EBF

Business Context and Reporting Period

Company: ENNIS, INC.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 31, 2011
Business Overview: Ennis operates two primary segments: the Print Segment (manufacturing business forms and printed products) and the Apparel Segment (manufacturing activewear, primarily under the Alstyle brand). The company distributes products primarily through independent dealers and distributors in North America.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 1.8% year-over-year, driven by a 4.2% increase in Apparel sales ($76.1M) which offset a 1.0% decline in Print sales ($67.1M).
• Margin Compression: Gross margin declined from 30.0% to 27.7%. This was primarily due to a 35% increase in cotton costs for the Apparel segment and higher raw material prices in the Print segment, alongside manufacturing inefficiencies during the transition to a new facility.
• Profitability: Net earnings decreased 12.4% to $11.4 million. Operating income fell 10.0% to $18.8 million, largely attributed to the reduced gross margins.
• Capital Expenditures: CapEx dropped significantly by 83.9% to $2.1 million, as the new Agua Prieta, Mexico manufacturing facility was substantially completed at the start of the fiscal year.
• Interest Expense: Interest expense increased from $0.4 million to $0.8 million. The prior year included $0.3 million of capitalized interest related to facility construction, whereas no interest was capitalized in the current quarter.

Guidance, Outlook, and Risks

• Apparel Transition Costs: Management estimates total negative impact from the start-up of the new Mexico facility and the phase-out of the California facility to be approximately $4.5 million to $5.0 million for fiscal year 2012. To date, approximately $6.8 million in costs have been incurred.
• Raw Material Volatility: The company faces sustained high costs for cotton and paper. While they attempt to pass costs to customers, competitive pressures may limit this ability. Cotton costs were 35% higher than the prior year quarter.
• Liquidity: The company maintains a $150 million revolving credit facility with approximately $96.8 million available as of May 31, 2011. They are in compliance with all financial covenants.
• Pension Obligations: The company expects to contribute between $2.0 million and $3.0 million to its defined benefit pension plan during fiscal year 2012.
• Key Risks: Significant risks include the erosion of demand for printed forms due to digital technology, volatility in cotton and paper prices, labor disputes (14% of domestic employees are unionized), and the successful ramp-up of the new manufacturing facility.

Investor Verification Checklist

• Cost Pass-Through: Verify the company's ability to fully pass increased cotton and paper costs to customers without losing market share.
• Facility Transition: Monitor the timeline and cost efficiency of the transition from the Anaheim, CA facility to the Agua Prieta, Mexico facility to ensure projected savings are realized.
• Print Segment Decline: Assess the long-term impact of digital substitution on the Print Segment's revenue and the success of new product introductions (e.g., healthcare wristbands, secure documents).
• Inventory Levels: Review inventory turnover given the significant build-up in apparel inventory ($115.3M total) driven by higher raw material costs and seasonal demand.
• Debt Covenants: Confirm continued compliance with the total funded debt to EBITDA ratio covenant under the credit facility maturing in August 2012.