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EXHIBIT 13.1 MANAGEMENTS STATEMENT The financial statements of Virco Mfg. Corporation (Virco or the Company) were prepared by
management, which is responsible for the integrity and objectivity of the financial information
presented, including amounts that must necessarily be based on judgments and estimates. The
statements were prepared in conformity with accounting principles generally accepted in the United
States, and in situations where acceptable alternative accounting principles exist, management
selected the method that it believed was most appropriate in the circumstances. The financial statements have been audited by the Companys independent auditors, Ernst & Young
LLP. The independent auditors provide an objective, independent review as to managements discharge
of its responsibilities insofar as they relate to the fairness of reported operating results and
financial condition. They obtain and maintain an understanding of Vircos accounting and financial
controls, and conduct such tests and procedures as they deem necessary to arrive at an opinion on
the fairness of the financial statements. The Audit Committee of the Board of Directors, which is composed of Directors from outside the
Company, maintains an ongoing appraisal of the effectiveness of audits and the independence of the
auditors. The Committee meets periodically with the auditors and management. The independent
auditors have free access to the Committee, without management present, to discuss the results of
their audit work and their opinions on the adequacy of internal financial controls and the quality
of financial reporting. Based on a review and discussions of the Companys 2004 audited consolidated financial statements
with management and discussions with the independent auditors, the Audit Committee recommended to
the Board of Directors that the Companys 2004 audited consolidated financial statements be
included in the Companys annual report on Form 10-K. The Board of Directors concurred. EXECUTIVE OVERVIEW Managements strategy is to position Virco as the overall value supplier of moveable furniture and
equipment. The markets that Virco serves include the education market (the Companys primary
market), which includes public and private schools (preschool through 12th grade), junior and
community colleges, four-year colleges and universities, and trade, technical and vocational
schools; convention centers and arenas; the hospitality industry, with respect to their banquet and
meeting facilities requirements; government facilities at the federal, state, county and municipal
levels; and places of worship. In addition, the Company sells to wholesalers, distributors,
retailers and catalog retailers that serve these same markets. These institutions are frequently
characterized by extreme seasonality and/or a bid-based purchasing function. The Companys business
model, which is designed to support this strategy, includes the development of several competencies
to enable superior service to the markets in which Virco competes. An important element of Vircos
business model is the Companys emphasis on developing and maintaining key manufacturing,
warehousing, distribution, and service capabilities. Finally, management continues to hone Vircos
ability to forecast, finance, manufacture, warehouse, deliver, and install furniture within the
relatively narrow delivery window associated with the highly seasonal demand for education sales.
In fiscal year 2004, over 50% of the Companys total sales were delivered in June, July, August and
September with an even higher portion of educational sales delivered in that period. Vircos
substantial warehouse space allows the Company to build adequate inventories to service this narrow
delivery window for the education market. The commercial furniture markets are beginning to recover from the worst recorded recession in
recent history. As a group, the members of BIFMA (the Business and Institutional Furniture
Manufacturers Association) recorded a 5% increase in shipments in calendar year 2004. This
followed decreases of 3%, 19.1% and 17.4% in 2003, 2002 and 2001, respectively. The impact of the
recession on the school market lagged the commercial market and did not hit with full intensity
until 2003. During this time Virco incurred sales declines of 21.5%, 5.1%, and 10.4% in 2003,
2002, and 2001 respectively. During 2004, Vircos shipping volume increased by approximately 4%.
Although current year sales results have stabilized, the Company incurred severe increases in
certain raw material costs. The cost of steel, which is the Companys largest raw material,
doubled during 2004, and is nearly three times higher than at the beginning of 2002. The cost of
plastic, which is a significant material cost, increased dramatically. Finally, the cost of fuel,
which impacts inbound freight on materials, certain manufacturing processes, and shipping costs to
customer locations, increased substantially. Due to the nature of the Companys annual contracts
with school districts, the Company was not able to pass on the increased material costs. The
causes of, and effects on, Virco of the general economic conditions are discussed below under
Results of Operations (2004 vs. 2003)Industry Overview. In response to the recession and the resulting decrease in sales of Vircos products during 2001,
2002, and 2003, the Company has used a variety of tactics to reduce spending, including its
Assemble-to-Ship operating model, which permits the Company to hold reduced inventory levels,
wage and hiring freezes, and reductions in its workforce. These cost-saving measures allowed the
Company to finish the year with cash flow from operations being slightly positive, despite having
incurred a large operating loss for the year. The Company does not anticipate that demand for furniture in the education markets will change
substantially in the coming year. We anticipate an increase in bond funded projects, and
relatively flat demand for replacement furniture due to the continued financial pressures placed on
school operating budgets. It is our intent to raise prices substantially, in order to recover the
increased raw material costs as well as the freight and service costs for those customers that
require full service installation and delivery. Actual volume shipped during 2005 will be impacted
by the behavior of our competitors in response to the increased material costs and selling prices.
We will maintain our core workforce at current levels for the near future, supplemented with
temporary labor as considered necessary in order to produce, warehouse, deliver, and install
furniture during the coming summer. Because the Company has not closed any manufacturing or
distribution facilities, any increase in demand for our product can be met without any required
investment in physical infrastructure, resulting in favorable operating
leverage. 1




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Managements Discussion and Analysis of Financial Condition and Results of Operations includes
a number of forward-looking statements that reflect the Companys current views with respect to
future events and financial performance. These forward-looking statements are subject to certain
risks and uncertainties, including those discussed herein, in Item 1, and elsewhere in this report
on Form 10-K, that could cause actual results to differ materially from historical results or those
anticipated. Risks and uncertainties that could cause actual results to vary materially from
anticipated results, include without limitation, material availability and cost of materials,
especially steel, plastic, fuel and energy; availability and cost of labor, demand for the
Companys products, and competitive conditions affecting selling prices and margins, capital costs
and general economic conditions. In this report, words such as anticipates, believes,
expects, will continue, estimates, projects, future, intends, plans, potential,
budgets, may, could and similar expressions identify forward-looking statements. Readers are
cautioned not to place undue reliance on these forward-looking statements, which speak only as of
the date hereof. CRITICAL ACCOUNTING POLICIES AND ESTIMATES This discussion and analysis of Vircos financial condition and results of operations is based upon
the Companys financial statements which have been prepared in accordance with U.S. generally
accepted accounting principles. The preparation of these financial statements requires Virco
management to make estimates and judgments that affect the Companys reported assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going
basis, management evaluates such estimates, including those related to revenue recognition,
allowance for doubtful accounts, valuation of inventory including LIFO and obsolescence reserves,
self-insured retention for products and general liability insurance, self-insured retention for
workers compensation insurance, provision for warranty, liabilities under defined benefit and other
compensation programs, and estimates related to deferred tax assets and liabilities. Management
bases its estimates on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances. This forms the basis of judgments about the carrying value
of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. Factors that could cause or
contribute to these differences include the factors discussed above under Item 1, Business, and
elsewhere in this report on Form 10-K. Vircos critical accounting policies are as follows: Revenue Recognition: The Company recognizes revenue in accordance with Staff Accounting Bulletin
(SAB) No. 101, Revenue Recognition, as revised by SAB No. 104. Sales are recorded when title
passes and collectability is reasonably assured under its various shipping terms. The Company
reports sales as net of sales returns and allowances. Allowances for Doubtful Accounts: Considerable judgment is required when assessing the ultimate
realization of receivables, including assessing the probability of collection, current economic
trends, historical bad debts and the current creditworthiness of each customer. The Company
maintains allowances for doubtful accounts that may result from the inability of our customers to
make required payments. Over the past five years, the Companys allowance for doubtful accounts has
ranged from approximately 0.7% to 1.4% of accounts receivable at year-end. The allowance is
evaluated using historic experience combined with a detailed review of past due accounts. The
Company does not typically obtain collateral to secure credit risk. The primary reason that Vircos
allowance for doubtful accounts represents such a small percentage of accounts receivable is that a
large portion of the accounts receivable are attributable to low-credit-risk governmental entities,
giving Vircos receivables a historically high degree of collectability. Although many states are
experiencing budgetary difficulties, it is not anticipated that Vircos credit risk will be
significantly impacted by these events. Over the next year, no significant change is expected in
the Companys sales to government entities as a percentage of total revenues. Inventory Valuation: Inventory is valued at the lower of cost or market. The Company uses the LIFO
(last-in, first-out) method of accounting for the material component of inventory. The Company
maintains allowances for estimated obsolete inventory to reflect the difference between the cost of
inventory and the estimated market value. Valuation allowances are determined through a physical
inspection of the product in connection with a physical inventory, a review of slow-moving product,
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 significant obsolescence
expense. If market conditions are less favorable than those anticipated by management, additional
allowances may be required. Due to reductions in sales volume in the past year, the 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. Self-Insured Retention: For 2003 and 2004, the Company was self-insured for product liability
losses up to $500,000 per occurrence, for workers compensation losses up to $250,000 per
occurrence, and for auto liability up to $50,000 per occurrence. The Company obtains annual
actuarial valuations for the self-insured retentions. Product liability and auto reserves for known
and unknown (IBNR) losses are recorded at the net present value of the estimated losses using a
6.0% discount rate. Given the relatively short term over which the IBNR losses are discounted, the
sensitivity to the discount rate is not significant. Estimated workers compensation losses are
funded during the insurance year and subject to retroactive loss adjustments. The Companys
exposure to self-insured retentions varies depending upon the market conditions in the insurance
industry and the availability of cost-effective insurance coverage. It is anticipated that
self-insured retentions for 2005 will be comparable to the retention levels for 2004. Warranty Reserve: The Company provides a product warranty on most products. The standard warranty
offered on products sold through January 31, 2005 is five years. Effective February 1, 2005, the
standard warranty has been increased to 10 years on products sold after February 1, 2005. It
generally warranties that customers can return a defective product during the specified warranty
period following purchase 2




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in exchange for a replacement product or that the Company can repair the product at no charge to
the customer. The Company determines whether replacement or repair is appropriate in each
circumstance. The Company uses historic 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. Warranty expense for the last
two years has been higher than normal due to a recurring cosmetic complaint relating to a
high-volume component. Defined Benefit Obligations: The Company has three defined benefit plans, the Virco Employees
Retirement Plan, the Virco Important Performers (VIP) Plan and the Non-Employee Directors
Retirement Plan, which provide retirement benefits to employees and outside directors. Virco
discounts the pension obligations under the plans using a 6.5% discount rate, before a 5.0% assumed
rate of increases in compensation rates, and estimating a 6.5% return on plan assets. These rate
assumptions can vary due to changes in interest rates, the employment market, and expected returns
in the stock market. In prior years, the discount rate and the anticipated rate of return on plan
assets have decreased by several percentage points, causing pension expense and pension obligations
to increase. Although the Company does not anticipate any change in these rates in the coming year,
any moderate change should not have a significant effect on the Companys financial position,
results of operations or cash flows. Effective December 31, 2003, the Company froze new benefit
accruals under all three plans. The effect of freezing future benefit accruals minimizes the impact
of future raises in compensation, but introduces a new assumption related to the plan freeze. It is
the Companys intent to resume a retirement benefit when the profitability and the financial
condition of the Company allow, and the actuarial valuations assume the plans will be frozen for
two years. If the assumption is modified to a permanent freeze, the Company would be required to
immediately recognize any prior service cost / benefit. If the Company had assumed a permanent
freeze, pension expense for 2004 and 2003 would decrease by approximately $57,000 and $125,000,
respectively. The Company obtains annual actuarial valuations for all three plans. Deferred Tax Assets and Liabilities: The Company recognizes deferred income taxes under the asset
and liability method of accounting for income taxes in accordance with the provisions of Statement
of Financial Accounting Standards (SFAS) No. 109, 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. In assessing the realizability of deferred tax
assets, the Company considers whether it is more likely than not that some portion or all of the
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. The Company considers
the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax
planning strategies in making this assessment. Based on this consideration, the Company anticipates
that it is more likely than not that the net deferred tax assets will not be realized, and a
valuation allowance has been recorded against the net deferred tax assets at January 31, 2005 and
January 31, 2004. At January 31, 2005, the Company has net operating loss carried forward for
federal and state income tax purposes, expiring at various dates through 2025 if not utilized.
Federal net operating losses that can potentially be carried forward total approximately
$20,750,000 at January 31, 2005. State net operating losses that can potentially be carried
forward total approximately $48,307,000 at January 31, 2005. RESULTS OF OPERATIONS (2004 VS. 2003) INDUSTRY OVERVIEW As discussed above, the commercial furniture markets, including Vircos core school markets, have
suffered from the recent economic recession. The financial difficulties experienced by our core
education customers derive primarily from budgetary pressures and shortfalls at state and local
government levels. In 2003, the State of California received significant press coverage regarding
its $15 billion budget shortfall, but funding issues existed at virtually every state and local
level. In 2004 funding levels were more stable, but budgetary pressures to control spending are
still prevalent. The last time states faced such difficult fiscal conditions was after the 1990-91
recession, but the states have reacted differently this time. In 1991, the states raised taxes by
approximately 5.4% of the previous years tax collections. In 2003, states raised taxes by 1.5% of
the previous years revenues. Reluctance to raise taxes as aggressively or cut spending may extend
the current budget condition. Because many states used debt to bridge budget gaps instead of
balancing budgets with tax increases or spending reductions, the outlook for 2005 suggests that the
market for school furniture will improve, but not substantially in the short term. Funding for school furniture comes from two primary sources. The first source is from bonds issued
to fund new school construction and major renovations of older schools. For 2004, funds relating to
new school construction and renovation improved slightly compared to the prior year. The second
source is the general operating fund, which is a primary source of replacement furniture. The
reduction in sales is primarily attributable to replacement furniture purchased from the general
fund. Approximately 80-85% of a schools budget is spent on salaries and benefits for teachers and
administrators. In times of budget shortfalls, schools traditionally attempt to retain teachers and
spend less on repairs, maintenance, and replacement furniture. During the last four years, many furniture manufacturers have responded by shutting down
significant portions of their manufacturing capacity and laying off thousands of workers, incurring
large restructuring charges in the process. For the first two years of this recession, Virco
responded with a different approach designed to preserve the Companys manufacturing and
distribution infrastructure and save the jobs of Vircos trained workforce. The Company used a
variety of tactics to reduce spending. Capital expenditures were reduced to approximately one-
quarter of depreciation expense in 2003 and 2002, and one third of depreciation expense in 2001.
The Company has embraced the Assemble-to-Ship operating model, which facilitated large
reductions in inventory levels in 2003 and 2001, and improved levels of customer service while
maintaining reduced levels of inventory in 2004 and 2002. To control and reduce the cost of Vircos
workforce, the Company 3




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used traditional measures such as wage freezes and hiring freezes, as well as more creative
measures that addressed the unique demands of a highly seasonal business. The more creative
measures included programs to encourage workforce flexibility; moreover, in 2002 the Company
introduced a sabbatical program for employees during the traditionally slow fourth quarter. The tactics used by Virco to weather the reductions in sales during 2001 and 2002 were not adequate
to address the 21.5% reduction in sales in 2003. In addition to the cost-saving efforts used in the
prior two years, Virco implemented a voluntary separation program, which was accepted by 485
employees (25% of the workforce) in the second quarter. In the third quarter, the Company laid off
an additional 160 employees. The reduction in headcount combined with other savings were intended
to allow the Company to operate profitably at an annual sales volume of approximately $200 million. The techniques used by Virco to reduce operating expenses have successfully structured the Company
to operate profitably at sales volumes of $200  220 million, had the Company not incurred volatile
increases in the cost of raw materials and transportation costs. During 2004 the Company incurred
no layoffs or restructuring charges, and does not anticipate any such changes for 2005. For 2005
the Company intends to raise prices substantially. Prices for all customers will be raised to
cover the increased cost of raw materials. Prices will be raised for customers that require higher
levels of service, including freight to and installation at the customer location, as well as for
customers with lower average order sizes. FINANCIAL RESULTS AND CASH FLOW For the year ended January 31, 2005, the Company had a net loss of $13,995,000 on net sales of
$199,854,000 compared to a net loss of $21,961,000 on net sales of $191,852,000 in the same period
last year. The loss was $1.07 per share for the year ended January 31, 2005, compared to a net loss
of $1.68 per share in the prior year. Cash flow from operations was $3,768,000 compared to
$(498,000) in the prior year. During 2004, the Company incurred a large operating loss, yet managed
to finish the year with cash flow from operations being slightly positive. To accomplish this, the
Company reduced accounts receivable and inventory balances despite an increase in sales volume.
The Company limited capital expenditures to $2,799,000 compared to depreciation expense of
$9,799,000. By year-end, the Company was able to reduce its long-term debt by more than $2.2
million. SALES Vircos sales increased by 4.2% in 2004 to $199,854,000 compared to $191,852,000 in 2003. As
discussed above, the furniture industry recovered modestly in 2004 after three consecutive years of
decline. The increase in sales was primarily attributable to increased projects. In addition, the
commercial furniture markets enjoyed a modest recovery as well. Although the market for school
furniture improved in 2004, states and local governments are still suffering budgetary pressures,
and the market still remains weak. Due to the significant reduction in the school furniture sales
in 2003, competition was pronounced and Virco was unable to increase prices during 2004. When the
Company incurred large increases in raw material costs, it was unable to pass along these costs
under the annual contracts with school districts. The increase in sales was attributable to volume
increases as opposed to price. For 2005 the Company will significantly raise selling prices to cover the increased cost of raw
materials and freight expenses. The Company continued to emphasize the value of Vircos products,
the value of Vircos distribution and delivery capabilities, and the value of timely deliveries
during the peak seasonal delivery period. Although this policy may have an adverse effect on unit
volume, the Company intends to restore its gross margins to those attained in earlier years. COST OF SALES Cost of sales was 72% of sales for both 2004 and 2003. The cost of sales in total was stable, but
the components of the cost varied dramatically in 2004 compared to 2003. During 2004, the cost of
raw materials increased dramatically, offset by a comparable reduction in manufacturing overhead
spending in 2004 compared to 2003. During the beginning of 2004, Virco had incurred significant
disruption in the supply of steel in addition to markedly higher prices. Very significant purchases
of steel by China, of both finished product and raw materials to produce steel, have impacted the
market for steel. In addition, a fire in one of the largest coal mines in the United States
disrupted the supply of domestic steel. During 2004 the cost of steel nearly doubled. In addition
to higher steel prices, the Company incurred increases in the prices of raw materials and operating
expenses that are impacted by the cost of oil, especially plastics and freight expense. The
increase in raw material costs was offset by a reduction in overhead spending. During 2003, in
response to a 21.5% decline in sales volume, production volume was reduced to match the decline in
sales volume, and further reduced to facilitate a $14 million reduction in inventory. The
decreases in production volume, combined with certain inefficiencies associated with the reduction
in workforce, caused overhead variances to increase. In 2005, the Company intends to maintain the improved overhead cost structure attained through the
restructuring in 2003 and recover the increased material costs incurred in 2004 by increased
selling prices. The Company intends to more tightly integrate the ATS model with our marketing
programs, product development programs, and product stocking plan. This anticipated improvement in
execution of ATS should allow the Company to offer a wide variety of product while improving
on-time delivery performance. Because the Company is beginning the year with slightly less
inventory, production levels, which will vary depending upon selling volumes, are anticipated to be
comparable to 2004. The Company anticipates continued upward pressure on costs, particularly in the areas of certain
raw materials, transportation, energy, and benefits in the coming year. Steel has stabilized
during the first quarter of 2005, but at the higher prices experienced in 2004. For more 4




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information, please see the section entitled Inflation and Future Change in Prices in the
Managements Discussion and Analysis section contained in Vircos Annual Report to Shareholders for
the year ended January 31, 2005. SELLING, GENERAL AND ADMINISTRATIVE AND OTHERS Selling, general and administrative expenses for the year ended January 31, 2005, excluding
severance costs, decreased by more than $2 million despite a 4% increase in sales, and were 34.1%
as a percentage of sales as compared to 36.8% in 2003. Freight costs increased by approximately
$250,000 and decreased slightly as a percentage of sales. Freight and installation costs in 2004
were adversely impacted by increased fuel costs and an increase in small orders requiring freight
and installation. During the summer of 2003 the Company reduced its workforce by 485 employees.
While the reduction in the workforce successfully lowered the Companys cost structure, the Company
incurred certain inefficiencies in coordinating production, shipment, and installation of customer
orders during the third quarter of 2003. The Company did not incur comparable inefficiencies in
2004. For 2004, the Company initiated programs to streamline product offerings, tightly integrated the
inventory stocking program to coordinate with marketing programs, and reorganized freight and
installation teams to improve the efficiency of freight and installation costs. The Company expects
to continue these programs. For 2005, the Company intends to raise selling prices to cover
increased raw material costs as well as increase prices on smaller orders requiring full service.
If successful, this should cause freight and installation costs to decline as a percentage of sales
in 2005, but there can be no assurance of attaining a reduction due to volatility in fuel and
freight rates as well as fluctuations in the portion of business requiring full service. During 2003, the Company initiated a voluntary separation program in the second quarter followed by
a non-voluntary reduction in workforce in the third quarter. In connection with these reductions,
the Company incurred $13,920,000 of severance costs. During 2004, the Company incurred no
restructuring costs, and was able to support an increased volume in sales by supplementing the
existing workforce with part-time or temporary labor. Management intends to maintain Vircos core
workforce at current levels for the near future, supplemented with temporary labor as considered
necessary in order to produce, warehouse, deliver, and install furniture during the coming summer. Interest expense was approximately $36,000 more than the prior year. Both borrowing levels and
interest rates were comparable to the prior year. In 2005, the Company anticipates comparable
average borrowing levels and an increase in the average interest rate paid. In 2004 Virco has no gain or loss on the disposition of assets, compared to 2003 when Virco
realized a significant gain on the sale of a former manufacturing facility. This facility had been
held as rental property since 1994 when the Company relocated to the Torrance, California,
manufacturing and distribution operation. The gain on sale for 2003 was $5,497,000. PROVISION 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 Statement of Financial Accounting Standards
(SFAS) No. 109, 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. In assessing the realizability of deferred tax assets, the Company considers
whether it is more likely than not that some portion or all of the 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. The Company considers the scheduled reversal of deferred
tax liabilities, projected future taxable income, and tax planning strategies in making this
assessment. Based on this consideration, the Company anticipates that it is more likely than not
that the net deferred tax assets will not be realized, and a valuation allowance has been recorded
against the net deferred tax assets at January 31, 2005 and January 31, 2004. At
January 31, 2005, the Company has net operating losses carried forward for federal and state
income tax purposes, expiring at various dates through 2025 if not utilized. Federal net operating
losses that can potentially be carried forward total approximately $20,750,000 at January 31, 2005.
State net operating losses that can potentially be carried forward total approximately $48,307,000
at January 31, 2005. For the fiscal year ended January 31, 2005, the Company incurred $115,000 of income and franchise
taxes as required by various states. For the fiscal year ended January 31, 2004, the Company
recognized an income tax benefit for an amount equal to the estimated available net operating loss
that could be carried back against prior year taxes paid by the Company. RESULTS OF OPERATIONS (2003 VS. 2002) FINANCIAL RESULTS AND CASH FLOW For the year ended January 31, 2004, the Company had a net loss of $21,961,000 on net sales of
$191,852,000 compared to a net income of $282,000 on net sales of $244,355,000 for the year ended
January 31, 2003. The loss was $1.68 per share for the year ended January 31, 2004, compared to net
income of $0.02 per share in the prior year. Cash flow from operations was $(498,000) compared to
$12,045,000 in the prior year. During 2003, the Company incurred a large operating loss, yet
managed to finish the year with cash flow from operations being slightly 5




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negative. To accomplish this, the Company reduced inventory balances by over $14 million. The
Company generated cash from investing activities by controlling capital expenditures, curtailing a
split dollar life insurance program, and selling a manufacturing plant that was no longer used in
operations. By year-end, the Company was able to reduce its long-term debt by more than $3.7
million. SALES Vircos sales decreased by 21.5% in 2003 to $191,852,000, from $244,355,000 in 2002. As previously
discussed, the reduction in sales is primarily attributable to severe budget shortfalls incurred by
the Companys primary customers, publicly funded schools. In addition, the commercial furniture
markets have not recovered from a severe recession incurred in 2001 and 2002. Although certain
states were impacted more severely than others, virtually all state and local governments had been
affected. Vircos sales declined in all but seven of the states in which Virco conducted business
in 2003. Throughout 2003, the Company continued to maintain pricing discipline in its primary
markets. The reduction in sales dollar volume was attributable to a reduction in unit volume, not
price. The Company continued to emphasize the value of Vircos products, the value of Vircos
distribution and delivery capabilities, and the value of timely deliveries during the peak seasonal
delivery period. Although this policy had an adverse effect on unit volume, the Company achieved a
slight net increase in selling prices. COST OF SALES For fiscal 2003, cost of sales was 72% of sales compared to 66% of sales in the prior year. Raw
material costs increased by approximately 2% of sales, primarily due to increased steel prices. The
balance of the increase was attributable to reduced levels of production. In response to reduced
levels of sales, the Company severely reduced levels of manufacturing output in 2003 in order to
control inventory levels. The Company ended 2003 with $14.5 million less inventory than in 2002.
Overhead spending was not reduced by a comparable amount, and the factories incurred unfavorable
production variances. Inflation rates had a moderate impact on the Companys cost of sales. In March 2002, tariffs of up
to 30% on imports of selected steel products were imposed pursuant to Section 201 of the Trade Act
of 1974. Cold-rolled steel is the single largest raw material used by many in the educational
furniture industry, including Virco, and was subject to the maximum 30% tariff. Because Virco had
acquired a substantial portion of its steel requirements by the effective date of the tariff, the
Company did not incur the higher steel prices until the latter part of 2002. Virco incurred higher
steel prices for all of 2003. SELLING, GENERAL AND ADMINISTRATIVE AND OTHERS Selling, general and administrative (SG&A) expenses for the year ended January 31, 2004, excluding
severance costs, decreased by nearly $9 million, and were 36.8% as a percentage of sales in 2003 as
compared to 32.5 % in 2002. During the summer of 2003 the Company reduced its workforce by 485
employees. While the reduction in the workforce successfully lowered the Companys cost structure,
the Company incurred certain inefficiencies in coordinating production, shipment, and installation
of customer orders during the third quarter of 2003. Freight costs declined by approximately
$2,250,000 due to a reduction in selling volume offset by increased freight rates and an increased
percentage of less-than-truckload (LTL) shipments. Other SG&A spending was adversely affected by
increased installation costs, offset by other reductions in selling and administrative expenses. During the second and third quarters of 2003, the Company determined that the reduced level of
orders received in the first quarter would likely continue for the rest of the year and possibly
through 2005 as well. In the second quarter of 2003 the Company announced a voluntary separation
program in addition to other measures that included voluntary part-time work and voluntary
sabbaticals. Under the program, employees who voluntarily terminated their employment with the
Company were paid six months of severance pay. During the second quarter, 485 employees accepted
this offer. Approximately 25% of the workforce severed their employment in June and July. Including
employer taxes, the Company incurred approximately $7.8 million in severance costs during the
second quarter. During the third quarter of 2003, the Company elected to further reduce expenses and head count
through a non-voluntary reduction in force. In September, the Company laid off an additional 160
employees. These employees were given six months of severance pay in addition to a variety of
outplacement service benefits to help them locate new employment. The Company incurred
approximately $2.6 million of severance costs in the third quarter related to this reduction in
workforce. In addition to the severance costs, the Company incurred additional pension settlement
costs of approximately $2 million in the third quarter and recorded another $1.5 million of pension
settlement costs during the fourth quarter. Interest expense for 2003 was approximately $1,300,000 less than in the prior year due to reduced
levels of borrowing and lower interest rates. In 2003, Virco realized a significant gain on the sale of a former manufacturing facility. This
facility had been held as rental property since 1994 when the Company relocated the Torrance,
California, manufacturing and distribution operation. The gain on sale for the current year was
$5,497,000. This compares to a loss on sale of assets of approximately $149,000 in the prior year. LIQUIDITY AND CAPITAL RESOURCES WORKING CAPITAL REQUIREMENTS Virco addresses liquidity and capital requirements in the context of short-term seasonal
requirements and the long-term capital requirements of 6




---



##### 



the business. The Companys core business of selling furniture to publicly funded educational
institutions is extremely seasonal. The seasonal nature of this business permeates most of Vircos
operational, capital, and financing decisions. The Companys working capital requirements during and in anticipation of the peak summer season
oblige management to make estimates and judgments that affect Vircos assets, liabilities, revenues
and expenses. Management expends a significant amount of time during the year, and especially in
the first quarter, developing a stocking plan and estimating the number of employees, the amount of
raw materials, and the types of components and products that will be required during the peak
season. If management underestimates any of these requirements, Vircos ability to fill customer
orders on a timely basis or to provide adequate customer service may be diminished. If management
overestimates any of these requirements, the Company may be required to absorb higher storage,
labor and related costs, each of which may affect profitability. On an ongoing basis, management
evaluates such estimates, including those related to market demand, labor costs, and inventory
levels, and continually strives to improve Vircos ability to correctly forecast business
requirements during the peak season each year. As part of Vircos efforts to address seasonality, financial performance and quality without
sacrificing service or market share, management has been refining the Companys ATS operating
model. ATS is Vircos version of mass-customization, which assembles standard, stocked components
into customized configurations before shipment. The Companys ATS program reduces the total amount
of inventory and working capital needed to support a given level of sales. It does this by
increasing the inventorys versatility, delaying assembly until the last moment, and reducing the
amount of warehouse space needed to store finished goods. In addition, Virco finances its largest balance of accounts receivable during the peak season. This
occurs for two primary reasons. First, accounts receivable balances naturally increase during the
peak season as shipments of products increase. Second, many customers during this period are
government institutions, which tend to pay accounts receivable more slowly than commercial
customers. As the capital required for the summer season generally exceeds cash available from operations,
Virco has historically relied on third-party bank financing to meet seasonal cash flow
requirements. Virco has established a long-term relationship with its primary lender, Wells Fargo
Bank. On an annual basis, the Company prepares a forecast of seasonal working capital requirements,
and renews its revolving line of credit. For fiscal 2005, Virco has entered into a revolving credit
facility with Wells Fargo Bank, amended and restated January 21, 2005, which provides a term loan
of $20,000,000 and a secured revolving line of credit that varies with levels of inventory and
receivables, up to a maximum of $40,000,000. The term loan is a two-year line amortizing at
$5,000,000 per year with interest payable monthly at a fluctuating rate equal to the Banks prime
rate plus a fluctuating margin. The revolving line has a 24-month maturity with interest payable
monthly at a fluctuating rate equal to the Banks prime rate plus a margin of 1.50%. The revolving
line typically provides for advances of 80% on eligible accounts receivable and 20%  60% on
eligible inventory. The revolving credit facility with Wells Fargo Bank is subject to various
financial covenants and places certain restrictions on capital expenditures, new operating leases,
dividends and the repurchase of the Companys common stock. Approximately $16,221,000 was
available for borrowing as of January 31, 2005. During 2004 and 2003, the Company incurred large operating losses, yet managed to finish each year
with less debt than at the beginning of the year. This was accomplished through the following
actions. In 2004, the Company spent $2.8 million on capital expenditures, compared to depreciation
expense of $9.8 million. In addition, receivables were reduced by over $1 million and inventories
were reduced by nearly $2.5 million. In 2003, the Company reduced inventory balances by over $14
million. This was accomplished by streamlining the product offering for 2004, delaying until
February Vircos seasonal production of stock inventory for summer delivery, and aggressively
reducing other inventories. The Company spent $2.3 million on capital expenditures, compared to
depreciation expense of $11.6 million, providing more than $9 million of cash. The Company sold a
former manufacturing facility, formerly held as rental property, which generated nearly $5,800,000
in cash. Finally, the Company terminated or curtailed certain benefit programs, including split
dollar life insurance and deferred compensation plans, which reduced other non-current assets by
$2.5 million. Many of these actions are one-time events, and will not be repeated in future years.
The only anticipated recurring event is the excess of depreciation over capital expenditures. The
Company is budgeting for capital expenditures to be less than depreciation for 2005, and the amount
of cash generated is expected to be approximately $4-5 million. As a result of the increased material costs previously described, the Company violated debt
covenants related to the line of credit with Wells Fargo at the end of the third quarter of 2004.
The violation of covenants was waived at the end of the quarter, and the Company re-negotiated its
line of credit with the bank effective January 21, 2005. Management believes cash generated from operations and from the previously described sources will
be adequate to meet its capital requirements in the next 12 months. LONG-TERM CAPITAL REQUIREMENTS In addition to short-term liquidity considerations, the Company continually evaluates long-term
capital requirements. In 1997, the Company initiated two large capital projects, which have had
significant effects on cash flow for the past five years. In the 1998, 1999, and 2000 fiscal years
the Company expended significant amounts of capital on these projects. Upon completion of these
projects, the Company dramatically reduced capital spending. As shown in the Companys consolidated
statements of cash flows, during 2001, 2002, 2003, and 2004 capital expenditures ranged from
one-quarter to one-third of depreciation expense. The first project was the implementation of the SAP enterprise resources planning system, initiated
in October 1997. The Company went live with the new system in March 1999, implemented a
business-to-business website along with sales force automation in the first quarter of 2000, and
upgraded to a more current version of SAP in the fourth quarter of 2000. The initial portion of
this project was financed with a lease from 7




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##### 



General Electric Capital Corporation (GECC). Capital and training costs not funded by the lease
were financed from cash flows from operations and from the loan facility from Wells Fargo Bank.
During fiscal year 2002 the Company paid off the balance of the capital lease. The second project was the expansion and re-configuration of the Conway, Arkansas, manufacturing
and distribution facility. During 1997, 1998, 1999, and 2000 the Company expended approximately
$67,000,000 to purchase 100 acres of land, and build a 1,200,000 sq. ft. manufacturing and
distribution facility equipped with new manufacturing and warehousing equipment. To finance this
project, the Company borrowed $30,000,000 from Wells Fargo Bank, obtained equipment with operating
leases from GECC, and used operating cash flow. As phases of the Conway expansion were completed,
the Company was able to vacate several leased warehouses, sell a small production facility, and
convert a second production facility into a warehouse. In addition, Virco sold a warehouse located
in Torrance, California, which had been held as rental property. Upon the completion of these substantial capital projects, the Company significantly reduced
capital spending in 2004, 2003, 2002 and 2001. Management intends to limit future capital spending
until growth in sales volume fully utilizes the new plant and distribution capacity. The Company
has established a goal of limiting capital spending to less than $5,000,000 for 2005, which is
approximately one-half of anticipated depreciation expense. ASSET IMPAIRMENT In 2002, Virco acquired certain assets of Furniture Focus. As part of this acquisition, the Company
recorded goodwill of $2,200,000. During 2003, the Company rolled out the Furniture Focus package
business nationwide. For 2005, Virco has expended significant effort training the sales force in
package selling. In addition, Virco stocks selected products of other manufacturers that complement
Vircos product line, enabling Virco to fill nearly the entire FF&E budget line item for a K-12
school from products carried in stock. Virco evaluates the impairment of goodwill at least
annually, or when indicators of impairment occur. As of January 31, 2005, there has been no
impairment to the goodwill recorded. In December 2003, Virco acquired certain assets of Corex Products, Inc., a manufacturer of
compression molded components, for approximately $1 million. The assets have been transferred to
the Companys Conway, Arkansas, location where they have been integrated with Vircos existing
compression molding operation. In connection with this acquisition, Virco acquired certain patents
and other intangible assets. As of January 31, 2005, there has been no impairment to the intangible
assets recorded. Virco made substantial investments in its infrastructure in 1998, 1999, and 2000. The investments
included a new factory, new warehouse, and new production and distribution equipment. The factory,
warehouse, and equipment acquired are used to produce, store, and ship a variety of product lines,
and the use of any one piece of equipment is not dependent on the success or volume of any
individual product. New products are designed to use as many common or existing components as
practical. As a result, both our ATS inventory components and the machines used to produce them
become more versatile. Virco evaluates the potential for impaired assets on a quarterly basis. As
of January 31, 2005, there has been no impairment to the long-term assets of the Company. CONTRACTUAL OBLIGATIONS AND OFF BALANCE SHEET ARRANGEMENTS The Company leases manufacturing, transportation, and office equipment, as well as real estate
under a variety of operating leases. The Company leases substantially all vehicles, including
trucks and passenger cars under operating leases where the lessor provides fleet management
services for the Company. The fleet management services provide Virco with operating efficiencies
relating to the acquisition, administration, and operation of leased vehicles. The use of operating
leases for manufacturing equipment has enabled the Company to qualify for and use Industrial
Revenue Bond financing. Real estate leases have been used where the Company did not want to make a
long-term commitment to a location, or when economic conditions favored leasing. The Company does
not have any capital lease obligations or purchase commitments in excess of normal recurring
obligations. CONTRACTUAL OBLIGATIONS PAYMENTS DUE BY PERIOD Less than 1
    
    
    
    
    
    
    
    
    
    
    More than 5(In thousands)
    
    Total
    
    
    year
    
    
    1-3 years
    
    
    3-5 years
    
    
    yearsLong-Term Debt Obligations
    
    $
    23,130
    
    
    $
    5,012
    
    
    $
    18,027
    
    
    $
    24
    
    
    $
    67Capital Lease Obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating Lease Obligations
    
    
    29,237
    
    
    
    9,340
    
    
    
    12,353
    
    
    
    7,512
    
    
    
    32Purchase Obligations
    
    
    25,316
    
    
    
    25,316
    
    
    
    
    
    
    
    
    
    
    
    Other Long-Term Obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    77,683
    
    
    $
    39,668
    
    
    $
    30,380
    
    
    $
    7,536
    
    
    $
    99
 Vircos largest market is publicly funded school districts. A significant portion of this business
is awarded on a bid basis. Many school districts 8




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##### 



require that a bid bond be posted as part of the bid package. In addition to bid bonds, many
districts require a performance bond when the bid is awarded. At January 31, 2005, the Company had
bonds outstanding valued at approximately $5,250,000. To the best of managements knowledge, in
over 50 years of selling to schools, Virco has never had a bid or performance bond called. The Company accrues an estimate of its exposure to warranty claims based upon both product sales
data and warranty claims incurred. For 2003 and 2004, warranty claims were higher than normal due
to a recurring cosmetic complaint relating to a high-volume component. At the current time,
management cannot reasonably determine whether warranty claims for the upcoming fiscal year will be
less than, equal to, or greater than warranty claims incurred in 2004. The following is a summary
of the Companys warranty-claim activity during 2004. Balance at January 31, 2004
    
    Provision
    
    
    Costs Incurred
    
    
    Balance at January 31, 2005$1,751,000
    
    $
    1,304,000
    
    
    $
    1,555,000
    
    
    $
    1,500,000
 RETIREMENT OBLIGATIONS The Company provides retirement benefits to employees and non-employee directors under three
defined benefit retirement plans; the Virco Employees Retirement Plan, the Virco Important
Performers (VIP) Retirement Plan, and the Retirement Plan for Non-Employee Directors. The Virco
Employee Retirement Plan is a qualified retirement plan that is funded through a trust held at
Wells Fargo Bank (Trustee). The other two plans are non-qualified retirement plans. The VIP Plan is
secured by life insurance policies held in a rabbi trust and the Plan for Non-Employee Directors is
not funded. In 2002 the Company adopted more conservative assumptions for estimating the return on plan assets
held in the Wells Fargo Bank Trust (Trust) and the rate used to discount the Projected Benefit
Obligation (PBO). For 2004, 2003 and 2002 the Company used a 6.5% expected return on plan assets, a
5.0% expected rate of increase in compensation, and a 6.5% discount rate. The result of using these
more conservative estimates was to increase annual pension expense for the fiscal year ended
January 31, 2004, by approximately $1.5 million and to increase the PBO by approximately $6
million. The combined impact of reduced discount rates and poor investment results over the three
years ended January 31, 2004 resulted in the plan being under-funded. To correct this condition,
the Company made an $8 million contribution to the Trust in September 2002, and a total
contribution of approximately $10 million for the fiscal year ended January 31, 2003. Three significant events occurred during 2003 that affected the retirement plans. First,
approximately 40% of Vircos employees severed their employment with Virco during the year. The
majority of these employees accepted a voluntary severance package. This severance was treated as
plan curtailment. Second, a significant number of employees that severed their employment elected a
lump sum benefit. During 2003 the pension trust disbursed approximately $6.3 million to severed
employees. These distributions were accounted for as a plan settlement. Finally, effective December
31, 2003, Virco froze all future benefit accruals under the plans. Employees can continue to vest
under the benefits earned to date, but no covered participants will earn additional benefits under
the plan freeze. As a result of these activities, Virco incurred additional pension expense of
approximately $1,250,000 related to the plan curtailment, additional pension expense of
approximately $1,540,000 related to the plan settlement, and additional pension expense of
approximately $40,000 related to the plan freeze. As a result of the freeze, the projected benefit
obligation decreased by approximately $7,500,000. The plan freeze is not intended to be permanent.
It is managements intention to restore a retirement benefit when the Companys profitability and
cash flow allow. During 2004, the Companys results of operations and financial position did not allow for a retire
benefit to be restored. Benefit accruals under the plans have remained frozen. Expenses related
to the pensions decreased by more than $6 million compared to 2003 and by more than $3 million
compared to 2002. It is the Companys intent to maintain the funded status of the qualified plan at a minimum of 90%
of the current liability as determined by the plans actuaries. As discussed above, the Company
made a large cash contribution to the plan in 2002. During 2003, the Company contributed
approximately $1,550,000 to the qualified plan and paid approximately $265,000 under the
non-qualified plans. During 2004 the Company paid approximately $255,000 under the non-qualified
plans. It is anticipated that contributions for 2005 will be less than $1 million. The Company does not anticipate making any significant changes to the pension assumptions in the
near future. If the Company were to have used different assumptions in the fiscal year ended
January 31, 2005, a 1% reduction in investment return would have increased expense by approximately
$155,000, a 1% change in the rate of compensation increase would had no impact, and a 1% reduction
in the discount rate would have increased expense by $370,000. A 1% reduction in the discount rate
would have increased the PBO by approximately $3.5 million. Refer to Note 4 to the consolidated
financial statements for additional information regarding the pension plans and related expenses. STOCKHOLDERS EQUITY In April 1998, the Board of Directors approved a stock buy-back program giving authorization to buy
back up to $5,000,000 of Company stock. The authorization of this stock buy-back program was
increased to $7,000,000, $14,000,000, $20,000,000 and $22,000,000 in January 1999, April 1999,
December 2001 and December 2002, respectively. As of the end of January 2005 and 2004, the Company
had repurchased 9




---



##### 



approximately 1,454,000 and 1,383,000 shares at a cost of approximately $18,788,000 and $18,151,000
respectively. During 2004, the Company retired the shares of treasury stock. The Company did not
repurchase any share of stock during 2004. The current line of credit with Wells Fargo Bank does
not allow for repurchases of stock. When the results of operations and cash flow allow, the Company
will re-evaluate the stock buyback program. Prior to 2003, Virco had established a track record of paying cash dividends to its stockholders
for more than 20 consecutive years. As a result of the recent operating losses, the Company
discontinued paying dividends in the second quarter of 2003. The current line of credit with Wells
Fargo Bank does not allow for cash dividends. When the results of operations, cash flow, and loan
covenants allow, the Company intends to reinstate the cash dividend policy. Virco issued a 10% stock dividend or 3/2 stock split every year beginning in 1982 through 2002.
Although the stock dividend has no cash consequences to the Company, the accounting methodology
required for 10% dividends has affected the equity section of the balance sheet. When the Company
records a 10% stock dividend, 10% of the market capitalization of the Company on the date of the
declaration is reclassified from retained earnings to additional paid-in capital. During the period
from 1982 through 2002, 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, 2005, reflects additional paid-in capital of approximately $108
million and deficit retained earnings of approximately $55 million. Other than the losses incurred
in the past two years, the retained deficit is a result of the accounting reclassification, and is
not the result of accumulated losses. ENVIRONMENTAL AND CONTINGENT LIABILITIES The Company and other furniture manufacturers are subject to federal, state, and local laws and
regulations relating to the discharge of materials into the environment and the generation,
handling, storage, transportation, and disposal of waste and hazardous materials. In addition to
policies and programs designed to comply with environmental laws and regulations, Virco has enacted
programs for recycling and resource recovery that have earned repeated commendations, including the
2004 California Waste Reduction Awards Program, designation in 2003 as a Charter Member of the
WasteWise Hall of Fame, in 2002 as a WasteWise Partner of the Year, and in 2001 as a WasteWise
Program Champion for Large Businesses by the United States Environmental Protection Agency. Despite
these significant accomplishments, environmental laws have changed rapidly in recent years, and
Virco may be subject to more stringent environmental laws in the future. The Company has expended,
and expects to continue to expend, significant amounts in the future for the investigation of
environmental conditions, installation of environmental control equipment, and remediation of
environmental contamination. In 2004 and 2003, the Company was self-insured for product liability losses up to $500,000 per
occurrence, for workers compensation losses up to $250,000 per occurrence, and for auto liability
up to $50,000 per occurrence. In prior years the Company has been self-insured for workers
compensation, automobile, product, and general liability losses. The Company has purchased
insurance to cover losses in excess of the self-insured retention or deductible up to a limit of
$30,000,000. For the insurance year beginning April 1, 2005, the Company will be self-insured for
product liability losses up to $500,000 per occurrence, for workers compensation losses up to
$250,000 per occurrence, and for auto liability up to $50,000 per occurrence. In future years, the
Companys exposure to self-insured retentions will vary depending upon the market conditions in the
insurance industry and the availability of cost-effective insurance coverage. During the past 10 years the Company has aggressively pursued a program to improve product quality,
reduce product liability claims and losses, and to more aggressively litigate product liability
cases. This program has continued through 2004 and has resulted in reductions in product liability
claims and litigated product liability cases. In addition, the Company has active safety programs
to improve plant safety and control workers compensation losses. Management does not anticipate
that any related settlement, after consideration of the existing reserves for claims and potential
insurance recovery, would have a material adverse effect on the Companys financial position,
results of operations, or cash flows. INFLATION AND FUTURE CHANGE IN PRICES Inflation rates had a significant impact on the results of operations for 2004, 2003, and 2002.
During these years the Company incurred substantial increases in the cost of raw materials and
energy, particularly steel. In 2002, President Bush announced that he would impose, tariffs of up
to 30% on imports of selected steel products pursuant to Section 201 of the Trade Act of 1974.
During the second half of 2002, the Company incurred higher costs related to steel prices. During
2003, steel prices remained relatively stable, but at the higher levels incurred in the later half
of 2002. During the beginning of 2004, Virco incurred significant disruption in the supply of steel
in addition to markedly higher prices. Very significant purchases of steel by China, of both
finished product and raw materials to produce steel, have impacted the market for steel. In
addition, a fire in one of the largest coal mines in the United States disrupted the supply of
domestic steel. During 2004 the cost of steel nearly doubled. In addition to higher steel prices,
the Company incurred increases in the prices of raw materials and operating expenses that are
impacted by the cost of oil, especially plastics and freight expense. For 2005, the Company anticipates upward pressure on costs, particularly in the areas of certain
raw materials, transportation, energy and employee benefits. The price and supply of steel have
stabilized compared to 2004, but remain at the higher levels. There is continued pressure on raw
material costs that are affected by the price of oil, especially plastics. Transportation costs are
also expected to be adversely affected by increased oil prices, in the form of increased operation
costs for our fleet, and surcharges on freight paid to third-party carriers. Virco expects to incur
continued pressure on employee benefit costs. Virco has aggressively addressed these costs by
reducing headcount, freezing pension 10




---



##### 



benefits, passing on a portion of increased medical costs to employees, and hiring temporary
workers who are not eligible for benefit programs. To counter the impact of increased costs, the Company has raised the list prices for Vircos
products. As a significant portion of Vircos business is obtained through competitive bids, the
Company is carefully considering the increased material cost in addition to increased
transportation costs as part of the bidding process. Total material costs for 2005, as a percentage
of sales, could be higher than in 2004, but it is the Companys intention to raise selling prices
enough so that material costs, as a percentage of sales, return to levels incurred in 2003.
However, no assurance can be given that the Company will experience stable, modest or substantial
increases in prices in 2005. The Company is working to control and reduce costs by improving
production and distribution methodologies, investigating new packaging and shipping materials, and
searching for new sources of purchased components and raw materials. The Company uses the LIFO method of accounting for the material component of inventory. Under this
method, the cost of products sold as reported in the financial statements approximates current
cost, and reduces the distortion in reported income due to increasing costs. Depreciation expense
represents an allocation of historic acquisition costs and is less than if based on the current
cost of productive capacity consumed. In 2004, 2003, 2002 and 2001, the Company significantly
reduced its expenditures for capital assets, but in the previous three fiscal years (1998, 1999,
and 2000) the Company made the significant fixed asset acquisitions described above. The assets
acquired result in higher depreciation charges, but due to technological advances should result in
operating cost savings and improved product quality. In addition, some depreciation charges were
offset by a reduction in lease expense. The Company is also subject to interest rate risk related to its $23,130,000 of borrowings as of
January 31, 2005, and any seasonal borrowings used to finance additional inventory and receivables.
Rising interest rates may adversely affect the Companys results of operations and cash flows
related to its variable-rate bank borrowings. Accordingly, a 100 basis point upward fluctuation in
the lenders base rate would have caused the Company to incur additional interest charges of
approximately $349,000 for the 12 months ended January 31, 2005. The Company would have benefited
from a similar interest savings if the base rate were to have fluctuated downward by a like amount. OFF-BALANCE SHEET ARRANGEMENTS The Company did not enter into any material off-balance sheet arrangements during its 2004 fiscal
year, nor did the Company have any material off-balance sheet arrangements outstanding at January
31, 2005 FINANCIAL STRATEGY Vircos financial strategy is to continue to strive to increase levels of profitability by
targeting specific profitable market segments and customers. The Company has organized its sales
force, developed products, and acquired production and distribution facilities for the specific
needs of these customers. During the fiscal years 1998, 1999, and 2000, the Company made
significant capital expenditures to support future sales growth in these targeted markets. For the
next several years, the Company intends to increase sales to these markets, and to service these
sales without making further significant investments in facilities or working capital. ACCOUNTING PRONOUNCEMENTS In
November 2004, the Financial Accounting Standards Board
(FASB) issued SFAS No. 151, Inventory
Costs (Statement No. 151). Statement No. 151 amends Accounting Research Bulletin No. 43, Chapter
4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense,
freight, handling costs and wasted material. Statement No. 151 requires that those items be
recognized as current-period charges and requires that allocation of fixed production overheads to
the cost of conversion be based on the normal capacity of the production facilities. Statement No.
151 is effective for fiscal years beginning after June 15, 2005. The Company will adopt this
Statement effective February 1, 2006 and does not expect the adoption to have a material impact on
the Companys financial position, results of operations or cash flows. In December 2004, the FASB issued SFAS No. 123 (Revised), Share-Based Payment, which is a
revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 (Revised)
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related
implementation guidance. SFAS No. 123 (Revised) requires companies to record compensation expense
for share-based payments to employees, including grants of employee stock options, at fair value.
SFAS No. 123 (Revised) is effective for most public companies at the beginning of the first interim
or annual period beginning after June 15, 2005. The Company will adopt this Statement effective
February 1, 2006 and does not expect it to have a material impact on the Companys financial
position, results of operations or cash flows. In December 2004, the FASB issued FASB Staff Position (FSP) No. FAS 109-1, Application of FASB
Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004, which states that the FASB believes
that the qualified production activities deduction provided by the American Jobs Creation Act of
2004 (the Act) should be accounted for as a special deduction in accordance with SFAS No. 109.
This FSP was effective upon issuance. FSP 109-1 has not had, nor is it expected to have, a material
impact on the Companys financial position, results of operations or cash flows. 11




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##### 



EXHIBIT 13.1  FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA in thousands except per share data
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Summary of OperationsNet sales (4) (5)
    
    $
    199,854
    
    
    $
    191,852
    
    
    $
    244,355
    
    
    $
    257,462
    
    
    $
    287,342Net (loss) income before cumulative effect of change in accounting
principle
    
    $
    (13,995
    )
    
    $
    (21,961
    )
    
    $
    282
    

    
    $
    246
    
    
    $
    4,313Cumulative effect of change in accounting principle, net of $191
tax benefit (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (297
    )Net (loss) income
    
    $
    (13,995
    )
    
    $
    (21,961
    )
    
    $
    282
    
    
    $
    246
    
    
    $
    4,016(Loss) income per share data(Loss) income before cumulative effect of change in accounting
principle (1)Basic
    
    $
    (1.07
    )
    
    $
    (1.68
    )
    
    $
    0.02
    
    
    $
    0.02
    
    
    $
    0.31Assuming dilution
    
    
    (1.07
    )
    
    
    (1.68
    )
    
    
    0.02
    
    
    
    0.02
    
    
    
    0.31Cumulative effect of change in accounting principle (1)Basic
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.02
    )Assuming dilution
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.02
    )Net (loss) income (1)Basic
    
    
    (1.07
    )
    
    
    (1.68
    )
    
    
    0.02
    
    
    
    0.02
    
    
    
    0.29Assuming dilution
    
    
    (1.07
    )
    
    
    (1.68
    )
    
    
    0.02
    
    
    
    0.02
    
    
    
    0.29Pro forma amounts assuming the accounting change is applied
retroactivelyNet (loss) income (5)
    
    $
    (13,995
    )
    
    $
    (21,961
    )
    
    $
    282
    
    
    $
    246
    
    
    $
    4,313Per share dataNet (loss) incomeBasic
    
    
    (1.07
    )
    
    
    (1.68
    )
    
    
    0.02
    
    
    
    0.02
    
    
    
    0.31Assuming dilution
    
    
    (1.07
    )
    
    
    (1.68
    )
    
    
    0.02
    
    
    
    0.02
    
    
    
    0.31Dividends declared per share, adjusted for 10% stock dividendCash dividends(3)
    
    $
    
    
    
    $
    0.04
    
    
    $
    0.08
    
    
    $
    0.07
    
    
    $
    0.06Other Financial DataTotal assets
    
    $
    114,041
    
    
    $
    126,268
    
    
    $
    154,796
    
    
    $
    161,372
    
    
    $
    199,549Working capital
    
    $
    15,334
    
    
    $
    25,404
    
    
    $
    38,748
    
    
    $
    34,464
    
    
    $
    43,173Current ratio
    
    
    1.5/1
    
    
    
    2.0/1
    
    
    
    2.4/1
    
    
    
    2.2/1
    
    
    
    1.9/1Total long-term obligations
    
    $
    34,090
    
    
    $
    37,934
    
    
    $
    44,702
    
    
    $
    43,154
    
    
    $
    59,608Stockholders equity
    
    $
    49,265
    
    
    $
    62,352
    
    
    $
    82,774
    
    
    $
    90,223
    
    
    $
    94,141Shares outstanding at year-end(3)
    
    
    13,098
    
    
    
    13,096
    
    
    
    13,111
    
    
    
    13,445
    
    
    
    13,652Stockholders equity per share (2)
    
    $
    3.76
    
    
    $
    4.76
    
    
    $
    6.31
    
    
    $
    6.71
    
    
    $
    6.90
   (1)
    
    Based on average number of shares outstanding each year after giving retroactive effect for
stock dividends and stock split.(2)
    
    Based on number of shares outstanding at year-end after giving effect for stock dividends and
stock split.(3)
    
    Adjusted for stock dividends and stock split.(4)
    
    The prior period statements of operations contain certain reclassifications to conform to the
presentation required by EITF No. 00-10, Accounting for Shipping and Handling Fees and Costs,
which the Company adopted during the fourth quarter of the year ended January 31, 2001.(5)
    
    During the fourth quarter of 2000, the Company changed its method of accounting for revenue
recognition in accordance with Staff Accounting Bulletin No. 101, Revenue Recognition in Financial
Statements. Pursuant to Financial Accounting Standards Board Statement No. 3, Reporting
Accounting Changes in Interim Financial Statements, effective February 1, 2000, the Company
recorded the cumulative effect of the accounting change. 12




---



##### 



FINANCIAL HIGHLIGHTS Financial Highlightsin thousands, except per share data
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Summary of OperationsNet sales (3, 4)
    
    $
    199,854
    
    
    $
    191,852
    
    
    $
    244,355
    
    
    $
    257,462
    
    
    $
    287,342Net (loss) incomeNet (loss) income before change in accounting methods
    
    $
    (13,995
    )
    
    
    (21,961
    )
    
    
    282
    
    
    
    246
    
    
    
    4,313Change in accounting methods
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (297
    )$
    (13,995
    )
    
    $
    (21,961
    )
    
    $
    282
    
    
    $
    246
    
    
    $
    4,016Net (loss) income per share (1)
    
    $
    (1.07
    )
    
    $
    (1.68
    )
    
    $
    0.02
    
    
    $
    0.02
    
    
    $
    0.29Stockholders equity
    
    
    49,265
    
    
    
    62,352
    
    
    
    82,774
    
    
    
    90,223
    
    
    
    94,141Stockholders equity per share (2)
    
    
    3.76
    
    
    
    4.76
    
    
    
    6.31
    
    
    
    6.71
    
    
    
    6.90
 1999
    
    
    1998
    
    
    1997
    
    
    1996
    
    
    1995Summary of OperationsNet sales (3, 4)
    
    $
    268,079
    
    
    $
    275,096
    
    
    $
    259,586
    
    
    $
    237,551
    
    
    $
    225,559Net (loss) incomeNet (loss) income before change in accounting methods
    
    
    10,166
    
    
    
    17,630
    
    
    
    13,852
    
    
    
    9,326
    
    
    
    5,209Change in accounting methods
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    10,166
    
    
    $
    17,630
    
    
    $
    13,852
    
    
    $
    9,326
    
    
    $
    5,209Net income per share (1)
    
    $
    0.72
    
    
    $
    1.20
    
    
    $
    0.94
    
    
    $
    0.64
    
    
    $
    0.36Stockholders equity
    
    
    93,834
    
    
    
    88,923
    
    
    
    77,077
    
    
    
    63,921
    
    
    
    55,386Stockholders equity per share (2)
    
    
    6.82
    
    
    
    6.30
    
    
    
    5.39
    
    
    
    4.48
    
    
    
    3.88
   (1)
    
    Based on average number of shares outstanding each year after giving retroactive effect for
stock dividends and stock split.(2)
    
    Based on number of shares outstanding at year-end giving effect for stock dividends and stock
split.(3)
    
    The prior period statements of operations contain certain reclassifications to conform to the
presentation required by EITF No. 00-10, Accounting for
Shipping and Handling Fees and Costs, which
the Company adopted during the fourth quarter of the year ended January 31, 2001.(4)
    
    During the fourth quarter of 2000, the Company changed its method of accounting for revenue
recognition in accordance with Staff Accounting Bulletin No. 101, Revenue Recognition in Financial
Statements. Pursuant to Financial Accounting Standards Board Statement No. 3, Reporting
Accounting Changes in Interim Financial Statements, effective February 1, 2000, the Company
recorded the cumulative effect of the accounting change. 13




---



##### 



MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management of Virco Mfg. Corporation (the Company) is responsible for establishing and
maintaining adequate internal control over financial reporting and for the assessment of the
effectiveness of internal control over financial reporting. As defined by the Securities and
Exchange Commission, internal control over financial reporting is a process designed by, or
supervised by, the Companys principal executive and principal financial officers, to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements in accordance with generally accepted accounting principles. The Companys internal control over financial reporting is supported by written policies and
procedures, that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the Companys assets; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with authorizations of the Companys
management and directors; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the Companys assets that could have a
material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate. In connection with the preparation of the Companys annual financial statements, management of
the Company has undertaken an assessment of the effectiveness of the Companys internal control
over financial reporting as of January 31, 2005, based on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Managements assessment included an evaluation of the design of the Companys internal
control over financial reporting and testing of the operational effectiveness of the Companys
internal control over financial reporting. Based on this assessment, management did not identify any material weakness in the Companys
internal control, and management has concluded that the Companys internal control over financial
reporting was effective as of January 31, 2005. Ernst & Young LLP, the independent registered public accounting firm that audited the
Companys financial statements, has issued an attestation report on managements assessment of
internal control over financial reporting, a copy of which is
included in this Annual Report to Stockholders. 14




---



##### 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders ofVirco Mfg. Corporation We have audited managements assessment, included in the accompanying Managements Report on
Internal Control Over Financial Reporting, that Virco Mfg. Corporation maintained effective
internal control over financial reporting as of January 31, 2005, based on criteria established in
Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria). Virco Mfg. Corporations management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to express an
opinion on managements assessment and an opinion on the effectiveness of the companys internal
control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinion. A companys internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material effect on the
financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that Virco Mfg. Corporation maintained effective internal
control over financial reporting as of January 31, 2005, is fairly stated, in all material
respects, based on the COSO criteria. Also, in our opinion, Virco Mfg. Corporation maintained, in
all material respects, effective internal control over financial reporting as of January 31, 2005,
based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheets as of January 31, 2005 and 2004, and the
related consolidated statements of operations, stockholders equity and cash flows for each of the
three years in the period ended January 31, 2005 of Virco Mfg. Corporation and our report dated
March 18, 2005 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Los Angeles, California
March 18, 2005 15




---



##### 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders ofVirco Mfg. Corporation We have audited the accompanying consolidated balance sheets of Virco Mfg. Corporation as of
January 31, 2005 and 2004, and the related consolidated statements of operations, stockholders
equity and cash flows for each of the three years in the period ended January 31, 2005. These
financial statements are the responsibility of the Companys management. Our responsibility is to
express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Virco Mfg. Corporation at January 31, 2005 and
2004, and the consolidated results of its operations and its cash flows for each of the three years
in the period ended January 31, 2005, in conformity with U.S. generally accepted accounting
principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of Virco Mfg. Corporations internal control over
financial reporting as of January 31, 2005, based on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 18, 2005 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Los Angeles, California
March 18, 2005 16




---



##### 



Virco Mfg. Corporation Consolidated Balance Sheets January 312005
    
    
    2004(In thousands,except share data)AssetsCurrent assets:Cash
    
    $
    1,192
    
    
    $
    2,059Trade accounts receivable (less allowance for doubtful
accounts of $225 in 2004 and 2003)
    
    
    15,997
    
    
    
    17,333Income taxes receivable
    
    
    1,279
    
    
    
    1,423Other receivables
    
    
    165
    
    
    
    138Inventories:Finished goods, net
    
    
    9,676
    
    
    
    10,470Work in process, net
    
    
    10,373
    
    
    
    11,141Raw materials and supplies, net
    
    
    5,998
    
    
    
    6,86026,047
    
    
    
    28,471Prepaid expenses and other current assets
    
    
    1,340
    
    
    
    1,962Total current assets
    
    
    46,020
    
    
    
    51,386Property, plant and equipment:Land and land improvements
    
    
    3,287
    
    
    
    3,287Buildings and building improvements
    
    
    49,542
    
    
    
    49,548Machinery and equipment
    
    
    104,762
    
    
    
    103,185Leasehold improvements
    
    
    1,307
    
    
    
    1,251158,898
    
    
    
    157,271Less accumulated depreciation and amortization
    
    
    102,009
    
    
    
    93,913Net property, plant and equipment
    
    
    56,889
    
    
    
    63,358Goodwill and other intangible assets
    
    
    2,337
    
    
    
    2,350Other assets
    
    
    8,795
    
    
    
    9,174Total assets
    
    $
    114,041
    
    
    $
    126,268
 17




---



##### 



Virco Mfg. Corporation Consolidated Balance Sheets January 312005
    
    
    2004(In thousands,except share data)LiabilitiesCurrent liabilities:Checks released but not yet cleared bank
    
    $
    1,759
    
    
    $
    2,702Accounts payable
    
    
    13,948
    
    
    
    9,513Accrued compensation and employee benefits
    
    
    5,722
    
    
    
    5,636Current portion of long-term debt
    
    
    5,012
    
    
    
    3,138Other accrued liabilities
    
    
    4,245
    
    
    
    4,993Total current liabilities
    
    
    30,686
    
    
    
    25,982Non-current liabilities:Accrued self-insurance retention and other
    
    
    3,221
    
    
    
    4,053Accrued pension expenses
    
    
    12,751
    
    
    
    11,686Long-term debt, less current portion
    
    
    18,118
    
    
    
    22,195Total non-current liabilities
    
    
    34,090
    
    
    
    37,934Commitments and contingenciesStockholders equity:Preferred stock:Authorized 3,000,000 shares, $.01 par value; none
issued or outstanding
    
    
    
    
    
    
    Common stock:Authorized 25,000,000 shares, $.01 par value;
issued 13,098,364 shares in 2004 and 14,583,331
shares in 2003
    
    
    131
    
    
    
    146Additional paid-in capital
    
    
    107,883
    
    
    
    127,133Retained deficit
    
    
    (55,407
    )
    
    
    (41,412
    )Less treasury stock at cost (0 shares in 2004
and 1,487,530 shares in 2003)
    
    
    
    
    
    
    (19,271
    )Less accumulated comprehensive loss
    
    
    (3,342
    )
    
    
    (4,244
    )Total stockholders equity
    
    
    49,265
    
    
    
    62,352Total liabilities and stockholders equity
    
    $
    114,041
    
    
    $
    126,268
 See accompanying notes. 18




---



##### 



Virco Mfg. Corporation Consolidated Statements of Operations Year ended January 312005
    
    
    2004
    
    
    2003(In thousands, except share data)Net sales
    
    $
    199,854
    
    
    $
    191,852
    
    
    $
    244,355Costs of goods sold
    
    
    143,415
    
    
    
    137,420
    
    
    
    160,652Gross profit
    
    
    56,439
    
    
    
    54,432
    
    
    
    83,703Selling, general and administrative expenses
    
    
    68,229
    
    
    
    70,593
    
    
    
    79,721Separation costs
    
    
    
    
    
    
    13,920
    
    
    
    Interest expense
    
    
    2,090
    
    
    
    2,054
    
    
    
    3,410(Gain) loss on sale of assets, net
    
    
    
    
    
    
    (5,497
    )
    
    
    149(Loss) income before income taxes
    
    
    (13,880
    )
    
    
    (26,638
    )
    
    
    423Provision for income taxes
    
    
    115
    
    
    
    (4,677
    )
    
    
    141Net (loss) income
    
    $
    (13,995
    )
    
    $
    (21,961
    )
    
    $
    282Cash dividends per share
    
    $
    
    
    
    $
    0.04
    
    
    $
    0.08Net (loss) income per common shareBasic
    
    $
    (1.07
    )
    
    $
    (1.68
    )
    
    $
    0.02Assuming dilution
    
    
    (1.07
    )
    
    
    (1.68
    )
    
    
    0.02Weighted average shares outstanding:Basic
    
    
    13,112
    
    
    
    13,106
    
    
    
    13,344Assuming dilution
    
    
    13,112
    
    
    
    13,106
    
    
    
    13,458
 See accompanying notes. 19




---



##### 



Virco Mfg. Corporation Consolidated Statements of Stockholders Equity Additional
    
    
    Retained
    
    
    
    
    
    
    
    
    
    
    AccumulatedPaid-in
    
    
    Earnings
    
    
    Comprehensive
    
    
    Treasury
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Capital
    
    
    (Deficit)
    
    
    Income (Loss)
    
    
    Stock
    
    
    Loss
    
    
    Total(In thousands, except share data)Balance at January 31, 2002
    
    
    12,223,047
    
    
    $
    132
    
    
    $
    109,638
    
    
    $
    (2,006
    )
    
    $
    
    
    
    $
    (13,975
    )
    

    $
    (3,566
    )
    
    $
    90,223Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    282
    
    
    
    282
    
    
    
    
    
    
    
    
    
    
    
    282Minimum pension liability,
net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,072
    )
    
    
    
    
    
    
    (3,072
    )
    
    
    (3,072
    )Derivative instrument, net of
tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    544
    
    
    
    
    
    
    
    544
    
    
    
    544Comprehensive loss, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,246
    )
    
    
    
    
    
    
    
    
    
    
    Stock issued under option
plans
    
    
    147,004
    
    
    
    1
    
    
    
    469
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    470Stock dividend (10%)
    
    
    1,212,671
    
    
    
    12
    
    
    
    16,177
    
    
    
    (16,189
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cash dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,014
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,014
    )Purchase of treasury stock
    
    
    (472,120
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,659
    )
    
    
    
    
    
    
    (4,659
    )Balance at January 31, 2003
    
    
    13,110,602
    
    
    
    145
    
    
    
    126,284
    
    
    
    (18,927
    )
    
    
    
    
    
    
    (18,634
    )
    
    
    (6,094
    )
    
    
    82,774Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,961
    )
    
    
    (21,961
    )
    
    
    
    
    
    
    
    
    
    
    (21,961
    )Minimum pension liability
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,732
    
    
    
    
    
    
    
    1,732
    
    
    
    1,732Derivative instrument
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    118
    
    
    
    
    
    
    
    118
    
    
    
    118Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,111
    )
    
    
    
    
    
    
    
    
    
    
    Stock issued under option and
tax benefits
    
    
    56,257
    
    
    
    1
    
    
    
    849
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    850Cash dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (524
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (524
    )Purchase of treasury stock
    
    
    (71,058
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (637
    )
    
    
    
    
    
    
    (637
    )Balance at January 31, 2004
    
    
    13,095,801
    
    
    
    146
    
    
    
    127,133
    
    
    
    (41,412
    )
    
    
    
    
    
    
    (19,271
    )
    
    
    (4,244
    )
    
    
    62,352Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (13,995
    )
    
    
    (13,995
    )
    
    
    
    
    
    
    
    
    
    
    (13,995
    )Minimum pension liability
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    902
    
    
    
    
    
    
    
    902
    
    
    
    902Derivative instrument
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (13,093
    )
    
    
    
    
    
    
    
    
    
    
    Stock issued under option
plans
    
    
    2,563
    
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6Cash dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Retirement of treasury stock
    
    
    
    
    
    
    (15
    )
    
    
    (19,256
    )
    
    
    
    
    
    
    
    
    
    
    19,271
    
    
    
    
    
    
    
    Balance at January 31, 2005
    
    
    13,098,364
    
    
    $
    131
    
    
    $
    107,883
    
    
    $
    (55,407
    )
    
    
    
    
    
    $
    
    
    
    $
    (3,342
    )
    
    $
    49,265
 See accompanying notes. 20




---



##### 



Virco Mfg. Corporation Consolidated Statements of Cash Flows Year ended January 312005
    
    
    2004
    
    
    2003(In thousands)Operating activitiesNet (loss) income
    
    $
    (13,995
    )
    
    $
    (21,961
    )
    
    $
    282Adjustments to reconcile net (loss) income to net cash
provided by operating activities:Depreciation and amortization
    
    
    9,799
    
    
    
    11,605
    
    
    
    13,659Provision for doubtful accounts
    
    
    17
    
    
    
    36
    
    
    
    267(Gain) loss on sale of property, plant and equipment
    
    
    
    
    
    
    (5,497
    )
    
    
    149Deferred income taxes
    
    
    
    
    
    
    674
    
    
    
    555Changes in assets and liabilitiesTrade accounts receivable
    
    
    1,319
    
    
    
    (191
    )
    
    
    4,156Other receivables
    
    
    (27
    )
    
    
    85
    
    
    
    (48
    )Inventories
    
    
    2,424
    
    
    
    14,568
    
    
    
    (4,356
    )Income taxes
    
    
    144
    
    
    
    (4,461
    )
    
    
    2,256Prepaid expenses and other current assets
    
    
    622
    
    
    
    (467
    )
    
    
    (560
    )Accounts payable and accrued liabilities
    
    
    3,364
    
    
    
    5,231
    
    
    
    (4,443
    )Other
    
    
    11
    
    
    
    (120
    )
    
    
    128Net cash provided by (used in) operating activities
    
    
    3,678
    
    
    
    (498
    )
    
    
    12,045Investing activitiesCapital expenditures
    
    
    (2,799
    )
    
    
    (2,236
    )
    
    
    (3,532
    )Proceeds from sale of property, plant and equipment
    
    
    9
    
    
    
    5,806
    
    
    
    93Net investment in life insurance
    
    
    442
    
    
    
    1,622
    
    
    
    (109
    )Acquisition of business
    
    
    
    
    
    
    
    
    
    
    (4,550
    )Net cash
(used in) provided by investing activities
    
    
    (2,348
    )
    
    
    5,192
    
    
    
    (8,098
    )Financing activitiesDividends paid
    
    
    
    
    
    
    (524
    )
    
    
    (1,014
    )Issuance of long-term debt
    
    
    1,862
    
    
    
    2,051
    
    
    
    4,240Repayment of long-term debt
    
    
    (4,065
    )
    
    
    (5,514
    )
    
    
    (3,049
    )Proceeds from issuance of common stock
    
    
    6
    
    
    
    153
    
    
    
    178Purchase of treasury stock
    
    
    
    
    
    
    (440
    )
    
    
    (4,367
    )Net cash used in financing activities
    
    
    (2,197
    )
    
    
    (4,274
    )
    
    
    (4,012
    )Net (decrease) increase in cash
    
    
    (867
    )
    
    
    420
    
    
    
    (65
    )Cash at beginning of year
    
    
    2,059
    
    
    
    1,639
    
    
    
    1,704Cash at end of year
    
    $
    1,192
    
    
    $
    2,059
    
    
    $
    1,639Supplemental disclosures of cash flow informationCash paid (received) during the year for:Interest, net of amounts capitalized
    
    $
    2,090
    
    
    $
    2,183
    

    
    $
    3,513Income tax, net
    
    
    (320
    )
    
    
    1,421
    
    
    
    (2,495
    )Non cash activitiesAccrued asset retirement obligations
    
    $
    540
    
    
    $
    
    
    
    $
    
 See accompanying notes. 21




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements January 31, 2005 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 50
years of manufacturing has 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. Principles of Consolidation The consolidated financial statements include the accounts of Virco Mfg. Corporation and its wholly
owned subsidiaries. All material intercompany balances and transactions have been eliminated in
consolidation. Fiscal Year End Fiscal years 2004, 2003 and 2002, refer to the years ended January 31, 2005, 2004 and 2003,
respectively. Cash and Cash Equivalents Cash and cash equivalents include cash on hand and highly liquid investments with maturities of
three months or less at the date of purchase. Concentration of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk
consist principally of accounts receivable. The Company performs ongoing credit evaluations of its
customers and maintains allowances for potential credit losses. The Company purchases insurance on
receivables from commercial sales to minimize the Companys credit risk. The Company does not
typically obtain collateral to secure credit risk. A substantial percentage of the Companys
receivables come from low-risk government entities. No customers exceeded 10% of the Companys
sales for each of the three years in the period ended January 31, 2005. Foreign sales were less
than 5% for each of the three years in the period ended January 31, 2005. No single customer accounted for more than 10% of the Companys accounts receivable at January 31,
2005 or 2004. Derivatives The Company uses derivative financial instruments to reduce interest rate risks. The Company does
not hold or issue derivative financial instruments for trading purposes. All derivatives are
recognized as either assets or liabilities in the statement of financial condition and are measured
at fair value. At January 31, 2005 and 2004, the Company has no derivative instruments. Inventories Inventories are stated at the lower of cost or market. Cost is determined using the last-in,
first-out (LIFO) method of valuation for the material content of inventories and the first-in,
first-out (FIFO) method for labor and overhead. 22




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements(continued) 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 yearsBuildings and building improvements
    
    5 to 40 yearsMachinery and equipment
    
    3 to 10 yearsLeasehold improvements
    
    shorter of lease or useful life
 Interest costs, amounting to $0, $13,000 and $38,000 for the years ended January 31, 2005, 2004 and
2003, respectively, have been capitalized as part of the acquisition cost of property, plant and
equipment. The Company capitalizes costs associated with software purchased or developed for its own use. Such
costs are amortized over three to seven years from the date the software becomes operational. The
net book value of capitalized software, included in machinery and equipment, was $1,766,000 and
$3,118,000 at January 31, 2005 and 2004, respectively. The Company has established asset retirement obligations related to leased manufacturing facilities
in accordance with Statement of Financial Accounting Standards
(SFAS) No. 143, Accounting for Asset Retirement
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 are $540,000 and $0 at January 31, 2005 and 2004, respectively. Impairment of Long-Lived Assets An impairment loss is recognized in the event facts and circumstances indicate the carrying amount
of an asset may not be recoverable, and an estimate of future undiscounted cash flows is less than
the carrying amount of the asset. Impairment is recorded based on the excess of the carrying amount
of the impaired asset over the fair value. Generally, fair value represents the Companys expected
future cash flows from the use of an asset or group of assets, discounted at a rate commensurate
with the risks involved. Net (Loss) Income Per Share Basic net (loss) income per share is calculated by dividing net (loss) income by the
weighted-average number of common shares outstanding. Diluted net
(loss) income per share is calculated by
dividing net (loss) income by the weighted-average number of common shares outstanding plus the dilution
effect of convertible securities. The following table sets forth the computation of basic and
diluted (loss) income per share: 2004
    
    
    2003
    
    
    2002Numerator:Net (loss) income
    
    $
    (13,995,000
    )
    
    $
    (21,961,000
    )
    
    $
    282,000Denominator:Denominator for basic (loss) earnings
per share:Weighted-average shares
    
    
    13,112,000
    
    
    
    13,106,000
    
    
    
    13,344,000Dilutive potential common shares
    
    
    
    
    
    
    
    
    
    
    114,000Denominator for diluted earnings per
share:Adjusted weighted-average share
and assumed conversions
    
    
    13,112,000
    
    
    
    13,106,000
    
    
    
    13,458,000Basic earnings per share:Net (loss) income
    
    $
    (1.07
    )
    
    $
    (1.68
    )
    
    $
    0.02Diluted earnings per share:Net (loss) income
    
    $
    (1.07
    )
    
    $
    (1.68
    )
    
    $
    0.02
 23




---



##### 



For the period ended January 31, 2005, approximately 225,000 shares of unvested stock awards and
incentive stock options were excluded in the computation of diluted net income per share, as the
effect would be anti-dilutive. For the period ended January 31, 2004, approximately 20,000 shares
of incentive stock options were excluded in the computation of diluted net income per share, as the
effect would be anti-dilutive. For the period ended January 31, 2003, per share and
weighted-average share amounts have been restated to reflect stock dividends and stock splits
previously declared. Goodwill and Other Intangible Assets The
Company accounts for goodwill and other intangible assets in
accordance with SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other
Intangible Assets. Under SFAS No. 142, goodwill and intangible assets deemed to have an indefinite
life are not amortized but are subject to annual impairment tests. Other intangible assets are
amortized over their useful lives. The adoption of SFAS No. 142 did not have a material effect on
the Companys financial position, results of operations or cash flows as prior to April 2002 the
Company did not have any recorded goodwill or any indefinite lived or finite lived intangible
assets, other than deferred pension assets. Information regarding the Companys goodwill and other intangible assets are as follows (in
thousands): 2004
    
    
    2003Accumulated
    
    
    
    
    
    
    
    
    
    
    AccumulatedGross Amount
    
    
    Amortization
    
    
    Net Amount
    
    
    Gross Amount
    
    
    Amortization
    
    
    Net AmountGoodwill (not amortized)
    
    $
    2,200
    
    
    $
    
    
    
    $
    2,200
    
    
    $
    2,200
    
    
    $
    
    
    
    $
    2,200Intangible assets
    
    
    150
    
    
    
    (13
    )
    
    
    137
    
    
    
    150
    
    
    
    
    
    
    
    150$
    2,350
    
    
    $
    (13
    )
    
    $
    2,337
    
    
    $
    2,350
    
    
    $
    
    
    
    $
    2,350
 The Company anticipates that amortization expense will be approximately $15,000 per year for the
next five years. The Company does not have amortization expense other than related to intangible
assets. Environmental Costs Costs incurred to investigate and remediate environmental waste are expensed as incurred, unless
the remediation extends the useful life of the assets employed at the site. Remediation costs that
extend the useful life of assets are capitalized and amortized over the useful life of the assets.
At January 31, 2005 and 2004, the Company has not capitalized any remediation costs and has not
recorded any amortization expense in fiscal years 2004, 2003 and 2002. Advertising Costs Advertising costs are expensed in the period in which they occur. Selling, general and
administrative expenses include advertising costs of $2,843,000 in 2004, $2,757,000 in 2003 and
$2,921,000 in 2002. Product Warranty Expense The Company provides for a product warranty on most of its products. It generally provides that
customers can return a defective product during the specified warranty period following purchase in
exchange for a replacement product or repair at no cost to the consumer. The 24




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) Company accrues an estimate of its exposure to warranty claims based upon both current and
historical product sales data and warranty costs incurred. The Company recorded reserves of
$1,500,000 and $1,751,000 as of January 31, 2005 and 2004, respectively. Self-Insurance The Company has a self-insured retention for workers compensation, automobile and general and
product liability claims. Actuaries assist the Company in determining its liability for the
self-insured component of claims, which have been discounted to their net present value. Stock-Based Compensation Plans Incentive Stock Options The Company uses the intrinsic value based method for accounting for stock options as prescribed
by Accounting Principles Board No. 25. The Company provides pro forma disclosures as if the fair
value method had been applied in accordance with SFAS No. 123 and SFAS No. 148. SFAS No. 123, as
amended by SFAS No. 148, requires pro forma information regarding net income and net income per
share to be disclosed for new options granted after fiscal year 1996. The fair value of these
options was determined at the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions: risk-free interest rates of 3.60% to 6.26%; dividend yield
of 0.00% to 0.98%; volatility factor of the expected market price of the Companys common stock of
0.26 to 0.42; and a weighted-average expected life of the option of five years. The estimated fair value of the options is amortized to expense over the options vesting period
for pro forma disclosures. The per share pro forma for the effects of SFAS No. 123, as amended by
SFAS 148, is not indicative of the effects on reported net (loss) income for future years. The
Companys reported and pro forma information is as follows: Year ended January 31,2005
    
    
    2004
    
    
    2003(In thousands)Net (loss) income, as reported
    
    $
    (13,995
    )
    
    $
    (21,961
    )
    
    $
    282Deduct: Total stock-based employee
compensation expense determined under
the fair value based
method for all awards, net of tax effects
    
    
    (54
    )
    
    
    (58
    )
    
    
    (41
    )Pro forma net (loss) income
    
    $
    (14,049
    )
    
    $
    (22,019
    )
    
    $
    241
 Year ended January 31,2005
    
    
    2004
    
    
    2003Basic earnings per share:Net (loss) income, as reported
    
    $
    (1.07
    )
    
    $
    (1.68
    )
    
    $
    .02Net (loss) income, pro forma
    
    
    (1.07
    )
    
    
    (1.68
    )
    
    
    .02Diluted earnings per share:Net (loss) income, as reported
    
    $
    (1.07
    )
    
    $
    (1.68
    )
    
    $
    .02Net (loss) income, pro forma
    
    
    (1.07
    )
    
    
    (1.68
    )
    
    
    .02
 Use of Estimates and Assumptions 25




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) The preparation of financial statements in conformity with U.S. generally accepted accounting
principles requires management to make estimates and assumptions that affect the amounts reported
in the financial statements and accompanying notes. Actual results could differ from those
estimates. Revenue Recognition The Company recognizes all sales when title passes under its various shipping terms and when
collectability is reasonably assured. The Company reports sales net of sales returns and
allowances. Shipping and Installation Fees Revenues related to shipping and installation are included as revenue in net sales. Costs related
to shipping and installation are included in operating expenses. For the years ended January 31,
2005, 2004 and 2003, shipping and installation costs of approximately $33,421,000, $34,443,000 and
$27,590,000, respectively, were included in selling, general and administrative expenses. 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 SFAS No. 109, 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. Impact of Recently Issued Accounting Standards In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151, Inventory
Costs SFAS No. 151 amends Accounting Research Bulletin No. 43, Chapter
4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense,
freight, handling costs and wasted material. SFAS No. 151 requires that those items be
recognized as current-period charges and requires that allocation of fixed production overheads to
the cost of conversion be based on the normal capacity of the production facilities. SFAS No.
151 is effective for fiscal years beginning after June 15, 2005. The Company will adopt this
Statement effective February 1, 2006 and does not expect the adoption to have a material impact on
the Companys financial position, results of operations or cash flows. In December 2004, the FASB issued SFAS No. 123 (Revised), Share-Based Payment, which is a
revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 (Revised)
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related
implementation guidance. SFAS No. 123 (Revised) requires companies to record compensation expense
for share-based payments to employees, including grants of employee stock options, at fair value.
SFAS No. 123 (Revised) is effective for most public companies at the beginning of the first interim
or annual period beginning after June 15, 2005. The Company will adopt this Statement effective
February 1, 2006 and does not expect it to have a material impact on the Companys financial
position, results of operations or cash flows. In December 2004, the FASB issued FASB Staff Position (FSP) No. FAS 109-1, Application of FASB
Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004, which states that the FASB believes
that the qualified production activities deduction provided by the American Jobs Creation Act of
2004 (the Act) should be accounted for as a special deduction in accordance with SFAS No. 109.
This FSP was effective upon issuance. FSP 109-1 has not had, nor is it expected to have, a material
impact on the Companys financial position, results of operations or cash flows. 2. Inventories The current material cost for inventories exceeded LIFO cost by $6,201,000 and $4,042,000 at
January 31, 2005 and 2004, respectively. Liquidation of prior year LIFO layers due to a reduction
in certain inventories increased (decreased) income by $410,000, $771,000 and $(423,000) in the
years ended January 31, 2005, 2004 and 2003, respectively. 26




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) Details of inventory amounts, including the material portion of inventory which is valued at LIFO,
at January 31, 2005 and 2004, are as follows (in thousands): January 31, 2005Material
    
    
    
    
    
    
    Labor,Content at
    
    
    LIFO
    
    
    OverheadFIFO
    
    
    Reserve
    
    
    and Other
    
    
    TotalFinished goods
    
    $
    6,890
    
    
    $
    (1,564
    )
    
    $
    4,350
    
    
    $
    9,676Work in process
    
    
    5,067
    
    
    
    (2,315
    )
    
    
    7,621
    
    
    
    10,373Raw materials and supplies
    
    
    8,321
    
    
    
    (2,322
    )
    
    
    
    
    
    
    5,998Total
    
    $
    20,278
    
    
    $
    (6,201
    )
    
    $
    11,971
    
    
    $
    26,047
 January 31, 2004Material
    
    
    
    
    
    
    Labor,Content at
    
    
    LIFO
    
    
    OverheadFIFO
    
    
    Reserve
    
    
    and Other
    
    
    TotalFinished goods
    
    $
    8,399
    
    
    $
    (1,493
    )
    
    $
    3,565
    
    
    $
    10,470Work in process
    
    
    7,789
    
    
    
    (1,033
    )
    
    
    4,384
    
    
    
    11,141Raw materials and supplies
    
    
    8,376
    
    
    
    (1,516
    )
    
    
    
    
    
    
    6,860Total
    
    $
    24,564
    
    
    $
    (4,042
    )
    
    $
    7,949
    
    
    $
    28,471
 3. Debt Outstanding balances (in thousands) for the Companys long-term debt were as follows: January 31,2005
    
    
    2004Revolving credit line with Wells Fargo Bank(a)
    
    $
    3,003
    
    
    $
    11,629Term note with Wells Fargo Bank(a)
    
    
    20,000
    
    
    
    12,500IRB with the City of Torrance(b)
    
    
    
    
    
    
    1,055Other
    
    
    127
    
    
    
    14923,130
    
    
    
    25,333Less current portion
    
    
    5,012
    
    
    
    3,138$
    18,118
    
    
    $
    22,195Outstanding stand-by letters of credit
    
    $
    2,540
    
    
    $
    
    27




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) The revolving line has a 24-month maturity with interest payable monthly at a fluctuating rate
equal to the Banks prime rate plus a fluctuating margin similar to the term note. The revolving
line typically provides for advances of 80% on eligible accounts receivable and 20%  60% on
eligible inventory. The advance rates fluctuate depending on the time of the year and the types
of assets. The agreement has an unused commitment fee of 0.375%. Approximately $16,221,000 was
available for borrowing as of January 31, 2005. The revolving credit facility with Wells Fargo Bank is subject to various financial covenants
including a liquidity requirement, a leverage requirement, a cash flow coverage requirement and
profitability requirements. The agreement also places certain restrictions on capital
expenditures, new operating leases, dividends and the repurchase of the Companys common stock.
The revolving credit facility is secured by the Companys accounts receivable, inventories,
equipment and property. The Company is in compliance with its covenants at January 31, 2005.
The $3,003,000 due under Wells Fargo Banks line of credit will be payable on February 15, 2007,
if the agreement is not renewed. The Company intends to renew the agreement. (b) 10-year $8,900,000 IRB issued through the City of Torrance. This 5.994% fixed interest
rate bond was payable in monthly installments of $99,000, including interest, through December
2004. At January 31, 2005, this obligation was paid in full. Long-term debt repayments are approximately as follows (in thousands): Year ending January 31,2006
    
    $
    5,0122007
    
    
    5,0122008
    
    
    13,0152009
    
    
    122010
    
    
    12Thereafter
    
    
    67$
    23,130
 The Company believes that the carrying value of debt under the Wells Fargo credit facility
approximates fair value at January 31, 2005 and 2004, as all of the long-term debt bears
interest at variable rates based on prevailing market conditions.4. Retirement PlansThe
Company maintains three defined benefit pension plans, the Virco Employees
Retirement Plan, the VIP Retirement Plan, and the Non-Employee Directors Retirement Plan. Pension
expense and cash contributions for the fiscal year ended January 31, 2005 were substantially less
than the prior years as a result of several major events during the prior year. Three significant
events occurred during the fiscal year ended January 31, 2004. First, approximately 40% of Vircos
employees severed their employment with Virco during the year. The majority of these employees
accepted a voluntary severance package. This severance was treated as a plan curtailment. Second, a
significant number of employees that severed their employment elected a lump sum benefit. During
2003, the pension trust disbursed approximately $6.3 million to severed employees. These
distributions were accounted for as a plan settlement. Finally,
effective December 31, 2003. The Company
froze all future benefit accruals under the plans. Employees can continue to vest under the
benefits earned to date, but no covered participants will earn additional benefits under the plan
freeze. The annual measurement date for the plans is December 31. As a result of these activities,
Virco incurred additional pension expense of approximately $1,250,000 related to the plan
curtailment, additional pension expense of approximately $1,540,000 related to the plan settlement,
and additional pension expense of approximately $40,000 related to the plan freeze. As a result of
the plan freeze, the projected benefit obligation decreased by approximately $7,500,000. 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.The discount rate represents an estimate of the rate at which retirement plan benefits could
effectively be settled. The Corporation obtains data on several reference points when setting the
discount rate including current rates of return available on longer term high-grade bonds and
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, is likely to
change from year to year.When setting its rate of compensation increase assumption, the Company takes into consideration
its recent experience with respect to average rates of compensation increase, compensation survey
data relative to average compensation increases that other large corporations have
 28




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) awarded, and compensation increases that other large corporations expect to award over the upcoming
year. This assumption is somewhat sensitive to inflation and may change from year to year.
Effective December 31, 2003, the Corporation froze future benefit accruals for all three defined
benefit plans. As such, the compensation increase assumption impacted the pension expense for the
fiscal year ended January 31, 2004, but did not impact the accumulated benefit obligation or
projected benefit obligation reported effective January 31, 2004. The compensation increase
assumption had no impact on pension expense, accumulated benefit obligation or projected benefit
obligation for the period ended January 31, 2005. 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. Two of the Companys defined benefit pension plans (the VIP Plan and the Non-Employee Directors
Plan) are executive benefit plans that are not funded and are subject to the Companys creditors.
Because these plans are not funded, the assumed rate of return has no impact on pension expense or
the funded status of the plans. The Company maintains a trust and funds the pension obligations for the Virco Mfg. Corporation
Employees Pension. The Board of Directors appoints a Retirement Plan Committee that establishes
policy for investment and funding strategies. Approximately 85% 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 Committee has established target asset allocations to its investment advisors, who
invest the trust assets in a variety of institutional collective trust funds. The long-term asset
allocation target provided to the investment advisors is 85% stock and 15% bond, with maximum
allocations of 80% large cap stocks, 30% small cap stocks, and 30%
international stock. The Company has
established a custom benchmark derived from a variety of stock and bond indices that are weighted
to approximate the asset allocation provided to the investment advisors. The investment advisors
performance is compared to the custom index as part of the evaluation of the investment advisors
performance. The Committee receives monthly reports from the investment advisors and meets
periodically with them to discuss investment performance. At December 31, 2004 and 2003, the amount
of the plan assets invested in bond or short-term investment funds were 5% and 10%, respectively,
and the balance in equity funds or 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 and Non-Employee Director Plans and to maintain the funded status of the Virco Mfg.
Corporation Employees Pension at a minimum of 90% of the current liability as determined by the
plan actuaries. It is anticipated that the Company will be required to contribute approximately
$478,000 to the plans during the fiscal year ending January 31, 2006. Payments made under the qualified plan are made from the trust fund. Payments made under the VIP
Plan and Non-Employee Directors Plan are made by the Company. Estimated payments under the plans
are as follows: Plan Year
    
    Qualified Plan
    
    
    VIP Plan
    
    
    Directors Plan
    
    
    Total(in thousands)2005
    
    $
    420
    
    
    $
    281
    
    
    $
    
    
    
    $
    7012006
    
    
    543
    
    
    
    272
    
    
    
    49
    
    
    
    8642007
    
    
    588
    
    
    
    277
    
    
    
    46
    
    
    
    9112008
    
    
    702
    
    
    
    266
    
    
    
    43
    
    
    
    1,0112009
    
    
    817
    
    
    
    288
    
    
    
    40
    
    
    
    1,145Thereafter
    
    
    6,053
    
    
    
    1,937
    
    
    
    228
    
    
    
    8,218
 29




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) Qualified Pension Plan The Company and its subsidiaries cover all employees under a non-contributory defined benefit
retirement plan, the Virco Employees Retirement Plan (the Plan). Benefits under the Plan are based
on years of service and career average earnings. The Companys general funding policy is to
contribute enough to maintain a funded status of at least 90% of the current liability as
determined by the Plan actuaries. Minimum pension liability adjustments for the years 2004, 2003
and 2002 were $550,000, $3,376,000 and ($3,072,000), respectively
(net of taxes of $352,000, $2,259,000 and ($2,005,000), respectively), and are included in comprehensive loss. At January 31,
2005 and 2004, a full valuation allowance has been recorded against the net deferred tax assets.
Accumulated comprehensive loss at January 31, 2005, was primarily composed of minimum pension
liability adjustments. Assets of the Plan are invested in common trust funds. The following table sets forth (in thousands) the funded status of the Plan at December 31, 2004
and 2003: Pension Benefits2004
    
    
    2003Change in benefit obligation:Benefit obligation at beginning of year
    
    $
    21,640
    
    
    $
    28,787Service cost
    
    
    230
    
    
    
    1,384Interest cost
    
    
    1,360
    
    
    
    1,706Plan amendments
    
    
    490
    
    
    
    611Settlement and curtailment
    
    
    
    
    
    
    (5,062
    )Actuarial (gain) loss
    
    
    (346
    )
    
    
    526Benefit paid
    
    
    (1,698
    )
    
    
    (6,312
    )Benefit obligation at end of year
    
    $
    21,676
    
    
    $
    21,640Change in plan assets:Fair value at beginning of year
    
    $
    16,476
    
    
    $
    17,074Actual return on plan assets
    
    
    1,414
    
    
    
    4,179Company contributions
    
    
    
    
    
    
    1,535Benefits paid
    
    
    (1,698
    )
    
    
    (6,312
    )Fair value at end of year
    
    $
    16,192
    
    
    $
    16,476
 Pension Benefits2004
    
    2003Funded status of plan
    
    $
    (5,484
    )
    
    $
    (5,164
    )Unrecognized net transition amount
    
    
    (89
    )
    
    
    (126
    )Unrecognized prior service cost
    
    
    3,431
    
    
    
    2,842Unrecognized net actuarial loss
    
    
    2,903
    
    
    
    4,370Net amount recognized
    
    $
    761
    
    
    $
    1,922Statements of financial position accrued benefit liabilityAccrued benefit liability
    
    $
    (5,483
    )
    
    $
    (5,163
    )Intangible asset
    
    
    2,902
    
    
    
    2,841Accumulated other comprehensive income
    
    
    3,342
    
    
    
    4,244Net amount recognized
    
    $
    761
    
    
    $
    1,922Supplementary dataProjected benefit obligation
    
    $
    21,676
    
    
    $
    21,640Accumulated benefit obligation
    
    
    21,676
    
    
    
    21,640
 30




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) Pension Benefits2004
    
    2003Weighted average assumptionsDiscount rate
    
    
    6.50
    %
    
    
    6.50
    %Expected return on plan assets
    
    
    6.50
    %
    
    
    6.50
    %Rate of compensation increase
    
    
    5.00
    %
    
    
    5.00
    %
 The total pension for the Plan (in thousands) included the following components: December 31,2004
    
    
    2003
    
    
    2002Components of net cost:Service cost
    
    $
    230
    
    
    $
    1,384
    
    
    $
    1,437Interest cost
    
    
    1,361
    
    
    
    1,864
    
    
    
    1,684Expected return on plan assets
    
    
    (1,011
    )
    
    
    (1,175
    )
    
    
    (820
    )Amortization of transition amount
    
    
    (37
    )
    
    
    (42
    )
    
    
    (42
    )Amortization of prior service cost
    
    
    429
    
    
    
    562
    
    
    
    601Recognized net actuarial loss
    
    
    189
    
    
    
    1,078
    
    
    
    1,039Settlement and curtailment
    
    
    
    
    
    
    3,077
    
    
    
    Benefit cost
    
    $
    1,161
    
    
    $
    6,748
    
    
    $
    3,899Additional information:(Decrease) Increase in minimum liability included in other
comprehensive income
    
    $
    (902
    )
    
    $
    (5,635
    )
    
    $
    5,077
 VIP Retirement Plan The Company also provides a supplementary retirement plan for certain key employees, the VIP
Retirement Plan (VIP Plan). The VIP Plan provides a benefit up to 50% of average compensation for
the last five years in the VIP Plan, offset by benefits earned under the Virco Employees
Retirement Plan. The VIP Plan benefits are secured by a life insurance program. The cash surrender
values of the policies securing the VIP Plan were $2,584,000 and $2,691,000 at January 31, 2005 and
2004, respectively. These cash surrender values are included in other assets in the consolidated
balance sheets. The Company maintains a Rabbi Trust to hold assets related to the VIP Retirement Plan.
Substantially all assets securing this Plan are held in the Rabbi Trust. The following table sets forth (in thousands) the funded status of the VIP Plan at December 31,
2004 and 2003: Non-Qualified VIP Pension2004
    
    
    2003Change in benefit obligation:Benefit obligation at beginning of year
    
    $
    5,254
    
    
    $
    7,756Service cost
    
    
    240
    
    
    
    801Interest cost
    
    
    334
    
    
    
    489Plan amendments
    
    
    (490
    )
    
    
    (610
    )Settlement and curtailment
    
    
    
    
    
    
    (3,442
    )Actuarial loss
    
    
    510
    
    
    
    524Benefit paid
    
    
    (256
    )
    
    
    (264
    )
 31




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) Non-Qualified VIP Pension2004
    
    
    2003Benefit obligation at end of year
    
    $
    5,592
    
    
    $
    5,254Change in plan assets:Company contributions
    
    $
    256
    
    
    $
    264Benefits paid
    
    
    (256
    )
    
    
    (264
    )Fair value at end of year
    
    $
    
    
    
    $
    Funded status of plan
    
    $
    (5,254
    )
    
    $
    (5,254
    )Unrecognized prior service cost
    
    
    (2,959
    )
    
    
    (2,968
    )Unrecognized net actuarial loss
    
    
    1,877
    
    
    
    1,489Accrued benefit cost
    
    $
    (6,674
    )
    
    $
    (6,733
    )Statements of financial position:Accrued benefit liability
    
    $
    (6,674
    )
    
    $
    (6,733
    )Net amount recognized
    
    $
    (6,674
    )
    
    $
    (6,733
    )
 Non-Qualified VIP Pension2004
    
    
    2003Supplementary data:Projected benefit obligation
    
    $
    5,592
    
    
    $
    5,254Accumulated benefit obligation
    
    
    5,592
    
    
    
    5,254Weighted average assumptions:Discount rate
    
    
    6.50
    %
    
    
    6.50
    %Rate of compensation increase
    
    
    5.00
    %
    
    
    5.00
    %
 The total plan expense for the VIP Retirement Plan included the following components (in
thousands): December 31,2004
    
    
    2003
    
    
    2002Components of net cost:Service cost
    
    $
    240
    
    
    $
    801
    
    
    $
    820Interest cost
    
    
    334
    
    
    
    489
    
    
    
    431Amortization of prior service cost
    
    
    (499
    )
    
    
    (499
    )
    
    
    (417
    )Recognized net actuarial loss
    
    
    122
    
    
    
    409
    
    
    
    355Settlement and curtailment
    
    
    
    
    
    
    (264
    )
    
    
    Benefit cost
    
    $
    197
    
    
    $
    936
    
    
    $
    1,189
 Non-Employee Directors Retirement Plan In April 2001, the Board of Directors established a non-qualified plan for non-employee directors
of the Company. The plan provides a lifetime annual retirement benefit equal to the directors
annual retainer fee for the fiscal year in which the director terminates his or her position with
the Board, subject to the director providing 10 years of service to the Company. At January 31,
2005, the plan did not hold any assets. The following table sets forth (in thousands) the funded status of the Non-Employee Directors
Retirement Plan at December 31, 2004: 32




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) Non-EmployeeDirector Pension2004
    
    
    2003Change in benefit obligationBenefit obligation at beginning of year
    
    $
    366
    
    
    $
    554Service cost
    
    
    21
    
    
    
    19Interest cost
    
    
    24
    
    
    
    23Actuarial (gain)/loss
    
    
    (20
    )
    
    
    (230
    )Benefit obligation at end of year
    
    $
    391
    
    
    $
    366Change in plan assets:Fair value of plan assets at inception and end of year
    
    $
    
    
    
    $
    Funded status of plan
    
    $
    (391
    )
    
    $
    (366
    )Unrecognized prior service cost
    
    
    111
    
    
    
    198Unrecognized net actuarial (gain)/loss
    
    
    (232
    )
    
    
    (237
    )Net amount recognized
    
    $
    (512
    )
    
    $
    (405
    )Statements of financial position:Accrued benefit liability
    
    $
    (512
    )
    
    $
    (405
    )Intangible asset
    
    
    
    
    
    
    Net amount recognized
    
    $
    (512
    )
    
    $
    (405
    )Weighted average assumptions:Discount rate
    
    
    6.50
    %
    
    
    6.50
    %Rate of compensation increase
    
    
    5.00
    %
    
    
    5.00
    %
 The total plan expense for the Non-Employee Directors Retirement Plan included the following
components (in thousands): December 31,2004
    
    
    2003
    
    
    2002Components of net cost:Service cost
    
    $
    21
    
    
    $
    19
    
    
    $
    29Interest cost
    
    
    24
    
    
    
    23
    
    
    
    34Actuarial gain
    
    
    (26
    )
    
    
    (23
    )
    
    
    Amortization of prior year
service cost
    
    
    88
    
    
    
    88
    
    
    
    88Benefit cost
    
    $
    107
    
    
    $
    151
    
    
    $
    148
 401(k) Retirement Plan The Companys retirement plan, which covers all U.S. employees, allows participants to defer from
1% to 15% of their eligible compensation through a 401(k) retirement program. Through December 31,
2001, the plan included an employee stock ownership component. The plan continues to include the
Virco stock as one of the investment options. Shares owned by the plan are held by the Plan
Trustee, Security Trust Company. At January 31, 2005 and 2004, the plan held 488,426 shares and
496,375 shares of Virco Stock, respectively. For the fiscal years ended January 31, 2005, 2004 and
2003, there was no employer match and therefore no compensation cost to the Company. Life Insurance The Company provided current and post-retirement life insurance to certain salaried employees with
split dollar life insurance policies under the Dual Option Life Insurance Plan. Effective January
2004, the Company terminated this plan for active employees. Cash surrender values of these
policies, which are included in other assets in the consolidated balance sheets, were $2,792,000
and $2,633,000 at January 31, 2005 and 33




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) 2004, respectively. The Company maintains a Rabbi Trust to hold assets related to the Dual Options
Life Insurance Plan. Substantially all assets securing this plan are held in the Rabbi Trust. Deferred Compensation Plan The Company established, effective January 1, 1997, a Deferred Compensation Plan, which allows
certain key employees to defer up to a maximum of 90% of their base annual salary and/or up to 90%
of their annual bonus on a pre-tax basis. The Deferred Compensation Plan was funded with investment
funds held in the Rabbi Trust. The Deferred Compensation Plan was terminated in December 2003 and
all assets were distributed to participants in January 2004. 5. Stock Options and Stockholders Rights The Companys two stock plans are the 1997 Employee Incentive Plan (the 1997 Plan) and the 1993
Employee Incentive Stock Plan (the 1993 Plan). Under the 1993 Plan, the Company may grant an
aggregate of 707,384 shares (as adjusted for stock splits and stock dividends) to its
employees in the form of stock options. The 1993 Plan expired in 2003 and had 52,760 unexercised
options outstanding at January 31, 2005. Under the 1997 Plan, the Company may grant an aggregate
of 724,729 shares (as adjusted for stock splits and stock dividends) to its employees
in the form of stock options or awards. As of January 31, 2005, the 1997 plan had 315,128
unexercised option outstanding and 120,249 shares remain available for future grant. Options
granted under the plans have an exercise price equal to the market price at the date of grant, have
a maximum term of 10 years and generally become exercisable ratably over a five-year period. During
2003, certain optionees satisfied the exercise price of their options by exchanging shares already
owned rather than paying cash. As a result, 0 and 19,991 shares were recorded as treasury stock for
the years ended January 31, 2005 and 2004, respectively. Non-employee directors automatically
receive a grant for options to purchase 2,000 shares of common stock on the first business day
following each annual meeting of the Companys stockholders. Incentive Stock Options A summary of the Companys stock option activity, and related information for the years ended
January 31, are as follows: 2005
    

    2004
    

    2003Weighted-
    
    
    
    
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Exercise
    
    
    
    
    
    
    ExerciseOptions
    
    
    Price
    
    
    Options
    
    
    Price
    
    
    Price
    
    
    PriceOutstanding at beginning
of year
    
    
    372,381
    
    
    $
    11.30
    
    
    
    481,774
    
    
    $
    10.82
    
    
    
    659,475
    
    
    $
    9.09Granted
    
    
    12,000
    
    
    
    6.89
    
    
    
    10,000
    
    
    
    8.40
    
    
    
    13,200
    
    
    
    13.59Exercised
    
    
    (2,563
    )
    
    
    2.41
    
    
    
    (56,257
    )
    
    
    6.22
    
    
    
    (149,431
    )
    
    
    3.15Forfeited
    
    
    (13,930
    )
    
    
    8.54
    
    
    
    (63,136
    )
    
    
    12.58
    
    
    
    (41,470
    )
    
    
    11.68Outstanding at end of year
    
    
    367,888
    
    
    
    11.17
    
    
    
    372,381
    
    
    
    11.15
    
    
    
    481,774
    
    
    
    10.82Exercisable at end of year
    
    
    336,352
    
    
    
    11.39
    
    
    
    337,509
    
    
    
    11.30
    
    
    
    433,280
    
    
    
    10.81Weighted-average fair value
of options granted
during the year
    
    
    
    
    
    
    2.86
    
    
    
    
    
    
    
    3.53
    
    
    
    
    
    
    
    5.54
 The data included in the above table have been retroactively adjusted, if applicable, for stock
dividends. 34




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) Information regarding stock options outstanding as of January 31, 2005, is as follows: Options Outstanding
    
    
    Options ExercisableWeighted-Average
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Remaining
    
    
    Average
    
    
    
    
    
    
    AverageNumber of
    
    
    Contractual
    
    
    Exercise
    
    
    Number of
    
    
    ExercisePrice Range
    
    Shares
    
    
    Life
    
    
    Price
    
    
    Shares
    
    
    Price$2.91-3.81
    
    
    5,578
    
    
    
    0.86
    
    
    $
    3.34
    
    
    
    5,578
    
    
    $
    3.34$6.36-8.82
    
    
    96,286
    
    
    
    4.63
    
    
    
    7.25
    
    
    
    71,350
    
    
    
    7.11$10.14-16.09
    
    
    266,024
    
    
    
    3.85
    
    
    
    12.76
    
    
    
    259,424
    
    
    
    12.74367,888
    
    
    
    
    
    
    
    
    
    
    
    336,352
 The Company has elected to account for its employee stock options under Accounting Principles Board
Opinion 25, Accounting for Stock Issued to Employees, (APB 25) and related interpretations in
accounting for employee stock options. No compensation expense is recorded under APB 25 because the
exercise price of the Companys employee common stock options equals the market price of the
underlying common stock on the grant date. Restricted Stock Unit Awards On June 30, 2004, the Company granted a total of 270,000 restricted stock units, with an estimated
fair value of $6.92 per unit and exercise price of $0.01 per unit, to eligible employees under the
1997 plan. Participants vest their interest in notional stock units ratably over five years, with
such units being 20% vested at each anniversary date. Compensation expense is recognized based on the
estimated fair value of restricted stock units and vesting provisions. For fiscal year 2004,
compensation expense incurred in connection with this award was $230,000. Stockholders Rights On October 15, 1996, the Board of Directors declared a dividend of one preferred stock purchase
right (a Right) for each outstanding share of the Companys common stock. Each Right entitles a
stockholder to purchase for an exercise price of $50.00 ($20.70, as adjusted for stock splits and
stock dividends), subject to adjustment, one one-hundredth of a share of Series A Junior
Participating Cumulative Preferred Stock of the Company, or under certain circumstances, shares of
common stock of the Company or a successor company with a market value equal to two times the
exercise price. The Rights are not exercisable, and would only become exercisable for all other
persons when any person has acquired or commences to acquire a beneficial interest of at least 20%
of the Companys outstanding common stock. The Rights expire on October 25, 2006, have no voting
privileges, and may be redeemed by the Board of Directors at a price of $.001 per Right at any time
prior to the acquisition of a beneficial ownership of 20% of the outstanding common shares. There
are 200,000 shares (483,153 shares as adjusted by stock splits and stock dividends) of Series A
Junior Participating Cumulative Preferred Stock reserved for issuance upon exercise of the Rights. 35




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) 6. Income Taxes The provisions for the last three years are reconciled to the statutory federal income tax rate
using the liability method as follows: January 31,2005
    
    
    2004
    
    
    2003Statutory
    
    $
    (4,719
    )
    
    $
    (9,057
    )
    
    $
    144State taxes (net of federal tax)
    
    
    (472
    )
    

    
    (906
    )
    
    
    0Change in valuation allowance
    
    
    4,865
    
    
    
    7,641
    
    
    
    0Nondeductible expenses and other
    
    
    441
    
    
    
    (2,355
    )
    
    
    (3
    )$
    115
    
    
    $
    (4,677
    )
    
    $
    141
 Significant components of the provision for income taxes (in thousands) attributed to continuing
operations are as follows: January 31,2005
    
    
    2004
    
    
    2003CurrentFederal
    
    $
    
    
    
    $
    (4,677
    )
    
    $
    (333
    )State
    
    
    115
    
    
    
    
    
    
    
    (81
    )115
    
    
    
    (4,677
    )
    
    
    (414
    )DeferredFederal
    
    
    (4,466
    )
    
    
    (6,359
    )
    
    
    469State
    
    
    (753
    )
    
    
    (1,283
    )
    
    
    86(5,219
    )
    
    
    (7,641
    )
    
    
    555Valuation allowance
    
    
    5,219
    
    
    
    7,641
    
    
    
    
    
    
    
    
    
    
    
    555$
    115
    
    
    $
    (4,677
    )
    
    $
    141
 Deferred tax assets and liabilities (in thousands) are comprised of the following: January 31,2005
    
    
    2004Deferred tax assetsAccrued vacation and sick leave
    
    $
    1,045
    
    
    $
    906Retirement plans
    
    
    3,961
    
    
    
    3,986Insurance reserves
    
    
    898
    
    
    
    1,626Inventory
    
    
    663
    
    
    
    665Net operating loss carryforwards
    
    
    8,697
    
    
    
    4,055Warranty
    
    
    561
    
    
    
    65415,825
    
    
    
    11,892Deferred tax liabilitiesTax in excess of book depreciation
    
    
    (2,927
    )
    
    
    (3,476
    )
 36




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##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) January 31,2005
    
    
    2004Capitalized software development costs
    
    
    (258
    )
    
    
    (472
    )Other
    
    
    (74
    )
    
    
    (243
    )(3,259
    )
    
    
    (4,191
    )Valuation allowance
    
    
    (12,566
    )
    
    
    (7,701
    )Net deferred tax asset
    
    $
    
    
    
    $
    
 In assessing the realizability of deferred tax assets, the Company considers whether it is more
likely than not that some portion or all of the 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. The Company considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies in making this
assessment. Based on this consideration, the Company anticipates that it is more likely than not
that the net deferred tax assets will not be realized, and a valuation allowance was recorded
against the net deferred tax assets at January 31, 2005 and January 31, 2004. At January 31, 2005, the Company had net operating losses that can potentially be carried forward
for federal and state income tax purposes, expiring at various dates through 2025 if not utilized.
Federal net operating losses that can potentially be carried forward total approximately
$20,750,000 at January 31, 2005. At January 31, 2005 state net operating losses that can
potentially be carried forward total approximately $48,307,000 at January 31, 2005. For the fiscal year ended January 31, 2005, the Company incurred $115,000 of income and franchise
taxes as required by various states. For the fiscal year ended January 31, 2004, the Company
recognized an income tax benefit for an amount equal to the estimated available net operating loss
that could be carried back against prior year taxes paid by the Company. 7. Commitments The Company has long-term leases on real property and equipment, which expire at various dates.
Certain of the leases contain renewal, purchase options and require payment for property taxes and
insurance. Minimum future lease payments (in thousands) for operating leases in effect as of January 31, 2005,
are as follows: Year ending January 31,2006
    
    $
    9,3402007
    
    
    7,2622008
    
    
    5,0912009
    
    
    3,8012010
    
    
    3,712Thereafter
    
    
    31$
    29,237
 Rent expense relating to operating leases was as follows (in thousands): Year ended January 31,2005
    
    $
    9,0502004
    
    
    9,9992003
    
    
    9,969
 The Company leases machinery and equipment under a 10-year operating lease arrangement. The Company
has the option of buying out the leases three to five years into the lease period. 8. Contingencies The Company and other furniture manufacturers are subject to federal, state and local laws and
regulations relating to the discharge of materials into the environment and the generation,
handling, storage, transportation and disposal of waste and hazardous materials. The Company has
expended, and may be expected to expend significant amounts for the investigation of environmental
conditions, installation of environmental control equipment and remediation of environmental
contamination. 37




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##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) The Company is subject to contingencies pursuant to environmental laws and regulations that in the
future may require the Company to take action to correct the effects on the environment of prior
disposal practices or releases of chemical or petroleum substances by the Company or other parties.
At January 31, 2005 and 2004, there were no required reserves for such environmental contingencies. The Company has a self-insured retention for product and general liability losses up to $500,000
per occurrence, workers compensation liability losses up to $250,000 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 the net present value of
$2,400,000 at January 31, 2005, based upon the Companys estimated payout period of four years
using a 6% discount rate. Workers compensation, automobile, general and product liability claims may be asserted in the
future for events not currently known by management. Management does not anticipate that any
related settlement, after consideration of the existing reserve for claims incurred and potential
insurance recovery, would have a material adverse effect on the Companys financial position,
results of operations or cash flows. The Company and its subsidiaries are defendants in various legal proceedings resulting from
operations in the normal course of business. It is the opinion of management, 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 accrues an estimate of its exposure to warranty claims based upon both current and
historical product sales data and warranty costs incurred. The majority of the Companys products
sold through January 31, 2005, carry a five-year warranty. Effective February 1, 2005, the Company
extended its standard warranty period to 10 years. The Company periodically assesses the adequacy
of its recorded warranty liabilities and adjusts the amounts as necessary. The warranty liability
is in accrued liabilities in the accompanying consolidated balance sheet. Changes in the Companys warranty liability were as follows (in thousands): January 31,2005
    
    
    2004Beginning
balance
    
    $
    1,751
    
    
    $
    900Provision
    
    
    1,304
    
    
    
    1,976Costs incurred
    
    
    (1,555
    )
    
    
    (1,125
    )Ending
balance
    
    $
    1,500
    
    
    $
    1,751
 10. Gain on Sale of Assets and Other Income In November 2003, the Company completed the sale of its Gardena, California, manufacturing
facility, which was held as rental property. The Company received $5,801,000 in cash and recorded a
$5,557,000 pre-tax gain on the disposition during the fiscal year ended January 31, 2004. 38




---



##### 



VIRCO MFG. CORPORATION Notes to Financial Statements (continued) 11. Quarterly Results (Unaudited) The Companys quarterly results for the years ended January 31, 2005 and 2004, are summarized as
follows (in thousands, except per share data): Apr. 30
    
    
    Jul. 31
    
    
    Oct. 31
    
    
    Jan. 31Year ended January 31, 2005:Net sales
    
    $
    30,321
    
    
    $
    68,813
    
    
    $
    69,502
    
    
    $
    31,218Gross profit
    
    
    10,317
    
    
    
    21,797
    
    
    
    20,391
    
    
    
    3,934Net (loss) income
    
    
    (4,601
    )
    
    
    2,031
    
    
    
    21
    
    
    
    (11,446
    )Per common share(1)Net lossBasic
    
    
    (0.35
    )
    
    
    0.16
    
    
    
    
    
    
    
    (0.87
    )Assuming dilution
    
    
    (0.35
    )
    
    
    0.15
    
    
    
    
    
    
    
    (0.87
    )Year ended January 31, 2004:Net sales
    
    $
    31,180
    
    
    $
    65,861
    
    
    $
    65,802
    
    
    $
    29,009Gross profit
    
    
    10,411
    
    
    
    20,966
    
    
    
    18,865
    
    
    
    4,190Net loss
    
    
    (4,013
    )
    
    
    (8,286
    )
    
    
    (7,675
    )
    
    
    (1,987
    )Per common share(1)Net lossBasic
    
    
    (0.31
    )
    
    
    (0.63
    )
    
    
    (0.59
    )
    
    
    (0.15
    )Assuming dilution
    
    
    (0.31
    )
    
    
    (0.63
    )
    
    
    (0.59
    )
    
    
    (0.15
    )
   (1)
    
    Per common share amounts for the quarters and full years have each been calculated
separately. Accordingly, quarterly amounts may not add to the annual amounts because of
differences in the average common shares outstanding during each period and with regard to
diluted per common share amounts only, because of the effect of potentially dilutive
securities only in the periods in which the effect would have been dilutive. 39




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##### 



EXHIBIT 13.1  SUPPLEMENTAL STOCKHOLDERS INFORMATION Annual Meeting The Annual Meeting of Virco stockholders will be held on Tuesday, June 7, 2005, at 10:00 a.m., at
2027 Harpers Way, Torrance, California 90501. The record date for this meeting is April 22, 2005.
The Proxy Statement and Proxy pertaining to this meeting will be mailed on or about May 10, 2005. SEC Form 10-K A copy of the annual report to the Securities and Exchange Commission on Form 10-K may be obtained
without charge upon written request to: Corporate Secretary
Virco Mfg. Corporation
2027 Harpers Way
Torrance, CA 90501 Virco Common Stock The American Stock exchange is the principal market on which Virco Mfg. Corporation (VIR) stock is
traded. As of April 4, 2005, there were approximately 338 registered stockholders according to the
transfer agent records. There are approximately 923 beneficial stockholders. Stockholder Records Records pertaining to stockholdings and dividends are maintained by Mellon Investor Services.
Inquiries with respect to these matters, as well as notices of address changes, should be directed
to: Mellon Investor Services, PO Box 3315
South Hackensack, New Jersey 07606
Phone: 1-800-356-2017 & foreign: 201-329-8660
TDD for Hearing Impaired: (800)231-5469
website address: www.melloninvestor.com If a stock certificate is lost or mutilated, immediately communicate with Mellon Investor Services
at the above addresses. Additional Services for Stockholders Information about the Company is now available to stockholders at the Companys website
(www.virco.com). A brief description of Vircos product line is offered together with
illustrations showing a sampling of our furniture. Quarterly Dividend and Stock Market Information Cash Dividends Declared
    
    
    Common Stock Range31-Jan-05
    
    
    31-Jan-04
    
    
    31-Jan-05
    
    
    31-Jan-04High
    
    
    Low
    
    
    High
    
    
    Low1st Quarter
    
    $
    
    
    
    $
    0.02
    
    
    $
    7.95
    
    
    $
    7.01
    
    
    $
    10.08
    
    
    $
    8.432nd Quarter
    
    
    
    
    
    
    0.02
    
    
    
    7.75
    
    
    
    6.70
    
    
    
    9.65
    
    
    
    6.113rd Quarter
    
    
    
    
    
    
    
    
    
    
    7.75
    
    
    
    7.20
    
    
    
    7.62
    
    
    
    5.604th Quarter
    
    
    
    
    
    
    
    
    
    
    7.94
    
    
    
    7.50
    
    
    
    7.55
    
    
    
    5.55
 The data included in the above table has been retroactively adjusted, if applicable, for the stock
split and stock dividends. 40




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##### 



Directors, Officers and Facilities Directors Robert A. Virtue
President, Chairman of the Board and Chief Executive Officer Donald S. Friesz
Former Vice President  Sales and Marketing Evan M. Gruber
Chief Executive Officer, Class Leasing, Inc. Robert K. Montgomery
Partner, Gibson, Dunn & Crutcher Albert J. Moyer
Board member of California Amplifier, Inc., Collectors Universe, Inc., LaserCard Corporation and
QAD Inc. Glen D. Parish
Former Vice President and General Manager, Conway Division Donald A. Patrick
Management Consultant, Diversified Business Resources, Inc. Douglas A. Virtue
Executive Vice President Dr. James R. Wilburn
Dean of the School of Public Policy, Pepperdine University Officers Robert A. Virtue
President, Chairman of the Board and Chief Executive Officer Douglas A. Virtue
Executive Vice President J. Scott Bell
Vice President  General Manager, Conway Division Andy Choy
Vice President  Planning and Information Technology Robert E. Dose
Vice President  Finance, Secretary and Treasurer Angelica Gamble
Vice President  Human Resources Patricia Quinones
Vice President  Logistics and Marketing Services D. Randal Smith
Vice President  Marketing Lori L. Swafford
Vice President  Legal Affairs Nick Wilson
Vice President  General Manager, Torrance Division 41




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##### 



Larry O. Wonder
Vice President  Sales Bassey Yau
Corporate Controller, Assistant Secretary and Treasurer Independent Registered Public Accounting Firm Ernst & Young LLP
725 South Figueroa Street, Suite 500
Los Angeles, California 90017 Legal Counsel Gibson, Dunn & Crutcher
2029 Century Park East
Los Angeles, California 90067 Corporate Headquarters 2027 Harpers Way
Torrance, California 90501
(310) 533-0474 Major Facilities Torrance Division
2027 Harpers Way
Torrance, California 90501 Conway Division
Highway 65, South
Conway, Arkansas 72032 42




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##### 



VIRCO MFG. CORPORATION AND SUBSIDIARIES
SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED JANUARY 31, 2005, 2004 AND 2003
(In Thousands) Col. B
    
    
    Col. C
    
    
    Col. E
    
    
    Col. FBalance at
    
    
    Charged to Costs
    
    
    Deductions from
    
    
    Balance at Close ofCol. A
    
    Beginning of Period
    
    
    and Expenses
    
    
    Reserves
    
    
    PeriodAllowance for doubtful accounts for the period ended:January 31,
2005
    
    $
    225
    
    
    $
    17
    
    
    $
    17
    
    
    $
    225January 31,
2004
    
    $
    225
    
    
    $
    36
    
    
    $
    36
    
    
    $
    225January 31,
2003
    
    $
    200
    
    
    $
    267
    
    
    $
    242
    
    
    $
    225Inventory valuation reserve for the period ended:January 31, 2005
    
    $
    1,150
    
    
    $
    250
    
    
    $
    0
    
    
    $
    1,400January 31,
2004
    
    $
    575
    
    
    $
    575
    
    
    $
    0
    
    
    $
    1,150January 31,
2003
    
    $
    628
    
    
    $
    0
    
    
    $
    53
    
    
    $
    575Warranty reserve for the period ended:January 31,
2005
    
    $
    1,751
    
    
    $
    1,304
    
    
    $
    1,555
    
    
    $
    1,500January 31,
2004
    
    $
    900
    
    
    $
    1,976
    
    
    $
    1,125
    
    
    $
    1,751January 31,
2003
    
    $
    150
    
    
    $
    2,091
    
    
    $
    1,341
    
    
    $
    900Product, workers compensation and automobile liability reserves for the period ended:January 31,
2005
    
    $
    4,297
    
    
    $
    0
    
    
    $
    1,897
    
    
    $
    2,400January 31,
2004
    
    $
    3,080
    
    
    $
    1,217
    
    
    $
    0
    
    
    $
    4,297January 31,
2003
    
    $
    3,500
    
    
    $
    1,407
    
    
    $
    1,827
    
    
    $
    3,080Deferred tax valuation allowance for the period ended:January 31,
2005
    
    $
    7,701
    
    
    $
    4,865
    
    
    $
    0
    
    
    $
    12,566January 31,
2004
    
    $
    0
    
    
    $
    7,701
    
    
    $
    0
    
    
    $
    7,701January 31,
2003
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0
 43