Business Context and Reporting Period
Company: Universal Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008 (Second Quarter of Fiscal Year 2009)
Business Overview: Universal is a leading global leaf tobacco merchant and processor. The company has divested most non-tobacco operations, which are now reported as discontinued operations. The business is highly seasonal, with significant working capital investment required in the first half of the fiscal year for crop purchases in Brazil and Africa.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2008 | Three Months Ended Sep 30, 2007 | Six Months Ended Sep 30, 2008 | Six Months Ended Sep 30, 2007 |
|---|---|---|---|---|
| Sales and Operating Revenues | $785,590 | $655,330 | $1,291,877 | $1,105,547 |
| Operating Income | $71,195 | $76,147 | $109,382 | $105,904 |
| Net Income | $41,782 | $39,798 | $62,893 | $58,506 |
| Diluted EPS (Net Income) | $1.38 | $1.23 | $2.02 | $1.80 |
| Cash and Cash Equivalents | $40,765 | $381,094 | $40,765 | $381,094 |
| Total Debt (Short-term + Long-term) | $582,128 | $516,445 | $582,128 | $516,445 |
| Operating Cash Flow (6 Months) | N/A | ($189,306) | $44,215 |
Note: Total Debt calculated as Notes payable ($260,511) + Current portion of long-term obligations ($79,500) + Long-term obligations ($321,617) as of Sep 30, 2008.
Material Changes vs. Prior Period
- Revenue Growth: Revenues increased 20% in the quarter and 17% for the six months, driven by higher green leaf costs passed through to customers and increased volumes, particularly in Africa following low crops the prior year.
- Operating Income Decline: Despite revenue growth, operating income for the quarter decreased 6.5% ($71.2M vs $76.1M). This was primarily due to a $25 million negative currency remeasurement impact related to Brazilian net monetary assets.
- Cash Flow Deterioration: Net cash used by operating activities was $189.3 million for the six months ended Sep 30, 2008, compared to $44.2 million provided in the prior year. This reflects seasonal working capital investments in inventory ($175M increase) and advances to suppliers.
- Share Repurchases: The company repurchased 2.1 million shares for $107 million during the six-month period, reducing cash balances significantly.
- Inventory Levels: Tobacco inventory rose to $778 million, reflecting seasonal buildup, higher local currency prices, and a weaker U.S. dollar at the time of purchase.
Outlook, Risks, and Management Commentary
- Currency Impact: Management highlighted a significant devaluation of the Brazilian currency (approx. 20% in the quarter), which caused substantial remeasurement losses. Further devaluation could lead to additional losses in the third quarter.
- Supply Outlook: Volumes recovered in Africa, with expectations of a very large burley crop next year. This could lead to a balanced or slightly oversupplied global market. Flue-cured supply is also expected to increase.
- Liquidity: Despite a drop in cash to $40.8 million, management asserts liquidity is adequate. The company has $255 million available under a committed revolving credit facility and approximately $400 million in unused uncommitted lines.
- Legal Contingencies:
- EU Fines: The company is appealing a €30 million fine imposed by the European Commission regarding antitrust violations in Italy. Management believes it is probable they will prevail and has not accrued a charge.
- FCPA Investigation: An ongoing SEC investigation into potential violations of the Foreign Corrupt Practices Act (approx. $1 million in payments over seven years) remains open. Sanctions could be material if imposed.
- Guarantees: The company holds guarantees for bank loans to Brazilian growers totaling $135 million, with an accrued liability of $8.2 million.
- Accounting Changes: Adoption of SFAS 157 (Fair Value Measurements) increased the liability for guarantees by $1.3 million. Future adoption of SFAS 158 is expected to reduce retained earnings by approximately $2 million in the fourth quarter.
Investor Verification Checklist
- Currency Exposure: Verify the extent of net monetary assets in Brazil and the potential for further remeasurement losses given the volatile exchange rate.
- Working Capital Cycle: Confirm the timing of crop sales and the expected conversion of the $778 million tobacco inventory into cash in the second half of the fiscal year.
- Legal Resolution: Monitor the status of the European Commission antitrust appeals and the SEC investigation regarding the Foreign Corrupt Practices Act.
- Debt Covenants: Review debt agreements to ensure compliance with covenants given the significant increase in short-term debt and reduction in cash reserves.
- Uncommitted Inventory: Assess the risk associated with the $74 million of uncommitted tobacco inventory (9% of total) in a potentially oversupplied market.