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Universal Corporation (NYSE:UVV)

F3Q08 Earnings Call

February 7, 2008 5:00 pm ET

Executives

Hartwell Roper – Vice President and Chief Financial Officer

Karen M.L. Whelan - Vice President and Treasurer

Analysts

Dax Vlassis – Gates Capital Management

Bryan Hunt – Wachovia

Christopher Dechiario – ISI Capital

Steve Marascia – Anderson & Strudwick

Ann Gurkin – Davenport & Co.

Operator

I would like to welcome everyone to the Universal Corporation’s third quarter fiscal year 2008 conference call. (Operator Instructions) Thank you. Ms. Whelan, you may begin your conference.

Karen M.L. Whelan

Thank you very much, and 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 these 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 7, 2008. If you’re 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, 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. As such, they are based on our current knowledge and some assumptions about the future events. 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 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.

As we have to the last several quarters, we will only discuss continuing operation with you today.

Income from continuing operations for the third quarter this year increased by 42% to about $51 million, or a $1.56 per diluted share. Last year, it was about $36 million, or $1.17 per diluted share.

For the nine months, we earned about a $109 million from continuing operations; that’s $3.38 per diluted share, up 85% compared to last year.

Sales and other operating revenues were up 12% in both the quarter the nine months, totaling $573 million for the quarter and $1.7 billion for the nine months.

In the quarter, the revenue growth was principally due to higher volume in Europe, Asia, Africa and the Special Services Group, as well as the impact of currency changes. A significant part of the volume increase was related to shipment timing as well.

For the nine months the increase has been more widely dispersed and caused by higher volumes and higher leaf prices in U.S. dollar terms, in most regions.

Now turning to the segment results. The North American segment of the flue-cured and burley operations was flat for the quarter, at about $19 million.

Despite the effect of crop reductions in Canada and the absence of last year sales of old crop U.S. burley, higher volumes of current crop tobacco in most origins, combined with improved pricing in some areas, largely offset the negative factors.

For the nine months, the North America segment reported operating income of about $18 million, down from $27 million last year. That reduction reflected lower carryover sales in the United States this year; last year’s benefit from old crop U.S. burley sales, and the significant reduction of the Canadian crop.

We also incurred higher operating costs in handling the U.S. crop, because of the effect of drought this year. However, we had improvements in pricing and volume in some origins that partially mitigated those factors.

In addition, you might recall that last year’s results reflected a $3 million gain from the sale of idle assets in the nine months.

The other segment of our flue-cured and burley operations called Other Regions are $52 million, up 13% from last year. And that was driven by improvement in operations in Europe and Asia.

The segment also recognized higher income that had been deferred on sales of leaf to another segment to provide just-in-time delivery services. That leaf has now been delivered to customers, so the profit has been recognized.

U.S. performance reflected earlier shipments, better product mix and additional blending and sheet volume, while Asia’s comparisons improved with the absence of last year’s flood-related costs in the Philippines and additional trading volume. Some of the trading volumes were delayed from earlier this year.

Despite higher volumes on earlier shipments, African results fell because of lower margins as smaller crops, high farmer leaf prices and the weaker U.S. dollars increased unit costs significantly.

In several origins, higher gains in currency related to both balance sheet re-measurement and to transactions offset part of the increased costs related to purchasing and processing tobacco with weaker U.S. dollars.

For the nine months, the Other Regions segment earned $148 million compared to $106 million last year, an increase of nearly 39%. The increase reflected improved results in all regions, and we saw many of the same factors that affected the quarter.

In addition to the improvements in Europe and Asia and the recognition of deferred income that I talked about earlier, the nine-month period reflected lower charges, especially in Africa, for inventory and farmer receivables this year, which contributed $26 million to the comparison.

Currency re-measurement gains from the balance sheet and transaction gains mitigated only some of the effect of the weaker U.S. dollar on costs. And we also had benefits from larger crops in the Philippines where flooding last year reduced crops, and lower overhead costs in both Africa and Asia.

In Africa, after adjusting for last year’s charges, operating margins were lower, and volumes shipped from the smaller burley crops there were higher, as the African season is rapidly drawing to a close.

The Other Tobacco Operations segment includes our oriental tobacco joint venture, Dark Tobacco Operations and Special Services. Results for the segment improved by $2 million in the quarter to $16 million, and revenues increased by $22 million to $66 million.

Most of these increases related to accelerated sales volumes for the Special Services Group. Part of their business is being absorbed by regional operations. That change was also primarily responsible for the 30% increase in segment operating income for the nine months and a 33% growth in revenues.

Earnings from the oriental tobacco joint venture were also up to the nine months, mainly due to a gain from the sale of an investment and re-measurement gains, which partly offset the adverse effect of currency changes on its cost.

As you would expect, we recorded higher interest income and lower interest expense as a result of funds provided by our operations this year; the sale of our non-tobacco businesses; asset sales; and executive stock option exercises.

In addition, our effective income tax rate for the nine months at about 36%, compared to about 43% last year, and that was primarily result of our Zambian operations.

To summarize, results for the third fiscal quarter and the nine months have improved, despite difficult supply shortages and rapidly rising costs that were due in part to the weak U.S. dollar.

Much of our improvement came from the reduction of restructuring charges and provisions for inventory valuation and farmer advances.

However, our inventory has fallen by over 25% since last year, primarily reflecting smaller crops in Africa and Canada and more rapid shipment of leaf during fiscal year 2008.

That acceleration of shipments, which has led to near completion of yearly shipping in some origins and the accompanying substantial reduction of total inventories, is likely to mean lower shipments in future quarters.

We will continue to work with our customers to mitigate the effect of the weak dollar on our unit costs. Despite these many challenges we believe that we have being taking the necessary actions to improve our performance.

Our business model is sound, and we believe that because of our dedication to producing quality leaf and service to our customers, we will continue to be successful in the long term.

We are prepared to take questions now, if you will open the line.

Question-and-Answer Session

Operator

(Opeartor Instructions) Your first question comes from the line of Ann Gurkin – Davenport & Co.

Ann Gurkin – Davenport & Co.

I wanted to start with your comment about nearing completion of shipping in some regions. Can you tell us the percentage of your annual shipping volume that you have completed now?

Hartwell Roper

Ann, we don’t have a precise percentage. But we know proportionally, we have shipped more tobacco out of the most of the regions – those are crops we handle in those regions – in the current year. So we just, proportionally, have shipped a lot more tobacco than we did at same point in time last year.

Ann Gurkin – Davenport & Co.

Okay. What was shipped in the fourth quarter, some of that was pulled into the third quarter? Is that fair?

Hartwell Roper

That’s right.

Ann Gurkin – Davenport & Co.

Okay.

Karen M.L. Whelan

If you just look at, for example, places like Africa, where the crops are smaller, we didn’t simply reduce the same percentage of our shipments by the percentage that the crop is lower. We are still shipping at a normal pace, or faster, but there is less crop to ship, so some of them are nearly finished. And you can see that in our inventory reduction.

Ann Gurkin – Davenport & Co.

So it’s more the crop size than customers pulling volume forward, because are they nervous?

Karen M.L. Whelan

I would never characterize our customers as nervous.

Ann Gurkin – Davenport & Co.

Okay. Sales were up 12%. Can you give us the percentage of that 12% that was due to timing of shipments? That’s another way of asking.

Hartwell Roper

Again we just don’t look at it that way; we don’t spend any time to try to figure that out. Maybe we should, but we don’t.

Ann Gurkin – Davenport & Co.

Okay.

Harwell Roper

I would suspect that good chunk of it is, though.

Ann Gurkin – Davenport & Co.

The chunk would be 50%?

Karen M.L. Whelan

Maybe even more than that. A very large part of the change in Other Tobacco Operations is shipment timing.

Ann Gurkin – Davenport & Co.

Okay. Can give me the amount of the gains from the sale of the investment in the oriental joint venture?

Hartwell Roper

I don’t know if we’ve disclosed that before or not. Our share of it was less then $2 million.

Karen M.L. Whelan

Comparison to this year is only a $2 million increase, year-to-date. So it’s not a huge number.

Ann Gurkin – Davenport & Co.

Okay. Last, can you give us any update on how are contract negotiations going, particularly in Brazil?

Karen M.L. Whelan

I think they are at the normal place they would be at this time in a year.

Ann Gurkin – Davenport & Co.

Are you finding in discussions with manufacturers or customers that they are trying to price leaf on a global basis, rather than market by market? Are they trying to shift how they do their business with you?

Hartwell Roper

I would say the answer to that is no.

Ann Gurkin – Davenport & Co.

Okay. They are still doing market by market?

Karen M.L. Whelan

I don’t think there has been a change in how we do business with our customers.

Ann Gurkin – Davenport & Co.

That’s great. Thank you.

Operator

Your next question comes from the line Steve Marascia – Anderson & Strudwick.

Steve Marascia – Anderson & Strudwick

Good afternoon, and congrats on a good quarter.

Just couple of questions for you. First, assuming the U.S. dollar, which has been rallying of late, continues, how should we look at that as impacting your overall businesses going forward? Generally speaking, of course.

Karen M.L. Whelan

It’s a uniform weakness change around the world. So I think it’s safe to say that all of our costs in local currency costs will be going up. Some places have been stronger than others, like Brazil. And that’s partly the strength of Brazil as a commodity producer. So it’s generally a negative effect on our costs.

Steve Marascia – Anderson & Strudwick

And a question I’m asking pretty much every corporation nowadays. With your financing situation, tell me what you have seen. Have you felt any effects from what’s going on in the subprime contagion, in terms of any type of collateralized; or I guess you wouldn’t own any.

But in terms of any short-term finance you are seeking, has it affected rates, or do you see it affecting or availability of short-term rates for you?

Karen M.L. Whelan

No, we are in a really nice position in today’s market, in that we have a substantial amount of cash. We are monitoring the investment of that very closely.

Steve Marascia – Anderson & Strudwick

Okay. So you have no subprime exposure? Or there are some that you are just monitoring?

Karen M.L. Whelan

I don’t think we have any. There is no direct subprime exposure at all.

Steve Marascia – Anderson & Strudwick

Okay. Thank you very much.

Operator

Your next question comes form the line of Dax Vlassis – Gates Capital Management.

Dax Vlassis – Gates Capital Management

You talked about some pricing increases in the quarter versus a year ago, can you expand on that? You said it was by region. Can you give me any more information on that?

Karen M.L. Whelan

To the extent we have prior leaf costs, and we try to pass that through, we’re getting higher leaf prices. It doesn’t mean we’re passing it entirely through in every region, but it’s typically an effect of higher leaf prices for the farmers.

Dax Vlassis – Gates Capital Management

Okay. But has there been any change in the customer? Are these previously negotiated, and then basically, they give you an increase because your costs are up?

Karen M.L. Whelan

I think it depends on the timing of the negotiation and the customer.

Dax Vlassis – Gates Capital Management

Okay.

Karen M.L. Whelan

We would have expected everybody has seen the dollar weakening for some time. So in discussions with customers, you are certainly talking about currency changes and cost increases, particularly in place like Africa, were the crops are short. You know that costs are going up.

Dax Vlassis – Gates Capital Management

Right. And you start negotiating pricing for the next big part of the year at this time of the year?

Karen M.L. Whelan

Some origins.

Dax Vlassis – Gates Capital Management

Okay. What was your uncommitted inventory at the end of the quarter?

Karen M.L. Whelan

About $63 million.

Dax Vlassis – Gates Capital Management

Okay. And I noticed that minority interests went down quite a bit, year over year, in the quarter. Can you explain that?

Hartwell Roper

That’s coming out of Africa, Dax. It’s a little bit complicated, but you have a local entity in Africa that we don’t own 100% of, and in the prior year, there were a lot of shipments from that company through our system.

Dax Vlassis – Gates Capital Management

So, last year was abnormally high?

Karen M.L. Whelan

It’s a matter of shipment timing.

Dax Vlassis – Gates Capital Management

Okay. And then, with the split from Altria and Philip Morris International, will there be any impact on your business?

Karen M.L. Whelan

We work with both entities as they are working through the split. And it’s too early to say what effect it could have.

Dax Vlassis – Gates Capital Management

Okay. Does that trigger any contract terminations, or anything as far as re-negotiating those contracts? Or are they just season by season?

Karen M.L. Whelan

We have a remaining contract in the Untied States. There are no issues.

Dax Vlassis – Gates Capital Management

Okay. And then on the cash, some of the $500 million would at some point go back into building back up your inventories. They seem historically at a very, very low point. How much of that $502 million do you assume is available for use for a repurchases or debt pay down, etc.?

Karen M.L. Whelan

Next week, we are going to pay down $150 million of debt that’s maturing.

Dax Vlassis – Gates Capital Management

Right.

Karen M.L. Whelan

And we are just at the very beginning – actually end of December – we hadn’t spent much at all on the Brazil season, which is fairly substantial season. So, we think we have a use for that, but if everything works the way at should, what goes out for inventory will come back. Our stock repurchase program is based on free cash flow.

Dax Vlassis – Gates Capital Management

Right, which was fairly large in the quarter. It doesn’t seem like you bought back any stock.

Karen M.L. Whelan

We’ve not been in the market for a full quarter, Dax.

Dax Vlassis – Gates Capital Management

Yes.

Karen M.L. Whelan

So we expect that to continue as the same pattern that we did. We had an extended share repurchase from 1998 to 2003, and our typical pattern is to be in the market every day. So that will continue.

Dax Vlassis – Gates Capital Management

Right. But what portion of your cash do you view as available,,if you assume you pay down the $150 million, it’d be $350 million roughly.

Karen M.L. Whelan

Our program is a $150 million.

Dax Vlassis – Gates Capital Management

Okay. And then, I think you still have an under-funded pension plan. Are you planning on making contributions to that this year? And if so, how much?

Hartwell Roper

The pension plan is not unfunded.

Karen M.L. Whelan

What you see when you look at our footnote includes an unfunded plan, basically. It’s not an ERISA plan. So that’s why it looks under-funded. We put in extra money last year. But the plan looks fairly well funded right now. So we’ll continue to put some in, because that’s what we do to be responsible to the plan. But we don’t think we’re under-funded.

Dax Vlassis – Gates Capital Management

Okay. And last question. How come you didn’t buy back stock in the quarter if you had the availability, and cash flow generation was fairly strong?

Hartwell Roper

We bought $4 million worth of stock in the quarter. I don’t think that’s nothing.

Dax Vlassis – Gates Capital Management

Okay. Thank you.

Operator

Your next question comes from the line of Christopher Dechiario – ISI Capital.

Christopher Dechiario – ISI Capital

Just couple of questions. Your level of provisions for farmer receivables, would you characterize that as back to a normal level now; is there an average level?

I see you had a significant reduction, just in the nine months, for provision of farmer receivables. Is that something that, going forward over the next fiscal year, there will be more reduction? Or are you pretty much at a level that you consider to be normal?

Karen M.L. Whelan

It’s going to vary seasonally. As the Brazilian crops come in, and we withhold money from the farmers, you will see a change in the amount. But we think it’s at a fairly normal level now.

Christopher Dechiario – ISI Capital

Right. So other than seasonal effects.

Karen M.L. Whelan

Yes.

Christopher Dechiario – ISI Capital

That’s fairly normal. Okay. Maybe just ask about the Brazil season a little differently. If you compare what you know so far in terms of this year crop and this year’s real, versus what you had at this point going to last year? How would you characterize the crop, one versus the other? And in terms of the impact the real would have on you, basically, so far?

Karen M.L. Whelan

The crop is going to be more expensive, for sure.

Christopher Dechiario – ISI Capital

And in terms of quality?

Karen M.L. Whelan

The quality – it’s just starting to come in. And there was some cold weather early on. I think we had either too much rain, or too little rain, I don’t recall which now, so it might be slightly off.

Christopher Dechiario – ISI Capital

And in terms of currency, if we just make the broad assumption, let’s just say the real stays exactly where it is right now for the next four, five months. Would that mean that you basically wouldn’t really be affected by the real? Is this a period where the real moving doesn’t really affect you?

Other than the fact of prices are higher from last year, I think that you haven’t finished negotiations with your customers yet. You can probably make a pretty good case already for passing this along. If the real happens to stay roughly flat here, do you think you’d have much in the way of unexpected real losses? Or crop prices that you can’t pass through?

Karen M.L. Whelan

The big effect on the real is the year-to-year change, because we fund in dollars what we buy. So during the season, weakening real will just cost us more through the season.

Christopher Dechiario – ISI Capital

Right.

Karen M.L. Whelan

But in your scenario, there is no change from now. You wouldn’t have a surprise, but you certainly would already have higher costs that you were expecting.

We’ve also had balance sheet re-measurement gains, and those actually aren’t realized yet. Those are on local currency assets; until they’re realized they are not done. So that could change.

Christopher Dechiario – ISI Capital

Okay. To the extent that whatever movements happened between last year and now, while you’re still negotiating with your customers, how receptive have they’ve been to allowing you to recover those costs so far?

Karen M.L. Whelan

We’re still in discussions, so that remains to be seen.

Christopher Dechiario – ISI Capital

Okay. And my last question. Has the improvement in sales you have had, in spite of some of the problems, does any of that come from a change in market share between you and AOI, that you can see? In any of your markets?

Karen M.L. Whelan

We always hope for market share change. I think to the extent we have it, with only two players, it tends to be fairly ephemeral. It comes back and forth, and there are a few regional players that may be picking up share. But on a permanent basis, I would never expect it.

Christopher Dechiario – ISI Capital

And then, let say the last nine months, is that something you would have seen that would have, so to say, temporarily gone one way or the other?

Karen M.L. Whelan

I don’t think we ought to comment on that.

Christopher Dechiario – ISI Capital

Okay. Thank you.

Operator

(Opeartor Instructions) And your next question comes from the line of Bryan Hunt – Wachovia.

Bryan Hunt – Wachovia

I was wondering if you could just comment on the recent headlines of Malawi crop damage, what impact it could have on quality and overall volume? Do you know how much of the crop may have been damaged?

Karen M.L. Whelan

I actually haven’t seen those headlines Bryan. We are aware that they have had a lot of rain this year in that region, as they did last year in Malawi and Mozambique. But it’s a little too early to say what effect that’s going to have on the crop. A very large crop was planted. So, we still would like to see more volume there. The headlines you are talking about, when were those?

Bryan Hunt – Wachovia

I think it was two weeks ago.

Karen M.L. Whelan

Okay.

Bryan Hunt – Wachovia

And then, with regards to, you say a very large crop, last year’s crop was obviously short, or small, relative to expectations and needs. Do you believe the amount of tobacco that’s being planted in Malawi and Mozambique is in line with your demands and your customers’ demand are in that region?

Karen M.L. Whelan

We think that if the entire crop came in, a very large crop, the world market would still be a bit short of burley. But it would go a long way toward helping the situation.

Hartwell Roper

Normally with the size of the shortage that we started with, when the crops were planted, we knew it wouldn’t get rectified with one crop. It would take at least two.

Bryan Hunt – Wachovia

Okay. And then switching gears and focusing back on Brazil and some of the comments you made. If you were to look at the Brazil quality of the flue-cured crop, so far, I know it’s early, would you say in line with historical average quality from this standpoint?

Or do you feel like you’re on the low-end or the high-end of average? Is there a better metric in which you could describe the quality of the crop for us?

Karen M.L. Whelan

Bryan, I really don’t have a characterization of it, but I am not aware of any huge problem with the quality of the crop.

I urge you, though, to stay in touch with our website, because we do publish every month an update on that. And there should be one in another ten days.

Bryan Hunt – Wachovia

Okay. And then, when we look at industry inventory, your uncommitted inventory is very low from historical standards. So is your competitor, just in our opinion, based on the tightness of inventory in the industry.

Do you feel like that gives the merchant tobacco producers pricing power relative to historical inventory levels? And what do you feel like the inventory levels are at your customers? Do you feel like their inventory levels are tight?

Karen M.L. Whelan

Low uncommitted inventories are little bit of it of a double-edged sword, unless you have big crops coming in, because you might get some pricing power, but you wouldn’t have anything to sell.

We have said for a long time that we have very big customers who rely on us for continuity of supply. They stay with us through tough times, and we don’t gouge them when the crop is short.

Having said that, we do need to cover our costs, and we’ve been working to that end. I have no way of knowing what customer inventories are. That’s not something that’s reported anywhere. But I am sure that burley given just the shortness in current crops is probably a concern there.

Bryan Hunt – Wachovia

And digging a little bit more into your statement, you don’t gouge them when the crop is short. Does the company feel like, or the Board of Directors of UVV feel like, that the company’s return on invested capital has been sufficient in the last couple of years?

Karen M.L. Whelan

We work with our customers continually on that, and that’s not an issue. I think it would just be short-sighted if we held our tobacco out to the highest bidder. We have very large customers, and they look to us.

Bryan Hunt – Wachovia

Looking in the context of the industry shortage, are you all pushing your farmers to plant bigger crops next year? And are your customers looking for you to commit more to committed inventories in light of the industry shortages?

Karen M.L. Whelan

I am not sure how to answer that, Bryan. We are pretty early in the game on some of this. The crops that are coming in for fiscal year 2009 are already planted. And all the numbers, or what we see for crops worldwide, are out there.

Hartwell Roper

Your question is about six months too soon.

Karen M.L. Whelan

And then it would be fiscal year 2010.

Bryan Hunt – Wachovia

Right, got you.

Hartwell Roper

We are just now beginning to kick off the major purchases in South America, and Africa will start in April.

Bryan Hunt – Wachovia

Given that the U.S. is more commission process market, do you think the tobacco companies – since we haven’t planted tobacco in North America yet – do you think they will push hard to increase acreage in North America?

Karen M.L. Whelan

I don’t know. I think certainly the weakness of the dollar has been benefiting the U.S. farmer, and we are all reading stories about how they may be returning to tobacco growing. So you could see that.

I think also, on our website, we have some projections for crops for 2008, which would be this year. I think there is an increased projection there.

Bryan Hunt – Wachovia

All right, I appreciate your time. Thank you very much.

Operator

Your next question is a follow-up from the line of Dax Vlassis – Gates Capital Management.

Dax Vlassis – Gates Capital Management

On cash flow statement, there is a deposit to escrow account. What is that?

Karen M.L. Whelan

We have a guaranteed bond in our appeal, on the EU fines. And there was a change in banks, and we ended up cash collateralizing that temporarily. That will be coming back.

Dax Vlassis – Gates Capital Management

Okay. When do you expect to get that back?

Karen M.L. Whelan

Maybe tomorrow; maybe next week. It’s very soon.

Dax Vlassis – Gates Capital Management

Okay. And then you’d mentioned some of the regional players in the market. Has the competition increased from them, or with shortness of crops, are they getting a bunch of the crops that are – I don’t know how to say this, but taken from other fields? Or however they get their crops?

Karen M.L. Whelan

We are at the point in the world market where we’re starting to buy in Brazil; Africa’s crops are just barely coming in. So, in terms of the coming crop, there’s just hasn’t been much action.

We always think that that our dedication to quality and to the market should stand us in good stead with our customers and that the regional competitors will do well up to a point. But they may have limited inroads. But we’ll see. They can certainly improve their quality, as well.

Dax Vlassis – Gates Capital Management

Okay, thanks.

Operator

(Opeartor Instructions) There are no further questions at this time.

Karen M.L. Whelan

Thanks very much. And thank all of you for joining us for the third quarter call, and we’ll talk to you next quarter. Thank you.

Operator

This concludes today’s conference call. You may now disconnect.

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