Universal Corporation
UNIVERSAL CORP /VA/ (Form: 10-Q, Received: 11/08/2016 16:21:56)
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, 2016
 
OR
 
o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________TO_______________

Commission File Number: 001-00652

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

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




Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of November 4, 2016 , the total number of shares of common stock outstanding was 22,783,633 .



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,
 
 
2016
 
2015
 
2016
 
2015
 
 
(Unaudited)
 
(Unaudited)
Sales and other operating revenues
 
$
456,942

 
$
456,382

 
$
752,417

 
$
731,801

Costs and expenses
 
 
 
 
 
 
 
 
Cost of goods sold
 
369,098

 
358,288

 
612,376

 
585,318

Selling, general and administrative expenses
 
40,834

 
60,810

 
101,033

 
112,106

Restructuring and impairment costs
 
3,682

 

 
3,682

 
2,389

Operating income
 
43,328

 
37,284

 
35,326

 
31,988

Equity in pretax earnings of unconsolidated affiliates
 
1,260

 
846

 
1,130

 
230

Interest income
 
271

 
205

 
634

 
444

Interest expense
 
4,335

 
3,912

 
8,389

 
7,796

Income before income taxes
 
40,524

 
34,423

 
28,701

 
24,866

Income tax expense
 
14,026

 
9,359

 
9,707

 
5,927

Net income
 
26,498

 
25,064

 
18,994

 
18,939

Less: net (income) loss attributable to noncontrolling interests in subsidiaries
 
(1,234
)
 
(2,599
)
 
794

 
(2,421
)
Net income attributable to Universal Corporation
 
25,264

 
22,465

 
19,788

 
16,518

Dividends on Universal Corporation convertible perpetual preferred stock
 
(3,687
)
 
(3,687
)
 
(7,374
)
 
(7,374
)
Earnings available to Universal Corporation common shareholders
 
$
21,577

 
$
18,778

 
$
12,414

 
$
9,144

 
 
 
 
 
 
 
 
 
Earnings per share attributable to Universal Corporation common shareholders:
 
 
 
 
 
 
 
 
Basic
 
$
0.95

 
$
0.83

 
$
0.55

 
$
0.40

Diluted
 
$
0.90

 
$
0.81

 
$
0.54

 
$
0.40

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
22,777,394

 
22,675,323

 
22,755,927

 
22,649,270

Diluted
 
27,968,156

 
27,850,628

 
23,073,341

 
22,936,631

 
 
 
 
 
 
 
 
 
Total comprehensive income, net of income taxes
 
$
29,651

 
$
19,470

 
$
17,321

 
$
21,850

Less: comprehensive (income) loss attributable to noncontrolling interests, net of income taxes
 
(1,007
)
 
(2,259
)
 
1,238

 
(1,995
)
Comprehensive income attributable to Universal Corporation, net of income taxes
 
$
28,644

 
$
17,211

 
$
18,559

 
$
19,855

 
 
 
 
 
 
 
 
 
Dividends declared per common share
 
$
0.53

 
$
0.52

 
$
1.06

 
$
1.04


See accompanying notes.


3


UNIVERSAL CORPORATION     
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)

 
 
September 30,
 
September 30,
 
March 31,
 
 
2016
  
2015
 
2016
 
 
(Unaudited)
 
(Unaudited)
 
 
ASSETS
 
 
 
 
 
 
Current assets
 
 
  
 
 
 
Cash and cash equivalents
 
$
294,894

  
$
68,970

 
$
319,447

Accounts receivable, net
 
251,805

  
303,963

 
428,659

Advances to suppliers, net
 
47,841

  
40,627

 
101,890

Accounts receivable—unconsolidated affiliates
 
51,558

  
59,370

 
2,316

Inventories—at lower of cost or market:
 
 
  
 
 
 
Tobacco
 
827,936

  
999,312

 
637,132

Other
 
86,472

  
85,222

 
60,888

Prepaid income taxes
 
24,448

  
19,779

 
17,814

Other current assets
 
56,026

  
75,122

 
70,400

Total current assets
 
1,640,980

  
1,652,365

 
1,638,546

 
 
 
 
 
 
 
Property, plant and equipment
 
 
  
 
 
 
Land
 
22,914

  
16,583

 
22,987

Buildings
 
266,107

  
252,153

 
264,838

Machinery and equipment
 
599,897

  
585,466

 
591,327

 
 
888,918

  
854,202

 
879,152

Less: accumulated depreciation
 
(566,686
)
  
(539,749
)
 
(553,265
)
 
 
322,232

  
314,453

 
325,887

Other assets
 
 
  
 
 
 
Goodwill and other intangibles
 
99,033

  
99,049

 
99,071

Investments in unconsolidated affiliates
 
81,441

  
79,995

 
82,441

Deferred income taxes
 
25,720

  
46,633

 
23,853

Other noncurrent assets
 
49,107

  
54,179

 
61,379

 
 
255,301

  
279,856

 
266,744

 
 
 
 
 
 
 
Total assets
 
$
2,218,513

  
$
2,246,674

 
$
2,231,177


See accompanying notes.

4


UNIVERSAL CORPORATION     
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)

 
 
September 30,
 
September 30,
 
March 31,
 
 
2016
  
2015
 
2016
 
 
(Unaudited)
  
(Unaudited)
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
Current liabilities
 
 
  
 
 
 
Notes payable and overdrafts
 
$
71,002

 
$
86,095

 
$
66,179

Accounts payable and accrued expenses
 
133,133

 
155,824

 
120,527

Accounts payable—unconsolidated affiliates
 

 
98

 
8,343

Customer advances and deposits
 
37,334

 
67,100

 
16,438

Accrued compensation
 
18,885

 
18,423

 
27,593

Income taxes payable
 
1,240

 
6,126

 
7,190

Current portion of long-term debt
 

 

 

Total current liabilities
 
261,594

  
333,666

 
246,270

 
 
 
 
 
 
 
Long-term debt
 
368,556

 
368,203

 
368,380

Pensions and other postretirement benefits
 
80,005

 
93,588

 
92,177

Other long-term liabilities
 
41,413

 
37,472

 
41,794

Deferred income taxes
 
28,047

 
26,034

 
29,494

Total liabilities
 
779,615

 
858,963

 
778,115

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

  

 

Series B 6.75% Convertible Perpetual Preferred Stock, no par value, 220,000 shares authorized, 218,490 shares issued and outstanding (218,490 at September 30, 2015 and March 31, 2016)
 
211,562

  
211,562

 
211,562

Common stock, no par value, 100,000,000 shares authorized, 22,783,633 shares issued and outstanding (22,680,233 at September 30, 2015, and 22,717,735 at March 31, 2016)
 
210,569

 
207,349

 
208,946

Retained earnings
 
1,054,004

  
1,005,353

 
1,066,064

Accumulated other comprehensive loss
 
(73,579
)
  
(71,657
)
 
(72,350
)
Total Universal Corporation shareholders' equity
 
1,402,556

  
1,352,607

 
1,414,222

Noncontrolling interests in subsidiaries
 
36,342

 
35,104

 
38,840

Total shareholders' equity
 
1,438,898

 
1,387,711

 
1,453,062

 
 
 
 
 
 
 
Total liabilities and shareholders' equity
 
$
2,218,513

  
$
2,246,674

 
$
2,231,177


See accompanying notes.



5


UNIVERSAL CORPORATION     
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
 
 
Six Months Ended September 30,
 
 
2016
 
2015
 
 
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net income
 
$
18,994

 
$
18,939

Adjustments to reconcile net income to net cash provided (used) by operating activities:
 
 
 
 
Depreciation
 
17,324

 
18,362

Net provision for losses (recoveries) on advances and guaranteed loans to suppliers
 
(2,038
)
 
(4,354
)
Foreign currency remeasurement loss (gain), net
 
11,119

 
21,981

Restructuring and impairment costs
 
3,682

 
2,389

Other, net
 
(1,108
)
 
927

Changes in operating assets and liabilities, net
 
(25,548
)
 
(200,010
)
Net cash provided (used) by operating activities
 
22,425

 
(141,766
)
 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Purchase of property, plant and equipment
 
(17,567
)
 
(28,457
)
Proceeds from sale of property, plant and equipment
 
447

 
1,155

Net cash used by investing activities
 
(17,120
)
 
(27,302
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Issuance (repayment) of short-term debt, net
 
5,210

 
23,827

Dividends paid to noncontrolling interests
 
(1,260
)
 
(1,260
)
Dividends paid on convertible perpetual preferred stock
 
(7,374
)
 
(7,374
)
Dividends paid on common stock
 
(24,106
)
 
(23,536
)
Other
 
(2,245
)
 
(2,037
)
Net cash used by financing activities
 
(29,775
)
 
(10,380
)
 
 
 
 
 
Effect of exchange rate changes on cash
 
(83
)
 
(365
)
Net decrease in cash and cash equivalents
 
(24,553
)
 
(179,813
)
Cash and cash equivalents at beginning of year
 
319,447

 
248,783

 
 
 
 
 
Cash and cash equivalents at end of period
 
$
294,894

 
$
68,970


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, 2016.

NOTE 2.   ACCOUNTING PRONOUNCEMENTS

Pronouncements Adopted in Fiscal Year 2017
    
In April 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”). ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for fiscal years beginning after December 31, 2015. The Company adopted ASU 2015-03 effective as of April 1, 2016, the beginning of fiscal year 2017. The implementation of ASU 2015-03, which requires retrospective application, resulted in a $1.8 million and $1.6 million reclassification of unamortized debt issuance costs from other noncurrent assets to long-term debt for the comparative prior periods ended September 30, 2015 and March 31, 2016 , respectively.

In May 2015, the FASB issued Accounting Standards Update No. 2015-07, "Fair Value Measurement, Disclosures for Investments in Certain Entities that Calculate Net Asset Value per Share or its Equivalent" ("ASU 2015-07"). ASU 2015-07 removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient and eliminates certain disclosures for investments that are eligible to be measured at fair value using the net asset value per share practical expedient. The Company adopted ASU 2015-07 effective as of April 1, 2016, the beginning of fiscal year 2017. Disclosures for all periods presented in Note 8 - Fair Value Measurements were adjusted accordingly.

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, "Compensation - Stock Compensation" ("ASU 2016-09"). ASU 2016-09 provides simplification for the accounting for employee stock-based payment transactions, including the related income tax consequences, treatment of excess tax benefits in determining income tax expense, the classification of awards as either equity or liabilities, and the classification of transactions in the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. The Company early adopted ASU 2016-09 effective as of April 1, 2016. Effective with the adoption of ASU 2016-09, employees that the Company has a statutory requirement to withhold taxes on behalf of can now elect to withhold income taxes upon settlement of stock-based compensation awards up to the maximum statutory tax rate without requiring classification of the awards as a liability. As required by ASU 2016-09, employee tax withholding payments and excess tax benefits resulting from stock-based compensation have been classified as financing activities and operating activities, respectively, in the consolidated statements of cash flows for all periods presented.

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 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

7


supplemental amendments effective April 1, 2018, which is the beginning of the fiscal year ending March 31, 2019.  The Company is currently evaluating the impact that the adoption of ASU 2014-09 and the related amendments will have on its consolidated financial statements and has not made a decision on the method of adoption.

In July 2015, the FASB issued Accounting Standards Update No. 2015-11, “Simplifying the Measurement of Inventory” (“ASU 2015-11”). ASU 2015-11 requires that most inventory be measured at the lower of cost or net realizable value. ASU 2015-11 defines net realizable value as the "estimated selling price in the ordinary course of business, less reasonable predictable costs of completion, disposal, and transportation." ASU 2015-11 is effective for fiscal years beginning after December 31, 2016. The Company is currently evaluating the impact that the adoption of ASU 2015-11 will have on its consolidated financial statements. ASU 2015-11 will be applied prospectively after the date of adoption, as required by the guidance.
    
In 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 ” (“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 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 August 2016, the FASB issued Accounting Standards Update No. 2016-15, "Statement of Cash Flows" ("ASU 2016-15"). ASU 2016-15 is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. This guidance is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the impact that the adoption of ASU 2016-15 will have on its consolidated financial statements.


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

Guarantees and Other Contingent Liabilities

Guarantees of Bank Loans and Other Contingent Liabilities

Guarantees of bank loans to tobacco growers for crop financing and construction of curing barns or other tobacco producing assets have long been industry practice in Brazil and support the farmers’ production of tobacco there. The Company's operating subsidiary in Brazil had guarantees outstanding at September 30, 2016 , all of which were for crop financing and 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, 2016 , was the face amount, $33 million including unpaid accrued interest ( $26 million at September 30, 2015 , and $13 million at March 31, 2016 ). The fair value of the guarantees was a liability of approximately $2 million at September 30, 2016 ( $1 million at September 30, 2015 , and $2 million at March 31, 2016 ). In addition to these guarantees, the Company has other contingent liabilities, primarily related to outstanding letters of credit, totaling approximately $2 million at September 30, 2016 .

Value-Added Tax Assessments in Brazil
As further discussed below, the Company’s local operating subsidiaries pay significant amounts of value-added tax (“VAT”) in connection with their normal operations. In Brazil, VAT is assessed at the state level when green tobacco is transferred between states. The Company’s operating subsidiary there pays VAT when tobaccos grown in the states of Santa Catarina and Parana are transferred to its factory in the state of Rio Grande do Sul for processing. The subsidiary has received assessments for additional VAT plus interest and penalties from tax authorities for the states of Santa Catarina and Parana based on audits of the subsidiary’s VAT filings for specified periods. In June 2011, tax authorities for the state of Santa Catarina issued assessments for tax, interest, and penalties for periods from 2006 through 2009 totaling approximately $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

8


million . Those amounts are based on the exchange rate for the Brazilian currency at September 30, 2016 . 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, 2016 , 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 $14 million (at the September 30, 2016 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 $14 million remaining assessment, based on the strength of the subsidiary’s defenses, no loss within that range is considered probable at this time and no liability has been recorded at September 30, 2016 .
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, 2016 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 taken the necessary steps to challenge the full amount of the claim. The range of reasonably possible loss is considered to be zero up to the full $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, 2016 .

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, 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 $78 million at September 30, 2016 , $71 million at September 30, 2015 , and $134 million at March 31, 2016 . The related valuation allowances totaled $28 million at September 30, 2016 , $27 million at September 30, 2015 , and $29 million at March 31, 2016 , and were estimated based on the Company’s historical loss information and crop projections. The allowances were reduced by net recoveries of approximately $2 million and $4 million in the six -month periods ended September 30, 2016 and 2015 , respectively. These net 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

9


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, 2016 , the aggregate balance of recoverable tax credits held by the Company’s subsidiaries totaled approximately $35 million ( $52 million at September 30, 2015 , and $52 million at March 31, 2016 ), and the related valuation allowances totaled approximately $10 million ( $21 million at September 30, 2015 , and $19 million at March 31, 2016 ). The net balances are reported in other current assets and other noncurrent assets in the consolidated balance sheets.

NOTE 4.   RESTRUCTURING AND IMPAIRMENT COSTS

Universal continually reviews its business for opportunities to realize efficiencies, reduce costs, and realign its operations in response to business changes. Restructuring and impairment costs are periodically incurred in connection with those activities.     For the reporting periods ended  September 30, 2016  and  2015 , the majority of restructuring costs incurred related to operations that are part of the Other Regions reportable segment of the Company's Flue-Cured and Burley Tobacco Operations.

Quarter and Six Months Ended September 30, 2016

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 expects to process all future tobaccos sourced from Hungary in the Company's facilities in Italy. The restructuring and impairment 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 before September 30, 2016 .

Six Months Ended September 30, 2015
In the first quarter of fiscal year 2016 , the Company recorded restructuring and impairment costs totaling  $2.4 million related to the scale back of its operations in Zambia. Those costs included statutory employee termination benefits, impairment charges related to outstanding balances on loans to farmers whose contracts were terminated as a result of the decision, and impairment charges on certain property and equipment. The majority of the termination benefits were paid during fiscal year 2016 .


10


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)
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Basic Earnings Per Share
 
 
 
 
 
 
 
 
Numerator for basic earnings per share
 
 
 
 
 
 
 
 
Net income attributable to Universal Corporation
 
$
25,264

 
$
22,465

 
$
19,788

 
$
16,518

Less: Dividends on convertible perpetual preferred stock
 
(3,687
)
 
(3,687
)
 
(7,374
)
 
(7,374
)
Earnings available to Universal Corporation common shareholders for calculation of basic earnings per share
 
21,577

 
18,778

 
12,414

 
9,144

 
 
 
 
 
 
 
 
 
Denominator for basic earnings per share
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
22,777,394

 
22,675,323

 
22,755,927

 
22,649,270

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
0.95

 
$
0.83

 
$
0.55

 
$
0.40

 
 
 
 
 
 
 
 
 
Diluted Earnings Per Share
 
 
 
 
 
 
 
 
Numerator for diluted earnings per share
 
 
 
 
 
 
 
 
Earnings available to Universal Corporation common shareholders
 
$
21,577

 
$
18,778

 
$
12,414

 
$
9,144

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

 
3,687

 

 

Earnings available to Universal Corporation common shareholders for calculation of diluted earnings per share
 
25,264

 
22,465

 
12,414

 
9,144

 
 
 
 
 
 
 
 
 
Denominator for diluted earnings per share
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
22,777,394

 
22,675,323

 
22,755,927

 
22,649,270

Effect of dilutive securities (if conversion or exercise assumed)
 
 
 
 
 
 
 
 
Convertible perpetual preferred stock
 
4,883,372

 
4,848,766

 

 

Employee share-based awards
 
307,390

 
326,539

 
317,414

 
287,361

Denominator for diluted earnings per share
 
27,968,156

 
27,850,628

 
23,073,341

 
22,936,631

 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
0.90

 
$
0.81

 
$
0.54

 
$
0.40


For the six months ended September 30, 2016 and 2015, conversion of the Company's outstanding Series B 6.75% Convertible Perpetual Preferred Stock was not assumed since the effect would have been antidilutive. The Company had the following potentially dilutive securities (stock appreciation rights) outstanding for the six months ended September 30, 2016 and 2015 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
 
2015
 
 
 
 
 
Potentially dilutive securities
 
127,400

 
133,600

Weighted-average exercise price
 
$
62.66

 
$
62.66


11


NOTE 6.   INCOME TAXES

The Company is subject to the tax laws of many jurisdictions. Changes in tax laws or the interpretation of tax laws can affect the Company’s earnings, as can the resolution of pending and contested tax issues. The Company's consolidated effective income tax rate on pretax earnings is affected by a number of factors, including the mix of domestic and foreign earnings, the effect of exchange rate changes on deferred taxes, and the Company’s ability to utilize foreign tax credits.
The Company's consolidated effective income tax rates were approximately 35% and 34% for the quarter and six months ended September 30, 2016 , respectively, compared to approximately 27% and 24% for the quarter and six months ended September 30, 2015 , respectively. The effective rates for the prior year periods were lower primarily due to a lower effective tax rate on dividend income from unconsolidated operations, as well as the effects of changes in currency exchange rates on deferred income tax assets and liabilities of foreign subsidiaries. The effective tax rates for the current year periods more closely approximate the 35% U.S. federal statutory rate because the effects of currency exchange rate changes have not been significant and because the dividend income from unconsolidated operations is not expected to impact the effective tax rate until the second half of the fiscal year.    

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 the consolidated balance sheets. In the consolidated statements of cash flows, the cash flows associated with all of these activities are reported in net cash provided by operating activities.

Hedging Strategy for Interest Rate Risk

In January 2015, the Company entered into receive-floating/pay-fixed interest rate swap agreements that were designated and qualified as hedges of the exposure to changes in interest payment cash flows created by fluctuations in variable interest rates on two outstanding non-amortizing bank term loans. 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, 2016 , 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 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 2017 and 2016 was as follows:

 
 
Six Months Ended September 30,
(in millions of dollars)
 
2016
 
2015
 
 
 
 
 
Tobacco purchases
 
$
9.7

 
$
19.8

Processing costs
 
2.7

 
5.6

Total
 
$
12.4

 
$
25.4



12


The reduced U.S. dollar notional amounts for tobacco purchases and processing costs hedged during the six months ended September 30, 2016 reflect the reduced size of the 2016 crop and a variation 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 2016 crop in Brazil matured and settled by September 30, 2016 . For substantially all hedge gains and losses recorded in accumulated other comprehensive loss at  September 30, 2016 , the Company expects to complete the sale of the tobacco and recognize the amounts in earnings during fiscal year 2017 .

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, 2016 and 2015 were approximately $29.3 million and $114.0 million , respectively. The reduced U.S. dollar notional amount outstanding at September 30, 2016 , reflects a lower net monetary asset position in Brazil. At March 31, 2016 , the net local monetary asset position in Brazil was not significant, and there were no foreign currency contracts outstanding at that time to manage currency remeasurement risk. 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.

13



Effect of Derivative Financial Instruments on the Consolidated Statements of Income

The table below outlines the effects of the Company’s use of derivative financial instruments on the consolidated statements of income for the three- and six -month periods ended September 30, 2016 and 2015 :
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(in thousands of dollars)
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Cash Flow Hedges - Interest Rate Swap Agreements
 
 
 
 
 
 
 
 
Derivative
 
 
 
 
 
 
 
 
Effective Portion of Hedge
 
 
 
 
 
 
 
 
Gain (loss) recorded in accumulated other comprehensive loss
 
$
2,012

 
$
(9,732
)
 
$
(2,392
)
 
$
(6,056
)
Gain (loss) reclassified from accumulated other comprehensive loss into earnings
 
$
(1,055
)
 
$
(1,341
)
 
$
(2,148
)
 
$
(2,676
)
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
 
$

 
$
101

 
$
453

 
$
1,283

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

 
$
344

 
$
668

 
$
358

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
 
$

 
$
(673
)
 
$
246

 
$
745

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
 
$
113

 
$
10,524

 
$
(1,356
)
 
$
8,380

Location of gain (loss) recognized in earnings
 
Selling, general and administrative expenses
    
For the interest rate swap agreements, the effective portion of the gain or loss on the derivative is recorded in accumulated other comprehensive loss and any ineffective portion is recorded in selling, general and administrative expenses. For the forward foreign currency exchange contracts designated as cash flow hedges of tobacco purchases in Brazil, a net hedge gain of approximately $0.3 million remained in accumulated other comprehensive loss at September 30, 2016 . That balance reflects gains and losses on contracts related to the 2016 crop, less the amount reclassified to earnings related to tobacco sold through September 30, 2016 . 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 2017 as the 2016 Brazilian crop 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.


14


Effect of Derivative Financial Instruments on the Consolidated Balance Sheets

The table below outlines the effects of the Company’s derivative financial instruments on the consolidated balance sheets at September 30, 2016 and 2015 , and March 31, 2016 :

 
 
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, 2016
 
Sept. 30, 2015
 
March 31, 2016
 
 
Sept. 30, 2016
 
Sept. 30, 2015
 
March 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap agreements
 
Other
non-current
assets
 
$

 
$

 
$

 
Other
long-term
liabilities
 
$
11,010

 
$
6,430

 
$
10,766

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward foreign currency exchange contracts
 
Other
current
assets
 

 

 
475

 
Accounts
payable and
accrued
expenses
 

 

 

Total
 
 
 
$

 
$

 
$
475

 
 
 
$
11,010

 
$
6,430

 
$
10,766

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
 
 
 
Forward foreign currency exchange contracts
 
Other
current
assets
 
$
140

 
$
4,354

 
$
297

 
Accounts
payable and
accrued
expenses
 
$
1,554

 
$
12

 
$
5

Total
 
 
 
$
140

 
$
4,354

 
$
297

 
 
 
$
1,554

 
$
12

 
$
5


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

NOTE 8.   FAIR VALUE MEASUREMENTS

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

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

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. As discussed in Note 2, under updated accounting guidance adopted effective

15


April 1, 2016, the fair values for those funds are no longer categorized within the fair value hierarchy and 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.

At September 30, 2016 and 2015 , and at March 31, 2016 , 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, 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


 
 
September 30, 2015
 
 
 
 
Fair Value Hierarchy
 
 
(in thousands of dollars)
 
NAV
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
1,574

 
$

 
$

 
$

 
$
1,574

Trading securities associated with deferred compensation plans
 

 
18,359

 

 

 
18,359

Forward foreign currency exchange contracts
 

 

 
4,354

 

 
4,354

Total financial assets measured and reported at fair value
 
$
1,574

 
$
18,359

 
$
4,354

 
$

 
$
24,287

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Guarantees of bank loans to tobacco growers
 
$

 
$

 
$

 
$
1,356

 
$
1,356

Interest rate swap agreements
 

 

 
6,430

 

 
6,430

Forward foreign currency exchange contracts
 

 

 
13

 

 
13

Total financial liabilities measured and reported at fair value
 
$

 
$

 
$
6,443

 
$
1,356

 
$
7,799




16


 
 
March 31, 2016
 
 
 
 
Fair Value Hierarchy
 
 
(in thousands of dollars)
 
NAV
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
116,618

 
$

 
$

 
$

 
$
116,618

Trading securities associated with deferred compensation plans
 

 
17,817

 

 

 
17,817

Forward foreign currency exchange contracts
 

 

 
772

 

 
772

Total financial assets measured and reported at fair value
 
$
116,618

 
$
17,817

 
$
772

 
$

 
$
135,207

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Guarantees of bank loans to tobacco growers
 
$

 
$

 
$

 
$
1,628

 
$
1,628

Interest rate swap agreements
 

 

 
10,766

 

 
10,766

Forward foreign currency exchange contracts
 

 

 
5

 

 
5

Total financial liabilities measured and reported at fair value
 
$

 
$

 
$
10,771

 
$
1,628

 
$
12,399


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

17



A reconciliation of the change in the balance of the financial liability for guarantees of bank loans to tobacco growers (Level 3) for the six months ended September 30, 2016 and 2015 is provided below.
 
 
Six Months Ended September 30,
(in thousands of dollars)
 
2016
 
2015
 
 
 
 
 
Balance at beginning of year
 
$
1,628

 
$
1,674

Payments under the guarantees and transfers to allowance for loss on direct loans to farmers (removal of prior crop year loans from portfolio)
 
(1,848
)
 
(1,841
)
Provision for loss or transfers from allowance for loss on direct loans to farmers (addition of current crop year loans)
 
1,756

 
1,821

Change in discount rate and estimated collection period
 
26

 
33

Currency remeasurement
 
160

 
(331
)
Balance at end of period
 
$
1,722

 
$
1,356

    
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, 2016 , September 30, 2015 , and March 31, 2016 . 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 issues or on the current interest rates available to the Company for debt of similar terms and maturities.

NOTE 9.   PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS

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

The components of the Company’s net periodic benefit cost were as follows:
 
 
Pension Benefits
 
Other Postretirement Benefits
 
 
Three Months Ended September 30,
 
Three Months Ended September 30,
(in thousands of dollars)
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Service cost
 
$
1,359

  
$
1,479

 
$
74

  
$
106

Interest cost
 
2,467

  
2,347

 
383

  
392

Expected return on plan assets
 
(3,589
)
  
(3,577
)
 
(11
)
  
(15
)
Net amortization and deferral
 
838

  
1,199

 
(100
)
  
(44
)
Net periodic benefit cost
 
$
1,075

 
$
1,448

 
$
346

 
$
439


18


 
 
Pension Benefits
 
Other Postretirement Benefits
 
 
Six Months Ended September 30,
 
Six Months Ended September 30,
(in thousands of dollars)
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
Service cost
 
$
2,720

  
$
2,962

 
$
147

  
$
214

Interest cost
 
4,936

  
4,693

 
758

  
799

Expected return on plan assets
 
(7,178
)
  
(7,153
)
 
(22
)
  
(30
)
Net amortization and deferral
 
1,676

  
2,398

 
(200
)
  
(88
)
Net periodic benefit cost
 
$
2,154

 
$
2,900

 
$
683

 
$
895


The net periodic benefit cost for the Company's pension and other postretirement benefit plans has declined from the prior fiscal year, primarily reflecting actuarial gains from higher market discount rates applicable to the most recent actuarial measurement of benefit liabilities.

During the six months ended September 30, 2016 , the Company made contributions of approximately $9.9 million to its pension plans. Additional contributions of approximately $1.1 million are expected during the remaining six months of fiscal year 2017 .


19



NOTE 10.   STOCK-BASED COMPENSATION

Universal’s shareholders have approved Executive Stock Plans (“Plans”) under which officers, directors, and employees of the Company may receive grants and awards of common stock, restricted stock, restricted stock units (“RSUs”), performance share awards (“PSAs”), stock appreciation rights (“SARs”), incentive stock options, and non-qualified stock options. The Company’s practice is to award grants of stock-based compensation to officers on an annual basis at the first regularly-scheduled meeting of the Executive Compensation, Nominating and Corporate Governance Committee of the Board of Directors (the “Compensation Committee”) in the fiscal year following the public release of the Company’s financial results for the prior year. The Compensation Committee administers the Company’s Plans consistently, following previously defined guidelines. Awards of restricted stock, RSUs, PSAs, and SARs are currently outstanding under the Plans. The SARs have an exercise price equal to the closing price of a share of the Company's common stock on the grant date. They are settled in shares of common stock, vest in equal one-third tranches one, two, and three years after the grant date , and expire on the earlier of three years after the grantee’s retirement date or ten years after the grant date. The Company has not made grants of SARs since fiscal year 2012. 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 years 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 or shares of restricted stock following each annual meeting of shareholders. RSUs awarded to outside directors vest three years after the grant date, and restricted shares vest upon the individual’s retirement from service as a director.

As discussed in Note 2, effective April 1, 2016, the Company early adopted recently-issued updates to the accounting guidance for stock-based compensation. Those updates primarily related to the income tax consequences of stock-based payment transactions, the treatment of excess tax benefits in determining income tax expense, the classification of awards as either equity or liabilities, and the classification of transactions in the statement of cash flows.

During the six -month periods ended September 30, 2016 and 2015 , 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,
 
 
2016
 
2015
 
 
 
 
 
RSUs:
 
 
 
 
Number granted
 
63,425

 
67,750

Grant date fair value
 
$
55.93

 
$
52.10

 
 
 
 
 
PSAs:
 
 
 
 
Number granted
 
54,675

 
57,750

Grant date fair value
 
$
49.17

 
$
45.06


As indicated in the table above, the Compensation Committee awarded only grants of RSUs and PSAs in both the current and prior fiscal years, and did not award any other types of stock-based compensation.
    
Fair value expense for stock-based compensation is recognized ratably over the period from grant date to the earlier of: (1) the vesting date of the award, or (2) the date the grantee is eligible to retire without forfeiting the award. For employees who are already eligible to retire at the date an award is granted, the total fair value of all non-forfeitable awards is recognized as expense at the date of grant. As a result, Universal typically incurs higher stock compensation expense in the first quarter of each fiscal year when grants are awarded to officers than in the other three quarters. For PSAs, the Company generally recognizes fair value expense ratably over the performance and vesting period based on management’s judgment of the ultimate award that is likely to be paid out based on the achievement of the predetermined performance measures. The Company accounts for forfeitures of stock-based awards as they occur. For the six -month periods ended September 30, 2016 and 2015 , the Company recorded total stock-based compensation expense of approximately $3.5 million and $3.0 million , respectively. The Company expects to recognize stock-based compensation expense of approximately $2.2 million during the remaining six months of fiscal year 2017 .

20


NOTE 11. OPERATING SEGMENTS

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

Operating results for the Company’s reportable segments for each period presented in the consolidated statements of income were as follows:
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
(in thousands of dollars)
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
 
SALES AND OTHER OPERATING REVENUES
 
 
 
 
 
 
 
 
Flue-Cured and Burley Leaf Tobacco Operations:
 
 
 
 
 
 
 
 
North America
 
$
80,789

 
$
49,421

 
$
153,471

   
$
97,993

Other Regions  (1)
 
318,576

 
371,032

 
496,592

   
548,433

Subtotal
 
399,365

 
420,453

 
650,063

 
646,426

Other Tobacco Operations  (2)
 
57,577

 
35,929

 
102,354

   
85,375

Consolidated sales and other operating revenues
 
$
456,942

 
$
456,382

 
$
752,417

 
$
731,801

 
 
 
 
 
 
 
 
 
OPERATING INCOME
 
 
 
 
 
 
 
 
Flue-Cured and Burley Leaf Tobacco Operations:
 
 
 
 
 
 
 
 
North America
 
$
13,531

   
$
3,783

 
$
20,379

   
$
7,199

Other Regions  (1)
 
32,342

   
34,202

 
15,325

   
26,355

Subtotal
 
45,873

 
37,985

 
35,704

 
33,554

Other Tobacco Operations  (2)
 
2,397

   
145

 
4,434

   
1,053

Segment operating income
 
48,270

 
38,130

 
40,138

 
34,607

Deduct: Equity in pretax earnings of unconsolidated affiliates (3)
 
(1,260
)
 
(846
)
 
(1,130
)
 
(230
)
              Restructuring and impairment costs (4)
 
(3,682
)
 

 
(3,682
)
 
(2,389
)
Consolidated operating income
 
$
43,328

 
$
37,284

 
$
35,326

 
$
31,988


(1)  
Includes South America, Africa, Europe, and Asia regions, as well as inter-region eliminations.
(2)  
Includes Dark Air-Cured, Special Services, and Oriental, as well as inter-company eliminations. Sales and other operating revenues for this reportable segment include limited amounts for Oriental because its financial results consist principally of equity in the pretax earnings of an unconsolidated affiliate.
(3)  
Equity in pretax earnings 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.


21


NOTE 12. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the changes in the accumulated balances for each component of accumulated other comprehensive income (loss) attributable to the Company for the six months ended September 30, 2016 and 2015 :
 
 
Six Months Ended September 30,
(in thousands of dollars)
 
2016
 
2015
Foreign currency translation:
 
 
 
 
Balance at beginning of year
 
$
(26,992
)
 
$
(31,138
)
Other comprehensive income (loss) attributable to Universal Corporation:
 
 
 
 
Net gain (loss) on foreign currency translation (net of tax (expense) benefit of $1,249 and $(1,155))
 
(2,319
)
 
2,147

Less: Net loss on foreign currency translation attributable to noncontrolling interests
 
444

 
426

Other comprehensive income (loss) attributable to Universal Corporation, net of income taxes
 
(1,875
)
 
2,573

Balance at end of period
 
$
(28,867
)
 
$
(28,565
)
 
 
 
 
 
Foreign currency hedge:
 
 
 
 
Balance at beginning of year
 
$
675

 
$
(1,834
)
Other comprehensive income (loss) attributable to Universal Corporation:
 
 
 
 
Net gain (loss) on derivative instruments (net of tax (expense) benefit of $58 and $(878))
 
(107
)
 
1,629

Reclassification of (gain) loss to earnings (net of tax expense of $189 and $90)   (1)
 
(351
)
 
(166
)
Other comprehensive income (loss) attributable to Universal Corporation, net of income taxes
 
(458
)
 
1,463

Balance at end of period
 
$
217

 
$
(371
)
 
 
 
 
 
Interest rate hedge:
 
 
 
 
Balance at beginning of year
 
$
(6,997
)
 
$
(1,982
)
Other comprehensive income (loss) attributable to Universal Corporation:
 
&#