Ennis, Inc.: Form 10-Q for the period ended Nov 30, 2012

Overview

Ennis, Inc. (formerly Ennis Business Forms, Inc.) was organized under the laws of Texas in 1909. Ennis, Inc. and its subsidiaries (collectively referred to as the “Company,” “Registrant,” “Ennis,” or “we,” “us,” or “our”) print and manufacture a broad line of business forms and other business products (the “Print Segment”) and also manufacture a line of activewear (the “Apparel Segment”) for distribution throughout North America. The Print Segment distributes business products and forms throughout the United States primarily through independent dealers. This distributor channel encompasses print distributors, stationers, quick printers, computer software developers, and advertising agencies, among others. The Apparel Segment produces and sells activewear, including t-shirts, fleece goods and other wearables. Distribution of our activewear throughout the United States, Canada and Mexico is primarily through sales representatives. The distributor channel encompasses activewear wholesalers and screen printers. We offer a great selection of high-quality activewear apparel and hats with a wide variety of styles and colors in sizes ranging from toddler to 6XL. The apparel line features a wide variety of tees, fleece and shorts.

On February 10, 2012, we acquired from Cenveo Corporation (“Cenveo”), and its subsidiaries, Cenveo Resale Ohio, LLC, and Printegra Corporation, certain assets of Cenveo’s document business, including the manufacturing facilities branded under the names of PrintXcel and Printegra for $40.0 million plus the assumption of certain trade liabilities. The cash portion of the purchase price was funded by borrowing under our line of credit facility. The original purchase price of $40.0 million was subsequently reduced to $36.2 million as a result of an adjustment made during the quarter ended August 31, 2012, to the acquisition date inventory balances and pursuant to the terms of the purchase agreement. The combined sales of the purchased operations were $74.4 million during the twelve month period ended December 31, 2011. The acquired assets will continue to be operated under their respective trade names of PrintXcel and Printegra. We expect the acquired assets will expand our pressure seal and high color commercial print capabilities, as well as our business check product lines, which will be sold through our independent distributor network.

On September 30, 2011, we purchased all of the outstanding equity of PrintGraphics, LLC (“PrintGraphics”), as well as associated land and buildings for an aggregate of $6.0 million in cash. PrintGraphics has locations in Vandalia, Ohio and Nevada, Iowa. The sales of the purchased operations were $15.1 million during the twelve month period ended December 31, 2010. The acquisition of PrintGraphics continues our strategy of targeted growth in the Print Segment of products to further service our existing customer base.

Business Segment Overview

We are one of the largest providers of business forms to independent distributors in the United States and are also one of the largest providers of blank t-shirts in North America to the activewear market. We operate in two reportable segments: Print and Apparel. For additional financial information concerning segment reporting, please see Note 14 of the Notes to the Consolidated Financial Statements beginning on page 18 included elsewhere herein, which information is incorporated herein by reference.

Print Segment

The Print Segment, which represented 63% and 62% of our consolidated net sales for the three and nine months ended November 30, 2012, is in the business of manufacturing, designing and selling business forms and other printed business products primarily to distributors located in the United States. The Print Segment operates 49 manufacturing locations throughout the United States in 19 strategically located states. Approximately 95% of the business products manufactured by the Print Segment are custom and semi-custom products, constructed in a wide variety of sizes, colors, and quantities on an individual job basis depending upon customers’ specifications.

The products sold include snap sets, continuous forms, laser cut sheets, tags, labels, envelopes, integrated products, jumbo rolls and pressure sensitive products in short, medium and long runs under the following labels: Ennis®, Royal Business Forms®, Block Graphics®, Specialized Printed Forms®, 360º Custom LabelsSM, Enfusion®, Uncompromised Check Solutions®, VersaSeal®, Witt Printing®, B&D Litho®, Genforms®, PrintGraphicsSM, Calibrated Forms®, PrintXcel™ and Printegra®. The Print Segment also sells the Adams-McClure® brand (which provides Point of Purchase advertising for large franchise and fast food chains as well as kitting and fulfillment); the Admore® brand (which provides presentation folders and document folders); Ennis Tag & LabelSM (which provides tags and labels, promotional products and advertising concept products); Atlas Tag & Label® (which provides tags and labels); Trade Envelopes® and Block Graphics® (which provide custom and imprinted envelopes) and Northstar® and General Financial Supply® (which provide financial and security documents).

The Print Segment sells predominantly through private printers and independent distributors. Northstar also sells direct to a small number of customers, generally large banking organizations (where a distributor is not acceptable or available to the end-user), as does Adams-McClure, where sales are generally through advertising agencies.

The printing industry generally sells its products either through sales made predominantly to end users, a market dominated by a few large manufacturers, such as Moore Wallace (a subsidiary of R.R. Donnelley), Standard Register, and Cenveo, or, like the Company, through a variety of independent distributors and distributor groups. While it is not possible, because of the lack of adequate statistical information, to determine the Company’s share of the total business products market, management believes the Company is one of the largest producers of business forms in the United States distributing primarily through independent dealers and that its business forms offering is more diversified than that of most companies in the business forms industry.

There are a number of competitors that operate in this segment, ranging in size from single employee-owner operations to multi-plant organizations. We believe our strategic locations and buying power permit us to compete on a favorable basis within the distributor market on competitive factors, such as service, quality, and price.

Distribution of business forms and other business products throughout the United States is primarily done through independent dealers, including business forms distributors, stationers, printers, computer software developers, and advertising agencies.

Raw materials of the Print Segment principally consist of a wide variety of weights, widths, colors, sizes, and qualities of paper for business products purchased from a number of major suppliers at prevailing market prices.

Business products usage in the printing industry is generally not seasonal. General economic conditions and contraction of the traditional business forms industry are the predominant factor in quarterly volume fluctuations.

Our Print Business Challenges - In our Print Segment, we are engaged in an industry undergoing significant changes. Technology advances have made electronic distribution of documents, internet hosting, digital printing and print-on-demand valid, cost-effective alternatives to traditional custom printed documents and customer communications. In addition, the economic downturn and the associated credit crunch created highly competitive conditions in an already over-supplied, price-competitive industry, continue to present challenges today. Thus, we believe we are facing the following challenges in the Print Segment of our business:

• Transformation of our portfolio of products
• Excess production capacity and price competition within our industry
• Continued economic uncertainties

The following is a discussion of these business challenges and our strategy for managing their effect on our print business.

Transformation of our portfolio of products – Traditional business documents are essential in order to conduct business. However, many are being replaced or devalued with advances in digital technologies, causing steady declines in demand for a large portion of our current product line. The same digital advances also introduce potential new growth opportunities, such as print-on-demand services and product offerings that assist customers in their transition to digital business environments. In addition, we will continue to look for new market opportunities and niches, such as the addition of our envelope offerings, healthcare wristbands, secure document solutions, innovative in-mold label offerings and long-run integrated products with high color web printing that provide us with an opportunity for growth and differentiate us from our competition. Transforming our product offerings in order to continue to provide innovative, valuable solutions to our customers on a proactive basis will require us to make investments in new and existing technology and to develop key strategic business relationships.

Excess production capacity and price competition within our industry – Paper mills continue to adjust production capacity through downtime and closures to attempt to keep supply in line with demand. Due to the limited number of paper mills, paper prices have been and are expected to remain fairly volatile.

Despite a continued competitive marketplace, we have generally been able to pass through increased paper costs, although it can often take several quarters to push these through due to the custom nature of our products and/or contractual relationships with some of our customers. We expect this trend to continue, however, any new downturn in the economy or continued protraction of the current recovery may limit our ability to recover all these costs. As such, we will continue to focus our efforts on effectively managing and controlling our product costs to minimize the effects of the foregoing on our operational results, primarily through the use of forecasting models and production and costing models. However, an inherent risk in this process is that our assumptions are inaccurate, which could have a negative impact on our reported profit margins.

Continued economic uncertainties – As a result of the past recessionary conditions, the economic climate has been volatile and challenging. Decreased demand and intense price competition resulted in a significant decline in our revenue during the past several fiscal years. Although we have seen improvement in some economic indicators within our markets, a generally weak domestic job market, global economic instabilities, a rather anemic domestic economic recovery and domestic policy uncertainties have and will continue to present a challenging environment for revenue growth. As we cannot predict the pace or continuance of the domestic economic recovery, the impact of continued global economic instability, nor the impact of domestic policy decisions, we continue to focus on customer retention, expanding our growth targeted products and continuing to develop new market niches. In addition, we have a proven history of managing our costs during tough economic times and would not expect this to change in the future.

Apparel Segment

The Apparel Segment represented 37% and 38% of our consolidated net sales for the three and nine months ended November 30, 2012, and operates under the name of Alstyle Apparel (“Alstyle”). Alstyle markets high quality knitted activewear (including t-shirts, tank tops and fleece) across all market segments. The main products of Alstyle are standardized shirts manufactured in a variety of sizes and colors. Approximately 97% of Alstyle’s revenues are derived from t-shirt sales, which make up 89% of domestic sales. Alstyle’s branded product lines are sold mainly under the AAA® and Murina® brands.

Effective July 2011, Alstyle operates in an owned manufacturing facility located in Agua Prieta, Mexico. Previously Alstyle operated in a leased manufacturing facility located in Anaheim, CA. Alstyle has three cut and sew facilities in Mexico (Agua Prieta, Ensenada and Hermosillo). In addition to its own cut and sew facilities, Alstyle also uses outsourced manufacturers located in El Salvador from time to time to supplement a portion of its cut and sew needs. After sewing and packaging is completed, the product is shipped to one of Alstyle’s nine distribution centers located across the United States, Canada, and Mexico.

Alstyle utilizes a customer-focused internal sales team comprised of twenty-one sales representatives assigned to specific geographic territories in the United States, Canada, and Mexico. Sales representatives are allocated performance objectives for their respective territories and are provided financial incentives for achievement of their target objectives. Sales representatives are responsible for developing business with large accounts and spend a majority of their time in the field.

Alstyle employs a staff of customer service representatives that handle call-in orders from smaller customers. Sales personnel sell directly to Alstyle’s customer base, which consists primarily of screen printers, embellishers, retailers, and mass marketers.

A majority of Alstyle’s sales are branded products, with the remainder being customer private label products. Generally, sales to screen printers and mass marketers are driven by price and the availability of products, which directly impacts our inventory level requirements. Sales in the private label business are characterized by slightly higher customer loyalty.

Alstyle’s most popular styles are produced based on demand management forecasts to permit quick shipment and to level production schedules. Alstyle offers same-day shipping and uses third-party carriers to ship products to its customers.

Alstyle’s sales are seasonal, with sales in the first and second fiscal quarters generally being the highest. The apparel industry is characterized by rapid shifts in fashion, consumer demand and competitive pressures, resulting in both price and demand volatility. However, the imprinted activewear market to which Alstyle sells is generally “event” driven. Blank t-shirts can be thought of as “walking billboards” promoting movies, concerts, sports teams, and “image” brands. Still, the demand for any particular product varies from time to time based largely upon changes in consumer preferences and general economic conditions affecting the apparel industry.

The apparel industry is comprised of numerous companies who manufacture and sell a wide range of products. Alstyle is primarily involved in the activewear market and produces t-shirts and outsources such products as fleece, hats, shorts, pants and other such activewear apparel from China, Thailand, Pakistan, and other foreign sources to sell to its customers through its sales representatives. Alstyle competes with many branded and private label manufacturers of knit apparel in the United States, Canada, and Mexico, some of which are larger in size and have greater financial resources than Alstyle. Alstyle competes on the basis of price, quality, service, and delivery. Alstyle’s strategy is to provide the best value to its customers by delivering a consistent, high-quality product at a competitive price. Alstyle’s competitive disadvantage is that its brand name, Alstyle Apparel, is not as well known as the brand names of its largest competitors, such as Gildan, Delta, Hanes, and Russell. While it is not possible to calculate precisely, based on public information available, management believes that Alstyle is one of the top three providers of blank t-shirts in North America.

Raw materials of the Apparel Segment principally consist of cotton and polyester yarn purchased from a number of major suppliers at prevailing market prices, although we purchase 53% of our cotton and yarn from one supplier.

Our Apparel Business Challenges - In our Apparel Segment, our market niche is highly competitive, commodity driven, and is generally dominated by a limited number of companies. The downturn in the economy and turmoil in the credit markets in 2009 and 2010 created an over-supply situation which further increased competitive pressures in this market. While the economic environment improved somewhat in 2011, which led to increased demand for our product during the later part of fiscal year 2011 and the start of fiscal year 2012, we have seen softness in the market due to domestic and global economic uncertainties. Whether this decline is behind us or will need to be dealt with for quarters to come is unknown. However, such uncertainty and volatility in the marketplace could have unanticipated adverse effects on our business during this fiscal year and beyond. In addition, a significant reduction in the spot price of cotton added additional complexities to an already competitive marketplace. The divergence between the current purchase cost of cotton and the cost residing in most manufacturer’s finished goods inventories were at historical levels, creating market valuation issues for some and sale side pressure for others. However, at this point, most of the higher cost of cotton has worked through our finished goods inventory and the divergence between the current purchase cost of cotton and the average costs in our finished goods inventory has returned to a more normalized spread. Thus, we believe we are facing the following challenges in our Apparel Segment in the remainder of fiscal 2013:

• Cotton prices and market pricing
• New manufacturing facility
• Continued economic uncertainties

Cotton prices – Cotton, which represents a significant portion of our cost, is a commodity product and subject to volatile fluctuations in price. Costs for cotton yarn and cotton-based textiles vary based upon the fluctuating cost of cotton, which is affected by, among other factors, weather, consumer demand, commodities market speculation, currency fluctuations, international actions and other factors that are generally unpredictable and beyond our control. Over the past several years, we have seen cotton prices reach levels never before seen in its history and have seen the prices recede back to levels that, while still high, are more in line with historical averages. We are able to lock in the cost of cotton reflected in the price we pay for yarn from our primary suppliers in an attempt to protect our business from the volatility of the market price of cotton. However, our business can be affected by dramatic movements in cotton prices as seen in years 2010 and 2011. The cost incurred for materials, i.e., yarn, thread, etc. are capitalized into inventory and impacts the Company’s operating results as this inventory is sold, which could be anywhere from six months to a year after the materials were in fact purchased. Consequently, significant and rapid increases or decreases in cotton costs can have a material impact of the Company’s operational results. As mentioned above, most of the higher cost of cotton has worked through our finished goods inventory at this point, and the divergence between the current purchase cost of cotton and the average costs in our finished goods inventory has returned to a more normalized spread. Absent some economic disruption (see below), we expect to see continuing improvement in our apparel margins in the quarters to come.

New manufacturing facility – The new manufacturing facility in Agua Prieta, Mexico (“AP”) is operational, and all production has now been transitioned from our Anaheim, CA (“Anaheim”) facility to the AP facility. We began producing fabric from this facility during the first quarter of fiscal 2012 and current production capabilities are on target with our original estimates. While the transition from Anaheim to AP has been completed, much still needs to be accomplished, such as increasing production levels and improving operational efficiency. We believe that operational efficiency will improve as production levels increase. However, the increase in production levels is dependent on improved market conditions (see below).

Continued economic uncertainties – As a result of the past recessionary conditions, the economic climate has been and continues to be volatile and challenging both domestically and internationally. Although we saw an increase in our apparel revenues during fiscal 2011 due to improving economic conditions, we saw a significant drop in our sales during the latter half of fiscal 2012 due to competitive pricing pressures, which we attribute to recent softness in the market. International instability and continued domestic policy and economic issues have had, and we believe will continue to have, an impact on the domestic economic environment. We are concerned with the economic discussions currently occurring in Washington, D.C. and how ultimate decisions may impact our next fiscal year. Many economic uncertainties remain for many businesses for which our government needs to provide clarity. How their actions or inactions will impact businesses, consumers and our economy in general over the short term and long term remains to be seen.

Cautionary Statements

You should read this discussion and analysis in conjunction with our Consolidated Financial Statements and the related notes appearing elsewhere in this Report. In addition, certain statements in this Report, and in particular, statements found in Management’s Discussion and Analysis of Financial Condition and Results of Operations, constitute forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “anticipate,” “preliminary,” “expect,” “believe,” “intend” and similar expressions identify forward-looking statements. We believe these forward-looking statements are based upon reasonable assumptions. All such statements involve risks and uncertainties, and as a result, actual results could differ materially from those projected, anticipated or implied by these statements. Such forward-looking statements involve known and unknown risks, including but not limited to, general economic, business and labor conditions and the potential impact on our operations; our ability to implement our strategic initiatives and control our operational costs; dependence on a limited number of key suppliers; our ability to recover the rising cost of raw materials and other costs (i.e., energy, freight, labor, benefit costs, etc.) in markets that are highly price competitive; our ability to timely or adequately respond to technological changes in the industry; the impact of the Internet and other electronic media on the demand for forms and printed materials; the impact of foreign competition, tariffs and import restrictions; customer credit risk; competitors’ pricing strategies; a decline in business volume and profitability could result in an impairment in our reported goodwill negatively impacting our operational results; our ability to retain key management personnel; our ability to identify, manage or integrate acquisitions; and changes in government regulations. In addition to the factors indicated above, you should carefully consider the risks described in and incorporated by reference herein and in the risk factors in our Annual Report on Form 10-K for the fiscal year ended February 29, 2012 before making an investment in our common stock.

In view of such uncertainties, investors should not place undue reliance on our forward-looking statements since such statements may prove to be inaccurate and speak only as of the date when made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Critical Accounting Policies and Estimates

In preparing our consolidated financial statements, we are required to make estimates and assumptions that affect the disclosures and reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and judgments on an ongoing basis, including those related to allowance for doubtful receivables, inventory valuations, property, plant and equipment, intangible assets, pension plan obligations, accrued liabilities and income taxes. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. We believe the following accounting policies are the most critical due to their effect on our more significant estimates and judgments used in preparation of our consolidated financial statements.

We maintain a defined benefit retirement plan (the “Pension Plan”) for employees. Included in our financial results are Pension Plan costs that are measured using actuarial valuations. The actuarial assumptions used may differ from actual results. As our Pension Plan assets are invested in marketable securities, fluctuations in market values could potentially impact our funding status and associated liability recorded.

Amounts allocated to amortizable intangibles are determined based on valuation analysis for our acquisitions and are amortized over their expected useful lives. We evaluate these amounts periodically (at least once a year) to determine whether a triggering event has occurred during the year that would indicate potential impairment.

We exercise judgment in evaluating our long-lived assets for impairment. We assess the impairment of long-lived assets that include other intangible assets, goodwill, and property, plant, and equipment annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In performing tests of impairment, we must make assumptions regarding the estimated future cash flows and other factors to determine the fair value of the respective assets in assessing the recoverability of our long-lived assets. If these estimates or the related assumptions change, we may be required to record impairment charges for these assets in the future. Actual results could differ from assumptions made by management. At November 30, 2012, our goodwill and other intangible assets were approximately $121.8 million and $84.9 million (includes $0.7 million relating to patents included in other long-term assets), respectively. We believe our businesses will generate sufficient undiscounted cash flow to more than recover the investments we have made in property, plant and equipment, as well as the goodwill and other intangibles recorded as a result of our acquisitions. However, we cannot predict the occurrence of future impairments or specific triggering events nor the impact such events might have on our reported asset values.

Revenue is generally recognized upon shipment of products. Net sales consist of gross sales invoiced to customers, less certain related charges, including discounts, returns and other allowances. Returns, discounts and other allowances have historically been insignificant. In some cases and upon customer request, we print and store custom print product for customer specified future delivery, generally within twelve months. In this case, risk of loss from obsolescence passes to the customer, the customer is invoiced under normal credit terms and revenue is recognized when manufacturing is complete. Approximately $3.1 million and $9.2 million of revenue were recognized under these agreements during the three and nine months ended November 30, 2012 as compared to $2.8 million and $7.5 million during the three and nine months ended November 30, 2011.

We maintain an allowance for doubtful receivables to reflect estimated losses resulting from the inability of customers to make required payments. On an on-going basis, we evaluate the collectability of accounts receivable based upon historical collection trends, current economic factors, and the assessment of the collectability of specific accounts. We evaluate the collectability of specific accounts using a combination of factors, including the age of the outstanding balances, evaluation of customers’ current and past financial condition and credit scores, recent payment history, current economic environment, discussions with our project managers, and discussions with the customers directly.

Our inventories are valued at the lower of cost or market. We regularly review inventory values on hand, using specific aging categories, and write down inventory deemed obsolete and/or slow-moving based on historical usage and estimated future usage to its estimated market value. As actual future demand or market conditions may vary from those projected by management, adjustments to inventory valuations may be required.

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each jurisdiction in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income. To the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance, we must include an expense within the tax provision in the consolidated statements of earnings. In the event that actual results differ from these estimates, our provision for income taxes could be materially impacted.

In addition to the above, we also have to make assessments as to the adequacy of our accrued liabilities, more specifically our liabilities recorded in connection with our workers compensation and health insurance, as these plans are self funded. To help us in this evaluation process, we routinely get outside third-party assessments of our potential liabilities under each plan.

In view of such uncertainties, investors should not place undue reliance on our forward-looking statements since such statements speak only as of the date when made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Results of Operations

The discussion that follows provides information which we believe is relevant to an understanding of our results of operations and financial condition. The discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto, which are incorporated herein by reference. This analysis is presented in the following sections:

• Consolidated Summary – this section provides an overview of our consolidated results of operations for the three and nine months ended November 30, 2012 and 2011.
• Segment Operating Results – this section provides an analysis of our net sales, gross profit margin and operating income by segment.

Consolidated Summary

Three months ended November 30, 2012 compared to three months ended November 30, 2011

Net Sales. Our consolidated net sales were $129.0 million for the third quarter ended November 30, 2012 compared to $121.8 million for the third quarter ended November 30, 2011, or an increase of 5.9%. Print sales increased 17.8% for the quarter, from $69.2 million to $81.5 million. Apparel sales for the quarter declined by 9.9% (down 6.9% on units and down 3.0% on price) from $52.6 million to $47.4 million. During the quarter we offset the decline in our apparel sales by additional sales associated with our print acquisitions. Our apparel sales continue to be impacted by softness in the market and resulting competitive pricing pressures.

Cost of Goods Sold. Our manufacturing costs increased by $6.7 million from $91.7 million for the three months ended November 30, 2011 to $98.4 million for the three months ended November 30, 2012, or 7.3%. Our consolidated gross profit margin (“margin”) decreased from 24.8% to 23.7% for the quarters ended November 30, 2011 and November 30, 2012, respectively. Our print margin increased from 27.8% to 28.7%, due to increased efficiencies, while our apparel margin, which continues to be impacted by higher residual cost of cotton remaining in finished goods inventory, decreased from 20.8% to 15.2% for the quarter. While our apparel results have been negatively impacted by higher raw material costs, most of this higher cost has now made its way through our finished goods inventory and the divergence between the current purchase cost of cotton and the average cost in our finished goods inventory has returned to a more normalized spread. As such, we expect to see a continual improvement in our apparel margin over the next several quarters, absent economic disruption.

Selling, general and administrative expense. For the three months ended November 30, 2012, our selling, general and administrative expenses were $20.6 million, or 15.9% of sales, compared to $19.1 million, or 15.7% of sales for the three months ended November 30, 2011, or an increase of approximately $1.5 million, or 7.9%. Selling, general and administrative expenses were up slightly over the comparable period last year on both a dollar and percentage of sales basis. Legacy costs associated with our recent print acquisitions remain as we integrate these locations into our ERP system. We believe our system conversions are going well and will provide a solid basis for lowering the overall cost structure of these plants in the future.

Gain from disposal of assets. The loss from disposal of assets of $3,000 during the quarter related to the sale of miscellaneous manufacturing equipment. The gain from disposal of assets of $8,000 for the three months ended November 30, 2011 resulted primarily from the sale of unused manufacturing equipment.

Income from operations. Our income from operations for the three months ended November 30, 2012 was $10.0 million or 7.8% of sales, as compared to $11.1 million, or 9.1% of sales for the three months ended November 30, 2011, a decrease of $1.1 million, or 9.9%. The decrease in our operational earnings related primarily to our decreased apparel margin during the quarter.

Other income and expense. Interest expense decreased from $0.4 million for the three months ended November 30, 2011 to $0.3 million for the three months ended November 30, 2012. Although our average outstanding borrowings were higher during the quarter when compared to the same quarter last year, our interest expense decreased due to our lower effective borrowing rate.

Provision for income taxes. Our effective tax rate was 35.1% for the three months ended November 30, 2012 compared to 37.4% for the three months ended November 30, 2011. The decrease in our effective tax rate related to an increase in the percentage benefit associated with our Domestic Production Activities Deduction (“DPAD”).

Net earnings. Due to the above factors, our net earnings for the three months ended November 30, 2012 were $6.2 million, or 4.8% of sales, as compared to $6.9 million, or 5.7% of sales for the three months ended November 30, 2011. Our basic earnings per share were $0.24 per share for the three months ended November 30, 2012, as compared to $0.27 per share for the three months ended November 30, 2011. Our diluted earnings per share were $0.24 per share for the three months ended November 30, 2012, as compared to $0.27 per share for the three months ended November 30, 2011.

Nine months ended November 30, 2012 compared to nine months ended November 30, 2011

Net Sales. For the nine month period, our net consolidated sales increased from $395.5 million to $409.9 million, or 3.6%. Print sales for the nine month period were $254.9 million, compared to $205.5 million for the same period last year, an increase of $49.4 million, or 24.0%. Apparel sales for the nine month period were $155.0 million, compared to $189.9 million for the same period last year, or a decrease of 18.4% (down 12.7% on units and down 5.7% on price). During the period we have been able to offset the decline in our apparel sales by the additional sales associated with our print acquisitions. Our apparel sales continue to be impacted by softness in the market and resulting competitive pricing pressures.

Cost of Goods Sold. Our manufacturing costs increased by $25.6 million from $291.5 million, or 73.7% of sales for the nine months ended November 30, 2011 to $317.1 million, or 77.4% of sales for the comparable period this year. Overall our margin decreased from 26.3% to 22.6% for the nine months ended November 30, 2011 and 2012, respectively. Our print margin increased during the period from 28.4% to 29.1%, while our apparel margin decreased from 24.0% to 12.0%, again due to higher cotton costs. As mentioned earlier, the negative impact associated with the higher cotton costs in our apparel inventory has for the most part abated and we expect to see our apparel margin continue to improve in each succeeding quarter.

Selling, general and administrative expense. For the nine months ended November 30, 2012, our selling, general and administrative expenses were $63.9 million compared to $58.4 million for the nine months ended November 30, 2011, or an increase of approximately $5.5 million, or 9.4%. As discussed earlier, our selling, general and administrative expenses were up both on a dollar and percentage of sales basis as a result of our print acquisitions last fiscal year. We expect these costs, on a percentage basis, to become more normalized once our ERP system is fully deployed in each of the plants.

Gain from disposal of assets. The gain from disposal of assets of $6,000 for the nine months ended November 30, 2012 resulted from the sale of a vehicle and miscellaneous manufacturing equipment. The gain from disposal of assets of $133,000 for the nine months ended November 30, 2011 resulted primarily from the sale of unused manufacturing equipment.

Income from operations. Our income from operations for the nine months ended November 30, 2012 was $28.9 million, or 7.0% of sales compared to $45.7 million, or 11.6% of sales for the same period last year, or a decrease of $16.8 million, or 36.8%. The decrease in our operational earnings related to our decreased apparel margin during the period.

Other income and expense. Our interest expense decreased from $1.9 million for the nine months ended November 30, 2011 to $1.2 million for the nine months ended November 30, 2012. Although our average outstanding borrowings were higher during this period when compared to the same period last year, our interest expense decreased due to our lower effective borrowing rate as well as an additional $0.6 million in interest related to the interest rate swap during the same period last year.

Provision for income taxes. Our effective tax rate was 36.0% for the nine months ended November 30, 2012 compared to 36.5% for the nine months ended November 30, 2011. The decrease in our effective tax rate related to an increase in the percentage benefit associated with our DPAD.

Net earnings. Due to the above factors, our net earnings for the nine months ended November 30, 2012 were $17.6 million, or 4.3% of sales, compared to $28.0 million, or 7.1% of sales for the nine months ended November 30, 2011. Our basic earnings per share for the nine months ended November 30, 2012 was $0.68 per share compared to $1.08 per share for the nine months ended November 30, 2011. Our diluted earnings per share for the nine months ended November 30, 2012 was $0.68 per share compared to $1.08 per share for the nine months ended November 30, 2011.

Segment Operating Results

Print Segment. Our net print sales, which represented 63% and 62% of our consolidated sales during the three and nine months ended November 30, 2012, were approximately $81.5 million and $254.9 million, respectively, compared to $69.2 million and $205.5 million for the three and nine months ended November 30, 2011, respectively, an increase of $12.3 million, or 17.8% for the quarter and an increase of $49.4 million, or 24.0% for the period. The increase in our sales during the quarter and period relate primarily to our print acquisitions, which added $19.0 million and $63.2 million for the quarter and period, respectively.

Apparel Segment. Our net apparel sales, which represented 37% and 38% of our consolidated sales for the three and nine months ended November 30, 2012, were approximately $47.4 million and $155.0 million, respectively, compared to approximately $52.6 million and $189.9 million for the three and nine months ended November 30, 2011, respectively, a decrease of $5.2 million, or 9.9% for the quarter and a decrease of $34.9 million, or 18.4% for the period. Our apparel sales continue to be impacted by soft market conditions; reduced retail and consumer sentiment attributed to the protracted and volatile economic recovery; the destocking of inventories at the retail, distributor, and screen-print levels; a drop in commodity prices and competitors’ pricing strategies. The drop in commodity prices caused expectations with respect to selling prices. These expectations caused some destocking of inventories at the retail and distributor levels, which added to the competitive pressures in the marketplace as manufacturers attempted to maintain production levels. We believe our competitors instituted various rebate programs (stock/restock programs, etc.) or announced price decreases, sometimes even selling products at prices lower than costs to produce those products. Since our pricing strategy has been to try to match our sale side price with our cost side, we believe this has negatively impacted our top-line results given our competitors pricing strategies during this fiscal year. However, as higher priced inventory in the marketplace is worked through, sales volumes should return to more normalized levels, pricing should stabilize as selling prices and the cost of cotton in inventories become aligned, and as such we expect a better business environment during the latter part of fiscal 2013 and into fiscal 2014.

FOR THE PERIOD ENDED NOVEMBER 30, 2012

Print Segment. Our print gross profit margin for the three and nine months ended November 30, 2012 was $23.4 million and $74.2 million, respectively, as compared to $19.2 million and $58.3 million for the three and nine months ended November 30, 2011, respectively, an increase for the quarter of $4.2 million, or 21.9% and an increase for the period of $15.9 million, or 27.3%. As a percentage of sales, the print gross profit increased from 27.8% to 28.7% for the three months ended November 30, 2011 and 2012, respectively, and increased from 28.4% to 29.1% for the nine months ended November 30, 2011 and 2012, respectively. The increase in our print gross profit on a dollar basis related principally to our print acquisitions. The percentage basis increase improved due to improved operational efficiencies.

Apparel Segment. Our apparel gross profit margin, for the three and nine months ended November 30, 2012 was $7.2 million and $18.6 million, respectively, as compared to $10.9 million and $45.6 million for the three and nine months ended November 30, 2011, respectively. As a percentage of sales, our apparel gross profit margin was 15.2% and 12.0% for the three and nine months ended November 30, 2012, respectively, as compared to 20.8% and 24.0% for the three and nine months ended November 30, 2011, respectively. Our apparel margin continued to be impacted by higher input costs and competitive pressures in the marketplace. Cotton costs included in cost of sales was 14% percent higher year over year, while our selling price per unit over this period was approximately 6% lower. While our apparel results continue to be negatively impacted by these higher costs, we are beginning to see improvement as most of this high cost cotton has been worked through, and the spread between the cost of cotton in finished goods inventory and the current purchase cost of cotton is normalizing to historical levels. As such, we expect to see continual improvement in our apparel margin over the next several quarters, absent economic disruption.

Print Segment. As a result of the increase in our print margin and our two print acquisitions last year, our print profit for the three and nine months ended November 30, 2012 was $13.0 million and $40.4 million, respectively, compared to $11.0 million and $34.0 million for the three and nine months ended November 30, 2011, respectively. As a percent of sales, our print profits remained at 15.9% for the three months ended November 30, 2011 and 2012, while print profits decreased from 16.5% to 15.9% for the nine months ended November 30, 2011 and 2012, respectively.

Apparel Segment. As a result of the decrease in our apparel sales and margin, our apparel profit decreased approximately $3.3 million, from $4.1 million for the three months ended November 30, 2011 to $0.8 million for the three months ended November 30, 2012. The apparel profit decreased $22.6 million, from $21.7 million to a loss of $0.9 million for the nine months ended November 30, 2011 and 2012, respectively. As a percent of sales, our apparel profits were 1.8% and -0.6% for the three and nine months ended November 30, 2012, respectively, compared to 7.8% and 11.4% for the three and nine months ended November 30, 2011, respectively.

Liquidity and Capital Resources

(Dollars in thousands)

Working Capital. Our working capital decreased by approximately $15.5 million, or 9.2%, from $169.0 million at February 29, 2012 to $153.5 million at November 30, 2012, due to the use of working capital to reduce our long-term debt. Our current ratio, calculated by dividing our current assets by our current liabilities, increased from 4.4 to 1.0 at February 29, 2012 to 4.8 to 1.0 at November 30, 2012. Our current ratio increased primarily because on a percentage basis, our current liabilities decreased by a larger percentage than our current assets, 20.2% and 11.7%, respectively.

(Dollars in thousands)

Cash flows from operating activities. Cash provided by operating activities increased by $13.7 million from $26.9 million for the nine months ended November 30, 2011 to $40.6 million for the nine months ended November 30, 2012. Our lower operational profits, which decreased our operational cash by $10.4 million during the period, was more than offset by our decreased inventory balances which increased our operational cash flow by $39.1 million. This was partially offset by a decrease in our outstanding payables, an increase in our accounts receivable and a decrease in our prepaid expenses, which impacted our operational cash by ($7.4) million, ($11.6) million and $1.6 million, respectively, during the period. Our inventory balances decreased mainly due to a reduction in our apparel finished goods, which decreased due to a reduction in our raw material input costs. This decrease was partially offset by an increase in our apparel units of finished goods.

Cash flows from investing activities. The decrease in our capital expenditures for the period relates primarily to the fact that our new apparel manufacturing facility located in Agua Prieta, Mexico was completed last fiscal year. Cash provided during the period related to a reduction in the purchase price of one of our print acquisitions made in connection with an adjustment to the inventory balances pursuant to the terms of the purchase agreement.

Cash flows from financing activities. We used $43.7 million in cash for financing activities during the quarter, compared to $11.9 million for the same three month period last year. This related primarily to the repayment of $30.0 million of outstanding debt on our credit line and an increase of $1.6 million in our dividends, which resulted from our Board of Directors approving an increase in our quarterly dividend from $0.155 to $0.175.

Credit Facility. On February 22, 2012, we entered into the Second Amendment to Second Amended and Restated Credit Agreement (the “Facility”) with a group of lenders led by Bank of America, N.A. (the “Lenders”). The Facility provides us access to $150.0 million in revolving credit, which we may increase to $200.0 million in certain circumstances, and matures on August 18, 2016. The Facility bears interest at the London Interbank Offered Rate (“LIBOR”) plus a spread ranging from 1.0% to 2.25% (LIBOR + 1.50% or 1.7% at November 30, 2012 and 2.52% at November 30, 2011), depending on our ratio of total funded debt to the sum of net earnings plus interest, tax, depreciation and amortization (“EBITDA”). As of November 30, 2012, we had $60.0 million of borrowings under the revolving credit line and $3.5 million outstanding under standby letters of credit arrangements, leaving us availability of approximately $86.5 million. The Facility contains financial covenants, restrictions on capital expenditures, acquisitions, asset dispositions, and additional debt, as well as other customary covenants, such as total funded debt to EBITDA ratio. We were in compliance with all these covenants as of November 30, 2012. The Facility is secured by substantially all of our domestic assets as well as all capital securities of each of the Company’s U.S. subsidiaries and 65% of all capital securities of each of the Company’s direct foreign subsidiaries.

It is anticipated that the available line of credit is sufficient to cover working capital requirements for the foreseeable future, should it be required.

We use derivative financial instruments to manage our exposure to interest rate fluctuations on our floating rate $150.0 million revolving credit facility from time to time. We account for our derivatives as cash flow hedges and record them as either assets or liabilities in the balance sheet, measure those instruments at fair value and recognize changes in the fair value of derivatives in earnings in the period of change, unless the derivative qualifies as an effective hedge that offsets certain exposures, at which time the changes in fair value would be recorded in Accumulated Other Comprehensive Income.

On July 7, 2008, we entered into a three-year Swap for a notional amount of $40.0 million which matured on July 22, 2011. The Swap effectively fixed the LIBOR rate at 3.79%.

Pension Plan – We are required to make contributions to our Pension Plan. These contributions are required under the minimum funding requirements of the Employee Retirement Pension Plan Income Security Act of 1974 (ERISA). Due to the recent enactment of the Moving Ahead for Progress in the 21st Century (MAP-21) in July 2012, which effectively raises the discount rates mandated for determining the value of a plan’s benefit liability and annual cost of accruals, our minimum required contribution to the Pension Plan is zero for the Pension Plan year ending February 28, 2013. However, we expect to make a cash contribution to the Pension Plan of between $2.0 million and $3.0 million during the fourth quarter of fiscal year 2013. We made contributions of $3.0 million to our Pension Plan during fiscal 2012. As our Pension Plan assets are invested in marketable securities, fluctuations in market values could potentially impact our funding status, associated liabilities recorded and future required minimum contributions. At November 30, 2012, we had an unfunded pension liability recorded on our balance sheet of $9.1 million.

Inventories – We believe our inventory levels are sufficient to satisfy our customer demands and we anticipate having adequate sources of raw materials to meet future business requirements. We have long-term contracts in effect with paper and yarn suppliers that govern prices, but do not require minimum purchase commitments. Certain of our rebate programs do, however, require minimum purchase volumes. Management anticipates meeting the required volumes.

Capital Expenditures – We expect our capital requirements for our current fiscal year, exclusive of capital required for possible acquisitions, will be below our historical levels of between $4.0 million and $5.0 million, as to date we have spent approximately $1.7 million on capital expenditures. We expect to fund these expenditures through existing cash flows.

We rely on our cash flows generated from operations and the borrowing capacity under our Facility to meet cash requirements of our business. The primary cash requirements of our business are payments to vendors in the normal course of business, capital expenditures, debt repayments and related interest payments, contributions to our pension plan, and the payment of dividends to our shareholders. We expect to generate sufficient cash flows from operations supplemented by our Facility as required to cover our operating and capital requirements for the foreseeable future.

Contractual Obligations & Off-Balance Sheet Arrangements – There have been no significant changes in our contractual obligations since February 29, 2012 that have, or are reasonably likely to have, a material impact on our results of operations or financial condition. We had no off-balance sheet arrangements in place as of November 30, 2012.

Market Risk

Interest Rates

We are exposed to interest rate risk on short-term and long-term financial instruments carrying variable interest rates. We may from time to time utilize interest rate swaps to manage overall borrowing costs and reduce exposure to adverse fluctuations in interest rates. We do not use derivative instruments for trading purposes. Our variable rate financial instruments, including the outstanding credit facility, totaled $60.0 million at November 30, 2012. We had entered into a $40.0 million interest rate swap designated as a cash flow hedge related to this debt, but this arrangement matured July 22, 2011; as such the entire balance of our line of credit is subject to fluctuations in the LIBOR rate. The impact on our results of operations of a one-point interest rate change on the outstanding balance of the variable rate financial instruments as of November 30, 2012 would be approximately $0.6 million.

Foreign Exchange

We have global operations and thus make investments and enter into transactions in various foreign currencies. The value of our consolidated assets and liabilities located outside the United States (translated at period end exchange rates) and income and expenses (translated using average rates prevailing during the period), generally denominated in Pesos and Canadian Dollars, are affected by the translation into our reporting currency (the U.S. Dollar). Such translation adjustments are reported as a separate component of consolidated statements of comprehensive income. In future periods, foreign exchange rate fluctuations could have an increased impact on our reported results of operations.

This market risk discussion contains forward-looking statements. Actual results may differ materially from this discussion based upon general market conditions and changes in domestic and global financial markets.

Evaluation of Disclosure Controls and Procedures. A review and evaluation were carried out under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our “disclosure controls and procedures” (as such term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q, pursuant to Exchange Act Rule 13a-15. Based upon that review and evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures as of November 30, 2012 are effective to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is accumulated and communicated to our management, including our principal executive and financial officers as appropriate to allow timely decisions regarding required disclosure. Due to the inherent limitations of control systems, not all misstatements may be detected. Those inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Additionally, controls could be circumvented by the individual acts of some persons or by collusion of two or more people. Our controls and procedures can only provide reasonable, not absolute, assurance that the above objectives have been met.

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rule 13a-15 that occurred during our fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting ended November 30, 2012.

There have been no material changes in our Risk Factors as previously discussed in our Annual Report on Form 10-K for the year ended February 29, 2012.