EBF

Business Context and Reporting Period

Company: ENNIS, INC.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: November 30, 2010
Business Overview: Ennis, Inc. operates two primary segments: the Print Segment, which manufactures business forms and printed products primarily for distributors in the U.S., and the Apparel Segment (Alstyle Apparel), which produces activewear including t-shirts and fleece goods. The company is currently constructing a new manufacturing facility in Agua Prieta, Mexico, to transition operations from its Anaheim, California facility.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 5.5% for the quarter and 5.6% for the nine-month period compared to the prior year. This growth was driven by the Apparel Segment, which saw sales rise 14.2% (quarter) and 17.8% (nine months). Conversely, the Print Segment sales declined 1.5% (quarter) and 4.5% (nine months) due to market contraction and digital substitution.
• Profitability: Net earnings increased 4.9% for the quarter and 37.2% for the nine-month period. Operating income rose 1.3% for the quarter and 30.9% for the nine-month period, largely due to improved gross margins in the Apparel Segment (up 150 basis points for the quarter) and operational efficiencies.
• Cash Flow: Net cash provided by operating activities decreased significantly by 57.1% to $30.6 million for the nine-month period. This decline was primarily due to a $22.6 million increase in inventory levels to support Apparel sales growth and the upcoming transition to the new Mexico facility.
• Investing Activities: Cash used in investing activities increased 165.5% to $31.1 million, driven by capital expenditures of $28.9 million, primarily for the Agua Prieta manufacturing facility and the acquisition of Atlas Tag and Label.

Guidance, Outlook, and Risks

• Outlook: Management anticipates continued revenue growth in the Apparel Segment but faces headwinds in the Print Segment due to the shift to digital technologies. The company expects the new Agua Prieta facility to begin operations in the next few quarters, with total project costs estimated between $50.0 million and $54.0 million.
• Cost Pressures: The company faces rising raw material costs, particularly cotton (approx. 40% of Apparel costs) and paper. While the company has passed some costs to customers, competitive pressures may limit future pass-throughs.
• Transition Costs: The ramp-up of the new Mexico facility and the wind-down of the Anaheim facility are expected to incur duplicate costs and inefficiencies, estimated to negatively impact operating results by $6.0 million to $8.0 million over fiscal years 2011 and 2012.
• Liquidity: The company maintains a $150.0 million revolving credit facility with approximately $96.8 million available. It is currently in compliance with all financial covenants.
• Risks: Key risks include economic uncertainty, volatility in cotton and paper prices, potential labor disputes (14% of domestic employees are unionized), and the risk of impairment for goodwill and intangible assets if market conditions deteriorate.

Investor Verification Checklist

• Inventory Build: Verify the necessity and valuation of the $22.6 million increase in inventory, specifically regarding the transition to the new Mexico facility.
• Capital Expenditure Progress: Monitor the completion timeline and cost overruns for the Agua Prieta facility, as delays could increase the estimated $6.0-$8.0 million transition cost impact.
• Raw Material Hedging: Assess the company's ability to pass through rising cotton and paper costs to customers without losing market share.
• Print Segment Decline: Evaluate the long-term sustainability of the Print Segment given the continued erosion of traditional business forms due to digital adoption.
• Debt Covenants: Confirm continued compliance with the total funded debt to EBITDA ratio covenant under the credit facility, especially given the heavy capital spending.