UNIVERSAL CORP /VA/ 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Unless the context otherwise requires, the terms “we,” “our,” “us” or “Universal” or the “Company” refer to Universal Corporation together with its subsidiaries. This Quarterly Report on Form 10-Q and the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Among other things, these statements relate to the Company’s financial condition, results of operation, and future business plans, operations, opportunities, and prospects. In addition, the Company and its representatives may from time to time make written or oral forward-looking statements, including statements contained in other filings with the Securities and Exchange Commission and in reports to shareholders. These forward-looking statements are generally identified by the use of words such as we “expect,” “believe,” “anticipate,” “could,” “should,” “may,” “plan,” “will,” “predict,” “estimate,” and similar expressions or words of similar import. These forward-looking statements are based upon management’s current knowledge and assumptions about future events and involve risks and uncertainties that could cause actual results, performance, or achievements to be materially different from any anticipated results, prospects, performance, or achievements expressed or implied by such forward-looking statements. Such risks and uncertainties include, but are not limited to: impacts of the COVID-19 pandemic; success in pursuing strategic investments or acquisitions and integration of new businesses and the impact of these new businesses on future results; product purchased not meeting quality and quantity requirements; reliance on a few large customers; our ability to maintain effective information systems and safeguard confidential information; anticipated levels of demand for and supply of our products and services; costs incurred in providing these products and services; timing of shipments to customers; changes in market structure; government regulation and other stakeholder expectations; economic and political conditions in the countries in which we and our customers operate, including the ongoing impacts from the conflict in Ukraine; product taxation; industry consolidation and evolution; changes in exchange rates and interest rates; impacts of regulation and litigation on our customers; industry-specific risks related to our plant-based ingredient businesses; exposure to certain regulatory and financial risks related to climate change; changes in estimates and assumptions underlying our critical accounting policies; the promulgation and adoption of new accounting standards; new government regulations and interpretation of existing standards and regulations; and general economic, political, market, and weather conditions. For a further description of factors that may cause actual results to differ materially from such forward-looking statements, see Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended March 31, 2022. We caution investors not to place undue reliance on any forward-looking statements as these statements speak only as of the date when made, and we undertake no obligation to update any forward-looking statements made in this report. This Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended March 31, 2022. Results of Operations Amounts described as net income (loss) and earnings (loss) per diluted share in the following discussion are attributable to Universal Corporation and exclude earnings related to non-controlling interests in subsidiaries. Adjusted operating income (loss), adjusted net income (loss) attributable to Universal Corporation, adjusted diluted earnings (loss) per share, and the total for segment operating income (loss) referred to in this discussion are non-GAAP financial measures. These measures are not financial measures calculated in accordance with GAAP and should not be considered as substitutes for operating income (loss), net income (loss) attributable to Universal Corporation, diluted earnings (loss) per share, cash from operating activities or any other operating or financial performance measure calculated in accordance with GAAP, and may not be comparable to similarly-titled measures reported by other companies. A reconciliation of adjusted operating income (loss) to consolidated operating (income), adjusted net income (loss) attributable to Universal Corporation to consolidated net income (loss) attributable to Universal Corporation and adjusted diluted earnings (loss) per share to diluted earnings (loss) per share are provided in Other Items below. In addition, we have provided a reconciliation of the total for segment operating income (loss) to consolidated operating income (loss) in Note 15. "Operating Segments" to the consolidated financial statements. Management evaluates the consolidated Company and segment performance excluding certain significant charges or credits. We believe these non-GAAP financial measures, which exclude items that we believe are not indicative of our core operating results, provide investors with important information that is useful in understanding our business results and trends. Overview We are pleased with our start to fiscal year 2023. In the quarter ended June 30, 2022, we continued to effectively navigate increased costs, particularly rising prices for green leaf tobacco, and shipping constraints. We succeeded in getting a significant amount of carryover tobacco shipped out of Brazil, and our plant-based ingredients platform continued to exceed our expectations. Results for our Tobacco Operations segment were down modestly in the quarter ended June 30, 2022, compared to the quarter ended June 30, 2021, largely on unfavorable foreign currency comparisons due to the strong U.S. dollar. Demand for leaf tobacco remains strong, and flue-cured, burley, oriental, and wrapper tobacco remain in an undersupply position. We are also 29 anticipating a reduction in African burley tobacco crop sizes due to weather conditions there. While we were able to ship a greater amount of carryover tobacco out of Brazil in the quarter ended June 30, 2022, compared to the quarter ended June 30, 2021, we continue to face a challenging logistical environment. We are also continuing to see increased costs for leaf tobacco across virtually all markets. Our Ingredients Operations segment performed well in the first quarter of fiscal year 2023. Sales for all of our businesses in this segment were up in the quarter ended June 30, 2022, compared to the quarter ended June 30, 2021, with strong volumes for both human and pet food product categories. In our Ingredients Operations segment, we are also seeing rising costs for raw materials and the impact of higher freight costs. Synergies captured across the plant-based ingredients platform continue to make good progress. Our businesses are working together on new product development and strategies to serve the platform’s diverse customers which utilize our portfolio of plant-based ingredients and botanical extracts and flavorings offerings. Results for the Ingredients Operations segment for the quarter ended June 30, 2022, include our October 2021 purchase of Shank’s Extracts, LLC (“Shank’s”). Our elevated borrowing levels reflect our acquisition of Shank’s as well as higher tobacco inventory levels, largely due to higher green leaf tobacco prices and tobacco shipment timing. We expect our seasonal borrowing levels to decrease in the second half of our fiscal year in line with our tobacco crop shipments, which are weighted to that period. At Universal, we are committed to providing transparency around our sustainability efforts and goals. We recently completed our submission to the global non-profit organization CDP regarding climate change, forestry, and water risk to provide more information on our achievements in these areas to our stakeholders. We are also excited to announce that we have engaged a third party to aid in analyzing and communicating our climate change policy as well as to provide independent, third party verification of our results. FINANCIAL HIGHLIGHTS Three Months Ended June 30, Change (in millions of dollars, except per share data) 2022 2021 $ % Consolidated Results Sales and other operating revenue $ 429.8 $ 350.0 $ 79.8 23 % Cost of goods sold $ 350.1 $ 287.6 $ 62.5 22 % Gross Profit Margin 18.5 % 17.8 % 70 bps Selling, general and administrative expenses $ 66.5 $ 49.8 $ 16.6 33 % Restructuring and impairment costs $ — $ 2.0 $ (2.0) (100) % Operating income (as reported) $ 13.3 $ 10.6 $ 2.7 25 % Adjusted operating income (non-GAAP)* $ 13.3 $ 12.6 $ 0.6 5 % Diluted earnings per share (as reported) $ 0.27 $ 0.26 $ 0.01 4 % Adjusted diluted earnings per share (non-GAAP)* $ 0.25 $ 0.30 $ (0.05) (17) % Segment Results Tobacco operations sales and other operating revenues $ 348.1 $ 293.8 $ 54.2 18 % Tobacco operations operating income $ 8.1 $ 8.9 $ (0.8) (9) % Ingredients operations sales and other operating revenues $ 81.8 $ 56.2 $ 25.6 46 % Ingredient operations operating income $ 4.6 $ 4.3 $ 0.2 6 % *See Reconciliation of Certain Non-GAAP Financial Measures in Other Items below. Net income for the quarter ended June 30, 2022, was $6.8 million, or $0.27 per diluted share, compared with $6.4 million, or $0.26 per diluted share, for the quarter ended June 30, 2021. Excluding restructuring and impairment costs and certain other non-recurring items, detailed in Other Items below, net income and diluted earnings per share decreased by $1.2 million and $0.05, respectively, for the quarter ended June 30, 2022, compared to the quarter ended June 30, 2021. Operating income of $13.3 million for the quarter ended June 30, 2022, increased by $2.7 million, compared to operating income of $10.6 million for the quarter ended June 30, 2021. Adjusted operating income, detailed in Other Items below, of $13.3 million increased by $0.6 million for the first quarter of fiscal year 2023, compared to adjusted operating income of $12.6 million for the first quarter of fiscal year 2022. 30 Consolidated revenues increased by $79.8 million to $429.8 million for the three months ended June 30, 2022, compared to the same period in fiscal year 2022, on higher carryover tobacco sales volumes and prices as well as the addition of Shank’s in October 2021 in the Ingredients Operations segment. Tobacco Operations The first fiscal quarter is historically a slow quarter for our tobacco businesses. Operating income for the Tobacco Operations segment decreased by $0.8 million to $8.1 million for the quarter ended June 30, 2022, compared with the quarter ended June 30, 2021. Although tobacco sales volumes were up modestly, Tobacco Operations segment results were down largely on unfavorable foreign currency comparisons due to the strong U.S. dollar in the quarter ended June 30, 2022, compared to the same quarter in the prior fiscal year. Carryover crop shipments were higher in Brazil in the quarter ended June 30, 2022, compared to the same quarter in the prior fiscal year, largely due to increased shipping availability. In Africa, carryover shipments were down in the quarter ended June 30, 2022, compared to the quarter ended June 30, 2021, on smaller crops grown in fiscal year 2022. Selling, general, and administrative expenses for the Tobacco Operations segment were higher in the quarter ended June 30, 2022, compared to June 30, 2021, primarily on unfavorable foreign currency comparisons. Revenues for the Tobacco Operations segment of $348.1 million for the quarter ended June 30, 2022, were up $54.2 million, compared to the same period in the prior fiscal year, on higher tobacco sales volumes and prices. Ingredients Operations Operating income for the Ingredients Operations segment was $4.6 million for the quarter ended June 30, 2022, compared to $4.3 million for the quarter ended June 30, 2021. Results for the segment improved year-over-year on the inclusion of the October 2021 Shank’s acquisition. Sales for all of our businesses in this segment were up in the quarter ended June 30, 2022, compared to the quarter ended June 30, 2021, with continued strong volumes for both human and pet food product categories. Selling, general, and administrative expenses for this segment increased in the quarter ended June 30, 2022, compared to the same quarter in the prior fiscal year, on the addition of Shank’s as well as higher labor costs. In the quarter ended June 30, 2022, the allocation of corporate overhead charges to the Ingredients Operations segment was also up, compared to the quarter ended June 30, 2021. Revenues for the Ingredients Operations segment of $81.8 million for the quarter ended June 30, 2022, were up $25.6 million compared to the quarter ended June 30, 2021, largely on the addition of the revenues for Shank’s as well as higher sales volumes and prices. Other Items Cost of goods sold in the quarter ended June 30, 2022, increased by 22% to $350.1 million, compared with the same period in the prior fiscal year, consistent with the similar percentage increase in revenues for the current period. Selling, general, and administrative costs for the quarter ended June 30, 2022, increased by $16.6 million to $66.5 million, compared to the same period in the prior fiscal year, primarily on additional costs from the acquisition of Shank’s in the Ingredients Operations segment and unfavorable foreign currency comparisons as well as inflationary increases in compensation and travel costs. Unfavorable foreign currency comparisons were approximately $6.6 million in the quarter ended June 30, 2022, compared to the quarter ended June 30, 2021. Interest expense for the quarter ended June 30, 2022, increased by $0.5 million to $6.7 million on increased costs from higher debt balances and interest rates, partially offset by a $1.8 million interest expense accrual reversal related to the sale of our previously idled operations in Tanzania. For the three months ended June 30, 2022, the Company’s consolidated effective income tax rate on pre-tax income was 54.6%. The consolidated effective income tax rate for the three months ended June 30, 2022 was affected by the sale of our Tanzania operations which resulted in $1.1 million of additional income taxes. Without this item, the consolidated effective income tax rate for the three months ended June 30, 2022 would have been approximately 36.2%. Additionally, the sale of our Tanzania operations resulted in a $1.8 million reduction to consolidated interest expense related to an uncertain tax position. For the three months ended June 30, 2021, the Company’s effective tax rate on pre-tax income was 23.7%. Reconciliation of Certain Non-GAAP Financial Measures The following tables set forth certain non-recurring items included in reported results to reconcile adjusted operating income to consolidated operating income and adjusted net income to net income attributable to Universal Corporation: 31 Adjusted Operating Income Reconciliation Three Months Ended June 30, (in thousands) 2022 2021 As Reported: Consolidated operating income $ 13,266 $ 10,605 Restructuring and impairment costs (1) — 2,024 Adjusted operating income $ 13,266 $ 12,629 Adjusted Net Income and Diluted Earnings Per Share (in thousands and reported net of income taxes) Three Months Ended June 30, 2022 2021 As Reported: Net income available to Universal Corporation $ 6,830 $ 6,357 Restructuring and impairment costs (1) — 1,005 Interest expense reversal on uncertain tax position and income tax from sale of operations in Tanzania (684) — Adjusted net income available to Universal Corporation $ 6,146 $ 7,362 As reported: Diluted earnings per share $ 0.27 $ 0.26 As adjusted: Diluted earnings per share $ 0.25 $ 0.30 (1) Restructuring and impairment costs are included in Consolidated operating income in the consolidated statements of income, but excluded for purposes of Adjusted operating income, Adjusted net income available to Universal Corporation, and Adjusted diluted earnings per share. See Note 4 for additional information. COVID-19 Pandemic Impact On March 11, 2020, the World Health Organization declared the coronavirus (“COVID-19”) a pandemic. Foreign governmental organizations and governmental organizations in the United States have taken various actions to combat the spread of COVID-19 and its subsequent variants, including imposing stay-at-home orders, closing “non-essential” businesses and their operations, and restricting international travel. We continue to closely monitor developments related to the COVID-19 pandemic and have taken and continue to take steps intended to mitigate the potential risks and impacts to us. It is paramount that our employees who operate our businesses are safe and informed. We have assessed and regularly update our existing business continuity plans for our business in the context of this pandemic. For example, we took precautions during the pandemic with regard to employee and facility hygiene, imposed travel limitations on our employees, implemented work-from-home procedures, and we continue to assess and reevaluate protocols designed to protect our employees, customers and the public. We continue to work with our suppliers to mitigate the impacts to our supply chain due to the pandemic. To date, we have not experienced a material impact to our supply chain, although the COVID-19 pandemic resulted in delays in certain operations during fiscal year 2021. Since March 2020, we have at times also experienced increased volatility in foreign currency exchange rates, which we believe has in part related to the uncertainties from COVID-19, as well as actions taken by governments and central banks in response to COVID-19. We are currently seeing and monitoring some logistical constraints around worldwide vessel and container availability and increased costs stemming from the COVID-19 pandemic. We believe we currently have sufficient liquidity to meet our current obligations and our business operations remain fundamentally unchanged other than shipping delays, which could continue to impact quarterly comparisons. This remains, however, a rapidly evolving situation, and we cannot predict the extent, resurgence, or duration of the COVID-19 pandemic, the effects of it on the global, national or local economy, including the impacts on our ability to access capital, or its effects on our business, financial position, results of operations, and cash flows. We continue to monitor developments affecting our employees, customers and operations. We will take additional steps and reevaluate current protocols to address the spread of COVID-19 and its impacts, as necessary, and remain thankful for the hard work of our employees and the continued support of our customers, growers, and other partners during these challenging times. 32 Liquidity and Capital Resources Overview Our first fiscal quarter is usually a period of significant working capital investment in both Africa and South America as tobacco crops are delivered by farmers. We funded our working capital needs in the quarter ended June 30, 2022, using a combination of cash on hand, short-term borrowings, customer advances, and operating cash flows. We are expecting higher and longer duration working capital needs in fiscal year 2023 compared to historical levels due to increased costs, specifically higher leaf tobacco costs, and tobacco shipment timing. Tobacco crop shipments are expected to be weighted to the second half of our fiscal year. Our liquidity and operating capital resource requirements are predominantly short term in nature and primarily relate to working capital for tobacco crop purchases. Working capital needs are seasonal within each geographic region. The geographic dispersion and the timing of working capital needs permit us to predict our general level of cash requirements, although tobacco crop size, prices paid to farmers, shipment and delivery timing, and currency fluctuations affect requirements each year. Peak working capital requirements are generally reached during the first and second fiscal quarters. Each geographic area follows a cycle of buying, processing, and shipping tobacco, and in many regions, we also provide agricultural materials to farmers during the growing season. The timing of the elements of each cycle is influenced by such factors as local weather conditions and individual customer shipping requirements, which may change the level or the duration of crop financing. Despite a predominance of short-term needs, we maintain a portion of our total debt as long-term to reduce liquidity risk. We also periodically have large cash balances that we utilize to meet our working capital requirements. To date, COVID-19 has not had a significant impact on our operations, and we currently anticipate our current cash balances, cash flows from operations, and our available sources of liquidity will be sufficient to meet our cash requirements for at least the next twelve months. This continues, however, to be a rapidly evolving situation, and we cannot predict the extent, resurgence, or duration of the ongoing COVID-19 pandemic, the effects of it on the global, national or local economy, including the impacts on our ability to access capital, or its effects on our business, financial position, results of operations, and cash flows. We continue to monitor developments affecting our employees, customers and operations. Operating Activities We used $225.8 million in net cash flows from our operations during the quarter ended June 30, 2022. That amount was $98.8 million higher than during the same period in fiscal year 2022. Our working capital needs to fund our operations in the quarter ended June 30, 2022, were higher, compared to the quarter ended June 30, 2021, primarily on higher green tobacco costs as well as tobacco shipment and purchase timing. Tobacco inventory levels increased by $258.0 million from March 31, 2022 levels to $1.1 billion at June 30, 2022, on seasonal leaf purchases. Tobacco inventory levels were $206.1 million above June 30, 2021 levels, mainly due to higher green tobacco costs and tobacco shipment timing. We generally do not purchase material quantities of tobacco on a speculative basis. However, when we contract directly with tobacco farmers, we are often obligated to buy all stalk positions, which may contain less marketable leaf styles. At June 30, 2022, our uncommitted tobacco inventories were $164.3 million, or about 15% of total tobacco inventory, compared to $130.1 million, or about 16% of our March 31, 2022 tobacco inventory, and $158.6 million, or about 18% of our June 30, 2021 tobacco inventory. While we target committed inventory levels of 80% or more of total tobacco inventory, the level of these uncommitted inventory percentages is influenced by timing of farmer deliveries of new crops, as well as the receipt of customer orders. Our balance sheet accounts reflected seasonal patterns in the quarter ended June 30, 2022, on deliveries of crops by farmers in both South America and Africa. Accounts receivable decreased by $66.3 million from March 31, 2022 levels, as we used collections on receivables, to fund seasonal working capital needs. Advances to suppliers were $99.9 million at June 30, 2022, a reduction of $30.0 million from March 31, 2022, as tobacco crops were delivered in payment on some of those balances, net of new advances on current tobacco crops. Accounts receivable—unconsolidated affiliates were up $44.0 million in the three months ended June 30, 2022, on the timing of tobacco crop purchases and shipments. Notes payable and overdrafts were up $272.0 million from March 31, 2022 levels, on increased notes payable usage rather than cash on hand to fund seasonal working capital needs. Cash balances available at March 31, 2022, were reduced due to the Shank's acquisition and working capital requirements in fiscal year 2022. 33 Accounts receivable were up $39.2 million for the quarter ended June 30, 2022, compared to the same quarter in the prior fiscal year, on the timing of tobacco crop purchases and shipments as well as higher leaf tobacco costs. Advances to suppliers were up $29.5 million at June 30, 2022, compared to at June 30, 2021, partly due to higher crop input costs. Inventories—Other were also up in the quarter ended June 30 2022, compared to the quarter ended June 30, 2021, on our acquisition of Shank’s. Notes payable and overdrafts were up $301.3 million compared to June 30, 2021 levels, on higher tobacco inventory costs and the acquisition of Shank’s in October 2021. Accounts payable and accrued expenses were up $77.6 million for the quarter ended June 30, 2022 compared to the quarter ended June 30, 2021, primarily on tobacco purchases. Investing Activities Our capital allocation strategy focuses on four strategic priorities: strengthening and investing for growth in our leaf tobacco business; increasing our strong dividend; exploring growth opportunities for our plant-based ingredients platform that utilize our assets and capabilities; and returning excess capital to our shareholders. In deciding where to invest capital resources, we look for opportunities where we believe we can earn an adequate return as well as leverage our assets and expertise or enhance our farmer base. Our capital expenditures are generally limited to those that add value, replace or maintain equipment, increase efficiency, or position us for future growth. During the quarters ended June 30, 2022 and 2021, we invested about $15.1 million and $14.4 million, respectively, in our property, plant and equipment. Depreciation expense was approximately $10.9 million and $9.7 million for the three months ended June 30, 2022 and 2021, respectively. Typically, our capital expenditures for maintenance projects are less than $30 million per fiscal year. In addition, from time to time, we undertake projects that require capital expenditures when we identify opportunities to improve efficiencies, add value for our customers, and position ourselves for future growth. We currently expect to spend approximately $40 to $50 million over the next twelve months on capital projects for maintenance of our facilities and other investments to grow and improve our businesses. Our Board of Directors approved our current share repurchase program in November 2020. The program authorizes the purchase of up to $100 million of our common stock through November 15, 2022. Under the current authorization, we may purchase shares from time to time on the open market or in privately negotiated transactions at prices not exceeding prevailing market rates. Repurchases of shares under the repurchase program may vary based on management discretion, as well as changes in cash flow generation and availability. During the three months ended June 30, 2022, we did not purchase any shares of common stock. As of June 30, 2022, approximately 24.6 million shares of our common stock were outstanding, and our available authorization under our current share repurchase program was about $96.9 million. Financing Activities We consider the sum of notes payable and overdrafts, long-term debt (including any current portion), and customer advances and deposits, less cash, cash equivalents, and short-term investments on our balance sheet to be our net debt. We also consider our net debt plus shareholders' equity to be our net capitalization. Net debt as a percentage of net capitalization was approximately 41% at June 30, 2022, up from the June 30, 2021 level of approximately 31%, largely on higher debt balances due in part to the Shank’s acquisition in October 2021 as well as higher working capital requirements, and up from the March 31, 2022 level of approximately 32%. As of June 30, 2022, we had $86.6 million in cash and cash equivalents, our short-term debt totaled $454.7 million, and we were in compliance with all covenants of our debt agreements, which require us to maintain certain levels of tangible net worth and observe restrictions on debt levels. As of June 30, 2022, we had $155 million available under a committed revolving credit facility that will mature in December 2023, and we had about $84 million in unused, uncommitted credit lines. We also maintain an effective, undenominated universal shelf registration statement that provides for future issuance of additional debt or equity securities. We have no long-term debt maturing until fiscal year 2024. Our seasonal working capital requirements for our tobacco business typically increase significantly between March and September and decline after mid-year. Available capital resources from our cash balances, committed credit facility, and uncommitted credit lines exceed our normal working capital needs and currently anticipated capital expenditure requirements over the next twelve months. Derivatives From time to time, we use interest rate swap agreements to manage our exposure to changes in interest rates. At June 30, 2022, the fair value of our outstanding interest rate swap agreements was an asset of about $4.3 million, and the notional amount swapped was $370 million. We entered into these agreements to eliminate the variability of cash flows in the interest 34 payments on a portion of our variable-rate term loans. Under the swap agreements we receive variable rate interest and pay fixed rate interest. The swaps are accounted for as cash flow hedges. We also use derivative instruments from time to time to hedge certain foreign currency exposures, primarily related to forecasted purchases of tobacco, related processing costs, and crop input sales in Brazil, as well as our net monetary balance sheet exposures in local currency there. We generally account for our hedges of forecasted tobacco purchases as cash flow hedges. At June 30, 2022, the fair value of our open hedges was a net asset of about $0.8 million. We had forward contracts outstanding that were not designated as hedges, and the fair value of those contracts was a net asset of approximately $7.5 million at June 30, 2022. 35