Universal Corporation
UNIVERSAL CORP /VA/ (Form: 10-Q, Received: 02/08/2011 16:12:56)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 3 1 , 20 1 0
 
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
(I.R.S. Employer
incorporation or organization)
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)

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 x    No ¨
 
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 x   No ¨

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   x     Accelerated filer   ¨      Non-accelerated filer   ¨     Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).  Yes  o    No x

As of February 1, 2011, the total number of shares of common stock outstanding was 23,455,653.


 
UNIVERSAL CORPORATION
FORM 10-Q
TABLE OF CONTENTS
 
Item No.
   
Page
   
PART I - FINANCIAL INFORMATION
 
1.
 
Financial Statements
3
2.
 
Management's Discussion and Analysis of  Financial Condition and Results of Operations
24
3.
 
Quantitative and Qualitative Disclosures About Market Risk
28
4.
 
Controls and Procedures
29
       
 
 
PART II - OTHER INFORMATION
 
       
1.
 
Legal Proceedings
30
1A.
 
Risk Factors
31
2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
31
5.
 
Other Information
31
6.
 
Exhibits
32
       
   
Signatures
33

 
2

 

PART I.    FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

UNIVERSAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
(In thousands of dollars, except per share data)
 
   
Three Months Ended
December 31,
   
Nine Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
Sales and other operating revenues
  $ 688,208     $ 661,205     $ 1,891,312     $ 1,925,235  
Costs and expenses
                               
Cost of goods sold
    534,164       516,541       1,501,757       1,493,864  
Selling, general and administrative expenses
    74,826       75,719       186,658       216,789  
Other income
    (19,368 )           (19,368 )      
Restructuring and impairment costs
    10,995             13,964        
Operating income
    87,591       68,945       208,301       214,582  
Equity in pretax earnings (loss) of unconsolidated affiliates
    (1,439 )     7,783       953       17,029  
Interest income
    754       130       2,614       926  
Interest expense
    6,257       5,438       17,245       20,287  
Income before income taxes and other items
    80,649       71,420       194,623       212,250  
Income taxes
    23,064       22,946       58,837       65,300  
Net income
    57,585       48,474       135,786       146,950  
Less:  net (income) loss attributable to noncontrolling interests in subsidiaries
    (5,287 )     (2,778 )     (6,337 )     (4,994 )
Net income attributable to Universal Corporation
    52,298       45,696       129,449       141,956  
Dividends on Universal Corporation convertible perpetual preferred stock
    (3,712 )     (3,712 )     (11,137 )     (11,137 )
Earnings available to Universal Corporation common shareholders
  $ 48,586     $ 41,984     $ 118,312     $ 130,819  
                                 
Earnings per share attributable to Universal Corporation common shareholders:
                               
Basic
  $ 2.05     $ 1.70     $ 4.93     $ 5.27  
Diluted
  $ 1.82     $ 1.54     $ 4.46     $ 4.78  
                                 
Retained earnings - beginning of year
                  $ 767,213     $ 686,960  
Net income attributable to Universal Corporation
                    129,449       141,956  
Cash dividends declared:
                               
Series B 6.75% Convertible Perpetual Preferred Stock
                    (11,137 )     (11,137 )
Common stock (2010 - $1.41 per share; 2009 - $1.38 per share)
                    (33,891 )     (34,384 )
Dividend equivalents on restricted stock units
                    (316 )     (286 )
Repurchase of common stock - cost in excess of stated capital amount
                    (27,074 )     (13,006 )
Retained earnings - end of period
                  $ 824,244     $ 770,103  
 
See accompanying notes.

 
3

 
 
UNIVERSAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands of dollars)
 
   
December 31,
2010
   
December 31,
2009
   
March 31,
2010
 
   
(Unaudited)
   
(Unaudited)
       
ASSETS
                 
Current
                 
Cash and cash equivalents
  $ 91,427     $ 164,170     $ 245,953  
Accounts receivable, net
    292,490       255,847       266,960  
Advances to suppliers, net
    132,815       134,209       167,400  
Accounts receivable - unconsolidated affiliates
    35,978       26,550       11,670  
Inventories - at lower of cost or market:
                       
Tobacco
    940,168       770,708       812,186  
Other
    50,551       50,716       52,952  
Prepaid income taxes
    8,633       14,632       13,514  
Deferred income taxes
    43,669       48,711       47,074  
Other current assets
    65,784       64,234       75,367  
Total current assets
    1,661,515       1,529,777       1,693,076  
                         
Land
    15,490       16,147       16,036  
Buildings
    265,390       259,912       266,350  
Machinery and equipment
    552,575       535,278       532,824  
      833,455       811,337       815,210  
Less accumulated depreciation
    (512,413 )     (483,349 )     (485,723 )
      321,042       327,988       329,487  
Other assets
                       
Goodwill and other intangibles
    99,602       106,000       105,561  
Investments in unconsolidated affiliates
    103,821       124,503       106,336  
Deferred income taxes
    36,373       13,961       30,073  
Other noncurrent assets
    96,493       122,057       106,507  
      336,289       366,521       348,477  
                         
Total assets
  $ 2,318,846     $ 2,224,286     $ 2,371,040  
 
See accompanying notes.

 
4

 

UNIVERSAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands of dollars)
 
   
December 31,
2010
   
December 31,
2009
   
March 31,
2010
 
   
(Unaudited)
   
(Unaudited)
       
LIABILITIES AND SHAREHOLDERS' EQUITY
                 
Current
                 
Notes payable and overdrafts
  $ 204,769     $ 151,252     $ 177,013  
Accounts payable and accrued expenses
    180,054       196,126       259,576  
Accounts payable - unconsolidated affiliates
    15,355       17,398       6,464  
Customer advances and deposits
    87,934       38,032       107,858  
Accrued compensation
    19,029       25,143       30,097  
Income taxes payable
    11,901       11,753       18,991  
Current portion of long-term obligations
    95,000       15,000       15,000  
Total current liabilities
    614,042       454,704       614,999  
                         
Long-term obligations
    322,486       414,222       414,764  
                         
Pensions and other postretirement benefits
    100,719       90,662       96,888  
                         
Other long-term liabilities
    47,661       71,607       69,886  
                         
Deferred income taxes
    44,963       41,608       46,1 28  
                         
Total liabilities
    1,129,871       1,072,803       1,242,665  
                         
Shareholders' equity
                       
Universal Corporation:
                       
Preferred stock:
                       
Series A Junior Participating Preferred Stock, no par value, 5,000,000 shares authorized, none issued or outstanding
                 
Series B 6.75% Convertible Perpetual Preferred Stock, no par value, 5,000,000 shares authorized, 219,999 shares issued and outstanding (219,999 at December 31, 2009, and March 31, 2010)
    213,023       213,023       213,023  
Common stock, no par value, 100,000,000 shares authorized, 23,569,443 shares issued and outstanding (24,617,987 at December 31, 2009, and 24,325,228 at March 31, 2010)
    193,263       195,679       195,001  
Retained earnings
    824,244       770,103       767,213  
Accumulated other comprehensive loss
    (53,670 )     (36,084 )     (52,667 )
Total Universal Corporation shareholders' equity
    1,176,860       1,142,721       1,122,570  
                         
Noncontrolling interests in subsidiaries
    12,115       8,762       5,805  
                         
Total shareholders' equity
    1,188,975       1,151,483       1,128,375  
                         
Total liabilities and shareholders' equity
  $ 2,318,846     $ 2,224,286     $ 2,371,040  
 
See accompanying notes.
 
5


UNIVERSAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)
 
   
Nine   Months   Ended
December   31,
 
   
2010
   
2009
 
   
(Unaudited)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 135,786     $ 146,950  
Adjustments to reconcile net income to net cash used by operating activities:
               
Depreciation
    32,474       30,888  
Amortization
    1,220       1,791  
Provisions for losses on advances and guaranteed loans to suppliers
    19,554       19,148  
Foreign currency remeasurement loss (gain), net
    (1,368 )     7,219  
Gain on assignment of farmer contracts and sale of related assets
    (19,368 )      
Restructuring and impairment costs
    13,964        
Other, net
    (9,366 )     (2,841 )
Changes in operating assets and liabilities, net
    (262,251 )     (148,345 )
Net cash provided (used) by operating activities
    (89,355 )     54,810  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of property, plant and equipment
    (31,801 )     (42,923 )
Proceeds from assignment of farmer contracts and sale of related assets
    34,946        
Proceeds from sale of property, plant and equipment, and other
    2,512       3,356  
Net cash provided (used) by investing activities
    5,657       (39,567 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Issuance (repayment) of short-term debt, net
    22,510       (23,935 )
Issuance of long-term obligations
          99,208  
Repayment of long-term obligations
    (15,000 )     (79,500 )
Dividends paid to noncontrolling interests
    (100 )     (105 )
Issuance of common stock
          205  
Repurchase of common stock
    (33,450 )     (15,342 )
Dividends paid on convertible perpetual preferred stock
    (11,137 )     (11,137 )
Dividends paid on common stock
    (34,011 )     (34,315 )
Other
           (943 )
Net cash used by financing activities
    (71,188 )     (65,864 )
                 
Effect of exchange rate changes on cash
    360       2,165  
Net decrease in cash and cash equivalents
    (154,526 )     (48,456 )
Cash and cash equivalents at beginning of year
    245,953       212,626  
Cash and cash equivalents at end of period
  $ 91,427     $ 164,170  
 
See accompanying notes.

6

 
UNIVERSAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.   BASIS OF PRESENTATION

Universal Corporation, with its subsidiaries (“Universal” or the “Company”), is the world’s leading leaf tobacco merchant and processor.  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, 2010.

NOTE 2.   ACCOUNTING PRONOUNCEMENTS

Recent Pronouncements Adopted Through December 31, 2010

In June 2009, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 168, "The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No. 162" ("SFAS 168"). This Statement established the newly-developed FASB Accounting Standards Codification ("Codification") as the single source of authoritative U.S. generally accepted accounting principles ("GAAP") for all nongovernmental entities. All guidance in the Codification carries the same level of authority, and all changes or additions to GAAP are now issued as Accounting Standards Updates (“ASU’s”). In addition to the Codification, rules and interpretive releases of the U.S. Securities and Exchange Commission (“SEC”) under federal securities laws remain sources of authoritative GAAP for SEC registrants. Universal was required to adopt SFAS 168 effective September 30, 2009. SFAS 168 did not make any changes to existing accounting guidance that impacted the Company’s accounting and financial reporting.

Through December 31, 2010, Universal adopted the following recent accounting pronouncements:

 
·
FASB Accounting Standards Update 2010-06, "Improving Disclosures about Fair Value Measurements" ("ASU 2010-06"), which was issued by the FASB in January 2010 and is effective for interim and annual financial statements for fiscal years beginning after December 15, 2009. ASU 2010-06 expands and clarifies the disclosure requirements related to fair value measurements. It requires companies to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 of the fair value hierarchy and describe the reasons for the transfers. In addition, information about purchases, sales, issuances, and settlements on a gross basis is required in the reconciliation of Level 3 fair-value measurements. ASU 2010-06 also clarifies existing fair value measurement disclosure guidance related to level of disaggregation, fair value inputs, and valuation techniques. Universal was required to apply most provisions of the new guidance effective April 1, 2010, the beginning of the current fiscal year. The adoption of ASU 2010-06 did not have a material effect on the Company’s financial statements.

 
·
FASB Staff Position No. 132(R)-1, "Employers' Disclosures about Postretirement Benefit Plan Assets" ("FSP 132(R)-1"), adopted effective March 31, 2010. This pronouncement, which is now a part of Topic 715 of the Codification, requires expanded disclosures about plan assets of defined benefit pension or other postretirement benefit plans. The new disclosures include information about investment allocation decisions, categories of plan assets, the inputs and valuation techniques used to measure the fair value of those assets, and significant concentrations of credit risk. The disclosures required by FSP 132(R)-1 were included in the Company’s annual financial statements at March 31, 2010, and did not have a material effect on those financial statements.

 
7

 

Pronouncements to be Adopted in Future Periods
 
In addition to the above accounting pronouncements adopted through December 31, 2010, the following pronouncement has been issued and will become effective in fiscal year 2012:

 
·
FASB Accounting Standards Update 2009-13, "Multiple-Deliverable Revenue Arrangements" ("ASU 2009-13"), which was issued by the FASB in October 2009. ASU 2009-13 establishes a selling price hierarchy for determining the selling price of a deliverable in a multiple-deliverable arrangement. It also requires additional disclosures about the methods and assumptions used to evaluate multiple-deliverable arrangements and to identify the significant deliverables within those arrangements. ASU 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, which means that Universal will be required to adopt the guidance effective April 1, 2011, the beginning of its fiscal year 2012. The Company is evaluating the potential impact of ASU 2009-13, but does not currently expect that it will have a material effect on its financial statements.

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

Guarantees and Other Contingent Liabilities

Guarantees of bank loans to growers for crop financing and construction of curing barns or other tobacco producing assets are industry practice in Brazil and support the farmers’ production of tobacco there.  At December 31, 2010, the Company’s total exposure under guarantees issued by its operating subsidiary in Brazil for banking facilities of farmers in that country was approximately $77 million ($97 million face amount including unpaid accrued interest, less $20 million recorded for the fair value of the guarantees).  About 94% of these guarantees expire within one year, and all of the remainder expire within five years.  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 their obligations to the third-party banks could result in a liability for the subsidiary under the related guarantees; however, in that case, the subsidiary would have recourse against the farmers.  The maximum potential amount of future payments that the Company’s subsidiary could be required to make at December 31, 2010, was the face amount, $97 million including unpaid accrued interest ($155 million as of December 31, 2009, and $112 million at March 31, 2010).  The fair value of the guarantees was a liability of approximately $20 million at December 31, 2010 ($26 million at December 31, 2009, and $26 million at March 31, 2010).  In addition to these guarantees, the Company has other contingent liabilities totaling approximately $51 million, primarily related to a bank guarantee that bonds an appeal of a 2006 fine in the European Union, as discussed below.

European Commission Fines and Other Legal Matters

European Commission Fines in Spain

In October 2004, the European Commission (the “Commission”) imposed fines on “five companies active in the raw Spanish tobacco processing market” totaling €20 million for “colluding on the prices paid to, and the quantities bought from, the tobacco growers in Spain.”  Two of the Company’s subsidiaries, Tabacos Espanoles S.A. (“TAES”), a purchaser and processor of raw tobacco in Spain, and Deltafina, S.p.A. (“Deltafina”), an Italian subsidiary, were among the five companies assessed fines.  In its decision, the Commission imposed a fine of €108,000 on TAES and a fine of €11.88 million on Deltafina.  Deltafina did not and does not purchase or process raw tobacco in the Spanish market, but was and is a significant buyer of tobacco from some of the Spanish processors.  The Company recorded a charge of about €12 million (approximately $14.9 million at the September 2004 exchange rate) in the second quarter of fiscal year 2005 to accrue the full amount of the fines assessed against the Company’s subsidiaries.

In January 2005, Deltafina filed an appeal in the General Court of the European Union (“General Court”).  A hearing was held in June 2009, and on September 8, 2010, the General Court issued its decision, in which it reduced the amount of the Deltafina fine to €6.12 million. The General Court held in part that the Commission erred in finding Deltafina acted as the leader of the Spanish cartel, and that the Commission’s corresponding increase of the underlying fine by 50% was not justified.  Deltafina filed an appeal to the General Court decision with the European Court of Justice on November 18, 2010.  Although Deltafina agreed with the General Court that there was no basis for finding that Deltafina had acted as the leader of the Spanish cartel, Deltafina believed the General Court erred in not reducing the remaining fine further based on numerous grounds.  A hearing has not been set and an ultimate resolution to the matter could take several years.  The Company had deposited funds in an escrow account with the Commission in February 2005 in an amount equal to the original fine.  The Company received funds from escrow in an amount equal to the reduction by the General Court plus interest that had accrued thereon.  As a result of the General Court’s decision in September 2010, during the quarter ended September 30, 2010, the Company reversed €5.76 million (approximately $7.4 million) of the charge previously recorded to accrue the fine and recognized approximately $1.2 million of interest income returned on the escrow funds. The reversal of the fine is included in selling, general and administrative expense in the consolidated statement of income.

 
8

 

European Commission Fines in Italy

In 2002, the Company reported that it was aware that the Commission was investigating certain aspects of the leaf tobacco markets in Italy.  Deltafina buys and processes tobacco in Italy.  The Company reported that it did not believe that the Commission’s investigation in Italy would result in penalties being assessed against it or its subsidiaries that would be material to the Company’s earnings.  The reason the Company held this belief was that it had received conditional immunity from the Commission because Deltafina had voluntarily informed the Commission of the activities that were the basis of the investigation.

On December 28, 2004, the Company received a preliminary indication that the Commission intended to revoke Deltafina’s immunity for disclosing in April 2002 that it had applied for immunity.  Neither the Commission’s Leniency Notice of February 19, 2002, nor Deltafina’s letter of provisional immunity, contains a specific requirement of confidentiality.  The potential for such disclosure was discussed with the Commission in March 2002, and the Commission never told Deltafina that disclosure would affect Deltafina’s immunity.  On November 15, 2005, the Company received notification from the Commission that the Commission had imposed fines totaling €30 million (about $40 million at the December 31, 2010 exchange rate) on Deltafina and the Company jointly for infringing European Union antitrust law in connection with the purchase and processing of tobacco in the Italian raw tobacco market.

The Company does not believe that the decision can be reconciled with either the Commission’s Statement of Objections or the facts.  In January 2006, the Company and Deltafina each filed appeals in the General Court.  Deltafina’s appeal was held on September 28, 2010.  For strategic reasons related to the defense of the Deltafina appeal, Universal withdrew its appeal.  Based on consultation with outside legal counsel, the Company believes it is probable that Deltafina will prevail in the appeals process and has not accrued a charge for the fine.  If the Company and Deltafina are ultimately found liable for the full amount of the fine, then accumulated interest on the fine would also be due and payable. Accumulated interest totaled approximately €5.2 million (about $7.0 million) at December 31, 2010.  Deltafina has provided a bank guarantee to the Commission in the amount of the fine plus accumulated interest in order to stay execution during the appeals process.

  Other Legal Matters

In addition to the above-mentioned matters, various subsidiaries of the Company are involved in other litigation and tax examinations incidental to their business activities.  While the outcome of these matters cannot be predicted with certainty, management is vigorously defending these matters and does not currently expect that any of them will have a material adverse effect on the Company’s 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.

Assignment of Farmer Contracts and Sale of Related Assets in Brazil

In October 2010, Universal’s operating subsidiary in Brazil completed the assignment of tobacco production contracts with approximately 8,100 farmers to Philip Morris Brasil Industria e Comercio (“PMB”), a subsidiary of Philip Morris International (“PMI”).  As part of the transaction, PMB acquired various related assets, including seasonal crop advances outstanding from the farmers, and hired certain employees who previously worked for the Company in agronomy and leaf procurement functions.  PMB also assumed the Company’s obligations under guarantees of bank loans to the farmers for crop financing.  The farmer contracts assigned represent approximately 20% of the annual volume handled by the Company in Brazil during the most recent crop year.  The Company has entered into an agreement to process tobaccos bought directly by PMB from farmers beginning with the 2011 crop year.  In addition, the Company expects to continue to sell processed leaf from Brazil to PMI and its subsidiaries.   The Company received total cash proceeds of approximately $34.9 million from the assignment of farmer contracts and sale of related assets and recorded a gain of approximately $19.4 million, which is reported in other income in the consolidated statement of income.  The determination of the gain included approximately $5.8 million of goodwill associated with the activities conveyed.

 
9

 

NOTE 4.   RESTRUCTURING AND IMPAIRMENT COSTS

In November 2010, Universal decided to close its leaf tobacco processing facility in Simcoe, Ontario, Canada.  The Company will continue to buy tobacco grown in Canada, but will process that leaf at its U.S. factory in North Carolina.  All full-time salaried personnel at the Simcoe location have been or will be terminated with the closure of the facility, and various seasonal employees will not be rehired for the coming crop year.  Under Canadian statutory and common law, the salaried employees and certain seasonal employees are entitled to termination benefits.  The Company accrued the cost of these benefits, which totaled approximately $2.7 million, during the quarter ended December 31, 2010, and they will be paid to the employees shortly after their respective departure dates.  The full-time salaried personnel have vested service under a defined benefit pension plan.  The Company expects to incur pension settlement costs of approximately $4 million to $5 million in one or more future accounting periods as a result of settling those benefit obligations; however, actual settlement costs will depend on a number of factors, including the value of plan assets, discount rates affecting final benefit calculations, and annuity market rates.  The Company has determined that the Simcoe processing facility and a separate storage complex met the accounting requirements for classification as “held for sale” at December 31, 2010.  Based on terms of sale currently being negotiated with a buyer for the processing facility and a recent independent offer for the storage complex, an impairment charge of approximately $5.6 million was recorded during the quarter ended December 31, 2010, to write those assets down to their fair values, net of selling costs.  The Canadian operations are included in the North America segment, and revenues and earnings for these operations have not been material to that segment in recent years.

In addition to the restructuring and impairment costs related to the decision to close the facility in Canada, the Company recorded other restructuring costs during the quarter and nine months ended December 31, 2010, associated with initiatives undertaken to adjust various operations and reduce costs.  Most of the restructuring costs represent employee termination benefits associated with voluntary early retirement offers and involuntary separations at the Company’s headquarters and operating locations in the United States, South America, Africa, and Europe that are part of the North America and Other Regions reportable segments.

A summary of the restructuring and impairment costs recorded through December 31, 2010, is as follows:

(in thousands of dollars)
 
Closure of
Processing
Facility
in Canada
   
Other
Restructuring
and Cost
Reduction
Initiatives
   
Total
 
Restructuring Costs:
                 
Employee termination benefits
  $ 2,711     $ 5,293     $ 8,004  
Other costs
          328       328  
      2,711       5,621       8,332  
Impairment Costs:
                       
Property, plant and equipment
    5,632             5,632  
Total restructuring and impairment costs
  $ 8,343     $ 5,621     $ 13,964  

A reconciliation of the Company’s liability for the restructuring costs outlined above through December 31, 2010, is as follows:

(in thousands of dollars) 
 
Employee
Termination
Benefits
   
Other Costs
   
Total
 
                   
Restructuring costs charged to expense during fiscal year 2011
  $ 8,004     $ 328     $ 8,332  
Payments during fiscal year 2011
    (2,682 )     (238 )     (2,920 )
Restructuring liability at December 31, 2010
  $ 5,322     $ 90     $ 5,412  

 
10

 

The employee termination benefits outlined in the tables above relate to approximately 170 total employees, including those affected by the facility closure in Canada.  Most of the restructuring liability at December 31, 2010, will be paid before the end of the current fiscal year.  Universal continually reviews its business for opportunities to realize efficiencies, reduce costs, and realign its operations in response to business changes.  The Company expects to incur additional restructuring costs and may also incur asset impairment charges in future periods as business changes occur and additional cost savings initiatives are implemented.

NOTE 5.   EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share:

   
Three Months Ended
December 31,
   
Nine Months Ended
December 31,
 
(in thousands, except per share data)
 
2010
   
2009
   
2010
   
2009
 
                         
Basic Earnings Per Share
                       
Numerator for basic earnings per share
                       
Net income attributable to Universal Corporation
  $ 52,298     $ 45,696     $ 129,449     $ 141,956  
Less:  Dividends on convertible perpetual preferred stock
    (3,712 )     (3,712 )     (11,137 )     (11,137 )
Earnings available to Universal Corporation common shareholders for calculation of basic earnings per share
    48,586       41,984       118,312       130,819  
                                 
Denominator for basic earnings per share
                               
Weighted average shares outstanding
    23,738       24,684       24,010       24,823  
                                 
Basic earnings per share
  $ 2.05     $ 1.70     $ 4.93     $ 5.27  
                                 
Diluted Earnings Per Share
                               
Numerator for diluted earnings per share
                               
Earnings available to Universal Corporation common shareholders
  $ 48,586     $ 41,984     $ 118,312     $ 130,819  
Add:  Dividends on convertible perpetual preferred stock (if conversion assumed)
    3,712       3,712       11,137       11,137  
Earnings available to Universal Corporation common shareholders for calculation of diluted earnings per share
    52,298       45,696       129,449       141,956  
                                 
Denominator for diluted earnings per share:
                               
Weighted average shares outstanding
    23,738       24,684       24,010       24,823  
Effect of dilutive securities (if conversion or exercise assumed)
                               
Convertible perpetual preferred stock
    4,752       4,735       4,747       4,731  
Employee share-based awards
    302       226       262       173  
                                 
Denominator for diluted earnings per share
    28,792       29,645       29,019       29,727  
                                 
Diluted earnings per share
  $ 1.82     $ 1.54     $ 4.46     $ 4.78  

For the nine months ended December 31, 2010 and 2009, certain employee share-based awards were not included in the computation of diluted earnings per share because their effect would have been anti-dilutive.  These awards included stock appreciation rights and stock options totaling 669,401 shares at a weighted-average exercise price of $52.48 for the period ended December 31, 2010, and 507,801 shares at a weighted-average exercise price of $56.52 for the period ended December 31, 2009.

 
11

 

NOTE 6.   COMPREHENSIVE INCOME

Comprehensive income for each period presented in the consolidated statements of income and retained earnings was as follows:

   
Three   Months   Ended
December   31,
   
Nine   Months   Ended
December   31,
 
(in thousands of dollars - all amounts net of income taxes)
 
2010
   
2009
   
2010
   
2009
 
                         
Net income
  $ 57,585     $ 48,474     $ 135,786     $ 146,950  
Foreign currency translation adjustment
    (2,252 )     222       (1,091 )     13,814  
Foreign currency hedge adjustment
    (304 )     482       161       14,750  
Total comprehensive income
    55,029       49,178       134,856       175,514  
Less:  comprehensive income attributable to noncontrolling interests in subsidiaries (including foreign currency translation adjustment)
    (5,279 )     (2,822 )     (6,410 )     (5,096 )
Comprehensive income attributable to Universal Corporation
  $ 49,750     $ 46,356     $ 128,446     $ 170,418  

NOTE 7.   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 consolidated income tax rate is affected by a number of factors, including the mix of domestic and foreign earnings and investments, local tax rates of subsidiaries, repatriation of foreign earnings, and the Company's ability to utilize foreign tax credits.

The Company’s consolidated effective income tax rates on pre-tax earnings were approximately 29% and 30% for the quarter and nine months ended December 31, 2010, respectively.  For the quarter and nine months ended December 31, 2009, the effective income tax rates were approximately 32% and 31%, respectively.  The rates were lower than the 35% U.S. statutory rate due in part to earnings of subsidiaries in the Company’s African region, which allowed the recognition of foreign tax credits.  The lower rates for each period also reflect the reversal of uncertain tax positions upon the expiration of statutes of limitations for the related tax years in the respective jurisdictions or upon favorable resolution of the positions with the applicable tax authorities.

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 foreign currency exchange contracts.  However, the Company’s policy also permits other instruments.  In addition, management works to manage foreign currency exchange rate risk by minimizing net monetary positions in non-functional currencies, which may include using local borrowings.  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 (used) by operating activities.

 
12

 

Fair Value Hedging Strategy for Interest Rate Risk

The Company has entered into interest rate swap agreements to manage its exposure to interest rate risk, with a strategy of maintaining a level of floating rate debt that approximates the interest rate exposure on its committed inventories.  The strategy is implemented by borrowing at floating interest rates and converting a portion of the Company’s fixed-rate debt to floating rates.  The interest rate swap agreements allow the Company to receive amounts equal to the fixed interest payments it is obligated to make on the underlying debt instruments in exchange for making floating-rate interest payments that are adjusted semi-annually based on changes in the benchmark interest rate.

The Company’s interest rate swap agreements are designated and qualify as hedges of the exposure to changes in the fair value of the underlying debt instruments created by fluctuations in prevailing market interest rates.  In all cases, the critical terms of each interest rate swap agreement match the terms of the underlying debt instrument, and there is no hedge ineffectiveness.  The total notional amount of the Company’s receive-fixed/pay-floating interest rate swaps was $245 million at December 31, 2010, March 31, 2010, and December 31, 2009.

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 and therefore can adversely impact the gross profit earned on the sale of that tobacco.  Since the Company is able to reasonably forecast the volume, timing, and local currency cost of its tobacco purchases and processing costs, it has routinely entered 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 those purchases and costs that are related to future purchases and processing pursuant to customer agreements.  This strategy contemplates the Company’s pricing arrangements with key customers and substantially eliminates the variability of future U.S. dollar cash flows for tobacco purchases and processing costs for the foreign currency notional amount hedged.  The hedging strategy has been used mainly for tobacco purchases and processing costs in Brazil, where the large crops, the terms of sale to customers, and the availability of derivative markets make it particularly desirable to manage the related foreign exchange rate risk.

For the crops bought, processed, and sold in fiscal years 2010 and 2011, all contracts related to tobacco purchases in Brazil were designated and qualify as hedges of the future cash flows associated with the forecast purchases of tobacco.  As a result, except for insignificant amounts related to any ineffective portion of the hedging strategy, 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.

From March through July 2010, the Company hedged approximately $109 million U.S. dollar notional amount related to 2009-2010 crop tobacco purchases in Brazil.  Additional forward contracts totaling approximately $58 million U.S. dollar notional amount were entered to mitigate currency exposure on processing costs related to that crop.  Purchases of the 2009-2010 crop were completed in July 2010, and all forward contracts to hedge those purchases matured and were settled by that time.  All hedge gains and losses recorded in accumulated other comprehensive loss were recognized in cost of goods sold with the sale of tobacco by September 30, 2010. As noted above, changes in the fair values of forward contracts related to processing costs were recognized in earnings each quarter on a mark-to-market basis.

From September 2008 through July 2009, the Company hedged approximately $241 million U.S. dollar notional amount related to 2008-2009 crop tobacco purchases in Brazil, primarily related to customer contractual requirements.  Purchases of that crop were completed in July 2009, and all forward contracts related to the crop matured and were settled by that time.  Sales of the 2008-2009 crop began during the first quarter of fiscal year 2010 and were completed by the end of the fiscal year.  As that tobacco was sold, all hedge gains and losses previously recorded in accumulated other comprehensive loss were reclassified to cost of goods sold.

 
13

 

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 at most times of the year, 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.   Due to the size of its operations and the fact that it provides significant financing to farmers for crop production, the Company’s subsidiary in Brazil has significant exposure to currency remeasurement gains and losses due to fluctuations in exchange rates at certain times of the year.  To manage a portion of its exposure to currency remeasurement gains and losses in Brazil during fiscal year 2011, the Company entered into forward contracts to sell the Brazilian currency and buy U.S. dollars 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 were recorded in earnings as a component of selling, general, and administrative expenses as they occurred, and thus directly offset the related remeasurement losses or gains for the notional amount hedged in the consolidated statements of income.  Accordingly, the Company did not designate these contracts as hedges for accounting purposes. The notional amount of these contracts totaled approximately $60 million in U.S. dollars. All of the contracts were entered and settled during the quarter ended June 30, 2010. No contracts were entered for this purpose in fiscal year 2010.  To further mitigate currency remeasurement exposure, some of the Company’s foreign subsidiaries have obtained short-term local currency financing during certain periods.  This strategy, while not involving the use of derivative instruments, is intended to minimize the subsidiary’s net monetary position by financing a portion of the local currency monetary assets with local currency monetary liabilities and thus hedging a portion of the overall position.

The Company has several foreign subsidiaries that 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.

 
14

 

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 quarters and nine months ended December 31, 2010 and 2009.

   
Three Months Ended
December 31,
   
Nine Months Ended
December 31,
 
(in thousands of dollars)
 
2010
   
2009
   
2010
   
2009
 
Fair Value Hedges - Interest Rate Swap Agreements
                       
Derivative
                       
Gain (loss) recognized in earnings
  $ (3,980 )   $ (2,683 )   $ 2,721     $ (2,586 )
Location of gain (loss) recognized in earnings
 
Interest expense
 
Hedged Item
                               
Description of hedged item
 
Fixed rate long-term debt
 
Gain (loss) recognized in earnings
  $ 3,980     $ 2,683     $ (2,721 )   $ 2,586  
Location of gain (loss) recognized in earnings
 
Interest expense
 
Cash Flow Hedges - Forward Foreign Currency Exchange Contracts
                               
Derivative
                               
Effective Portion of Hedge
                               
Gain (loss) recorded in accumulated other comprehensive loss
  $     $     $     $ 7,162  
Gain (loss) reclassified from accumulated other comprehensive loss into earnings
  $     $ (1,274 )   $ 100     $ (14,492 )
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
  $     $     $ 101     $ 1,444  
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
                               
Contracts related to forecast processing costs and forecast purchases of tobacco, primarily in Brazil
                               
Gain (loss) recognized in earnings
  $ (64 )   $     $ 1,138     $  
Location of gain (loss) recognized in earnings
 
Selling, general and administrative expenses
 
Contracts related to net local currency monetary assets and liabilities of subsidiary in Brazil
                               
Gain (loss) recognized in earnings
  $     $     $ 661     $  
Location of gain (loss) recognized in earnings
 
Selling, general and administrative expenses
 
Contracts related to fixed-price orders and accounts receivable of non-U.S. dollar subsidiaries
                               
Gain (loss) recognized in earnings
  $ (511 )   $ 826     $ (169 )   $ 1,161  
Location of gain (loss) recognized in earnings
 
Selling, general and administrative expenses
 
Total gain (loss) recognized in earnings for forward foreign
                               
currency exchange contracts not designated as hedges
  $ (575 )   $ 826     $ 1,630     $ 1,161  

For the interest rate swap agreements designated as fair value hedges, since the hedges have no ineffectiveness, the gain or loss recognized in earnings on the derivative is offset by a corresponding loss or gain on the underlying hedged debt.  For the forward foreign currency exchange contracts designated as cash flow hedges of tobacco purchases in Brazil, no hedge gain or loss remained in accumulated other comprehensive loss at December 31, 2010.

 
15

 

Effect of Derivative Financial Instruments on the Consolidated Balance Sheets

The table below outlines the effects of the Company’s derivative financial instruments on the consolidated balance sheets at December 31, 2010 and 2009, and March 31, 2010:
 
   
Derivatives   in   a   Fair   Value   Asset   Position
 
Derivatives   in   a   Fair   Value   Liability   Position
 
   
Balance
 
Fair   Value   as   of
 
Balance
 
Fair   Value   as   of
 
   
Sheet
 
Dec. 31,
   
Dec. 31,
   
March 31,
 
Sheet
 
Dec. 31,
   
Dec. 31,
   
March 31,
 
(in   thousands   of   dollars)
 
Location
 
2010
   
2009
   
2010
 
Location
 
2010
   
2009
   
2010
 
Derivatives Designated
                                         
as Hedging Instruments
                                         
Interest rate swap
 
Other
                                     
agreements
 
non-
                 
Long-term
                 
   
current
                 
obligations
                 
   
assets
  $ 12,486     $ 10,833     $ 10,358       $     $ 1,611     $ 593  
                                                       
Forward foreign currency
 
Other
                       
Accounts
                       
exchange contracts
 
current
                       
 payable and 
                       
   
assets
                       
accrued
                       
                      84  
expenses
                73  
Total
      $ 12,486     $ 10,833     $ 10,442       $     $ 1,611     $ 666  
Derivatives Not Designated
                                                     
as Hedging Instruments
                                                     
Forward foreign currency
 
Other
                       
Accounts
                       
exchange contracts
 
current
                       
payable and
                       
   
assets
                       
accrued
                       
        $ 172     $ 556     $ 740  
expenses
  $ 272     $ 287     $ 512  
Total
      $ 172     $ 556     $ 740       $ 272     $ 287     $ 512  
 
16

 
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 assessments of goodwill and long-lived assets for potential impairment.

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 under the guidance is based on a fair value hierarchy that distinguishes between observable inputs (i.e., inputs that are based on market data obtained from independent sources) and unobservable inputs (i.e., inputs that require the Company to make its own assumptions about market participant assumptions because little or no market data exists).  There are three levels within the fair value hierarchy:

Level
 
Description
     
1
 
quoted prices in active markets for identical assets or liabilities that the Company has the ability to access as of the reporting date;
     
2
 
quoted prices in active markets for similar assets or liabilities, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability; and
     
3
 
unobservable inputs for the asset or liability.

In measuring the fair value of liabilities, the Company considers the risk of non-performance in determining fair value.

At December 31, 2010, 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 table below and classified based on how their values were determined under the fair value hierarchy:

   
December   31,   2010
 
(in   thousands   of   dollars)
 
Level   1
   
Level   2
   
Level   3
   
Total
 
                         
Assets:
                       
Money market funds
  $ 42,801     $     $     $ 42,801  
Trading securities associated with deferred compensation plans
    20,422                   20,422  
Interest rate swaps
          12,486             12,486  
Forward foreign currency exchange contracts
          172             172  
Total assets
  $ 63,223     $ 12,658     $     $ 75,881  
Liabilities:
                               
Guarantees of bank loans to tobacco growers
  $     $     $ 19,678     $ 19,678  
Forward foreign currency exchange contracts
          272             272  
Total liabilities
  $     $ 272     $ 19,678     $ 19,950  

Money market funds

The fair values of money market funds, which are reported in cash and cash equivalents in the consolidated balance sheets, are based on quoted market prices (Level 1).  The fair values of the Company’s money market funds approximate cost due to the short-term maturities and high credit quality of the issuers of the underlying securities.

 
17

 

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 and their underlying securities.

Interest rate swaps

The fair values of interest rate swap contracts 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 fair values of the Company’s guarantees of bank loans to tobacco growers are determined by using internally-tracked historical loss data for such loans to develop an estimate of future losses under the guarantees outstanding at the measurement date.  The present value of the cash flows associated with those estimated losses is then calculated at a risk-adjusted interest rate.  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.  The guarantees of bank loans to tobacco growers are therefore classified within Level 3 of the fair value hierarchy.

A reconciliation of the change in the balance of the financial liability for guarantees of bank loans to tobacco growers (Level 3) for the nine months ended December 31, 2010, is as follows:

(in thousands of dollars)
 
Nine Months
Ended
December 31, 2010
 
       
Balance at beginning of year
  $ 25,997  
Transfer to allowance for loss on direct loans to farmers (removal of prior crop year loans from portfolio and addition of current crop year loans)
    (7,336 )
Assumption of guarantees related to assignment of farmer contracts (see Note 3)
    (1,110 )
Change in discount rate and estimated collection period
    1,001  
Currency remeasurement
    1,126  
Balance at end of period
  $ 19,678  

The effects of currency remeasurement and the change in discount rate and estimated collection period are recorded in earnings and reported in selling, general, and administrative expense. Universal has not elected to report at fair value any financial instruments or other items not otherwise required to be reported at fair value under current accounting guidance.

 
18

 

NOTE 10.   PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS

The Company has 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 provides postretirement health and life insurance benefits for eligible U.S. employees attaining specific age and service levels.

The components of the Company’s net periodic benefit cost were as follows:

   
Pension Benefits
   
Other Postretirement Benefits
 
   
Three Months Ended
December 31,
   
Three Months Ended
December 31,
 
(in thousands of dollars)
 
2010
   
2009
   
2010
   
2009
 
Service cost
  $ 1,261     $ 1,030     $ 203     $ 162  
Interest cost
    3,601       3,710       624       705  
Expected return on plan assets
    (3,728 )     (3,469 )     (35 )     (38 )
Settlement cost
          2,084              
Net amortization and deferral
    1,006       245       (77 )     (255 )
Net periodic benefit cost
  $ 2,140     $ 3,600     $ 715     $ 574  
                                 
   
Pension Benefits
   
Other Postretirement Benefits
 
   
Nine Months Ended
December 31,
   
Nine Months Ended
December 31,
 
(in thousands of dollars)
 
2010
   
2009
   
2010
   
2009
 
Service cost
  $ 3,743     $ 3,071     $ 611     $ 489  
Interest cost
    10,704       11,076       1,873       2,116  
Expected return on plan assets
    (11,127 )     (10,360 )     (107 )     (114 )
Settlement cost
          3,334              
Net amortization and deferral
    2,999       735       (233 )     (765 )
Net periodic benefit cost
  $ 6,319     $ 7,856     $ 2,144     $ 1,726  

During the nine months ended December 31, 2010, the Company made contributions of approximately $5.2 million to its qualified and non-qualified pension plans.  Additional contributions of approximately $1.5 million are expected during the remaining three months of fiscal year 2011.

 
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NOTE 11.   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, which is scheduled on a day between two and twelve business days following the public release of the Company’s annual financial results.  The Compensation Committee administers the Company’s Plans consistently following previously defined guidelines.  Awards of restricted stock, RSUs, PSAs, SARs, and non-qualified stock options are currently outstanding under the Plans.  The non-qualified stock options and SARs have an exercise price equal to the closing price of a share of the Company’s common stock on the grant date.  All stock options currently outstanding are fully vested and exercisable, and they expire ten years after the grant date.  The SARs are settled in shares of common stock, vest in equal one-third tranches one, two, and three years after the grant date, and expire ten years after the grant date, except that SARs granted after fiscal year 2007 expire on the earlier of three years after the grantee’s retirement date or ten years after the grant date.  The RSUs vest five years from the grant date and are then paid out in shares of common stock.  Under the terms of the RSU awards, grantees receive dividend equivalents in the form of additional RSUs that vest and are paid out on the same date as the original RSU grant.  The PSAs vest three years from the grant date, are paid out in shares of common stock at the vesting date, and do not carry rights to dividends or dividend equivalents prior to vesting.  Shares ultimately paid out under PSA grants are dependent on the achievement of predetermined performance measures established by the Compensation Committee and can range from zero to 150% of the stated award.  The Company’s outside directors automatically receive restricted stock units or shares of restricted stock following each annual meeting of shareholders.  RSUs awarded to outside directors vest three years from the grant date, and restricted shares vest upon the individual’s retirement from service as a director.

During the nine-month periods ended December 31, 2010 and 2009, Universal issued the following stock-based awards, representing the regular annual grants to officers and outside directors of the Company:

   
Nine Months Ended
December 31,
 
   
2010
   
2009
 
             
SARs:
           
Number granted
    153,600       253,800  
Exercise price
  $ 39.71     $ 35.30  
Grant date fair value
  $ 8.35     $ 7.85  
                 
RSUs:
               
Number granted
    53,700       63,450  
Weighted average grant date fair value
  $ 41.14     $ 35.30  
                 
PSAs:
               
Number granted
    38,400       63,450  
Grant date fair value
  $ 33.95     $ 29.67  
                 
Restricted Shares:
               
Number granted
          17,550  
Grant date fair value
  $     $ 39.76  

 
20

 
 
The grant date fair value of the SARs was estimated using the Black-Scholes pricing model and the following assumptions:
 
   
2010
   
2009
 
             
Expected term
 
5.0 years
   
5.0 years
 
Expected volatility
    35.3 %     39.0 %
Expected dividend yield
    4.73 %     5.21 %
Risk-free interest rate
    2.36 %     2.51 %

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 than in the other three quarters.  For PSAs, the Company generally recognizes fair value expense ratably over the performance and vesting period based on management’s judgment of the ultimate award that is likely to be paid out based on the achievement of the predetermined performance measures.  For the nine-month periods ended December 31, 2010 and 2009, the Company recorded total stock-based compensation expense of approximately $4.8 million and $4.6 million, respectively.  The Company expects to recognize stock-based compensation expense of approximately $1.2 million during the remaining three months of fiscal year 2011.

 
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NOTE 12.   OPERATING SEGMENTS

The principal approach used by management to evaluate the Company’s performance is by geographic region, although some components of the business are 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 pretax earnings of unconsolidated affiliates.

Operating results for the Company’s reportable segments for each period presented in the consolidated statements of income and retained earnings were as follows:

   
Three Months Ended
December 31,
   
Nine Months Ended
December 31,
 
(in thousands of dollars)
 
2010
   
2009
   
2010
   
2009
 
                         
SALES AND OTHER OPERATING REVENUES
                       
                         
Flue-cured and burley leaf tobacco operations:
                       
North America
  $ 124,072     $ 101,302     $ 243,990     $ 187,308  
Other regions (1)
    506,568       502,624       1,468,326       1,570,973  
Subtotal
    630,640       603,926       1,712,316       1,758,281  
Other tobacco operations (2)
    57,568       57,279       178,996       166,954  
                                 
Consolidated sales and other operating revenues
  $ 688,208     $ 661,205     $ 1,891,312     $ 1,925,235  
                                 
OPERATING INCOME
                               
                                 
Flue-cured and burley leaf tobacco operations:
                               
North America
  $ 26,693     $ 23,826     $ 42,383     $ 32,080  
Other regions (1)
    47,620       42,320       138,530       167,706  
Subtotal
    74,313       66,146       180,913       199,786  
Other tobacco operations (2)
    3,466       10,582       15,492       31,825  
                                 
Segment operating income
    77,779       76,728       196,405       231,611  
                                 
Deduct: Equity in pretax (earnings) loss of unconsolidated affiliates (3)
    1,439       (7,783 )     (953 )     (17,029 )
  Restructuring and impairment costs (4)
    (10,995 )           (13,964 )      
Add:     Other income (4)
    19,368             19,368        
  Reversal of European Commission fines (4)
                7,445        
                                 
Consolidated operating income
  $ 87,591     $ 68,945     $ 208,301     $ 214,582  

(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)
Item is included in segment operating income, but not included in consolidated operating income.
(4)
Item is not included in segment operating income, but is included in consolidated operating income.

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

A reconciliation of the changes in the Company’s shareholders’ equity and noncontrolling interests in subsidiaries for the nine months ended December 31, 2010 and 2009 is as follows:

   
Nine Months Ended
December 31, 2010
   
Nine Months Ended
December 31, 2009
 
   
Universal
   
Noncontrolling
         
Universal
   
Noncontrolling
       
(in thousands of dollars)
 
Corporation
   
Interests
   
Total
   
Corporation
   
Interests
   
Total
 
                                     
Balance at beginning of year
  $ 1,122,570     $ 5,805     $ 1,128,375     $ 1,029,473     $ 3,771     $ 1,033,244  
                                                 
Changes in common stock
                                               
Issuance of common stock
                      205             205  
Repurchase of common stock
    (6,297 )           (6,297 )     (3,457 )           (3,457 )
Accrual of stock-based compensation
    4,808             4,808       4,609             4,609  
Withholding of shares for grantee