Universal Corp (UVV) Q3 2023 Earnings Call Transcript

Good afternoon. Thank you for joining today's Universal Corporation Third Quarter Fiscal Year 2023 Earnings Call. My name is Meghan, and I will be your moderator. I would now like to hand the conference over to Candace Formacek, Vice President and Treasurer. Candace, please go ahead.

Thank you, Meghan, and thank you all for joining us today. George Freeman, our Chairman, President and CEO; Airton Hentschke, our Chief Operating Officer; and Johan Kroner, 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 8, 2023. Other than a 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. 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, 2022, as well as our Form 10-Q for the quarter ended December 31, 2022. 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 resources. 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. We are extremely pleased with our results driven by strong tobacco shipments in the nine months and quarter ended December 31, 2022, compared to the same periods in fiscal year 2022. Tobacco shipments are generally moving smoothly, and we are not seeing logistical constraints that we saw in the prior fiscal year. Our Ingredients Operations segment also continued to positively contribute to and diversify our results in the nine months and quarter ended December 31, 2022. There continues to be significant demand for leaf tobacco with all types of leaf tobacco currently in an undersupplied position. Short burley tobacco crops in Africa, largely due to weather conditions, have contributed to the lower leaf tobacco supply. As of December 31, 2022, our uncommitted inventory levels stood at less than 7% of our tobacco inventory, an exceptionally low level. Although it is still early, we are forecasting larger crops in several key tobacco origins in fiscal year 2024. In our Ingredients Operations segment, we have recently been experiencing some softening of demand for some of our ingredients products, which we believe is temporary and largely due to customers adjusting their inventory levels. Some of our ingredients customers have been carrying higher inventory levels because of supply chain uncertainties. Increased costs, particularly selling, general and administrative expenses, including costs related to the expansion of sales and product development resources and deferred compensation costs from acquisitions reduced our results for our Ingredients Operations segment in the quarter and nine months ended December 31, 2022. We remain excited about the long-term outlook for our ingredients businesses and continue to make significant capital investments to enhance and increase the capabilities of our plant-based ingredients platform. We are ahead of achieving some of the earlier identified operational synergies across the platform and making considerable progress on our vision for this segment. As announced on February 1, 2023, we have appointed a new director with extensive experience in the ingredients and value-added supplier space to our corporate Board of Directors to assist us as we continue to promote and expand this business. Turning to the results. Net income for the nine months ended December 31, 2022, was $70.3 million or $2.82 per diluted share compared with $60.8 million or $2.44 per diluted share for the nine months ended December 31, 2021. Excluding certain nonrecurring items detailed in today's earnings release, net income and diluted earnings per share increased by $1.1 million and $0.04, respectively, for the nine months ended December 31, 2022, compared to the nine months ended December 31, 2021. Adjusted operating income, also detailed in today's earnings release, of $128.7 million increased by $12.2 million for the nine months ended December 31, 2022, compared to adjusted operating income of $116.5 million for the nine months ended December 31, 2021. Net income for the quarter ended December 31, 2022, was $41.7 million or $1.67 per diluted share compared with $34.9 million or $1.40 per diluted share for the quarter ended December 31, 2021. Excluding certain nonrecurring items detailed in today's earnings release, net income and diluted earnings per share decreased by $3.1 million and $0.13, respectively, for the quarter ended December 31, 2022, compared to the quarter ended December 31, 2021. Adjusted operating income, also detailed in today's earnings release, of $77.5 million increased by $2.7 million for the third quarter of fiscal year 2023 compared to adjusted operating income of $74.9 million for the third quarter of fiscal year 2022. Consolidated revenues increased by $419.2 million to $1.9 billion for the nine months ended December 31, 2022, compared to the same period in fiscal year 2022, on higher tobacco sales volumes and prices, as well as the addition of the business acquired in October 2021 in the Ingredients Operations segment. For the quarter ended December 31, 2022, consolidated revenues were $795 million, an increase of $142.4 million compared to $652.6 million for the quarter ended December 31, 2021, on higher tobacco sales volumes and prices. Turning to the segment detail. Tobacco Operations. Operating income for the Tobacco Operations segment increased by $13.4 million to $119 million and by $7.3 million to $77.1 million, respectively, for the nine months and quarter ended December 31, 2022, compared to the same periods in the prior fiscal year. Tobacco Operations segment results improved primarily due to large shipments of both carryover and current crop tobacco. While sales volumes were higher in the Tobacco Operations segment in the nine months and quarter ended December 31, 2022, compared to the same periods in the prior fiscal year, margins were lower due to sales mix and sales of tobaccos that were written down in prior quarters. Tobacco shipments from Brazil of both carryover and current crops were up significantly in the nine months and quarter ended December 31, 2022, compared to the same periods in the previous fiscal year. In Africa, despite some lower burley tobacco crop sizes, Tobacco sales volumes were up due to earlier shipment timing in the nine months and quarter ended December 31, 2022, compared to the same periods in fiscal year 2022. Results for our oriental tobacco joint venture were down in the nine months and quarter ended December 31, 2022, compared to the same periods in the prior fiscal year, on lower sales volumes and unfavorable foreign currency comparisons. Selling, general and administrative expenses for the Tobacco Operations segment were higher in the nine months ended December 31, 2022, compared to the nine months ended December 31, 2021, primarily due to unfavorable foreign currency comparisons, higher provisions to suppliers and higher compensation costs. For the quarter ended December 31, 2022, selling, general and administrative expenses for the Tobacco Operations segment were higher compared to the quarter ended December 31, 2021, largely due to higher compensation costs and larger provisions to suppliers in part due to lower crop yields, partially offset by favorable foreign exchange comparisons. Moving to the Ingredients Operations. Operating income for the Ingredients Operations segment was $9.9 million for the nine months ended December 31, 2022, compared to $10.6 million for the nine months ended December 31, 2021, as benefits from increased sales, better margins and the inclusion of the October 2021 purchase of Shank's Extract, LLC were offset by increased costs, mainly higher selling, general and administrative expenses. Operating income for the segment was $0.8 million for the quarter ended December 31, 2022, compared to $3.5 million for the quarter ended December 31, 2021, on lower sales, particularly lower sales of extracts and higher costs. Selling, general and administrative expenses for the segment increased in the nine months and quarter ended December 31, 2022, compared to the same periods in the prior fiscal year, largely on higher compensation costs including final deferred compensation costs from acquisitions as well as costs related to the expansion of sales and product development capabilities of our plant-based ingredients platform. In Other Items, we successfully refinanced and expanded our bank credit facility in the quarter ended December 31, 2022, positioning us to meet our future financial needs. In line with our previous expectations, we also reduced our outstanding borrowings considerably in the three months ended December 31, 2022, as we moved beyond our peak working capital requirements for fiscal year 2023. Also, our fiscal year 2022 Sustainability Report was published in December 2022 and is available on our website. Sustainability is an essential pillar of our business at Universal. We are committed to disclosing our operational activities as well as our sustainability performance in a consistent and transparent manner. We are excited about our sustainability achievements and the new and updated information and disclosures contained in our 2022 Sustainability Report. At this time, we're available to take your questions. Meghan, I'll turn it back to you.

Thank you. Our first question comes from Ann Gurkin with Davenport & Company.

I want to start with the ingredients segment and the slowdown in sales. And I think Candace, you just said it was mainly due to extracts, but I wanted to walk through the different segments and see if anything else is going on. Begin with FruitSmart. Is there any kind of slowdown in the end market for the use of those derivatives and beverages?

No, Ann, what we're really seeing is due to the uncertainty surrounding COVID. Many customers currently have extra inventory they are trying to sell off, which is causing the slowdown, but we believe this is temporary.

It seems to me that the end market for specialty ingredients is very strong and growing at a strong double-digit rate. Are you also seeing reduced inventory in that area? I thought the demand from that segment was very robust.

Again, depending on what products you're talking about, you're partially right but in all products, it's down a little bit. But again, we truly believe that it's temporary at this point in time. We saw it through the quarter; there's a bit of an uptick, but we just have to see what the rest of the quarter will do and the rest of the year.

Okay. How do I think about fiscal '24 for the Ingredients business?

That remains to be seen. But it looks really positive. We're making some significant investments; we received quite a bit of upside. So, we're really excited about that, but we're incurring some additional costs as well in order to get that all up to speed. So, it looks good. Margins are holding up nicely. We just have to see what the sales do throughout the year.

In terms of SG&A for the entire company, it was approximately $70 million, slightly less than that this quarter. Should I carry that figure into fiscal '24, or should I consider that some of this amount includes compensation expenses and possibly Shank's payments and other factors that might not apply going forward? I'm uncertain how to approach that number for fiscal '24.

There are many factors to consider, such as exchange rates and rising compensation costs due to inflation. Currently, we're in a reasonable range. We're continuously seeking efficiencies and areas for improvement. Additionally, we're increasing our hiring on the ingredients side, which will contribute to growth. However, at this moment, everything appears to be aligned.

Ann? Are you…

Did we lose you, Ann?

Meghan?

It does seem that Ann has muted her line?

Is there another question, Meghan? Maybe we can move along if she can get back in or dial back in, we can take an extra moment for her. If you have someone else, we can...

There are no further questions registered. Okay. Our next question comes from the line of Chris Reynolds with Neuberger Berman.

Good afternoon. Congratulations on the good quarter. I wanted to ask you just a general question about global tobacco consumption. And it seems like it continues to be pressured because of trends towards smoking less and then combustibles and then sort of general economic conditions being weak. That doesn't appear to be showing up in your numbers though. And I'm just wondering if you can give some commentary about sort of how you view the tobacco segment. You've always been fairly conservative with your guidance for growth, but maybe if you could just give an update on how you view global industry consumption trends this year?

Yes. Chris, it's different from market to market, of course. I mean, if you separate the U.S. and the Americas, of course, Europe and Asia. We see different dynamics in different markets. But overall, we still see a very positive consumption out there, which our major customers reported numbers. And we're very positive about the combustible side. At the same time, as we all know, there are new products in these new generation products, whether it's heat-not-burn and vaping products out there, but we remain positive about the consumption of combustible cigarettes.

Our next question comes from the line of Bruce Monrad with Northeast Investors.

A question, you made a reference in I think the script that there were some indications of crops for fiscal year '24 looking favorable. Can you add a little color on that? And then, maybe step on to that, what that might mean in terms of pricing? And I guess I'm also asking what that would mean for your inventory levels going forward and sort of on a comparison basis because I think maybe part of the reason inventories are elevated is pricing. So what's the crop outlook or if there's any color to add on that and how does that fit in, please?

Certainly, Bruce. In our key markets, especially where we operate, we are seeing increased crop sizes, which is a positive development as we play a significant role in promoting tobacco production in these regions. Regarding costs, we are experiencing inflationary pressures and rising fertilizer costs impacting these crops, leading to higher tobacco prices for farmers. This situation varies across different markets. However, we remain optimistic about demand. Our uncommitted inventory is currently at its lowest level in many years, below 7%. While we prefer having some additional uncommitted inventory to avoid missing any customer opportunities, we are looking into the 2023 crop cycle with a positive outlook. Crop sizes are confirmed in some areas, while in others, such as Africa, they are still developing or have not yet begun the growing season. Nonetheless, we are confident about the increased crop sizes, and Universal is well prepared for this.

Great. If I could elaborate a bit further. Looking at the bigger picture, we have experienced a few years of transportation challenges. I believe it's accurate to say that your end customers may have substantial inventory and longer cycle times. Would it be fair to suggest that the situation is improving, and do you expect your customers to look to replenish their inventories after the past shipping issues? Is there a structural advantage for you in terms of your customers wanting to rebuild their inventories to previous levels? How would you characterize that?

No, we don't see that, and each customer has its own policies on inventory durations. What we have observed is that transportation and logistics costs have significantly decreased. Additionally, the demand appears to be strong. Therefore, we don't anticipate major changes in their duration policy.

Our next question is a follow-up from Ann Gurkin with Davenport & Company.

I don't know if you all talked about the refinance bank credit facility, but have you fixed that rate, or is that a variable floating rate on that new facility?

We fixed some of it, Ann. Based on where the current rates are and not knowing where the Fed is going with this whole thing, we decided to fix some of it and just wait to see if we do more in the future. But...

The details will be in the Q.

I couldn't read it fast enough to see how much is fixed in the Q.

Yes. About 50...

Yes. Okay. So rates should go up; interest rate expense should go up in fiscal '24, depending on what happens.

Yes, rates are increasing, influenced by our working capital and borrowing needs. We do have some existing hedges that could provide some benefits, but overall, rates are up and our borrowings increased throughout the year.

Right. And how should I think of the margin progression for the tobacco segment in fiscal '24 versus fiscal '23? Margin was a little bit less than I was looking for this quarter, I think, due to mix, maybe some carryover. You said you wrote down some tobacco. So, I'm not sure how to think about tobacco margin over the next, say, 12 to 18 months for this segment.

It's too early for that, Ann. Brazil just started and hopefully that market remains where it is, and it doesn't go into the situation where it was last year. But if we get the crops and everything, there certainly is a strong demand, as Airton pointed out. So, we believe it looks all positive. But again, it's really early. The African crops are in the ground and we'll have to see. Hopefully, the weather will continue to cooperate there. And in some areas, we don't have it even in the ground yet. So we'll have to determine what volumes are out there and everything. And hopefully, we can do what we need to do and get the margins that we require. But yes, certainly, this year, we had some of the mix and some of those written down inventories that we moved in the last nine months.

Okay. And then the worldwide uncommitted inventory number, Candace?

Ann, the worldwide unsold flue-cured and burley stocks are at $47 million at 12/31, which is down $2 million from the June rate level.

Okay. And then with your inventory, you were just saying your inventory level for Universal at 7%. That is low given that you usually keep a little reserve for customers. So, can you walk me through kind of the thought process behind that?

It just wasn't there, Ann. We fully agree with you. Airton just pointed out on one of the other questions that we prefer to have a little bit more because we certainly like to be able to offer tobacco to customers, and we have very little at the moment. And so, we're trying to get the crops up where we can and it looks all positive, certainly for the 2023 crop. But like I said, some of them are not even in the ground yet, but we're certainly working on that. If the weather cooperates and all, then we will certainly get some additional volume.

Okay. And then CapEx plans for fiscal '24? Do you have any range for that?

No, for the next 12 months, we are estimating between $70 million and $80 million. This is due to our plans for significant investments in the ingredients platform to enhance our capabilities.

Okay. And then the synergy number for the ingredients platform, is that $20 million, if I remember that correctly?

No. We have not put out a synergy number. We're talking about operational synergies there where we're going across the platform, hiring some R&D people and some sales folks, which, again, that's where you have the addition to some of the SG&A costs. But we need to do that to be able to do all these things that we have in mind with the platform.

Okay, great. And then the last thing is I'm just bracing for a volatile year in the tobacco landscape for your customers with potential standards being set for reducing nicotine and maybe a menthol ban later in the year in California. California's well-banning sale of menthol, smokable products went into effect beginning of '23. I guess, how are you working with customers, how are you positioning Universal? And what is the transition to a heat-not-burn or smoke-free world and what could be a volatile combustible environment. I just like an update kind of on your thoughts here on assets from time to time and I'm just curious.

Well, Airton you addressed the outlook on combustibles earlier, but just remind, so Ann has not to relisten.

Yes, we remain positive about the combustible markets overall. And of course, as stated in previous quarters, we operate also in the heat-not-burn market with our sheet operations there in Europe and our AmeriNic, the liquid nicotine still continues to develop, but it's not material for us today. But we do see opportunities for Universal within all these segments. What is also very strong there is in the cigar business; we do see increased demand for wrappers and binders for that segment of the market, which we are also working hard to increase production there. So, but we remain positive about this market.

Additionally, it's important to remember that cigarette consumption in the U.S. is less than 5% of the worldwide total compared to China. While the U.S. is a significant customer for us, keep in mind that we lack insight into potential impacts from legal lawsuits when discussing this topic.

There are currently no further questions registered. There are no additional questions waiting at this time. I do apologize.

That's okay. Sorry, I didn't mean to jump in on you. Just was going to say, thanks to the folks listening in, and we appreciate your time as usual. We look forward to talking to you in the quarter. Bye-bye.

That concludes the Universal Corporation third quarter fiscal year 2023 earnings call. Thank you for your participation. Have a wonderful rest of your day.