Universal Corp (UVV) 2009 Q3 法說會逐字稿

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 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 our hostess, Ms. Karen Whelan, Vice President and Treasurer. Ma'am, you may begin your conference.

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're reading a transcription, we have not authorized such recording or transcription. It's 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 31, 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 unaudited allocations and is subject to reclassification.

Turning to our third quarter, earnings per share were up by 14% to $1.78, bringing the nine-month results to $3.78, which is up 12%. There were four key factors in that performance -- first, larger burley crops in Africa after the very small crops last year; second, good operations in virtually all our regions that were offset by currency remeasurement losses in several countries, but especially in Brazil; higher net interest expense as we funded more expensive crops 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 -- sorry -- was about $74 million, up 3% on 27% revenue increase. Both revenues and operating income for North America increased on higher volumes, partly due to earlier shipments this year and partly on additional trading opportunities.

Operating income for the Other Regions segment decreased slightly for the quarter, despite a significant operating improvement in Africa and volume increases from larger burley crops there. The segment's performance was hurt by lower results from our South American operations due to $20 million in currency remeasurement losses in Brazil, where the local currency weakened by approximately 22% during the quarter.

Some of those remeasurement losses were attributable to advances to farmers for fertilizer and seeds but relate to the crop that will be sold next year. Crop inputs were more expensive this year due to increased fertilizer prices and the 30% to 40% weaker US 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 remeasured in US dollars, along with all other monetary assets and liabilities each reporting period. As a result, the related remeasurement 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 Catarina State.

For the nine months, results for flue-cured and burley operations increased by more than 5% to nearly $175 million. That improvement was due to stronger performance in North America, where cost savings in Canada and increased volumes in the United States boosted income and revenues. The Other Regions segment reflected stronger performance in the African region from higher volumes and from reduced charges and write-downs there. And as I said earlier, South American results were reduced by the effect of remeasurement losses, where the local currency devalued by 32% in Brazil. Those losses totaled $43 million for the nine months related to Brazil.

Other Tobacco Operations 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 in 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. But I'm highlighting it because that's where the currency effects are reflected.

SG&A expense increased by about $41 million in the quarter and $72 million for the nine months, primarily due to large currency remeasurement 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've seen the US dollar dramatically strengthen against most currencies, producing the opposite effect.

Although we have focused on Brazil, where it's most visible, the impact has also been evident in the Philippines, Indonesia, and Africa, especially where we have local currency receivables 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 the whole, the strengthening US dollar reduces our cost as is 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 don't tell the whole story, certainly as evidenced by the remeasurement cost 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 20, 2007, was $128 million. And we've 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're pleased with our operations so far this year. All of the regions have delivered operating improvements. And we're especially glad to see the recovery of results in Africa after all of the changes there, which now have culminated in larger crops, greater efficiencies, and wonderful teamwork. But the continued devaluation of the Brazilian currency has again hurt our results because of our balance sheet exposure there.

Tobacco competes with commodity crops for acreage. And world markets for commodity products have changed a great deal during the fiscal year. Earlier 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. Flue-cured 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 effects of financial chaos in world markets. Remeasurement 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've 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've already passed the peak working capital requirement this year. And during a period of very weak dollar, we were able to withstand that. We believe our financial resources are adequate to meet our needs. And, Kayla, we'd be glad to take questions now.

(Operator Instructions) And your first question will come from the line of Ann Gurkin.

Good afternoon.

Hi, Ann.

I wanted 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 that you're seeing? Or does that reflect any weakening in demand from customers for potential burley purchases as they look out to 2010, given tougher economies and higher taxes, that kind of stuff?

Ann, it's not -- excuse me -- it's not based on any weakening of demand at all. It's largely attributable to large burley crops in Africa.

Okay. And given -- what's your outlook for working capital needs for 2010, given this projected larger crop?

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

And then can we get an update on farmer bad debt in Brazil for the year?

Ann, I don't have that number. I don't think it's extraordinary this year, or we would've disclosed it.

Okay.

We expect to have a certain amount every year.

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

Based on --?

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

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

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?

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

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

And then just to clarify the $0.91 in the release is a year to date number, is that correct?

Yes, that's year to date. And that relates only to Brazil currency losses this year.

Okay. Great. And finally, can I just get your uncommitted inventory levels as of the end of the third quarter?

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

Okay. That's great. Thank you all.

Yes.

And your next question will come from the line of Saurabh Jain with Bay Harbour.

Hi, Saurabh. How are you?

Good. How you guys doing?

Just fine.

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

There's a lot of questions there. I'm not sure if I've got them all. If you look at our balance sheet, I think we had about $600 million in inventory. And 85% or so of that is committed for sale. We don't 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 is a lot bigger than the actual kilos would reflect. So we -- our orders are in good condition. I'm not sure if I missed the rest of your question.

I think part of it -- I mean, if the African crops -- 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.

Okay. That's helpful. And then, lastly, on -- I'm going to have one other follow up. In terms of the currency weakness in the real and strengthening in the US dollar, do you see a big benefit in terms of working capital use for next year as well as improvement potentially in margins because of lower-cost inventory?

Working capital usage, assuming that the dollar remains strong, should be reduced by that. I mean, you should see the dollars needed to acquire the local currency should be down. Of course, in addition to that, you had a lot of green price increases over the last year. You probably wouldn't see a continued increase in the local currency cost going up.

And you'll get sort of a delayed impact. The upcoming crop -- obviously, we've 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 stayed where it was, the crop would be cheaper also the year after in US dollar terms.

Well, that's great. And then, lastly, what is the number of shares outstanding at the end of the quarter?

I'm going to have to cheat and look. Hold on a second. I can tell you what's fully diluted. It's easier than the outstanding -- 27.3 million.

That's with the -- .

I'm sorry.

That seems a lot.

[For repurchase], it's 25 million even.

Okay. Thanks so much.

And your next question will come from the line of Dax Vlassis of Gates Capital Management.

Hi, Dax.

Couple questions -- can you talk about the Special Services group in a little bit more detail on the historical perspective and why it had operating income this quarter and what you would expect going forward?

It actually didn't have much 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 reverted back to the various origins so the timing would come the same as any other timing now. At that -- last year, as it was ending, we shipped out the remaining inventories that were being held for just in time.

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

No, I think that's more timing of shipments and maybe the mix of customer. We're not seeing any major shift in customer payments.

And some of it's just due to the higher leaf prices around the world just makes the receivables higher in dollar terms.

Okay. And can you talk about the -- in South America, it sounded like the shipments again were delayed a little bit, maybe hit by the floods. Could -- is some of that crop -- a larger percentage of that crop spilling over into the next quarter versus year ago?

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

Into the current quarter that we're in.

Right.

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

I think all of that is in uncommitted lines.

Okay. 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?

I mean, they're always competing. Right now, we're all buying the crop in Brazil. Everybody's talking to customers. So I don't know that I've seen anything unusual.

Yes, is it -- is the market share and your -- the competitive environment similar to how it's been for buying other crops this year?

You mean for other non-tobacco crops?

No, tobacco crops.

I'd say it's similar. One of them -- one of the regional players is building a factory. That's new. But otherwise, I'd say the competition is similar. African pricing certainly went up a great deal this year. That was burley shortage combined with lots of competition. But I'd say on the whole it's business as usual.

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

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 a pretty normal pattern. This should be a good cash flow quarter. And of course, the currency -- all of those remeasurement losses are non-cash.

Yes.

They just didn't affect that at all.

All right. What about the -- when do you expect to see the benefits of the basically P&L hits that you're taking now that basically should benefit you in the future? Will that be like a couple quarters from now, or -- ?

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

Yes.

I think it depends on how good our folks are at talking it through with their customers and understanding the cost. This isn't anything new. I think the size of it is new. So it's part of the total cost. And you would see next two quarters, three quarters -- I'm sorry -- second half of next year would be basically when you see it.

Hey, Karen, this is [Jeff]. I just walked in the room. But I just -- I had two quick questions. One is it looks like about $300 million in working capital has gone into the business because of the higher input costs and the currency over the past year. And I'm 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, 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?

At this point, we are looking at our cash requirements for the coming year. I would expect -- 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 more earlier, it'll change that. So there's always a timing factor in it that's 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're a crop-based company.

You mean back to zero for the year.

Yes, I mean, that would be the normal expectation. But you'll -- I couldn't say that's really going to happen because you can have timing differences.

Right. But last year, it went up by 100 or something like that.

Pardon?

Last year, it went up by 100. And it's gone up by about 200 this year.

Yes.

And I'm just -- so on a trailing basis, it's -- .

Coming back, you're having to invest less in the new crop. That should bring it back down earlier as you've shipped out and collected.

Okay. So you think you'll get last year's build back as well?

I don't think so because the currency wasn't that far off, I mean, if you just took the Brazilian currency, which is seasonally what you're looking at, at that time of the year.

All right. 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.

We're looking at that. And actually, we're in our planning process now looking at what we think we'll need for the coming crop. So it's a little hard to answer the question. But that would be the intent at this point. We're also looking at what the markets have.

Thanks.

(Operator Instructions) And you have a follow-up question from Saurabh Jain with Bay Harbour.

Hi, Saurabh.

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?

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

And it is more expensive.

Yes, it's definitely more expensive than US.

Okay. Thanks.

And your next question will come from the line of Paul Carpenter with Semaphore Management.

Good afternoon, Karen.

Hi, Paul.

I have the same type of question that I asked in November when you were here and would appreciate some follow up if you could. It really has to do with how the current liability side on the working capital doesn't seem to capture all the increases in terms of higher green cost, higher fertilizer cost you're being faced with in terms of the increase on the current asset side on working capital. So almost all those current assets, accounts receivable, advances to suppliers, both tobacco and other inventories are 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 on the surface that all the current liability items of working capital 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 at it to get at the seasonality. So I just wonder if you're passing through enough price to make up for -- even aside from the remeasurement -- passing through enough price to make up for these very high carrying costs, which just continue to absorb cash, which you could otherwise redeploy into retiring debt or buying back more stock.

Yes, if 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 last year. So you didn't see a current liability increase for that. In terms of whether we're passing enough cost through, our gross margins did increase this year. So I'd say that we did. But now maybe I'm looking at it more simplistically than you are.

I think you also mentioned that in the context of the remeasurement losses. But the remeasurement affects next year's crop. The higher income statement and financial statements reflect the crop -- this year's crop as opposed to the crop the remeasurement's going to affect.

I do appreciate that. My concern is just with escalating costs, are you pushing through enough of the burden of that escalating cost 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 in other means, which would 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're reluctant to pass on too much price to your customer base. And then when you have some of these working capital effects, they're not there for you when you need them to be. And so if you'd had an extra $400 million of cash on your balance sheet today, you could've reduced interest or bought back more stock. And you and your shareholders end up being the net losers on sort of both sides of the disequilibrium.

Well, remember, we did buy back stock with some of the cash that was on the balance sheet last year.

I know.

And we also repaid --

I think that was great. But you could've had -- I don't know. Maybe I'm being too greedy. But it just seems that in good times and bad that you bear a lot of the burden. And if you hadn't had to bear as much of that working capital [bill] by yourself, then maybe you could've had an extra $100 million or $200 million. Maybe you wouldn't have bought back more stock. I know you're very judicious about it. But you could've done something else with it. You could've paid down some kind of debt instrument.

We did, so -- .

Redeployed it that way.

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

No, I'm aware. And I think that -- .

So the actual --.

Steps in the right direction.

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

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

I actually don't. I think our receivables increase is commensurate with our revenue increase. Our inventories, yes, they're more expensive inventories. But that will change as this year goes by. 85% of them will ship out.

Thanks for answering the question. Maybe I'll talk about it with you offline.

Okay. That's fine.

Thank you.

At this time, there are no questions in queue.

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

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