Item 1. Business
Introduction
Virco Mfg. Corporation, a Delaware Corporation, is a leader in the design, production, and distribution of quality furniture for the contract and education markets worldwide. Forty-nine years of manufacturing has resulted in a wide product line targeted for both education and commercial markets. Over these years, Virco has developed several core competencies that position the Company to service its selected markets. Included in these competencies is what we believe to be the largest direct sales force in the education market, where our primary competitors rely upon distributorships.
The trend in educational sales is becoming increasingly seasonal. The ability to forecast, finance, manufacture, and warehouse furniture for this narrow delivery window is a significant competency, which gives the Company a competitive advantage in this market niche. The Company has approximately one million square feet of distribution and warehouse facilities. Substantial warehouse space is required to build adequate inventories to service the highly seasonal demand for educational sales. Approximately 47% of total sales are delivered in July, August, September, and October with an even higher portion of educational sales delivered in that period.
One of the important elements of Virco's success is its manufacturing capabilities. The Company has developed competencies in several processes, which are important to the markets we serve. These processes include finishing systems, plastic molding, metal fabrication and woodworking. Virco's manufacturing facilities are located in California and Arkansas. Over one million square feet of manufacturing and support facilities are organized for the production of furniture. During the year ended January 31, 1995, Virco made a significant investment in a new manufacturing and distribution facility in Torrance, California to service the western region of the United States. The Company consolidated all western region distribution facilities at this location in 1994 and transferred the former western region manufacturing plant to this facility in 1995.
The Company has continued to make significant capital investments in the Conway, Arkansas manufacturing facility, which services the eastern region of the United States. The main manufacturing plant was expanded in 1991 and again in 1993. Capital spending at this facility of nearly $5,700,000 in 1996, $6,100,000 in 1997 and $8,700,000 in 1998.
In late 1997 and early 1998, the Company acquired approximately 100 acres of land in Conway, Arkansas, which will support up to 1,700,000 square feet of manufacturing, warehousing, office, and showroom facilities. For a more detailed discussion on this expansion project, please refer to the MD&A section of the Company's 1998 annual report and the Property section of the Form 10-K.
Principal Products
The Company offers the broadest line of furniture for the K-12 market of any Company in the United States. The Company also provides a variety of products for the preschool markets and has recently
developed products that are targeted for college, university, and corporate learning center environments. These products include a variety of student and teacher desks, chairs, computer stations, folding and adjustable height tables, mobile tables, mobile cabinets, and folding and stacking chairs for cafeteria and auditorium seating. The Company also produces a variety of tables, chairs, and storage equipment designed primarily for the hospitality market, convention centers, churches, and corporate and government facilities.
The Company's primary furniture lines are constructed of tubular metal legs and frames, combined with wood and plastic tops, plastic seats and backs, upholstered seats and backs, and upholstered rigid polyethylene and polypropylene shells. The Company purchases steel, aluminum, plastic, polyurethane, polyethylene, polypropylene, plywood, particleboard, cartons and other raw materials in the manufacture of its principal products from many different sources and is not more vulnerable on sources and availability than other manufacturers.
Marketing and Distribution
The educational product line is marketed through what we believe to be the largest direct sales force in the educational furniture industry. During the fourth quarter of 1997, Virco terminated distribution arrangements with several major educational dealerships and increased the size of the direct sales force to cover these territories. Virco has historically increased both sales and margins in territories where our direct sales force has replaced educational dealerships. The sales force calls directly upon school business officials, who can include purchasing agents or individual school principals where site based management is practiced. During the fourth quarter of 1998, the Company hired several education sales representatives dedicated to the college and university markets. Our direct sales force is considered to be an important competitive advantage over competitors who rely primarily upon dealer networks for distribution of their products. Significant portions of educational furniture are sold on a bid basis.
Sales of commercial and contract furniture are made throughout the United States by distributorships and by Company sales representatives who service the distributorship network. Company representatives call directly upon convention centers, individual hospitality installations, and to mass merchants. Sales to this market include preschools, private schools, and office training facilities, which typically purchase furniture through commercial channels.
Sales are made to thousands of customers, and no single customer represents a significant amount of the Company's business.
Other Matters
Foreign Operation Information
Foreign operation information attributable to the Company's operations for the years ended January 31, 1999, 1998 and 1997, which appear in Note 9 of the consolidated financial statements included in Virco Mfg. Corporation's Annual Report to Stockholders for 1998, is incorporated by reference in this Form 10-K Annual Report.
Competition
The Company has numerous competitors in each of its markets. In the educational furniture market, competitors include Artco-Bell Corporation, Royal, Smith Systems, Scholarcraft, Fleetwood, and Irwin Seating Co. Competitors in contract furniture vary depending upon the specific product line or sales market and include Falcon Products, Inc., Krueger Metal Products, Inc., Globe, MTS, Mity Lite, and Shelby Williams Industries, Inc.
Backlog
Sales order backlog for continuing operations of the consolidated companies at January 31, 1999, totaled $12.0 million and approximates three weeks of sales, compared to $11.8 million at January 31, 1998, and $9.6 million at January 31, 1997.
Patents and Trademarks
Virco has a number of patents and trademarks for which the Company has not appraised or established a value. It is believed that the loss of any of the patents would not have a material effect on its manufacturing business.
Employees
Virco Mfg. Corporation and its Subsidiaries employ approximately 2,373 full-time employees at various locations. Of this number, approximately 2,100 are involved in manufacturing and distribution, 201 in sales and marketing and 72 in administrative.
Environmental Compliance
The Company and other furniture manufacturers are subject to federal, state and local laws and regulations relating to the discharge of materials into the environment and the generation, handling, storage, transportation and disposal of waste and hazardous materials. The Company has expended, and may be expected to expend significant amounts in the future for the investigation of environmental conditions, installation of environmental control equipment, or remediation of environmental contamination.
Item 2.
Item 2. Properties
Torrance, California
The Company leases a 560,000 square feet office, manufacturing and warehousing facility located on 23.5 acres of land. This facility is occupied under a ten-year lease (with two five-year renewal options) expiring January 2005. This facility also includes the Corporate headquarters, the West Coast showroom, and all West Coast distribution operations. In addition, the Company owns a 200,000 square feet warehouse located on 8.5 acres of land in Torrance, California. This warehouse is held as rental property and is leased under a five-year lease expiring January 2001.
Los Angeles, California
The Company owns a 160,000 square feet manufacturing facility located on 8 acres of land in Gardena, California. This manufacturing facility is held as rental property and is leased under a 15-year lease expiring September 2010.
Conway, Arkansas
The Company is currently expanding manufacturing operations and consolidating distribution facilities in Conway, Arkansas. During 1997 and 1998, the Company acquired approximately 100 acres of land. A long-term master plan was developed for this site, which will allow up to 1,700,000 square feet of manufacturing, warehousing, and office space. During 1998, the Company constructed a 400,000 square feet manufacturing facility, which initiated production in March 1999. In addition to the production facility, the Company initiated development of an 800,000 square feet distribution facility. This facility will be constructed in two 400,000 square feet segments, and is anticipated to be completed in fall 1999 and spring 2000 respectively.
During 1998 the Company operated three manufacturing facilities, two of which were owned and one leased. The main plant features approximately 350,000 square feet of building located on nearly 18 acres of land. A second facility consists of 155,000 square feet of building located on approximately 7 acres of land. Subsequent to year-end, the production equipment from this location was moved to the new facility described above, and this building was converted to a warehouse. A third 200,000 square feet facility, used for the production and storage of plastic components, is occupied under a ten-year lease expiring in March of 2008.
In addition to the production facilities described above, the Company leases three finished goods warehouses. The first consists of 250,000 square feet of warehouse space located on 11 acres of land. This warehouse is occupied under a lease expiring in December 1999. A second warehouse has a 310,000 square feet building, which is occupied under leases expiring from September 1999 to December 1999. A third facility is an 87,000 square feet facility, which is leased on a month to month basis. A fourth facility, owned by the Company, consists of 60,000 square feet of building on 4.5 aces of land. All of these warehousing facilities will be consolidated in the 800,000 square feet warehouse currently under construction.
Newport, Tennessee
The Company owns a 55,000 square feet manufacturing facility located on 3.5 acres of land in Newport, Tennessee which was previously used to manufacture melamine plastic seats, backs and table tops for classroom furniture. This factory is currently used to warehouse finished goods inventory.
Item 3.
Item 3. Legal Proceedings
Virco has various legal actions pending against it which in the opinion of Management are either not meritorious or are fully covered by insurance. While it is impossible to estimate with certainty the ultimate legal and financial liability with respect to these suits and claims, Virco believes the aggregate amount of such liabilities will not be material to the results of operations, financial position, or cash flows of the Company.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
None
PART II
Item 5.
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.
Incorporated herein by reference is the information appearing under the caption "Supplemental Stockholders' Information" which appears in the registrant's Annual Report to Stockholders for the year ended January 31, 1999. As of April 17, 1999, there were approximately 372 Registered Stockholders according to transfer agent records. There were approximately 3,000 Beneficial Stockholders.
Dividend Policy
It is the Board of Directors' policy to periodically review the payment of cash and stock dividends in light of the Company's earnings and liquidity. In 1998, the Company declared $.076 per share (adjusted for stock dividends) cash dividend and a 10% stock dividend.
Item 6.
Item 6. Selected Financial Data
Incorporated herein by reference is the Selected Financial Data information, which appears in the registrant's Annual Report to Stockholders for the year ended January 31, 1999.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation
This information is incorporated herein by reference to "Management's Discussion and Analysis and Results of Operations" included in the registrant's Annual Report to Stockholders for the year ended January 31, 1999.
Item 8.
Item 8. Financial Statements and Supplementary Data
The report of independent auditors and consolidated financial statements included in the Annual Report to Stockholders for the year ended January 31, 1999 are incorporated herein by reference.
Unaudited quarterly results in Note 10 of the financial statements included in the Annual Report to Stockholders for the year ended January 31, 1999 are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
None
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
- -------------- (1) Appointed Chairman in 1990; has been employed by the Company for 43 years. Has served as the President since 1982.
(2) Appointed in 1995; has been employed by the Company for 9 years and has served as the Corporate Controller, and currently as Vice President- Finance, Secretary and Treasurer.
(3) Appointed in 1997; has been employed by the Company for 4 years and has served as the Corporate Counsel, currently as Vice President and General Manager of Torrance division.
(4) Appointed in 1995; has been employed by the Company for 18 years in a variety of sales and marketing positions, currently as a Corporate Vice President of the Commercial Sales Group.
(5) Appointed in 1995; has been employed by the Company for 14 years in a variety of sales and marketing positions, currently as Corporate Vice President Marketing.
(6) Appointed in 1998; has been employed by the Company for 4 years and has served as Associate Corporate Counsel, and currently as Vice President of Legal Affairs.
(7) Appointed in 1988; has been employed by the Company for 30 years and has served as Division Credit Manager, Accounting Manager, Division Controller and currently as Vice President and General Manager of the Conway division.
(8) Appointed in 1992; has been employed by the Company for 14 years and has served in Production Control, as Contract Administrator, as Manager of Marketing Services, as General Manager of Torrance Division, and currently as Corporate Executive Vice President.
(9) Appointed in 1995; has been employed by the Company for 21 years in a variety of sales and marketing positions, currently as Corporate Vice President of the Education Sales Group.
(10) Company officers do not have employment contracts.
The information required by this Item regarding Directors will be contained in the Company's Proxy Statement to be filed within 120 days after the end of the Company's most recent fiscal year and is incorporated herein by this reference.
Item 11.
Item 11. Executive Compensation
The information required by this Item will be contained in the Company's Proxy Statement to be filed within 120 days after the end of the Company's most recent fiscal year and is incorporated herein by this reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item will be contained in the Company's Proxy Statement to be filed within 120 days after the end of the Company's most recent fiscal year and is incorporated herein by this reference.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The information required by this Item will be contained in the Company's Proxy Statement to be filed within 120 days after the end of the Company's most recent fiscal year and is incorporated herein by this reference.
PART IV
Item 14.
Item 14. Financial Statements, Financial Statement Schedules, Exhibits, and Reports on Form 8-K.
a) 1. The following consolidated financial statements of Virco Mfg. Corporation, included in the annual report of the registrant to its stockholders for the year ended January 31, 1999 are incorporated by reference in Item 8.
Consolidated balance sheets - January 31, 1999 and 1998.
Consolidated statements of income - Years ended January 31, 1999, 1998, and 1997.
Consolidated statements of stockholders' equity - Years ended January 31, 1999, 1998, and 1997.
Consolidated statements of cash flows - Years ended January 31, 1999, 1998, and 1997.
Notes to consolidated financial statements - January 31, 1999.
2. The following consolidated financial statement schedule of Virco Mfg. Corporation is included in item 14(d):
Schedule II Valuation and Qualifying Accounts and Reserves.
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
3. Exhibits
13 Annual Report to Stockholders for the year ended January 31, 1999.
21 List of all subsidiaries of the registrant.
23 Consent of Ernst & Young LLP.
27 Financial Data Schedule.
b) Reports on Form 8-K.
None
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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, in the City of Torrance, and State of California, on the 29th of April, 1999.
VIRCO MFG. CORPORATION
By /s/ ROBERT A. VIRTUE ---------------------------------------- Robert A. Virtue, Chairman of the Board (Principle Executive Officer)
By /s/ ROBERT E. DOSE ---------------------------------------- Robert E. Dose, Vice President - Finance & Secretary & Treasurer (Principal Financial Officer)
By /s/ BASSEY YAU ---------------------------------------- Bassey Yau, Corporate Controller (Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Torrance, and State of California, on the 29th of April, 1999.
VIRCO MFG. CORPORATION
By /s/ ROBERT A. VIRTUE ---------------------------------------- Robert A. Virtue, Chairman of the Board (Principle Executive Officer)
By /s/ ROBERT E. DOSE ---------------------------------------- Robert E. Dose, VP.- Finance, & Secretary & Treasurer (Principal Financial Officer)
By /s/ BASSEY YAU ---------------------------------------- Bassey Yau, Corporate Controller (Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
VIRCO MFG. CORPORATION AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED JANUARY 31, 1997, 1998 AND 1999 (In Thousands)
- -------------- (1) Uncollectible accounts written off, net of recoveries.
FINANCIAL HIGHLIGHTS
- -------------- * Based on average number of shares outstanding each year after giving retroactive effect for stock dividends and 3 for 2 stock split.
** Based on number of shares outstanding at year-end giving effect for stock dividends and 3 for 2 stock split.
MANAGEMENT'S STATEMENT
The financial statements of Virco Mfg. Corporation were prepared by management, which is responsible for the integrity and objectivity of the data presented, including amounts that must necessarily be based on judgments and estimates. The statements were prepared in conformity with generally accepted accounting principles, and in situations where acceptable alternative accounting principles exist, management selected the method that was most appropriate in the circumstances.
Virco depends upon the Corporation's system of internal controls in meeting its responsibilities for reliable financial statements. This system is designed to provide reasonable assurance that assets are safeguarded and that transactions are properly recorded and executed in accordance with management's authorization. Judgments are required to assess and balance the relative cost and expected benefits of these controls.
The financial statements have been audited by our independent auditors, Ernst & Young LLP. The independent auditors provide an objective, independent review as to management's discharge of its responsibilities insofar as they relate to the fairness of reported operating results and financial condition. They obtain and maintain an understanding of Virco's accounting and financial controls, and conduct such tests and procedures as they deem necessary to arrive at an opinion on the fairness of the financial statements.
The Audit Committee of the Board of Directors, which is composed solely of Directors from outside the Company, maintains an ongoing appraisal of the effectiveness of audits and the independence of the auditors. The Committee meets periodically with the auditors and management. The independent auditors have free access to the Committee, without management present, to discuss the results of their audit work and their opinions on the adequacy of internal financial controls and the quality of financial reporting.
MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS
REVENUE AND INCOME
1998 vs. 1997
Net sales from operations increased to $273,600,000 for fiscal 1998, compared to $258,200,000 for fiscal 1997. Roughly two thirds of this increase was attributable to volume and one third attributable to price. This modest increase in sales was attained by a continuation of practices, which have been followed for the last several years. The Company continues to be more selective and more disciplined in what business it pursues in terms of product mix, customer mix, and pricing in order to emphasize profitable business rather than pursue sheer sales volume. As the Company has grown in certain more profitable markets and products, we have reduced our business in certain commodity type products which generate lower profit margins and customers which sell these products. The results of the 1998 fiscal year reflect these efforts.
Virco sells primarily to facility managers. Examples of these facilities served by the Company include public and private schools, colleges and universities, convention centers, federal and state institutions, churches, and other businesses. We also sell to wholesalers, distributors, retailers and catalog retailers.
Virco has one product line and one catalog, which is used to promote sales of product to all sales channels. A core marketing group, which reports to the President and is composed of representatives from sales, product development, corporate marketing, and customer service prepare annual plans which allocate resources for product development, marketing and selling expense for all sales channels, customer service, and the product stocking plan (quick ship program).
Virco maintains two interdependent manufacturing and distribution facilities, one in Torrance, California and one in Conway, Arkansas. Customer service departments are located at each of these locations. Much of our product line can be produced at either location, but many products or components are produced at only one factory due to space, cost, or process requirements. Sales support and order fulfillment is typically provided by the factory/distribution center nearest to the end user.
In order to divide workload into manageable amounts, Virco has divided the sales force into two groups, Education and Commercial. In 1997 the former Special Markets Sales Group was folded into these two groups. Similar adjustments of sales responsibility occur from time to time in response to changing markets or the introduction of new products.
Education sales, which are composed of sales to publicly funded K-12 schools represents 61% of corporate revenues increased by $12,700,000 to $168,200,000 from $155,500,000. Sales of our newer computer furniture, our line of core-a-gator lightweight tables, mobile cabinets, and mobile tables improved, offset by reductions in some of our older product lines. The gross margin in the newer product lines are typically greater than sales of the older lines, which explains a portion of our improvement in gross margin as a percentage of sales. In the fourth quarter of 1998, the Company hired several sales representatives to call directly upon the college and university markets. The impact of these representatives was a slight increase in selling expenses in the fourth quarter, with no significant impact on sales volume. During the fourth quarter of 1997, the Company terminated relationships with several major educational dealers, which represented nearly 15% of educational sales, and hired additional direct sales representatives to cover the affected territories. The net impact of this change in 1998 was that sales in the affected territories were approximately level, with the Company realizing larger margins on these sales offset in large part by increases in selling expenses. While the impact in the first year of this change was largely neutral, the Company has historically improved market penetration and profitability in territories where it has gone direct. A result of terminating several dealer relationships, combined with an overall trend in the nations schools where school districts are closing their warehouses and requiring delivery direct to the school site, is that sales are becoming even more seasonal, with sales becoming more concentrated in July, August, and September.
Commercial sales, which include private schools, pre-schools, churches and church affiliated schools, convention centers, federal and county and city agencies, furniture distributors, retailers, and catalog retailers represents 39% of corporate revenues and increased by $2,700,000 to $105,400,000 from $102,700,000 in the prior year. Commercial sales have been affected more significantly by our efforts to improve margins. As the Company has increased sales of more profitable product, we have reduced our business with mass merchants and smaller distributors. Sales of our core-a-gator lightweight table, the breadth of our product line for target niche markets, and the continuing success of our quick ship stocking program favorably affected sales for the other commercial sales channels.
The $15,400,000 increase in sales provided an additional $9,735,000 of gross margin. As discussed above, the increase in sales of higher margin newer products, combined with increased discipline in our pricing to support improved margins contributed to the increase in gross margin. In addition, material costs were stable and for some items slightly reduced in 1998 compared to 1997. Selling, general, and administrative expenses increased over the prior year, and as a percentage of sales, increased slightly.
1997 vs. 1996
Net sales from operations increased to $258,200,000 for fiscal 1997, compared to $236,300,000 in fiscal 1996. The increase in sales was attained by selected increases in selling prices, a change in product mix to higher priced products, and increased volumes.
Educational sales represented 58% of corporate revenues and increased by $17,200,000 from $138,300,000 to $155,500,000. The growth in educational sales reflected strong acceptance of our newer line of computer furniture as well as continued growth of our mobile cabinet and mobile table product lines. These newer product lines typically command higher prices and margins than our more mature products. Sales of some of our more mature product lines showed slower rates of growth and in selected cases declines in sales volume, as the Company elected to maintain margins at the expense of volume growth. In addition, finished goods inventories of educational products going into the summer shipping season were higher than the prior year. This increased level of inventory allowed for increased sales volume during the summer as well as contributed to improve on time delivery during this peak season. During the fourth quarter, as part of our effort to improve penetration and service levels in the public education market, Virco terminated distribution arrangements with several major educational dealerships and increased the size of the direct sales force to cover these territories. Sales in the fourth quarter, which are traditionally very low compared to the second and third quarters, were adversely affected during this transition.
Commercial sales represented 42% of corporate revenues and increased by $4,700,000 from $98,000,000 to $102,700,000. Sales in this market include private schools, pre-schools, churches, banquet and meeting halls, and cafeterias. Continued improvement in our marketing techniques to these niche markets drove the increase in sales volume. Sales increases in these markets were offset slightly by decreases in sales of high volume, low margin products to mass merchants.
The $21,900,000 increase in sales provided an additional $13,300,000 of gross margin. As discussed above, the increase in sales of higher margin newer products, combined with increased discipline in our pricing to support improved margins contributed to the increase in gross margin. In addition, material costs were stable in 1997 compared to 1996. Continued investment in factory automation and efficiencies in distribution contributed to the improved performance. Selling, general, and administrative expenses increased over the prior year, but as a percentage of sales, declined slightly. Interest expenses decreased by $700,000 reflecting lower levels of borrowing. Fiscal year 1997 earnings were affected by a $2,970,000 provision for the shutdown of our manufacturing subsidiary in San Luis, Mexico.
OTHER OPERATING ACTIVITIES
In August 1997, the Board of Directors authorized an expansion and re-configuration of the Conway, Arkansas manufacturing facility. In late 1997 and early 1998, the Company acquired approximately 100 acres of land in Conway, which will support up to 1,700,000 square feet of manufacturing, warehousing, office, and showroom facilities. Phase one of the project consisted of a 400,000 square feet manufacturing plant. This plant will replace an existing 150,000 square feet manufacturing facility, providing an additional 250,000 square feet which is earmarked for new manufacturing processes to support our product development efforts as well as support future growth in sales. This plant will utilize the cell manufacturing concepts, which have proven successful in our Torrance, California manufacturing facility. Finally, the plant will contain new manufacturing equipment, which is selected to improve manufacturing efficiency and flexibility as well as improve product quality. This new factory initiated production in March of 1999, when substantially all of the production equipment from the existing 150,000 square feet facility had been transferred to the new plant. New processes and equipment are being brought on line as capacity and process requirement demand. The abandoned 150,000 square feet facility, which is adjacent to the main factory in Conway, has been converted to a finished goods warehouse.
Phase two of our Conway project consists of an 800,000 square feet distribution facility, which will be constructed in two 400,000 square feet segments. Construction on the first segment began in March of 1999, and was projected to be completed in the summer of 1999. On April 15, 1999 a severe windstorm caused significant damage to the skeletal frame of the construction in process. While the loss related to the damage is insured, there will be some delay to the project as a result of this damage. The extent of the delay is not yet determined, but could be as great as six months. The second segment is projected to be complete by February 2000. This new distribution facility will replace several leased facilities, which are scattered throughout the Conway vicinity. While the total amount of square footage dedicated to warehousing is projected to remain the same, we anticipate that we will benefit from operational efficiencies as well as more effectively support growth in sales with this consolidated operation.
In April 1994, the Company entered into a ten-year lease for a 560,000 square feet manufacturing and warehousing facility in Torrance, California. This facility has enabled the Company to combine both manufacturing and warehousing operations for the Western Region under one roof, reducing materials handling and distribution expenses. In connection with the move, the factory was redesigned to implement a "manufacturing cell" concept. This cell concept required a substantial investment in capital equipment, but reduced labor costs as well as throughput time for production of the Company's significant product lines. In addition, the new equipment broadened the Company's manufacturing capabilities to facilitate expansion into targeted markets and product lines. This facility supported new product development from 1994 to date, but is currently operating near capacity.
In 1994, the Board of Directors authorized the Company to investigate the possible sale of our Virsan, Mexico manufacturing facility. This action was taken in connection with our program of moving manufacturing operations into more automated facilities which are closer to our primary markets. In addition, this decision was consistent with the Company's efforts to reduce emphasis on the sale of high volume, low margin products to mass merchants, many of which were produced at this factory. In May 1997 the Company announced plans to close this facility. Later in 1997, the Company reached an agreement for the
bulk sale of the assets. The Company recorded a provision for $2,970,000 during 1997. The provision is primarily composed of mandatory severance payments in accordance with Mexico law. Other components of the reserve include environmental remediation and other miscellaneous costs. The Company did not incur any significant costs related to the liquidation of this subsidiary in 1998.
At the end of the third quarter 1998, the Company announced the intent to close two of its distribution facilities effective January 31, 1999. This follows decisions in 1993 and 1994 when nine distribution facilities were eliminated. This leaves the Company with its main distribution facilities at the Torrance and Conway factories, and one satellite facility in Pennsylvania.
IMPACT OF THE YEAR 2000
The year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs or hardware that have date sensitive software of embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things a temporary inability to process transactions, manufacture product, or engage in similar normal business activities.
The Company completed an assessment of its primary information systems in early 1997. The Company's legacy mainframe system would require modifications to be year 2000 compliant. The cost of these modifications was estimated to be approximately $200,000. As part of this assessment, the Company reviewed various software packages that would be Year 2000 compliant and improve our information system capabilities. After extended review, the Company determined that the benefits attainable by implementing an enterprise resource planning system justified the additional cost of acquiring and implementing such a system.
In August 1997, the Board of Directors approved the implementation of a SAP Enterprise Resource Planning System. This implementation was started in October 1997 and Virco contracted with Hewlett Packard and SAP to provide hardware, software, and consulting services related to this implementation. The hardware, software, and operating systems selected were determined to be year 2000 compliant prior to beginning the implementation. Subsequent to year-end, on March 1, 1999 the Company went live on the SAP system for all required modules except for payroll, which was converted in April 1999. As of January 31, 1999 the Company has expended approximately $7,500,000 on the implementation in addition to dedicating considerable management time and effort to this project. Local area networks, which were installed as part of the SAP project, are approximately 90% complete. Remediation is approximately 70% complete, while testing and implementation are approximately 15% complete.
The Company's primary information systems do not have any significant interfaces with third party vendors. The Company does have remote access with financial institutions, credit institutions, and other parties. The Company has queried the financial institutions and is not aware of any related Year 2000 issue, which would materially affect the Company.
In addition to the primary information systems, the Company is dependent on computer controlled production and manufacturing equipment. Assessment of the equipment is approximately 95% complete. Remediation is approximately 80% complete, while testing and implementation are approximately 50% complete. The Company expects to complete these efforts by the fall of 1999.
The Company has queried significant suppliers and vendors that do not share information systems with the Company (external agents). To date, the Company is not aware of any external agent with a Year 2000 issue that would materially impact the Company's results of operations, liquidity, of capital resources. However, the Company has no means of ensuring that external agents will be Year 2000 ready. The inability of external agents to complete their Year 2000 resolution process in a timely fashion could materially impact the Company. The effect of non-compliance by external agents is not determinable.
The Company has not queried customers to determine whether they are Year 2000 ready. The Company does not have any one significant customer upon which it is dependent.
With regard to the Company's product line, the Company manufactures furniture, including furniture designed for computers. There is no software or hardware imbedded in the furniture. Accordingly, the Company believes that there is no year 2000 exposure for any products it has sold.
The Company will utilize both internal and external resources to reprogram, replace, test, and implement the software and operating equipment for the Year 2000. The total cost of the Year 2000 project is estimated at $8,000,000. This includes cost to implement the SAP Enterprise Resource Planning System, which is expected to significantly enhance the Company's operating capabilities. This expenditure is being financed with lease financing through GE Capital and operating cash flows. The projected costs and the date on which the Company believes it will complete the year 2000 issues are based on management's best estimates. There can be no guarantee that these estimates will be achieved and actual results could differ from those anticipated. Specific factors that might cause such differences include but are not limited to, the availability and cost of personnel and the need to modify or replace hardware, software, communication or manufacturing equipment.
Management of the Company believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, the Company has not yet completed all necessary phases of the Year 2000 program. In the event that the Company does not complete any additional phases, the Company could be unable to manufacture certain products, which are dependent upon automated production equipment. The Company sells a significant amount of furniture to publicly funded facilities. While no one customer is significant to the Company, if a large government agency which funds educational institutions were to have Year 2000 issues which affected school funding, the Company could incur a material loss of sales and cash flow. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company. The Company could be subject to litigation related to computer systems failure. The amount of potential liability and lost revenue cannot be reasonably estimated at this time. The Company does not have a contingency plan in the event it does not complete all phases of the Year 2000 Program. The Company plans to continually evaluate the status of completion of the program and prepare a contingency plan if it becomes apparent that the program will not be completed on a timely basis.
ENVIRONMENTAL AND CONTINGENT LIABILITIES
The Company and other furniture manufacturers are subject to federal, state, and local laws and regulations relating to the discharge of materials into the environment and the generation, handling, storage, transportation, and disposal of waste and hazardous materials. The Company has expended, and can be expected to expend, significant amounts in the future for the investigation of environmental conditions, installation of environmental control equipment, and remediation of environmental contamination.
Currently, the Company is self-insured for Product Liability losses up to $100,000 per occurrence. In prior years the Company has been self-insured for Workers Compensation, Automobile, Product, and General Liability losses. The Company has purchased insurance to cover losses in excess of $100,000 up to a limit of $30,000,000. In 1993, the Company initiated a program to reduce product liability losses and to more aggressively litigate product liability cases. This program has continued through 1998 and has resulted in reductions in litigated product liability cases. Management does not anticipate that any related settlement, after consideration of the existing reserves for claims and potential insurance recovery, would have a material adverse effect on the Company's financial position, results of operations, or cash flows.
INFLATION AND FUTURE CHANGE IN PRICES
Inflation rates in the U.S. did not have a significant impact on the Company's operating results for the fiscal year just ended. Material costs were stable and for some components reduced in 1998. If current trends continue, we anticipate that total material costs for 1999, as a percentage of sales, could be comparable to or slightly higher than in 1998. However, no assurance can be given that the Company will experience stable or modestly increasing prices in 1999. The Company is working to control and reduce costs by improving production methodologies, investigating new packaging and shipping materials, and searching for new sources of purchased components.
The Company uses the LIFO method of accounting for inventory. Under this method, the cost of products sold as reported in the financial statements approximates current cost, and reduces the distortion in reported income due to increasing costs. Depreciation expense represents an allocation of historic acquisition costs and is less than if based on the current cost of productive capacity consumed. The Company has made significant fixed asset acquisitions during the last three fiscal years. The assets acquired will result in higher depreciation charges, but due to technological advances should result in operating cost savings. In addition, some depreciation charges will be offset by a reduction is lease expense. Anticipated fixed asset additions in 1999 will be significant, with budgeted expenditures for the Conway, Arkansas expansion of approximately $17,000,000; budgeted additional expenditures for the SAP Enterprise Resource Planning System of approximately $2,000,000; and ongoing capital expenditures at the Torrance, California facility of approximately $2,000,000.
LIQUIDITY
In October 1998, the Company renewed its loan facility with Wells Fargo Bank, extending the agreement to a three-year commitment. The line was increased to $50,000,000 with a feature, which increases the line to $60,000,000 during the period between May 1, 1999 to October 31, 1999. The terms of the facility are described in Note 3 of the notes to the consolidated financial statements. Major provisions of the agreement include that the line is uncollateralized and the interest rate is at prime. This new facility allows the Company the option to borrow under 30, 60,and 90 day fixed term rates at LIBOR plus 1.25%. Under this agreement, there is letter of credit sub feature where the Company issues commercial and standby letters of credit. This loan facility is intentionally large enough to finance more production in the early part of the year to have adequate inventories available for the summer / fall educational delivery season.
In April 1998, the Board of Directors approved a stock buyback program giving authorization to buy back up to $5,000,000 of Company Stock. In January 1999 the Board increased the authorization to $7,000,000 and subsequent to year-end the authorization was increased to $14,000,000. As of January 31, 1999 the Company had repurchased approximately 268,000 shares at a cost of approximately $5,344,000. The Company intends to continue buying back shares of Virco stock as long as the Company feels the shares are undervalued and operating cash flow and borrowing capacity under the Wells Fargo line allow.
In 1997, the Company initiated two large capital projects, which will have significant cash flow effects on the 1998 fiscal year. The first project is the implementation of the SAP Enterprise Resource Planning system, initiated in October 1997. General Electric Capital Corporation (GECC) agreed to finance this project under a lease arrangement, which will be treated as a capital lease for book purposes and an operating lease for tax purposes. This allowed the Company to initiate the project in 1997 without violating the limitations on capital investment at the Torrance, CA facility imposed by the Industrial Revenue Bond. Capital and training costs, which are not funded by the lease, will be financed by cash flow from operations.
The second project is the expansion and re-configuration of the Conway, Arkansas manufacturing and distribution facility. During the fourth quarter of 1997 the Company expended approximately $1,200,000 to acquire roughly 70 acres of land for the expansion. The Company budgeted approximately $25,000,000 during 1998 to buy an additional 30 acres of land, construct a 400,000 square feet manufacturing facility, and purchase production equipment for the new plant. Approximately $10,000,000 worth of equipment will be leased from General Electric Capital Corporation (GECC) under operating leases. The balance of the cash required was provided by the loan facility with Wells Fargo Bank and by operating cash flow. For the year ended January 31, 1999 the Company had incurred approximately $18,000,000 on this project. The second phase of this project, which was approved in 1998 and initiated in March of 1999, includes an 800,000 square feet distribution facility, which is expected to be completed by fiscal year ended January 31, 2000. This facility is expected to cost approximately $17,000,000. In addition to these authorized expenditures, it is likely that the Company will identify additional production equipment needs in the new manufacturing facility. These capital expenditures will be financed out of operating cash flow and by the expanded line of credit with Wells Fargo Bank. Capital investments for land, machinery and equipment installed at the Conway, Arkansas facility totaled $8,700,000 in 1998. These capital investments were financed by operating cash flow and from the loan facility with Wells Fargo Bank.
During 1994, the Company issued an $8,900,000 Industrial Revenue Bond through the City of Torrance, California. The Bond was privately placed with General Electric Capital Corporation (GECC). This Industrial Revenue Bond provides capital funds which are limited to the acquisition of machinery, equipment, and leasehold improvements in the Torrance, California facility. Under the terms of the Bond, capital spending at the Torrance facility was be limited to $8,900,000 over a three-year period. The Company has drawn down $8,900,000 to cover capital expenditures and bond issuance costs. To supplement the Bond proceeds, the Company has entered into true tax leases with GECC for approximately $1,090,000 and $60,000 worth of machinery and equipment in fiscal years 1997 and 1996. Capital assets obtained through these true tax leases were not be applied toward the $8,900,000 three year limit on capital spending in Torrance, California.
As a result of the sale of the Mexico manufacturing facility, the Company reduced the levels of raw material and work in process inventory at this location. Inventory levels (at FIFO) at this facility were $0, $0, and $3,100,000 at January 31, 1999, 1998, and 1997, respectively. In 1997, the sale of production equipment and real property at this facility generated an additional $2,210,000 of cash, offset by closing costs incurred related to the shutdown.
In the second quarter of 1998, the Company sold the manufacturing facility in Southern Pines, North Carolina. This sale generated approximately $945,000 in cash and resulted in a $128,000 loss on disposition.
In December 1996, the Company's Board of Directors voted to initiate a quarterly cash dividend effective January 31, 1997. A quarterly dividend of $.02 per share was paid in 1998. The amount of quarterly dividend will be reviewed each quarter in the light of the Company's earnings and liquidity.
Management believes cash raised from the previously described sources will be adequate to meet its capital requirements in the short term.
FINANCIAL STRATEGY
Virco's financial strategy is to continue to increase levels of profitability by targeting specific profitable market segments for future growth, accelerating new product development for those target markets, acquisition of automated production equipment and new production technologies, and continual reassessment of the manufacturing and distribution capacity needed to meet future demand. This continual assessment of production capacity led to a significant expansion of our Conway, Arkansas production facility in 1997, the 1994 move from the Los Angeles, California plant to a larger, more automated facility in Torrance, CA and the shutdown of the manufacturing subsidiary in Mexico in 1997. We have almost completed our effort to eliminate or lease underutilized real estate.
The Company has not provided an allowance against the deferred tax assets recorded in the financial statements. The Company has a net deferred tax liability at January 31, 1999. The gross deferred tax asset represents approximately 4% of current pre-tax earnings. Management believes that it is more likely than not that future earnings will be sufficient to recover deferred tax assets.
The Company discounts the pension obligations under the Virco Employees Retirement Plan and the Virco Important Performers Plan (VIP) utilizing an 8% discount rate. Although the Company does not anticipate any change in this rate in the coming year, any such change would not have a significant effect on the Company's financial position, results of operations, or cash flows.
FORWARD-LOOKING STATEMENTS
From time to time, the Company or its representatives have made or 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," "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, material costs, demand for the Company's products, and competitive conditions affecting selling prices and margins.
ACCOUNTING PRONOUNCEMENTS
During the year ending January 31, 1999, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information," and Statement of Financial Accounting Standards No. 132, "Employer's Disclosures about Pensions and Other Postretirement Benefits", which became effective during that year. During the year ending January 31, 2000, the Company will adopt AICPA SOP 98-1 "Accounting For the Costs of Computer Software Developed for or Obtained for Internal-Use". During the year ended January 31, 2002 the Company will adopt Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." The adoption of these new accounting standards is not expected to have a material impact on the Company.
FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA
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* Based on average number of shares outstanding each year after giving retroactive effect for stock dividends and 3 for 2 stock split.
** Based on number of shares outstanding at year-end giving effect for stock dividends and 3 for 2 stock split.
*** Adjusted for stock dividends and 3 for 2 stock split.
Report of Independent Auditors
The Board of Directors and Stockholders Virco Mfg. Corporation
We have audited the accompanying consolidated balance sheets of Virco Mfg. Corporation as of January 31, 1999 and 1998, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended January 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Virco Mfg. Corporation at January 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 31, 1999, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Long Beach, California March 19, 1999
Virco Mfg. Corporation
Consolidated Balance Sheets (In thousands, except per share data)
See accompanying notes.
Virco Mfg. Corporation
Consolidated Statements of Income (In thousands, except per share data)
See accompanying notes.
Virco Mfg. Corporation Consolidated Statements of Stockholders' Equity (In thousands, except per share amounts)
See accompanying notes.
Virco Mfg. Corporation
Consolidated Statements of Cash Flows (In thousands, except per share data)
Virco Mfg. Corporation
Consolidated Statements of Cash Flows (continued) (In thousands, except per share data)
See accompanying notes.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements
January 31, 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Virco Mfg. Corporation, which operates in one business segment, is engaged in the design, production and distribution of quality furniture for the commercial and education markets. Forty-nine years of manufacturing has resulted in a wide product range. Major products include student desks, computer stations, chairs, activity tables, folding chairs and folding tables. The Company manufactures its products in Torrance, California, and in Conway, Arkansas, for sale primarily in the United States.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Virco Mfg. Corporation and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 1997 and 1996 information to conform to the 1998 presentation.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of accounts receivable. The Company performs ongoing credit evaluations of its customers and maintains allowances for potential credit losses. The Company purchases insurance on receivables from commercial sales to minimize the Company's credit risk. No customers exceeded 10% of the Company's sales for each of the three years in the period ended January 31, 1999. Foreign sales were less than 5% for each of the three years in the period ended January 31, 1999.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined using the last-in, first-out (LIFO) method of valuation for the material content of inventories and the first-in, first-out (FIFO) method for labor and overhead.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost, less accumulated depreciation. Depreciation and amortization is computed on the straight-line method for financial reporting purposes based upon the following estimated useful lives:
Certain assets are depreciated under accelerated methods for income tax purposes.
Interest costs, amounting to $375,000, $120,000 and $122,000 for the years ended January 31, 1999, 1998 and 1997, respectively, have been capitalized as part of the acquisition cost of property, plant and equipment.
The Company capitalizes costs associated with software developed for its own use. Such costs are amortized over three years from the date the software becomes operational. The Company capitalized $0, $129,000 and $359,000 and recorded depreciation expense of $224,000, $353,000 and $376,000 in fiscal years ended January 31, 1999, 1998 and 1997, respectively. The net book value of capitalized software for its legacy system was $98,000 and $322,000 at January 31, 1999 and 1998, respectively.
In March 1999, the Company completed development of a new business information system. At January 31, 1999, the Company had capitalized $7,435,000, including labor costs of $2,143,000, related to its development. Such costs will be amortized over the estimated useful life of three to seven years.
IMPAIRMENT OF LONG-LIVED ASSETS
An impairment loss is recognized in the event facts and circumstances indicate the carrying amount of an asset may not be recoverable, and an estimate of future undiscounted cash flows is less than the carrying amount of the asset. Impairment is recorded based on the excess of the carrying amount of the impaired asset over the fair value. Generally, fair value represents the Company's expected future cash flows from the use of an asset or group of assets, discounted at a rate commensurate with the risks involved.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME PER SHARE
Basic net income per share is calculated by dividing net income by the weighted-average number of common shares outstanding. Diluted net income per share is calculated by dividing net income by the weighted-average number of common shares outstanding plus the dilution effect of convertible securities.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME PER SHARE (CONTINUED)
On August 11, 1998, the Company's board of directors authorized a 10% stock dividend payable on September 30, 1998, to stockholders of record as of September 4, 1998. This resulted in the issuance of 891,213 additional shares of common stock. All per share and weighted-average share amounts have been restated to reflect this stock dividend and any splits or dividends previously declared.
FOREIGN CURRENCY TRANSLATION
As is described more fully in Note 9, the Company discontinued its Mexican subsidiary operations. The "functional currency" for the financial statements of the Mexican subsidiary was the U.S. dollar. In accordance with SFAS No. 52, all nonmonetary balance sheet accounts were remeasured using historical rates. Income statement amounts were remeasured using the average exchange rate in effect during the year. All remeasurement gains and losses were included in the consolidated statements of income. The effect on the statements of income of gains and losses was insignificant.
INTANGIBLE ASSETS
Intangible assets, which consist principally of deferred pension assets and which are included in other noncurrent assets, are recorded at cost and are amortized over their estimated useful lives using the straight-line method.
ENVIRONMENTAL COSTS
Costs incurred to investigate and remediate environmental waste are expensed as incurred, unless the remediation extends the useful life of the assets employed at the site. Remediation costs, which extend the useful life of assets are capitalized and amortized over the useful life of the assets.
ADVERTISING COSTS
Advertising costs are expensed in the period in which they occur. Selling, general and administrative expenses include advertising costs of $3,535,000 in 1998, $3,007,000 in 1997 and $3,024,000 in 1996.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SELF-INSURANCE
The Company has a self-insured retention for general and product liability claims. Consulting actuaries assist the Company in determining its liability for the self-insured component of claims, which have been discounted to their net present value.
STOCK-BASED COMPENSATION PLANS
Stock-based compensation is recognized using the intrinsic-value method. For disclosure purposes, pro forma net income and earnings per share impacts are provided as if the fair-value method had been applied.
NEW ACCOUNTING PRONOUNCEMENTS
In 1998, the Company adopted SFAS No, 130, "Reporting Comprehensive Income." The Statement established standards for the reporting and display of comprehensive income, which comprises certain specific items previously reported directly in stockholders' equity. Other comprehensive income is made up of minimum pension liability adjustments. The amount of comprehensive income recorded, net of tax was $17,472,000, $13,648,000 and $9,357,000 in 1998, 1997 and 1996, respectively.
The Company also adopted SFAS No. 132, "Employers' Disclosures About Pensions and Other Postretirement Benefits." This statement does not change the measurement or recognition of assets or liabilities; however, it does revise and require more extensive disclosures about pension and other postretirement benefits. The adoption of SFAS No. 132 did not affect the Company's pension liabilities.
USE OF ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
Revenue from product sales is recognized upon shipment of merchandise.
FISCAL YEAR END
Fiscal years 1998, 1997 and 1996, refer to the years ended January 31, 1999, 1998 and 1997, respectively.
FUTURE ACCOUNTING REQUIREMENTS
In March 1998, the AICPA issued SOP 98-1, "Accounting For the Costs of Computer Software Developed For or Obtained for Internal-Use." The SOP is effective for the Company beginning on February 1, 1999. The SOP will require the capitalization of certain costs incurred after the date of adoption in connection with developing or obtaining software for internal use. The Company currently capitalizes costs associated with software developed for its own use. The Company does not believe adoption of this SOP will have a material impact on the Company's future earnings or financial position.
2. INVENTORIES
The current material cost for inventories exceeded LIFO cost by $2,809,000 and $3,930,000 at January 31, 1999 and 1998, respectively. Liquidation of prior year LIFO layers due to a reduction in certain inventories increased (decreased) income by $8,000, $29,000 and ($90,000) in the years ended January 31, 1999, 1998 and 1997, respectively.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
2. INVENTORIES (CONTINUED)
Details of inventory amounts, including the material portion of inventory, which is valued at LIFO, at January 31, 1999 and 1998, are as follows (in thousands):
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
3. NOTES PAYABLE
Outstanding balances (in thousands) for the Company's long-term debt were as follows:
(a) A credit facility with Wells Fargo Bank effective October 1998, provides an unsecured revolving line of credit of up to $50,000,000 from October 1, 1998 through and including April 30, 1999, not to exceed at any time the aggregate principal amount of $60,000,000 from May 1, 1999 through and including October 31, 1999, and not to exceed at any time the aggregate principal amount of $50,000,000 from November 1, 1999 through and including October 1, 2001. This is a three-year non-amortizing line with interest payable monthly at a fluctuating rate equal to the Bank's prime rate (7.75% at January 31, 1999). The line also allows the Company the option to borrow under 30- 60- and 90-day fixed term rates at LIBOR plus 1.25%. Approximately $34,104,000 was available for borrowing as of January 31, 1999.
(b) Ten-year $8,900,000 IRB issued through the City of Torrance. This 5.994% fixed interest rate bond is payable in monthly installments of $99,000, including interest, through December 2004.
(c) In October 1998, the Company finalized a credit agreement with General Electric Capital Corporation (GECC) to finance the new business information system. This is a four-year amortizing capital lease with principal and interest (approximately 7.5%) payable of $87,500 monthly. The Company has the option of buying out the lease three years into the lease period.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
3. NOTES PAYABLE (CONTINUED)
Long-term debt repayments for the next five years and thereafter are approximately as follows (in thousands):
* The $11,944,000 due under Wells Fargo Bank's line of credit will be payable in fiscal year ended January 31, 2002, if the agreement is not renewed. The Company has the intention to renew prior to the due date.
The Company believes that the carrying value of debt under the Wells Fargo credit facility approximates fair value at January 31, 1999 and 1998, as the debt bears interest at variable rates or is fixed for periods equal to or less than 90 days. The carrying value of other debt instruments approximates their fair value given the Company's incremental borrowing rate for similar types of financing arrangements.
The Company guarantees a $1,500,000 line of credit from Wells Fargo Bank to the Virco Employee Stock Ownership Plan (ESOP). At January 31, 1999 and 1998, $246,000 and $316,000, respectively, was outstanding under the line.
4. RETIREMENT PLANS
The Company and its subsidiaries cover all employees under a noncontributory defined benefit retirement plan, the Virco Employees' Retirement Plan (the Plan). Benefits under the Plan are based on years of service and career average earnings. The Company's general funding policy is to contribute amounts deductible for federal income tax purposes. Assets of the Plan are invested in common trust funds.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
4. RETIREMENT PLANS (CONTINUED)
The following table sets forth (in thousands) the funded status of the Plan at December 31, 1998 and 1997:
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
4. RETIREMENT PLANS (CONTINUED)
The total pension expense for the Plan (in thousands) included the following components:
The Company also provides a supplementary retirement plan for certain key employees, the VIP Retirement Plan (VIP Plan). The VIP Plan provides a benefit up to 50% of average compensation for the last five years in the VIP Plan, offset by benefits earned under the Virco Employees' Retirement Plan. The VIP Plan is funded by a life insurance program. The cash surrender values of the policies funding the VIP Plan were $2,901,000 and $2,393,000 at January 31, 1999 and 1998, respectively. These cash surrender values are included in other assets in the consolidated balance sheets.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
4. RETIREMENT PLANS (CONTINUED)
The following table sets forth (in thousands) the funded status of the VIP Plan at January 31, 1999 and 1998:
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
4. RETIREMENT PLANS (CONTINUED)
The total plan expense for the VIP retirement plan included the following components (in thousands):
The Company's Employee Stock Ownership Plan, which covers all U.S. employees, allows participants to defer from 1% to 15% of their eligible compensation through a 401(k) retirement program. One of the four investment options is the Virco Stock Fund. Shares owned by the ESOP are held by the Plan Trustee, U.S. Trust Company of California. At January 31, 1999, the Plan held 453,252 shares of Virco Stock including 444,596 shares allocated to participants' accounts. Using the January 31, 1999, closing price of $17.75, the unallocated account has 8,656 shares valued at $153,644. At January 31, 1999, the Plan had borrowed $246,000 directly from Wells Fargo Bank. This loan is secured by the unallocated shares and guaranteed by Virco. Allocated shares held by the Trust are included in shares outstanding and the related dividends are charged to retained earnings. For the fiscal years ended January 31, 1999 and 1998, there was no employer match and therefore no compensation cost to the Company.
The Company provides current and post-retirement life insurance to certain salaried employees with split dollar life insurance policies under the Dual Option Life Insurance Plan. Cash surrender values of these policies, which are included in other assets in the consolidated balance sheets, were $3,182,000 and $2,681,000 at January 31, 1999 and 1998, respectively.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
4. RETIREMENT PLANS (CONTINUED)
The Company established, effective January 1, 1997, a Deferred Compensation Plan, which allows certain key employees to defer up to a maximum of 90% of their base annual salary and/or up to 90% of their annual bonus on a pretax basis. The total participant deferrals were $608,000 and $231,000 for the years ended January 31, 1999 and 1998, respectively.
The Company maintains a Rabbi Trust to hold assets related to the VIP Retirement Plan, the Dual Option Life Insurance Plan, and the Deferred Compensation Plan. Substantially all assets funding these Plans are held in the Rabbi Trust.
5. STOCK OPTIONS AND STOCKHOLDERS' RIGHTS
The Company's two stock plans are the 1997 Employee Incentive Plan (the 1997 Plan) and the 1993 Employee Incentive Stock Plan (the 1993 Plan). Under these stock plans, the Company may grant an aggregate of 978,153 shares (as adjusted for the stock split and stock dividends) to its employees in the form of stock options. Nonemployee directors automatically receive a grant for options to purchase 500 shares of common stock on the first business day following each annual meeting of the Company's stockholders. As of January 31, 1999, 330,553 shares remain available for future grant. Options granted under the plans have an exercise price equal to the market price at the date of grant, have a maximum term of 10 years and generally become exercisable ratably over a five-year period. During fiscal year 1998, certain optionees elected to satisfy the exercise price of their options by exchanging matured shares already owned. As a result, the Company recorded 10,438 shares as treasury stock.
Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the fair-value method of SFAS No. 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following ranges of weighted-average assumptions: risk-free interest rates of 5.00% to 6.26%; dividend yield of 0.31% to 0.98%; volatility factor of the expected market price of the Company's common stock of 0.26 to 0.39; and a weighted-average expected life of the option of five years.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
5. STOCK OPTIONS AND STOCKHOLDERS' RIGHTS (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The pro forma impact only takes into account options granted since January 1, 1993, and is likely to increase in future years as additional options are granted and amortized ratably over the vesting period. The Company's pro forma information follows (in thousands except for net income per share information):
A summary of the Company's stock option activity, and related information for the years ended January 31 follows:
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
5. STOCK OPTIONS AND STOCKHOLDERS' RIGHTS (CONTINUED)
The data included in the above table has been retroactively adjusted, if applicable, for stock dividends and the stock split.
Information regarding stock options outstanding as of January 31, 1999, is as follows:
On October 15, 1996, the board of directors declared a dividend of one preferred stock purchase right (a Right) for each outstanding share of the Company's common stock. Each Right entitles a stockholder to purchase for an exercise price of $50.00 ($30.30, as adjusted for the stock split and stock dividend), subject to adjustment, one one-hundredth of a share of Series A Junior Participating Cumulative Preferred Stock of the Company, or under certain circumstances, shares of common stock of the Company or a successor company with a market value equal to two times the exercise price. The Rights are not exercisable, and would only become exercisable for all other persons when any person has acquired or commences to acquire a beneficial interest of at least 20% of the Company's outstanding common stock. The Rights expire on October 25, 2006, have no voting privileges, and may be redeemed by the board of directors at a price of $.001 per Right at any time prior to the acquisition of a beneficial ownership of 20% of the outstanding common shares. There are 200,000 shares (330,000 shares as adjusted by the stock split and stock dividend) of Series A. Junior Participating Cumulative Preferred Stock reserved for issuance upon exercise of the Rights.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
6. PROVISION FOR INCOME TAXES
The Company utilizes the liability method to determine the provision for income taxes. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
The provisions for the last three years are reconciled to the statutory federal income tax rate using the liability method as follows:
Significant components of the provision for income taxes (in thousands) are as follows:
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
6. PROVISION FOR INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities (in thousands) are as follows:
7. COMMITMENTS
The Company has long-term leases on real property and equipment, which expire at various dates. Certain of the leases contain renewal, purchase options and require payment for property taxes and insurance.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
7. COMMITMENTS (CONTINUED)
Minimum future lease payments (in thousands) for operating leases in effect as of January 31, 1999, are as follows:
Rent expense relating to operating leases was as follows (in thousands):
The Company leases machinery and equipment from GECC under a 10-year operating lease arrangement. The total amount of machinery and equipment leased for 1997 and 1996, was $1,090,000 and $60,000, respectively. The Company has the option of buying out the leases three to five years into the lease period. In addition, the Company has obtained a commitment from GECC for $10 million worth of additional machinery and equipment to be leased under operating leases.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
7. COMMITMENTS (CONTINUED)
Minimum future lease-receipts (in thousands) for leases relating to properties owned or subleased as of January 31, 1999, are as follows:
8. CONTINGENCIES
The Company and other furniture manufacturers are subject to federal, state and local laws and regulations relating to the discharge of materials into the environment and the generation, handling, storage, transportation and disposal of waste and hazardous materials. The Company has expended, and may be expected to expend significant amounts for the investigation of environmental conditions, installation of environmental control equipment and remediation of environmental contamination.
The Company is subject to contingencies pursuant to environmental laws and regulations that in the future may require the Company to take action to correct the effects on the environment of prior disposal practices or releases of chemical or petroleum substances by the Company or other parties. At January 31, 1999 and 1998, there are no required reserves for such environmental contingencies.
The Company has a self-insured retention for product and general liability losses up to $100,000 per occurrence. The Company has purchased insurance to cover losses in excess of $100,000 up to a limit of $30,000,000. The Company has obtained an actuarial estimate of, and recorded the net present value of its total expected future losses for liability claims of $2.7 million at January 31, 1999, based upon the Company's estimated payout period of four years using a 10% discount rate.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
8. CONTINGENCIES (CONTINUED)
Workers' compensation, automobile, general and product liability claims may be asserted in the future for events not currently known by management. Management does not anticipate that any related settlement, after consideration of the existing reserve for claims incurred and potential insurance recovery would have a material adverse effect on the Company's financial position, results of operations or cash flows.
The Company and its subsidiaries are defendants in various legal proceedings resulting from operations in the normal course of business. It is the opinion of management that the ultimate outcome of all such matters will not materially affect the Company's financial position, results of operations or cash flows.
9. FOREIGN OPERATION
In May 1997, the Company decided to shut down its Mexican manufacturing facility. Subsequently, the Company sold a majority of the assets of the Mexican facility on October 8, 1997. The facility ceased operations on October 20, 1997. Total revenues of this operation, consisting primarily of transfers between geographic areas of the Company, were $5,389,000 and $11,735,000 for the years ended January 31, 1998 and 1997, respectively. The production requirements from this facility were transferred to the Torrance, California, and Conway, Arkansas, manufacturing plants. For fiscal year 1997, the Company incurred $2,970,000 in connection with the shutdown of the facility. The primary component of this amount related to severance benefits paid to the employees in accordance with Mexican law.
Virco Mfg. Corporation
Notes to Consolidated Financial Statements (continued)
10. QUARTERLY RESULTS (UNAUDITED)
The Company's quarterly results for the years ended January 31, 1999 and 1998, are summarized as follows (in thousands, except per share data):
Net income per share has been adjusted to reflect the 10% stock dividend declared in August 1998, and the 3 for 2 stock split declared in August 1997.