UVV

Universal Corporation 10-Q Summary: Period Ended September 30, 2009

Business Context and Reporting Period

Universal Corporation, the world's leading leaf tobacco merchant and processor, filed its quarterly report (Form 10-Q) for the period ended September 30, 2009. The company operates globally with significant seasonal working capital requirements, particularly in Brazil and Africa during the first half of the fiscal year. As of November 1, 2009, there were 24,684,175 shares of common stock outstanding.

Key Financial Metrics

Note: Operating cash flow was negative due to seasonal working capital investments in tobacco inventory and advances to suppliers.

Material Changes vs. Prior Period

• Revenue: Revenues for the six months ended September 30, 2009, were flat compared to the prior year ($1.26 billion vs. $1.29 billion). Lower volumes due to shipment delays and reduced old crop sales were offset by a better product mix and higher prices in certain regions.
• Profitability: Net income increased significantly to $96.3 million (six months) from $62.9 million in the prior year. This improvement was driven by a $17 million decline in currency-related costs, better margins, and a favorable tax rate due to the reversal of provisions for uncertain tax positions.
• Costs: Cost of goods sold decreased by approximately 5% for the six-month period, and selling, general, and administrative expenses fell by 5%, largely due to reduced currency remeasurement losses.
• Inventory: Tobacco inventory increased by $334 million to $920 million, reflecting seasonal crop purchases. Uncommitted inventory remained at a healthy 7% of total tobacco inventory.

Guidance, Outlook, and Risks

Management Commentary: Management expressed satisfaction with performance, citing effective cost controls and global coordination. While volumes were lower in the second quarter due to accelerated shipments in the first quarter and delays in Africa, margins improved. The company does not foresee an oversupply of flue-cured tobacco in the coming year, though rains in Brazil could impact the crop.

Outlook: The company anticipates continued volume reductions with Japan Tobacco Inc. (JTI) regarding U.S. flue-cured and Malawi burley tobacco as JTI enhances direct procurement, though this is not expected to impact volumes in the current fiscal year. The company plans to spend approximately $30 million on facility expansions and customer-related investments.

Risks and Contingencies:

• Legal Proceedings: The company is appealing European Commission fines totaling approximately €30 million ($44 million) related to antitrust violations in Italy and €12 million ($14.9 million) related to Spain. The company believes it is probable it will prevail in the appeals and has not accrued a charge for the Italian fine.
• FCPA Investigation: The company is in ongoing settlement discussions with the DOJ and SEC regarding payments that may have violated the U.S. Foreign Corrupt Practices Act. Accruals have been recorded that management believes are adequate to satisfy the estimated settlement.
• Guarantees: The company has approximately $154 million in exposure under guarantees for bank loans to tobacco growers in Brazil.

Investor Verification Checklist

• Verify the status and potential financial impact of the ongoing European Commission antitrust appeals in Italy and Spain.
• Confirm the final terms and total cost of the settlement with the DOJ and SEC regarding the FCPA investigation.
• Monitor the impact of the weakening U.S. dollar on future purchasing costs for the next tobacco season.
• Assess the timeline and volume impact of Japan Tobacco Inc.'s shift toward direct leaf procurement.
• Review the company's ability to manage seasonal working capital needs given the negative operating cash flow in the first half of the fiscal year.