Document
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 SEPTEMBER 30, 2017
 
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, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth 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
Emerging growth company o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 November 3, 2017, the total number of shares of common stock outstanding was 25,114,349.



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 September 30,
 
Six Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
(Unaudited)
 
(Unaudited)
Sales and other operating revenues
 
$
488,248

 
$
456,942

 
$
772,870

 
$
752,417

Costs and expenses
 
 
 
 
 
 
 
 
Cost of goods sold
 
395,172

 
369,098

 
625,937

 
612,376

Selling, general and administrative expenses
 
48,101

 
40,834

 
95,403

 
101,033

Restructuring and impairment costs
 

 
3,682

 

 
3,682

Operating income
 
44,975

 
43,328

 
51,530

 
35,326

Equity in pretax earnings of unconsolidated affiliates
 
667

 
1,260

 
232

 
1,130

Interest income
 
526

 
271

 
1,196

 
634

Interest expense
 
3,964

 
4,335

 
7,896

 
8,389

Income before income taxes and other items
 
42,204

 
40,524

 
45,062

 
28,701

Income taxes
 
13,898

 
14,026

 
13,435

 
9,707

Net income
 
28,306

 
26,498

 
31,627

 
18,994

Less: net (income) loss attributable to noncontrolling interests in subsidiaries
 
(2,139
)
 
(1,234
)
 
(1,883
)
 
794

Net income attributable to Universal Corporation
 
26,167

 
25,264

 
29,744

 
19,788

Dividends on Universal Corporation convertible perpetual preferred stock
 

 
(3,687
)
 

 
(7,374
)
Earnings available to Universal Corporation common shareholders
 
$
26,167

 
$
21,577

 
$
29,744

 
$
12,414

 
 
 
 
 
 
 
 
 
Earnings per share attributable to Universal Corporation common shareholders:
 
 
 
 
 
 
 
 
Basic
 
$
1.03

 
$
0.95

 
$
1.17

 
$
0.55

Diluted
 
$
1.02

 
$
0.90

 
$
1.16

 
$
0.54

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
25,334,661

 
22,777,394

 
25,370,783

 
22,755,927

Diluted
 
25,546,546

 
27,968,156

 
25,589,158

 
23,073,341

 
 
 
 
 
 
 
 
 
Total comprehensive income, net of income taxes
 
$
33,079

 
$
29,651

 
$
42,188

 
$
17,321

Less: comprehensive income attributable to noncontrolling interests, net of income taxes
 
(2,076
)
 
(1,007
)
 
(1,772
)
 
1,238

Comprehensive income attributable to Universal Corporation, net of income taxes
 
$
31,003

 
$
28,644

 
$
40,416

 
$
18,559

 
 
 
 
 
 
 
 
 
Dividends declared per common share
 
$
0.54

 
$
0.53

 
$
1.08

 
$
1.06


See accompanying notes.


3


UNIVERSAL CORPORATION     
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)

 
 
September 30,
 
September 30,
 
March 31,
 
 
2017
  
2016
 
2017
 
 
(Unaudited)
 
(Unaudited)
 
 
ASSETS
 
 
 
 
 
 
Current assets
 
 
  
 
 
 
Cash and cash equivalents
 
$
41,203

  
$
294,894

 
$
283,993

Accounts receivable, net
 
338,700

  
251,805

 
439,288

Advances to suppliers, net
 
66,580

  
47,841

 
103,750

Accounts receivable—unconsolidated affiliates
 
50,533

  
51,558

 
2,373

Inventories—at lower of cost or net realizable value:
 
 
  
 
 
 
Tobacco
 
869,325

  
827,936

 
565,943

Other
 
90,108

  
86,472

 
68,087

Prepaid income taxes
 
21,110

  
24,448

 
16,713

Other current assets
 
94,294

  
56,026

 
81,252

Total current assets
 
1,571,853

  
1,640,980

 
1,561,399

 
 
 
 
 
 
 
Property, plant and equipment
 
 
  
 
 
 
Land
 
22,822

  
22,914

 
22,852

Buildings
 
268,702

  
266,107

 
266,802

Machinery and equipment
 
612,722

  
599,897

 
597,213

 
 
904,246

  
888,918

 
886,867

Less accumulated depreciation
 
(587,465
)
  
(566,686
)
 
(569,527
)
 
 
316,781

  
322,232

 
317,340

Other assets
 
 
  
 
 
 
Goodwill and other intangibles
 
99,059

  
99,033

 
98,888

Investments in unconsolidated affiliates
 
86,247

  
81,441

 
78,457

Deferred income taxes
 
23,136

  
25,720

 
25,422

Other noncurrent assets
 
42,434

  
49,107

 
41,899

 
 
250,876

  
255,301

 
244,666

 
 
 
 
 
 
 
Total assets
 
$
2,139,510

  
$
2,218,513

 
$
2,123,405


See accompanying notes.

4


UNIVERSAL CORPORATION     
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)

 
 
September 30,
 
September 30,
 
March 31,
 
 
2017
  
2016
 
2017
 
 
(Unaudited)
  
(Unaudited)
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
Current liabilities
 
 
  
 
 
 
Notes payable and overdrafts
 
$
98,268

 
$
71,002

 
$
59,133

Accounts payable and accrued expenses
 
142,337

 
133,133

 
153,515

Accounts payable—unconsolidated affiliates
 
56

 

 
7,231

Customer advances and deposits
 
16,807

 
37,334

 
11,007

Accrued compensation
 
19,509

 
18,885

 
32,007

Income taxes payable
 
3,935

 
1,240

 
5,103

Current portion of long-term debt
 

 

 

Total current liabilities
 
280,912

  
261,594

 
267,996

 
 
 
 
 
 
 
Long-term debt
 
368,909

 
368,556

 
368,733

Pensions and other postretirement benefits
 
74,636

 
80,005

 
80,689

Other long-term liabilities
 
31,338

 
41,413

 
31,424

Deferred income taxes
 
54,733

 
28,047

 
47,985

Total liabilities
 
810,528

 
779,615

 
796,827

 
 
 
 
 
 
 
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, no shares outstanding (218,490 at September 30, 2016, and none at March 31, 2017)
 

  
211,562

 

Common stock, no par value, 100,000,000 shares authorized 25,114,349 shares issued and outstanding (22,783,633 at September 30, 2016, and 25,274,506 at March 31, 2017)
 
320,121

 
210,569

 
321,207

Retained earnings
 
1,027,147

  
1,054,004

 
1,034,841

Accumulated other comprehensive loss
 
(58,887
)
  
(73,579
)
 
(69,559
)
Total Universal Corporation shareholders' equity
 
1,288,381

  
1,402,556

 
1,286,489

Noncontrolling interests in subsidiaries
 
40,601

 
36,342

 
40,089

Total shareholders' equity
 
1,328,982

 
1,438,898

 
1,326,578

 
 
 
 
 
 
 
Total liabilities and shareholders' equity
 
$
2,139,510

  
$
2,218,513

 
$
2,123,405


See accompanying notes.



5


UNIVERSAL CORPORATION     
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
 
 
Six Months Ended September 30,
 
 
2017
 
2016
 
 
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net income
 
$
31,627

 
$
18,994

Adjustments to reconcile net income to net cash provided (used) by operating activities:
 
 
 
 
Depreciation
 
17,485

 
17,324

Net provision for losses (recoveries) on advances and guaranteed loans to suppliers
 
937

 
(2,038
)
Foreign currency remeasurement (gain) loss, net
 
(3,944
)
 
11,119

Restructuring and impairment costs
 

 
3,682

Other, net
 
8,610

 
(1,108
)
Changes in operating assets and liabilities, net
 
(278,560
)
 
(25,548
)
Net cash provided (used) by operating activities
 
(223,845
)
 
22,425

 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Purchase of property, plant and equipment
 
(14,769
)
 
(17,567
)
Proceeds from sale of property, plant and equipment
 
3,273

 
447

Net cash used by investing activities
 
(11,496
)
 
(17,120
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Issuance (repayment) of short-term debt, net
 
36,085

 
5,210

Dividends paid to noncontrolling interests
 
(1,260
)
 
(1,260
)
Repurchase of common stock
 
(12,639
)
 

Dividends paid on convertible perpetual preferred stock
 

 
(7,374
)
Dividends paid on common stock
 
(27,324
)
 
(24,106
)
Other
 
(2,828
)
 
(2,245
)
Net cash used by financing activities
 
(7,966
)
 
(29,775
)
 
 
 
 
 
Effect of exchange rate changes on cash
 
517

 
(83
)
Net decrease in cash and cash equivalents
 
(242,790
)
 
(24,553
)
Cash and cash equivalents at beginning of year
 
283,993

 
319,447

 
 
 
 
 
Cash and cash equivalents at end of period
 
$
41,203

 
$
294,894

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, 2017.

NOTE 2.   ACCOUNTING PRONOUNCEMENTS

Pronouncements Adopted in Fiscal Year 2018

In July 2015, the Financial Accounting Standards Board ("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, and was adopted by the Company effective April 1, 2017, the beginning of fiscal year 2018. As required under the guidance, ASU 2015-11 is applied prospectively after the date of adoption, and its adoption did not have a material impact on the Company's consolidated financial statements.

Pronouncements to be Adopted in Future Periods
In May 2014, the 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 modified retrospective transition method that recognizes the cumulative effect on prior periods at the date of adoption together with additional footnote disclosures. Since the issuance of ASU 2014-09, the FASB has issued several amendments to provide additional supplemental guidance on certain aspects of the original pronouncement.  Universal expects to adopt ASU 2014-09 and the related supplemental amendments effective April 1, 2018, which is the beginning of the fiscal year ending March 31, 2019.  The Company formed a cross-functional project team to review its current revenue accounting policies and control processes, to complete a comprehensive analysis of the new guidance, and to determine the effect it will have on revenue recognition and financial statement disclosures for all customer contracts. The team has classified its customer contracts into primary revenue streams and is continuing the process of completing individual contract reviews and making final determinations with respect to provisions in the new guidance that may impact the timing of revenue recognition for certain customer arrangements.  At this time, the Company does not expect that the adoption of ASU 2014-09 will have a material impact on its consolidated financial statements.  The Company expects to use the modified retrospective transition method as its method of adoption.

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 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.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). ASU 2016-02 requires a lessee to recognize lease payment obligations as a lease liability and the corresponding right-of-use asset

7


as a leased asset in the balance sheet for the term of the lease. This guidance supersedes Topic 840 “Leases” and is effective for fiscal years beginning after December 15, 2018. The Company will be required to adopt ASU 2016-02 effective April 1, 2019, which is the beginning of its fiscal year ending March 31, 2020, and is currently evaluating the impact that the updated guidance will have on its consolidated financial statements.

In January 2017, the FASB issued Accounting Standards Update No. 2017-04, "Intangibles - Goodwill and Other (Topic 350)" ("ASU 2017-04"). Under current accounting guidance, the fair value of a reporting unit to which a specific goodwill balance relates is first compared to its carrying value in the financial statements (Step 1). If that comparison indicates that the goodwill is impaired, an implied fair value for the goodwill must then be calculated by deducting the individual fair values of all other assets and liabilities, including any unrecognized intangible assets, from the total fair value of the reporting unit. ASU 2017-04 simplifies the accounting guidance by eliminating Step 2 from the goodwill impairment test and using the fair value of the reporting unit determined in Step 1 to measure the goodwill impairment loss. The updated guidance is effective for fiscal years beginning after December 15, 2019. The Company will be required to adopt ASU 2017-04 effective April 1, 2020, which is the beginning of its fiscal year ending March 31, 2021, and is currently evaluating the impact that the updated guidance will have on its consolidated financial statements.

In March 2017, the FASB issued Accounting Standards Update No. 2017-07, "Compensation - Retirement Benefits (Topic 715)" ("ASU 2017-07"). ASU 2017-07 requires that an employer report the service cost component of pension or other postretirement benefits expense in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item or items are used to present the other components of net benefit cost, the line item or items must be appropriately described. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. The guidance is effective for fiscal years beginning after December 15, 2017. The Company will be required to adopt ASU 2017-07 effective April 1, 2018, which is the beginning of its fiscal year ending March 31, 2019. The line item classification changes required by the new guidance will not impact the Company's pretax earnings or net income; however, operating income and interest expense will increase by offsetting amounts that are not expected to be material to the Company's consolidated financial statements.
In August 2017, the FASB issued Accounting Standards Update No. 2017-12, "Derivatives and Hedging (Topic 815)"("ASU 2017-12").  ASU 2017-12 expands derivative strategies that quality for hedge accounting and amends presentation and disclosure requirements. The Company will be required to adopt ASU 2017-12 using a modified retrospective approach effective April 1, 2019, which is the beginning of its fiscal year ending March 31, 2020, and is currently evaluating the impact that the updated guidance 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 have long been industry practice in Brazil and support the farmers’ production of tobacco there. The Company's operating subsidiary in Brazil had guarantees outstanding at September 30, 2017, all of which 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 September 30, 2017, was the face amount, $31 million including unpaid accrued interest ($33 million at September 30, 2016, and $17 million at March 31, 2017). The fair value of the guarantees was a liability of approximately $1 million at September 30, 2017 ($2 million at September 30, 2016, and $1 million at March 31, 2017). In addition to these guarantees, the Company has other contingent liabilities totaling approximately $2 million at September 30, 2017, primarily related to outstanding letters of credit.

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 operations, which generate tax credits that they normally are entitled to recover through offset, refund, or sale to third parties. 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

8


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 $15 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 $17 million. Those amounts are based on the exchange rate for the Brazilian currency at September 30, 2017. 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 September 30, 2017, 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 $15 million (at the September 30, 2017 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 $15 million remaining assessment with interest, 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 September 30, 2017.
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 $5 million at the September 30, 2017 exchange rate, reflecting a substantial reduction from the original $17 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 challenged the full amount of the claim. The range of reasonably possible loss is considered to be zero up to the full $5 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 September 30, 2017.

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 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, seedlings, 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 $91 million at September 30, 2017, $78 million at September 30, 2016, and $134 million at March 31, 2017. The related valuation allowances totaled $22 million at September 30, 2017, $28 million at September 30, 2016, and $27 million at March 31, 2017, and were estimated based on the Company’s historical loss information and crop projections. The allowances were increased by net provisions of approximately $1 million and reduced by net recoveries of $2 million in the six-month periods ended September 30, 2017 and 2016, respectively. These net provisions and recoveries 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.


9


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 September 30, 2017, the aggregate balance of recoverable tax credits held by the Company’s subsidiaries totaled approximately $53 million ($35 million at September 30, 2016, and $45 million at March 31, 2017), and the related valuation allowances totaled approximately $17 million ($10 million at September 30, 2016, and $13 million at March 31, 2017). The net balances are reported in other current assets and other noncurrent assets in the consolidated balance sheets.

Conversion of Series B 6.75% Convertible Perpetual Preferred Stock
In December 2016, holders of 111,072 shares of the Company’s Series B 6.75% Convertible Perpetual Preferred Stock (approximately 50.8% of the outstanding shares) voluntarily exercised their conversion rights under the original issuance terms of the preferred shares. The Company chose to satisfy the full conversion obligation for those preferred shares with shares of its common stock, issuing 2,487,118 common shares at the applicable conversion rate in exchange for the preferred shares tendered. The Company recorded a non-cash reclassification of $107.6 million from preferred stock to common stock in the third quarter of fiscal year 2017 to reflect the conversion of those preferred shares.
On January 9, 2017, the Company announced a mandatory conversion of all 107,418 remaining outstanding shares of the preferred stock after meeting the requirements to initiate the mandatory conversion under the original terms of the preferred shares. The Company chose to satisfy the full conversion obligation for the mandatory conversion in cash, paying approximately $178.4 million for those preferred shares on January 31, 2017 to complete the conversion.
With the completion of the mandatory conversion in January 2017, the Company’s outstanding equity securities consist only of its common stock. Dividend payments on the preferred shares, which previously totaled approximately $15 million annually, were discontinued. Although the conversions of the preferred stock into common stock or for cash did not impact the Company’s net income, the shares converted for cash under the mandatory conversion in January 2017 resulted in a one-time reduction of retained earnings of approximately $74.4 million during the fourth quarter of fiscal year 2017, representing the excess of the conversion cost over the carrying value of those shares. The reduction in retained earnings also resulted in a corresponding one-time reduction of earnings available to common shareholders for the fourth quarter and fiscal year ended March 31, 2017 for purposes of determining the amounts reported for basic and diluted earnings per share for those periods.


10


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.

In the second quarter of fiscal year 2017, the Company recorded restructuring and impairment costs totaling $3.7 million primarily related to the Company's decision to close its tobacco processing facility in Hungary. The Company is now processing tobaccos sourced from Hungary in its factories in Italy. The costs incurred for the change in operations in Hungary included statutory employee termination benefits and impairment charges related to certain property and equipment.  All of the termination benefits were paid in the quarter the charge was recorded. The majority of the restructuring and impairment costs incurred were related to operations that are part of the Other Regions reportable segment of the Company's Flue-Cured and Burley Tobacco Operations.

There were no restructuring and impairment costs incurred for the six-month period in fiscal year 2018. 

NOTE 5.   EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share:
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(in thousands, except share and per share data)
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
Basic Earnings Per Share
 
 
 
 
 
 
 
 
Numerator for basic earnings per share
 
 
 
 
 
 
 
 
Net income attributable to Universal Corporation
 
$
26,167

 
$
25,264

 
$
29,744

 
$
19,788

Less: Dividends on convertible perpetual preferred stock
 

 
(3,687
)
 

 
(7,374
)
Earnings available to Universal Corporation common shareholders for calculation of basic earnings per share
 
26,167

 
21,577

 
29,744

 
12,414

 
 
 
 
 
 
 
 
 
Denominator for basic earnings per share
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
25,334,661

 
22,777,394

 
25,370,783

 
22,755,927

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
1.03

 
$
0.95

 
$
1.17

 
$
0.55

 
 
 
 
 
 
 
 
 
Diluted Earnings Per Share
 
 
 
 
 
 
 
 
Numerator for diluted earnings per share
 
 
 
 
 
 
 
 
Earnings available to Universal Corporation common shareholders
 
$
26,167

 
$
21,577

 
$
29,744

 
$
12,414

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

 
3,687

 

 

Earnings available to Universal Corporation common shareholders for calculation of diluted earnings per share
 
26,167

 
25,264

 
29,744

 
12,414

 
 
 
 
 
 
 
 
 
Denominator for diluted earnings per share:
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
25,334,661

 
22,777,394

 
25,370,783

 
22,755,927

Effect of dilutive securities (if conversion or exercise assumed)
 
 
 
 
 
 
 
 
Convertible perpetual preferred stock
 

 
4,883,372

 

 

Employee share-based awards
 
211,885

 
307,390

 
218,375

 
317,414

Denominator for diluted earnings per share
 
25,546,546

 
27,968,156

 
25,589,158

 
23,073,341

 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
1.02

 
$
0.90

 
$
1.16

 
$
0.54

As discussed Note 3, all outstanding shares of the Company's convertible perpetual preferred stock were converted for common stock or cash in the third and fourth quarters of fiscal year 2017, and therefore none were outstanding for the three- and six-month periods ended September 30, 2017.


11


The Company had the following potentially dilutive securities (stock appreciation rights) outstanding for the six months ended September 30, 2016 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:
 
 
Six Months Ended September 30,
 
 
2016
Potentially dilutive securities
 
127,400

Weighted-average exercise price
 
$
62.66

At September 30, 2017, all previously-granted stock appreciation rights had been exercised or had expired, and none were outstanding.

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 for the quarter ended September 30, 2017 was 32.9%, compared to 34.6% for the same quarter in the prior fiscal year.  In the current quarter, the Company recorded income from a life insurance benefit that is not subject to income tax.  That income was treated as a discrete item for tax purposes in the quarter, which primarily accounted for the lower effective tax rate.  For the six months ended September 30, 2017, the consolidated effective tax rate was 29.8%, compared to 33.8% for the prior year period.  In addition to the non-taxable life insurance income in the second quarter, the six-month rate for the current year was favorably impacted by a lower effective tax rate on dividend income from unconsolidated operations and by excess tax deductions related to the vesting of stock-based compensation, both of which were accounted for as discrete items in the first quarter.  Excluding the discrete items, the effective tax rates for the current and prior year periods would have been relatively comparable and slightly below the 35% U.S. federal statutory income tax rate primarily due to the effect of exchange rate changes on deferred tax assets and liabilities of foreign subsidiaries.


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 has been managed by entering into interest rate swap agreements, and foreign currency exchange rate risk has been 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 comprehensive 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.

Cash Flow 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. Although no significant ineffectiveness is expected with this hedging strategy, the effectiveness of the interest rate swaps is evaluated on a quarterly basis. At September 30, 2017, the total notional amount of the interest rate swaps was $370 million, which corresponded with the aggregate outstanding balance of the term loans.

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

12


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 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 six months of fiscal years 2018 and 2017 was as follows:

 
 
Six Months Ended September 30,
(in millions of dollars)
 
2017
 
2016
 
 
 
 
 
Tobacco purchases
 
$
19.4

 
$
9.7

Processing costs
 
7.3

 
2.7

Total
 
$
26.7

 
$
12.4


The increased U.S. dollar notional amounts for tobacco purchases and processing costs hedged during the six months ended September 30, 2017 reflect the increased size of the 2017 Brazilian crop and variations in the timing of fixed-price orders from customers for their purchases from the respective crop years. 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.

All forward contracts to hedge purchases of the 2017 crop in Brazil matured and settled by September 30, 2017. For substantially all hedge gains and losses recorded in accumulated other comprehensive loss at September 30, 2017, the Company expects to complete the sale of the tobacco and recognize the amounts in earnings during fiscal year 2018.

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
September 30, 2017 and 2016, and March 31, 2017, were approximately $37.8 million, $29.3 million, and $33.0 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, thus hedging a portion of the overall position.


13


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.

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 six-month periods ended September 30, 2017 and 2016:

 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(in thousands of dollars)
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
Cash Flow Hedges - Interest Rate Swap Agreements
 
 
 
 
 
 
 
 
Derivative
 
 
 
 
 
 
 
 
Effective Portion of Hedge
 
 
 
 
 
 
 
 
Gain (loss) recorded in accumulated other comprehensive loss
 
$
86

 
$
2,012

 
$
(1,426
)
 
$
(2,392
)
Gain (loss) reclassified from accumulated other comprehensive loss into earnings
 
$
(353
)
 
$
(1,055
)
 
$
(917
)
 
$
(2,148
)
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
 
$
491

 
$

 
$
(1,101
)
 
$
453

Gain (loss) reclassified from accumulated other comprehensive loss into earnings
 
$
(440
)
 
$
654

 
$
(442
)
 
$
668

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
 
$
(2
)
 
$

 
$
(5
)
 
$
246

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
 
$
(140
)
 
$
113

 
$
(703
)
 
$
(1,356
)
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 loss of approximately $0.7 million remained in accumulated other comprehensive loss at September 30, 2017. That balance reflects gains and losses on contracts related to the 2017 crop, less the amount reclassified to earnings related to tobacco sold through September 30, 2017. 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 2018 as the 2017 Brazilian crop tobacco is sold to customers. Based on the hedging strategy, as the gain

14


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.
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 September 30, 2017 and 2016, and March 31, 2017:

 
 
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)
 
 
Sept. 30, 2017
 
Sept. 30, 2016
 
March 31, 2017
 
 
Sept. 30, 2017
 
Sept. 30, 2016
 
March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap agreements
 
Other
non-current
assets
 
$
1,640

 
$

 
$
2,149

 
Other
long-term
liabilities
 
$

 
$
11,010

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward foreign currency exchange contracts
 
Other
current
assets
 

 

 
56

 
Accounts
payable and
accrued
expenses
 

 

 
55

Total
 
 
 
$
1,640

 
$

 
$
2,205

 
 
 
$

 
$
11,010

 
$
55

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Forward foreign currency exchange contracts
 
Other
current
assets
 
$
394

 
$
140

 
$
917

 
Accounts
payable and
accrued
expenses
 
$
248

 
$
1,554

 
$
120

Total
 
 
 
$
394

 
$
140

 
$
917

 
 
 
$
248

 
$
1,554

 
$
120


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 values 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.


15


As permitted under the accounting guidance, the Company uses net asset value per share ("NAV") as a practical expedient to measure the fair value of its money market funds. 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.

At September 30, 2017 and 2016, and at March 31, 2017, 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 or the NAV practical expedient:
 
 
September 30, 2017
 
 
 
 
Fair Value Hierarchy
 
 
(in thousands of dollars)
 
NAV
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
1,622

 
$

 
$

 
$

 
$
1,622

Trading securities associated with deferred compensation plans
 

 
17,386

 

 

 
17,386

Interest rate swap agreements
 

 

 
1,640

 

 
1,640

Forward foreign currency exchange contracts
 

 

 
394

 

 
394

Total financial assets measured and reported at fair value
 
$
1,622

 
$
17,386

 
$
2,034

 
$

 
$
21,042

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Guarantees of bank loans to tobacco growers
 
$

 
$

 
$

 
$
970

 
$
970

Forward foreign currency exchange contracts
 

 

 
248

 

 
248

Total financial liabilities measured and reported at fair value
 
$

 
$

 
$
248

 
$
970

 
$
1,218


 
 
September 30, 2016
 
 
 
 
Fair Value Hierarchy
 
 
(in thousands of dollars)
 
NAV
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
136,879

 
$

 
$

 
$

 
$
136,879

Trading securities associated with deferred compensation plans
 

 
17,310

 

 

 
17,310

Forward foreign currency exchange contracts
 

 

 
140

 

 
140

Total financial assets measured and reported at fair value
 
$
136,879

 
$
17,310

 
$
140

 
$

 
$
154,329

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Guarantees of bank loans to tobacco growers
 
$

 
$

 
$

 
$
1,722

 
$
1,722

Interest rate swap agreements
 

 

 
11,010

 

 
11,010

Forward foreign currency exchange contracts
 

 

 
1,554

 

 
1,554

Total financial liabilities measured and reported at fair value
 
$

 
$

 
$
12,564

 
$
1,722

 
$
14,286




16


 
 
March 31, 2017
 
 
 
 
Fair Value Hierarchy
 
 
(in thousands of dollars)
 
NAV
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
137,145

 
$

 
$

 
$

 
$
137,145

Trading securities associated with deferred compensation plans
 

 
17,726

 

 

 
17,726

Interest rate swap agreements
 

 

 
2,149

 

 
2,149

Forward foreign currency exchange contracts
 

 

 
973

 

 
973

Total financial assets measured and reported at fair value
 
$
137,145

 
$
17,726

 
$
3,122

 
$

 
$
157,993

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Guarantees of bank loans to tobacco growers
 
$

 
$

 
$

 
$
1,177

 
$
1,177

Forward foreign currency exchange contracts
 

 

 
175

 

 
175

Total financial liabilities measured and reported at fair value
 
$

 
$

 
$
175

 
$
1,177

 
$
1,352


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 NAV, which is the amount at which the funds are redeemable and is used as a practical expedient for fair value. These funds are not classified in the fair value hierarchy, but are disclosed as part of the fair value table above.

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. 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 six months ended September 30, 2017 and 2016 is provided below.
 
 
Six Months Ended September 30,
(in thousands of dollars)
 
2017
 
2016
 
 
 
 
 
Balance at beginning of year
 
$
1,177

 
$
1,628

Payments under the guarantees and transfers to allowance for loss on direct loans to farmers (removal of prior crop year loans from portfolio)
 
(1,169
)
 
(1,848
)
Provision for loss or transfers from allowance for loss on direct loans to farmers (addition of current crop year loans)
 
960

 
1,756

Change in discount rate and estimated collection period
 
11

 
26

Currency remeasurement
 
(9
)
 
160

Balance at end of period
 
$
970

 
$
1,722

    
Long-term Debt

The fair value of the Company’s long-term debt, including the current portion, was approximately $370 million at each of the balance sheet dates September 30, 2017, September 30, 2016, and March 31, 2017. The Company estimates the fair value of its long-term debt using Level 2 inputs which are based upon quoted market prices for the same or similar obligations or on calculations that are based 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, although postretirement life insurance is no longer provided for active employees.

The components of the Company’s net periodic benefit cost were as follows:
 
 
Pension Benefits
 
Other Postretirement Benefits
 
 
Three Months Ended September 30,
 
Three Months Ended September 30,
(in thousands of dollars)
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
Service cost
 
$
1,318

  
$
1,359

 
$
65

  
$
74

Interest cost
 
2,439

  
2,467

 
386

  
383

Expected return on plan assets
 
(3,717
)
  
(3,589
)
 
(22
)
  
(11
)
Net amortization and deferral
 
815

  
838

 
(71
)
  
(100
)
Net periodic benefit cost
 
$
855

 
$
1,075

 
$
358

 
$
346


18


 
 
Pension Benefits
 
Other Postretirement Benefits
 
 
Six Months Ended September 30,
 
Six Months Ended September 30,
(in thousands of dollars)
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
Service cost
 
$
2,629

  
$
2,720

 
$
129

  
$
147

Interest cost
 
4,873

  
4,936

 
769

  
758

Expected return on plan assets
 
(7,434
)
  
(7,178
)
 
(44
)
  
(22
)
Net amortization and deferral
 
1,630

  
1,676

 
(142
)
  
(200
)
Net periodic benefit cost
 
$
1,698

 
$
2,154

 
$
712

 
$
683

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

During the six months ended September 30, 2017, the Company made contributions of approximately $7.2 million to its pension plans. Additional contributions of approximately $0.7 million are expected during the remaining six months of fiscal year 2018.


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, and PSAs are currently outstanding under the Plans. The Company has not made grants of SARs or stock options in recent years, and all remaining SARs and stock options were either exercised or expired by the end of fiscal year 2017. 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 at the end of a three-year performance period that begins with the year of the grant, are paid out in shares of common stock shortly after 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 following each annual meeting of shareholders and previously received restricted stock. 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 six-month periods ended September 30, 2017 and 2016, Universal issued the following stock-based awards, representing the regular annual grants to officers and outside directors of the Company:
 
 
Six Months Ended September 30,
 
 
2017
 
2016
 
 
 
 
 
RSUs:
 
 
 
 
Number granted
 
59,550

 
63,425

Grant date fair value
 
$
66.05

 
$
55.93

 
 
 
 
 
PSAs:
 
 
 
 
Number granted
 
39,100

 
54,675

Grant date fair value
 
$
60.37

 
$
49.17


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

19


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. The Company accounts for forfeitures of stock-based awards as they occur. For the six-month periods ended September 30, 2017 and 2016, the Company recorded total stock-based compensation expense of approximately $4.2 million and $3.5 million, respectively. The Company expects to recognize stock-based compensation expense of approximately $3.0 million during the remaining six months of fiscal year 2018.


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 and comprehensive income were as follows:

 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(in thousands of dollars)
 
2017
 
2016
 
2017
 
2016
 
 
 
 
 
 
 
 
 
SALES AND OTHER OPERATING REVENUES
 
 
 
 
 
 
 
 
Flue-Cured and Burley Leaf Tobacco Operations:
 
 
 
 
 
 
 
 
   North America
 
$
58,668

 
$
80,789

 
$
111,992

   
$
153,471

   Other Regions (1)
 
381,164

 
318,576

 
565,576

   
496,592

      Subtotal
 
439,832

 
399,365

 
677,568

 
650,063

Other Tobacco Operations (2)
 
48,416

 
57,577

 
95,302

   
102,354

Consolidated sales and other operating revenue
 
$
488,248

 
$
456,942

 
$
772,870

 
$
752,417

 
 
 
 
 
 
 
 
 
OPERATING INCOME (LOSS)
 
 
 
 
 
 
 
 
Flue-Cured and Burley Leaf Tobacco Operations:
 
 
 
 
 
 
 
 
   North America
 
$
7,899

   
$
13,531

 
$
10,264

   
$
20,379

   Other Regions (1)
 
37,516

   
32,342

 
41,593

   
15,325

      Subtotal
 
45,415

 
45,873

 
51,857

 
35,704

Other Tobacco Operations (2)
 
227

   
2,397

 
(95
)
   
4,434

Segment operating income
 
45,642

 
48,270

 
51,762

 
40,138

 Deduct: Equity in pretax earnings of unconsolidated affiliates (3)
 
(667
)
 
(1,260
)
 
(232
)
 
(1,130
)
   Restructuring and impairment costs (4)
 

 
(3,682
)
 

 
(3,682
)
Consolidated operating income
 
$
44,975

 
$
43,328

 
$
51,530

 
$
35,326


(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 the business is accounted for on the equity method and its financial results consist principally of equity in the pretax earnings of an unconsolidated affiliate.
(3) 
Equity in pretax earnings 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.


20


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 six months ended September 30, 2017 and 2016:
 
 
Six Months Ended September 30,
(in thousands of dollars)
 
2017
 
2016
Foreign currency translation:
 
 
 
 
Balance at beginning of year
 
$
(33,138
)
 
$
(26,992
)
Other comprehensive income (loss) attributable to Universal Corporation:
 
 
 
 
Net gain (loss) on foreign currency translation (net of tax (expense) benefit of $(4,874) and $1,249)
 
9,053

 
(2,319
)
Less: Net loss on foreign currency translation attributable to noncontrolling interests
 
111

 
444

Other comprehensive income (loss) attributable to Universal Corporation, net of income taxes
 
9,164

 
(1,875
)
Balance at end of period
 
$
(23,974
)
 
$
(28,867
)
 
 
 
 
 
Foreign currency hedge:
 
 
 
 
Balance at beginning of year
 
$
(258
)
 
$
675

Other comprehensive income (loss) attributable to Universal Corporation:
 
 
 
 
Net gain (loss) on derivative instruments (net of tax (expense) benefit of $(573) and $58)
 
1,064

 
(107
)
Reclassification of (gain) loss to earnings (net of tax expense of $71 and $189) (1)
 
(132
)
 
(351
)
Other comprehensive income (loss) attributable to Universal Corporation, net of income taxes
 
932

 
(458
)
Balance at end of period
 
$
674

 
$
217

 
 
 
 
 
Interest rate hedge:
 
 
 
 
Balance at beginning of year
 
$
1,398

 
$
(6,997
)
Other comprehensive income (loss) attributable to Universal Corporation:
 
 
 
 
Net gain (loss) on derivative instruments (net of tax benefit of $499 and $837)
 
(926
)
 
(1,556
)
Reclassification of loss to earnings (net of tax benefit of $(321) and $(752)) (2)
 
596

 
1,397

Other comprehensive income (loss) attributable to Universal Corporation, net of income taxes
 
(330
)
 
(159
)
Balance at end of period
 
$
1,068

 
$
(7,156
)
 
 
 
 
 
Pension and other postretirement benefit plans:
 
 
 
 
Balance at beginning of year
 
$
(37,561
)
 
$
(39,036
)
Other comprehensive income (loss) attributable to Universal Corporation:
 
 
 
 
Amortization included in earnings (net of tax benefit of $(488) and $(680)) (3)
 
906

 
1,263

Other comprehensive income (loss) attributable to Universal Corporation, net of income taxes
 
906

 
1,263

Balance at end of period
 
$
(36,655
)
 
$
(37,773
)
 
 
 
 
 
Total accumulated other comprehensive loss at end of period
 
$
(58,887
)
 
$
(73,579
)
(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 underlying 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.

21


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 six months ended September 30, 2017 and 2016 is as follows:

 
 
Six Months Ended September 30, 2017
 
Six Months Ended September 30, 2016
(in thousands of dollars)
 
Universal Corporation
 
Non-controlling Interests
 
Total
 
Universal Corporation
 
Non-controlling Interests
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of year
 
$
1,286,489

 
$
40,089

 
$
1,326,578

 
$
1,414,222

 
$
38,840

 
$
1,453,062

 
 
 
 
 
 
 
 
 
 
 
 
 
Changes in common stock
 
 

 
 

 
 
 
 

 
 

 
 
Repurchase of common stock
 
(2,790
)
 

 
(2,790
)
 

 

 

Accrual of stock-based compensation
 
4,181

 

 
4,181

 
3,535

 

 
3,535

Withholding of shares from stock-based compensation for grantee income taxes
 
(2,828
)
 

 
(2,828
)
 
(2,245
)
 

 
(2,245
)
Dividend equivalents on RSUs
 
351

 

 
351

 
333

 

</