Universal Corporation Q3 2009 Earnings Call Transcript

| About: Universal Corporation (UVV)

Universal Corporation (NYSE:UVV)

Q3 2009 Earnings Call Transcript

February 5, 2009 at 5:00 pm ET

Executives

David Moore - Chief Financial Officer

Karen Whelan - Vice President and Treasurer

Analysts

Ann Gurkin - Davenport & Company LLC

Sirov James - Bay Harbor

Dax Vlassis - Gates Capital Management

[Jeff]

Paul Carpenter - Semaphore Management

Operator

Good afternoon. My name is Kayla and I will be your conference operator today. At this time, I would like to welcome everyone to the Universal Corporation's Q3 fiscal year 2009 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions) Thank you.

I would now like to turn the call over to your host Ms. Karen Whelan, Vice President and Treasurer. Ma’am, you may begin your conference.

Karen Whelan

Thank you, Kayla and thank you all for joining us. David Moore, our Chief Financial Officer, is here with me today and he will join me in answering questions after these brief remarks.

This call is being webcast live and will be available on our website and on telephone-taped replay. It will remain on our website until May 5th. If you are listening to this call after that date or if you are reading a transcription, we have not authorized such recording or transcription.

It has been made available to you without our permission, review, or approval. We take no responsibility for such presentation. Any transcription inaccuracies or omissions or failure to present available updates are the responsibility of the party who is providing it to you.

Before I begin to discuss our results, I caution you that we will be making forward-looking statements that are based on our current knowledge and some assumptions about the future. I urge you to read our 10-K for the year-ended March 31st, 2008 for information on some of the factors that can affect our estimates.

Those factors can include such things as customer-mandated timing of shipments, weather conditions, political and economic environment, changes in currency, and changes in market structure or sources.

Finally, some of the information I have for you today is based on un-audited allocations and is subject to reclassification.

Turning to our third quarter, earnings per share were up by 14% to $1.78, bringing the 9 months results to $3 and $0.78 which is up to 12%.

There were four key factors in that performance. First, larger burley crops in Africa as of the very small crops last year, second, good operations and virtually all our regions that were offset by currency re-measurement losses in several countries but especially in Brazil. Higher net interest expense as we funded more expensive crop along with our share repurchase program; and fourth, a lower tax rate.

Looking at the details, operating income for our flue-cured and burley operations was up about $74 million up 3% on 27% revenue increase. Both revenues and operating income for North America increased on higher volume, partly due to earlier shipments this year and partly on additional trading opportunities.

Operating income for the other region segment decreased slightly for the quarter, despite a significant operating improvement in Africa and volume increases from larger burley crops there. This segments performance was heard by lower results from our South American operations due to $20 million in currencies re-measurement losses in Brazil or the local currency weakened by approximately 22% during the quarter.

Some of those re-measurement losses were attributable to advances to farmers, for fertilizer and feeds that relate to the crop that will be sold next year. Crop inputs were more expensive this year due to increase fertilizer prices and the 30% to 40% weaker U. dollar at the time they were purchased. Although, those materials are being used for production of a crop that will be sold next year, the advances to farmers for the inputs are re-measured in US dollars, along with all other monetary assets and liabilities each recording period. As a result, the related re-measurement loss affects operating income this year when the prior crop is being sold.

Shipments this quarter from South America were higher than last year, despite a port closure related to flooding in Santa Katarina State. For the nine months, results for flue-cured and burley operations increased by more than 5% to nearly a $175 million. That improvement was due to a stronger performance in North America were cost savings in Canada and the increased volumes in the United States boosted income and revenue.

The other regions segment reflected stronger performance in the African region from higher volume and from reduced charges and write-downs there. And as I said earlier, South American results for reduced by the effect of re-measurement losses were the local currency devalued by 32% in Brazil. Those losses totaled $43 million for the nine months related to Brazil.

Other tobacco operation results were down for the quarter and the nine months, mostly because of last year’s earnings from the special services group. Sales in that group were accelerated last year because of a shift of business to the origins. So we expected the decrease this year. That change also caused a decline of segment revenue for the quarter.

We saw a big change in our selling, general and administrative expenses in both the quarter and the nine months. The effects of that change are included in our discussion of our operating segments that I am highlighting it because that is where the currency effects are reflected. As G&A expense increased by about $41 million in the quarter and $72 million for the nine months, primarily due to large currency re-measurement and exchange losses this year, compared to similar gains last year.

Last year, when the US dollar was weakening against most other world currencies, we generated currency-related gains. In contrast, this year, primarily beginning in September, we have seen the US dollar dramatically strengthen against most currencies, producing the opposite effect. Although, we have focused on Brazil, where it is most visible, the impact has also been evident in the Philippines, Indonesia, and Africa, especially where we have local currency receivable from suppliers.

The combined currency gains from last year and losses this year produced net increases in expense of approximately $35 million in the quarter and $68 million for the nine months. On a whole, a strengthening US dollar reduces our costs as it takes fewer dollars to buy the local currency. However, the costs associated with a given crop are incurred over a long period. Some of those costs are recognized as period costs, while others are deferred in inventory. So the most recent exchange rates do not tell the whole story, certainly as evidence by the re-measurement costs of this year.

Net interest expense increased by $5.4 million in the quarter compared to last year, mostly because of increased cash requirements to fund our share repurchase program and working capital needs which were higher because of the weaker dollar earlier in the year.

We made substantial progress on our share repurchase program. Total program since November 20th, 2007 was $128 million and we have bought just over $2.5 million shares. The effective tax rate fell to 26% for the quarter and 30% for the nine months. For the full year, we expect our effective tax rate to be approximately 31%.

We are pleased with our operation so far this year. All of the regions have delivered operating improvements and we are especially glad to see the recovery of results in Africa, after all of the changes there which now have culminated in larger crop, greater efficiencies, and wonderful teamwork.

With the continued evaluation of the Brazilian currency has again heard our results because of our balance sheet exposure there. Tobacco competes with commodity crops for Elkridge, and world markets for commodity product have changed the great deal during the fiscal year.

Early in the year, the cost of green tobacco escalated as all areas worked to ensure sustainability of supply in the face of competing crops.

Looking ahead, the market situation for fiscal year 2010 is likely to be very different. We saw a much needed recovery in burley volumes in Africa this year, but signs are pointing to an extremely large burley crop there next year, which is likely to move worldwide markets to oversupply. This year, tobacco markets are expected to remain mostly balanced.

Notwithstanding, the 12% increases in earnings per share this year we have not been immune to the effect of financial chaos in world market. Re-measurement losses related to the rapid and severe weakening of the local Brazilian currency reduced our earnings per share by $0.91. The value of our pension assets has been reduced by the general market decline and we expect to provide up to $20 million in additional funding to our qualified defined benefit plan. But our business is healthy and our balance sheet is strong.

We have prudently managed the cash inflow from the sale of our non-tobacco businesses two years ago, and we continue to work on cost control measures. We have already passed the peak working capital requirements this year and during a period of a very weak dollar, we were able to withstand that. We believe our financial resources are adequate to meet our needs.

And Kayla, we will be glad to take questions now.

Question-and-Answer Session

Operator

(Operator instruction) Your first question comes from the line of Ann Gurkin - Davenport & Company LLC.

Ann Gurkin - Davenport & Company LLC

I want to start with the comment in the release about a move towards a potential oversupply of burley tobacco and is that just based on crop sizes, as you are saying, or is that reflects any weakening in demand from customers for potential burley purchases as we look out to 2010, given tougher economies and maybe higher taxes, that kind of stuff?

David Moore

Ann, it is not based on any weakening of demand. The dollar is largely attributable to large burley crop in Africa.

Ann Gurkin - Davenport & Company LLC

Okay. And what is your outlook for working capital needs for 2010 given this projected larger crop?

Karen Whelan

I would expect that was a stronger dollar. Working capital needs would be down. Of course, we will wait and see where the dollar is when it is time to buy it. But the biggest thing, if you say on what we have on our website in December, the crop in Malawi went from a normal, say a 120 million kilos to the shortage when it was just below 90 and then last year it exceeded 150, it was up almost to 170 and now, we see 245. So really our expectations a lot of them are related to the Malawi crop.

Ann Gurkin - Davenport & Company LLC

And then, can we get an update on former bad debts in Brazil for the year?

Karen Whelan

Ann, I do not have that number. I do not think it is extraordinary this year or we would have disclosed it.

Ann Gurkin - Davenport & Company LLC

Okay.

Karen Whelan

We expect to have a certain amount every year.

Ann Gurkin - Davenport & Company LLC

Okay. And in Europe, are you all going to need to take a charge to better align that business?

Karen Whelan

Based on?

Ann Gurkin - Davenport & Company LLC

Based on your presence and if the supply of leaf continues to deteriorate.

Karen Whelan

That business is a good business for us right now and we are certainly aware of the potential for the future and are working on it.

Ann Gurkin - Davenport & Company LLC

Okay. And then given the tightness in the credit markets and particularly overseas and the fact that you all are very well positioned, are you able to gain some market share right now in various markets?

Karen Whelan

Well, of course, market share depends on what you can sell as much as what you can buy.

David Moore

Yes, I think going back to your comment about working capital as it relates the larger burley crop and notwithstanding the size of those crops, we are going to buy to feel the customer orders that we have. We, certainly, not going out in the world market because the crops are bigger to buy market share.

Ann Gurkin - Davenport & Company LLC

Okay. And then just to clarify the $0.91 in the release is a year-to-date number. Is that correct?

Karen Whelan

Yes. That is year-to-date and that relates only to Brazil currency losses this year.

Ann Gurkin - Davenport & Company LLC

Okay great. Finally, can I just get your uncommitted inventory levels as of the end of the third quarter?

Karen Whelan

We were at about correct me if I am wrong, 15% of inventory for the year and just under $100 million. That is in our 10-Q.

Operator

Your next question comes from the line of Sirov James - Bay Harbor.

Sirov James - Bay Harbor

It is, I guess some quick observations and a few question. It seemed like this quarter if you back out the currency the margins looked a lot better, and it seems like there is a fair amount of improvement in pricing dynamic. I wanted to get a sense of what did volumes look like year-over-year and how much of the burley crop have you sold through and is the fourth quarter, what percentage is left over?

Karen Whelan

There is a lot of questions there. I am not sure if I have got them all. If you look at our balance sheet I think we had about $600 in inventory and 85% or so that it committed for sale. We do not have a substantial amount of uncommitted inventory left, especially when you consider the strength of the dollar when we were buying it. The inventory we had is fairly expensive so the dollar amount that is a lot bigger than the actual kilos would reflect. So, our orders are in good condition. I am not sure if I missed the rest of your question.

David Moore

I think part of it, I mean if the African crop, the burley crops were definitely larger this year and we did ship them out. The smaller crops last year obviously shipped a lot quicker. So, the crops this year are moving more in a normal pattern.

Sirov James - Bay Harbor

Okay. That is helpful. And then lastly, and then I have one other follow up. In terms of the currency weakness in the real and strengthen in the US dollar, do you see a big benefit in terms of working capital use for next year as well as improvements potentially in margins because of lower cost inventory?

Karen Whelan

Working capital usage assuming that the dollar remained strong should be reduced by that when you should see the dollars needed to require the local currency should be down and of course in addition to that you had a lot of green price increases over the last period. You probably would not see a continued increase in the local currency cost going up.

David Moore

And you will get sort of a delayed impact the upcoming craft. Obviously, we have purchased all the inputs for that crop, prior to the devaluation hitting and so, you would see some reduction in working capital this year but all things being equal, if the currency stays where it was, if the crop would be cheaper also the year after in US dollar firms.

Sirov James - Bay Harbor

Wow. That is great. And then lastly, what is the number of shares outstanding at the end of the quarter?

Karen Whelan

I am going to cheat and look. Hold on a second. I can tell you what is fully diluted. It is easier than the outstanding, $27.3 million. I am sorry. For repurchase, it is $25 million even.

Operator

Your next question comes from the line of Dax Vlassis - Gates Capital Management

Dax Vlassis - Gates Capital Management

Couple of questions, can you talk about the special services group and a little more detail on the historical perspective and why it had operating income this quarter and what you would expect going forward?

Karen Whelan

It actually did not much have effect on operating income at all this quarter. It was last year. This was a group that sort of consolidated purchases for just in time delivery and the business there was less need for that sort of business and so it is reverted back to the various origins. So, the timing was come the same as any other timing now. At that last year as it was ending, we shipped out the remaining inventories were being held for just in time.

Dax Vlassis - Gates Capital Management

Okay. And then, have there been any changes in customer purchasing or payment terms? I think the accounts receivable were up just a little bit this quarter.

Karen Whelan

No. I think that is more timing of shipment and maybe the mix of customer. We are not seeing any major shift in customer’s payments.

David Moore

And some others just due to the how leaf prices around the world just makes the receivables higher in dollar terms.

Dax Vlassis - Gates Capital Management

Okay. Can you talk about, in South America it sounds like the shipments again were delayed a little bit, maybe hit by the floods could if some of that crop a larger percentage of that crops spilling over into the next quarter versus year ago?

Karen Whelan

They have been delayed somewhat they were little bit delayed last quarter because of containers that caught up some of that and then one of the ports in Santa Katarina is closed. Shipments were up even with that closure but I think some will be delayed a little bit into the next quarter.

Dax Vlassis - Gates Capital Management

Into the current quarter that we are in?

Karen Whelan

Right.

Dax Vlassis - Gates Capital Management

I got you. And then, I think you had a $154 million outside of your fixed debt. Is that all on a revolver or is there some in a line in credit as well?

Karen Whelan

I think all of that is in uncommitted line.

Dax Vlassis - Gates Capital Management

Alright. And what are you seeing in the competitive environment from the third party, basically your major competitor and also the smaller regional players and that third player that had come in?

Karen Whelan

I mean they are always competing right now. We are all buying the crop in Brazil. Everybody is talking to customer. So, I do not know but I have seen anything unusual.

Dax Vlassis - Gates Capital Management

Yes. I mean is the market share and your competitive environment similar to how it has been for buying other crops this year?

David Moore

You mean for other non-tobacco crops?

Dax Vlassis - Gates Capital Management

No. Tobacco crops.

Karen Whelan

I would say it is similar one of the regional players is building a factory. That is new but otherwise I would say the competition is similar. African pricing certainly went up a great deal this year. That was burley shortage combined with lots of competition. So, let us say on a whole, it is business as usual.

Dax Vlassis - Gates Capital Management

Alright. And Karen, it seemed like a pretty good cash flow quarter for the Company even with the re-measurement gains and I am just wondering for next. Will we continue to see the revolver or the lines come down in the next quarter in building more cash with the continued sale of the crops and the receivables coming down?

Karen Whelan

We would expect to generate cash this quarter, the third quarter that you just saw and again in the fourth and then use it again as the Brazilian and African crops come to market through the first half of the fiscal year. So, this is the pretty normal pattern. This should be a good cash flow quarter and of course the currency, all of those re-measurement losses are noncash. So, they just did not affect that at all.

Dax Vlassis - Gates Capital Management

Right. When do you expect to see the benefits of the, basically P&L hits that you are taking now that basically should benefit you in the future, will that be like a couple of quarters from now or?

Karen Whelan

Those P&L hits that are related to the crop inputs?

Dax Vlassis - Gates Capital Management

Yes.

Karen Whelan

I think it depends on how good our folks are at talking it through with their customers in understanding the costs. This is not anything new. I think the size of it is new. So, it is part of the total costs and you would see in the second half of next year would be basically when you see it.

[Jeff]

Hey, Karen this is Jeff. I just walked in the room. I had two quick questions. One is it looks like $300 million working capitals gone in the business because of the higher input costs and the currency over the past year and I am just kind of wondering, if the currency stayed at today’s levels and given the other input costs falling with the substitute crops kind of falling away here and how long would it take or would you expect to recapture most of that, number one? And then secondly, what would you do with the money? And third, do you have some near term debt maturities coming up here on some of your medium-term notes. Do you plan to just mature those or refinance them?

Karen Whelan

At this point, we are looking at our cash requirements for the coming year and this is just seasonal changes. I would expect the working capital to get fairly close to zero by the end of March. That would be a typical pattern, but, if Brazil’s purchasing pattern starts earlier or they buy earlier it will change that. So, there is always a timing factor and it does not terribly meaningful, but you would expect that the working capital investment would then be sold in a relatively short period of time because we are in a crop-based company.

[Jeff]

You mean back to zero for the year?

Karen Whelan

Yes. I mean that would be the normal expectations, but I could not say that is really going to happen because you can have timing differences.

[Jeff]

Alright. And the last year it went up by 100 or something like that?

Karen Whelan

Pardon?

[Jeff]

Last year, it went up by a 100 and it is gone up by the 200 this year.

Karen Whelan

Yes.

[Jeff]

And I am just so, on a trailing basis.

Karen Whelan

Coming back, you have to invest less in the new crops. That should bring it back down earlier as you have shipped out and collected, right.

[Jeff]

Okay. So, you think you will get last years’ build back as well?

Karen Whelan

I do not think so because the currency was not that far off. I mean if you just took the Brazilian currencies, which is seasonally what you are looking at that time of the year.

[Jeff]

Alright. So, it looks like you could just mature this debt from the cash that you are going to take out of working capital on the input costs coming down?

Karen Whelan

Well, looking at that and actually we are in planning process now, looking at what we think will need for the coming crop. That is little hard to answer the question, but that would be the intent at this point. We are also looking at what the market has.

Operator

(Operator instruction) You have a follow-up question comes from the line of Sirov James - Bay Harbor.

Sirov James - Bay Harbor

In terms of the credit availability in Brazil and South America, have you guys seen any major changes with respect to the amount or the rate and kind of any views on that? I know you guys have a great balance sheet and can fund that in cash, but just the interim seasonal working lines, have you seen any changes?

Karen Whelan

I think like every other market, Brazil has gone through some fluctuations and availability of capital not because that it is not available but maybe just a little harder to access from time to time. On the whole, I do not think there is an issue there. We do not typically fund with local currency. We do some, but I think it is available. You just might have to wait a week or two for it.

Sirov James - Bay Harbor

And it is more expensive?

Karen Whelan

Yes. It is definitely more expensive than US.

Operator

Your next question comes from the line of Paul Carpenter - Semaphore Management.

Paul Carpenter - Semaphore Management

I have the same type of question that I asked in November when you are here and would appreciate some follow up if you could. It really has to do with how the current liability side in the working capital does not seen to capture all the increases in terms of higher green cost, higher fertilizer cost you are being faced with in terms of the increase in the current asset side in working capital. So, almost all those current assets, accounts receivables, advances to suppliers, both tobacco and tobacco another inventories were all up quite a bit and I think I joined the call late, so I apologize if this is not right. But it looked to me in the surface that all the current liability items are working capital. The accounts payable accrued expenses, customer advances, and deposits as a group are down year-over-year from December ’07 to December ’08 which I think is the right way to look it at it to get up the seasonality. So, I just wondered if you are passing through enough price to make up for even aside for the re-measurement, from the re-measurement passing through enough price to make up for this very high carrying costs which just continue to absorb cash, which you could otherwise redeploy into retiring debt or buying back more stock?

Karen Whelan

Yes. I understand your question right. I think I hear two pieces to it, but you might need to clarify for me. In funding the higher working capital, we used cash balances from the last year. So, you did not see a current liability increase for that. In terms of whether we are passing enough costs through, our gross margins did increase this year. So, I would say that we did, but now maybe I am looking at it more simplistically than you are.

David Moore

I think you also had mentioned that in the context of the re-measurement losses, but the re-measurement affects next year’s crop. Our income statement and financial statements reflected the crop. This year’s crop is opposed to the crop that re-measurements were going to affect.

Paul Carpenter - Semaphore Management

I do appreciate that. My concern is just with the escalating costs. Are you pushing through enough of the burden of that escalating costs on your customer base because you took year-over-year $400 million plus use of your cash, you said, you funded those increased costs out of cash which I can see but I would rather you pass that burden on somehow to your customers either by getting them to put more upfront or to collect on the receivables more quickly or just to pass it through and another means, which should be higher price and then you would at least capture more in the near term on the earnings side.

I feel like to some degree you sort of got the short end of the stick on both scenarios. When supply is too tight, you are reluctant to pass on too much price to your customer base and then when you have some of this working capital effects that they are not there for you when you need them to be, and so you have had an extra $400 million of cash in your balance sheet. Today, it could have reduced interest or cut back more stock and you and your shareholders end up being the net losers on sort of both sides of the disequilibrium.

Karen Whelan

No. Remember, we did buyback stock with some of cash that was on the balance sheet last year and then we also we paid…

Paul Carpenter - Semaphore Management

I think that was great but you could have had I do not know maybe I am being too greedy. But it just seems that in good times and bad that you bear a lot of the burdens and if you have not had to bear as much of that gap or do it by yourself then maybe you could have had an extra, extra $100 million or two. Maybe you would not have buyback more stock. I know you are very judicious about it, but you could have done something else with that. You could have paid down some of kind debt instrument.

Karen Whelan

We did two things after December of last year. We bought back stock about a $110 million or so maybe more than that, and we have retired a $150 million worth of debt.

Paul Carpenter - Semaphore Management

No. I am aware and I think that is all steps in the right direction.

Karen Whelan

Yes and you are right. It did cost more, but if you watch what is going through our cost of sales line, we passed through the costs of that and increased gross margins. Unfortunately, the re-measurement losses which are next year’s crop related and took it away from earnings and we would love to pass more through. All you have to do is call our customers and say they should do that.

Paul Carpenter - Semaphore Management

I guess I am just holding out hope for a quarter and which had working capital gets drained drown to a more historical level. Maybe it is not going to happen the entire way because green prices are up compared to the previous years, but it still seems to me that their working capital investment on your part is perhaps higher than it needs to be that you have more of a working capital investment than one would expect by just looking at the increase in green prices. Do you think that is the first statement?

Karen Whelan

I actually do not. I think our receivables increase is commensurate with our revenue increase. Our inventories, they are more expensive inventories but that will change as if year goes by. That is 85% of them will ship out.

Paul Carpenter - Semaphore Management

Thanks for answering my question. Maybe I will talk about with you offline.

Operator

At this time there are no questions in queue.

Karen Whelan

Okay. Well, I would like to thank you all for joining us and hope we will see you at the end of the next quarter.

Operator

Ladies and gentlemen, this does conclude today’s conference call. You may now disconnect.

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