LIQUIDITY AND CAPITAL RESOURCES

Overview

Our operating cash flow improved by $63 million during fiscal year 2010. We continued our conservative financial policies, maintained our discipline on using our free cash flow, and were able to return $93 million to shareholders through dividends and share repurchases.

Our liquidity and capital resource requirements are predominantly short-term in nature and primarily relate to working capital required for seasonal tobacco crop purchases. Working capital needs are seasonal within each geographic region. The geographic dispersion and the timing of working capital needs permit us to predict our general level of cash requirements although crop size, prices paid to farmers, and currency fluctuations affect requirements each year. The marketing of the crop in each geographic area is heavily influenced by weather conditions and follows the cycle of buying, processing, and shipping of the tobacco crop. The timing of individual customer shipping requirements may change the level or the duration of crop financing. Despite a predominance of short-term needs, we maintain a relatively large portion of our total debt as long-term to avoid liquidity risk.

We believe that our financial resources are adequate to support our capital needs. Our seasonal working capital requirements typically increase from March to September by as much as $200 million. That funding requirement is primarily related to our Other Regions segment and includes purchasing crops in South America and Africa. The amount can vary significantly depending upon such factors as crop sizes, the price of leaf, the relative strength of the U.S. dollar, and shipment and customer payment timing differences. We deal with this uncertainty by maintaining substantial credit lines and cash balances. In addition to our operating requirements for working capital, we have $15 million in medium-term notes maturing in December 2010, we plan to spend approximately $50 million on capital projects, and we expect to provide around $8 million in funding to our pension plans. Available capital resources from our cash balances, a committed credit facility, and uncommitted credit lines exceed those anticipated needs. After balancing our capital structure, any excess cash flow from operations after dividends and capital expenditures will be available to fund expansion, purchase our stock, or otherwise enhance shareholder value.

Cash Flow

During fiscal year 2010, we generated $162 million in cash flow from our operations. We spent $58 million on capital projects, returned $61 million to shareholders in the form of dividends, and spent $32 million on repurchases of our common stock. At March 31, 2010, cash balances totaled $246 million.

We repurchased shares of our common stock during fiscal year 2010. In November 2009, the Board of Directors approved a new share repurchase program, which superseded an expiring program. Under the expiring program, which was approved by our Board of Directors in November 2007, we repurchased $141 million of common stock. The new program expires November 5, 2012 and authorizes purchases of up to $150 million of our common stock. Under the authorization, we will purchase shares from time to time in the open market or in privately negotiated transactions at prices not exceeding prevailing market rates. In determining our level of common share repurchase activity, our intent is to use only cash available after meeting our capital investment, dividend, and working capital requirements. As a result, our execution of the repurchase program may vary as we realize changes in cash flow generation and availability. In fiscal year 2010, we purchased 743,876 shares of our common stock at a total cost of about $33 million, based on trading dates. At March 31, 2010, our available authorization under our current share repurchase program was $130 million, and approximately 24.3 million common shares were outstanding.

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Working Capital

Working capital at March 31, 2010, was nearly $1.1 billion, up $124 million from last year’s level of $954 million. The largest factor contributing to the increase was the $226 million increase in tobacco inventory. Higher green tobacco prices, foreign currency appreciation, later shipments from some regions, and purchases of old crop tobacco in the United States all contributed to the inventory increase. Inventory is usually financed with a mix of cash, notes payable, and customer deposits, depending on our borrowing capabilities, interest rates, and exchange rates, as well as those of our customers. We generally do not purchase material quantities of tobacco on a speculative basis. Our uncommitted tobacco inventories increased by approximately $37 million to $161 million, or about 20% of tobacco inventory, primarily due to higher balances in South America caused by higher green leaf costs compared to last year. Uncommitted inventories at March 31, 2009, were $124 million, which represented 21% of tobacco inventory.

Advances to suppliers decreased by $46.9 million compared to prior year’s levels, which had been relatively high because of higher farm input costs when those advances were made and because of later deliveries in some regions. Earlier shipments in Asia and recognition of $18.5 million in provisions for estimated uncollectible amounts contributed to the decline. Customer advances and deposits increased $94 million compared to prior year levels, as some customer prepayments for tobacco purchases were made earlier in the crop cycle. These deposits also contributed to the higher cash balances on hand at March 31, 2010.

Capital Spending

Our capital expenditures are generally limited to those that add value for the customer, replace or maintain equipment, increase efficiency, or position us for future growth. Our capital expenditures were approximately $58 million in fiscal year 2010, $36 million in fiscal year 2009, and $28 million in fiscal year 2008. Depreciation expense was approximately $41 million in each of fiscal years 2010, 2009, and 2008. Our intent is to limit routine capital spending to a level below depreciation expense in order to maintain strong cash flow. However, from time to time we may undertake additional projects pursuant to customer contracts. Our capital expenditures in fiscal year 2010 included investments to expand and upgrade our facility in Lancaster, Pennsylvania, to accommodate the consolidation of our U.S. dark tobacco processing operations. That facility resumed operations in December 2009 and is operating well. We have several other customer-driven opportunities that will require about $26 million of capital investment in the aggregate. We spent approximately $15 million on those projects in fiscal year 2010, and we expect to spend the remaining $11 million in fiscal year 2011.

Outstanding Debt and Other Financing Arrangements

We consider the sum of notes payable and overdrafts, long-term debt (including current portion), and customer advances and deposits, less cash, cash equivalents, and short-term investments on our balance sheet to be our net debt. We also consider our net debt plus shareholders’ equity to be our total capitalization. Net debt increased by $88 million to $469 million during the twelve months ended March 31, 2010. The increase primarily reflects higher customer deposits and advances offset by higher cash balances this year. Net debt as a percentage of capitalization was approximately 29% at March 31, 2010, up from 27% at March 31, 2009, and was lower than our target range of 35% to 45% of total capitalization. We repaid $79.5 million in long-term debt that matured in September 2009. In November 2009, we issued $100 million in 6.25% senior, unsecured notes due December 1, 2014. The proceeds were used to repay debt obligations, including notes payable and overdrafts incurred to repay the September 2009 long-term debt maturity, and for general corporate purposes. We also have an active, undenominated shelf registration filed with the SEC, which provides for future issuance of additional debt or equity securities.

As of March 31, 2010, we, together with our consolidated affiliates, had approximately $752 million in uncommitted lines of credit, of which approximately $575 million were unused and available to support seasonal working capital needs. We also had approximately $246 million in cash and cash equivalents, and we have a five-year committed revolving credit facility totaling $400 million. We entered into the facility in August 2007, and it will mature on August 31, 2012. As of March 31, 2010, we had no borrowings under the facility. Under the terms of our bank agreement, we must maintain certain levels of tangible net worth and observe restrictions on debt levels. We were in compliance with all such covenants at March 31, 2010. Our long-term credit ratings are Ba1 with Moody’s Investors Service and BBB- with Standard & Poor’s.

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Derivatives

From time to time, we use interest rate swap agreements to manage our exposure to changes in interest rates. These agreements typically adjust interest rates on designated long-term obligations from fixed to variable. The swaps are accounted for as fair value hedges. At March 31, 2010, the fair value of our outstanding interest rate swap agreements was $9.8 million, and the notional amount swapped was $245 million. In fiscal year 2010, active swaps reduced interest expense by $6 million.

We also enter forward contracts from time to time to hedge certain foreign currency exposures, primarily related to forecast purchases of tobacco and related processing costs in Brazil, as well as our net monetary asset exposure in the local currency there. We generally account for our hedges of forecast tobacco purchases as cash flow hedges. At March 31, 2010, the fair value of our open contracts was not material. We also had other forward contracts outstanding that were not designated as hedges, and the fair value of those contracts was also not material at March 31, 2010. For additional information, see Note 10 to the consolidated financial statements in Item 8.

Pension Funding

Funds supporting our ERISA-regulated U.S. defined benefit pension plans increased by $44 million to $164 million because of gains in the investment portfolio during the fiscal year. By April 30, 2010, the market value of the fund was about $168 million. The accumulated benefit obligation (“ABO”) and the projected benefit obligation (“PBO”) were approximately $171 million and $191 million, respectively, as of March 31, 2010. The ABO and PBO are calculated on the basis of certain assumptions that are outlined in Note 12 to the consolidated financial statements in Item 8. We expect to make contributions of $7.8 million to our ERISA-regulated plans during the next year. It is our policy to monitor the performance of the funds and to review the adequacy of our funding and plan contributions.

Contractual Obligations

Our contractual obligations as of March 31, 2010, were as follows:

In addition to principal and interest payments on notes payable and long-term debt, our contractual obligations include operating lease payments, inventory purchase commitments, and capital expenditure commitments. Operating lease obligations represent minimum payments due under leases for various production, storage, distribution, and other facilities, as well as vehicles and equipment. Tobacco inventory purchase obligations primarily represent contracts to purchase tobacco from farmers. The amounts shown above are estimates since actual quantities purchased will depend on crop yield and prices will depend on the quality of the tobacco delivered. About half of our crop year contracts to purchase tobacco are with farmers in Brazil. We have partially funded our tobacco purchases in Brazil and in other regions with advances to farmers and other suppliers, which totaled approximately $167 million at March 31, 2010. In addition, we have guaranteed bank loans to farmers in Brazil that relate to a portion of our tobacco purchase obligations there. At March 31, 2010, we were contingently liable under those guarantees for outstanding balances of approximately $112 million (including accrued interest), and we had recorded a liability of approximately $26 million for the fair value of those guarantees. As tobacco is purchased and the related bank loans are repaid, our contingent liability is reduced.

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CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS

In preparing the financial statements in accordance with GAAP, we are required to make estimates and assumptions that have an impact on the assets, liabilities, revenue, and expense amounts reported. These estimates can also affect our supplemental information disclosures, including information about contingencies, risk, and financial condition. We believe, given current facts and circumstances, our estimates and assumptions are reasonable, adhere to GAAP, and are consistently applied. However, changes in the assumptions used could result in a material adjustment to the financial statements. Our critical accounting estimates and assumptions are in the following areas:

Inventories

Inventories of tobacco are valued at the lower of cost or market with cost determined under the specific cost method. Raw materials are clearly identified at the time of purchase. We track the costs associated with raw materials in the final product lots, and maintain this identification through the time of sale. We also capitalize direct and indirect costs related to processing raw materials. This method of cost accounting is referred to as the specific cost or specific identification method. We write down inventory for changes in market value based upon assumptions related to future demand and market conditions if the indicated market value is below cost. Future demand assumptions can be impacted by changes in customer sales, changes in customers’ inventory positions and policies, competitors’ pricing policies and inventory positions, changing customer needs, and varying crop sizes and qualities. Market conditions that differ significantly from those assumed by management could result in additional write downs. We experience inventory write downs routinely. Inventory write downs in fiscal years 2010, 2009, and 2008 were $1.3 million, $3.5 million, and $2.2 million, respectively.

Advances to Suppliers and Guarantees of Bank Loans to Suppliers

We provide agronomy services and seasonal crop advances of, or for, seed, fertilizer, and other supplies. These advances are short term in nature and are customarily repaid upon delivery of tobacco to us. Primarily in Brazil, we have also made long-term advances to tobacco farmers to finance curing barns and other farm infrastructure. In Brazil, we also guarantee both short-term and long-term loans made to farmers for the same purposes. In some years, due to low crop yields and other factors, individual farmers may not deliver sufficient volumes of tobacco to repay maturing advances. In that case, we may extend repayment of the advances into the following crop year or satisfy the guarantee by acquiring the loan from the bank. In either situation, we will incur losses whenever we are unable to recover the full amount of the loans and advances. At each reporting period, we must make estimates and assumptions in determining the valuation allowance for advances to farmers and the liability to accrue for our obligations under bank loan guarantees.

Goodwill

We review the carrying value of goodwill for potential impairment on an annual basis and at any time that events or business conditions indicate that it may be impaired. We follow applicable accounting guidance in determining the fair value of goodwill, which normally involves the use of discounted cash flow models (Level 3 of the fair value hierarchy under GAAP). The calculations in these models are normally not based on observable market data from independent sources and therefore require significant management judgment with respect to operating earnings growth rates and the selection of an appropriate discount rate. Neither a one-percentage-point increase in the discount rate assumption nor a one-percentage-point decline in the cash flow growth rate assumption would result in an impairment charge. However, significant changes in estimates of future cash flows, such as those caused by unforeseen events or changes in market conditions, could result in an impairment charge.

Fair Value Measurements

We hold various financial assets and financial liabilities that are required to be measured and reported at fair value in our financial statements, including money market funds, trading securities associated with deferred compensation plans, interest rate swaps, forward foreign currency exchange contracts, and guarantees of bank loans to tobacco growers in Brazil. We follow the relevant accounting guidance in determining the fair values of these financial assets and liabilities. Quoted market prices (Level 1 of the fair value hierarchy) are used in most cases to determine the fair values of trading securities. Interest rate swaps and forward foreign currency exchange contracts are valued based on dealer quotes using discounted cash flow models matched to the contractual terms of each instrument (Level 2 of the fair value hierarchy). The fair value of the guarantees of bank loans to tobacco growers, which was approximately $26 million at March 31, 2010, is derived using an internally-developed discounted cash flow model. The model requires various inputs, including historical loss percentages for comparable loans and a risk-adjusted interest rate. Because significant management judgment is required in determining and applying these inputs to the valuation model, our process for determining the fair value of these guarantees is classified as Level 3 of the fair value hierarchy. At March 31, 2010, a 1% increase in the

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expected loss percentage for all guaranteed farmer loans would have increased the fair value of the guarantee obligation by approximately $1.2 million. A 1% change in the risk-adjusted interest rate would not have had a material effect on the fair value of the guarantee obligation. We incorporate credit risk in determining the fair values of our financial assets and financial liabilities, but that risk did not materially affect the fair values of any of those assets or liabilities at March 31, 2010.

Income Taxes

Our consolidated effective income tax rate is based on our expected taxable income, tax laws and statutory tax rates, and tax planning opportunities in the various jurisdictions in which we operate. Significant judgment is required in determining the effective tax rate and evaluating our tax position. The effective tax rate is applied to quarterly operating results. We are subject to the tax laws of many jurisdictions, and could be subject to a tax audit in each of these jurisdictions, which could result in adjustments to tax expense in future periods. In the event that there is a significant, unusual, or one-time item recognized in our results, the tax attributed to that discrete item would be recorded at the same time as the item.

Our accounting for uncertain tax positions requires that we review all significant tax positions taken, or expected to be taken, in income tax returns for all jurisdictions in which we operate. In this review, we must assume that all tax positions will ultimately be audited, and either accepted or rejected based on the applicable tax regulations by the tax authorities for those jurisdictions. We must recognize in our financial statements only the tax benefits associated with tax positions that are “more likely than not” to be accepted upon audit, at the greatest amount that is considered “more likely than not” to be accepted. These determinations require significant management judgment, and changes in any given quarterly or annual reporting period could affect our consolidated income tax rate.

Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. As a result, our effective tax rate reflected in the financial statements is different than that reported in our tax returns. Some of these differences are permanent, such as expenses that are not tax deductible, while others are related to timing issues, such as differences in depreciation methods. Timing differences create deferred tax assets and liabilities. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred or income taxes related to expenses that have not yet been recognized in the financial statements but have been deducted in our tax return. Deferred tax assets generally represent items that can be used as a tax deduction or credit in future tax returns for which we have already recorded the tax benefit in our financial statements. We record valuation allowances for deferred tax assets when the amount of estimated future taxable income is not likely to support the use of the deduction or credit. Determining the amount of such valuation allowances requires significant management judgment, including estimates of future taxable income in multiple tax jurisdictions where we operate. Based on our periodic earnings forecasts, we project the upcoming year’s taxable income to help us evaluate our ability to realize deferred tax assets. We had small net operating loss (“NOL”) carryforwards in several foreign jurisdictions at March 31, 2010. Based on future estimates of taxable income and/or available tax planning strategies in those jurisdictions, we expect to fully realize those NOL carryforwards.

At the beginning of fiscal year 2010, we had approximately $52 million of undistributed earnings of foreign subsidiaries on which no provision for U.S. income taxes had been recorded because those earnings were designated as permanently reinvested. Effective March 31, 2010, we changed the classification of those earnings to reflect a change in our intent to repatriate the earnings consistent with appropriate tax planning and good business practice in the respective foreign countries. As a result of this change, approximately $3.5 million of additional income tax expense was recognized to record the applicable U.S. tax liability. After this change, we no longer have any undistributed earnings of foreign subsidiaries that are classified as permanently reinvested.

The functional currency in most of our significant foreign operations is the U.S. dollar, as export tobacco sales are generally made in dollars. Purchasing and processing costs are usually incurred in local currency. When the U.S. dollar is weakening relative to the local currency, purchasing and processing costs increase in dollar terms, resulting in higher cost inventory. The sale of that inventory in dollars generates less taxable income in local currency, which results in lower income taxes owed when translated into U.S. dollars. This causes the effective income tax rate on dollar income to be lower than the statutory rate in the local country. The reverse can occur when the local currency is weakening relative to the U.S. dollar, thereby causing the effective income tax rate on dollar earnings to be above the statutory rate. This impact on our effective income tax rate in a country can be significant during a normal crop cycle. A prolonged period of strengthening or weakening over more than one crop may increase the impact if we sell material quantities of old crop inventories. Lower-taxed foreign source income increases our ability to use foreign tax credits. Higher-taxed foreign source income has the reverse effect. When these changes occur in our larger operations, such as our operations in Brazil, they can have a material impact on our overall tax position.

For additional disclosures on income taxes, see Notes 1 and 6 to the consolidated financial statements in Item 8.

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Pension and Other Postretirement Benefit Plans

The measurement of our pension and postretirement obligations and costs are dependent on a variety of assumptions determined by management and used by our actuaries. These assumptions include estimating the present value of projected future pension payments to all plan participants, taking into consideration the likelihood of potential future events such as salary increases and demographic experience. The assumptions we have made may have an effect on the amount and timing of future contributions. The plan trustee conducts an independent valuation of the fair value of pension plan assets. The significant assumptions used in the calculation of pension and postretirement obligations are:

The effects 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.

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Sensitivity Analysis . The effect of the indicated decrease or increase in the selected assumptions is shown below, assuming no change in benefit levels:

See Note 12 to the consolidated financial statements in Item 8 for additional information on pension and postretirement benefit plans.

Other Estimates and Assumptions

Other management estimates and assumptions are routinely required in preparing our financial statements, including the determination of valuation allowances on accounts receivable, advances to suppliers, and certain value-added tax credits, as well as the determination of the fair value of long-lived assets. Changes in market and economic conditions, local tax laws, and other related factors are considered each reporting period, and adjustments to the accounts are made based on management’s best judgment.

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OTHER INFORMATION REGARDING TRENDS

AND MANAGEMENT’S ACTIONS

Our financial performance depends on our ability to obtain an appropriate price for our products, to secure the tobacco volumes and quality desired by our customers, and to maintain efficient operations. We continually monitor issues that may impact supply and demand of leaf tobacco. During the last several years, supply factors have been especially important to our results, but now, demand and pricing are becoming more important.

Supply

Production

Worldwide flue-cured tobacco production in fiscal year 2010 increased by 3.5% to 4.32 billion kilos. The total includes China, an extremely large market that is primarily domestic. Because very little of that tobacco is available to trade, we generally consider worldwide production excluding the Chinese crops. Excluding China, worldwide flue-cured tobacco production in fiscal year 2010 increased by about 5.2%, to 1.97 billion kilos. After three years of declining production, burley crops marketed in fiscal year 2009 recovered significantly, and increased again in fiscal year 2010, by about 14%. Most of the increase occurred in Africa, where Malawi and Mozambique again produced record crops. We estimate that industry uncommitted flue-cured and burley inventories totaled about 50 million kilos, excluding inventories of Asian government-owned monopolies, at March 31, 2010. That amount is over 30% higher than the level one year earlier due to the rise in flue-cured stocks in the hands of smaller regional dealers. Nonetheless, uncommitted inventories in the hands of dealers remain at very low levels.

Flue-cured production (excluding China) is expected to continue at about 2.0 billion kilos, an increase of less than 1% in fiscal year 2011, despite weather related decreases in Brazil. Burley production is forecast to decline by about 7% from its very high levels to about 778 million kilos in fiscal year 2011. Supplies of oriental tobacco available for trading have continued to decline as the former monopoly inventories have been reduced.

Pricing

Factors that affect green tobacco prices include competition from other crops, production costs, market conditions, and global supply and demand. We work with farmers to maintain tobacco production and to secure product at price levels that are attractive to our customers. Tobacco competes with agricultural commodity products for farmer production. As prices for soybeans, wheat, rice, and seed oils rise, green tobacco prices may have to rise to maintain tobacco production levels. This factor could provide momentum to efforts of the WHO to shift farmer production from leaf tobacco to other crops. After reductions through early 2009, commodity prices and crop production costs are again rising, albeit at a much slower pace than in 2008. Any current growth in farm input costs would affect crops sold in fiscal year 2012. In the recent past, market shortages have also led to green tobacco price increases. Recent customer efforts to procure leaf directly would increase competition for available leaf and could disrupt markets and further increase green tobacco prices, at least in the short term.

Recent excise tax increases and related reductions in consumption of tobacco products are likely to increase cost sensitivity of customers. In recent months, we have seen an increasing customer focus on costs. In the intermediate term, because of those cost reduction efforts, we expect that U.S. contracts for processing tobacco will be renewed at lower volume levels, under different terms and conditions, or both, at expiration in May 2011. That change will reduce margins and volumes handled in fiscal year 2012. If that business is not replaced at similar margins, the change could represent as much as half of the operating income of our North America segment. It could also result in a decision to reduce our processing capacity in the United States. The North Carolina factory is state of the art, and we will use this opportunity to continue to expand our business with existing and new customers there. In addition, U.S. flue-cured leaf is becoming more competitive in the world market.

Change in E.U. Subsidy Program

The European Union’s (E.U.) recent modification of their system of granting subsidies to tobacco farmers has created an additional supply risk. Following the implementation of the first step of the reform in 2006, crops were reduced, but around 200 million kilos of good quality flue-cured and burley tobacco have been produced in Europe each year since then. Current projections are for another decline of between 10% and 15% in production, as the effects of the staged reduction in the subsidy are felt, beginning with the crop that is currently being transplanted and will be sold in fiscal year 2012. As in 2006, it is likely that these reductions will be in less desirable varieties and production areas, which will improve the average quality of the European tobaccos. We believe that customers continue to value European tobacco. At present, no significant unsold inventory is held by the trade, and commercial prices have followed world market trends.

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In order to address the issue of the current and future crops, the national governments of the main tobacco producing countries in the E.U. have been working to find solutions to the problem because of the importance of tobacco production to local economies. While the new support system is being structured, on a country-by-country basis, a major influence on the farmers’ decisions to produce tobacco will be the level of commercial prices for green tobacco. Higher farm income will depend on leaf quality and on cost reduction at the farm level, as well as through the whole supply chain. In addition, confirmed support from tobacco product manufacturers will be crucial to the long-term viability of tobacco production in Europe. Our operations in the E.U. seem well positioned to play an important role during the transition period, as they have in the past and more recently, because of their well-established relationships with the farmer base and with major customers and because of our state-of-the-art, efficient factories.

In the intermediate term, we believe that the possibility for sustainable tobacco production in the E.U. exists. Within the general discussion on the future of the E.U. Common Agricultural Policy, it looks probable that a major driving factor will be the support of employment in the rural areas, in which framework tobacco production could reasonably be considered eligible for adequate support.

We believe that if farmer commercial income does not increase, as the level of support available to farmers decreases, the volume of tobacco produced in Europe will decline over time, which could disrupt supply and require changes in sourcing. In this case, our results of operations could be negatively affected. The recorded value of our equity interests in long-lived assets, including both consolidated and unconsolidated operations, that could be affected by these changes was approximately $28 million at March 31, 2010. In addition, we had unrealized foreign currency translation losses of approximately $14 million before income taxes at March 31, 2010, related to our subsidiary in Hungary, which is one of the operations that could be affected by these changes.

Demand

We expect that near-term demand for leaf tobacco will be flat or decline slightly, primarily due to the flattening trend in world cigarette consumption and more efficient leaf utilization by cigarette manufacturers. The efficiencies in leaf utilization by manufacturers may mean that demand for cigarette leaf tobacco will not grow at the same pace as worldwide consumption and may have peaked. On a year-to-year basis, we are susceptible to fluctuations in leaf supply due to crop size and leaf demand as manufacturers adjust inventories or respond to changes in the cigarette market. We are beginning to see evidence of softer market conditions in some markets that may have been caused by purchasing patterns during the last few years or by consumption declines over the same period. If that is the case, then demand for leaf from dealers could fall further in the near term, and crops would have to be reduced.

Our sales consist primarily of flue-cured and burley tobaccos. Those types of tobacco, along with oriental tobaccos, are the major ingredients in American-blend cigarettes. Industry data shows that consumption of American-blend cigarettes has declined at a compound annual rate of 1.2% for the ten years that ended in 2009. Over the ten years, industry data also shows that total world consumption of cigarettes grew at the compound annual rate of 0.9%, including annual growth of about 3.4% in China, which experienced higher increases during the second half of the period. Outside China, consumption fell by 0.3% during the ten years. These patterns indicate declining demand for premium products. They also indicate a shift in demand, reducing the need for burley and oriental tobaccos used in American-blend cigarettes and increasing the need for flue-cured tobacco that is used in English-blend cigarettes, which are predominant in China.

In 2009, total cigar consumption in the United States increased by about 2%, while consumption within the main E.U. markets has declined by 2% to 3%. The recent increases in U.S. federal excise taxes on tobacco products caused a migration from small cigars to large cigars. Within the smokeless segment of the dark tobacco business, 2009 U.S. consumption of loose-leaf chewing tobacco declined by 9%, while the consumption of moist snuff products grew by about 1%. We believe that supplies of dark filler tobacco worldwide are generally in line with demand; however, these supplies are likely to be affected by changes in the E.U. tobacco subsidy program with the 2010 crop. Wrapper tobacco continues to be in tight supply.

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Competition

We have experienced an increase in competition from small tobacco processors in some of the markets where we conduct business. These small competitors typically have lower overhead requirements and provide little or no support to farmers. Due to their lower cost structures, they often can offer a price for products that is lower than our price. We believe that the quality controls and farm programs we provide are necessary for our customers and make our products highly competitive. For example, we have established worldwide farm programs designed to prevent non-tobacco related materials from being introduced into the green tobacco delivered to our factories. In addition, we have established programs for good agricultural practices and have been active in social responsibility endeavors in many of the developing countries in which we do business. We believe that our major customers value these services and that our programs increase the quality of the products and services we offer. We also believe that our customers value the steady supply that we are able to provide due to our relationship with our farmer base. However, if our customers shift significant purchases to these smaller competitors, our financial results could be negatively impacted.

In addition, we will face an increased number of competitors for available leaf during the next year in the United States, Brazil, and Africa because of increased customer interest in procuring tobacco directly.

Regulation

Decreased social acceptance of smoking and increased pressure from anti-smoking groups have had an ongoing adverse effect on sales of tobacco products, particularly in the United States and Western Europe. Also, a number of foreign governments have taken or proposed steps to restrict or prohibit cigarette advertising and promotion, to increase taxes on cigarettes, to prohibit smoking in public areas, and to discourage cigarette consumption. A number of such measures are included in the Framework Convention on Tobacco Control, which was negotiated under the auspices of the WHO. In some cases, such restrictions are more onerous than those proposed or in effect in the United States. We cannot predict the extent to which government efforts to reduce tobacco consumption might affect the business of our primary customers. However, a significant decrease in worldwide tobacco consumption brought about by existing or future governmental laws and regulations would reduce demand for our products and services and could have a material adverse effect on our results of operations. Given recent growth in Asia, it seems unlikely that world consumption of tobacco products will decrease sharply in the next few years.

Most recently, the U.S. Congress passed the Family Smoking Prevention and Tobacco Control Act (“FSPTCA”). This legislation authorizes the FDA to regulate the manufacturing and marketing of tobacco products. At this time it is not possible to assess the impact FDA regulation will have on our operations or the tobacco industry.

Product Taxation

A number of governments, particularly federal and local governments in the United States and the E.U., impose excise or similar taxes on tobacco products. There has been, and will likely continue to be, new legislation proposing new or increased taxes on tobacco products. In some cases, proposed legislation seeks to significantly increase existing taxes on tobacco products, or impose new taxes on products that to date have not been subject to tax. Any future increase in excise or similar taxes on tobacco products could lead to reduced consumption for these products, thereby reducing our customers’ demand for our products. For example, in the United States, increases in federal excise taxes to fund the expansion of the Children’s Health Insurance Program (“CHIP”) are expected to reduce consumption.

Industry Consolidation

An important trend in the tobacco industry has been consolidation among manufacturers of tobacco products. For example, in the last several years, Imperial Tobacco Group PLC acquired Altadis S.A.; Japan Tobacco Inc. acquired Gallaher Group PLC; and British American Tobacco PLC acquired the cigarette assets of Tekel. This activity is expected to continue, particularly as further privatization of state monopolies occurs, providing opportunities for acquisitions by international manufacturers, and as multinational manufacturers expand their product offerings by acquisition. This concentration trend could provide additional opportunities for us and also increase the importance of each individual customer to our results. A key success factor for leaf dealers is the ability to provide customers with the quality of leaf and the level of service they desire on a global basis at the lowest cost possible, consistent with stability of supply. In addition, the international leaf dealers have larger historical market shares with some customers than with others. Consequently, our potential growth will be affected by the growth of our major customers, and consolidation of customers may have at least a short-term favorable or unfavorable impact on our business.

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Industry Evolution

Recent customer efforts to procure leaf directly from farmers may change parts of our business. As we reported last summer, Japan Tobacco announced steps to enhance their direct leaf procurement capabilities by acquiring and entering joint ventures with smaller leaf merchants. They enumerated several factors that prompted their moves, including the desire to enhance internal expertise in leaf procurement, actively manage the leaf supply chain, and work more directly with tobacco growers. That effort will reduce volumes in our North America segment and in Malawi and Brazil in our Other Regions segment. We have been working to replace those volumes, and although we are encouraged by results so far, some regions will be affected in fiscal year 2011.

The Japan Tobacco activities are consistent with a recurrent theme of manufacturers wanting to get closer to tobacco farmers for many stated reasons, including political considerations and potential regulatory compliance. Several of our customers made a similar move in the United States nearly 10 years ago. Our challenge continues to be to adapt our way of doing business to meet customer needs, and we have been working with some of our customers to examine our arrangements in certain markets. That process is ongoing and is likely to produce some changes in the near term. Any changes or new arrangements are likely to entail more structured dealings than we have had in the past and to include long-term supply or service agreements. Some customers may purchase green tobacco from us or from farmers in markets they deem to be strategic, and through long-term agreements, rely on us for individual services, such as agronomy, logistics, and processing. Most of our customers do not utilize the entire run of the crop, so these new arrangements are likely to be supplemented by traditional purchases of processed leaf tobacco from us or other dealers.

We believe that these customer efforts are likely to strengthen our relationships over the long term because we believe that independent leaf dealers add significant value to the system, providing expertise in dealing with large numbers of farmers and providing a clearinghouse for various qualities of leaf produced in each crop. Our key challenge in the coming year is to adapt our business model to meet our customers’ evolving needs while continuing to provide stability of supply and the quality that distinguishes our products and services.