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Universal Corp. (NYSE:UVV)

F2Q07 (Qtr End 09/30/07) Earnings Call

November 7, 2007, 5:00 p.m. ET

Executives

Hart Roper - Chief Financial Officer and VP

Karen Whelan - VP and Treasurer

Analysts

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Dex Vlassis – Gates Capital

Steve Marascia - Anderson & Strudwick

Peter Kim - ISI Capital

Kevin Zietz – Goldman Sachs

Operator

Good day and welcome to this Universal Corporation Second Quarter Fiscal Year 2008 Results Conference Call. This call is being recorded. At this time for opening comments, I would like to turn the call over to Vice President and Treasurer, Ms. Karen Whelan. Karen, please go ahead.

Karen Whelan

Thank you all for joining us. Hart Roper, our Chief Financial Officer is here with me today and he will join me in answering questions after this 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 February 7. 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 permission, review or approval and 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, so I urge you to read our 10-K for the year ended March 31, 2007 for information on some of the factors that can affect our estimates. Those factors can include such things as costumer 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 unaudited allocations and is subject to reclassification. We will only discuss continuing operations with you today.

We had a good quarter with income from continuing operations up 9% to $40.5 million, or $1.25 per diluted share. For the six months, we earned $58.7 million from continuing operations or $1.81 per diluted share of almost 200% from the $0.63 we earned last year. Most regions showed solid improvement in the quarter and the six months. The key factors were lower provisions for farmer receivables and lower inventory valuation adjustments which in aggregate decline by $27 million in Africa for the quarter. We also had lower restructuring and impairment costs for the six months.

Other positives were shipment timing benefits and operational improvements in addition to lowering that interest expense and a lower effective tax rate.

As we noted last quarter, the smaller crops in Africa have caused higher leaf purchase prices and higher unit processing in agronomic cost. The effect of that reduced margins offsetting part of that region’s improvement.

Revenues were up 20% to $655 million in the quarter and up 11.5% to $1.1 billion for the six months. In both periods, the growth was principally due to higher volumes and leaf prices in Brazil, where currency changes were an important factor, as well as to higher volumes of African tobacco shipped, and higher African prices due to short crops in Malawi and Mozambique where demand was strong. The North America segment of the of the flue-cured and burley operations reported income of about $4 million for the quarter, as US operations moved into full swing for the season. Results were $3 million lower than last year. Key factors in this year’s decline were last year’s $3 million gain on the sale of assets of closed facilities and the effects of drought conditions on the US flue-cured crop.

Revenues for the quarter also reflected those reductions but they were more than offset by earlier Canadian sales and increased volumes in smaller regions. For the six months, the segment reported loss of a million dollars compared to earnings of over $7 million from the prior year. The reduction reflected the same factors of the quarter, but in addition, we had lower carry over sales this year, several one time sales last year especially of old crop burley and significant reduction of the Canadian crop. Those factors also caused revenues for this segment to fall by over $41 million compared to last year.

The other region segment of the flue-cured and burley operations earned almost $64 million up 34% from the same quarter last year, driven by improvement in Africa, Europe and Asia.

In South America, margins were lower because of the effect of the strong local currency in Brazil on lease and operating cost. We entered forward contracts related to certain customer contracts to hedge some of the currency effect, but because we did not elect hedge accounting, the mark-to-market gains on those contracts were recognized in the first quarter ahead of the crop sales.

In Africa, we had lower margins related to a 32% decline in crop sizes in Malawi and Mozambique, but results improved there due to lower provisions for farmer receivables and reduced inventory valuation adjustments. As I said earlier, those items declined by $27 million in the quarter compared to last year.

Europe saw improvement in the quarter due to a better product mix, and Asia's comparisons improved with additional trading volumes and the absence of last year's flood-related costs. Revenues for this segment increased by over $95 million in this quarter.

For the six months, the other region segment of the flue-cured and burley operations earned about $96 million compared to $61 million last year, which was as 58% improvement fueled by improvement in all regions. The dramatic improvement resulted from the reduced charges for inventory and receivables in Africa that I talked about earlier, higher volumes in Brazil where forward exchange contracts mitigated part of the effect of the strong local currency, and higher volumes in other regions due to timing benefits. In addition, provisions for bad debts related to farmer receivables in Brazil were over $6 million lower than last year. Those improvements were partially offset by Africa’s lower margins, revenues for the other regions increased by about 15% to $885 million for the six months.

Now leaving our flue-cured and barley operations to go to other tobacco operations, results were down slightly in the quarter to $6.0 million despite higher revenues, primarily because of currency effects, timing of shipments, and mix of business. Results for dark air-cured operations declined in large measure due to currency remeasurement, higher domestic operating costs, and timing differences within current year shipments. The oriental tobacco joint venture experienced lower volumes that were partially offset by remeasurement gains during the quarter, and the special services group realized accelerated sales volumes and improved results as part of its business is changing being absorbed by our other regional operations.

For the six months, this segment's performance reflected the same factors that were present in the quarter, but in addition, we had a one-time gain on the sale of investment securities, and the adverse effect of currency remeasurement on dark operations in the second quarter was largely mitigated in the six months.

I would like to highlight some line items on our income statements selling, general and administrative expenses are included in segment operating results, but I am mentioning them separately because of the dramatic change. This caption fell by nearly $10 million in the quarter, primarily related to a reduction of $17 million in provisions for farmer receivables. For the six months, SG&A expenses decreased by approximately $24 million. In addition to lower provisions for farmer receivables, that were down $19 million for the period, $11 million of the decline related to net foreign exchange gains. Of that total, $6 million was associated was the forward exchange contracts that I mentioned earlier in the Brazilian currency.

We recorded higher interest income and lower interest expense as a result of funds provided by tobacco operations, the sale of our non-tobacco businesses, asset sales, and employee stock option exercises. Net interest savings were $6 million for the quarter and $11.5 million for the six months. Our effective tax rate remains higher than the U.S. federal statutory tax rate primarily because we do business in many countries where the tax rates are higher than U.S. rates. In addition, tax benefits on our restructuring charges were at rates lower than the U.S. statutory rate and that also increases the overall tax rate.

For the full fiscal year, we expect the rate to be slightly below 37%. Last year, it was about 52% in the first half, and it was so high primarily because we did not record any tax benefits on our asset impairment charge last year and in addition, we recorded a valuation allowance of $4.9 million on deferred tax assets in Zambia.

As I said earlier, most regions showed solid improvement in the first half of the fiscal year. The challenges remain and I would be remiss if I did not point them out to you.

This year, we are facing a very tight supply of burley tobacco which has been exacerbated by short crops in Africa, as well as the challenge of controlling cost in the face of the weakening U.S. dollar. We have reduced our Brazilian flue-cured production to address the previous over supply in worldwide flue-cured tobacco and the quality of that crop is better. As the smaller burley crops in Africa and the drought effects on the U.S. flue-cured crop along with higher costs in most of the major producing areas of the world are presenting challenges.

The U.S. dollar continues to be weak against many currencies and although we work with our customers to mitigate the effects of that where we can, it remains a source of higher cost.

African operations are experiencing margin difficulties on current crop reduction as unit costs have risen primarily due to the smaller crops coupled with much higher prices to farmers as I said in Malawi and Mozambique.

Inventories of African tobacco are substantially lower than they were at this time last year, that reduction reflects the crop shortfall and indicates lower shipments for the remainder of the season. In addition, as we noted last year, our North American operations benefited from the higher sales volume associated with the sale of old crop burley tobacco and those volumes will not recur this year.

North America is also dealing with the effects of the drought in the Eastern United States. Tobacco production in Canada has fallen severely over the last two years and is forecast to decline by about one-third for fiscal year 2008. We recognize the restructuring costs related to that operation and to our flue-cured growing operations in Africa this year, however, impairments and restructuring costs in fiscal year 2008 should be significantly below the level we have seen over the last two years.

We believe that we have been taking the necessary actions to improve our performance for the long term or highly confident in our regional management teams and we believe they have handled these challenges well in the first half of the fiscal year and that we have had a good first six months.

Travis, we would be happy to take questions.

Question-and-Answer Session

Operator

We will take our first questions from the side of Ann Gurkin of Davenport. Go ahead please.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

I wanted to start with the announcement about the share repurchase plan and do you plan on repurchasing shares before the end of the calendar year?

Karen Whelan

As we said in the press release, it will be in the market from time to time.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

I fold up.

Karen Whelan

I could not tell you exactly when or how much, but yes.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

And do you plan to fund it through cash, cash flow, credit line?

Karen Whelan

Ann, we have not changed our philosophy about that and we are buying shares out of out free cash flow.

Hart Roper

And we would definitely not borrow money to buy shares.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Okay, switching to shipments, can you give us any numbers on volume that was maybe shipped earlier in this quarter? Accelerated sales volumes? Can you give us any numbers around that statement?

Hart Roper

Of course not.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Can you help us with interest expense for the year?

Karen Whelan

I think it would be reasonably safe and annualizing what we have, we have a big repayment coming up in February, so that is pretty close to the end of the year.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Okay, capital spending for the year, any changes?

Hart Roper

Not material. We expect capital spending to be below depreciation, we are greatly under depreciation through the six months and we will be under for the year.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Currently, what are you forecasting for currency for the back half of the year?

Karen Whelan

Which currency?

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Riyal, and actually the dollar versus the Canadian dollar too.

Karen Roper

The market seems to expect it to continue to strengthen, and conversely against other currencies, the market seems to expect the dollar to weaken.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

SG&A for the second half of the year, can you help us with that? Given that like this quarter have benefited from, or actually the first half has benefited from some one time thing.

Karen Whelan

Now, I do not think that is a benefit to this quarter. It is just the comparison is different. Last year was worse.

Hart Roper

I cannot remember, Ann sitting here without looking at the disclosures and the 10-K, do you remember the 10-K we had at the table where we showed all the unusual stuff. And my memory is not very good, but I think most of the farmer write offs that we took last year were in the first half. So you should not see these kinds of “favorable” comparison on SG&A over the second half, but if you go look at that footnote in the K, if there are any major farmer write offs in the second half of the year, it will be disclosed there and that will give you a tip.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Great.

Karen Whelan

Also in the quarter footnote, whatever is there.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Over your uncommitted inventories at the end of the quarter?

Karen Whelan

They were $78 million. We do not have uncommitted inventory industry volumes for you though this quarter, I am sorry, Ann. Second quarter, we usually do not.

Hart Roper

It was $60 million less than last September and it is 12% of the inventory this year. Last year, it was 18% in the record, so uncommitted is down to that.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Are there any issues with getting containers to ship lease?

Karen Whelan

I am not aware of any.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

We have heard from some other consumer companies that there are some little bit of issue in getting containers, but no problems?

Karen Whelan

That is not going to affect any of the numbers that we have here.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

And then, what should we look for for sales of lease in North America this year versus last year?

Karen Whelan

Sales of lease in North America, I mean, we have said that the one time burley sale that we had last year will not continue.

Hart Roper

Is that what you are asking?

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Right. More on an organic basis, do you think, can you grow sales in North America on an organic basis versus last year?

Karen Whelan

But that is organic. We are not sure what you mean.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Well, backing out the one time sales of the older lease inventory?

Karen Whelan

Okay, on a normalized basis?

Hart Roper

I think our export sales are actually up predicted, but the crop is less.

Karen Whelan

The crop is less than we expected because of the drought, but not, I think it is still above last year a little bit.

Ann Gurkin - Davenport & Co. Of Virginia, Inc.

Okay, that is great. That is all I have. Thank you.

Operator

Thank you, we will take our next question from the side of Dex Vlassis of Gates Capital. Go ahead please.

Dex Vlassis – Gates Capital

Hi, yes, I was wondering, can you give the absolute amounts for the inventory valuation adjustment, farmer receivable and current remeasurement for each quarter, not just the doubts of it, but the absolute amount.

Karen Whelan

Dex, I think we have that in the footnote to the 10-K. It might be footnote 15.

Dex Vlassis – Gates Capital

I mean for the quarter.

Karen Whelan

It is the quarterly footnote, and this note 15 which talks about $12.8 million in lower of cost for market inventory charges. Uncollectable farmer advances in several countries of 25. It is footnote 15.

Dex Vlassis – Gates Capital

Okay, and was there something special that happened as far as the cash flow looked really strong in the quarter. I was just wondering what was driving that if some of that is timing or have you permanently improved the working capital management?

Karen Whelan

Working capital management in our business is kind of an unusual concept because we have to buy the crops when it comes in and if the dollar is weak, you are going to spend that money and our customers know that is part of the green cost that is going to happen, so it is not terribly risky, but working capital is going to go up. In addition, because our customers pay a carrying cost, we often fold inventories, so working capital management as sort of an unusual concept for us. But what happened this year is the smaller crops in Africa in particular, there just wasn’t there to buy. So we would normally would have expected this to be a peak working capital investment period and it just did not happen that way. We had smaller crop in Canada, Africa is the big one and I think we had maybe some shipment timing in Brazil that benefited the inventory balances.

Dex Vlassis – Gates Capital

Given that this would typically would be a peak, working capital, would you expect the back half of the year to be different than in the past?

Karen Whelan

No, I really do not. I think we just did not have the big investment. I guess you would not have the cash inflow in the second half from that African inventory that is not there because we have already had that, so maybe you have a little bit less in prior years.

The other things that happened in the first half of the year, we had cash from employee option exercises. We sold two airplanes and we got cash from the sale of the non-tobacco businesses, so we had had additional cash flow.

Dex Vlassis – Gates Capital

Has something changed because I believe in the past, you had talked about not be willing to do share repurchase before repaying some of the debt that was coming due in February, what sort of change since then?

Karen Whelan

Nothing really. Cash balances are still there to repay that debt. Our philosophy on share repurchase is that we use free cash flow after the balance sheet is in the right position. Our balance sheet is in the right position. It is very favorable at this time of the year and we have free cash flow coming out of last year that we could use and so that is what we are spending.

Dex Vlassis – Gates Capital

Okay, thanks.

Operator

Thank you, we will take our next question from the side of Steve Marascia of Anderson & Strudwick, go ahead please.

Steve Marascia -Anderson & Strudwick

Good afternoon everyone. Actually, Ann got two questions asked from you, but I have got two more to throw at you. While you guys would not comment on terms of a calendar parameter. In terms of buying back your stock, might the actual share price influence, your movements in that direction?

Karen Whelan

We really do not talk about share price in this at all.

Steve Marascia -Anderson & Strudwick

And secondly, on a more generic question, with what is going on in the credit markets that started here and now spreading overseas, are you guys seeing any tightening of lending or credit in the overseas markets now?

Karen Whelan

Actually, it is one of the real benefits of having cash. We had not really seen any issues. In fact, we replaced our revolving credit facility this summer. And everything is fine. We have actually reduced our cost somewhat in doing that. We have not had an issue from it.

Steve Marascia -Anderson & Strudwick

Good, thank you very much.

Operator

We will take our next question from the side of Chris Dechiario of ISI Capital, go ahead please.

Peter Kim - ISI Capital

Hi Karen, this is Peter Kim. Chris could not make it today, so I am asking a couple of questions for him. Could you give us a little more color in terms of what kind of improvements do you expect in Africa for the rest of this year?

Karen Whelan

We do not expect improvements in Africa particularly for the rest of the year because of other than that we are not going to have whatever kind of write offs that we had last year, Africa has done very well. We have had new management since last September, but they really have been fighting a tough issue with very short burley crops. There is just not enough tobacco to go around there, so the fact that the inventories are lower means they do not have tobacco to sell for the remainder of the year or as much tobacco to sell for the remainder of the year?

Peter Kim - ISI Capital

Could you describe the supply and demand balance for the flue-cured tobacco?

Karen Whelan

Flue-cured has been an over supply and it is moving towards balance, maybe spurred on by some of the shortages in burley in fact. I would say, it is moving towards balance and could probably even move to a short fall within the foreseeable future.

Peter Kim - ISI Capital

Okay, and the last question is, do you have any cost cutting initiatives in plan for the remainder of the fiscal year or perhaps next year, is there other quantifiable objectives that you are trying to reach?

Karen Whelan

No, we do not. We have a consistent and constant program to cut cost. We do have key retirement that might save cost. It depends on how much we pay his successor. But we do have an ongoing program. The most recent thing that we did was to sell corporate aircraft, particularly the one in the United States. We just simply could not justify that cause, so we are always looking at it. Our customers are not really willing to support waste in corporate management and so it is a constant review on our side.

Peter Kim - ISI Capital

Okay, that is all I have for now. Thank you very much.

Operator

So, we’ll take our next question from the side of Kevin Zietz of Goldman Sachs. Go ahead please.

Kevin Zietz - Goldman Sachs

A question on share repurchases, just real quick, have you at all changed the debt targets, the debted capitals are conceivably laid out historically or did you stop writing under those?

Karen Whelan

Well, historically we were higher. We set new targets at 35% to 45% net debt to capital. So that includes customer deposits. We count that really as, because we have to cover it at some point.

Kevin Zietz -Goldman Sachs

Okay.

Hart Roper

We are at 27% right now.

Karen Whelan

We actually subtract cash from that as well because it is here.

Kevin Zietz - Goldman Sachs

With this program, is it sufficient to get you into that range or do you think--

Karen Whelan

Not if we are spending free cash flow.

Kevin Zietz - Goldman Sachs

Okay, so we can stay tuned for something to move you towards those targets perhaps.

Karen Whelan

I am not sure what you mean.

Kevin Zietz - Goldman Sachs

If this is going to still keep you under the 35% to 45% range then that would imply that there maybe more share repurchases or activities to get you to that target.

Karen Whelan

For our safety margin.

Kevin Zietz - Goldman Sachs

Is it too early to be asking about growing conditions in Brazil for the next year’s crop?

Karen Whelan

Yes, I mean it is planted. I think everything is going well so far. There was a dry period for a while, but it was pretty early in the game. So it is just awfully early to say one thing or the other.

Kevin Zietz - Goldman Sachs

Okay. I guess just looking at the SG&A and knowing that you have been focusing on controlling cost. Just a sort of the net of the farmer receivables, it looks SG&A was up a bit for the quarter so is there something, is there a current impact or something?

Hart Roper

Other factors in there, one was we had a gain from asset sales last year in the quarter of about $3 million and there are exchange effects in the quarter fling is 3-1/2, so between the farmer’s stuff and those two items, you are right back basically the same level for our year.

Kevin Zietz - Goldman Sachs

Okay, and then I guess, sort of longer term if the burley crop is going to be under supply for a longer period of time, are there investments that you are thinking of making now to all through that, I guess, the converse of what you did with the flue-cured crops.

Karen Whelan

We probably would not undertake something like that lightly, again, but in the areas where the burley crop has been short, the infrastructure is there, and Malawi in fact is an auction market where the farmers would grow the crop independently. Mozambique is a contract market, but the infrastructure is already there, it is just a matter of encouraging the growth. Typically though, short supply does not last long very long. And we really do it, it is not like the paper industry. It takes years to build the new capacity.

Hart Roper

The expectation is that the Malawi crop for example will go back to the far-year levels and 120 to 130 maybe as much as 140 million kilos.

Karen Whelan

The seedbeds have been planted and they are very large, so the early signs are the bad crop size will come up, now whether it is enough to undo this, the shortfall in one year—

Hart Roper

It will probably take two crops to get us back.

Kevin Zietz - Goldman Sachs

Okay. I appreciate it, thanks.

Operator

Thank you we’ll take our next question as a follow up from the side of Dex Vlassis of Gates Capital. Go ahead please.

Dex Vlassis - Gates Capital

What was the currency remeasurement gain in the quarter if there was one?

Hart Roper

The fling from last year was $3.5 million and was at a higher cost. So the gains were lower this year than last year.

Dex Vlassis - Gates Capital

Okay, do you have any update to the crop sizes for the different classes of tobacco?

Karen Whelan

What are you looking at in particular?

Dex Vlassis of Gates Capital

Just flue-cured, burley, oriental, just down the line.

Karen Whelan

Okay, Excluding China, to begin with flue-cured total exporters, we published this on our website.

Dex Vlassis of Gates Capital

You do not have an update now from the last time?

Karen Whelan

No.

Hart Roper

No, this is dated October 18th.

Dex Vlassis - Gates Capital

Okay, I can pull that up.

Karen Whelan

Okay.

Dex Vlassis of Gates Capital

And then, you have talked about prices and speaking with your customers about getting price increases, can you provide any sort of update since the last quarter if some of those that you have been able to increase prices or the negotiations are leaning one way or another?

Karen Whelan

We continue to discuss this with our customers and particularly when the crops are in short supply. I keep saying that you are not gauge your good customers for pricing just because the crops are short because you know they will stand by you, but at the same time, they have to understand when it costs us more and I think that customers understand that, so very much impressive.

Dex Vlassis - Gates Capital

Have you seen any changes in the competitive environment from Alliance One or anybody else?

Karen Whelan

The only thing we would know of that is by rumor.

Dex Vlassis - Gates Capital

Any good rumors lately?

Karen Whelan

I never spread rumors.

Dex _ of Gates Capital

Alright, Karen, thanks.

Operator

Thank you, currently there are no questions in the queue.

Karen Whelan

Well I appreciate you all joining us today. We had a good quarter and we are glad that you are here to share it with us. Thanks.

Operator

Thank you. This concludes today’s conference call, you may disconnect at any time.

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