Notes to Consolidated Financial Statements
January 31, 2022
1. Summary of Business and Significant Accounting Policies
Business
Virco Mfg. Corporation (the “Company”), which operates in one business segment, is engaged in the design, production and distribution of quality furniture for the commercial and education markets. Over 72 years of manufacturing operations have resulted in a wide product assortment. Major products include mobile tables, mobile storage equipment, desks, computer furniture, chairs, activity tables, folding chairs and folding tables. The Company manufactures its products in Torrance, California, and Conway, Arkansas, for sale primarily in the United States.
The Company operates in a seasonal business and requires significant amounts of working capital under its credit facility to fund acquisitions of inventory and finance receivables during the summer delivery season. The educational sales market is extremely seasonal. Historically Virco ships approximately 50% of its annual revenue in the months of June, July, and August. In fiscal 2022 the seasonal peak was distorted due to severe supply chain interruptions, labor shortages, and COVID-19 related employee absences. The Company delivered a reduced proportion of sales during June, July, and August compared to the traditional seasonal concentration of sales. The Company anticipates that the traditional seasonal peak will return when COVID and supply chain disruptions normalize. Shipments during peak weeks in July and August can be as great as six times the level of shipments in the winter months.
Restrictions imposed by the terms of the Company’s credit facility may limit the Company’s operating and financial flexibility (see Note 3).
Principles of Consolidation and Reclassification
The consolidated financial statements include the accounts of Virco Mfg. Corporation and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Management Use of Estimates
Preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities - and disclosure of contingent assets and liabilities - at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Estimates made by management include, but are not limited to, valuation of inventory; deferred tax assets and liabilities; useful lives of property, plant and equipment; liabilities under pension, warranty, self-insurance and environmental claims; and the accounts receivable allowance for doubtful accounts.
As a result of the COVID-19 pandemic and its ongoing impact in the future may cause demand for our products to decline and competitive pricing pressures to increase, and other unforeseen effects, which makes these estimates more challenging and actual results could differ materially from these estimates. In fiscal 2022 the cost of sales were volatile compared to prior years. The Company incurred material increases in steel, plastic and other materials.
Effects of COVID-19 Pandemic
The COVID-19 pandemic had an immediate impact on the Company’s operating activities during fiscal 2021, and this impact continued through fiscal 2022. In March 2020, most school districts that we serve closed their doors to students and initiated remote learning. Most school districts in the United States kept campuses closed to students for the remainder of the 2019-2020 academic year, and district business officials typically operated from home offices. During the 2020-2021 academic year many school districts and private schools successfully re-introduced in-class or hybrid learning, but the majority of students in the United States were learning remotely during the Company’s fiscal year ended January 31, 2021. These mass closures impacted more than ten of the twelve months included in this fiscal year, including all of the traditionally busy summer season. The demand for school furniture was adversely impacted by COVID-19 in fiscal year 2021. School administrators were challenged by COVID-19, and purchases of furniture for empty classrooms were not a priority. As a result, order rates declined by approximately 20% compared to the prior year.
During the first quarter of fiscal 2022 many schools reopened and virtually all schools were reopened for the beginning of academic year beginning August 2021. The strong rebound in order rates continued through fiscal 2022 as schools reopened. Order rates for fiscal year 2022 increased by nearly 40% compared to the prior year.
Going into fiscal 2022, the Company was cautious about building inventory and began the year with a reduced level of product. The Company was able to support the first quarter increase in orders as the first quarter is a traditionally slow time of the year. The Company experienced severe supply chain issues throughout the rest of the year. The cost and availability of container freight adversely impacted the cost and timely delivery of components imported from China. Domestic suppliers raised prices dramatically, with the cost of steel nearly tripling and the cost of plastic nearly doubling. In addition to increased costs, many domestic suppliers put the Company on allocation as they did not have the production capacity to service all of their customers. When this occurs, the supplier allocates their available capacity to existing customers based upon the customers historic purchase activity.
In addition to severe shortages of materials, the Company incurred a severe shortfall of both temporary and full-time labor. This shortfall was exacerbated by COVID-19 related absences that caused significant portions of our workforce to be out at any time. In order to meet required levels of production, the Company made a decision to reward our full-time workforce by paying them double-time in lieu of time and one-half for all overtime hours worked. This successfully motivated our employees to work extended hours but cost the Company approximately $2 million. Inability to hire production workers continued through the year, and in October and November the Company significantly increased the starting wages for production workers followed by raises for all hourly workers. With these raises the Company was able to attract and retain additional workers, and as of the date of this report, the Company has an adequate workforce to support anticipated levels of business.
Factory efficiencies deteriorated as a result of these events. Rather than execute efficient production runs, factories ran smaller less efficient production runs to utilize whatever materials were available and to fulfill urgent orders. Customers were asked to substitute products requested for products for which materials were available. Labor shortages and absences contributed to the inefficiencies. The cost of materials, unavailability of materials, and labor issues adversely affected gross margins for the year.
The education system and education budgets are typically highly dependent on state and local tax revenues. The severity of this pandemic may materially adversely impact state and local tax revenues and result in changes in spending priorities for state and local governments, which may have a material adverse effect on future school budgets. The loss of state and local revenues may be substantially or partially offset by federal programs providing assistance to state governments, local governments and schools, although there can be no assurance that any federal funds could be used for capital expenditures or that the level of federal funding, if any, will be sufficient to maintain our historic order rates for school furniture.
The Company expects the impact of supply chain constraints and COVID-19 to continue to be a challenge for the foreseeable future and believes the economy will be adversely impacted for an indeterminate period, including the demand for its products and supply of materials and labor required to manufacture products. The extent of the impact will depend on numerous factors that are unknown, uncertain and cannot be reasonably predicted.
Fiscal Year End
Fiscal years 2022 and 2021 refer to the fiscal years ended January 31, 2022 and 2021, respectively.
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. Sales to the Company’s recurring customers are generally made on open account with terms consistent with the industry. Credit is extended based on an evaluation of the customer’s financial condition and payment history. Past due accounts are determined based on how recently payments have been made in relation to the terms granted. Amounts are written off against the allowance in the period that the Company determines that the receivable is not collectable. The Company purchases insurance on receivables from certain commercial customers to minimize the Company’s credit risk. The Company does not typically obtain collateral to secure credit risk. Customers with inadequate credit are required to provide cash in advance or letters of credit. The Company does not assess interest on receivable balances. A substantial percentage of the Company’s receivables come from low-risk government entities. No customer accounted for more than 10% of the Company's accounts receivable at January 31, 2022 and January 31, 2021. Because of the short time between shipment and collection, the net carrying value of receivables approximates the fair value for these assets. No customer exceeded 10% of the Company’s net sales for fiscal years ended January 31, 2022 and January 31, 2021. Foreign net sales were approximately 3.6% and 4.5% of the Company’s net sales for fiscal years 2022 and 2021, respectively.
Cash
Cash consists of cash on hand, and the Company has no cash equivalents. Outstanding checks, representing a book overdraft, are classified in accounts payable on the accompanying consolidated balance sheets and in operating activities in the accompanying consolidated statements of cash flows.
Fair Values of Financial Instruments
The fair values of the Company’s cash, accounts receivable, accounts payable and debt approximate their carrying amounts due to their short-term nature. For fair value of debt, see Note 3.
Financial assets and liabilities measured at fair value on a recurring basis are classified in one of the three following categories, which are described below:
Level 1 — Valuations based on unadjusted quoted prices for identical assets in an active market.
Level 2 — Valuations based on quoted prices in markets where trading occurs infrequently or whose values are based on quoted prices of instruments with similar attributes in active markets.
Level 3 — Valuations based on inputs that are unobservable and involve management judgment and our own assumptions about market participants and pricing.
Financial assets measured at fair value on a recurring basis include assets associated with the Virco Employees Retirement Plan (see Note 4).
Inventories
Inventory is valued at the lower of cost or net realizable value (determined on a first-in, first-out basis) and includes material, labor and factory overhead. The Company records valuation adjustments for the excess cost of the inventory over its estimated net realizable value. Valuation adjustments for slow-moving and obsolete inventory are calculated using an estimated percentage applied to inventories based on a physical inspection of the product in connection with a physical inventory, a review of slow-moving products and component stage, inventory category, historical and forecasted consumption of sales, and consideration of active marketing programs. The market for education furniture is traditionally driven by value, not style, and the Company has not typically incurred material obsolescence expenses. If market conditions are less favorable than those anticipated by management, additional valuation adjustments may be required. Due to reductions in sales volume in the past years, the Company's manufacturing facilities are operating at reduced levels of capacity. The Company records the cost of excess capacity as a period expense, not as a component of capitalized inventory valuation.
The following table presents an updated breakdown of the Company’s net inventory (in thousands) as of January 31, 2022 and 2021:
| | | | | | | | | | | | | | |
| | January 31, |
| | 2022 | | 2021 |
| | | | |
Finished goods | | $ | 16,731 | | | $ | 15,606 | |
Work in Process | | 14,732 | | | 11,907 | |
Raw materials | | 15,910 | | | 10,757 | |
Inventories, net | | $ | 47,373 | | | $ | 38,270 | |
Property, Plant and Equipment
Property, plant and equipment are stated at cost, less accumulated depreciation. Depreciation and amortization are computed on the straight-line method for financial reporting purposes based upon the following estimated useful lives:
| | | | | |
Land improvements | 5 to 25 years |
Buildings and building improvements | 5 to 40 years |
Machinery and equipment | 3 to 10 years |
Leasehold improvements | shorter of lease or useful life |
The Company capitalizes the cost of betterments that extend the life of an asset. Repairs and maintenance that do not extend the life of an asset are expensed as incurred. Repair and maintenance expense were $1,959,000 and $1,727,000 for fiscal years ended January 31, 2022 and 2021, respectively. Property, plant and equipment purchased during the year that remains unpaid as of January 31, 2022 and 2021 was $189,000 and $113,000, respectively.
The Company has established asset retirement obligations related to leased manufacturing facilities in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 410, Asset Retirement and Environmental Obligations. Accrued asset retirement obligations are recorded at net present value and discounted over the life of the lease. Asset retirement obligations, included in other non-current liabilities were $198,000 and $192,000 at January 31, 2022 and 2021, respectively.
| | | | | | | | | | | |
| January 31, |
| 2022 | | 2021 |
| | | |
Balance at beginning of period | $ | 192,000 | | | $ | 186,000 | |
Decrease in obligation | — | | | — | |
Accretion expense | 6,000 | | | 6,000 | |
Balance at end of period | $ | 198,000 | | | $ | 192,000 | |
Impairment of Long-Lived Assets
An impairment loss is recognized in the event facts and circumstances indicate the carrying amount of a long-lived 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. There were no impairments for fiscal years ended January 31, 2022 and 2021.
Net Loss per Share
Net loss per share is calculated by dividing net loss by the basic weighted-average number of common shares outstanding. For fiscal years 2022 and 2021, approximately 96,000 and 52,000 shares of common stock equivalents were excluded in the computation of diluted net loss per share, as the effect would be anti-dilutive since the Company reported a net loss. The following table sets forth the computation of basic and diluted loss per share:
| | | | | | | | | | | | | | |
| | January 31, |
| | 2022 | | 2021 |
| | (In thousands, except per share) |
Numerator | | | | |
Net loss | | $ | (15,136) | | | $ | (2,232) | |
Denominator | | | | |
Weighted-average shares — basic | | 15,954 | | | 15,759 | |
Dilutive effect of common stock equivalents from equity incentive plans | | — | | | — | |
Weighted-average shares | | $ | 15,954 | | | $ | 15,759 | |
Net loss per common share | | | | |
Basic | | $ | (0.95) | | | $ | (0.14) | |
Diluted | | (0.95) | | | (0.14) | |
Environmental Costs
The Company is subject to numerous environmental laws and regulations in the various jurisdictions in which it operates that (a) govern operations that may have adverse environmental effects, such as the discharge of materials into the environment, as well as handling, storage, transportation and disposal practices for solid and hazardous wastes, and (b) impose liability for response costs and certain damages resulting from past and current spills, disposals or other releases of hazardous materials. Normal, recurring expenses related to operating the Company's factories in a manner that meets or exceeds environmental laws and regulations are matched to the cost of producing inventory.
Despite our efforts to comply with existing laws and regulations, compliance with more stringent laws or regulations or stricter interpretation of existing laws, may require additional expenditures by us, some of which may be material. We reserve amounts for such matters when expenditures are probable and reasonably estimable.
Costs incurred to investigate and remediate environmental waste are expensed, unless the remediation extends the useful life of the assets employed at the site. At January 31, 2022 and 2021, the Company had not capitalized any remediation costs and had not recorded any amortization expense in fiscal years 2022 and 2021.
Advertising Costs
Advertising costs are expensed in the period during which the advertising space is run. Selling, general and administrative expenses include advertising costs for the years ended January 31, 2022 and 2021 of $785,000 and $468,000, respectively, and are expensed as incurred. The increase in advertising expenses during fiscal year 2022 was attributable to higher participation in shows and exhibitions as compared to fiscal 2021. Prepaid advertising costs reported as a prepaid asset on the accompanying consolidated balance sheets at January 31, 2022 and 2021, were $296,000 and $341,000, respectively.
Product Warranty Expense
The Company provides a product warranty on most products. The standard warranty offered on products sold through January 31, 2013 is ten years. Effective February 1, 2014 through December 31, 2016, the Company modified its warranty to a limited lifetime warranty. Effective January 1, 2017, the Company modified the warranty offered to provide specific warranty periods by product component, with no warranty period longer than ten years. The Company generally provides that customers can return a defective product during the specified warranty period following purchase in exchange for a replacement product or the repair of the product by the Company at no charge to the customer. The Company determines whether replacement or repair is appropriate in each circumstance. The Company uses historical data to estimate appropriate levels of warranty reserves. Because product mix, production methods and raw material sources change over time, historic data may not always provide precise estimates for future warranty expense. The Company recorded warranty reserves of $600,000 and $700,000 as of January 31, 2022 and 2021, respectively, as other long-term liabilities in the accompanying consolidated balance sheets. The current portion of the warranty reserve was $250,000 and $300,000 as of January 31, 2022 and 2021, respectively; and included in other accrued liabilities in the accompanying consolidated balance sheets.
Self-Insurance
In fiscal 2022 and 2021, the Company was self-insured for product liability losses up to $250,000 per occurrence, workers’ compensation losses up to $250,000 per occurrence, general liability losses up to $50,000 per occurrence and auto liability losses up to $50,000 per occurrence. Actuaries assist the Company in determining its liability for the self-insured component of claims, which have been discounted to their net present value utilizing a discount rate of 4.00% in both fiscal 2022 and fiscal 2021.
Stock-Based Compensation Plans
The Company recognizes stock-based compensation cost for shares that are expected to vest, on a straight-line basis, over the requisite service period of the award.
Virco issued a 10% stock dividend or 3/2 stock split every year beginning in 1983 through 2003. Although the stock dividend had no cash consequences to the Company, the accounting methodology required for 10% dividends affected the equity section of the balance sheet. When the Company recorded a 10% stock dividend, 10% of the market capitalization of the Company on the date of the declaration was reclassified from retained earnings to additional paid-in capital. During the period from 1983 through 2003, the cumulative effect of the stock dividends has been to reclassify over $122 million from retained earnings to additional paid-in capital. The equity section of the balance sheet on January 31, 2022 reflects additional paid-in capital of approximately $120 million and accumulated deficit of approximately $67 million. Other than the losses incurred during 2004-2006, 2011-2014, 2018-2019, 2021 and 2022, the accumulated deficit is a result of the accounting reclassification and is not the result of accumulated losses.
Accumulated Other Comprehensive Loss, Net of Tax
The following table summarizes the changes in accumulated balances of other comprehensive loss (in thousands) for the years ended January 31, 2022 and 2021:
| | | | | | | | | | | | | | |
| | January 31, |
| | 2022 | | 2021 |
| | | | |
Balance as of beginning of year | | $ | (13,585) | | | $ | (14,311) | |
| | | | |
Other comprehensive income (loss) before reclassifications | | 5,782 | | | (1,105) | |
Amounts reclassified from AOCI | | 1,774 | | | 1,831 | |
Net current period other comprehensive income | | 7,556 | | | 726 | |
| | | | |
Balance as of end of year | | $ | (6,029) | | | $ | (13,585) | |
| | | | |
The reclassifications out of accumulated other comprehensive loss of $1,774,000 and $1,831,000 for the years ended January 31, 2022 and 2021, respectively, related to amortization of actuarial losses and settlements (See Note 4).
Revenue Recognition
The Company manufactures, markets and distributes a wide variety of school and office furniture to wholesalers, distributors, educational institutions and governmental entities. Revenue is recorded for promised goods or services when control is transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services.
The Company's sales generally involve a single performance obligation to deliver goods pursuant to customer purchase orders. Prices for our products are based on published price lists and customer agreements. The Company has determined that the performance obligations are satisfied at a point in time when the Company completes delivery per the customer contract. The majority of sales are free on board ("FOB") destination where the destination is specified per the customer contract and may include delivering the furniture into the classroom, school site or warehouse. Sales of furniture that are sold FOB factory are typically made to resellers of our product who in turn provide logistics to the ultimate customer. Once a product has been delivered per the shipping terms, the customer is able to direct the use of, and obtain substantially all of the remaining benefits from, the asset. The Company considers control to have transferred upon shipment or delivery in accordance with shipping terms because the Company has a present right to payment at that time, the customer has legal title to the asset, the Company has transferred physical possession of the asset, and the customer has significant risks and rewards of ownership of the asset.
Sales are recorded net of discounts, sales incentives and rebates, sales taxes and estimated returns and allowances. The Company offers sales incentives and discounts through various regional and national programs to our customers. These programs include product rebates, product returns allowances and trade promotions. Variable consideration for these programs is estimated in the transaction price at contract inception based on current sales levels and historical experience using the expected value method, subject to constraint.
The Company generates revenue primarily by manufacturing and distributing products through resellers and direct-to-customers. Control transfers to both resellers and direct customers at a point in time when the delivery process is complete as determined by the corresponding shipping terms. Therefore, we do not consider them to be meaningfully different revenue streams given similarities in the nature of the products, performance obligation and distribution processes. Sales are predominately in the United States and to a similar class of customer. We do not manage or evaluate the business based on product line or any other discernable category.
For product produced by and sourced from third parties, management has determined that it is the principal in all cases, since it (i) bears primary responsibility for fulfilling the promise to the customer; (ii) bears inventory risk before and/or after the good or service is transferred to the customer; and (iii) has discretion in establishing the price for the sale of good or service to the customer.
Delivery Costs
For the fiscal years ended January 31, 2022 and 2021, shipping and classroom delivery costs of approximately $18,758,000, and $15,090,000, respectively, were included in selling, general and administrative expenses in the accompanying consolidated statements of operations.
Accounting for Income Taxes
The Company recognizes deferred income taxes under the asset and liability method of accounting for income taxes in accordance with the provisions of FASB ASC Topic 740, Accounting for Income Taxes. Deferred income taxes are recognized for differences between the financial statement and tax basis of assets and liabilities at enacted statutory tax rates in effect for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance against deferred tax assets is recorded when it is determined to be more likely than not that the asset will not be realized.
2. New Accounting Pronouncements
Recently Issued Accounting Updates
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 replaces the incurred loss impairment methodology for measuring and recognizing credit losses with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The adoption date, as modified by the recently issued ASU 2019-10, will be for the fiscal year beginning after December 15, 2022 and interim periods therein. The Company is currently evaluating the effect the standard will have on the consolidated financial statements and related disclosures.
Other recently issued accounting updates are not expected to have a material impact on the Company’s consolidated financial statements.
3. Debt
Outstanding balances (in thousands) for the Company’s long-term debt were as follows:
| | | | | | | | | | | | | | |
| | January 31, |
| | 2022 | | 2021 |
| | | | |
Revolving credit line | | $ | 9,551 | | | $ | 4,590 | |
Other | | 4,962 | | | 5,850 | |
Total debt | | 14,513 | | | 10,440 | |
Less current portion | | 340 | | | 887 | |
Non-current portion | | $ | 14,173 | | | $ | 9,553 | |
The Company and Virco Inc., its wholly-owned subsidiary (the “Borrowers”) have a Revolving Credit and Security Agreement (the “Credit Agreement”) with PNC Bank, National Association, as administrative agent and lender (“PNC”). The Credit Agreement was amended numerous times since its origination in December 2011. On September 28, 2021, the Borrowers entered into an Amended and Restated Revolving Credit and Security Agreement (the “Restated Credit Agreement”) with PNC Bank, which amended and restated the prior Credit Agreement and effectively incorporated all of the prior amendments into an amended and restated form of agreement.
The Restated Credit Agreement permits the Company to issue dividends or make payments with respect to the Company’s capital stock in an aggregate amount up to $3,000,000 during any fiscal year, provided that no default shall have occurred or is continuing or would result from any such payment, and the Company must demonstrate pro forma compliance with a 12-month trailing fixed charge coverage ratio of not less than 1.20:1.00 as of the fiscal quarter immediately preceding the date of any such dividend or payment. The Restated Credit Agreement also requires the Company to maintain a minimum fixed charge coverage ratio, and contains numerous other covenants that limit under certain circumstances the ability of the Borrowers and their subsidiaries to, among other things, merge with or acquire other entities, incur new liens, incur additional indebtedness, sell assets outside of the ordinary course of business, enter into transactions with affiliates, or substantially change the general nature of the business of the Borrowers. In connection with the Restated Credit Agreement, the Company also agreed to pay to
PNC Bank a non-refundable fee of $50,000. The original maturity date of the Restated Credit Agreement was March 19, 2023, which date was extended to April 15, 2027 under Amendment No. 2 to the Restated Credit Agreement discussed below.
The other material terms of the Restated Credit Agreement are substantially the same as those of the original Credit Agreement, consisting of (i) a revolving line of credit with a Maximum Revolving Advance Amount of $65,000,000 that is subject to a borrowing base limitation and generally provides for advances of up to 85% of eligible accounts receivable, plus a percentage equal to the lesser of 60% of the value of eligible inventory or 85% of the liquidation value of eligible inventory, plus $15,000,000 from January through July of each year, minus undrawn amounts of letters of credit and reserves and (ii) an equipment loan of $2,000,000. The Restated Credit Agreement is secured by substantially all of the Borrowers’ personal property and certain of the Borrowers’ real property. The Restated Credit Agreement is subject to certain prepayment penalties upon early termination of the Restated Credit Agreement. Prior to the maturity date, principal amounts outstanding under the Restated Credit Agreement may be repaid and reborrowed at the option of the Borrowers without premium or penalty, subject to borrowing base limitations, seasonal adjustments and certain other conditions, including reduced borrowings under the revolving line to less than or equal $10,000,000 for a period of 30 consecutive days during the fourth quarter of each fiscal year. The Restated Credit Agreement also contains certain financial covenants, including covenants requiring a minimum fixed charge coverage ratio and limits on capital expenditures.
Prior to the changes under Amendment No. 2 discussed below, the Revolving Credit Facility bore interest, at the Borrowers’ option, at either the Alternate Base Rate (as defined in the Restated Credit Agreement) or the LIBOR Rate (as defined in the Restated Credit Agreement), in each case plus an applicable margin. The applicable margin for Alternate Base Rate loans is a percentage within a range of 1.25% to 1.75%, and the applicable margin for LIBOR Rate loans is a percentage within a range of 2.25% to 2.75%, and may be increased at the Lender’s option by 2.0% during the continuance of an event of default. Accrued interest with respect to principal amounts outstanding under the Restated Credit Agreement is payable in arrears on a monthly basis for Alternative Base Rate loans, and at the end of the applicable interest period, but at most every three months for LIBOR Rate loans. The interest rate as of January 31, 2022 was 5.0%. The Company also incurs a fee on the unused portion of the revolving line of credit at a rate of 0.375%.
On December 7, 2021 the Company entered into Amendment No. 1 to the Restated Credit Agreement, which provided a limited waiver of the Company’s violation of the covenant to maintain a fixed charge coverage ratio of at least 1.10 to 1.00 for the four fiscal quarter periods ended October 31, 2021, and amended the fixed charge coverage ratio as follows: (i) 1.00 to 1.00 for each of the consecutive four fiscal quarter periods of Borrowers ending January 31, 2022 and April 30, 2022, and (ii) 1.10 to 1.00 for each consecutive four fiscal quarter periods of Borrowers ending thereafter.
The Company was in violation of its financial covenants under the Restated Credit Agreement as of January 31, 2022, due to a decline in the Company’s net income primarily attributable to the effects of supply chain disruptions and labor shortages. On April 15, 2022, the Company entered into Amendment No. 2 to the Credit Agreement (“Amendment No. 2”), which implemented the following changes to the Credit Agreement and Revolving Credit Facility:
i.extended the final maturity date of the Revolving Credit Facility from March 19, 2023 to April 15, 2027;
ii.increased the borrowing limit from $65,000,000 to $70,000,000 in July 2022 and August 2022, and increased the borrowing limit from $40,000,000 to $45,000,000 in October 2022;
iii.waived the Company’s violation of the covenant to maintain a fixed charge coverage ratio of at least 1.00 for the period ended January 31, 2022;
iv.for the first and second quarters of fiscal 2023, implemented a temporary year-to-date adjusted EBITDA covenant in lieu of testing the fixed charge coverage ratio covenant as of such quarters, with quarterly testing of the fixed charge coverage ratio to resume for the third fiscal quarter and thereafter;
v.permits a sale and leaseback transaction of the Company’s property at 1655 Amity Road and release of the lender’s pledge on the property, with the net proceeds to be used for a proposed share repurchase;
vi.retired LIBOR pricing on the Revolving Credit Facility and replaced with BSBY index, with pricing tiers and spreads to remain the same;
vii.extended the P-card, ACH Credit, and ACH debit facilities for an additional year beyond their current maturities; and
viii.Borrowers to pay a $250,000 extension fee and $75,000 waiver and amendment fee, with $200,000 due at closing and $125,000 due on the first anniversary of closing.
Based on the Company’s current projections, including COVID-19 related costs, raw material costs and its ability to introduce price increases, management believes it will maintain compliance with the financial covenants within Amendment No. 2, although there are uncertainties therewithin, such as raw material costs and supply chain challenges.
In addition to the financial covenants, the Restated Credit Agreement provides for customary events of default, subject to certain cure periods and other limitations. Substantially all of the Borrowers' accounts receivable are automatically and promptly swept to repay amounts outstanding under the Restated Credit Agreement upon receipt by the Borrowers. Due to this automatic liquidating nature of the Restated Credit Agreement, if the Borrowers breach any covenant, violate any representation or warranty or suffer a deterioration in their ability to borrow pursuant to the borrowing base calculation, the Borrowers may not have access to cash liquidity unless provided by PNC at its discretion.
During the fiscal year ended January 31, 2022 and 2021, the impact of COVID-19 on liquidity was to moderate the seasonal increase in accounts receivable and production of inventory for summer delivery. Seasonal increases in accounts receivable and inventory are traditionally financed through the Company’s line of credit with PNC Bank.
The Company's revolving line of credit with PNC is structured to provide seasonal credit availability during the Company's peak summer season. Approximately $20,449,000 was available for borrowing as of January 31, 2022.
The long-term debt repayments have been adjusted to reflect the terms of Amendment No. 2 and are approximately as follow as of January 31, 2022 (in thousands):
| | | | | |
Year ending January 31, | |
2023 | $ | 340 | |
2024 | 238 | |
2025 | 248 | |
2026 | 258 | |
2027 | 269 | |
Thereafter | 13,160 | |
Management believes that the carrying value of debt approximated fair value at January 31, 2022 and 2021, as all of the long-term debt bears interest at variable rates based on prevailing market conditions.
4. Retirement Plans
Pension Plans
The Company maintains two defined benefit pension plans, the Virco Employees Retirement Plan (“Employee Plan”), and the Virco Important Performers Retirement Plan (“VIP Plan”). The annual measurement date for both plans is January 31. The Company and its subsidiaries cover all employees hired prior to December 31, 2003 under the Employee Plan, which is a qualified noncontributory defined benefit retirement plan. Benefits under the Employee Plan are based on years of service and career average earnings. Benefit accruals under the Employee Plan were frozen effective December 31, 2003. All benefits were fully vested as of January 31, 2022 and 2021.
The Company also provides a supplementary retirement plan for certain key employees, the 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 Employee Plan. Benefit accruals under the VIP Plan were frozen effective December 31, 2003. Substantially all assets, consisting of life insurance contracts and cash equivalents, securing the VIP Plan are held in a rabbi trust. The cash surrender values of the life insurance policies are included in other assets and money market funds in the accompanying consolidated balance sheets. The cash surrender values of the life insurance policies securing the VIP Plan were $3,457,000 and $3,430,000 at January 31, 2022 and 2021, respectively. Death benefits payable under life insurance policies held by the Plan were approximately $8,762,000 and $8,845,000 at January 31, 2022 and 2021, respectively.
Accounting policy regarding pensions requires management to make complex and subjective estimates and assumptions relating to amounts which are inherently uncertain. Three primary economic assumptions influence the reported values of plan liabilities and pension costs. The Company takes the following factors into consideration: discount rate, assumed rate of return, and plan settlements.
The discount rate represents an estimate of the rate of return on a portfolio of high-quality, fixed-income securities that would provide cash flows that match the expected benefit payment stream from the plans. When setting the discount rate, the
Company utilizes a spot-rate yield curve developed from high-quality bonds currently available which reflects changes in rates that have occurred over the past year. This assumption is sensitive to movements in market rates that have occurred since the preceding valuation date, and therefore, may change from year to year. Discount rate ranges for the Employee Plan and the VIP Plan 3.20% and 2.75% - 2.80% at January 31, 2022 and 2021, respectively.
Because the Company’s future benefit accruals for both benefit plans were frozen in 2003, the compensation increase assumption had no impact on pension expense, accumulated benefit obligation or projected benefit obligation for the period ended January 31, 2022 or 2021.
The assumed rate of return on plan assets represents an estimate of long-term returns available to investors who hold a mixture of stocks, bonds and cash equivalent securities. When setting its expected return on plan asset assumptions, the Company considers long-term rates of return on various asset classes (both historical and forecasted, using data collected from various sources generally regarded as authoritative) in the context of expected long-term average asset allocations for its defined benefit pension plan.
The Company maintains a trust for and funds the pension obligations for the Employee Plan. The Board of Directors appoints a Retirement Plan Committee that establishes a policy for investment and funding strategies. Approximately 40%-50% of the trust assets are managed by investment advisors and held in common trust funds with the balance managed by the Retirement Plan Committee. The Retirement Plan Committee has established target asset allocations for its investment advisors, who invest the trust assets in a variety of institutional collective trust funds. The Company’s investment advisors have developed a funding strategy that moves fund asset allocation from equity and other investments to fixed income instruments designed to mirror the changes in discount rates as the Plan becomes more fully funded. At January 31, 2022, approximately 11% of the trust assets were held in these investments. The Retirement Plan Committee receives quarterly reports addressing investment returns, funded status of the plan and progress on the glidepath to fully funded status from the investment advisors and meets periodically with them to discuss investment performance. At January 31, 2022 and 2021, the amount of the plan assets invested in bond or short-term investment funds was 13% and 15%, respectively, and the balance of the trust was held in equity funds or other investments. The trust does not hold any Company stock.
It is the Company's policy to contribute adequate funds to the trust accounts to cover benefit payments under the VIP Plan and to maintain the funded status of the Employee Plan at a level which is adequate to avoid significant restrictions to the Employee Plan under the Pension Protection Act of 2006. Contributions to the Qualified Plan Trust and benefit payments under the VIP Plan totaled $654,000 in fiscal 2022 and $604,000 in fiscal 2021. Contributions during fiscal 2023 will depend upon actual investment results and benefit payments but are anticipated to be approximately $615,000. At January 31, 2022, accumulated other comprehensive loss of approximately $6.0 million, net of tax, is attributable to the pension plans.
The following tables set forth (in thousands) the combined funded status of the Company’s pension plans at January 31, 2022 and 2021:
| | | | | | | | | | | | | | |
| Combined Employee Retirement Plans | |
1/31/2022 | | 1/31/2021 | |
| | | | |
Change in Benefit Obligation |
Benefit obligation at beginning of year | $ | 44,178 | | | $ | 43,292 | | |
Service cost | — | | | — | | |
Interest cost | 1,113 | | | 1,211 | | |
Participant contributions | — | | | — | | |
Amendments | — | | | — | | |
Actuarial losses (gains) | (2,373) | | | 1,588 | | |
Plan settlement | — | | | — | | |
Benefits paid | (2,332) | | | (1,913) | | |
Benefit obligation at end of year | $ | 40,586 | | | $ | 44,178 | | |
Change in Plan Assets | | | | |
Fair value at beginning of year | $ | 23,972 | | | $ | 23,654 | | |
Actual return on plan assets | 4,099 | | | 1,591 | | |
Company contributions | 690 | | | 640 | | |
Settlements | — | | | — | | |
Benefits paid | (2,332) | | | (1,913) | | |
Fair value at end of year | $ | 26,429 | | | $ | 23,972 | | |
Funded Status | | | | |
Unfunded status of the plans | $ | (14,157) | | | $ | (20,206) | | |
Amounts Recognized in Statement of Financial Position | | | | |
Current liabilities | $ | (344) | | | $ | (364) | | |
Non-current liabilities | (13,813) | | | (19,842) | | |
Accrued benefit cost | $ | (14,157) | | | $ | (20,206) | | |
Amounts Recognized in Statement of Financial Position and Operations | | | | |
Accrued benefit liability | (14,157) | | | (20,206) | | |
Accumulated other compensation loss | 6,889 | | | 14,444 | | |
Net amount recognized | $ | (7,268) | | | $ | (5,762) | | |
Items not yet Recognized as a Component of Net Periodic Pension Expense, included in AOCI | | | | |
Unrecognized net actuarial loss | $ | 6,889 | | | $ | 14,444 | | |
Unamortized prior service costs | — | | | — | | |
Net initial asset recognition | — | | | — | | |
| $ | 6,889 | | | $ | 14,444 | | |
| | | | | | | | | | | | | | |
| Combined Employee Retirement Plans | |
1/31/2022 | | 1/31/2021 | |
| | | | |
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income |
Net (gain) loss | $ | (5,782) | | | $ | 849 | | |
Prior service cost | — | | | — | | |
Amortization of loss | (1,774) | | | (1,831) | | |
Amortization of prior service cost (credit) | — | | | — | | |
Amortization of initial asset | — | | | — | | |
Total recognized in other comprehensive loss | $ | (7,556) | | | $ | (982) | | |
Items to be Recognized as a Component of Periodic Pension Cost for next fiscal year | | | | |
Prior service cost | $ | — | | | $ | — | | |
Net actuarial loss | 536 | | | 1,771 | | |
| $ | 536 | | | $ | 1,771 | | |
Supplemental Data | | | | |
Projected benefit obligation | $ | 40,586 | | | $ | 44,178 | | |
Accumulated benefit obligation | 40,586 | | | 44,178 | | |
Fair value of plan assets | 26,429 | | | 23,972 | | |
Components of Net Cost | | | | |
Service cost | $ | — | | | $ | — | | |
Interest cost | 1,113 | | | 1,211 | | |
Expected return on plan assets | (690) | | | (869) | | |
Amortization of transition amount | — | | | — | | |
Recognized (gain) loss due to settlement | — | | | — | | |
Amortization of prior service cost | — | | | — | | |
Recognized net actuarial loss | 1,774 | | | 1,831 | | |
Benefit cost | $ | 2,197 | | | $ | 2,173 | | |
Estimated Future Benefit Payments | | | | |
FYE 01-31-2023 | $ | 6,264 | | | | |
FYE 01-31-2024 | 3,012 | | | | |
FYE 01-31-2025 | 3,231 | | | | |
FYE 01-31-2026 | 2,649 | | | | |
FYE 01-31-2027 | 2,597 | | | | |
FYE 01-31-2028 to 2032 | 11,387 | | | | |
Total | $ | 29,140 | | | | |
Weighted Average Assumptions to Determine Benefit Obligations at Year-End | | | | |
Discount rate | 3.20% | | 2.75% - 2.80% | |
Rate of compensation increase | N/A | | N/A | |
Weighted Average Assumptions to Determine Net Periodic Pension Cost | | | | |
Discount rate | 2.75% - 2.80% | | 3.00% - 3.05% | |
Expected return on plan assets | 6.00% | | 6.00% | |
Rate of compensation increase | N/A | | N/A | |
The Employee Plan held no Level 2 or 3 investments at January 31, 2022 and 2021. The following table sets for the fair value of the Level 1 investments for the Employee Plan as of January 31, 2022 and 2021 (in thousands):
Fair Value Measurements of Plan Assets
Employee Plan
| | | | | | | | | | | |
| 1/31/2022 | | 1/31/2021 |
| | | |
Level 1 Measurement | | | |
Common Stock | 14,094 | | | 10,323 | |
Principal Money Market | 523 | | | 458 | |
PNC Govt Money Fund | 204 | | | 271 | |
Vanguard INTM Term Investment | 394 | | | 410 | |
Vanguard LT Investment | 983 | | | 1,044 | |
Ishares Russell 2000 | 1,457 | | | 1,724 | |
Ishares Russell MID-CAP | 1,958 | | | 1,890 | |
Ishares Emerging Markets | 1,091 | | | 1,191 | |
Ishares MCSI RAFE | 1,713 | | | 1,636 | |
Ishares S&P Index | 781 | | | 2,091 | |
Vanguard INTM Term Treasury | 404 | | | 410 | |
Vanguard LT Treasury | 1,036 | | | 1,047 | |
Total Level 1 Investments | $ | 24,638 | | | $ | 22,495 | |
In addition to the holdings above, the Employee Plan has a holding in a mutual fund investment, Managed Investment Fund. The mutual fund investment is valued using the net asset value (“NAV”) as a practical expedient and is not required to be categorized in the fair value hierarchy table. The total fair value of this investment was $1,912,000 and $1,454,000 as of January 31, 2022 and 2021, respectively, and is not included in the table above. In relation to this investment, there is no unfunded commitments and the shares can be redeemed on a daily basis with minimal restrictions. Events that may lead to a restriction to transact with the fund is not considered probable.
401(k) Retirement Plan
The Company’s retirement plan, which covers all U.S. employees, allows participants to defer from 1% to 75% of their eligible compensation through a 401(k)-retirement program. Through December 31, 2001, the plan included an employee stock ownership component. The plan continues to include Virco stock as one of the investment options. At January 31, 2022 and 2021, the plan held 1,077,995 shares and 915,542 shares of the Company’s common stock, respectively. Effective January 1, 2020, the Company initiated an employer match. For the fiscal years ended January 31, 2022 and 2021, the compensation costs incurred for employer match was $867,000 and $774,000, respectively.
Life Insurance
The Company provided post-retirement life insurance to certain retired employees under the Dual Option Life Insurance Plan (the "Plan"). Effective January 2004, the Company terminated this plan for active employees. The Company has purchased split-dollar life insurance on the lives of the remaining covered participants. Death benefits due to participants are approximately $1,800,000. Cash surrender values of these policies, which are included in other assets in the accompanying consolidated balance sheets, were $1,380,000 and $1,895,000 at January 31, 2022 and 2021, respectively. Death benefits payable under the policies were approximately $2,967,000 and $3,917,000 at January 31, 2022 and 2021, respectively. Death benefits received under the Plan in excess of the benefit obligation will be retained in the trust and used to secure and fund benefits payable under the VIP Pension Plan. The Company maintains a rabbi trust to hold assets related to the Dual Option Life Insurance Plan. All assets securing this plan are held in the rabbi trust.
The following sets forth the Company's change in death benefits payable during the years ended January 31, 2022 and 2021:
| | | | | | | | | | | |
| 1/31/2022 | | 1/31/2021 |
| | | |
Liability beginning of year | $ | 2,034,000 | | | $ | 1,986,000 | |
Accretion expense | 60,000 | | | 48,000 | |
Death benefits paid | (478,000) | | | — | |
Liability end of year | $ | 1,616,000 | | | $ | 2,034,000 | |
5. Stock-Based Compensation
Stock Incentive Plans
The Company's two stock plans are the 2019 Employee Stock Incentive Plan (the “2019 Plan”) and the 2011 Employee Incentive Stock Plan (the “2011 Plan”).
Under the 2019 Plan, the Company may grant an aggregate of 1,000,000 shares to its employees in the form of restricted stock units and non-employee directors in the form of restricted stock awards. Restricted stock units and awards granted under the 2019 Plan are expensed ratably over the vesting period of the awards. The Company determines the fair value of its restricted stock units or awards and related compensation expense as the difference between the market value of the units or awards on the date of grant less the exercise price of the units or awards granted. During fiscal year 2022, the Company granted 68,870 awards to non-employee directors, vested 140,295 shares according to their terms and forfeited 0 shares under the 2019 Plan. As of January 31, 2022, there were approximately 628,435 shares available for future issuance under the 2019 Plan.
Under the 2011 Plan, the Company may grant an aggregate of 2,000,000 shares to its employees in the form of restricted stock units and non-employee directors in the form of restricted stock awards. Restricted stock units and awards granted under the 2011 Plan are expensed ratably over the vesting period of the awards. The Company determines the fair value of its restricted stock units or awards and related compensation expense as the difference between the market value of the units or awards on the date of grant less the exercise price of the units or awards granted. During fiscal year 2022, the Company granted 0 restricted awards to non-employee directors and 0 units to its employees; vested 0 stock awards and 119,200 units according to their terms and forfeited 0 stock units under the 2011 Plan. As of January 31, 2022, there were approximately 12,892 shares available for future issuance under the 2011 Plan.
During fiscal year 2022, stock-based compensation expense related to restricted stock units and awards recognized in cost of goods sold and selling, general and administrative expenses was $219,000 and $794,000, respectively. During fiscal year 2021, stock-based compensation expense related to restricted stock units and/or awards recognized in cost of goods sold and selling, general and administrative expenses was $257,000 and $755,000, respectively.
Accounting for the Plans
A summary of the Company’s restricted stock unit awards activity, and related information for the following years ended January 31, is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2022 | | 2021 |
| Restricted stock units | | Weighted- Average Exercise Price | | Restricted stock units | | Weighted- Average Exercise Price |
| | | | | | | | |
Outstanding at beginning of year | | 611,495 | | | $ | 4.26 | | | 740,985 | | | $ | 4.54 | |
Granted | | 68,870 | | | 3.63 | | | 94,695 | | | 2.64 | |
Exercised | | (259,495) | | | 3.55 | | | (224,185) | | | 2.60 | |
Forfeited | | — | | | — | | | — | | | — | |
Outstanding at end of year | | 420,870 | | | 4.37 | | | 611,495 | | | 4.26 | |
Weighted-average fair value of restricted stock units granted during the year | | | | 3.63 | | | | | 2.64 | |
The aggregate fair value of restricted stock awards vested during fiscal years 2022 and 2021 was $921,207 and $582,881, respectively. The Company recognized compensation expense, net of forfeitures, for the restricted stock awards of $1,013,000 and $1,012,000 for fiscal 2022 and 2021, respectively. The Company records forfeitures as incurred.
The weighted-average grant-date fair value of restricted stock awards is the quoted market price of the Company’s common stock on the date of grant, as shown in the table above. The weighted-average grant-date fair value of restricted stock awards granted in fiscal 2022 and 2021 was $3.63 per share and $2.64 per share, respectively.
As of January 31, 2022, there was $1.2 million of total unrecognized compensation expense related to restricted stock awards. That expense is expected to be recognized over a weighted-average period of 2.90 years.
To satisfy employee minimum statutory tax withholding requirements for restricted stock awards that vest, the Company withholds and retires a portion of the vesting common shares, unless an employee elects to pay cash. In fiscal 2022 and 2021, the Company withheld 50,289 and 54,402 common shares, respectively, with a total value of approximately $176,000 and $156,000, respectively. These amounts are presented as a cash outflow from financing activities in the accompanying consolidated statement of cash flows.
6. Income Taxes
The income tax benefit for the last two years is reconciled to the statutory federal income tax rates of 21% for the tax years ended January 31, is as follows (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
| | | |
Statutory | $ | (782) | | | $ | (625) | |
State taxes (net of federal tax) | 14 | | | 9 | |
Change in valuation allowance | 12,303 | | | (119) | |
State rate adjustment | (197) | | | (104) | |
Change in unrecognized tax benefits | 5 | | | (4) | |
Stock Compensation | 48 | | | 85 | |
Expirations of attributes | 55 | | | 16 | |
Permanent differences | (31) | | | 11 | |
Return to provision | (7) | | | (13) | |
Income tax expense (benefit) | $ | 11,408 | | | $ | (744) | |
Significant components of the benefit for income taxes attributed to continuing operations are as follows for the years ended January 31, is as follows (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
| | | |
Current | | | |
Federal | $ | — | | | $ | — | |
State | 92 | | | (2) | |
| 92 | | | (2) | |
Deferred | | | |
Federal | (731) | | | (555) | |
State | (256) | | | (68) | |
| (987) | | | (623) | |
Change in valuation allowance | 12,303 | | | (119) | |
| 11,316 | | | (742) | |
Income tax expense (benefit) | $ | 11,408 | | | $ | (744) | |
Deferred tax assets and liabilities are comprised of the following as of January 31, respectively, as follows (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
| | | |
Deferred tax assets | | | |
Accrued vacation and sick leave | $ | 943 | | | $ | 835 | |
Retirement plans | 3,930 | | | 5,657 | |
Insurance reserves | 300 | | | 293 | |
Warranty | 154 | | | 181 | |
Net operating loss carryforwards | 4,445 | | | 4,501 | |
Right of use liabilities | 4,159 | | | 5,237 | |
Inventory | 2,124 | | | 1,287 | |
Business interest expense limitation | — | | | — | |
Other | 361 | | | 324 | |
| $ | 16,416 | | | $ | 18,315 | |
Deferred tax liabilities | | | |
Tax in excess of book depreciation | $ | (984) | | | $ | (924) | |
Right of use assets | (3,567) | | | (4,541) | |
Other | (54) | | | (70) | |
| $ | (4,605) | | | $ | (5,535) | |
Valuation allowance | (11,412) | | | (1,064) | |
Net long term deferred tax asset | $ | 399 | | | $ | 11,716 | |
In assessing the realizability of deferred tax assets, the Company considers whether it is more-likely-than-not that some portion or all of its deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income or reversal of deferred tax liabilities during the periods in which those temporary differences become deductible. As a part of this evaluation, the Company assesses all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, the availability of tax carry backs, tax-planning strategies, and results of recent operations (including cumulative losses in recent years), to determine whether sufficient future taxable income will be generated to realize existing deferred tax assets. During 2022 and 2021 the Company incurred operating losses and when combined with operating results from 2020, the Company has incurred a cumulative operating loss for the last three years. As a result, the Company has identified objective and verifiable negative evidence in the form of cumulative losses in the U.S. and in certain state jurisdictions over the preceding twelve quarters ended January 31, 2022. While the Company has taken significant measures to return to profitability, and order rates at the beginning of the year are favorable, the short-term outlook for the school furniture market is challenging, particularly relating to ongoing supply chain difficulties. During the fourth quarter of the year ended January 31, 2022, based on this evaluation, and after considering future reversals of existing taxable temporary differences and the effects of seasonality on the Company’s business, the Company determined the realization of a majority of the net deferred tax assets no longer met the more likely than not criteria and a valuation allowance was recorded against the majority of the net deferred tax assets. Valuation allowances of $11,412,000 are needed for federal and certain state net operating loss carryforwards to reduce the carrying amount of deferred tax assets to an amount that is more likely than not to be realized. At January 31, 2022, the Company has net operating loss carryforwards of approximately $12,513,000 for U.S. federal, with no expirations, and $31,222,000 for state income tax purposes, expiring at various dates through January 31, 2041. At January 31, 2021, the Company recorded a partial valuation allowance of $1,064,000 against its net deferred tax assets. The net change in the valuation allowance for the year ended January 31, 2022, was an increase of $10,348,000 and for the year ended January 31, 2021, was a decrease of $119,000.
The following table summarizes the activity related to our gross unrecognized tax benefits for the years ended January 31, respectively, as follows (in thousands):
| | | | | | | | | | | |
| 2022 | | 2021 |
| | | |
Balances as of February 1, | $ | 54 | | | $ | 60 | |
Increases related to prior year tax positions | — | | | — | |
Decreases related to prior year tax positions | (1) | | | (4) | |
Increases related to current year tax positions | 10 | | | 8 | |
Decreases related to lapsing of statute of limitations | (6) | | | (10) | |
Balance as of January 31, | $ | 57 | | | $ | 54 | |
At January 31, 2022, the Company’s unrecognized tax benefits associated with uncertain tax positions were $57,000, of which $45,000 if recognized, would favorably affect the effective tax rate.
The Company recognizes interest and penalties related to unrecognized tax benefits as a component of income tax expense which is consistent with the recognition of the items in prior reporting. The Company had recorded a liability for interest and penalties related to unrecognized tax benefits of $13,000 at January 31, 2022, and $11,000 at January 31, 2021. The year ended January 31, 2017 and subsequent years remain open for examination by the IRS and state tax authorities. The Company is currently under IRS examination for fiscal year ended January 31, 2016. The Company is not currently under state examinations.
The specific timing of when the resolution of each tax position will be reached is uncertain. As of January 31, 2022, it is reasonably possible that unrecognized tax benefits will decrease by $6,000 within the next 12 months due to the expiration of the statute of limitations.
On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"). The Company has performed an analysis of the impact of the CARES Act and determined the impact is not significant.
7. Leases and Commitments
The Company has operating leases on real property, equipment, and automobiles that expire at various dates. The Company determines if an arrangement is a lease at inception and assesses classification of the lease at commencement. All of the Company’s leases are classified as operating leases, as a lessee. Beginning on the first day of fiscal 2020, the Company adopted ASC 842 to account for its leases. Pursuant to ASC 842, the Company uses the implicit rate when readily determinable, or the incremental borrowing rate. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments using company specific credit spreads. The Company’s lease terms include options to extend or terminate the lease only when it is reasonably certain that we will exercise that option. Lease expense for our operating leases is recognized on a straight-line basis over the lease term.
The Company has an operating lease for its corporate office, manufacturing and distribution facility located in Torrance, CA, currently with a remaining lease term through December 2025. The Company leases equipment under a 5-year operating lease arrangement. The Company has the option of buying the assets at the end of the lease period at a price that does not result in the Company being reasonably certain of exercising the option. In addition, the Company leases trucks, automobiles, and forklifts under operating leases that include certain fleet management and maintenance services. Certain of the leases contain renewal or purchase options and require payment for property taxes and insurance. The Company records lease expense on a straight-line basis based on the contractual lease payments. In accordance with ASC 842, the Company recognizes the present value of the future lease commitments as an operating lease liability, and a corresponding right-of-use asset ("ROU asset"), net of tenant allowances. Tenant improvements and related tenant allowances are recorded as a reduction to the ROU asset. The Company elected to account for leases with an original term of 12 months or less that do not contain a purchase option as short-term leases. Additionally, certain of the leases provide for variable payment for property taxes, insurance, and common area maintenance payments among others. The Company recognizes variable lease expenses for these leases in the period incurred. The Company's lease agreements do not contain any material residual value guarantees or material restrictive covenants.
In accordance with ASC 842, quantitative information regarding our leases is as follows:
| | | | | | | | | | | |
| Twelve-Months Ended |
| 1/31/2022 | | 1/31/2021 |
| (in thousands) |
| | | |
Operating lease cost | $ | 5,086 | | | $ | 5,742 | |
Short-term lease cost | 332 | | | 263 | |
Sublease income | (40) | | | (40) | |
Variable lease cost | 1,033 | | | 766 | |
Total lease cost | $ | 6,411 | | | $ | 6,731 | |
| | | |
Other operating leases information: | | | |
| | | |
Cash paid for amounts included in the measurement of lease liabilities | $ | 5,482,000 | | | $ | 5,163,000 | |
Right-of-use assets obtained in exchange for new lease liabilities | $ | 599,000 | | | $ | 622,000 | |
Weighted-average remaining lease term (years) | 3.10 | | 4.06 |
Weighted-average discount rate | 6.40 | % | | 6.41 | % |
Minimum future lease payments (in thousands) for operating leases in effect as of January 31, 2022, are as follows:
| | | | | | | | |
| | Operating Lease |
Year ending January 31, | | |
2023 | | $ | 5,618 | |
2024 | | 5,473 | |
2025 | | 5,473 | |
2026 | | 1,382 | |
2027 | | — | |
Thereafter | | — | |
Remaining balance of lease payments | | $ | 17,946 | |
| | |
Short-term lease liabilities | | $ | 4,734 | |
Long-term lease liabilities | | 11,437 | |
Total lease liabilities | | $ | 16,171 | |
| | |
Difference between undiscounted cash flows and discounted cash flows | | $ | 1,775 | |
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 expects to continue to spend, significant amounts in the future to comply with environmental laws. Normal recurring expenses relating to operating the Company factories in a manner that meets or exceeds environmental laws are matched to the cost of producing inventory. Despite the Company’s significant dedication to operating in compliance with applicable laws, there is a risk that the Company could fail to comply with a regulation or that applicable laws and regulations change. On these occasions, the Company records liabilities for remediation costs when remediation costs are probable and can be reasonably estimated.
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.
The Company has a self-insured retention for product liability losses up to $250,000 per occurrence, workers’ compensation liability losses up to $250,000 per occurrence, general liability losses up to $50,000 and automobile liability losses up to $50,000 per occurrence. The Company has purchased insurance to cover losses in excess of the retention up to a limit of $30,000,000. The Company has obtained an actuarial estimate of its total expected future losses for liability claims and recorded a liability equal to the net present value of $1,165,000 and $1,135,000 at January 31, 2022 and 2021, respectively, based upon the Company’s estimated payout period of five years using a 4.0% and 4.0% discount rate, respectively.
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. Estimated payments under the self-insurance programs are as follows (in thousands):
| | | | | |
Year ending January 31, | |
2023 | $ | 200 | |
2024 | 260 | |
2025 | 260 | |
2026 | 260 | |
2027 | 255 | |
Thereafter | — | |
Total | $ | 1,235 | |
Discount to net present value | (70) | |
| $ | 1,165 | |
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, in consultation with legal counsel, that the ultimate outcome of all such matters will not materially affect the Company’s financial position, results of operations or cash flows.
9. Warranty
The Company provides a warranty against all substantial defects in material and workmanship. The standard warranty offered on products sold through January 31, 2013 is ten years. Effective February 1, 2014 the Company modified its warranty to a limited lifetime warranty. The warranty effective February 1, 2014 is not anticipated to have a significant effect on warranty expense. Effective January 1, 2017, the Company modified the warranty offered to provide specific warranty periods by product component, with no warranty period longer than ten years. The Company’s warranty is not a guarantee of service life, which depends upon events outside the Company’s control and may be different from the warranty period. The Company accrues an estimate of its exposure to warranty claims based upon both product sales data and an analysis of actual warranty claims incurred. The following is a summary of the Company’s warranty-claim activity during for the years ended January 31 (in thousands):
| | | | | | | | | | | | | | |
| | 2022 | | 2021 |
| | | | |
Beginning balance | | $ | 700 | | | $ | 800 | |
Provision for current year | | 370 | | | 380 | |
Benefits from prior years | | (340) | | | (325) | |
Costs incurred | | (130) | | | (155) | |
Ending balance | | $ | 600 | | | $ | 700 | |
10. Subsequent Events
As discussed in Note 3, the Company executed Amendment No. 2 to the Restated Credit Agreement.