Universal Corporation

Good evening. Thank you for attending today's Universal Corporation third quarter fiscal year 2022 earnings conference call. My name is Tania and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star one on your telephone keypad. I will now like to pass the conference over to our host, Candace Formatek, Vice President and Treasurer. Please go ahead.

Thank you, Tania, and thank you all for joining us. George Freeman, our Chairman, President, and CEO, Ayerson Henschke, our Chief Operating Officer, and Johan Kroener, our Chief Financial Officer, are here with me today and 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 through May 2, 2022. Other than the replay, we have not authorized and disclaim responsibility for any recording, replay, or distribution of any transcription of this call. This call is copyrighted and may not be used without our permission. 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 and are representative as of today only. Actual results could differ materially from projected or estimated results, and we assume no obligation to update any forward-looking statements. This is a particular note during the current ongoing COVID-19 pandemic when the length and severity of the crisis and results in economic and business impacts are difficult to predict. For information on some of the factors that can affect our estimates, I urge you to read our 10-K for the year ended March 31, 2021, and the Form 10-Q for the most recently ended fiscal quarter. Such risks and uncertainties include, but are not limited to, the ongoing COVID-19 pandemic, customer mandated timing of shipments, weather conditions, political and economic environment, government regulation and taxation, changes in exchange rates and interest rates, industry consolidation and evolution, 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. In an effort to provide useful information to investors, our comments today may include non-GAAP financial measures. For details on these measures, including reconciliations to the most comparable GAAP measures, please refer to our current earnings press release. Our operations produced solid results in the nine months ended December 31, 2021. We are especially pleased by the strong results from our ingredients operations segment. That segment is developing nicely and was bolstered by our acquisition of shanks extracts Inc shanks on October 4 2021 shanks adds valuable capabilities to the segment, including flavors and extracts custom packaging bottling and product development. We continue to experience the impact of tobacco shipment timing on our results in the nine months and quarter ended December 31 2021. Tobacco shipments through the nine months ended December 31, 2021 were lower compared to the same period in fiscal year 2021, in part due to elevated tobacco shipments in the third quarter of fiscal year 2021 related to earlier customer mandated shipment timing. Logistical challenges due to continued limitations in worldwide shipping availability stemming from the ongoing COVID-19 pandemic also slowed tobacco shipments in the nine months ended December 31, 2021. However, despite the shipment timing variations and logistical challenges, we believe that our tobacco business remains robust with strong customer demand and our uncommitted tobacco inventory levels remain well within our target range. Turning to the results, net income for the nine months ended December 31, 2021 was $60.8 million or $2.44 per diluted share compared with $48 million or $1.94 per diluted share for the nine months ended December 31, 2020. Excluding restructuring and impairment costs and certain other non-recurring items detailed in other items in today's earnings release, net income and diluted earnings per share increased by $4.5 million and 17 cents respectively for the nine months ended December 31, 2021 compared to the nine months ended December 31, 2020. Adjusted operating income also detailed in other items of 116.5 million increased by 8.9 million for the nine months ended December 31, 2021 compared to adjusted operating income of 107.6 million for the nine months ended December 31, 2020. Net income for the quarter ended December 31, 2021 was 34.9 million or $1.40 per diluted share compared with 33.3 million or $1.34 per diluted share for the quarter ended December 31, 2020. Excluding restructuring and impairment costs and certain other non-recurring items, detailed in other items in today's earnings release, net income and diluted earnings per share decreased by $9.7 million and 39 cents respectively for the quarter ended December 31, 2021, compared to the quarter ended December 31, 2020. Adjusted operating income also detailed in other items of $74.9 million decreased by $10.4 million for the third quarter of fiscal year 2022 compared to adjusted operating income of $85.2 million for the third quarter of fiscal year 2021. Consolidated revenues increased by $90.9 million to $1.5 billion for the nine months ended December 31, 2021, compared to the same period in the prior fiscal year. On the addition of the businesses acquired in the ingredients operations segment, and a better product mix and higher sales prices in the tobacco operations segment. In the quarter ended December 31, 2021, consolidated revenues decreased by 20.3 million to 652.6 million, compared to the quarter ended December 31, 2020, on lower tobacco sales volumes, offset in part by a better tobacco product mix and higher tobacco sales prices. as well as the inclusion of the shanks acquisition in the ingredients operations segment. Turning to the segments, tobacco operations, operating income for the tobacco operations segment decreased by 2.1 million to 105.6 million and by 14.3 million to 69.8 million respectively for the nine months and quarter ended December 31, 2021. compared to the same periods in fiscal year 2021. Tobacco operations segment results declined largely due to tobacco shipment timing, partially offset by favorable product mix consisting of a higher percentage of lamina tobacco, as well as increased value-added services to customers in the nine months and quarter ended December 31, 2021, compared to the nine months and quarter ended December 31, 2020. Africa sales volumes were lower in the nine months and quarter ended December 31, 2021, compared to the same periods in the prior fiscal year on smaller burly crops, as well as slower shipment timing. Sales volumes for Brazil were lower in the nine months ended December 31, 2021, compared to the same period in the prior year, when high volumes of lower margin carryover tobaccos shipped. Vessel and container availability has also been limited in Brazil in fiscal year 2022, which has slowed shipments. In Asia, although trading volumes were down on high freight costs, our operations saw a more favorable product mix, as well as increased value added services for customers during the nine months and quarter ended December 31, 2021, compared to the same periods in the prior fiscal year. Our operations in Europe experienced higher energy costs in the quarter and nine months ended December 31, 2021, compared to the same periods in the prior fiscal year. Selling general and administrative expenses for the tobacco operations segment were higher in the nine months and quarter ended December 31, 2021, compared to the same periods in the previous fiscal year, primarily on unfavorable foreign currency exchange comparisons. mainly from non-cash remeasurements. Ingredients operations. Operating income for the ingredients operations segment was $10.6 million and $3.5 million respectively for the nine months and quarter ended December 31, 2021, compared to operating losses in the prior fiscal year of $4.7 million and $2.5 million respectively for the nine months and quarter ended December 31, 2020. Results for the segment include our October 2020 acquisition of Silva International Inc. Silva and our October 2021 acquisition of Shanks. For both the nine months and quarter ended December 31, 2021, our ingredients operations saw strong volumes in both human and pet food categories, as well as some rebound in demand from sectors that have been impacted by the ongoing COVID-19 pandemic. In addition, the segment saw strong sales of organic-based products, certain dehydrated products, and flavors and extracts. Selling general and administrative expenses for the segment increased in the nine months and quarter ended December 31, 2021, compared to the same periods in the prior fiscal year on the addition of the acquired businesses. Our businesses have performed well, managing global supply chain constraints, particularly shipping availability. However, due to continued lack of containers, trucks and vessels in certain geographies, we expect that some tobacco shipments from certain origins will be pushed into fiscal year 2023. Inflationary pressures, including higher freight and labor expenses, have driven up our costs in both our tobacco and ingredients operations. We are also seeing higher raw materials costs for both tobacco and ingredients products. And we have been working diligently to build these increased costs into our product costs and customer contracts. Despite rising prices, we believe demand remains strong for both our tobacco and ingredients products. While it is still very early, we are also forecasting smaller crops in several key origins for fiscal year 2023. And finally, sustainability has long been a core tenet of how we conduct our business, and we work to clearly communicate our sustainability goals and efforts. We published our fiscal year 2021 sustainability report in December 2021, and it is available on our website, www.universalcorp.com. We are excited about our measurable sustainability goals and targets outlined in the report, and are committed to continue to build on our global sustainability programs to reinforce the sustainability of our supply chains. At this time, we're available to take your questions.

Thank you. If you would like to ask a question, please press star followed by 1 on your telephone keypad. If for any reason you would like to remove that question, please press star followed by 2. Again, to ask a question, press star 1. As a reminder, if you're using a speakerphone, Please remember to pick up your handset before asking your question. We'll pause here briefly as questions are registered. The first question is from the line of Anne Gerken with Davenport. Your line is open.

Hello, everybody. Good evening. Hey. Hi, Anne. I wanted to start with your comments in the release about some tobacco shipments from some origins will be pushed into fiscal 23. Can you quantify that? Is some the same as significant or less than significant that you may be targeted last press release? I don't know. Can you help me at all with that?

Yeah, and it will be very difficult to say at this point in time exactly how much of it will be pushed into 23. Lead times to get bookings have gone to six weeks. Container availability. shipping lanes actually going to the ports that they're supposed to go to is questionable. So at this point in time, we just wanted to put it out there that there is a very good likelihood that we are going to see it. We just cannot quantify it at this point in time.

So have you reached out and confirmed schedules as best as you can with existing customers? Are schedules still kind of in flux in terms of of securing these vessels. Any other detail?

Yeah, no, look, we have had constant communication with our customers to ensure that they are getting the tobaccos that they need. But again, we are depending on the shipping lines to take the containers that are at port onto their vessels. Sometimes those vessels just completely bypass some of the ports. or they just leave containers at port. So it's difficult for us. Of course, then we automatically going to put it on the next boat that gets there. But still, that's where the difficulty is in estimating exactly what those numbers are. And we will have to see what is going to be pushed into 23. But we just wanted to put it out there that it's a very likely possibility that that will happen.

But this is committed volume. It's just a timing factor.

Oh, yes. No, again, we are very happy with the committed volume numbers that we have put out there. You can see we're right in the middle of the range. We're at 15%, which we're very happy with down from last year. So all of that demand is great, you know, so no issues there whatsoever. There is strong, robust demand for the product. Just the question is can we get it on the boat quick enough, you know, to get it to our customers prior to year end.

Fair enough. Okay, then your outlook for crops, forecasting potentially smaller crops in 23. It looks like Burley is headed for another relatively, I think, historically small crop here, so the third one in a row here. So you're looking for Burley to tighten again in 23, or what's going to happen with the Burley? I would think customers would start getting nervous to secure enough supply of needed leaf, given that we're going into another smaller crop year.

Yeah, and what we have seen the last few weeks, a couple months, some extreme weather conditions that are adversely impacting the projected volume that we have. And that, of course, is still early in some areas. In Brazil, the crop is basically done. But in Africa, the tobacco is in the growing period. So we're still going to see a couple months from now what the final effect is. But we do see tight market conditions for some tobacco styles and qualities. And we don't see that just on the barley. We see that on the fluke and on the oriental market as well.

Okay. Okay. Looking at your investor presentation in November, slide 21, which is the operating margin. Looks like there was nice recovery in 21. How should we think about recovery? Or can you have continued recovery in fiscal 22? What is your target operating margin range for the company? Any details there?

You know it well enough. And you're not going to see my numbers for you. But again, I try every quarter. Yeah, you do. Good for you. And we fully understand the question. We saw some nice changes in the margins with regard to mix, which helped, and we saw certainly some value-added business that we had in the tobacco. The ingredients should help there as well. So, you know, it looks like a positive trend with regard to the margins.

Nine months number looks like a nice trend. It's just, can that hold given timing of shipments?

for the full year? That remains to be seen. There's a couple of things in there that we still have some tobacco to be shipped, some broadleaf still needs to be shipped. So those are all positive. So again, it all depends on the mix. And again, ingredients, if some of those freight costs go down, that certainly will help them as well because we saw a bit of compression there with regard to the margin. There is certainly some upside, you know, still to be had there.

Okay, great. And then the next slide. I don't like the trend in slide 22 in that presentation, the free cash flow trend. Not a fan of that. And the net debt target. What's the target? It's up to 25% and 21. What are your targets there? How should we think about that looking at a couple of years?

And again, we're not going to, you know, point exactly to internal targets, but what we're looking at, of course, is with the acquisition, certainly leverage has gone up. You know, we'll be looking at that very closely to make sure that, you know, it doesn't go too far out of bounds. Rating agencies, we're having constant communication with them. And, you know, the ratings were confirmed, although put us on a negative outlook. So, you know, we'll be looking at that leverage going forward here a little bit and see where we can bring it down a little bit to ensure that, you know, we can do the things that we want to do.

And maintain our ratings.

Fair enough. And then switching to the ingredients business, it's nice to see a margin on that business. For the quarter and the nine months, where should I think about the margin objective for that business in a more – favorable operating environment without these freight issues?

Yeah, look, and it's a bit muddy still, right? You still have some, if you look at the comparisons and everything from last year, you still had SIFI in there, and then now you have only one quarter of shanks in there. So it's quite muddy to look at it. So you need to wait a couple more quarters, and then you will get a clearer picture of what we're looking at. But again, it's value-added business where margins are nice and healthy and that's, you know, where we think we can create shareholder value.

And any impact on the pace of recovery in the business from Omicron end of December, January? Are you seeing any kind of pullback in demand, particularly on the human food side because of Omicron, like the pace of recovery?

No. Look, Omicron really has done little with regard to those businesses. It started early on where you saw a bit of a shift because of where the product was being used, whether or not it was in the entertainment-type bar setting or if it was going to grocery stores, so there was a bit of a shift there. That mix has gone back a little bit, so that's all good. So Omicron is not really the issue. It's really currently, it's the freight, the inflationary pressures with regard to labor costs and the freight costs that are out there. And then, you know, in certain areas, you know, you're using dehydrated products. On the tobacco side, you have sheet product, which uses a lot of heat and a lot of gas. So energy prices have had an impact on those. But again, those are the types of things that we're looking at. But, you know, the trend's positive.

Okay, great. Looks like you pulled back on CapEx a little bit. What are the reasons?

Well, keep in mind that over the last couple of years, we have made some significant investments to value-added things, primarily on the broadleaf side, where we're asked by customers to do certain things for them where, again, there is nice margins in those, and that's where those investments are now paying off for us. That's why it came down a little bit. In this quarter, you know, we also, that number that is in the current nine months, that $39 million, includes the buildings that we bought for Shanks. So, you know, we're happy with those numbers. You know that our CapEx normally maintenance is around $25 million, so we're still hovering about that number. But if we can make investments in tobacco, we'll go as long as it makes sense to us.

Okay. Candace, do you have a worldwide uncommitted number, least number? Sure, Ann.

We've got the new worldwide as of 12-31-21 is 55 million kilos, which is down 18 million from the June 30-21 number.

Okay. And then last, I don't know if you all can share any insight. It looks like April the FDA is going to come out or announce plans perhaps about their approach to use of menthol in cigarettes and then characterizing flavors in cigars. Are you making any preparations? Are you seeing any changes in customer orders or inventory levels? Are you engaged in comments with the FDA? Any insight into this potential update from the FDA in April? Anything you can share?

No, we've not really seen any changes. change to customer patterns again if we when we talk to our regulatory folks they say this is going to be a long drawn process and we'll take you know between the regs and the commentary period and litigation it's going to take a long time for any of these rules to come into effect okay that's great that's all i have thank you all for all your time i appreciate it thanks thanks

Thank you, Ms. Gerken. Again, to ask a question, press star 1. The next question is from the line of Chris Reynolds with Neuberger-Berman. Your line is open.

Good evening, and thank you for taking my question. I apologize. I was not on for the first part of your call, but I just wanted to clarify any comments that you've might have made about your dividend. You're one of the dividend aristocrats, and you continue to modestly grow that dividend, but you're diversifying and obviously doing a good job with those investments, and I just wanted to make sure that there wasn't any change in your longstanding dividend policy for shareholders.

Sure. When we announced our capital allocation strategy two years ago, I think our Our number one thing was investing in our tobacco business, but our number two thing was maintaining our dividend and growing it annually. So that is a core of our corporate strategy.

Okay. Thank you so much. Nice results. Thank you. Thank you.

Thank you, Mr. Reynolds. There are no additional questions waiting at this time. I'm going to turn the conference over to the presenters for any closing remarks.

Thank you very much this evening, and thanks all of you for joining us. We will talk with you next quarter. Thank you.

That concludes the Universal Corporation Third Quarter Fiscal Year 2022 Earnings Conference Call. Thank you for your participation. You may now disconnect your line.