
   
     
 
Cash at end of period
  $ 2,284     $ 7,843  
 
 
   
     
 

See Notes to Condensed Consolidated Financial Statements.

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VIRCO MFG. CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

October 31, 2003

     
Note 1:   The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine-months ended October 31, 2003, are not necessarily indicative of the results that may be expected for the year ending January 31, 2004. The balance sheet at January 31, 2003, has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended January 31, 2003.
 
Note 2.   Inventories
 
    Year end financial statements reflect inventories verified by physical counts with the material content valued by the LIFO method. At this interim date, there has been no physical verification of inventory quantities. Cost of sales is recorded at current cost. The effect of penetrating LIFO layers is not recorded at interim dates unless the reduction in inventory is expected to be permanent. An estimated provision has been made for the period ended October 31, 2003. Management continually monitors production costs, material costs and inventory levels to determine that interim inventories are fairly stated.
 
Note 3.   Debt
 
    Effective January 31, 2003, the Company entered into a credit facility with Wells Fargo Bank that provides a secured revolving line of credit that ranges from $40,000,000 to $70,000,000. At October 31, 2003, the Company was in violation of certain of its loan covenants. In December 2003 Wells Fargo provided the Company with a waiver of these covenants as of October 31, 2003. However, based on management’s forecasts 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 at 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. 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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Note 4.   Income Taxes
 
    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’s 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.
 
Note 5.   Reclassifications
 
    Certain prior year amounts have been reclassified to conform to the current year presentation.
 
Note 6.   Net (Loss)/Income Per Share

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:

                                 
    Three Months Ended   Nine Months Ended
    October 31   October 31
   
 
    2003   2002   2003   2002
   
 
 
 
Net (loss)/income
  $ (7,675,000 )   $ 3,244,000     $ (19,974,000 )   $ 5,367,000  
 
   
     
     
     
 
Average shares outstanding
    13,099,000       13,311,000       13,107,000       13,349,000  
Net effect of dilutive stock options — based on the treasury stock method using average market price
    35,000       146,000       23,000       144,000  
 
   
     
     
     
 
Totals
    13,134,000       13,457,000       13,130,000       13,493,000  
 
   
     
     
     
 
Net loss per share — basic
  $ (0.59 )   $ 0.24     $ (1.52 )   $ 0.40  
 
   
     
     
     
 
Net loss per share — diluted
  $ (0.59 )   $ 0.24     $ (1.52 )   $ 0.40  
 
   
     
     
     
 

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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:

                                 
    Three Months Ended   Nine Months Ended
    October 31   October 31
   
 
    2003   2002   2003   2002
   
 
 
 
Net (loss)/income, as reported
  $ (7,675,000 )   $ 3,244,000     $ (19,974,000 )   $ 5,367,000  
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects
    16,000       9,000       43,000       28,000  
 
   
     
     
     
 
Pro forma net (loss)/income
  $ (7,691,000 )   $ 3,235,000     $ (20,017,000 )   $ 5,339,000  
 
   
     
     
     
 
Basic and diluted earnings per share, as reported:
  $ (0.59 )   $ 0.24     $ (1.52 )   $ 0.40  
 
   
     
     
     
 
Basic and diluted earnings per share, pro forma:
  $ (0.59 )   $ 0.24     $ (1.52 )   $ 0.40  
 
   
     
     
     
 
     
Note 7.   Comprehensive (Loss)/Income
 
    Comprehensive loss for the quarter ended October 31, 2003 was $7,675,000 compared to comprehensive income of $3,398,000 for the quarter ended October 31, 2002. Comprehensive loss for the nine months ended October 31, 2003 was $19,856,000 compared to comprehensive income of $5,742,000 for the nine months ended October 31, 2002. The difference between results reported on the income statement and comprehensive (loss)/income is primarily attributable to adjustments in the prior year to account for a derivative financial investment that expired in March 2003.
 
    Accumulated comprehensive loss at the quarter ended October 31, 2003 is primarily composed of minimum pension liability adjustments.
 
Note 8.   Separation Charges
 
    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.

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    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 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.
 
Note 9.   New Accounting Standards
 
    In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends and clarifies financial accounting and reporting derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement is effective for contracts entered into or modified and for hedging relationships designated after June 30, 2003. The Company does not expect the adoption of this statement to have a material impact on its financial statements.
 
    In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The impact upon adoption of SFAS No. 150 is not expected to have a material impact on the results of operations or the financial position of the Company.

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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

     
Item 1.   Legal Proceedings
 
    None
     
Item 2.   Changes in Securities and Use of Proceeds
 
    None
     
Item 3.   Defaults upon Senior Securities
 
    None
     
Item 4.   Submission of Matters to a Vote of Security Holders
 
    None
     
Item 5.   Other Information
 
    None
     
Item 6.   Exhibits and Reports on Form 8-K
 
    (a) Exhibits
 
    Exhibit 31.1 — Certification of Robert A. Virtue, President, pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act, as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002
 
    Exhibit 31.2 — Certification of Robert E. Dose, Vice President, Finance, pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act, as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002
 
    Exhibit 32.1 — Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
    (b) Reports on Form 8-K
 
    On December 15, 2003, we filed a Current Report on Form 8-K in which we furnished, pursuant to Item 5, our interim report on the Company’s third quarter results.

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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.

     
  VIRCO MFG. CORPORATION
 
 
Date: December 15, 2003 By:  /s/ Robert E. Dose
 
    Robert E. Dose
Vice President — Finance

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