UVV

Universal Corporation 10-K Summary: Fiscal Year Ended March 31, 2010

Business Context and Reporting Period

Company: Universal Corporation (Universal)

Reporting Period: Fiscal year ended March 31, 2010

Business Overview: Universal is the world's leading independent leaf tobacco merchant and processor. The company procures, processes, packs, and supplies flue-cured, burley, dark air-cured, and oriental leaf tobacco to manufacturers of consumer tobacco products. Operations are organized into three reportable segments: North America, Other Regions (aggregating South America, Africa, Europe, and Asia), and Other Tobacco Operations (dark tobacco, oriental joint venture, and services).

Key Operational Principles: Strategic alliances with major customers, strong local management, diversified sourcing, low-cost quality production, and financial strength.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Surge: Net income increased 28% to a record $168 million, and diluted EPS rose 31% to $5.68. This improvement was primarily driven by the absence of the significant currency remeasurement losses that impacted Fiscal 2009.
• Currency Impact: Fiscal 2009 included approximately $50 million in currency remeasurement losses due to the devaluation of the Brazilian currency. In Fiscal 2010, net remeasurement losses were only $9.3 million, and the stronger U.S. dollar reduced inventory costs in South America.
• Revenue Decline: Revenues decreased 2.5% to $2.49 billion. This was attributed to lower volumes in several regions, shipment delays, and lower trading volumes in North America, partially offset by improved sales mix and higher Asian trading volumes.
• Expense Reduction: Selling, general, and administrative (SG&A) expenses decreased by $24.4 million (8%), largely due to the reduction in currency losses. Interest expense also declined by approximately $11 million due to lower short-term borrowing rates.
• Segment Performance:
  • Flue-cured and Burley: Operating income rose 27% to $240 million, a record for the group.
  • North America: Operating income increased 19% to $57 million despite a 14% revenue decline, driven by better pricing and lower provisions for farmer receivables.
  • Other Regions: Operating income improved 30% to $183 million, benefiting from lower currency costs and higher Asian volumes.
  • Other Tobacco Operations: Operating income declined 5% to $40 million, mainly due to lower earnings from dark tobacco operations following accelerated shipments in the prior year.

Guidance, Outlook, and Risks

Management Commentary & Outlook:

• Market Balance: The leaf tobacco market is currently in balance with low uncommitted inventories. However, demand is expected to be flat or decline slightly due to flattening global cigarette consumption and more efficient leaf utilization by manufacturers.
• Customer Direct Sourcing: Major customers, notably Japan Tobacco Inc., are increasing direct procurement of leaf from farmers in the U.S., Brazil, and Malawi. This trend is expected to reduce volumes in Universal's North America and Other Regions segments in Fiscal 2011.
• North America Contracts: U.S. processing contracts expiring in May 2011 are expected to be renewed at lower volumes or different terms, potentially reducing margins and volumes in Fiscal 2012. This could impact up to half of the North America segment's operating income if not replaced.
• Supply Risks: Flue-cured crops in Brazil decreased due to excess rains, and African burley crops are forecast to decline by nearly 8% in Fiscal 2011. European production is also expected to decline due to subsidy reforms.

Key Risks & Contingencies:

• Legal Proceedings:
  • European Commission Fines: A €30 million fine (approx. $41 million) was imposed in Italy for antitrust violations. Universal has appealed and believes it is probable to prevail; no charge has been accrued. A separate €12 million fine in Spain was accrued in 2005 and is under appeal.
  • FCPA Investigation: The company voluntarily reported potential violations of the U.S. Foreign Corrupt Practices Act involving approx. $2 million in payments. Settlement discussions with the DOJ and SEC have reached agreements in principle, and accruals have been recorded. Management does not expect a material effect on financial condition.
• Foreign Currency: Significant exposure to currency fluctuations in sourcing countries (e.g., Brazil, Africa). While hedging strategies are used, remeasurement gains/losses can materially impact results.
• Customer Concentration: Three customers (Philip Morris International, Japan Tobacco, and Imperial Tobacco) each accounted for 10% or more of revenues in Fiscal 2010.

Investor Verification Checklist

• Customer Concentration Risk: Verify the stability of relationships with the top three customers (Philip Morris, Japan Tobacco, Imperial Tobacco) and the extent of their direct sourcing initiatives.
• North America Segment Exposure: Assess the impact of expiring U.S. processing contracts (May 2011) on future revenue and margin stability in the North America segment.
• Legal Settlements: Monitor the final resolution of the European Commission antitrust appeals (Italy and Spain) and the FCPA settlement to ensure no unexpected liabilities materialize.
• Currency Hedging Effectiveness: Review the company's ability to manage foreign exchange risk, particularly in Brazil, given the volatility experienced in prior years.
• Inventory Levels: Confirm that uncommitted inventory levels remain manageable and that the company is not holding excess stock in light of potential demand softening.