ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS

Executive Overview

The following executive overview is intended to provide significant highlights of the discussion and analysis that follows.

Operating Results

From the outset of our shortened fiscal year we anticipated that our financial results would be relatively weak due to the ongoing major transition in global sourcing of leaf tobacco.  Specifically, we anticipated that fiscal 2004 would be negatively affected by ongoing crop declines in both the United States and Zimbabwe.  Due to the shortened year, we were unable to benefit from much larger South American crops which would have substantially offset this negative impact.  As the year progressed, that situation was aggravated by weather related declines in prior year crops in both Brazil and Malawi.  These global conditions resulted in lower sales and other operating revenues.

          Our financial results further suffered from the effect of the profoundly weak U.S. dollar, which inflated our reported selling, administrative and general expenses and depressed gross profits on our largely U.S. dollar denominated global sales.  Our gross profit for the 2004 fiscal year also reflects a $4.5 million lower-of-cost-or-market charge against inventories during the third quarter, most of which relates to Italian operations where the anticipated U.S. dollar revenue generated from the tobacco, in comparison to the Euro-denominated costs to produce that tobacco, did not justify the inventory’s carrying value.  

Restructuring  and Asset Impairment Charges

As a consequence of the ongoing transition in global sourcing of leaf tobacco and over-capacity within certain markets of the industry, we initiated a strategic review in the period to adjust our production capacity and organization to better match current requirements. This review resulted in restructuring and asset impairment charges of $29.5 million in fiscal 2004.  The major initiatives are highlighted below followed by further discussion.  See Note B to the “Notes to Consolidated Financial Statements.”  

     ●   United States and European fixed asset impairment charges, primarily machinery and equipment, were $16.8 million and severance and other costs for employees notified were $1.7 million.

A restructuring plan designed to improve long-term profitability was approved by our Board of Directors.  The decision to implement this restructuring plan, especially the closure of our Danville processing facility, has been a difficult one and we regret the dislocation it will inevitably cause our employees.  However, we expect that the non-competitive leaf prices for U.S. grown tobacco will continue to diminish the volume of tobacco available to process in this country, and that consolidating our U.S. production into a single facility will enable us to continue to compete effectively while serving our customers.  In Europe, the expected reduction or elimination of EU subsidies to tobacco growers will make these markets extremely challenging, and we are exiting those European markets that show insufficient growth and profitability opportunities.  As a result of these actions in the United States and Europe, we also expect to incur additional severance charges, estimated at $7 million, in our 2005 fiscal year.

     ●   In Zimbabwe, fixed asset impairment charges, relating to land and buildings no longer used in operations, were  $4.9 million.

Although we remain committed to Zimbabwe as a major source of good quality, reasonably priced leaf tobacco, diminished forecasted cash flows related to the continued political and social instability in that country have impaired the value of certain non-production assets there.

     ●   Impairment charges related to a non-tobacco investment totaled $6.1 million.

The results for the third quarter also reflect additional asset impairment charges in connection with an investment in a newly consolidated U.S.-based non-tobacco business.  These charges include asset impairment charges of $.7 million and $5.4 million for goodwill impairment.

Covenant Compliance

As a consequence of our weak financial results at March 31, 2004, we were again unable to remain in compliance with the consolidated fixed charge coverage ratio covenant in our syndicated bank credit facility.  As explained in more detail under “Liquidity and Capital Resources” we obtained a waiver and amendment resetting the required coverage ratio to lower but escalating levels through fiscal year 2005.  

Outlook

We will continue to focus on regions of the world that are growing in market importance in an effort to achieve profitable financial results.  We believe that the restructuring plans should position us to better capitalize on anticipated larger crops in South America, and allow us to focus on delivering outstanding customer service, exercise expense discipline and maintain a strong balance sheet over the long term.  Although we are optimistic about the longer-term effects of our restructuring plans, it is too early to quantify the benefits that facility consolidation and strategic sourcing will have on our cost structure.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Change in Fiscal Year

On June 23, 2003, our Board of Directors adopted a change in fiscal year end from June 30 to March 31.  The primary purpose of the change is to better match the financial reporting cycle with natural global crop cycles for leaf tobacco.  Our predecessor companies selected the June 30 fiscal year end many years ago when operations were substantially domestic because it matched the U.S. crop cycle. However, given the importance of our international operations today, particularly those in South America, a March 31 year-end is a more appropriate fiscal end.  As a result of this change, we are reporting a nine month transition year ending March 31, 2004. Our new fiscal year 2005 commenced on April 1, 2004. In order to facilitate comparison with the nine month period ended March 31, 2004, we have provided condensed consolidated financial data for the nine month period ended March 31, 2003 (unaudited) in Note A to the “Notes to Consolidated Financial Statements.”

General

DIMON was formed through the April 1, 1995 merger of Dibrell Brothers, Incorporated (established in 1873) and Monk-Austin, Inc. (established in 1907).  We believe that we are the world's second largest independent purchaser and processor of leaf tobacco.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

          Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions.  Our critical accounting policies have been reviewed with the Audit Committee of the Board of Directors.

Inventories

Inventories are valued at the lower of cost or market. Inventories are reviewed and written down for changes in market value based on assumptions related to future demand and worldwide and local market conditions. If actual demand and market conditions vary from those projected by management, additional write downs to lower of cost or market value may be required.  Inventory write downs as of March 31, 2004 and June 30, 2003 were $7.7 million and $3.5 million, respectively.

Income Taxes

We operate in multiple tax jurisdictions both inside and outside the United States.  Accordingly, we must estimate current income tax provisions in each of these jurisdictions as well as assess the income tax effects resulting from differing treatment of items for financial reporting and income tax purposes. We are also subject to tax audits in each of these jurisdictions, which could result in changes to estimated income tax expense.  Because tax audit adjustments in certain jurisdictions can be significant, we record accruals representing our best estimate of the probable resolution of these matters.  In determining the valuation allowances to establish against deferred tax assets, we consider many factors, including the specific taxing jurisdiction, any applicable loss or credit carryforward period, income tax strategies and forecasted earnings for the entities in each jurisdiction.  A valuation allowance is recorded if, based on the weight of available evidence, we conclude that it is more likely than not that some portion or all of the deferred tax asset will not be realized.  These factors could be subsequently affected by changes in future taxable income and its sources and by changes in U.S. or foreign tax laws. Our effective income tax rate could be impacted by changes in these factors.  See Note J to the "Notes to Consolidated Financial Statements" for further disclosure on income taxes.

Goodwill and Other Intangible Assets

We test the carrying amount of goodwill annually as of the first day of  the last quarter of our fiscal year and whenever events or circumstances indicate that impairment may have occurred. Impairment testing is performed in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Impairment testing is based on a discounted cash flow approach to determine fair value. The determination of fair value requires significant management judgment including estimating future sales volumes, growth rates of selling prices and costs, changes in working capital, investments in property and equipment and the selection of an appropriate discount rate. We also test the sensitivities of these fair value estimates to changes in our earnings growth rate and discount rate.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Critical Accounting Policies (Continued)

A one-percentage-point decrease in the earnings growth rate would not indicate possible impairment.  At January 1, 2004, the discount rate would need to increase more than 84 basis points before a possible impairment would be indicated. If the carrying amount of the net assets exceeds fair value, a possible impairment would be indicated. If a possible impairment is indicated, we would estimate the implied fair value of goodwill by comparing the carrying amount of the net assets excluding goodwill to the total fair value. If the carrying amount of goodwill exceeds its implied fair value, an impairment charge would be recorded. We also use judgment in assessing whether we need to test more frequently for impairment than annually. Factors such as unexpected adverse economic conditions, competition and other external events may require more frequent assessments.  See Notes A and B to the “Notes to Consolidated Financial Statements” for further disclosure of goodwill and impairment.

We have no intangible assets with indefinite useful lives. We have other intangible assets with a gross carrying amount of approximately $18.7 million and a net carrying amount of about $10.5 million. These intangibles are being amortized over their estimated useful lives and are tested for impairment whenever events or circumstances indicate that impairment may have occurred. If the carrying amount of an intangible asset exceeds its fair value based on estimated future undiscounted cash flows, an impairment loss would be indicated. The amount of the impairment loss to be recorded would be based on the excess of the carrying amount of the intangible asset over its discounted future cash flows. We use judgment in assessing whether the carrying amount of our intangible assets is not expected to be recoverable over their estimated remaining useful lives. The factors considered are similar to those outlined in the goodwill impairment discussion above.  See Note A to the “Notes to Consolidated Financial Statements.”

Property and Depreciation

Estimating the useful lives of property, plant and equipment requires the exercise of management judgment, and actual lives may differ from these estimates. Changes to these initial useful life estimates are made when appropriate. Property, plant and equipment are tested for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” whenever events or changes in circumstances indicate that the carrying amounts of such long-lived assets may not be recoverable from future cash flows. Impairment testing requires significant management judgment including estimating the future sales volumes, growth rates for selling prices and costs, alternative uses for the assets and estimated proceeds from disposal of the assets. Impairment testing is conducted at the lowest level where cash flows can be measured and are independent of cash flows of other assets. An asset impairment would be indicated if the sum of the expected future cash flows from the use of the asset (undiscounted and without interest charges) is less than the carrying amount of the asset. An impairment loss would be measured based on the difference between the fair value of the asset and its carrying amount. Fair value is the amount at which the asset could be bought or sold in a current transaction between willing parties and may be estimated using a number of techniques, including quoted market prices or valuations by third parties, present value techniques based on estimates of cash flows, or multiples of earnings or revenue performance measures.  The fair value of the asset could be different using different estimates and assumptions in these valuation techniques which would increase or decrease the impairment charge.  See Note B to the “Notes to Consolidated Financial Statements” for further disclosure of asset impairment.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Critical Accounting Policies (Continued)

Pensions and Postretirement Health Care and Life Insurance Benefits

The valuation of our pension and other postretirement health care and life insurance plans requires the use of assumptions and estimates that are used to develop actuarial valuations of expenses, assets and liabilities. These assumptions include discount rates, investment returns, projected salary increases and benefits and mortality rates. The significant assumptions used in the calculation of pension and postretirement obligations are:

Discount rate:  The discount rate is based on returns available on high-quality fixed income obligations, such as those included in the Moody’s Aa bond index.

Salary increase assumption:  The salary increase assumption reflects our expectations with respect to long-term salary increases of its workforce.  Historical pay increases, expectations for the future, and anticipated inflation and promotion rates are considered in developing this assumption.

Cash Balance Crediting Rate:  Interest is credited on cash balance accounts based on the yield on one-year Treasury Constant Maturities plus 1%.  The assumed crediting rate thus considers the discount rate, current treasury rates, current inflation rates, and expectations for the future.

Mortality Rates:  Mortality rates are based on gender-distinct group annuity mortality (GAM) tables.

Expected return on plan assets:  The expected return reflects asset allocations, investment strategy and our historical actual returns.

Termination and Retirement Rates:  Termination and retirement rates are based on standard tables reflecting past experience and anticipated future experience under the plan.  No early retirement rates are used since benefits provided are actuarially equivalent and there are not early retirement subsidies in the plan.

Management periodically reviews actual demographic experience as it compares to the actuarial assumptions. Changes in assumptions are made if there are significant deviations or if future expectations change significantly.  Based upon anticipated changes in assumptions, pension and postretirement expense is expected to increase by $1.7 million in the twelve months ended March 31, 2005 as compared to the nine months ended March 31, 2004.  We continually evaluate ways to better manage benefits and control costs.  For fiscal 2005, we are considering several alternatives to our postretirement benefits which could significantly reduce our costs.  The cash contribution to our cash balance plan in 2004 was $0.9 million and is expected to be $0.6 million in 2005.

The effect of actual results differing from our assumptions are accumulated and amortized over future periods and, therefore, generally affect our recognized expense in such future periods. Changes in other assumptions and future investment returns could potentially have a material impact on our pension and postretirement expenses and related funding requirements.

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Contingencies

A contingency is an existing condition, situation, or set of circumstances involving uncertainty that will ultimately be resolved when one or more future events occur or fail to occur.  Provisions for contingencies are required to be established when it is probable that the future event will or will not occur and that its impact can be reasonably estimated.  When we either are not able to make an assessment of an amount or have determined that the probability of a loss occurring is not likely, no liability is recorded in the consolidated financial statements for the contingency.  Provisions may be required as circumstances change with respect to ongoing matters or as new issues emerge.  See Note N to the “Notes to Consolidated Financial Statements.”

Accounting Matters

In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity."  Under the provisions of SFAS No. 150 certain financial instruments that previously could be accounted for as equity must be presented as liabilities, and assets in some cases, on the balance sheet.  We adopted this new standard July 1, 2003 and it did not have a material effect on our financial statements.

In December 2003, the FASB issued a revised Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46R”).  FIN 46R requires a new approach in determining if a reporting entity consolidates certain legal entities referred to as variable interests entities (“VIEs”), including joint ventures, limited liability companies and equity investments.  A VIE is an entity in which the equity investors do not have a controlling interest or have insufficient resources to finance the entity’s activities without receiving additional financial support from the other parties.  Under FIN 46R, consolidation of a VIE is required by the investor with the majority of the variable interests in the entity.  The revised interpretation delays the effective date to periods ending after December 15, 2003 for special purpose entities and to periods ending after March 15, 2004 for all other types of VIE’s.  The adoption of the revised FIN 46R did not have a material effect on our financial position or results of operations.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Accounting Matters (Continued)

In December 2003, the FASB issued a revision to FASB Statement No. 132 – Employers’ Disclosures about Pensions and Other Postretirement Benefits (“FASB No. 132R”).  The revision expands disclosures for defined benefit plans and other postretirement plans in both annual and interim financial statements.  The effective date for FASB No. 132R is for fiscal years ending after December 15, 2003.  Interim period disclosure is required for interim periods beginning after December 15, 2003.  We adopted the additional annual disclosure requirements as of the fiscal year ending March 31, 2004.

Results of Operations

Operating Environment:

Global

We believe that the global supply and demand for leaf tobacco continues to be substantially balanced.  However, there are indications that production forecasts, if achieved, could exceed global customer demand.  In addition, notable significant tobacco production volume reductions continue in both the United States and Zimbabwe.  These reductions, as well as anticipated future reductions in Western Europe, have created a shift in the sourcing of customer requirements primarily to Argentina, Brazil, Asia and certain African countries other than Zimbabwe.  This has and will continue to impact the ongoing requirements of our organizational structure and asset base.

Africa

The political and economic situations in Zimbabwe continue to present uncertainties as the country remains in a period of civil unrest accompanied by a deteriorating economy. A further reduction in the Zimbabwe flue-cured crop size from 85 million kilos for the 2003 crop year to approximately 60 million kilos for the 2004 crop year has occurred; however, we are expecting to buy, process and sell quantities similar to that handled in the 2003 crop year. Some customers have shifted portions of their Zimbabwe purchases to Brazil, Argentina and certain other African countries.  Flue-cured and burley production in Tanzania, Malawi, Mozambique, the Democratic Republic of Congo and Zambia continues to expand in an effort to retain our customer volumes shifted from Zimbabwe.  Utilization of our regional processing facilities continues with tobaccos from Mozambique, Zambia and the Democratic Republic of Congo being packed and exported from our plants in Tanzania, Malawi and Zimbabwe. Customer reactions to our efforts in the African region have been positive and our traditional customer base has remained stable.

South America

We continue to see excellent results in our Brazilian operation as customers shift portions of their Zimbabwe and U.S. requirements to Brazil. Brazil is among our largest source countries in terms of volume and revenue. We consider this region to be a viable area for continued growth in tobacco leaf production and customer commitment. This year Brazil has produced the largest crop recorded in its history, and next year’s crop is predicted to be even larger.  However, processing of the current crop has been substantially delayed due to slow delivery of tobacco by farmers.  In addition, reduced levels of imports into Brazil have resulted in a shortage of shipping containers and vessels available for tobacco and other exports.  These shipping delays could impact the timing of shipments between quarters in fiscal 2005.  Argentina has also benefited from the smaller crop size in Zimbabwe and is considered as an additional reliable source to Zimbabwe, Brazil and the United States for flavor tobaccos.  The customer base for both Guatemala and Mexico is somewhat limited by the high production costs in those countries. Our operations in those countries generally purchase and process only to customer orders.

Asia

The Asian region provides our customers with a good quality product at a comparatively lower cost. The importance of the Asian region is increasing as our customers expand their cigarette manufacturing operations into the region. In Thailand, we purchase and process tobacco through our own operations. In other areas of Asia, we supervise the purchase and processing of tobacco in conjunction with operations owned by governmental and other third parties. The demand for Asian origin leaf continues to rise and DIMON is expanding its existing operations to accommodate the increasing demand and to participate in this growth.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

Operating Environment: (Continued)

Europe

DIMON remains active in the flue-cured and burley EU markets. The Common Agricultural Policy (CAP) support for tobacco has recently been reformed and will have varying impact on individual EU countries regarding subsidy payments to producers starting in 2006. We are actively addressing the potential effects this will have on our operations in these markets and believe there could be material reductions in production volumes specifically in Western Europe.  We believe that Turkey will remain the most important oriental tobacco market. As a result of the introduction of the direct contract buying system, we anticipate crop sizes more in line with demand and a subsequent gradual ending of the large government stocks of the past. Our other “Classical” oriental operations including those in Greece, Bulgaria and Macedonia continue to contribute to the region’s growth, with Macedonia and Bulgaria being markets with a high potential to supply customers needs in the future. To compliment the oriental market, our operations in the “Non-Classical” semi-oriental areas of Kyrgyzstan and Moldova continue to contribute to the total development of the region and serve our customers. We believe DIMON has a strong presence in all the important oriental and semi-oriental markets.  We continue to evaluate our European processing operations in order to achieve improved efficiencies and cost reductions.

North America

The production of leaf tobacco in the United States currently operates under a USDA-administered Tobacco Program that restricts supply and induces non-value added costs into the price of farm cured, or “green” tobacco.  Increasingly, the relatively high cost of U.S. grown tobacco makes it uncompetitive in the world market.  The market for U.S. grown leaf tobaccos has largely become limited to domestic customers, as traditional foreign buyers have significantly reduced or eliminated these tobaccos from their product blends.  Based upon diminished U.S. crop production and processing requirements, the Board of Directors approved the fiscal 2005 closing  of our Danville-based production facility at the completion of the processing of the 2004 U.S. crop.  This resulted in restructuring and asset impairment charges in fiscal 2004 which is discussed further in Note B to the “Notes to Consolidated Financial Statements.”  Further severance charges are expected in fiscal 2005.  The current U.S. market has substantially converted to direct contract purchasing over the past several years with certain domestic customers now purchasing their requirements directly from farmers.  As a result, our U.S. operations are increasingly focused on providing processing services to our customers.  There are legislative bills before Congress that could eliminate the Tobacco Program with the potential effect of making U.S. grown leaf tobacco more competitive and stabilizing production in the country.  Our Canadian operations continue to contribute to the region’s profitability.

Dark Tobacco

DIMON’s dark air-cured tobacco operations service manufacturers of cigars, dark cigarettes, chewing tobacco, pipe tobacco and roll-your-own. Strong demand continues to exist for quality wrappers and binders for the cigar industry.  Demand for both cigar and cigarette dark filler tobaccos remains weak, resulting in continued lower sales volumes from this type of tobacco.  Unfavorable weather related growing conditions in Northern Brazil and Indonesia have also resulted in lower quality tobacco crops in these countries.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

Condensed Statement of Consolidated Income

Nine Months Ended March 31,   

Twelve Months Ended June 30,    

(in millions)

2004 

Increase/
(Decrease)

2003    

(unaudited)

2003 

Increase/
(Decrease)

2002 

Sales and other operating revenues

$835.3 

$(40.3)

$875.6 

$1,268.8  

$13.1   

$1,255.7 

Gross profit

103.2 

(35.3)

138.5 

207.3  

5.9   

201.4 

Selling, administrative and general expenses

90.3 

12.5 

77.8 

116.1  

6.7   

109.4 

Restructuring  and asset impairment charges

29.5 

29.5 

- 

-   

-   

-  

Interest expense

32.2 

(2.1)

34.3 

46.9  

(1.0)  

47.9 

Interest income

6.4 

3.9 

2.5 

2.9  

(1.1)  

4.0 

Derivative financial instruments
    (income)/expense

(6.5)

(16.9)

10.4 

12.4  

2.2   

10.2 

Income taxes (benefit)

(0.7)

(4.9)

4.2 

9.1  

(1.1)  

10.2 

Equity in net income (loss) of investee
     companies

(0.5)

(0.3)

(0.2)

0.3  

0.6   

(0.3)

Minority interests (income)

(2.8)

(2.9)

0.1 

(0.2) 

(0.1)  

(0.1)

Extraordinary item – Iraqi receivable recovery,

     net of $1.0 income tax

-  

-  

-  

1.8  

1.8   

-  

NET INCOME (LOSS)

$(32.9)

$(46.9)

$ 14.0 

*

$    28.1*

$ 0.6 *

$ 27.5 

* Amounts do not equal column totals due to rounding.

Sales and Other Operating Revenue Supplemental Information

Nine Months Ended March 31,    

Twelve Months Ended June 30,   

(in millions, except per kilo amounts)

2004 

Increase/
(Decrease)

2003     

(unaudited)

2003 

Increase/
(Decrease)

2002 

Tobacco sales and other operating revenues:

     Sales and other operating revenues

$798.0 

$(38.1)

$836.1

$1,218.0 

$    3.8 

$1,214.2 

     Kilos

269.3 

(3.2)

272.5

398.7 

9.7 

389.0 

     Average price per kilo

$  2.96 

$(0.11)

$  3.07

$     3.05 

$ (0.07)

$     3.12 

Processing and other revenues

$  37.3 

$  (2.2)

$   39.5

$     50.8 

$    9.3 

$     41.5 

Total sales and other operating revenues

$835.3 

$(40.3)

$875.6

$1,268.8 

$  13.1 

$1,255.7 

Comparison of the Nine Months Ended March 31, 2004 to the Nine Months Ended March 31, 2003 (Unaudited)

Sales and other operating revenues decreased 4.6% from $875.6 million in 2003 to $835.3 million in 2004.  This $40.3 million decrease is a combination of a $38.1 million decrease from sales and other operating revenues of tobacco owned and sold and a $2.2 million decrease in processing and other service revenues.

          The $38.1 million decrease in sales and other operating revenues of tobacco owned and sold results from a 3.2 million kilo or 1.2% decrease in quantities sold and an $0.11 or 3.6% decrease in the average price per kilo.  Sales of U.S. tobacco decreased $34.0 million and sales of non-U.S. tobacco decreased $4.1 million.   The decrease in sales of U.S. tobacco was primarily due to a decrease of $26.2 million from a decrease in quantities of 4.4 million kilos as well as a decrease of $7.8 million resulting from lower average sales prices due to changes in product mix.  The reduction in U.S. sales resulted from reduced sales to both U.S. and non-U.S. customers due to the higher price of U.S. tobacco relative to similar tobacco from other origins.  Lower average sales prices of non-U.S. tobacco resulted in decreases of  $7.3 million primarily due to both shifts in origins of tobacco and changes in product mix and was partially offset by increased sales of $3.2 million due to increased quantities.  Although the change in non-U.S. tobacco sales was only $4.1 million this was the net result of decreases in Brazil, Zimbabwe and Malawi offset by increases in European oriental and Asian tobaccos. Quantities of tobacco from Brazil were reduced due to the weather related lower crop yield as well as earlier shipments of current crop tobaccos to customers which resulted in a shift of sales into fiscal 2003.  Zimbabwe tobacco quantities were reduced due to smaller crop sizes as a result of continued political interference in agricultural production.  Quantities from Malawi were reduced due to less than favorable growing conditions.  The increases in quantities of European oriental tobacco and Asian tobacco were due to improved customer demand. The Asian products are lower priced and have the impact of reducing the average price of non-U.S. products sold.

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ITEM 7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

Comparison of the Nine Months Ended March 31, 2004 to the Nine Months Ended March 31, 2003 (Continued)

          The $2.2 million decrease in processing and other service revenues relates to lower U.S. revenues as a result of lower quantities of customer-owned tobacco processed.

           Gross profit as a percentage of sales decreased to 12.4% in 2004 compared to 15.8% in 2003.  Our gross profit decreased $35.3 million to $103.2 million in 2004 from $138.5 million in 2003.  This decrease was primarily due to the decreased volumes in the United States, Brazil, Zimbabwe and Malawi.  Margins in Zimbabwe were further eroded by higher product costs.  In addition to lower volumes, margins in the United States were negatively impacted by higher insurance costs.  The increased quantities from Asia consisted of lower margin products.  In Europe, increases in margin resulting from higher quantities of oriental tobacco were substantially offset by the impact of a poor oriental crop in Greece.  Gross profit was also negatively impacted by the 2004 $4.8 million increase in the lower of cost or market adjustment (LCM) related to the March 31st tobacco inventories. In 2004, we recognized a $7.7 million LCM compared to $2.9 million LCM in 2003.  The increased LCM in 2004 is primarily attributable to the impact on Greek and Italian flue-cured and burley tobacco of both higher costs due to the relative strength of the euro as well as decreased customer demand for these tobaccos. We believe the decreased customer demand is a result of changes scheduled to occur in the European Common Agricultural Policy support program.  The LCM increase in 2004 also relates to the impact of unfavorable growing conditions in Indonesia and northern Brazil on our dark tobacco operations.

           Selling, administrative and general expenses increased $12.5 million or 16.1% from $77.8 million in 2003 to $90.3 million in 2004.  Personnel related costs increased a net of $5.0 million primarily due to increases in salary, retirement expense and other personnel costs offset by a decrease of $2.7 million related to incentive compensation plans. Exchange rate changes on expenses denominated in euros, sterling and real resulted in an estimated increase of $3.1 million.  Legal and professional fees increased $2.4 million primarily due to Sarbanes-Oxley requirements and the compression of audit fees into the nine month fiscal year.  Insurance expense increased $1.1 million due to continued higher premium charges.  Other increases of $1.1 million relate primarily to travel.

          Restructuring and asset impairment charges were $29.5 million in 2004.  These charges are comprised of $27.8 million for asset impairments and $1.7 million for employee separations.  See Note B to the “Notes to Consolidated Financial Statements.”

           Interest expense decreased $2.1 million from $34.3 million in 2003 to $32.2 million in 2004.  This change is primarily due to a $4.2 million decrease related to lower average rates offset by a $2.1 million increase related to higher average borrowings.

          Interest income increased $3.9 million from $2.5 million in 2003 to $6.4 million in 2004 primarily due to higher interest rates and average cash balances in Zimbabwe.

           Derivative financial instruments resulted in a $6.5 million benefit in 2004 compared to a $10.4 million charge in 2003.  The charge or benefit relates to the changes in fair value of non-qualifying interest rate swap agreements as discussed in Note D to the “Notes to Consolidated Financial Statements.”

          Effective income tax rates of 2% in 2004 and 23% in 2003 relate primarily to the distribution of taxable income among various taxing jurisdictions as well as assumptions on the inability to utilize deferred tax assets resulting from net operating losses.  In addition, the effective income tax rate in 2004 is adversely affected by deferred income tax expense related to expiring tax credits and undistributed earnings of foreign subsidiaries no longer considered permanently reinvested and by certain asset impairment charges for which no income tax benefit is realized.

           Minority interests resulted in income of $2.8 million in 2004 compared to a loss of $0.1 million in 2003.  This change is primarily due to the acquisition of majority interest in an entity previously reported using the equity method of accounting.  This entity had losses, including impairment charges, which resulted in an allocation to minority interest shareholders of $2.8 million.  See Note B to the “Notes to Consolidated Financial Statements.”

Comparison of the Year Ended June 30, 2003 to the Year Ended June 30, 2002

Sales and other operating revenues increased 1.0% from $1,255.7 million in 2002 to $1,268.8 million in 2003.  This $13.1 million increase is a combination of a $3.8 million increase from sales and other operating revenues of tobacco owned and sold and a $9.3 million increase in processing and other service revenues.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

Comparison of the Year Ended June 30, 2003 to the Year Ended June 30, 2002 (Continued)

          The $3.8 million increase in sales and other operating revenues of tobacco owned and sold results from a 9.7 million kilo or 2.5% increase in quantities sold offset by a $0.07 or 2.2% decrease in the average price per kilo.  This change results from increases in quantities and average prices of non-U.S. tobacco offset by decrease in quantities and average prices of U.S. tobacco.  The sales and other revenues of non-U.S. tobacco increased $84.3 million offset by an $80.5 million decrease from U.S. tobacco. Quantities of non-U.S. tobacco, primarily due to earlier shipments from Brazil, increased 21.3 million kilos over the prior year resulting in increased revenues of $57.7 million.  Quantities from our African operations were minimally impacted by decreases in the Zimbabwe crop size as quantities from other countries in the region increased.  Average prices of non-U.S. tobacco increased resulting in a $26.6 million increase over the prior year due to changes in product mix as the greater quantities consisted of higher priced product.  Quantities of U.S. tobacco sold decreased 11.6 million kilos over the previous year resulting in a $70.5 million decrease in sales.  The decrease in the U.S. quantities was primarily due to reduced sales to non-U.S. customers and non-recurring 2002 sales of prior crop tobacco.  Average prices of U.S. tobacco decreased resulting in a $10.0 million decrease primarily due to product mix as the reductions in quantity were also comprised of higher priced product.

          The $9.3 million increase in processing and other service revenues relates primarily to higher quantities of customer owned tobacco processed in the U.S.

           Gross profit as a percentage of sales increased to 16.3% in 2003 compared to 16.0% in 2002.  Our gross profit increased $5.9 million to $207.3 million in 2003 from $201.4 million in 2002.  This increase was primarily due to the increased volume in Brazil, which was partially offset by lower volumes of U.S. tobacco sold to non-U.S. customers.  The increase in gross profit is also due to charges recognized in 2002 of $2.9 million related to devaluation of the Argentine peso partially offset by a gain of $1.7 million realized in 2002 related to the sale of unutilized Zimbabwe assets.  In Africa, gross profit decreases in Zimbabwe were offset by increased gross profit from Malawi and Tanzania.  In Europe, gross profit decreased as costs increased due to the strength of the euro.

           Selling, administrative and general expenses increased $6.7 million or 6.1% from $109.4 million in 2002 to $116.1 million in 2003.  This increase is primarily due to $7.8 million in increased legal and professional fees substantially due to the recognition of $6.0 million in settlement of the DeLoach class action lawsuit and increases due to related legal fees, increases in retirement expense of $3.4 million primarily due to changes in defined benefit and postretirement plan actuarial assumptions including the rate of return assumption on cash balance plan assets, insurance expense increases of $1.5 million due to changes in business risk related to events that have occurred in recent years and an estimated $2.7 million impact from exchange rate changes on expenses denominated in euros and sterling.  These increases were somewhat offset by the adoption of SFAS No. 142 in 2003 that resulted in cessation of goodwill amortization that was $6.5 million in 2002 as well as decreases of $3.2 million in incentive compensation awards that are related directly to our operating results.

            Interest expense decreased $1.0 million from $47.9 million in 2002 to $46.9 million in 2003.  This change is primarily due to a $14.6 million decrease related to lower average rates offset by a $13.6 million increase related to higher average borrowings partially resulting from the effect of carrying $125 million of redundant debt during the thirty-day call period associated with the refinancing transaction completed in May 2003.

           Interest income decreased $1.1 million from $4.0 million in 2002 to $2.9 million in 2003 primarily due to lower average cash balances.

           Derivative financial instruments expense increased $2.2 million from 2002 to 2003.  This charge relates to the changes in fair value of non-qualifying interest rate swap agreements as discussed in Note D of the “Notes to Consolidated Financial Statements.”

          Effective income tax rates of 26% in 2003 and 27% in 2002 relate primarily to the distribution of taxable income among various taxing jurisdictions.  Changes in the rate from 2002 to 2003 are also partially attributable to the non-amortization of goodwill in 2003.

         Extraordinary Item – On May 1, 2003, the Company received $2.7 million from the United Nations Compensation Commission in connection with a claim filed by a predecessor company, Monk-Austin, Incorporated.  The claim arose from an uncollected trade receivable from the Iraqi Tobacco Monopoly, which related to transactions that occurred prior to Iraq’s invasion of Kuwait in August 1990.  The extraordinary gain of $1.8 million is recorded net of tax of $0.9 million.

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ITEM 7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources

The following table is a summary of items from the Consolidated Balance Sheet and the Statement of Consolidated Cash Flows.

Nine Months  

Ended       

Years Ended June 30,

(in millions, except for current ratio)

March 31, 2004

2003

2002

Cash and cash equivalents

$18.8       

$  88.9

$  109.0

Net trade receivables

198.2       

179.5

173.6

Inventories and advances on purchases of tobacco

598.9       

529.9

478.1

Total current assets

863.6       

839.8

792.0

Notes payable to banks

243.7       

210.2

181.6

Accounts payable

72.6       

73.5

76.8

Total current liabilities

444.6       

403.2

363.0

Current ratio

1.9 to 1       

2.1 to 1

2.2 to 1

Revolving Credit Notes and Other Long-Term Debt

11.9       

10.3

7.5

Convertible Subordinated Debentures

73.3       

73.3

73.3

Senior Notes

335.8       

341.3

321.4

Stockholders’ equity

414.9       

454.6

434.7

Purchase of property and equipment.

26.4       

28.3

20.2

Proceeds from sale of property and equipment

1.4       

2.8

5.9

Depreciation and amortization

27.0       

35.3

41.9

          The purchasing and processing activities of our business are seasonal.  Our need for capital fluctuates accordingly and, at any one of several seasonal peaks, our outstanding indebtedness may be significantly greater or less than at year end.  We historically have needed capital in excess of cash flow from operations to finance inventory and accounts receivable.  We also prefinance tobacco crops in numerous foreign countries, including Argentina, Brazil, Canada, Greece, Guatemala, Indonesia, Italy, Malawi, Mexico, Mozambique, Tanzania, Thailand and Turkey, by making advances to growers and grower co-operatives prior to and during the growing season.

          Our working capital decreased from $436.6 million at June 30, 2003 to $419.0 million at March 31, 2004.  Our current ratio was 1.9 to 1 at March 31, 2004 compared to 2.1 to 1 at June 30, 2003.  At March 31, 2004, our current assets had increased $23.8 million and current liabilities had increased $41.4 million from June 30, 2003.  The $23.8 million increase in current assets is primarily due to a $69.0 million increase in inventories and advances on purchases of tobacco, an $18.7 million increase in accounts receivable and a $2.8 million increase in current deferred and recoverable income taxes partially offset by a $70.1 million decrease in cash.  The $41.4 million increase in current liabilities relates primarily to increases of $33.5 million in notes payable to banks, a $4.8 million increase in advances from customers and a $4.7 million increase in accrued expenses.  The increase in inventories and advances on purchases of tobacco relates to build up of inventories as European crops have not yet completed the sales cycle and South American inventories are in production.  Increases in inventory and advances on purchases in Europe and South America were partially offset by decreases in Africa.  The changes in cash and notes payable to banks are related to financing the higher inventory and advance levels at March 31, 2004 compared to June 30, 2003 and a net loss in 2004 compared to net income in 2003.

          Cash used by operating activities was $52.8 million in 2004 compared to cash provided of $9.7 million in 2003 and $67.1 million in 2002.  The decrease in cash flows from operations in 2004 compared to 2003 is due primarily to $60.9 decrease in net income, $14.4 more cash used to finance accounts receivable and $16.0 million change in deferred items partially offset by non-cash restructuring and asset impairment charges of $29.5 million.  The increases in accounts receivable relate to Europe, North America and Africa and the relative position of the crop cycles.  Changes in deferred items relate primarily to deferred taxes and the increase in non-current deferred tax assets related to current year operating losses.  The decrease in cash flows from operations in 2003 compared to 2002 was due primarily to $30.0 million more cash used for inventory and advances on purchases of tobacco, $17.8 million more cash used for accounts payable and accrued expenses and $8.5 million less cash provided by accounts receivable.  The changes in these accounts in 2003 compared to 2002 are primarily due to higher levels of inventory committed to customers.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

          Cash flows used by investing activities were $28.9 million in 2004, $31.5 million in 2003 and $10.9 million in 2002.  The decrease in cash used for investing activities in 2004 compared to 2003 is primarily due to $4.1 million used in 2003 to purchase a 75% interest in an Indonesian tobacco processing subsidiary, $5.0 million used to purchase a 25% interest in a North Carolina company that purchases, processes and sells kenaf, a renewable agricultural product, $1.9 million lower purchases of property and equipment and $1.6 million of other changes related to Brazilian escrow taxes and life insurance premiums.  The decreases in cash used were partially offset by net changes in notes receivable of $7.1 million due primarily to notes issued in regard to the current Argentine and Brazilian crops, $1.5 million used for purchase of an additional 32.5% interest in the kenaf business and $1.4 million less cash provided from sales of property and equipment.   The increased cash used in investing activities in 2003 compared to 2002 is due in part to higher purchases of property and equipment and lower proceeds from the sale of property and equipment.  In addition, in 2003, there was a $5.0 million purchase of 25% interest in a company in North Carolina and a $4.1 million purchase of a 75% interest in an Indonesian company.  Other uses of cash amounted to $0.2 million and relate primarily to life insurance premiums and Brazilian escrow taxes paid, offset in part by tax deposits recovered in Italy.

          Cash flows from financing activities provided $13.5 million in 2004 compared to $2.4 million in 2003 and $36.4 million in 2002.  The greater provision of cash in 2004 compared to 2003 is due to $6.8 million increase in short term borrowings, $2.1 million less dividends paid to stockholders, lower debt issuance costs of $1.1 million related to instruments discussed below and $0.7 million proceeds from the exercise of stock options. The increase in cash from short term borrowings relates to financing higher levels of accounts receivable and inventory.  The decrease in dividends relates to the current nine month transitional fiscal year compared to a twelve month fiscal year in 2003.  The lower provision of cash in 2003 compared to 2002 is due to issuance of $125 million Senior Notes in 2003 compared to issuance of $200 million Senior notes in 2002 and a $165 million syndicated bank credit facility that was entered into in 2002.  The decreased provisions from 2002 to 2003 were partially offset by repayments of borrowings in 2002 that were issued under an older $250 million credit facility.  

          At March 31, 2004, we had seasonally adjusted lines of credit of $594.3 million of which $243.7 million was  outstanding with a weighted average interest rate of 2.99%.  Unused short-term lines of credit amounted to $305.1 million.  At March 31, 2004, we had $35.5 million of letters of credit outstanding and an additional $10.0 million of  letters of credit lines available.  Total maximum borrowings, excluding the long-term credit agreements, during the fiscal  year were $349.2 million.

          Cash dividends paid to stockholders during 2004 remained at $.075 per share per quarter.

Availability of Short-Term Uncommitted Bank Credit Facilities

We generally rely on a broad group of global and regional lenders to provide economical crop financing in each significant source country.  The availability of such credit facilities can be negatively affected by ongoing consolidation within the banking industry, changing lender policies regarding the tobacco industry, and geopolitical instability.  To mitigate the risk associated with our reliance on short-term uncommitted bank credit facilities, we have accessed capital markets to obtain long-term debt funding, and maintain a substantially undrawn syndicated bank facility.

Customer Arrangements For Committed Inventories

We hold substantial amounts of inventories that are committed to specific customers and, to the extent that those customers do not provide advance funding, we must provide financing for such inventories.  We have experienced a trend of increasing levels of customer funding for committed inventories in recent years.  However, a reversal of that trend could negatively affect our short-term liquidity.

Long Term Debt

During fiscal years 2002 and 2003 we completed two strategic refinancing transactions that, in aggregate, have expanded our sources and available amounts of liquidity, extended the average maturity of our debt portfolio from 3.2 years to 8.0 years, and significantly reduced our dependence on short-term uncommitted debt facilities.

          On October 30, 2001, we issued $200 million principal amount of 9 5/8% Senior Notes due 2011.  The proceeds of this Note issuance were used to repay certain existing indebtedness, including all amounts drawn under our $250 million syndicated credit facility then existing.  The financial covenants of the Senior Notes are substantially similar to those  for the $125 million principal amount of 8 7/8% Senior Notes due 2006, that were outstanding at that time.  Concurrent with the completion of the Note issuance, we entered into a derivative financial instrument to swap the entire $200 million notional amount to a floating interest rate equal to LIBOR plus 4.11%, set six months in arrears.  The effective rate at March 31, 2004 was 5.27%.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

Long Term Debt ( Continued )

          On May 30, 2003, we issued $125 million principal amount of 7 3/4% Senior Notes due 2013.  The proceeds of this Note issuance were used to redeem in full $125 million of our outstanding 8 7/8% Senior Notes due 2006.  The financial covenants of the Senior Notes are substantially similar to those for the aforementioned $200 million principal amount of 9 5/8% Senior Notes due 2011.  Concurrent with the completion of the Note issuance, we entered into a derivative financial instrument to swap the entire $125 million notional amount to a floating interest rate equal to LIBOR plus 3.69%, set six months in arrears.  The effective rate at March 31, 2004 was 4.85%.  The existing 8 7/8% Senior Notes due 2006 were fully redeemed at June 30, 2003.

          The indentures governing our Senior Notes contain certain covenants that, among other things, limit our ability to (i) transfer or issue shares of capital stock of subsidiaries to third parties, (ii) pay dividends or make certain other payments, (iii) incur additional indebtedness, (iv) issue preferred stock, (v) incur liens to secure our indebtedness, (vi) apply net proceeds from certain asset sales, (vii) enter into certain transactions with affiliates, (viii) merge with or into any other person or (ix) enter into certain sale and leaseback transactions.

          On October 27, 2003, we completed a new three-year $150 million syndicated bank credit facility with a group of seven banks.  The credit facility is subject to certain commitment fees and covenants that, among other things, require us to maintain minimum working capital and tangible net worth amounts, require specific liquidity and long-term solvency ratios, including certain borrowing base restrictions, and restrict acquisitions.  We continuously monitor our compliance with these covenants. At December 31, 2003 our consolidated fixed charge coverage ratio was 1.14 to 1, which was below the required covenant hurdle of 1.20 to 1.  We obtained, with unanimous approval from the lender banks, a waiver for the December 31, 2003 covenant together with an amendment resetting the required hurdle in future periods to 1.00 to 1 through the period ending September 29, 2004.  At March 31, 2004, our consolidated fixed charge coverage ratio was 0.969 to 1, which was below the amended covenant hurdle of 1 to 1.  We obtained a waiver from the lender banks for the March 31, 2004 covenant together with an amendment resetting the required hurdle in future periods to 0.75 to 1 through the period ending September 29, 2004; 0.90 to 1 for the period from September 30 to December 30, 2004; and 1.05 to 1 for the period from December 31, 2004 through March 30, 2005.  Thereafter, the hurdle returns to its originally defined level of 1.25 to 1 for the remainder of the facility’s term.

          The credit facility’s initial term expires on October 26, 2006, and, subject to approval by the lenders, may be extended. The rates of interest are based on our published credit rating and vary according to the type of loan requested by us.  During the life of the agreement, the interest rate could be the prime rate or the LIBOR rate adjusted. The primary advance rate is the agent bank’s base lending rate, 4% at March 31, 2004. We pay a commitment fee of 1% per annum on any unused portion of the facility.  The new facility replaced a $165 million facility.

          For all of the derivative financial instruments mentioned above, the notional amount, maturity, and payment dates of the derivative financial instruments match those of the Notes.  In accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” the derivatives qualify for hedge accounting treatment.   See also Note D to the “Notes to Consolidated Financial Statements.”

          We have historically financed our operations through a combination of short-term lines of credit, revolving credit arrangements, customer advances, cash from operations and equity and equity-linked securities.  At March 31, 2004, we had capital expenditure commitments of $2.0 million.  We believe that these sources of funds will be sufficient to fund our anticipated needs for fiscal year 2005.  There can be no assurance, however, that these sources of capital will be available in the future or, if available, that any such sources will be available on favorable terms.

Aggregate Contractual Obligations and Off-Balance Sheet Arrangements

We have summarized in the table below our contractual cash obligations and other commercial commitments as of March 31, 2004.

Payments / Expirations by Period

(in millions)

Total

Year 1

Years 2-3

Years 4-5

More than
5 years

Long Term Debt

$  419.7

$   2.4

$  76.8

$1.7

$338.8

Capital Lease Obligations

5.3

0.8

1.5

1.4

1.6

Operating Leases

28.5

5.8

7.4

3.2

12.1

Capital Expenditure Commitments

2.0

2.0

- 

- 

- 

Tobacco Purchase Obligations

531.8

442.3

89.5

- 

- 

Grower Financing Guarantees

142.3

90.5

33.8

14.8

3.2

Total Contractual Obligations and Other
     Commercial Commitments

$1,129.6

$543.8

$209.0

$21.1

$355.7

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ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
                   CONDITION AND RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

Aggregate Contractual Obligations and Off-Balance Sheet Arrangements ( Continued )

          We do not have any off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources, as defined under the rules of SEC Release No. FR-67.

Lease Obligations

We have both capital and operating leases.  In accordance with accounting principles generally accepted in the United States, operating leases are not reflected in the accompanying Consolidated Balance Sheet.  The operating leases are for land, buildings, automobiles and other equipment; the capital leases are primarily for production machinery and equipment.  The capitalized lease obligations are payable through 2010.  Operating assets that are of long-term and continuing benefit are generally purchased.

Tobacco Purchase Obligations and Grower Financing Guarantees

Tobacco purchase obligations result from contracts with growers, primarily in the United States, Brazil and Malawi, to buy either specified quantities of tobacco or the grower’s total tobacco production.  Amounts shown as tobacco purchase obligations are estimates based on projected purchase prices of the future crop tobacco.  Payment of these obligations is net of our advances to these growers. Our tobacco purchase obligations do not exceed our projected requirements over the related terms and are in the normal course of business.  In certain non-U.S. markets, we provide growers and grower cooperatives with materials necessary to grow tobacco and may either directly loan or guarantee bank loans to growers to finance the crop.  Under longer-term arrangements, we may also finance or guarantee financing on growers’ construction of curing barns or other tobacco production assets.  We are obligated to repay any guaranteed loan should the grower default.  See also Note N to the “Notes to Consolidated Financial Statements.”

Planned Capital Expenditures

We have projected a total of $18.6 million in capital investments for the coming year.  We forecast our capital expenditure needs for routine replacement of equipment as well as investment in assets that will add value to the customer or increase efficiency.  Purchase commitments of $2.0 million are included in these expenditures at March 31, 2004.

Tax and Repatriation Matters

We are subject to income tax laws in each of the countries in which we do business through wholly owned subsidiaries and through affiliates.  We make a comprehensive review of the income tax requirements of each of our operations, file appropriate returns and make appropriate income tax planning analyses directed toward the minimization of our income tax obligations in these countries.  Appropriate income tax provisions are determined on an individual subsidiary level and at the corporate level on both an interim and annual basis.  These processes are followed using an appropriate combination of internal staff at both the subsidiary and corporate levels as well as independent outside advisors in review of the various tax laws and in compliance reporting for the various operations.

          We consider unremitted earnings of subsidiaries operating outside the United States to be invested indefinitely.  No U.S. income taxes or foreign withholding taxes are provided on such permanently reinvested earnings, in accordance with APB 23,”Accounting for Income Taxes, Special Area.”  We regularly review the status of the accumulated earnings of each of our foreign subsidiaries and reassess this determination as part of our overall financing plans.  Following this assessment, we provide deferred income taxes, net of any foreign tax credits, on any earnings that are determined to no longer be indefinitely invested.

Factors that May Affect Future Results

The following important factors, among other things, in some cases have affected, and in the future could affect, our actual operating and financial results and could cause our actual results for 2005 and beyond to differ materially from those expressed in any forward-looking statements made by us.  

Risks Relating To Our Operations

Global shifts in sourcing customer requirements may negatively impact our operating results.

The global leaf tobacco industry is currently experiencing shifts in the sourcing of customer requirements for tobacco.  For example, significant tobacco production volume decreases have occurred and may continue to occur in the United States and Zimbabwe, and we expect future reductions in volume will occur in Western Europe.  At the same time, production volumes in other sourcing origins, such as Brazil, continue to grow.

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ITEM 7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Risks Relating To Our Operations ( Continued )

This shift in sourcing origins in Europe may be exacerbated by recent modifications to the tobacco price support system in the European Union (“EU”).  The Agricultural Counsel of the EU recently implemented changes in the quota and volume programs across the EU that may result in material reductions in production volumes in certain EU countries after 2006.  The implementation of these new programs will vary significantly by each EU country, decreasing our ability to plan effectively for the longer term in Europe.

          We may not be able to timely or efficiently adjust to these shifts in sourcing origins, and adjusting to these shifts may require changes in our production facilities in certain origins and changes of our fixed asset base.  We have incurred, and may continue to incur, restructuring charges as we continue to adjust to these shifts in sourcing.  Adjusting our capacity and adjusting to these shifts in sourcing may have an adverse impact on our ability to manage our costs, and could have an adverse effect on our financial performance and results of operations.

Our financial results will vary according to growing conditions, customer indications and other factors, which also reduces your ability to gauge our performance and increases the risk of an investment in our securities.

Our financial results, particularly the quarterly financial results, may be significantly affected by fluctuations in tobacco growing seasons and crop sizes.  The cultivation period for tobacco is dependent upon a number of factors, including the weather and other natural events, such as hurricanes or tropical storms, and our processing schedule and results of operations can be significantly altered by these factors.

          Further, the timing and unpredictability of customer indications, orders and shipments causes us to keep tobacco in inventory, increases our risk and results in variations in quarterly and annual financial results.  In addition, reduced levels of imports into Brazil have resulted in a shortage of shipping containers and vessels available for tobacco and other exports.  These shipping delays could impact the timing of shipments between quarters in fiscal 2005.  We may from time to time in the ordinary course of business keep a significant amount of processed tobacco in inventory for our customers to accommodate their inventory management and other needs.  Sales recognition by us and our subsidiaries is based on the passage of ownership, usually with shipment of product.  Since individual shipments may represent significant amounts of revenue, our quarterly and annual financial results may vary significantly depending on our customers’ needs and shipping instructions.  

          These fluctuations result in varying volumes and sales in given periods, which also reduces your ability to compare our financial results in different periods or in the same periods in different years.

Our adoption and application of certain standards in financial accounting could cause our annual and quarterly financial results to vary and will reduce your ability to gauge our performance, increasing the risk of an investment in our securities.

Effective July 1, 2000, we adopted Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities.”  As a result of adoption of SFAS No. 133, we recognize all derivative financial instruments, such as interest rate swap contracts and foreign exchange contracts, in the consolidated financial statements at fair value regardless of the purpose or intent for holding the instrument.  We use forward contracts to mitigate our exposure to changes in foreign currency exchange rates on forecasted transactions.  The effective portion of unrealized gains and losses associated with forward contracts and the intrinsic value of option contracts are deferred as a component of accumulated other comprehensive income until the underlying hedge transactions are reported on our consolidated statement of earnings.  We have traditionally used interest rate swaps to mitigate our exposure to changes in interest rates related to certain debt agreements.  The swaps convert floating-rate debt to fixed-rate debt.  Interest rate swaps, to the extent they are effective hedges, are accounted for as cash flow hedges, with the changes in the fair values of these instruments being recorded in accumulated other comprehensive income net of deferred taxes.  Changes in the fair values of derivatives not qualifying as hedges are reported in net income.  As a result of fluctuations in interest rates and volatility in market expectations, the fair market value of interest rate swap instruments can be expected to appreciate or depreciate over time.  We plan to continue the practice of economically hedging various components of our debt.  However, as a result of SFAS No. 133, certain swap instruments have and may continue to create volatility in future reported earnings.  See Note D to the “Notes to Consolidated Financial Statements.”

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ITEM 7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Risks Relating To Our Operations (Continued)

The shift to direct contract buying of green tobacco by many of our U.S. customers affects your ability to compare our year to year results and could have an adverse effect on our results of operations.

Comparability of our sales revenues has been affected by the shift to direct contract buying in the United States.  In the United States, prior to 2002, we took ownership of all green tobaccos we purchased, then processed and resold that tobacco to our customers.  Concurrent with the shift from an auction system to a direct contract buying system in the United States, certain major U.S. customers began purchasing green tobacco directly from the growers.  We no longer take ownership of that tobacco and no longer record revenues associated with its resale.  To the extent that the auction market in the United States continues to represent a smaller portion of overall tobacco purchases in the U.S., we could be forced to buy more tobacco directly from growers under contracts that require us to buy a particular grower’s total crop, potentially elevating our levels of uncommitted inventories.  When we purchase under an auction system, we continue to purchase tobaccos primarily to match specific customer orders.  We continue to need buying personnel for these residual auction markets, which could affect our ability to manage our costs.

Our extension of credit to tobacco growers could have an adverse effect on our financial condition.

We make advances to tobacco growers in many countries to finance their growing of tobacco for sale to us.  Crop advances to growers are generally secured by the grower's agreement to deliver green tobacco.  In the event of crop failure, recovery of advances could be delayed until deliveries of future crops or indefinitely.  The temporary or permanent loss of these advances to growers could have a material adverse effect on our financial condition or results of operations.

Competition could adversely affect our operating results.

The leaf tobacco industry is highly competitive.  Competition among leaf tobacco merchants is based primarily on the price charged for products and services as well as the merchant’s ability to meet customer specifications in the buying, processing and financing of tobacco.  In addition, there is competition in all countries to buy the available tobacco and in many areas, total leaf tobacco processing capacity exceeds demand.  There are three major global independent leaf tobacco merchants, and they are dependent upon a few large tobacco manufacturing customers.  The number of manufacturers has declined in recent years due to consolidation.  The loss of, or a substantial reduction in the services provided to, any large or significant customer could have a material adverse effect on our financial condition or results of operations.

          In addition to the three primary global independent leaf tobacco merchants, the cigarette manufacturers increasingly buy tobacco directly from farmers, and other industry players are entering the leaf purchasing and processing business.  We face increasing competition from new local and regional independent leaf merchants with low fixed costs and overhead and good customer connections at the local level.  These new independent merchants are buying an increasing portion of the crops in certain international markets, particularly Brazil, where the new entrants have been able to capitalize in the global transition to that market.  In the United States, the Flue-Cured Tobacco Stabilization Cooperative (“FCTSC”) has announced its intention to purchase the Vector facility in Roxboro, North Carolina.  That facility will enable the FCTSC to process tobacco and manufacture cigarettes.  Any of these sources of new competition may result in less tobacco available for us to purchase and process in the applicable markets.

Our reliance on a small number of significant customers may adversely affect our results of operations.

Our customers are manufacturers of cigarette and other tobacco products.  Several of these customers individually account for a significant portion of our sales in a normal year. Of our consolidated tobacco sales in 2004, 2003 and 2002, approximately 16%, 21% and 22%, respectively, were to various tobacco customers which we have been led to believe are owned by or under common control of Japan Tobacco Inc. and approximately 18%, 17% and 13%, respectively, were to various tobacco customers which we have been led to believe are owned by or under common control of Altria Group, Inc.  In addition, tobacco product manufacturers are currently experiencing a period of consolidation (including the pending merger of R.J. Reynolds Tobacco Holdings and Brown & Williamson), and further consolidation among our customers could decrease such customer's demand for our leaf tobacco or processing services.  The loss of any one or more of such customers could have a material adverse effect on our financial condition or results of operations.  

We face increased risks of doing business due to the extent of our international operations.

We do business in over 40 countries, many of which do not have stable economies or governments.  Our international operations are subject to international business risks, including unsettled political conditions, expropriation, import and export restrictions, exchange controls, inflationary economies and currency risks and risks related to the restrictions on repatriation of earnings or proceeds from liquidated assets of foreign subsidiaries. These risks are exacerbated in countries where we have advanced substantial sums or guaranteed local loans or lines of credit for the purchase of tobacco from growers.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Risks Relating To Our Operations (Continued)

          We have significant investments in our purchasing, processing and exporting operations in Brazil, Malawi, Tanzania, Zimbabwe, Turkey, Italy and Thailand.  In particular, we derive significant operating profit from our operations in Brazil and Zimbabwe.  In recent years, these countries' economic problems have received wide publicity related to devaluation of the local currency and inflation.  Devaluation and appreciation of local currencies can affect our purchase costs of tobacco and our processing costs.

          In addition, we do business in countries that have tax regimes in which the rules are not clear or not consistently applied.  This is especially true with regard to international transfer pricing.

We face increased risk of doing business in Zimbabwe due to political instability and civil unrest.

Zimbabwe remains in a period of civil unrest in combination with a deteriorating economy.  Should the current political situation continue, we could experience disruptions and delays associated with our Zimbabwe operations.  The government’s forced land resettlement program has caused disruptions to both tobacco and food farm production in Zimbabwe.  The volume of the 2003 tobacco crop declined by approximately 49% in comparison to the prior year crop from 165 to 85 million kilos.  The 2004 crop is projected to decrease to 60 million kilos; however, we are expecting to buy, process and sell an equivalent quantity as we did for the 2003 crop year.  If the political situation in Zimbabwe continues to deteriorate, our ability to recover our assets there could be impaired.  See Note B to the “Notes to Consolidated Financial Statements.”  Our Zimbabwe subsidiary has long-lived assets of approximately $39.7 million as of March 31, 2004.

Fluctuations in foreign currency exchange and interest rates could adversely affect our results of operations.

Local country operating costs, including the purchasing and processing costs for tobaccos, are subject to the effects of exchange fluctuations of the local currency against the U.S. dollar.  We attempt to minimize such currency risks by matching the timing of our working capital borrowing needs against the tobacco purchasing and processing funds requirements in the currency of the country where the tobacco is grown.  Fluctuations in the value of foreign currencies can significantly affect our operating results.

          In addition, the devaluation of foreign currencies, particularly Asian and Eastern European currencies, has resulted and may in the future result in reduced purchasing power from customers in these areas.  We may incur a loss of business as a result of the devaluation of these currencies now or in the future.

          Various outstanding interest-bearing instruments are sensitive to changes in interest rates. With respect to our variable-rate debt, a 10% change in interest rates would have the effect of increasing or decreasing interest expense by $1.7 million.

Our indentures and credit agreements contain, and in the future could contain additional, covenants and tests that would limit our ability to take actions or cause us to take actions we may not normally take.

Our existing indentures and credit agreements contain a number of significant covenants.  These covenants will limit our ability to, among other things:

 ●

borrow additional money;

 ●

make capital expenditures and other investments;

 ●

merge, consolidate or dispose of our assets;

 ●

acquire assets in access of certain dollar amounts; and

 ●

grant liens on our assets.

          Our credit facility and existing indentures require, and any future indenture may require, us to meet certain financial tests.  The failure to comply with these covenants and tests would cause a default under those agreements.  A default, if not waived, could result in the debt under our credit facility and indentures becoming immediately due and payable and could result in a default or acceleration of our other indebtedness with cross-default provisions.  If this occurs, we may not be able to pay our debt or borrow sufficient funds to refinance it.  Even if new financing is available, it may not be on terms that are acceptable to us.  Complying with these covenants and tests may cause us to take actions that we otherwise would not take or not take actions that we otherwise would take.

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Risks Relating to the Tobacco Industry

Provisions in our indentures restrict our ability to make payments, including payments of dividends to our shareholders.

Under the terms of the Indentures relating to our 9 5/8% Senior Notes due 2011 and 7 3/4% Senior Notes due 2013, we will not be permitted to make certain payments that are restricted by such Indentures, including cash dividends on our common stock.  We generally may make such restricted payments, provided that (1) we are not in default under the Indentures, (2) we are able to incur at least $1.00 of additional indebtedness under a consolidated interest coverage ratio test set forth in the Indentures, and (3) the aggregate amount of the payments to be made is less than the total of (x) $20.0 million, (y) 50% of our consolidated net income for the period from April 1, 1996, through the end of our most recent fiscal quarter and (z) the net cash proceeds from our sale of any equity securities or debt securities that are converted into equity securities.  At March 31, 2004 and June 30, 2003, we were permitted to make restricted payments, including cash dividends on our common stock, of up to $30.0 million and $39.4 million, respectively.

Reductions in demand for consumer tobacco products could adversely affect our results of operations.

The tobacco industry, both in the United States and abroad, continues to face a number of issues that may reduce the consumption of cigarettes and adversely affect our business, sales volume, results of operations, cash flows and financial condition.

          These issues, some of which are more fully discussed below, include:

                ·

governmental actions seeking to ascribe to tobacco product manufacturers liability for adverse health effects associated with smoking and exposure to environmental tobacco smoke;

                ·

smoking and health litigation against tobacco product manufacturers;

                ·

tax increases on consumer tobacco products;

                ·

current and potential actions by state attorneys general to enforce the terms of the Master Settlement Agreement (“MSA”) between state governments in the United States and tobacco product manufacturers;

                ·

governmental and private bans and restrictions on smoking;

                ·

actual and proposed price controls and restrictions on imports in certain jurisdictions outside the United States;

                ·

restrictions on tobacco product manufacturing, marketing, advertising and sales;

                ·

the diminishing social acceptance of smoking;

                ·

increased pressure from anti-smoking groups; and

                ·

other tobacco product legislation that may be considered by Congress, the states and other countries.

Tobacco product manufacturer litigation may reduce demand for our services.

Our primary customers, the leading cigarette manufacturers, face thousands of lawsuits brought throughout the United States and, to a lesser extent, the rest of the world.  The effects of the lawsuits on our customers could reduce their demand for tobacco from us.  These lawsuits have been brought by plaintiffs, including (1) individuals and classes of individuals alleging personal injury and/or misleading advertising, (2) governments (including governmental and quasi-governmental entities in the United States and abroad) seeking recovery of health care costs allegedly caused by cigarette smoking, and (3) other groups seeking recovery of health care expenditures allegedly caused by cigarette smoking, including third-party health care payors, such as unions and health maintenance organizations.  Damages claimed in some of the smoking and health cases range into the billions of dollars.  In September 1999, the United States Department of Justice filed a lawsuit against the leading cigarette manufacturers, seeking to recover billions of dollars.    There have been several jury verdicts in tobacco product litigation during the past several years.  Additional plaintiffs continue to file lawsuits.

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ITEM 7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Risks Relating to the Tobacco Industry (Continued)

          In November 1998, certain United States tobacco product manufacturers entered into the MSA with 46 states and certain territories to settle asserted and unasserted health care cost recovery and other claims.  These manufacturers had previously settled similar claims brought by Mississippi, Florida, Texas and Minnesota and an environmental tobacco smoke and health class action brought on behalf of airline flight attendants.  The MSA has received final judicial approval in all 52 settling jurisdictions.

          Key provisions of the MSA are as follows:

                ·

payments of approximately $206 billion over 25 years from the cigarette manufacturers to the states;

                ·

marketing and advertising restrictions, including bans on cartoon characters, point-of-sale advertising, billboards, bus and taxi placards and sponsorships of most sporting events by brand names;

                ·

disbanding the Tobacco Institute, the Council for Tobacco Research and the Council for Indoor Air Research;

                ·

eliminating vending machine sales and requiring that all tobacco products be behind a counter; and

                ·

making payments of $1.7 billion for educational efforts about the dangers of smoking and to discourage youth smoking.

          The MSA and other state settlement agreements include provisions relating to advertising and marketing restrictions, public disclosure of industry documents, limitations on challenges to tobacco product control and underage use laws, lobbying activities and other provisions.  The provisions of the Master Settlement Agreement and any similar settlement agreements could have a material adverse impact on our customer’s purchase from us.

Legislative and regulatory initiatives could reduce consumption of consumer tobacco products and demand for our services.

In recent years, members of Congress have introduced legislation, some of which has been the subject of hearings or floor debate, that would subject cigarettes to various regulations under the Department of Health and Human Services or regulation under the Consumer Products Safety Act, establish anti-smoking educational campaigns or anti-smoking programs, or provide additional funding for governmental anti-smoking activities, further restrict the advertising of cigarettes, including requiring additional warnings on packages and in advertising, provide that the Federal Cigarette Labeling and Advertising Act and the Smoking Education Act could not be used as a defense against liability under state statutory or common law, allow state and local governments to restrict the sale and distribution of cigarettes, and eliminate or reduce the tax deductibility of tobacco product advertising.  If any or all of the foregoing were to be implemented, our business, volume, results of operations, cash flows and financial condition could be materially adversely affected.

          A number of foreign nations also have taken steps to restrict or prohibit cigarette advertising and promotion, to increase taxes on cigarettes and to discourage cigarette smoking.  In some cases, such restrictions are more onerous than those in the United States.  For example, advertising and promotion of cigarettes has been banned or severely restricted for a number of years in Australia, Canada, Finland, France, Italy, Singapore and other countries.  Further, in May of 2003, the World Health Organization adopted a treaty, the Framework Convention for Tobacco Control, which requires signatory nations to enact legislation that would require, among other things, specific actions to prevent youth smoking; restrict or prohibit tobacco product marketing; inform the public about the health consequences of smoking and the benefits of quitting; regulate the content of tobacco products; impose new package warning requirements including the use of pictorial or graphic images; eliminate cigarette smuggling and counterfeit cigarettes; restrict smoking in public places; increase and harmonize cigarette excise taxes; abolish duty-free tobacco sales; and permit and encourage litigation against tobacco product manufacturers.  The treaty will take effect after forty countries ratify it, and must be implemented by national laws in the ratifying nations.

          Due to the present regulatory and legislative environment, a substantial risk exists that past growth trends in tobacco product sales may not continue and that existing sales may decline.

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ITEM 7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS (Continued)

Risks Relating to the Tobacco Industry (Continued)

We have been, and continue to be, subject to governmental investigations into, and litigation concerning, leaf tobacco industry buying practices.

The leaf tobacco industry, from time to time, has been the subject of government investigations regarding trade practices.  For example, in 1998 we were the subject of an investigation by the Antitrust Division of the United States Department of Justice into certain buying practices alleged to have occurred in the industry.  More recently, we have been a named defendant in the DeLoach, et al. v. Philip Morris Companies Inc., et al. , antitrust class action litigation alleging a conspiracy to rig bids in the tobacco auction markets.

In addition, certain other, similar investigations are ongoing.  In October 2001, the Directorate General for Competition (DGCOMP) of the European Commission (EC) began conducting an administrative investigation into certain tobacco buying and selling practices alleged to have occurred within the leaf tobacco industry in Spain and Italy. We believe that the DGCOMP may be conducting similar investigations in other countries.  Our subsidiaries in Spain (Agroexpansion) and Italy (DIMON Italia) have been the subject of those investigations.  Based on our understanding of the facts pertaining to the activities of Spanish and Italian tobacco processors, including Agroexpansion and DIMON Italia, respectively, we believe there have been infringements of EU law.  We expect that administrative penalties will be assessed, and those penalties could be material to our earnings.   However, we are not able to make an assessment of the amount of any such penalties at this time.

In September 2002, the Argentina National Commission for Defense of Competition (“NCDC”) began an administrative inquiry into the tobacco and cigarette industry in Argentina including our subsidiary, DIMON Argentina S.A.

Adverse determinations in these or similar proceedings may negatively impact our future results.

Risks Relating to Owning Our Stock

Anti-takeover provisions could discourage a takeover that you consider to be in your best interest or prevent the removal of our current directors and management.

We have adopted a number of provisions that could have anti-takeover effects or prevent the removal of our current directors and management.  We have adopted a shareholder protection rights plan, commonly referred to as a poison pill. The rights plan is intended to deter an attempt to acquire our company in a manner or on terms not approved by our Board of Directors.  The rights plan will not prevent an acquisition that is approved by our Board of Directors.  See also Note M to the “Notes to Consolidated Financial Statements.”

          Our Articles of Incorporation authorize the Board of Directors to determine the terms of up to 10 million shares of undesignated preferred stock and issue such stock without stockholder approval. The issuance of preferred stock could make it more difficult for a third party to acquire, or discourage a third party from acquiring, voting control of our company in order to remove our current directors and management. These provisions could make more difficult the removal of our current directors and management or a takeover of our company, even if the events would be beneficial to our stockholders. These provisions could also limit the price that investors might be willing to pay for our common stock.

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