10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2015
 
OR
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________TO_______________

Commission File Number: 001-00652

UNIVERSAL CORPORATION
(Exact name of registrant as specified in its charter)
Virginia
(State or other jurisdiction of
incorporation or organization)
 
54-0414210
(I.R.S. Employer
Identification Number)
 
 
 
9201 Forest Hill Avenue,
Richmond, Virginia
(Address of principal executive offices)
 
23235
(Zip Code)

804-359-9311
(Registrant's telephone number, including area code)




Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of January 29, 2016, the total number of shares of common stock outstanding was 22,717,448.



UNIVERSAL CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Item No.
 
Page
 
PART I - FINANCIAL INFORMATION
 
1.
2.
3.
4.
 
PART II - OTHER INFORMATION
 
1.
2.
Unregistered Sales of Equity Securities and Use of Proceeds
 

2




PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

UNIVERSAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(in thousands, except share and per share data)

 
 
Three Months Ended December 31,
 
Nine Months Ended December 31,
 
 
2015
 
2014
 
2015
 
2014
 
 
(Unaudited)
 
(Unaudited)
Sales and other operating revenues
 
$
584,592

 
$
758,054

 
$
1,316,393

 
$
1,493,642

Costs and expenses
 
 
 
 
 
 
 
 
Cost of goods sold
 
464,686

 
610,482

 
1,050,004

 
1,205,459

Selling, general and administrative expenses
 
54,081

 
53,539

 
166,187

 
177,125

Other income
 
(3,390
)
 

 
(3,390
)
 

Restructuring and impairment costs
 

 
1,143

 
2,389

 
4,493

Operating income
 
69,215

 
92,890

 
101,203

 
106,565

Equity in pretax earnings (loss) of unconsolidated affiliates
 
2,326

 
(527
)
 
2,556

 
3,391

Interest income
 
452

 
148

 
896

 
358

Interest expense
 
3,937

 
4,637

 
11,733

 
13,509

Income before income taxes
 
68,056

 
87,874

 
92,922

 
96,805

Income tax expense
 
21,441

 
29,797

 
27,368

 
22,719

Net income
 
46,615

 
58,077

 
65,554

 
74,086

Less: net income attributable to noncontrolling interests in subsidiaries
 
(2,081
)
 
(5,038
)
 
(4,502
)
 
(5,305
)
Net income attributable to Universal Corporation
 
44,534

 
53,039

 
61,052

 
68,781

Dividends on Universal Corporation convertible perpetual preferred stock
 
(3,687
)
 
(3,712
)
 
(11,061
)
 
(11,137
)
Cost in excess of carrying value on repurchase of convertible perpetual stock
 

 
(18
)
 

 
(18
)
Earnings available to Universal Corporation common shareholders
 
$
40,847

 
$
49,309

 
$
49,991

 
$
57,626

 
 
 
 
 
 
 
 
 
Earnings per share attributable to Universal Corporation common shareholders:
 
 
 
 
 
 
 
 
Basic
 
$
1.80

 
$
2.13

 
$
2.20

 
$
2.49

Diluted
 
$
1.60

 
$
1.87

 
$
2.18

 
$
2.43

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
22,717,043

 
23,095,861

 
22,671,943

 
23,165,553

Diluted
 
27,854,908

 
28,291,017

 
22,957,050

 
28,339,431

 
 
 
 
 
 
 
 
 
Total comprehensive income, net of income taxes
 
$
19,470

 
$
4,954

 
$
21,850

 
$
6,303

Less: comprehensive loss attributable to noncontrolling interests, net of income taxes
 
(2,259
)
 
(178
)
 
(1,995
)
 
(230
)
Comprehensive income attributable to Universal Corporation, net of income taxes
 
$
17,211

 
$
4,776

 
$
19,855

 
$
6,073

 
 
 
 
 
 
 
 
 
Dividends declared per common share
 
$
0.53

 
$
0.52

 
$
1.57

 
$
1.54


See accompanying notes.


3


UNIVERSAL CORPORATION     
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)

 
 
December 31,
 
December 31,
 
March 31,
 
 
2015
  
2014
 
2015
 
 
(Unaudited)
 
(Unaudited)
 
 
ASSETS
 
 
 
 
 
 
Current assets
 
 
  
 
 
 
Cash and cash equivalents
 
$
167,625

  
$
120,315

 
$
248,783

Accounts receivable, net
 
267,632

  
290,234

 
434,362

Advances to suppliers, net
 
84,905

  
106,563

 
114,883

Accounts receivable—unconsolidated affiliates
 
762

  
342

 
1,907

Inventories—at lower of cost or market:
 
 
  
 
 
 
Tobacco
 
965,917

  
1,011,234

 
636,488

Other
 
65,123

  
74,791

 
62,195

Prepaid income taxes
 
16,359

  
13,842

 
17,811

Deferred income taxes
 
25,303

  
40,588

 
36,611

Other current assets
 
67,456

  
80,683

 
81,570

Total current assets
 
1,661,082

  
1,738,592

 
1,634,610

 
 
 
 
 
 
 
Property, plant and equipment
 
 
  
 
 
 
Land
 
22,870

  
16,868

 
16,790

Buildings
 
256,970

  
239,177

 
238,372

Machinery and equipment
 
591,292

  
580,026

 
576,010

 
 
871,132

  
836,071

 
831,172

Less: accumulated depreciation
 
(545,518
)
  
(530,731
)
 
(525,783
)
 
 
325,614

  
305,340

 
305,389

Other assets
 
 
  
 
 
 
Goodwill and other intangibles
 
99,035

  
99,220

 
99,146

Investments in unconsolidated affiliates
 
75,351

  
82,341

 
76,512

Deferred income taxes
 
21,999

  
12,358

 
6,301

Other noncurrent assets
 
53,953

  
60,975

 
76,515

 
 
250,338

  
254,894

 
258,474

 
 
 
 
 
 
 
Total assets
 
$
2,237,034

  
$
2,298,826

 
$
2,198,473


See accompanying notes.

4


UNIVERSAL CORPORATION     
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)

 
 
December 31,
 
December 31,
 
March 31,
 
 
2015
  
2014
 
2015
 
 
(Unaudited)
  
(Unaudited)
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
Current liabilities
 
 
  
 
 
 
Notes payable and overdrafts
 
$
65,894

 
$
116,771

 
$
59,862

Accounts payable and accrued expenses
 
132,572

 
146,516

 
140,112

Accounts payable—unconsolidated affiliates
 
21,768

 
12,500

 
3,281

Customer advances and deposits
 
41,209

 
65,450

 
30,183

Accrued compensation
 
20,681

 
20,469

 
28,232

Income taxes payable
 
8,568

 
12,596

 
9,243

Current portion of long-term obligations
 

 

 

Total current liabilities
 
290,692

  
374,302

 
270,913

 
 
 
 
 
 
 
Long-term obligations
 
370,000

 
370,000

 
370,000

Pensions and other postretirement benefits
 
90,643

 
73,052

 
97,048

Other long-term liabilities
 
33,179

 
34,077

 
36,790

Deferred income taxes
 
33,324

 
42,843

 
26,628

Total liabilities
 
817,838

 
894,274

 
801,379

 
 
 
 
 
 
 
Shareholders’ equity
 
 
  
 
 
 
Universal Corporation:
 
 
 
 
 
 
Preferred stock:
 
 
  
 
 
 
Series A Junior Participating Preferred Stock, no par value, 500,000 shares authorized, none issued or outstanding
 

  

 

Series B 6.75% Convertible Perpetual Preferred Stock, no par value, 220,000 shares authorized, 218,490 shares issued and outstanding (219,596 at December 31, 2014 and 218,490 at March 31, 2015)
 
211,562

  
212,633

 
211,562

Common stock, no par value, 100,000,000 shares authorized, 22,717,448 shares issued and outstanding (23,839,717 at December 31, 2014, and 22,593,266 at March 31, 2015)
 
206,941

 
205,699

 
206,002

Retained earnings
 
1,033,986

  
997,380

 
1,020,155

Accumulated other comprehensive loss
 
(70,439
)
  
(47,168
)
 
(74,994
)
Total Universal Corporation shareholders' equity
 
1,382,050

  
1,368,544

 
1,362,725

Noncontrolling interests in subsidiaries
 
37,146

 
36,008

 
34,369

Total shareholders' equity
 
1,419,196

 
1,404,552

 
1,397,094

 
 
 
 
 
 
 
Total liabilities and shareholders' equity
 
$
2,237,034

  
$
2,298,826

 
$
2,198,473


See accompanying notes.



5


UNIVERSAL CORPORATION     
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
 
 
Nine Months Ended December 31,
 
 
2015
 
2014
 
 
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net income
 
$
65,554

 
$
74,086

Adjustments to reconcile net income to net cash used by operating activities:
 
 
 
 
Depreciation
 
27,221

 
26,355

Amortization
 
668

 
1,635

Net provision for losses (recoveries) on advances and guaranteed loans to suppliers
 
(1,026
)
 
668

Foreign currency remeasurement loss (gain), net
 
21,492

 
14,231

Fair value gain upon acquisition of partner's interest in joint venture
 
(3,390
)
 

Restructuring and impairment costs
 
2,389

 
4,493

Other, net
 
17,336

 
(719
)
Changes in operating assets and liabilities, net
 
(123,781
)
 
(122,372
)
Net cash provided (used) by operating activities
 
6,463

 
(1,623
)
 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Purchase of property, plant and equipment
 
(38,504
)
 
(43,207
)
Purchase of partner's interest in joint venture, net of cash held by the business
 
(5,964
)
 

Proceeds from sale of property, plant and equipment
 
1,380

 
3,791

Other
 
(398
)
 

Net cash used by investing activities
 
(43,486
)
 
(39,416
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Issuance (repayment) of short-term debt, net
 
4,168

 
57,075

Issuance of long-term obligations
 

 
370,000

Repayment of long-term obligations
 

 
(356,250
)
Dividends paid to noncontrolling interests
 
(1,260
)
 
(1,977
)
Issuance of common stock
 

 
187

Repurchase of convertible perpetual preferred stock
 

 
(349
)
Repurchase of common stock
 

 
(20,473
)
Dividends paid on convertible perpetual preferred stock
 
(11,061
)
 
(11,137
)
Dividends paid on common stock
 
(35,349
)
 
(35,485
)
Debt issuance costs and other
 

 
(2,985
)
Net cash used by financing activities
 
(43,502
)
 
(1,394
)
 
 
 
 
 
Effect of exchange rate changes on cash
 
(633
)
 
(784
)
Net decrease in cash and cash equivalents
 
(81,158
)
 
(43,217
)
Cash and cash equivalents at beginning of year
 
248,783

 
163,532

 
 
 
 
 
Cash and cash equivalents at end of period
 
$
167,625

 
$
120,315


See accompanying notes.

6


UNIVERSAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.   BASIS OF PRESENTATION

Universal Corporation, which together with its subsidiaries is referred to herein as “Universal” or the “Company,” is the leading global leaf tobacco supplier. Because of the seasonal nature of the Company’s business, the results of operations for any fiscal quarter will not necessarily be indicative of results to be expected for other quarters or a full fiscal year. All adjustments necessary to state fairly the results for the period have been included and were of a normal recurring nature. Certain amounts in prior year statements have been reclassified to conform to the current year presentation. This Form 10-Q should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2015.

NOTE 2.   ACCOUNTING PRONOUNCEMENTS

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which supersedes substantially all of the current revenue recognition guidance under U.S. generally accepted accounting principles (“U.S. GAAP”).  ASU 2014-09 was developed under a joint project with the International Accounting Standards Board (“IASB”) to improve and converge the existing revenue recognition accounting guidance in U.S. GAAP and International Accounting Standards.  Under ASU 2014-09, the central underlying principle is to recognize revenues when promised goods or services are transferred to customers at an amount determined by the consideration a company expects to receive for those goods or services.  The guidance outlines a five-step process for determining the amount and timing of revenue to be recognized from those arrangements.  It is more principles-based than the existing guidance under U.S. GAAP, and therefore is expected to require more management judgment and involve more estimates than the current guidance.  ASU 2014-09 is effective for annual periods beginning after December 15, 2017, including all interim periods within the year of adoption. Companies are allowed to select between two transition methods:  (1) a full retrospective transition method with the application of the new guidance to each prior reporting period presented, or (2) a retrospective transition method that recognizes the cumulative effect on prior periods at the date of adoption together with additional footnote disclosures.  Universal expects to adopt ASU 2014-09 effective April 1, 2018, which is the beginning of the fiscal year ending March 31, 2019.  The Company is currently evaluating the impact that the adoption of ASU 2014-09 will have on its consolidated financial statements and has not made any decision on the method of adoption.

In April 2015, the FASB issued Accounting Standards Update No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”). ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for fiscal years beginning after December 31, 2015. The Company will make the required balance sheet presentation change upon adoption of ASU 2015-03 effective for the quarter ending June 30, 2016, which is the first quarter of the fiscal year ending March 31, 2017.

In July 2015, the FASB issued Accounting Standards Update No. 2015-11, “Simplifying the Measurement of Inventory” (“ASU 2015-11”). ASU 2015-11 requires that most inventory be measured at the lower of cost or net realizable value. ASU 2015-11 defines net realizable value as the "estimated selling price in the ordinary course of business, less reasonable predictable costs of completion, disposal, and transportation." ASU 2015-11 is effective for fiscal years beginning after December 31, 2016. The Company is currently evaluating the impact that the adoption of ASU 2015-11 will have on its consolidated financial statements. ASU 2015-11 will be applied prospectively after the date of adoption, as required by the guidance.

In November 2015, the FASB issued Accounting Standards Update No. 2015-17, "Balance Sheet Classification of Deferred Taxes" ("ASU 2015-17"). ASU 2015-17 eliminates the current requirement for an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified balance sheet. ASU 2015-17 requires that deferred tax liabilities, deferred tax assets, and valuation allowances be classified as noncurrent in a classified balance sheet. ASU 2015-17 is effective for fiscal years beginning after December 15, 2016. Early adoption is permitted. The Company will make the required balance sheet presentation change upon early adoption of ASU 2015-17 effective for the quarter ending March 31, 2016.

In January 2016, the FASB issued Accounting Standards Update No. 2016-01 “Financial Instruments-Recognition and Measurement of Financial Assets and Financial Liabilities” ("ASU 2016-01"). ASU 2016-01 requires all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under the equity method of accounting or those that result in consolidation of the investee). This guidance is effective for fiscal years

7


beginning after December 15, 2017. The Company is currently evaluating the impact that the adoption of ASU 2016-01 will have on its consolidated financial statements.


NOTE 3.   GUARANTEES, OTHER CONTINGENT LIABILITIES, AND OTHER MATTERS

Guarantees and Other Contingent Liabilities

Guarantees of Bank Loans and Other Contingent Liabilities

Guarantees of bank loans to tobacco growers for crop financing and construction of curing barns or other tobacco producing assets have long been industry practice in Brazil and support the farmers’ production of tobacco there. At December 31, 2015, the Company’s total exposure under guarantees issued by its operating subsidiary for banking facilities of farmers in Brazil was approximately $26 million ($27 million face amount including unpaid accrued interest, less $1 million recorded for the fair value of the guarantees). All of these guarantees expire within one year. The subsidiary withholds payments due to the farmers on delivery of tobacco and forwards those payments to the third-party banks. Failure of farmers to deliver sufficient quantities of tobacco to the subsidiary to cover its obligations to the third-party banks could result in a liability for the subsidiary under the related guarantees; however, in that case, the subsidiary would have recourse against the farmers. The maximum potential amount of future payments that the Company’s subsidiary could be required to make at December 31, 2015, was the face amount, $27 million including unpaid accrued interest ($38 million at December 31, 2014, and $17 million at March 31, 2015). The fair value of the guarantees was a liability of approximately $1 million at December 31, 2015 ($2 million at December 31, 2014, and $2 million at March 31, 2015). In addition to these guarantees, the Company has other contingent liabilities, primarily related to outstanding letters of credit, totaling approximately $2 million at December 31, 2015.

Value-Added Tax Assessments in Brazil
As further discussed below, the Company’s local operating subsidiaries pay significant amounts of value-added tax (“VAT”) in connection with their normal operations. In Brazil, VAT is assessed at the state level when green tobacco is transferred between states. The Company’s operating subsidiary there pays VAT when tobaccos grown in the states of Santa Catarina and Parana are transferred to its factory in the state of Rio Grande do Sul for processing. The subsidiary has received assessments for additional VAT plus interest and penalties from tax authorities for the states of Santa Catarina and Parana based on audits of the subsidiary’s VAT filings for specified periods. In June 2011, tax authorities for the state of Santa Catarina issued assessments for tax, interest, and penalties for periods from 2006 through 2009 totaling approximately $12 million. In September 2014, tax authorities for the state of Parana issued an assessment for tax, interest, and penalties for periods from 2009 through 2014 totaling approximately $14 million. Those amounts are based on the exchange rate for the Brazilian currency at December 31, 2015. Management of the operating subsidiary and outside counsel believe that errors were made by the tax authorities for both states in determining all or significant portions of these assessments and that various defenses support the subsidiary’s positions.
With respect to the Santa Catarina assessments, the subsidiary took appropriate steps to contest the full amount of the claims. As of December 31, 2015, a portion of the subsidiary’s arguments had been accepted, and the outstanding assessment had been reduced. The reduced assessment, together with the related accumulated interest through the end of the current reporting period, totaled approximately $11 million (at the December 31, 2015 exchange rate). The subsidiary is continuing to contest the full remaining amount of the assessment. While the range of reasonably possible loss is zero up to the full $11 million remaining assessment, based on the strength of the subsidiary’s defenses, no loss within that range is considered probable at this time and no liability has been recorded at December 31, 2015.
With respect to the Parana assessment, management of the subsidiary and outside counsel challenged the full amount of the claim. A significant portion of the Parana assessment was based on positions taken by the tax authorities that management and outside counsel believe deviate significantly from the underlying statutes and relevant case law. In addition, under the law, the subsidiary’s tax filings for certain periods covered in the assessment were no longer open to any challenge by the tax authorities. In December 2015, the Parana tax authorities withdrew the initial claim, and subsequently issued a new assessment covering the same tax periods. The new assessment totaled approximately $4 million at the December 31, 2015 exchange rate, reflecting a substantial reduction from the original $14 million assessment. Notwithstanding the reduction, management and outside counsel continue to believe that the new assessment is not supported by the underlying statutes and relevant case law and have taken the necessary steps to challenge the full amount of the claim. The range of reasonably possible loss is considered to be zero up to the full $4 million assessment. However, based on the strength of the subsidiary's defenses, no loss within that range is considered probable at this time and no liability has been recorded at December 31, 2015.


8


In both states, the process for reaching a final resolution to the assessments is expected to be lengthy, and management is not currently able to predict when either case will be concluded. Should the subsidiary ultimately be required to pay any tax, interest, or penalties in either case, the portion paid for tax would generate value-added tax credits that the subsidiary may be able to recover.
 
Other Legal and Tax Matters

Various subsidiaries of the Company are involved in other litigation and tax examinations incidental to their business activities.  While the outcome of these matters cannot be predicted with certainty, management is vigorously defending the matters and does not currently expect that any of them will have a material adverse effect on the Company’s business or financial position.  However, should one or more of these matters be resolved in a manner adverse to management’s current expectation, the effect on the Company’s results of operations for a particular fiscal reporting period could be material.
 
 
 
 
Advances to Suppliers

In many sourcing origins where the Company operates, it provides agronomy services and seasonal advances of seed, fertilizer, and other supplies to tobacco farmers for crop production, or makes seasonal cash advances to farmers for the procurement of those inputs. These advances are short term, are repaid upon delivery of tobacco to the Company, and are reported in advances to suppliers in the consolidated balance sheets. In several origins, the Company has made long-term advances to tobacco farmers to finance curing barns and other farm infrastructure. In some years, due to low crop yields and other factors, individual farmers may not deliver sufficient volumes of tobacco to fully repay their seasonal advances, and the Company may extend repayment of those advances into future crop years. The long-term portion of advances is included in other noncurrent assets in the consolidated balance sheets. Both the current and the long-term portions of advances to suppliers are reported net of allowances recorded when the Company determines that amounts outstanding are not likely to be collected. Short-term and long-term advances to suppliers totaled $116 million at December 31, 2015, $153 million at December 31, 2014, and $156 million at March 31, 2015. The related valuation allowances totaled $28 million at December 31, 2015, $40 million at December 31, 2014, and $35 million at March 31, 2015, and were estimated based on the Company’s historical loss information and crop projections. The allowances were reduced by net recoveries of approximately $1 million in the nine-month period ended December 31, 2015, but increased by net provisions for uncollectible amounts of approximately $1 million in the nine-month period ended December 31, 2014. These net recoveries and provisions are included in selling, general, and administrative expenses in the consolidated statements of income. Interest on advances is recognized in earnings upon the farmers’ delivery of tobacco in payment of principal and interest.

Recoverable Value-Added Tax Credits

In many foreign countries, the Company’s local operating subsidiaries pay significant amounts of value-added tax (“VAT”) on purchases of unprocessed and processed tobacco, crop inputs, packing materials, and various other goods and services. In some countries, VAT is a national tax, and in other countries it is assessed at the state level. Items subject to VAT vary from jurisdiction to jurisdiction, as do the rates at which the tax is assessed. When tobacco is sold to customers in the country of origin, the operating subsidiaries generally collect VAT on those sales. The subsidiaries are normally permitted to offset their VAT payments against the collections and remit only the incremental VAT collections to the tax authorities. When tobacco is sold for export, VAT is normally not assessed. In countries where tobacco sales are predominately for export markets, VAT collections generated on downstream sales are often not sufficient to fully offset the subsidiaries’ VAT payments. In those situations, unused VAT credits can accumulate. Some jurisdictions have procedures that allow companies to apply for refunds of unused VAT credits from the tax authorities, but the refund process often takes an extended period of time and it is not uncommon for refund applications to be challenged or rejected in part on technical grounds. Other jurisdictions may permit companies to sell or transfer unused VAT credits to third parties in private transactions, although approval for such transactions must normally be obtained from the tax authorities, limits on the amounts that can be transferred may be imposed, and the proceeds realized may be heavily discounted from the face value of the credits. Due to these factors, local operating subsidiaries in some countries can accumulate significant balances of VAT credits over time. The Company reviews these balances on a regular basis and records valuation allowances on the credits to reflect amounts that are not expected to be recovered, as well as discounts anticipated on credits that are expected to be sold or transferred. At December 31, 2015, the aggregate balance of recoverable tax credits held by the Company’s subsidiaries totaled approximately $51 million ($66 million at December 31, 2014, and $60 million at March 31, 2015), and the related valuation allowances totaled approximately $19 million ($32 million at December 31, 2014, and $23 million at March 31, 2015). The net balances are reported in other current assets and other noncurrent assets in the consolidated balance sheets.

Acquisition of Partner's Interest in Tobacco Processing Joint Venture
For a number of years, the Company has held a 50% joint venture ownership interest in Procesadora Unitab, S.A., a tobacco processing entity in Guatemala. On December 23, 2015, the Company acquired the 50% interest held by its joint venture partner for $6.0 million in cash. In accordance with Accounting Standards Codification Topic 805, Business Combinations (“ASC 805”),

9


the transaction was accounted for using the acquisition method of accounting, which required the Company to record all underlying assets and liabilities of the entity at their fair values as of the transaction date and to consolidate the financial statements of the entity.  Based on those fair values, the Company recorded a pretax gain of $3.4 million on the transaction during the quarter ended December 31, 2015, which is reported in Other Income in the consolidated statements of income and comprehensive income. The purchase price of the newly-acquired 50% interest approximated fair value, and the gain resulted from remeasuring the Company’s original 50% ownership interest in the entity to fair value. No goodwill or identifiable intangible assets were recorded as part of the transaction, and acquisition-related costs were not significant.
The pro forma result of operations of the combined companies would not be materially different from the Company’s historical results, and the revenues and earnings of the acquired entity since the date of acquisition are not material.  The allocation of the fair values to the net assets acquired is complete. Based on the nature of its operations, the net assets of the acquired entity are comprised primarily of property, plant, and equipment, and the fair values recorded for those assets based primarily on a third-party appraisal totaled approximately $12.0 million. The acquired entity is included in the Company’s North America operating segment.

NOTE 4.   RESTRUCTURING AND IMPAIRMENT COSTS

Universal continually reviews its business for opportunities to realize efficiencies, reduce costs, and realign its operations in response to business changes. Restructuring and impairment costs are periodically incurred in connection with those activities.     For the reporting periods ended December 31, 2015 and 2014, all restructuring costs incurred related to operations that are part of the Other Regions reportable segment of the Company's Flue-Cured and Burley Tobacco Operations.

Nine Months Ended December 31, 2015

In the first quarter of fiscal year 2016, the Company recorded restructuring and impairment costs totaling $2.4 million related to plans to significantly scale back its operations in Zambia. Those costs included statutory employee termination benefits, impairment charges related to outstanding balances on loans to farmers whose contracts were terminated as a result of the decision, and impairment charges on certain property and equipment. The total restructuring liability related to these costs at December 31, 2015, was $1.1 million, the majority of which the Company expects will be paid before the end of the current fiscal year.

Three and Nine Months Ended December 31, 2014

In the second quarter of fiscal year 2015, the Company announced plans to suspend its operations in Argentina. In connection with that decision, during the quarter ended December 31, 2014, the Company's subsidiary in Argentina incurred costs related to employee terminations, as well as costs related to exiting its business arrangements with a supplier. Substantially all operations in Argentina were discontinued effective December 31, 2014. The Company also initiated and completed a program to downsize certain functions at its operations in Brazil during fiscal year 2015 and recorded employee termination costs in connection with that initiative. Restructuring costs totaled approximately $1.1 million and $4.5 million, respectively, for the quarter and nine months ended December 31, 2014 on a consolidated basis, all of which was paid by the end of fiscal year 2015.


10


NOTE 5.   EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share:
 
 
Three Months Ended December 31,
 
Nine Months Ended December 31,
(in thousands, except share and per share data)
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
 
Basic Earnings Per Share
 
 
 
 
 
 
 
 
Numerator for basic earnings per share
 
 
 
 
 
 
 
 
Net income attributable to Universal Corporation
 
$
44,534

 
$
53,039

 
$
61,052

 
$
68,781

Less: Dividends on convertible perpetual preferred stock
 
(3,687
)
 
(3,712
)
 
(11,061
)
 
(11,137
)
Less: Cost in excess of carrying value on repurchases of convertible perpetual preferred stock
 

 
(18
)
 

 
(18
)
Earnings available to Universal Corporation common shareholders for calculation of basic earnings per share
 
40,847

 
49,309

 
49,991

 
57,626

 
 
 
 
 
 
 
 
 
Denominator for basic earnings per share
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
22,717,043

 
23,095,861

 
22,671,943

 
23,165,553

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
1.80

 
$
2.13

 
$
2.20

 
$
2.49

 
 
 
 
 
 
 
 
 
Diluted Earnings Per Share
 
 
 
 
 
 
 
 
Numerator for diluted earnings per share
 
 
 
 
 
 
 
 
Earnings available to Universal Corporation common shareholders
 
$
40,847

 
$
49,309

 
$
49,991

 
$
57,626

Add: Dividends on convertible perpetual preferred stock (if conversion assumed)
 
3,687

 
3,712

 

 
11,137

Add: Cost in excess of carrying value on repurchases of convertible perpetual preferred stock
 

 
18

 

 
18

Earnings available to Universal Corporation common shareholders for calculation of diluted earnings per share
 
44,534

 
53,039

 
49,991

 
68,781

 
 
 
 
 
 
 
 
 
Denominator for diluted earnings per share
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
22,717,043

 
23,095,861

 
22,671,943

 
23,165,553

Effect of dilutive securities (if conversion or exercise assumed)
 
 
 
 
 
 
 
 
Convertible perpetual preferred stock
 
4,857,262

 
4,852,940

 

 
4,845,818

Employee share-based awards
 
280,603

 
342,216

 
285,107

 
328,060

Denominator for diluted earnings per share
 
27,854,908

 
28,291,017

 
22,957,050

 
28,339,431

 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
1.60

 
$
1.87

 
$
2.18

 
$
2.43


For the nine months ended December 31, 2015, conversion of the Company's outstanding Series B 6.75% Convertible Perpetual Preferred Stock was not assumed since the effects would have been antidilutive. The Company had the following potentially dilutive securities (stock appreciation rights) outstanding for the nine months ended December 31, 2015 and 2014 that were not included in the computation of diluted earnings per share because their exercise price exceeded the market price of the Company's common stock, and thus their effect would have been antidilutive:
 
 
Nine Months Ended December 31,
 
 
2015
 
2014
 
 
 
 
 
Potentially dilutive securities
 
133,600

 
160,800

Weighted-average exercise price
 
$
62.66

 
$
61.86


11


NOTE 6.   INCOME TAXES

The Company is subject to the tax laws of many jurisdictions. Changes in tax laws or the interpretation of tax laws can affect the Company’s earnings, as can the resolution of pending and contested tax issues. The Company's consolidated effective income tax rate on pretax earnings is affected by a number of factors, including the mix of domestic and foreign earnings, the effect of exchange rate changes on deferred taxes, and the Company’s ability to utilize foreign tax credits.
The consolidated effective income tax rate was approximately 32% for the quarter ended December 31, 2015, compared to 34% for the quarter ended December 31, 2014. The effective rate for both quarters was lower than the 35% U.S. federal statutory rate, primarily due to the effect of changes in exchange rates on deferred income tax assets and liabilities of foreign subsidiaries.

The consolidated effective income tax rate for the nine months ended December 31, 2015 was approximately 29%, compared to 23% for the nine months ended December 31, 2014. The effective income tax rate for the nine-month period ended December 31, 2014 was affected by an income tax benefit of $8 million recorded in the prior year period, arising from the ability of a subsidiary to pay a significant portion of a fine and related interest charges that were settled during that period following the unsuccessful appeal of a case involving anti-competitive activities in the Italian tobacco market. Although the portion of the fine paid by the subsidiary was not deductible for income tax purposes in its local tax jurisdiction, it reduced the subsidiary’s cumulative undistributed earnings and the associated consolidated tax liability, resulting in the $8 million benefit in the Company’s consolidated income tax provision. Excluding this discrete item, the consolidated effective income tax rate for the nine months ended December 31, 2014 was approximately 32%. The effective tax rates for both nine-month periods benefited from a lower effective tax rate on dividend income from unconsolidated operations and from the effect of exchange rate changes on deferred income tax assets and liabilities of foreign subsidiaries. The effect of the exchange rate changes was more significant for the nine months ended December 31, 2015.

NOTE 7.   DERIVATIVES AND HEDGING ACTIVITIES

Universal is exposed to various risks in its worldwide operations and uses derivative financial instruments to manage two specific types of risks – interest rate risk and foreign currency exchange rate risk. Interest rate risk is managed by entering into interest rate swap agreements, and foreign currency exchange rate risk is managed by entering into forward foreign currency exchange contracts. However, the Company’s policy also permits other types of derivative instruments. In addition, foreign currency exchange rate risk is also managed through strategies that do not involve derivative instruments, such as using local borrowings and other approaches to minimize net monetary positions in non-functional currencies. The disclosures below provide additional information about the Company’s hedging strategies, the derivative instruments used, and the effects of these activities on the consolidated statements of income and the consolidated balance sheets. In the consolidated statements of cash flows, the cash flows associated with all of these activities are reported in net cash provided by operating activities.

Hedging Strategy for Interest Rate Risk

In January 2015, the Company entered into receive-floating/pay-fixed interest rate swap agreements that were designated and qualified as hedges of the exposure to changes in interest payment cash flows created by fluctuations in variable interest rates on two outstanding non-amortizing bank term loans that were funded as part of a new bank credit facility in December 2014. Although no significant ineffectiveness is expected with this hedging strategy, the effectiveness of the interest rate swaps is evaluated on a quarterly basis. At December 31, 2015, the total notional amount of the interest rate swaps was $370 million, which corresponded with the aggregate outstanding balance of the term loans.
Previously, the Company had receive-floating/pay-fixed interest rate swap agreements that were designated and qualified as cash flow hedges on an amortizing bank term loan that was repaid concurrent with closing on the new bank credit facility. Those swap agreements, which had an aggregate notional amount of approximately $74 million reflecting the principal balance outstanding on the loan, were terminated upon repayment of the debt in December 2014.

Cash Flow Hedging Strategy for Foreign Currency Exchange Rate Risk Related to Forecast Purchases of Tobacco and Related Processing Costs

The majority of the tobacco production in most countries outside the United States where Universal operates is sold in export markets at prices denominated in U.S. dollars. However, purchases of tobacco from farmers and most processing costs (such as labor and energy) in those countries are usually denominated in the local currency. Changes in exchange rates between the U.S. dollar and the local currencies where tobacco is grown and processed affect the ultimate U.S. dollar cost of the processed tobacco. From time to time, the Company enters into forward contracts to sell U.S. dollars and buy the local currency at future dates that coincide with the expected timing of a portion of the tobacco purchases and processing costs. This strategy offsets the variability

12


of future U.S. dollar cash flows for tobacco purchases and processing costs for the foreign currency notional amount hedged. This hedging strategy has been used mainly for tobacco purchases and processing costs in Brazil. The aggregate U.S. dollar notional amount of forward contracts entered for these purposes during the first nine months of fiscal years 2016 and 2015, was as follows:

 
 
Nine Months Ended December 31,
(in millions of dollars)
 
2015
 
2014
 
 
 
 
 
Tobacco purchases
 
$
19.8

 
$
53.8

Processing costs
 
5.6

 
12.3

Total
 
$
25.4

 
$
66.1


All contracts related to tobacco purchases were designated and qualify as hedges of the future cash flows associated with the forecast purchases of tobacco. As a result, except for amounts related to any ineffective portion of the hedging strategy or any early de-designation of the hedge arrangement, changes in fair values of the forward contracts have been recognized in comprehensive income as they occurred, but only recognized in earnings upon sale of the related tobacco to third-party customers. Forward contracts related to processing costs have not been designated as hedges, and gains and losses on those contracts have been recognized in earnings on a mark-to-market basis.

Purchases of the 2015 crop in Brazil were completed in August 2015, and all forward contracts to hedge those purchases matured and settled by that time. For substantially all hedge gains and losses recorded in accumulated other comprehensive loss at December 31, 2015, the Company expects to complete the sale of the tobacco and recognize the amounts in earnings during fiscal year 2016.

Hedging Strategy for Foreign Currency Exchange Rate Risk Related to Net Local Currency Monetary Assets and Liabilities of Foreign Subsidiaries

Most of the Company’s foreign subsidiaries transact the majority of their sales in U.S. dollars and finance the majority of their operating requirements with U.S. dollar borrowings, and therefore use the U.S. dollar as their functional currency. These subsidiaries normally have certain monetary assets and liabilities on their balance sheets that are denominated in the local currency. Those assets and liabilities can include cash and cash equivalents, accounts receivable and accounts payable, advances to farmers and suppliers, deferred income tax assets and liabilities, recoverable value-added taxes, and other items. Net monetary assets and liabilities denominated in the local currency are remeasured into U.S. dollars each reporting period, generating gains and losses that the Company records in earnings as a component of selling, general, and administrative expenses. The level of net monetary assets or liabilities denominated in the local currency normally fluctuates throughout the year based on the operating cycle, but it is most common for monetary assets to exceed monetary liabilities, sometimes by a significant amount. When this situation exists and the local currency weakens against the U.S. dollar, remeasurement losses are generated. Conversely, remeasurement gains are generated on a net monetary asset position when the local currency strengthens against the U.S. dollar. To manage a portion of its exposure to currency remeasurement gains and losses, the Company enters into forward contracts to buy or sell the local currency at future dates coinciding with expected changes in the overall net local currency monetary asset position of the subsidiary. Gains and losses on the forward contracts are recorded in earnings as a component of selling, general, and administrative expenses for each reporting period as they occur, and thus directly offset the related remeasurement losses or gains in the consolidated statements of income for the notional amount hedged. The Company does not designate these contracts as hedges for accounting purposes. The contracts are generally arranged to hedge the subsidiary's projected exposure to currency remeasurement risk for specified periods of time, and new contracts are entered as necessary throughout the year to replace previous contracts as they mature. The Company is currently using forward currency contracts to manage its exposure to currency remeasurement risk in Brazil. The total notional amounts of contracts outstanding at December 31, 2015 and 2014, and March 31, 2015, were approximately $56.8 million, $109.0 million, and $80.4 million, respectively. To further mitigate currency remeasurement exposure, the Company’s foreign subsidiaries may utilize short-term local currency financing during certain periods. This strategy, while not involving the use of derivative instruments, is intended to minimize the subsidiary’s net monetary position by financing a portion of the local currency monetary assets with local currency monetary liabilities and thus hedging a portion of the overall position.

Several of the Company’s foreign subsidiaries transact the majority of their sales and finance the majority of their operating requirements in their local currency, and therefore use their respective local currencies as the functional currency for reporting purposes. From time to time, these subsidiaries sell tobacco to customers in transactions that are not denominated in the functional currency. In those situations, the subsidiaries routinely enter into forward exchange contracts to offset currency risk for the period of time that a fixed-price order and the related trade account receivable are outstanding with the customer. The contracts are not designated as hedges for accounting purposes.

13



Effect of Derivative Financial Instruments on the Consolidated Statements of Income

The table below outlines the effects of the Company’s use of derivative financial instruments on the consolidated statements of income for the three- and nine-month periods ended December 31, 2015 and 2014:
 
 
Three Months Ended December 31,
 
Nine Months Ended December 31,
(in thousands of dollars)
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
 
Cash Flow Hedges - Interest Rate Swap Agreements
 
 
 
 
 
 
 
 
Derivative
 
 
 
 
 
 
 
 
Effective Portion of Hedge
 
 
 
 
 
 
 
 
Gain (loss) recorded in accumulated other comprehensive loss
 
$
3,529

 
$
2

 
$
(2,527
)
 
$
(107
)
Gain (loss) reclassified from accumulated other comprehensive loss into earnings
 
$
(1,328
)
 
$
(636
)
 
$
(4,004
)
 
$
(1,042
)
Location of gain (loss) reclassified from accumulated other comprehensive loss into earnings
 
Interest expense
Ineffective Portion of Hedge
 
 
 
 
 
 
 
 
Gain (loss) recognized in earnings
 
$

 
$

 
$

 
$

Location of gain (loss) recognized in earnings
 
Selling, general and administrative expenses
Hedged Item
 
 
 
 
 
 
 
 
Description of hedged item
 
Floating rate interest payments on term loan
 
 
 
 
 
 
 
 
 
Cash Flow Hedges - Forward Foreign Currency Exchange Contracts
 
 
 
 
 
 
 
 
Derivative
 
 
 
 
 
 
 
 
Effective Portion of Hedge
 
 
 
 
 
 
 
 
Gain (loss) recorded in accumulated other comprehensive loss
 
$

 
$

 
$
1,283

 
$
1,700

Gain (loss) reclassified from accumulated other comprehensive loss into earnings
 
$
362

 
$
1,148

 
$
720

 
$
2,607

Location of gain (loss) reclassified from accumulated other comprehensive loss into earnings
 
Cost of goods sold
Ineffective Portion and Early De-designation of Hedges
 
 
 
 
 
 
 
 
Gain (loss) recognized in earnings
 
$

 
$

 
$
745

 
$
257

Location of gain (loss) recognized in earnings
 
Selling, general and administrative expenses
Hedged Item
 
 
 
 
 
 
 
 
Description of hedged item
 
 Forecast purchases of tobacco in Brazil
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedges - Forward Foreign Currency Exchange Contracts
 
 
 
 
 
 
 
 
Gain (loss) recognized in earnings
 
$
(2,366
)
 
$
3,552

 
$
6,014

 
$
6,433

Location of gain (loss) recognized in earnings
 
Selling, general and administrative expenses
    
For the interest rate swap agreements, the effective portion of the gain or loss on the derivative is recorded in accumulated other comprehensive loss and any ineffective portion is recorded in selling, general and administrative expenses. For the forward foreign currency exchange contracts designated as cash flow hedges of tobacco purchases in Brazil, a net hedge gain of approximately $0.3 million remained in accumulated other comprehensive loss at December 31, 2015. That balance reflects gains and losses on contracts related to the 2015 crop, less the amount reclassified to earnings related to tobacco sold through December 31, 2015. The majority of the balance in accumulated other comprehensive loss is expected to be recognized in earnings as a component of cost of goods sold in fiscal year 2016 as the related tobaccos are sold to customers. Based on the hedging strategy, as the gain or loss is recognized in earnings, it is expected to be offset by a change in the direct cost for the tobacco or by a change in sales prices if the strategy has been mandated by the customer. Generally, margins on the sale of the tobacco will not be significantly affected.


14


Effect of Derivative Financial Instruments on the Consolidated Balance Sheets

The table below outlines the effects of the Company’s derivative financial instruments on the consolidated balance sheets at December 31, 2015 and 2014, and March 31, 2015:

 
 
Derivatives in a Fair Value Asset Position
 
Derivatives in a Fair Value Liability Position
 
 
Balance
Sheet
Location
 
Fair Value as of
 
Balance
Sheet
Location
 
Fair Value as of
(in thousands of dollars)
 
 
December 31,
2015
 
December 31,
2014
 
March 31, 2015
 
 
December 31,
2015
 
December 31,
2014
 
March 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap agreements
 
Other
non-current
assets
 
$

 
$

 
$

 
Other
long-term
liabilities
 
$
1,573

 
$

 
$
3,050

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward foreign currency exchange contracts
 
Other
current
assets
 

 

 
106

 
Accounts
payable and
accrued
expenses
 

 

 
396

Total
 
 
 
$

 
$

 
$
106

 
 
 
$
1,573

 
$

 
$
3,446

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Forward foreign currency exchange contracts
 
Other
current
assets
 
$
540

 
$
6,075

 
$
5,148

 
Accounts
payable and
accrued
expenses
 
$
90

 
$
270

 
$
183

Total
 
 
 
$
540

 
$
6,075

 
$
5,148

 
 
 
$
90

 
$
270

 
$
183


Substantially all of the Company's forward foreign exchange contracts are subject to master netting arrangements whereby the right to offset occurs in the event of default by a participating party. The Company has elected to present these contracts on a gross basis in the consolidated balance sheets.

NOTE 8.   FAIR VALUE MEASUREMENTS

Universal measures certain financial and nonfinancial assets and liabilities at fair value based on applicable accounting guidance. The financial assets and liabilities measured at fair value include money market funds, trading securities associated with deferred compensation plans, interest rate swap agreements, forward foreign currency exchange contracts, and guarantees of bank loans to tobacco growers. The application of the fair value guidance to nonfinancial assets and liabilities primarily includes the determination of fair value for goodwill and long-lived assets when indicators of potential impairment are present.

Under the accounting guidance, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The framework for measuring fair value is based on a fair value hierarchy that distinguishes between observable inputs and unobservable inputs. Observable inputs are based on market data obtained from independent sources. Unobservable inputs require the Company to make its own assumptions about the value placed on an asset or liability by market participants because little or no market data exists. There are three levels within the fair value hierarchy:
Level
 
Description
 
 
 
1
  
quoted prices in active markets for identical assets or liabilities that the Company has the ability to access as of the reporting date;
 
 
 
2
  
quoted prices in active markets for similar assets or liabilities, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability; and
 
 
 
3
  
unobservable inputs for the asset or liability.

In measuring the fair value of liabilities, the Company considers the risk of non-performance in determining fair value. Universal has not elected to report at fair value any financial instruments or any other assets or liabilities that are not required to be reported at fair value under current accounting guidance.

15



At December 31, 2015 and 2014, and at March 31, 2015, the Company had certain financial assets and financial liabilities that were required to be measured and reported at fair value on a recurring basis. These assets and liabilities are listed in the tables below and are classified based on how their values were determined under the fair value hierarchy:
 
 
December 31, 2015
(in thousands of dollars)
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Money market funds
 
$

 
$
26,578

 
$

 
$
26,578

Trading securities associated with deferred compensation plans
 
18,907

 

 

 
18,907

Forward foreign currency exchange contracts
 

 
540

 

 
540

Total financial assets measured and reported at fair value
 
$
18,907

 
$
27,118

 
$

 
$
46,025

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Guarantees of bank loans to tobacco growers
 
$

 
$

 
$
1,469

 
$
1,469

Interest rate swap agreements
 

 
1,573

 

 
1,573

Forward foreign currency exchange contracts
 

 
90

 

 
90

Total financial liabilities measured and reported at fair value
 
$

 
$
1,663

 
$
1,469

 
$
3,132



 
 
December 31, 2014
(in thousands of dollars)
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Money market funds
 
$

 
$
1,546

 
$

 
$
1,546

Trading securities associated with deferred compensation plans
 
20,417

 

 

 
20,417

Forward foreign currency exchange contracts
 

 
6,075

 

 
6,075

Total financial assets measured and reported at fair value
 
$
20,417

 
$
7,621

 
$

 
$
28,038

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Guarantees of bank loans to tobacco growers
 
$

 
$

 
$
1,989

 
$
1,989

Forward foreign currency exchange contracts
 

 
270

 

 
270

Total financial liabilities measured and reported at fair value
 
$

 
$
270

 
$
1,989

 
$
2,259



16


 
 
March 31, 2015
(in thousands of dollars)
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Money market funds
 
$

 
$
86,552

 
$

 
$
86,552

Trading securities associated with deferred compensation plans
 
20,692

 

 

 
20,692

Forward foreign currency exchange contracts
 

 
5,254

 

 
5,254

Total financial assets measured and reported at fair value
 
$
20,692

 
$
91,806

 
$

 
$
112,498

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Guarantees of bank loans to tobacco growers
 
$

 
$

 
$
1,674

 
$
1,674

Interest rate swap agreements
 

 
3,050

 

 
3,050

Forward foreign currency exchange contracts
 

 
579

 

 
579

Total financial liabilities measured and reported at fair value
 
$

 
$
3,629

 
$
1,674

 
$
5,303


Money market funds

The fair value of money market funds, which are reported in cash and cash equivalents in the consolidated balance sheets, is based on net asset value, which is computed based on amortized cost (Level 2). The fair values of these investments approximate cost due to the short-term maturities and the high credit quality of the issuers of the underlying securities.

Trading securities associated with deferred compensation plans

Trading securities represent mutual fund investments that are matched to employee deferred compensation obligations. These investments are bought and sold as employees defer compensation, receive distributions, or make changes in the funds underlying their accounts. Quoted market prices (Level 1) are used to determine the fair values of the mutual funds.

Interest rate swap agreements

The fair values of interest rate swap agreements are determined based on dealer quotes using a discounted cash flow model matched to the contractual terms of each instrument. Since inputs to the model are observable and significant judgment is not required in determining the fair values, interest rate swaps are classified within Level 2 of the fair value hierarchy.

Forward foreign currency exchange contracts

The fair values of forward foreign currency exchange contracts are also determined based on dealer quotes using a discounted cash flow model matched to the contractual terms of each instrument. Since inputs to the model are observable and significant judgment is not required in determining the fair values, forward foreign currency exchange contracts are classified within Level 2 of the fair value hierarchy.

Guarantees of bank loans to tobacco growers

The Company guarantees bank loans to tobacco growers in Brazil for crop financing and has previously guaranteed loans to those growers for the construction of curing barns or other tobacco producing assets. In the event that the farmers default on their payments to the banks, the Company would be required to perform under the guarantees. The Company regularly evaluates the likelihood of farmer defaults based on an expected loss analysis and records the fair value of its guarantees as an obligation in its consolidated financial statements. The fair value of the guarantees is determined using the expected loss data for all loans outstanding at each measurement date. The present value of the cash flows associated with the estimated losses is then calculated at a risk-adjusted interest rate that is aligned with the expected duration of the liability and includes an adjustment for nonperformance risk. This approach is sometimes referred to as the “contingent claims valuation method.” Although historical loss data is an observable input, significant judgment is required in applying this information to the portfolio of guaranteed loans outstanding at each measurement date and in selecting a risk-adjusted interest rate. Significant increases or decreases in the risk-adjusted interest rate may result in a significantly higher or lower fair value measurement. The guarantees of bank loans to tobacco growers are therefore classified within Level 3 of the fair value hierarchy.

17



A reconciliation of the change in the balance of the financial liability for guarantees of bank loans to tobacco growers (Level 3) for the nine months ended December 31, 2015 and 2014 is provided below.
 
 
Nine Months Ended December 31,
(in thousands of dollars)
 
2015
 
2014
 
 
 
 
 
Balance at beginning of year
 
$
1,674

 
$
2,270

Payments under the guarantees and transfers to allowance for loss on direct loans to farmers (removal of prior crop year loans from portfolio)
 
(1,826
)
 
(2,392
)
Provision for loss or transfers from allowance for loss on direct loans to farmers (addition of current crop year loans)
 
1,851

 
2,332

Change in discount rate and estimated collection period
 
76

 
83

Currency remeasurement
 
(306
)
 
(304
)
Balance at end of period
 
$
1,469

 
$
1,989

    
Long-term Obligations

The fair value of the Company’s long-term obligations, including the current portion, was approximately $370 million at each of the balance sheet dates December 31, 2015, December 31, 2014, and March 31, 2015. The Company estimates the fair value of its long-term obligations using Level 2 inputs which are based upon quoted market prices for the same or similar issues or on the current interest rates available to the Company for debt of similar terms and maturities.

NOTE 9.   PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS

The Company sponsors several defined benefit pension plans covering U.S. salaried employees and certain foreign and other employee groups. These plans provide retirement benefits based primarily on employee compensation and years of service. The Company also sponsors defined benefit plans that provide postretirement health and life insurance benefits for eligible U.S. employees attaining specific age and service levels.

The components of the Company’s net periodic benefit cost were as follows:
 
 
Pension Benefits
 
Other Postretirement Benefits
 
 
Three Months Ended December 31,
 
Three Months Ended December 31,
(in thousands of dollars)
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
 
Service cost
 
$
1,469

  
$
1,296

 
$
106

  
$
108

Interest cost
 
2,345

  
2,629

 
387

  
458

Expected return on plan assets
 
(3,574
)
  
(3,677
)
 
(15
)
  
(26
)
Net amortization and deferral
 
1,201

  
783

 
(44
)
  
(133
)
Net periodic benefit cost
 
$
1,441

 
$
1,031

 
$
434

 
$
407


18


 
 
Pension Benefits
 
Other Postretirement Benefits
 
 
Nine Months Ended December 31,
 
Nine Months Ended December 31,
(in thousands of dollars)
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
 
Service cost
 
$
4,431

  
$
3,957

 
$
320

  
$
336

Interest cost
 
7,038

  
7,954

 
1,186

  
1,423

Expected return on plan assets
 
(10,727
)
  
(10,904
)
 
(45
)
  
(78
)
Curtailment gain
 

 

 

 
(1,503
)
Net amortization and deferral
 
3,599

  
2,343

 
(132
)
  
(399
)
Net periodic benefit cost
 
$
4,341

 
$
3,350

 
$
1,329

 
$
(221
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The net periodic benefit cost for the Company's pension and other postretirement benefit plans has increased from the prior fiscal year, primarily reflecting actuarial losses from lower market discount rates applicable to the most recent actuarial measurement of benefit liabilities and from lower expected long-term asset returns due to changes made during fiscal year 2015 to move toward a liability-driven investment strategy for the assets in the Company's U.S. ERISA-regulated defined benefit pension plan. The curtailment gain reflected in the above table for the nine months ended December 31, 2014 was attributable to the elimination of postretirement life insurance benefits for active U.S. employees.

During the nine months ended December 31, 2015, the Company made contributions of approximately $10.6 million to its pension plans. Additional contributions of approximately $1.8 million are expected during the remaining three months of fiscal year 2016, including $1.4 million to the Company's ERISA-regulated U.S. plan and $0.4 million to its non-ERISA regulated and other plans.

NOTE 10.   STOCK-BASED COMPENSATION

Universal’s shareholders have approved Executive Stock Plans (“Plans”) under which officers, directors, and employees of the Company may receive grants and awards of common stock, restricted stock, restricted stock units (“RSUs”), performance share awards (“PSAs”), stock appreciation rights (“SARs”), incentive stock options, and non-qualified stock options. The Company’s practice is to award grants of stock-based compensation to officers on an annual basis at the first regularly-scheduled meeting of the Executive Compensation, Nominating and Corporate Governance Committee of the Board of Directors (the “Compensation Committee”) in the fiscal year following the public release of the Company’s financial results for the prior year. The Compensation Committee administers the Company’s Plans consistently, following previously defined guidelines. Awards of restricted stock, RSUs, PSAs, and SARs are currently outstanding under the Plans. The SARs have an exercise price equal to the closing price of a share of the Company's common stock on the grant date. They are settled in shares of common stock, vest in equal one-third tranches one, two, and three years after the grant date, and expire ten years after the grant date, except that SARs granted after fiscal year 2007 expire on the earlier of three years after the grantee’s retirement date or ten years after the grant date. The RSUs vest five years from the grant date and are then paid out in shares of common stock. Under the terms of the RSU awards, grantees receive dividend equivalents in the form of additional RSUs that vest and are paid out on the same date as the original RSU grant. The PSAs vest three years from the grant date, are paid out in shares of common stock at the vesting date, and do not carry rights to dividends or dividend equivalents prior to vesting. Shares ultimately paid out under PSA grants are dependent on the achievement of predetermined performance measures established by the Compensation Committee and can range from zero to 150% of the stated award. The Company’s outside directors automatically receive restricted stock units or shares of restricted stock following each annual meeting of shareholders. RSUs awarded to outside directors vest three years after the grant date, and restricted shares vest upon the individual’s retirement from service as a director.

During the nine-month periods ended December 31, 2015 and 2014, Universal issued the following stock-based awards, representing the regular annual grants to officers and outside directors of the Company:

19


 
 
Nine Months Ended December 31,
 
 
2015
 
2014
 
 
 
 
 
RSUs:
 
 
 
 
Number granted
 
67,750

 
80,950

Grant date fair value
 
$
52.10

 
$
52.67

 
 
 
 
 
PSAs:
 
 
 
 
Number granted
 
57,750

 
48,450

Grant date fair value
 
$
45.06

 
$
46.41


As indicated in the table above, the Compensation Committee awarded only grants of RSUs and PSAs in both the current and prior fiscal years, and did not award any other types of stock-based compensation.
    
Fair value expense for stock-based compensation is recognized ratably over the period from grant date to the earlier of: (1) the vesting date of the award, or (2) the date the grantee is eligible to retire without forfeiting the award. For employees who are already eligible to retire at the date an award is granted, the total fair value of all non-forfeitable awards is recognized as expense at the date of grant. As a result, Universal typically incurs higher stock compensation expense in the first quarter of each fiscal year when grants are awarded to officers than in the other three quarters. For PSAs, the Company generally recognizes fair value expense ratably over the performance and vesting period based on management’s judgment of the ultimate award that is likely to be paid out based on the achievement of the predetermined performance measures. For the nine-month periods ended December 31, 2015 and 2014, the Company recorded total stock-based compensation expense of approximately $4.2 million and $4.8 million, respectively. The Company expects to recognize stock-based compensation expense of approximately $1.1 million during the remaining three months of fiscal year 2016.

20


NOTE 11. OPERATING SEGMENTS

The principal approach used by management to evaluate the Company’s performance is by geographic region, although the dark air-cured and oriental tobacco businesses are each evaluated on the basis of their worldwide operations. The Company evaluates the performance of its segments based on operating income after allocated overhead expenses (excluding significant non-recurring charges or credits), plus equity in the pretax earnings of unconsolidated affiliates.

Operating results for the Company’s reportable segments for each period presented in the consolidated statements of income were as follows:
 
 
Three Months Ended December 31,
 
Nine Months Ended December 31,
(in thousands of dollars)
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
 
SALES AND OTHER OPERATING REVENUES
 
 
 
 
 
 
 
 
Flue-Cured and Burley Leaf Tobacco Operations:
 
 
 
 
 
 
 
 
North America
 
$
81,463

 
$
118,844

 
$
179,456

   
$
203,850

Other Regions (1)
 
460,729

 
604,100

 
1,009,162

   
1,173,341

Subtotal
 
542,192

 
722,944

 
1,188,618

 
1,377,191

Other Tobacco Operations (2)
 
42,400

 
35,110

 
127,775

   
116,451

Consolidated sales and other operating revenues
 
$
584,592

 
$
758,054

 
$
1,316,393

 
$
1,493,642

 
 
 
 
 
 
 
 
 
OPERATING INCOME
 
 
 
 
 
 
 
 
Flue-Cured and Burley Leaf Tobacco Operations:
 
 
 
 
 
 
 
 
North America
 
$
5,750

   
$
15,864

 
$
12,949

   
$
21,821

Other Regions (1)
 
61,318

   
78,958

 
87,673

   
90,044

Subtotal
 
67,068

 
94,822

 
100,622

 
111,865

Other Tobacco Operations (2)
 
1,083

   
(1,316
)
 
2,136

   
2,584

Segment operating income
 
68,151

 
93,506

 
102,758

 
114,449

Deduct: Equity in pretax (earnings) loss of unconsolidated affiliates (3)
 
(2,326
)
 
527

 
(2,556
)
 
(3,391
)
Restructuring and impairment costs (4)
 

 
(1,143
)
 
(2,389
)
 
(4,493
)
Add: Other income (5)
 
3,390

 

 
3,390

 

Consolidated operating income
 
$
69,215

 
$
92,890

 
$
101,203

 
$
106,565


(1) 
Includes South America, Africa, Europe, and Asia regions, as well as inter-region eliminations.
(2) 
Includes Dark Air-Cured, Special Services, and Oriental, as well as inter-company eliminations. Sales and other operating revenues for this reportable segment include limited amounts for Oriental because its financial results consist principally of equity in the pretax earnings of an unconsolidated affiliate.
(3) 
Equity in pretax (earnings) loss of unconsolidated affiliates is included in segment operating income (Other Tobacco Operations segment), but is reported below consolidated operating income and excluded from that total in the consolidated statements of income and comprehensive income.
(4) 
Restructuring and impairment costs are excluded from segment operating income, but are included in consolidated operating income in the consolidated statements of income and comprehensive income.
(5) 
Other income represents a gain from remeasuring to fair value the Company's original 50% ownership interest in Procesadora Unitab, S.A., a tobacco processing joint venture in Guatemala, upon acquiring the 50% interest held by the Company's joint venture partner. This item is excluded from segment operating income, but is included in consolidated operating income in the consolidated statements of income and comprehensive income.

21


NOTE 12. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the changes in the accumulated balances for each component of accumulated other comprehensive income (loss) attributable to the Company for the nine months ended December 31, 2015 and 2014:
 
 
Nine Months Ended December 31,
(in thousands of dollars)
 
2015
 
2014
Foreign currency translation:
 
 
 
 
Balance at beginning of year
 
$
(31,138
)
 
$
(8,476
)
Other comprehensive income (loss) attributable to Universal Corporation:
 
 
 
 
Net gain (loss) on foreign currency translation (net of tax benefit of $319 and $6,928)
 
(508
)
 
(12,925
)
Less: Net loss on foreign currency translation attributable to noncontrolling interests
 
465

 
18

Other comprehensive income (loss) attributable to Universal Corporation, net of income taxes
 
(43
)
 
(12,907
)
Balance at end of period
 
$
(31,181
)
 
$
(21,383
)
 
 
 
 
 
Foreign currency hedge:
 
 
 
 
Balance at beginning of year
 
$
(1,834
)
 
$
769

Other comprehensive income (loss) attributable to Universal Corporation:
 
 
 
 
Net gain (loss) on derivative instruments (net of tax (expense) benefit of $(464) and $1,001)
 
861

 
(1,858
)
Reclassification of gain (loss) to earnings (net of tax expense (benefit) of $(188) and $118) (1)
 
352

 
(219
)
Other comprehensive income (loss) attributable to Universal Corporation, net of income taxes
 
1,213

 
(2,077
)
Balance at end of period
 
$
(621
)
 
$
(1,308
)
 
 
 
 
 
Interest rate hedge:
 
 
 
 
Balance at beginning of year
 
$
(1,982
)
 
$
(608
)
Other comprehensive income (loss) attributable to Universal Corporation:
 
 
 
 
Net loss on derivative instruments (net of tax benefit of $885 and $38)
 
(1,643
)
 
(69
)
Reclassification of loss to earnings (net of tax benefit of $(1,402) and $(365)) (2)
 
2,603

 
677

Other comprehensive income (loss) attributable to Universal Corporation, net of income taxes
 
960

 
608

Balance at end of period
 
$
(1,022
)
 
$

 
 
 
 
 
Pension and other postretirement benefit plan:
 
 
 
 
Balance at beginning of year
 
$
(40,040
)
 
$
(26,017
)
Other comprehensive income (loss) attributable to Universal Corporation:
 
 
 
 
Amortization included in earnings (net of tax benefit of $(1,257) and $(806)) (3)
 
2,425

 
1,540

Other comprehensive income (loss) attributable to Universal Corporation, net of income taxes
 
2,425

 
1,540

Balance at end of period
 
$
(37,615
)
 
$
(24,477
)
 
 
 
 
 
Total accumulated other comprehensive loss at end of period
 
$
(70,439
)
 
$
(47,168
)
(1)  
Gain (loss) on foreign currency cash flow hedges related to forecast purchases of tobacco is reclassified from accumulated other comprehensive income (loss) to cost of goods sold when the tobacco is sold to customers. See Note 7 for additional information.
(2)  
Gain (loss) on interest rate cash flow hedges is reclassified from accumulated other comprehensive income (loss) to interest expense when the related interest payments are made on the debt or upon termination of the interest rate swap agreements prior to their scheduled maturity dates. See Note 7 for additional information.
(3)  
This accumulated other comprehensive income (loss) component is included in the computation of net periodic benefit cost. See Note 9 for additional information.

22


NOTE 13. CHANGES IN SHAREHOLDERS' EQUITY AND NONCONTROLLING INTERESTS IN SUBSIDIARIES

A reconciliation of the changes in Universal Corporation shareholders’ equity and noncontrolling interests in subsidiaries for the nine months ended December 31, 2015 and 2014 is as follows:

 
 
Nine Months Ended December 31, 2015
 
Nine Months Ended December 31, 2014
(in thousands of dollars)
 
Universal Corporation
 
Non-controlling Interests
 
Total
 
Universal Corporation
 
Non-controlling Interests
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of year
 
$
1,362,725

 
$
34,369

 
$
1,397,094

 
$
1,378,230

 
$
32,662

 
$
1,410,892

Changes in preferred stock
 
 
 
 
 
 
 
 
 
 
 
 
Repurchase of Series B 6.75% convertible perpetual preferred stock
 

 

 

 
(390
)
 

 
(390
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Changes in common stock
 
 

 
 

 
 
 
 

 
 

 
 
Issuance of common stock
 

 

 

 
187

 

 
187

Repurchase of common stock