Notes to Consolidated Financial Statements
January 31, 2023
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 73 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 and the Company delivered less than 40% of sales during June, July, and August. In fiscal 2023, the Company started to return to the traditional seasonality and delivered approximately 47% of annual sales in June, July, and August.
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; recoverability of 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.
Fiscal Year End
Fiscal years 2023 and 2022 refer to the fiscal years ended January 31, 2023 and 2022, 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, 2023 and 2022. 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, 2023 and 2022. Foreign net sales were approximately 4.4% and 3.6% of the Company’s net sales for fiscal years 2023 and 2022, 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 current portion of 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, and assets held in the Rabbi Trust securing the VIP Pension (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. 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, 2023 and 2022:
| | | | | | | | | | | | | | |
| | January 31, |
| | 2023 | | 2022 |
| | | | |
Finished goods | | $ | 25,740 | | | $ | 16,731 | |
Work in Process | | 25,303 | | | 14,732 | |
Raw materials | | 16,363 | | | 15,910 | |
Inventories | | $ | 67,406 | | | $ | 47,373 | |
Property, Plant, and Equipment
Property, plant, and equipment are stated at cost, less accumulated depreciation and amortization. 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 $2,049,000 and $1,959,000 for fiscal years ended January 31, 2023 and 2022, respectively. Property, plant, and equipment purchased during the year that remains unpaid were $634,000 and $189,000 as of January 31, 2023 and 2022, respectively.
The Company has established asset retirement obligations related to leased manufacturing facilities. 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 $205,000 and $198,000 at January 31, 2023 and 2022, respectively.
| | | | | | | | | | | |
| January 31, |
| 2023 | | 2022 |
| | | |
Balance at beginning of period | $ | 198,000 | | | $ | 192,000 | |
Decrease in obligation | — | | | — | |
Accretion expense | 7,000 | | | 6,000 | |
Balance at end of period | $ | 205,000 | | | $ | 198,000 | |
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, 2023 and 2022.
Net Income (loss) per Share
For fiscal year 2023, net income per share is calculated by dividing net income by the diluted weighted-average number of common shares outstanding. There were zero anti-dilutive shares in fiscal 2023. For fiscal year 2022, approximately 96,000 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, |
| | 2023 | | 2022 |
| | (In thousands, except per share) |
Numerator | | | | |
Net income (loss) | | $ | 16,547 | | | $ | (15,136) | |
Denominator | | | | |
Weighted-average shares — basic | | 16,142 | | | 15,954 | |
Dilutive effect of common stock equivalents from equity incentive plans | | 50 | | | — | |
Weighted-average shares | | 16,192 | | | 15,954 | |
Net income (loss) per common share | | | | |
Basic | | $ | 1.03 | | | $ | (0.95) | |
Diluted | | $ | 1.02 | | | $ | (0.95) | |
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, 2023 and 2022, the Company had not capitalized any remediation costs and had not recorded any amortization expense in fiscal years 2023 and 2022.
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, 2023 and 2022 of $1,209,000 and $785,000, respectively, and are expensed as incurred. Prepaid advertising costs reported as a prepaid asset on the accompanying consolidated balance sheets at January 31, 2023 and 2022, were $355,000 and $296,000, respectively.
Product Warranty Expense
The Company provides a product warranty on most products. Products sold prior to January 31, 2013 are out of warranty. 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 as of January 31, 2023 and 2022, as other long-term liabilities in the accompanying consolidated balance sheets. The current portion of the warranty reserve were $250,000 as of January 31, 2023 and 2022, and included in other accrued liabilities in the accompanying consolidated balance sheets.
Self-Insurance
In fiscal 2023 and 2022, 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 2023 and fiscal 2022. 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 $1.3 million at January 31, 2023 in the accompanying consolidated balance sheets. The current portion of the self-insurance reserve was $200,000 as of January 31, 2023 and included in other accrued liabilities in the accompanying consolidated balance sheets.
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. Between 1983 and 2003, the Company issued approximately $122 million in stock dividends for which the reductions in retained earnings were offset by increases to additional paid-in capital.
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, 2023 and 2022:
| | | | | | | | | | | | | | |
| | January 31, |
| | 2023 | | 2022 |
| | | | |
Balance as of beginning of year | | $ | (6,029) | | | $ | (13,585) | |
| | | | |
Other comprehensive income before reclassifications | | 3,162 | | | 5,782 | |
Amounts reclassified from accumulated comprehensive loss | | 507 | | | 1,774 | |
Net current period other comprehensive income | | 3,669 | | | 7,556 | |
| | | | |
Balance as of end of year | | $ | (2,360) | | | $ | (6,029) | |
| | | | |
The reclassifications out of accumulated other comprehensive loss of $507,000 and $1,774,000 for the years ended January 31, 2023 and 2022, respectively, related to amortization of actuarial losses and settlements (See Note 4). The reclassifications were included in pension expense in the accompanying consolidated statements of operations.
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, 2023 and 2022, shipping and classroom delivery costs of approximately $23.8 million, and $18.8 million, 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 2022, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) 2022-03, “Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions.” This ASU clarifies that a contractual restriction on the sale of an equity security is not considered in measuring fair value. The ASU also requires certain disclosures for equity securities subject to contractual sale restrictions. The new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2023. Early adoption is permitted. As of January 31, 2023, the Company holds equity securities in the Rabbi Trust. We do not currently expect that this guidance will have a material impact on our financial position and results of operations.
In March 2022, the FASB issued ASU No. 2022-02 – Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, to address certain concerns identified in the Post-Implementation Review process for ASU Topic 326. The amendments in ASU 2022-02 eliminate the accounting guidance for troubled debt restructurings by creditors in ASC Subtopic 310-40, Receivables – Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancing and restructuring by creditors when a borrower is experiencing financial difficulty. In addition, for public business entities, the amendments in ASU 2022-02 require that an entity disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of ASC Subtopic 326-20, Financial Instruments – Credit Losses – Measured at Amortized Cost. The amendments in ASU 2022-02 will become effective for us as of the beginning of our 2024 fiscal year. Early adoption is permitted. We do not expect that this guidance will have a material impact on our financial position and results of operations.
In March 2020, the FASB issued ASU 2020-04 "Reference Rate Reform (Topic 848) – Facilitation of the Effects of Reference Rate Reform on Financial Reporting" ("ASU 2020-04"). ASU 2020-04 provides optional expedients and exceptions for applying GAAP to debt instruments, derivatives, and other contracts that reference London Interbank Offered Rate ("LIBOR") or other reference rates expected to be discontinued as a result of reference rate reform. In December 2022, the FASB issued ASU 2022-06 "Reference Rate Reform (Topic 848) - Deferral of the Sunset Date of Topic 848" ("ASU 2022-06"), which defers the expiration of ASC 848 from December 31, 2022, to December 31, 2024. We have loan agreements, debt agreements, and an interest rate cap that incorporate LIBOR as a referenced interest rate. It is difficult to predict what effect, if any, the phase-out of LIBOR and the use of alternative benchmarks may have on our business or on the overall financial.
The FASB regularly issues updates to the FASB Accounting Standards Codification that are communicated through issuance of an ASU. None of the accounting guidance issued by the FASB effective for current and future periods has had a material impact on the Company's current financial statements, and we do not believe it will have a material impact on our future financial position and results of operations.
3. Debt
Outstanding balances (in thousands) for the Company’s long-term debt were as follows:
| | | | | | | | | | | | | | |
| | January 31, |
| | 2023 | | 2022 |
| | | | |
Revolving credit line | | $ | 17,122 | | | $ | 9,551 | |
Other | | 4,622 | | | 4,962 | |
Total debt | | 21,744 | | | 14,513 | |
Less current portion | | 7,360 | | | 340 | |
Non-current portion | | $ | 14,384 | | | $ | 14,173 | |
The Company has 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 $3.0 million 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 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 $65.0 million to $70.0 million in July 2022 and August 2022, and increased the borrowing limit from $40.0 million to $45.0 million 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 (London Inter-Bank Offered Rate) pricing on the Revolving Credit Facility and replaced with BSBY (Bloomberg Short-Term Bank Yield) 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.
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.
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 $65.0 million 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 $15.0 million from January through July of each year, minus undrawn amounts of letters of credit and reserves and (ii) an equipment loan of $2.0 million. 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 $10.0 million 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.
The Company's revolving line of credit with PNC is structured to provide seasonal credit availability during the Company's peak summer season. Approximately $12.9 million and $20.4 million were available for borrowing as of January 31, 2023 and 2022, respectively. Interest rates were 9.25% and 5.00% as of January 31, 2023 and 2022, respectively. The Company also incurs a fee on the unused portion of the revolving line of credit at a rate of 0.375%.
In addition to the outstanding debt balance of $17.1 million on the Company's revolving credit line, the Company also carries a mortgage on a manufacturing building in Conway Arkansas. The original note was dated August 2017 for $5.8 million, at a fixed rate of 4% per year and 20 years term. The outstanding amount under this note was $4.6 million as of January 31, 2023.
The Company was in compliance with its debt covenants as of January 31, 2023. 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 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.
The long-term debt repayments are approximately as follow as of January 31, 2023 (in thousands):
| | | | | |
Year ending January 31, | |
2024 | $ | 7,360 | |
2025 | 248 | |
2026 | 258 | |
2027 | 269 | |
2028 | 10,280 | |
Thereafter | 3,329 | |
| $ | 21,744 | |
Management believes that the carrying value of debt approximated fair value at January 31, 2023 and 2022, as majority of the long-term debt bears interest at variable rates based on prevailing market conditions. The Company also carries a mortgage on a manufacturing building in Conway Arkansas at an annual fixed rate of 4%.
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, 2023 and 2022.
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, equity investments, 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 $0.7 million and $3.5 million at January 31, 2023 and 2022, respectively. Death benefits payable under life insurance policies held by the Plan were approximately $1.6 million and $8.8 million at January 31, 2023 and 2022, respectively. Equity investments held in the Rabbi Trust to secure retirement benefits were $4.7 million as of January 31, 2023. Assets held in the Rabbi Trust were included in the other non-current asset of the accompanying consolidated balance sheets.
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 rates for the Employee Plan and the VIP Plan were 4.85% and 3.20% at January 31, 2023 and 2022, 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 years ended January 31, 2023 or 2022.
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 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, 2023, approximately 28% 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, 2023 and 2022, the amount of the plan assets invested in bond or short-term investment funds was 29% and 13%, 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 $0.6 million in fiscal 2023 and $0.7 million in fiscal 2022. Contributions during fiscal 2024 will depend upon actual investment results and benefit payments but are anticipated to be approximately $0.5 million. At January 31, 2023, accumulated other comprehensive loss of approximately $2.4 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, 2023 and 2022:
| | | | | | | | | | | | | | |
| Combined Employee Retirement Plans | |
1/31/2023 | | 1/31/2022 | |
| | | | |
Change in Benefit Obligation |
Benefit obligation at beginning of year | $ | 40,586 | | | $ | 44,178 | | |
Service cost | — | | | — | | |
Interest cost | 1,295 | | | 1,113 | | |
Participant contributions | — | | | — | | |
Amendments | — | | | — | | |
Actuarial losses (gains) | (6,892) | | | (2,373) | | |
Plan settlement | — | | | — | | |
Benefits paid | (2,004) | | | (2,332) | | |
Benefit obligation at end of year | 32,985 | | | 40,586 | | |
Change in Plan Assets | | | | |
Fair value at beginning of year | 26,429 | | | 23,972 | | |
Actual return on plan assets | (1,428) | | | 4,099 | | |
Company contributions | 631 | | | 690 | | |
Settlements | — | | | — | | |
Benefits paid | (2,004) | | | (2,332) | | |
Fair value at end of year | 23,628 | | | 26,429 | | |
Funded Status | | | | |
Unfunded status of the plans | $ | (9,357) | | | $ | (14,157) | | |
Amounts Recognized in Statement of Financial Position | | | | |
Current liabilities | $ | (324) | | | $ | (344) | | |
Non-current liabilities | (9,033) | | | (13,813) | | |
Accrued benefit cost | $ | (9,357) | | | $ | (14,157) | | |
Amounts Recognized in Statement of Financial Position and Operations | | | | |
Accrued benefit liability | $ | (9,357) | | | $ | (14,157) | | |
Accumulated other compensation loss | 1,910 | | | 6,889 | | |
Net amount recognized | $ | (7,447) | | | $ | (7,268) | | |
Items not yet Recognized as a Component of Net Periodic Pension Expense, included in AOCI | | | | |
Unrecognized net actuarial loss | $ | 1,910 | | | $ | 6,889 | | |
Unamortized prior service costs | — | | | — | | |
Net initial asset recognition | — | | | — | | |
| $ | 1,910 | | | $ | 6,889 | | |
| | | | | | | | | | | | | | |
| Combined Employee Retirement Plans | |
1/31/2023 | | 1/31/2022 | |
| | | | |
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income |
Net loss | $ | (4,472) | | | $ | (5,782) | | |
Prior service cost | — | | | — | | |
Amortization of loss | (507) | | | (1,774) | | |
Amortization of prior service cost (credit) | — | | | — | | |
Amortization of initial asset | — | | | — | | |
Total recognized in other comprehensive loss | $ | (4,979) | | | $ | (7,556) | | |
Items to be Recognized as a Component of Periodic Pension Cost for next fiscal year | | | | |
Prior service cost | $ | — | | | $ | — | | |
Net actuarial loss | 6 | | | 536 | | |
| $ | 6 | | | $ | 536 | | |
Supplemental Data | | | | |
Projected benefit obligation | $ | 32,985 | | | $ | 40,586 | | |
Accumulated benefit obligation | $ | 32,985 | | | $ | 40,586 | | |
Fair value of plan assets | $ | 23,628 | | | $ | 26,429 | | |
Components of Net Cost | | | | |
Service cost | $ | — | | | $ | — | | |
Interest cost | 1,295 | | | 1,113 | | |
Expected return on plan assets | (1,000) | | | (690) | | |
Amortization of transition amount | — | | | — | | |
Recognized (gain) loss due to settlement | — | | | — | | |
Amortization of prior service cost | — | | | — | | |
Recognized net actuarial loss | 521 | | | 1,774 | | |
Benefit cost | $ | 816 | | | $ | 2,197 | | |
Estimated Future Benefit Payments | | | | |
FYE 01-31-2024 | $ | 6,234 | | | | |
FYE 01-31-2025 | 3,272 | | | | |
FYE 01-31-2026 | 2,581 | | | | |
FYE 01-31-2027 | 2,449 | | | | |
FYE 01-31-2028 | 2,397 | | | | |
FYE 01-31-2029 to 2033 | 10,289 | | | | |
Total | $ | 27,222 | | | | |
Weighted Average Assumptions to Determine Benefit Obligations at Year-End | | | | |
Discount rate | 4.85% | | 3.20% | |
Rate of compensation increase | N/A | | N/A | |
Weighted Average Assumptions to Determine Net Periodic Pension Cost | | | | |
Discount rate | 3.20% | | 2.75% - 2.80% | |
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, 2023 and 2022. The following table sets for the fair value of the Level 1 investments for the Employee Plan as of January 31, 2023 and 2022 (in thousands):
Fair Value Measurements of Plan Assets
Employee Plan
| | | | | | | | | | | |
| 1/31/2023 | | 1/31/2022 |
| | | |
Level 1 Measurement | | | |
Common Stock | $ | 9,389 | | | $ | 14,094 | |
Principal Money Market | 233 | | | 523 | |
Federated Herme Gove Oblig | 722 | | | — | |
PNC Govt Money Fund | — | | | 204 | |
Vanguard INTM Term Investment | 930 | | | 394 | |
Vanguard LT Investment | 2,382 | | | 983 | |
Ishares Russell 2000 | 718 | | | 1,457 | |
Ishares Russell MID-CAP | 738 | | | 1,958 | |
Ishares Emerging Markets | 748 | | | 1,091 | |
Ishares MCSI RAFE | 1,857 | | | 1,713 | |
Ishares S&P Index | 483 | | | 781 | |
Vanguard INTM Term Treasury | 2,352 | | | 404 | |
Vanguard LT Treasury | 921 | | | 1,036 | |
Total Level 1 Investments | $ | 21,473 | | | $ | 24,638 | |
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 $2.2 million and $1.9 million as of January 31, 2023 and 2022, 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. The plan continues to include Virco stock as one of the investment options. At January 31, 2023 and 2022, the plan held 1,265,586 shares and 1,077,995 shares of the Company’s common stock, respectively. Effective January 1, 2021, the Company initiated an employer match. For the fiscal years ended January 31, 2023 and 2022, the compensation costs incurred for employer match was $1.4 million and $0.9 million, 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 $1.8 million. Cash surrender values of these policies, which are included in other assets in the accompanying consolidated balance sheets, were $1.5 million and $1.4 million at January 31, 2023 and 2022, respectively. Death benefits payable under the policies were approximately $3.0 million at January 31, 2023 and 2022, 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 securing assets held in the rabbi trust were included in the other assets of the accompanying consolidated balance sheets.
The following sets forth the Company's change in death benefits payable during the years ended January 31, 2023 and 2022 (in thousands):
| | | | | | | | | | | |
| 1/31/2023 | | 1/31/2022 |
| | | |
Liability beginning of year | $ | 1,616 | | | $ | 2,034 | |
Accretion expense | 27 | | | 60 | |
Death benefits paid | — | | | (478) | |
Liability end of year | $ | 1,643 | | | $ | 1,616 | |
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 2023, the Company granted 0 awards to non-employee directors, vested 114,470 shares according to their terms and forfeited 0 shares under the 2019 Plan. As of January 31, 2023, there were approximately 608,435 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. The 2011 Plan expired in 2021 and no new awards may be made under the 2011 Plan. During fiscal year 2023, the Company vested 119,200 stock awards according to their terms and forfeited 0 stock units under the 2011 Plan.
The following table summarizes the stock-based compensation expense related to restricted stock awards recognized in the Company's statement of operations during fiscal years ended January 31, is as follows:
| | | | | | | | | | | | | | |
| | 2023 | | 2022 |
| | (in thousands) |
| | | | |
Cost of goods sold | | $ | 148 | | | $ | 219 | |
Selling, general and administrative expenses | | 464 | | | 794 | |
Total stock-based compensation expense | | $ | 612 | | | $ | 1,013 | |
| | | | |
The following table summarizes the Company’s restricted stock unit awards activity, and related information for fiscal years ended January 31,:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2023 | | 2022 |
| Restricted stock units | | Weighted- Average Exercise Price | | Restricted stock units | | Weighted- Average Exercise Price |
| | | | | | | | |
Outstanding at beginning of year | | 420,870 | | | $ | 4.37 | | | 611,495 | | | $ | 4.26 | |
Granted | | — | | | — | | | 68,870 | | | 3.63 | |
Exercised | | (233,670) | | | 3.82 | | | (259,495) | | | 3.55 | |
Forfeited | | — | | | — | | | — | | | — | |
Outstanding at end of year | | 187,200 | | | 4.40 | | | 420,870 | | | 4.37 | |
Weighted-average fair value of restricted stock units granted during the year | | | | — | | | | | 3.63 | |
The aggregate fair value of restricted stock unit awards vested during fiscal years 2023 and 2022 was $892,619 and $921,207, respectively. The Company recognized compensation expense, net of forfeitures, for the restricted stock awards of $612,000 and $1,013,000 for fiscal 2023 and 2022, 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. There were no awards granted in fiscal 2023. The weighted-average grant-date fair value of restricted stock awards granted in fiscal 2022 was $3.63 per share.
As of January 31, 2023, there was $549,000 of total unrecognized compensation expense related to restricted stock awards. That expense is expected to be recognized over a weighted-average period of 1.3 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 2023 and 2022, the Company withheld 55,838 and 50,289 common shares, respectively, with a total value of approximately $213,000 and $176,000, 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) expense 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):
| | | | | | | | | | | |
| 2023 | | 2022 |
| | | |
Statutory | $ | 1,689 | | | $ | (782) | |
State taxes (net of federal tax) | 746 | | | 14 | |
Change in valuation allowance | (10,546) | | | 12,303 | |
State rate adjustment | (397) | | | (197) | |
Change in unrecognized tax benefits | 6 | | | 5 | |
Stock compensation | 35 | | | 48 | |
Expirations of attributes | 17 | | | 55 | |
Permanent differences | (13) | | | (31) | |
Return to provision | (41) | | | (7) | |
Income tax (benefit) expense | $ | (8,504) | | | $ | 11,408 | |
Significant components of the (benefit) expense for income taxes attributed to continuing operations are as follows for the years ended January 31, is as follows (in thousands):
| | | | | | | | | | | |
| 2023 | | 2022 |
| | | |
Current | | | |
Federal | $ | 82 | | | $ | — | |
State | 125 | | | 92 | |
| 207 | | | 92 | |
Deferred | | | |
Federal | 1,524 | | | (731) | |
State | 311 | | | (256) | |
| 1,835 | | | (987) | |
Change in valuation allowance | (10,546) | | | 12,303 | |
| (8,711) | | | 11,316 | |
Income tax (benefit) expense | $ | (8,504) | | | $ | 11,408 | |
Deferred tax assets and liabilities are comprised of the following as of January 31, respectively, as follows (in thousands):
| | | | | | | | | | | |
| 2023 | | 2022 |
| | | |
Deferred tax assets | | | |
Accrued vacation and sick leave | $ | 1,925 | | | $ | 943 | |
Retirement plans | 2,729 | | | 3,930 | |
Insurance reserves | 325 | | | 300 | |
Warranty | 156 | | | 154 | |
Net operating loss carryforwards | 1,949 | | | 4,445 | |
Right of use liability | 3,087 | | | 4,159 | |
Inventory | 1,820 | | | 2,124 | |
Other | 401 | | | 361 | |
| 12,392 | | | 16,416 | |
Deferred tax liabilities | | | |
Tax in excess of book depreciation | (987) | | | (984) | |
Right of use assets | (2,630) | | | (3,567) | |
Other | (111) | | | (54) | |
| (3,728) | | | (4,605) | |
Valuation allowance | (864) | | | (11,412) | |
Net long term deferred tax asset | $ | 7,800 | | | $ | 399 | |
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 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 income (losses) in recent years), to determine whether sufficient future taxable income will be generated to realize existing deferred tax assets.
During fiscal 2022, the Company incurred operating losses, and when combined with operating results from fiscal 2021 and 2020, the Company incurred a cumulative operating loss for the last three years. As a result, the Company 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 had 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. At
January 31, 2022, the Company recorded a valuation allowance of $11.4 million against its net deferred tax assets. At January 31, 2022, the Company has NOL of approximately $12.5 million for U.S. federal tax purposes, with no expirations, and $31.2 million for state income tax purposes, expiring at various dates through January 31, 2041.
During the fiscal year ended January 31, 2023, the Company was profitable and returned to a cumulative 3-year profit in the fourth quarter. The Company benefited from continued growth in order rates, growth in sales volume, and improvements in gross margin. The Company utilized a material portion of its federal and certain state net operating loss carryforwards (“NOL”) in fiscal 2023 and anticipates that all federal NOL may be utilized by the end of fiscal 2024. During the fourth quarter of the year ended January 31, 2023, 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 met the more-likely-than-not criteria and reversed a majority of its valuation allowances against its net deferred tax assets. At January 31, 2023, the Company recorded a partial valuation allowances of $0.9 million on certain state NOL to reduce the carrying amount of deferred tax assets to an amount that is more-likely-than-not to be realized. The net change in the valuation allowance for the year ended January 31, 2023, was a decrease of $10.5 million. At January 31, 2023, the Company has NOL of approximately $2.7 million for U.S. federal tax purposes, with no expirations, and $25.1 million for state income tax purposes, expiring at various dates through January 31, 2041.
The following table summarizes the activity related to our gross unrecognized tax benefits for the years ended January 31, respectively, as follows (in thousands):
| | | | | | | | | | | |
| 2023 | | 2022 |
| | | |
Balances as of February 1, | $ | 57 | | | $ | 54 | |
Increases related to prior year tax positions | — | | | — | |
Decreases related to prior year tax positions | (5) | | | (1) | |
Increases related to current year tax positions | 19 | | | 10 | |
Decreases related to lapsing of statute of limitations | (9) | | | (6) | |
Balance as of January 31, | $ | 62 | | | $ | 57 | |
At January 31, 2023, the Company’s unrecognized tax benefits associated with uncertain tax positions were $62,000, of which $49,000 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 $16,000 at January 31, 2023, and $13,000 at January 31, 2022. The year ended January 31, 2018 and subsequent years remain open for examination by the IRS and state tax authorities. The Company is not currently under IRS or state examination.
The specific timing of when the resolution of each tax position will be reached is uncertain. As of January 31, 2023, it is reasonably possible that unrecognized tax benefits will decrease by $11,000 within the next 12 months due to the expiration of the statute of limitations.
7. Leases and Commitments
The Company has operating leases on real property, equipment, and automobiles, expiring at various dates through 2026. 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. 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 April 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 and automobiles 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 |
| 1/31/2023 | | 1/31/2022 |
| (in thousands) |
| | | |
Operating lease cost | $ | 5,174 | | | $ | 5,086 | |
Short-term lease cost | 388 | | | 332 | |
Sublease income | (40) | | | (40) | |
Variable lease cost | 883 | | | 1,033 | |
Total lease cost | $ | 6,405 | | | $ | 6,411 | |
| | | |
Other operating leases information: | | | |
| | | |
Cash paid for amounts included in the measurement of lease liabilities (in thousands) | $ | 5,716 | | | $ | 5,482 | |
Right-of-use assets obtained in exchange for new lease liabilities (in thousands) | $ | 545 | | | $ | 599 | |
Weighted-average remaining lease term (years) | 2.20 | | 3.10 |
Weighted-average discount rate | 6.30 | % | | 6.40 | % |
Minimum future lease payments (in thousands) for operating leases in effect as of January 31, 2023, are as follows:
| | | | | | | | |
| | Operating Lease |
Year ending January 31, | | |
2024 | | $ | 5,679 | |
2025 | | 5,674 | |
2026 | | 1,432 | |
2027 | | — | |
2028 | | — | |
Thereafter | | — | |
Remaining balance of lease payments | | 12,785 | |
| | |
Short-term lease liabilities | | 5,082 | |
Long-term lease liabilities | | 6,796 | |
Total lease liabilities | | 11,878 | |
| | |
Difference between undiscounted cash flows and discounted cash flows | | $ | 907 | |
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 $30.0 million. 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 $1.3 million and $1.2 million at January 31, 2023 and 2022, respectively, based upon the Company’s estimated payout period of five years using a 4.0% discount rate for both years.
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, | |
2024 | $ | 225 | |
2025 | 275 | |
2026 | 275 | |
2027 | 275 | |
2028 | 275 | |
Thereafter | — | |
Total | 1,325 | |
Discount to net present value | (75) | |
| 1,250 | |
Less current portion | (200) | |
Non-current portion | $ | 1,050 | |
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. 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):
| | | | | | | | | | | | | | |
| | 2023 | | 2022 |
| | | | |
Beginning balance | | $ | 600 | | | $ | 700 | |
Provision for current year | | 350 | | | 370 | |
Benefits from prior years | | (140) | | | (340) | |
Costs incurred | | (210) | | | (130) | |
Ending balance | | 600 | | | 600 | |
Less current portion | | (250) | | | $ | (250) | |
Non-current portion | | $ | 350 | | | $ | 350 | |
10. Subsequent Events
None.