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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
                        FOR THE QUARTERLY PERIOD ENDED
SEPTEMBER 30, 2019
 
 
OR
 
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
 
 
54-0414210
(State or other jurisdiction of
incorporation or organization)
 
 
(I.R.S. Employer
Identification Number)
 
 
 
 
9201 Forest Hill Avenue,
Richmond,
Virginia
23235
(Address of principal executive offices)
 
(Zip Code)


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

Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class
Trading Symbols
Name of Exchange on which registered
Common Stock, no par value
UVV
New York Stock Exchange

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.    Yesþ No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 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
Non-accelerated filer
Smaller reporting company
Emerging growth company
 
 
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 No
As of November 4, 2019, the total number of shares of common stock outstanding was 24,804,346.



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,
 
 
2019
 
2018
 
2019
 
2018
 
 
(Unaudited)
 
(Unaudited)
Sales and other operating revenues
 
$
475,921

 
$
539,604

 
$
772,836

 
$
919,323

Costs and expenses
 
 
 
 
 
 
 
 
Cost of goods sold
 
379,892

 
440,144

 
618,157

 
747,642

Selling, general and administrative expenses
 
52,830

 
45,090

 
103,966

 
108,942

Operating income
 
43,199

 
54,370

 
50,713

 
62,739

Equity in pretax earnings of unconsolidated affiliates
 
2,310

 
(614
)
 
2,350

 
(75
)
Other non-operating income
 
633

 
196

 
1,260

 
386

Interest income
 
240

 
299

 
1,248

 
811

Interest expense
 
5,136

 
4,593

 
9,164

 
8,542

Income before income taxes and other items
 
41,246

 
49,658

 
46,407

 
55,319

Income taxes
 
11,499

 
15,365

 
15,765

 
9,966

Net income
 
29,747

 
34,293

 
30,642

 
45,353

Less: net income attributable to noncontrolling interests in subsidiaries
 
(1,670
)
 
(2,847
)
 
(493
)
 
(728
)
Net income attributable to Universal Corporation
 
$
28,077

 
$
31,446

 
$
30,149

 
$
44,625

 
 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
 
Basic
 
$
1.12

 
$
1.25

 
$
1.20

 
$
1.78

Diluted
 
$
1.11

 
$
1.24

 
$
1.19

 
$
1.76

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
25,086,580

 
25,152,864

 
25,122,283

 
25,108,724

Diluted
 
25,197,325

 
25,337,720

 
25,240,600

 
25,311,292

 
 
 
 
 
 
 
 
 
Total comprehensive income, net of income taxes
 
$
14,908

 
$
34,582

 
$
11,456

 
$
32,105

Less: comprehensive income attributable to noncontrolling interests
 
(1,546
)
 
(2,742
)
 
(492
)
 
(464
)
Comprehensive income (loss) attributable to Universal Corporation
 
$
13,362

 
$
31,840

 
$
10,964

 
$
31,641

 
 
 
 
 
 
 
 
 
Dividends declared per common share
 
$
0.76

 
$
0.75

 
$
1.52

 
$
1.50


See accompanying notes.


3


UNIVERSAL CORPORATION     
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)

 
 
September 30,
 
September 30,
 
March 31,
 
 
2019
  
2018
 
2019
 
 
(Unaudited)
 
(Unaudited)
 
 
ASSETS
 
 
 
 
 
 
Current assets
 
 
  
 
 
 
Cash and cash equivalents
 
$
53,173

  
$
67,876

 
$
297,556

Accounts receivable, net
 
337,825

  
355,674

 
368,110

Advances to suppliers, net
 
75,828

  
53,823

 
106,850

Accounts receivable—unconsolidated affiliates
 
82,812

  
107,198

 
30,951

Inventories—at lower of cost or net realizable value:
 
 
  
 
 
 
Tobacco
 
918,592

  
935,406

 
629,606

Other
 
97,536

  
87,958

 
69,611

Prepaid income taxes
 
13,454

  
17,131

 
14,264

Other current assets
 
70,338

  
73,862

 
71,197

Total current assets
 
1,649,558

  
1,698,928

 
1,588,145

 
 
 
 
 
 
 
Property, plant and equipment
 
 
  
 
 
 
Land
 
22,696

  
23,020

 
22,952

Buildings
 
261,599

  
269,738

 
261,976

Machinery and equipment
 
609,320

  
642,915

 
608,191

 
 
893,615

  
935,673

 
893,119

Less accumulated depreciation
 
(598,184
)
  
(613,130
)
 
(590,625
)
 
 
295,431

  
322,543

 
302,494

Other assets
 
 
  
 
 
 
Operating lease right-of-use assets
 
34,838

 

 

Goodwill and other intangibles
 
97,998

  
98,860

 
97,994

Investments in unconsolidated affiliates
 
79,072

  
83,962

 
80,482

Deferred income taxes
 
16,250

  
20,473

 
13,357

Other noncurrent assets
 
45,085

  
47,480

 
50,712

 
 
273,243

  
250,775

 
242,545

 
 
 
 
 
 
 
Total assets
 
$
2,218,232

  
$
2,272,246

 
$
2,133,184


See accompanying notes.

4


UNIVERSAL CORPORATION     
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)

 
 
September 30,
 
September 30,
 
March 31,
 
 
2019
  
2018
 
2019
 
 
(Unaudited)
  
(Unaudited)
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
Current liabilities
 
 
  
 
 
 
Notes payable and overdrafts
 
$
155,352

 
$
148,049

 
$
54,023

Accounts payable and accrued expenses
 
158,731

 
162,972

 
145,506

Accounts payable—unconsolidated affiliates
 
56

 
4,862

 
106

Customer advances and deposits
 
6,513

 
45,098

 
21,675

Accrued compensation
 
22,046

 
22,610

 
31,372

Income taxes payable
 
1,155

 
6,668

 
1,066

Current portion of operating lease liabilities
 
8,591

 

 

Current portion of long-term debt
 

 

 

Total current liabilities
 
352,444

  
390,259

 
253,748

 
 
 
 
 
 
 
Long-term debt
 
368,633

 
369,262

 
368,503

Pensions and other postretirement benefits
 
54,113

 
56,347

 
59,257

Long-term operating lease liabilities
 
23,331

 

 

Other long-term liabilities
 
56,146

 
41,758

 
43,214

Deferred income taxes
 
24,982

 
36,202

 
28,584

Total liabilities
 
879,649

 
893,828

 
753,306

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

  

 

Common stock, no par value, 100,000,000 shares authorized 24,841,863 shares issued and outstanding at September 30, 2019 (24,968,799 at September 30, 2018 and 24,989,946 at March 31, 2019)
 
324,927

 
324,626

 
326,600

Retained earnings
 
1,088,608

  
1,084,763

 
1,106,178

Accumulated other comprehensive loss
 
(114,876
)
  
(73,048
)
 
(95,691
)
Total Universal Corporation shareholders' equity
 
1,298,659

  
1,336,341

 
1,337,087

Noncontrolling interests in subsidiaries
 
39,924

 
42,077

 
42,791

Total shareholders' equity
 
1,338,583

 
1,378,418

 
1,379,878

 
 
 
 
 
 
 
Total liabilities and shareholders' equity
 
$
2,218,232

  
$
2,272,246

 
$
2,133,184


See accompanying notes.



5


UNIVERSAL CORPORATION     
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
 
 
Six Months Ended September 30,
 
 
2019
 
2018
 
 
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net income
 
$
30,642

 
$
45,353

Adjustments to reconcile net income to net cash used by operating activities:
 
 
 
 
Depreciation
 
18,231

 
18,440

Net provision for losses (recoveries) on advances and guaranteed loans to suppliers
 
(1,885
)
 
(5,408
)
Foreign currency remeasurement (gain) loss, net
 
1,767

 
3,952

Restructuring payments
 
(298
)
 
(27
)
Other, net
 
(301
)
 
(2,459
)
Changes in operating assets and liabilities, net
 
(327,975
)
 
(272,847
)
Net cash used by operating activities
 
(279,819
)
 
(212,996
)
 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Purchase of property, plant and equipment
 
(13,308
)
 
(20,043
)
Proceeds from sale of property, plant and equipment
 
1,254

 
858

Other
 

 
2,000

Net cash used by investing activities
 
(12,054
)
 
(17,185
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Issuance of short-term debt, net
 
104,003

 
102,489

Dividends paid to noncontrolling interests
 
(3,359
)
 
(1,260
)
Repurchase of common stock
 
(12,338
)
 
(1,443
)
Dividends paid on common stock
 
(37,721
)
 
(32,430
)
Other
 
(2,883
)
 
(2,657
)
Net cash provided by financing activities
 
47,702

 
64,699

 
 
 
 
 
Effect of exchange rate changes on cash
 
(212
)
 
(770
)
Net decrease in cash and cash equivalents
 
(244,383
)
 
(166,252
)
Cash and cash equivalents at beginning of year
 
297,556

 
234,128

 
 
 
 
 
Cash and cash equivalents at end of period
 
$
53,173

 
$
67,876


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, 2019.

NOTE 2.   ACCOUNTING PRONOUNCEMENTS

Recently Adopted Pronouncements

The Company adopted Financial Accounting Standards Board ("FASB") Accounting Standards Update No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”) effective April 1, 2019, the beginning of the current fiscal year. For leases with fixed payment arrangements, ASU 2016-02 requires a lessee to recognize lease payment obligations as a lease liability and corresponding right-of-use asset in the balance sheet for the term of the lease. This guidance superseded Topic 840 “Leases.” The Company elected the practical expedient to not include leases with terms less than 12 months on the consolidated balance sheet. The Company elected the transition package of practical expedients that retained the historical lease identification, lease classification, and treatment of initial direct costs for leases prior to the adoption of ASU 2016-02. Additionally, as permitted under the new guidance the Company elected to not separate lease and non-lease components for certain classes of leased assets, including real estate. The Company elected the modified retrospective transition adoption method. Accordingly, on the date of adoption $36.6 million of operating lease right-of use assets and corresponding operating lease liabilities of $34.2 million were recognized on the Company's consolidated balance sheet.  The adoption of ASU 2016-02 did not result in a cumulative-effect adjustment to retained earnings. The disclosures required for lease accounting under the new guidance are provided in Note 7.

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, although early adoption is permitted. The Company early adopted ASU 2017-04 effective July 1, 2019. There was no material impact to the consolidated financial statements from the adoption of ASU 2017-04.
 
Pronouncements to be Adopted in Future Periods

In June 2016, the FASB issued Accounting Standards Update 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" (“ASU 2016-13”).  ASU 2016-13 requires companies to measure credit losses utilizing a methodology that reflects expected credit losses and requires a consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company will be required to adopt ASU 2016-13 effective April 1, 2020, which is the beginning of its fiscal year ending March 31, 2021, although early adoption is permitted. The Company is currently evaluating the impact of adopting this standard on its consolidated financial statements.

In August 2018, the FASB issued Accounting Standards Update No. 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of FASB Emerging Issues Task Force)" ("ASU 2018-15"). ASU 2018-15 aligns the requirements for capitalizing implementation costs in a cloud computing arrangement service contract with the requirements for capitalizing implementation costs incurred for an internal-use software license. Under that model, implementation costs are capitalized or expensed depending on the nature of the costs and the project stage during which they are incurred. Capitalized implementation costs are amortized over the term of the associated hosted cloud computing arrangement service contract on a straight-line basis, unless another systematic and rational basis is more representative of the pattern in which the entity expects to benefit from its right to access the hosted software. Capitalized implementation costs would then be assessed for impairment in a manner similar to long-

7


lived assets. The new guidance is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Entities can choose to adopt the new guidance either prospectively to eligible costs incurred on or after the date the guidance is first applied or retrospectively. The Company will be required to adopt ASU 2018-15 effective April 1, 2020, which is the beginning of its fiscal year ending March 31, 2021, although early adoption is permitted. The Company is currently evaluating the impact of adopting this standard on its consolidated financial statements.

NOTE 3.  REVENUE FROM CONTRACTS WITH CUSTOMERS

The majority of the Company’s consolidated revenue consists of sales of processed leaf tobacco to customers. The Company also earns revenue from processing leaf tobacco owned by customers and from various other services provided to customers. Payment terms with customers vary depending on customer creditworthiness, product types, services provided, and other factors. Contract durations and payment terms for all revenue categories generally do not exceed one year. Therefore, the Company has applied a practical expedient to not adjust the transaction price for the effects of financing components, as the Company expects that the period from the time the revenue for a transaction is recognized to the time the customer pays for the related good or service transferred will be one year or less. Below is a description of the major revenue-generating categories from contracts with customers.

Tobacco Sales

The majority of the Company’s business involves purchasing leaf tobacco from farmers in the origins where it is grown, processing and packing the tobacco in its factories, and then transferring ownership and control of the tobacco to customers. On a much smaller basis, the Company also sources processed tobacco from third-party suppliers for resale to customers. The contracts for tobacco sales with customers create a performance obligation to transfer tobacco to the customer. Transaction prices for the sale of tobaccos are primarily based on negotiated fixed prices, but the Company does have a small number of cost-plus contracts with certain customers. Cost-plus arrangements provide the Company reimbursement of the cost to purchase and process the tobacco, plus a contractually agreed-upon profit margin. The Company utilizes the most likely amount methodology under the accounting guidance to recognize revenue for cost-plus arrangements with customers. Shipping and handling costs under tobacco sales contracts with customers are treated as fulfillment costs and included in the transaction price. Taxes assessed by government authorities on the sale of leaf tobacco products are excluded from the transaction price. At the point in time that the customer obtains control over the tobacco, which is typically aligned with physical shipment under the contractual terms with the customer, the Company completes its performance obligation and recognizes the revenue for the sale.

Processing Revenue

Processing and packing of customer-owned leaf tobacco is a short-duration process. Processing charges are primarily based on negotiated fixed prices per unit of weight processed. Under normal operating conditions, customer-owned raw tobacco that is placed into the production line exits as processed and packed tobacco within one hour and is then later transported to customer-designated storage facilities. The revenue for these services is recognized when the performance obligation is satisfied, which is generally when processing is completed. The Company’s operating history and contract analyses indicate that customer requirements for processed tobacco are consistently met upon completion of processing.

Other Revenue

From time to time, the Company enters into various arrangements with customers to provide other value-added services that may include blending, chemical and physical testing of tobacco, and service cutting for select manufacturers. These other arrangements are a much smaller portion of the Company’s business, are typically less frequent, and are separate and distinct contractual agreements from the Company’s tobacco sales or processing arrangements with customers. The transaction prices and timing of revenue recognition of these items are determined by the specifics of each contract.


8


Disaggregation of Revenue from Contracts with Customers

The following table disaggregates the Company’s revenue by significant revenue-generating category:

 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(in thousands of dollars)
 
2019
 
2018
 
2019
 
2018
 
 
 
 
 
 
 
 
 
Tobacco sales
 
$
449,431

 
$
509,632

 
$
717,488

 
$
854,769

Processing revenue
 
16,701

 
17,394

 
35,135

 
39,101

Other sales and revenue from contracts with customers
 
8,381

 
10,520

 
17,791

 
18,646

   Total revenue from contracts with customers
 
474,513

 
537,546

 
770,414

 
912,516

Other operating sales and revenues
 
1,408

 
2,058

 
2,422

 
6,807

   Consolidated sales and other operating revenues
 
$
475,921

 
$
539,604

 
$
772,836

 
$
919,323


Other operating sales and revenues consists principally of interest on advances to suppliers and dividend income from unconsolidated affiliates.

NOTE 4.   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, 2019, 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, 2019, was the face amount, $5 million including unpaid accrued interest ($29 million at September 30, 2018, and $17 million at March 31, 2019). The fair value of the guarantees was a liability of approximately $0.1 million at September 30, 2019 ($0.9 million at September 30, 2018, and $0.8 million at March 31, 2019). In addition to these guarantees, the Company has other contingent liabilities totaling approximately $1 million at September 30, 2019, 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 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 $11 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 $13 million. Those amounts are based on the exchange rate for the Brazilian currency at September 30, 2019. 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, 2019, 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 September 30, 2019 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 with

9


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, 2019.
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, 2019 exchange rate, reflecting a substantial reduction from the original $13 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, 2019.

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 VAT credits that the subsidiary may be able to recover.

Tanzania Fair Competition Commission Proceeding

In June 2012, the Company’s Tanzanian subsidiary, Tanzania Leaf Tobacco Company Ltd. (“TLTC”), entered into a two crop-year supply agreement for unprocessed “green” tobacco with a newly-formed Tanzanian subsidiary of one of the Company’s major customers. The agreement involved green tobacco purchases from four of the approximately 400 grower cooperatives in Tanzania, which allowed the customer and its Tanzanian subsidiary on a small test basis to evaluate whether it would be a viable alternative for the customer to establish its own vertically integrated supply operations in that market. Prior to that time, the customer’s subsidiary did not exist, and it only purchased processed Tanzanian tobacco from tobacco dealers in specified amounts and only for certain grades and stalk positions. In contrast, the agreement with TLTC required the customer’s subsidiary to purchase green tobacco on a “run of crop” basis. “Run of crop” requires the purchase of all green tobacco produced on the tobacco plant, regardless of grade or stalk position. The agreement, therefore, enabled the customer’s subsidiary on a small test basis to evaluate the quality of green tobacco purchased on a “run of crop” basis and to assess how such tobacco would be suited to the customer's tobacco requirements. The customer unilaterally elected to establish its own vertically integrated supply operations in Tanzania after the expiration of the agreement, and its subsidiary began purchasing green tobacco directly from Tanzanian grower cooperatives during the second crop year thereafter.

Despite the pro-competitive object and effect of the agreement between TLTC and the customer’s subsidiary, in October 2016, the Tanzania Fair Competition Commission (“FCC”) notified TLTC and the customer’s subsidiary that it reviewed the agreement and provisionally concluded that it infringed Tanzania antitrust law by having the object and effect of preventing competition in the purchase of unprocessed green tobacco in the area in which the four grower cooperatives were located. The FCC also provisionally concluded that the Company’s U.S. subsidiary, Universal Leaf Tobacco Company, Inc. (“ULT”), and additional subsidiaries of the customer, were jointly and severally liable for the actions of TLTC and the customer’s Tanzanian subsidiary, respectively. TLTC and ULT submitted a written response contesting the FCC’s allegations, and on February 27, 2018, the FCC issued its decision to TLTC and ULT which ignored TLTC's and ULT's submissions and confirmed its initial conclusion that the agreement infringed Tanzanian antitrust law. In its decision, the FCC concluded incorrectly that the parties to the agreement unfairly benefited in the amount of $105 thousand. The FCC arbitrarily assessed a fine jointly against TLTC and ULT of approximately $197 million and a fine jointly against the customer’s Tanzanian subsidiary and another subsidiary of the customer exceeding $1 billion.

TLTC and ULT have worked closely with expert legal advisors and economists on this matter. Based on these engagements and consultations, the Company firmly believes the FCC’s allegations are frivolous and clearly without merit or support from the facts, law or economic analysis. The Company further believes the FCC’s proceedings were rife with irregularities and did not comply with applicable legal and regulatory procedures with respect to this matter, including failing to establish jurisdiction over ULT or to offer a legal justification for including ULT in the proceeding. To the contrary, the Company believes the facts, law, and economic analysis clearly support the legality and pro-competitive nature of the agreement and support a proper conclusion that there was no infringement of Tanzania antitrust law, and the agreement had no negative impact on the Tanzania tobacco market. The Company further believes the FCC’s proposed fine is ludicrous, unwarranted, and contrary to Tanzania law. TLTC and ULT immediately appealed the FCC findings to the Tanzania Fair Competition Tribunal, which immediately stayed the execution of any FCC fines. The Company is unable to predict how long the appeal process will take; however, the Company believes it could last several years. At this time, the Company believes that the likelihood of incurring any material liability in this matter is remote, and no amount has been recorded.

10



On January 22, 2019, the FCC delivered provisional findings regarding two new allegations of antitrust violations. In those two new provisional findings, the FCC has manufactured claims against ULT and ULT's subsidiaries in Tanzania, in addition to other parties in Tanzania. ULT and its Tanzania subsidiaries have already begun working closely with expert legal advisors on these matters and have prepared and submitted to the FCC proper and comprehensive responses. Based on the legal consultations to date the Company firmly believes the FCC's new allegations are frivolous and clearly without merit and lack facts, law or economic analysis to support them. In one of the two new matters, based on the Company's review of the provisional findings and consultation with counsel, the Company believes the FCC is seeking an equally large, ludicrous, unwarranted, and unlawful fine as the one sought in the current matter. The FCC's motivations for initiating these additional, spurious allegations against the Company's subsidiaries are unclear. At this time, the Company is unable to predict how long it will take to defend against the new matters including, if necessary, to appeal any final FCC decisions; however, the Company believes it could last several years. At this time, the Company believes that the likelihood of incurring any material liability in the new matters is remote, and no amount has been recorded for either one.
 
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 $94 million at September 30, 2019, $73 million at September 30, 2018, and $129 million at March 31, 2019. The related valuation allowances totaled $16 million at September 30, 2019, $16 million at September 30, 2018, and $18 million at March 31, 2019, and were estimated based on the Company’s historical loss information and crop projections. The allowances were reduced by net recoveries of approximately $1.9 million and $5.4 million in the six-month periods ended September 30, 2019 and 2018, 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.

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,

11


2019, the aggregate balance of recoverable tax credits held by the Company’s subsidiaries totaled approximately $56 million ($54 million at September 30, 2018, and $53 million at March 31, 2019), and the related valuation allowances totaled approximately $20 million ($17 million at September 30, 2018, and $17 million at March 31, 2019). The net balances are reported in other current assets and other noncurrent assets in the consolidated balance sheets.

Stock Repurchase Plan

A stock repurchase plan, which was authorized by our Board of Directors, became effective and was publicly announced on November 7, 2017 and further extended on May 29, 2019. This stock repurchase plan authorized the purchase of up to $100 million in common and/or preferred stock in open market or privately negotiated transactions, subject to market conditions and other factors. This stock repurchase program will expire on the earlier of November 15, 2020, or when the funds authorized for the program are exhausted. The program had $77.2 million of remaining capacity for repurchases of common and/or preferred stock at September 30, 2019.


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)
 
2019
 
2018
 
2019
 
2018
 
 
 
 
 
 
 
 
 
Basic Earnings Per Share
 
 
 
 
 
 
 
 
Numerator for basic earnings per share
 
 
 
 
 
 
 
 
Net income attributable to Universal Corporation
 
$
28,077

 
$
31,446

 
$
30,149

 
$
44,625

 
 
 
 
 
 
 
 
 
Denominator for basic earnings per share
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
25,086,580

 
25,152,864

 
25,122,283

 
25,108,724

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
1.12

 
$
1.25

 
$
1.20

 
$
1.78

 
 
 
 
 
 
 
 
 
Diluted Earnings Per Share
 
 
 
 
 
 
 
 
Numerator for diluted earnings per share
 
 
 
 
 
 
 
 
Net income attributable to Universal Corporation
 
$
28,077

 
$
31,446

 
$
30,149

 
$
44,625

 
 
 
 
 
 
 
 
 
Denominator for diluted earnings per share:
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
25,086,580

 
25,152,864

 
25,122,283

 
25,108,724

Effect of dilutive securities
 
 
 
 
 
 
 
 
Employee share-based awards
 
110,745

 
184,856

 
118,317

 
202,568

Denominator for diluted earnings per share
 
25,197,325

 
25,337,720

 
25,240,600

 
25,311,292

 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
1.11

 
$
1.24

 
$
1.19

 
$
1.76


NOTE 6.   INCOME TAXES

The Company operates in the United States and many foreign countries and 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 is affected by a number of factors, including the mix of domestic and foreign earnings and the effect of exchange rate changes on deferred taxes. Effective tax rates also reflect the benefit of various tax planning opportunities, as well as the net effect of items that were accounted for on a discrete basis in each period.
    
The consolidated effective income tax rates for the quarter and six months ended September 30, 2019 were 28% and 34%, respectively. In the first quarter of fiscal year 2020, the Company's consolidated effective income tax rate for the six months ended September 30, 2019 was affected by a $2.8 million net tax provision related to an unresolved tax matter at a foreign subsidiary.  Without the discrete item for the unresolved tax matter, the consolidated effective income tax rate for the six months ended September 30, 2019 would have been approximately 28% .

12



The consolidated effective income tax rates for the quarter and six months ended September 30, 2018 were approximately 31% and 18%, respectively.  During the first and second quarters of fiscal year 2019, the Company reversed amounts previously recorded for dividend withholding taxes on distributed and undistributed retained earnings of a foreign subsidiary.  The reversal followed the resolution of uncertainties with the local country taxing authorities with respect to the inclusion of the tax under a tax holiday applicable to the subsidiary and was attributable to retained earnings amounts previously distributed or expected to be distributed prior to the expiration of the tax holiday.  Without the dividend withholding tax reversal, the consolidated effective income tax rates for the quarter and six months would have been approximately 33% and 32%, respectively. 

NOTE 7.   LEASES

The Company, as a lessee, enters into operating leases for land, buildings, equipment, and vehicles. For all operating leases with terms greater than 12 months and with fixed payment arrangements, a lease liability and corresponding right-of-use asset are recognized in the balance sheet for the term of the lease by calculating the net present value of future lease payments. On the date of lease commencement, the present value of lease liabilities is determined by discounting the future lease payments by the Company’s collateralized incremental borrowing rate, adjusted for the lease term and currency of the lease payments. If a lease contains a renewal option that the Company is reasonably certain to exercise, the Company accounts for the original lease term and expected renewal term in the calculation of the lease liability and right-of-use asset.

The following table sets forth the right-of-use assets and lease liabilities for operating leases included in the Company’s consolidated balance sheet:
(in thousands)
 
September 30, 2019
 
 
 
Assets
 
 
   Operating lease right-of-use assets
 
$
34,838

 
 
 
Liabilities
 
 
    Current portion of operating lease liabilities
 
8,591

    Long-term operating lease liabilities
 
23,331

          Total operating lease liabilities
 
$
31,922


The following table sets forth the location and amount of operating lease costs included in the Company's consolidated statement of income:
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(in thousands)
 
2019
 
2019
 
 
 
 
 
Income Statement Location
 
 
 
 
   Cost of goods sold
 
$
2,591

 
$
5,209

   Selling, general, and administrative expenses
 
2,064

 
4,050

          Total operating lease costs(1)
 
$
4,655

 
$
9,259

(1) 
Includes variable operating lease costs.

For the fiscal year ended March 31, 2019, the Company recorded $17.6 million of total expense for operating leases.


13


The following table reconciles the undiscounted cash flows to the operating lease liabilities in the Company’s consolidated balance sheet:
(in thousands)
 
September 30, 2019
Maturity of Operating Lease Liabilities
 
 
2020 (excluding the six months ended September 30, 2019)
 
$
5,369

2021
 
8,807

2022
 
5,636

2023
 
4,309

2024
 
3,293

2025 and thereafter
 
9,995

          Total undiscounted cash flows for operating leases
 
$
37,409

          Less: Imputed interest
 
(5,487
)
Total operating lease liabilities
 
$
31,922



As of September 30, 2019, the Company has entered into additional operating leases that have not yet commenced, representing $1.0 million of future payments.

The following table sets forth supplemental information related to operating leases:
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(in thousands, except lease term and incremental borrowing rate)
 
2019
 
2019
 
 
 
 
 
Supplemental Cash Flow Information
 
 
 
 
Cash paid for amounts included in the measurement of operating lease liabilities
 
$
4,213

 
$
7,259

Right-of-use assets obtained in exchange for new operating leases
 
$
3,633

 
$
4,101

 
 
 
 
 
Weighted Average Remaining Lease Term (years)
 
 
 
6.15

 
 
 
 
 
Weighted Average Collateralized Incremental Borrowing Rate
 
 
 
4.75
%

NOTE 8.   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 and option 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 February 2019, the Company entered into receive-floating/pay-fixed interest rate swap agreements that were designated and qualify 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 2018. 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, 2019, 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 for two outstanding non-amortizing bank loans that were repaid concurrent with closing on the new bank credit facility. Those swap agreements were subsequently terminated in February 2019 concurrent with the inception of the new swap

14


agreements. The fair value of the previous swap agreements, approximately $5.4 million, was received from the counterparties upon termination and is being amortized from accumulated other comprehensive loss into earnings as a reduction of interest expense through the original maturity dates of those agreements.
Cash Flow Hedging Strategy for Foreign Currency Exchange Rate Risk Related to Sales of Crop Inputs, 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, sales of crop inputs (such as seeds and fertilizers) to farmers, 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 sales of crop inputs and cost of processed tobacco. From time to time, the Company enters into forward and option contracts to buy U.S. dollars and sell the local currency at future dates that coincide with the sale of crop inputs to farmers. In the case of forecast purchases of tobacco and the related processing costs, the Company enters into forward and option 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. These strategies offset the variability of future U.S. dollar cash flows for sales of crop inputs, tobacco purchases, and processing costs for the foreign currency notional amount hedged. These hedging strategies have been used mainly for sales of crop inputs, tobacco purchases, and processing costs in Brazil, although the Company has entered forward contracts to hedge exchange rate risk for a portion of the forecast tobacco purchases from the 2019 crop in Mozambique. The aggregate U.S. dollar notional amount of forward and option contracts entered for these purposes during the first six months of fiscal years 2020 and 2019 was as follows:

 
 
Six Months Ended September 30,
(in millions of dollars)
 
2019
 
2018
 
 
 
 
 
Tobacco purchases
 
$
72.0

 
$
59.8

Processing costs
 
26.3

 
18.1

Crop input sales
 
21.7

 

Total
 
$
120.0

 
$
77.9



The increased U.S. dollar notional amounts for tobacco purchases and processing costs hedged during the six months ended September 30, 2019, primarily reflect purchase and processing hedges entered into for the 2020 crop year in Brazil, which historically were entered into during the fourth quarter of the fiscal year. 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, 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 and option contracts related to sales of crop inputs and 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.

For substantially all hedge gains and losses related to 2019 crops recorded in accumulated other comprehensive income at September 30, 2019, the Company expects to complete the sale of the tobacco and recognize the amounts in earnings during fiscal year 2020. Purchases of the 2019 Brazilian crop are expected to be completed by August 2019, and all forward contracts to hedge these purchases will mature and be settled by that time. For hedged gains and losses related to the 2020 Brazilian crop recorded in accumulated other comprehensive income at September 30, 2019, the Company expects to complete the sale of tobacco and recognize the amounts in earnings during fiscal year 2021.

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, operating lease liabilities, 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

15


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, 2019 and 2018, and March 31, 2019, were approximately $36.0 million, $24.6 million, and $24.8 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.

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.

16



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:

 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(in thousands of dollars)
 
2019
 
2018
 
2019
 
2018
 
 
 
 
 
 
 
 
 
Cash Flow Hedges - Interest Rate Swap Agreements
 
 
 
 
 
 
 
 
Derivative
 
 
 
 
 
 
 
 
Effective Portion of Hedge
 
 
 
 
 
 
 
 
Gain (loss) recorded in accumulated other comprehensive loss
 
$
(5,443
)
 
$
1,119

 
$
(15,255
)
 
$
2,675

Gain (loss) reclassified from accumulated other comprehensive loss into earnings
 
$
(220
)
 
$
441

 
$
(225
)
 
$
732

Gain on terminated interest rate swaps amortized from accumulated other comprehensive loss into earnings
 
$
779

 
$

 
$
1,558

 
$

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 - Foreign Currency Exchange Contracts
 
 
 
 
 
 
 
 
Derivative
 
 
 
 
 
 
 
 
Effective Portion of Hedge
 
 
 
 
 
 
 
 
Gain (loss) recorded in accumulated other comprehensive loss
 
$
(1,993
)
 
$
101

 
$
39

 
$
(2,930
)
Gain (loss) reclassified from accumulated other comprehensive loss into earnings
 
$
276

 
$
(529
)
 
$
265

 
$
(554
)
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
 
$

 
$

 
$

 
$

Location of gain (loss) recognized in earnings
 
Selling, general and administrative expenses
Hedged Item
 
 
 
 
 
 
 
 
Description of hedged item
 
 Forecast purchases of tobacco in Brazil and Mozambique
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedges - Foreign Currency Exchange Contracts
 
 
 
 
 
 
 
 
Gain (loss) recognized in earnings
 
$
(2
)
 
$
2,688

 
$
49

 
$
(2,757
)
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 and Mozambique, a net hedge gain of approximately $0.1 million remained in accumulated other comprehensive loss at September 30, 2019. That balance reflects gains and losses on contracts related to the 2019 and 2020 Brazil crops and 2019 Mozambique crop, less the amount reclassified to earnings related to tobacco sold through September 30, 2019. The balance in accumulated other comprehensive loss associated with the 2019 crops in Brazil and Mozambique is expected to be recognized in earnings as a component

17


of cost of goods sold in fiscal year 2020 as those tobaccos are sold to customers. The balance in accumulated other comprehensive loss related to the 2020 Brazil crop is expected to be recognized in earnings in fiscal year 2021 as that tobacco is 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.

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, 2019 and 2018, and March 31, 2019:

 
 
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)
 
 
September 30, 2019
 
September 30, 2018
 
March 31, 2019
 
 
September 30, 2019
 
September 30, 2018
 
March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
Interest rate swap agreements
 
Other
non-current
assets
 
$

 
$
10,205

 
$

 
Other
long-term
liabilities
 
$
21,381

 
$

 
$
6,351

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency exchange contracts
 
Other
current
assets
 

 

 
307

 
Accounts
payable and
accrued
expenses
 
762

 

 

Total
 
 
 
$

 
$
10,205

 
$
307

 
 
 
$
22,143

 
$

 
$
6,351

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
Foreign currency exchange contracts
 
Other
current
assets
 
$
45

 
$
142

 
$
233

 
Accounts
payable and
accrued
expenses
 
$
532

 
$
384

 
$
386

Total
 
 
 
$
45

 
$
142

 
$
233

 
 
 
$
532

 
$
384

 
$
386


Substantially all of the Company's foreign exchange derivative instruments 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 9.   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.

18


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.

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. The fair values for those funds are presented under the heading "NAV" in the tables that follow in this disclosure. 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.

Recurring Fair Value Measurements

At September 30, 2019 and 2018, and at March 31, 2019, 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, 2019
 
 
 
 
Fair Value Hierarchy
 
 
(in thousands of dollars)
 
NAV
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
2,032

 
$

 
$

 
$

 
$
2,032

Trading securities associated with deferred compensation plans
 

 
16,100

 

 

 
16,100

Foreign currency exchange contracts
 

 

 
45

 

 
45

Total financial assets measured and reported at fair value
 
$
2,032

 
$
16,100

 
$
45

 
$

 
$
18,177

 
 
 
 
 
 
 
 
 
 
 
Liabilities