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 and new subvariants; 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; our 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 including increased transportation costs and delays attributed to global supply chain challenges; timing of shipments to customers; higher inflation rates; 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, 2023. 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, 2023. 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 11. "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 Our tobacco operations performed well and are off to a good start for our fiscal year 2024. Segment operating income was higher for our Tobacco Operations segment in the quarter ended June 30, 2023, compared to the quarter ended June 30, 2022, even though we did not have the benefit of large shipments of carryover tobacco from certain origins that we had in first quarter of fiscal year 2023. Demand for leaf tobacco from our customers remains strong, and our level of uncommitted tobacco inventory was 16% of tobacco inventory at June 30, 2023. We are forecasting increased leaf tobacco production in fiscal year 2024, 25 compared to fiscal year 2023, and believe that even with that increased production, leaf tobacco will remain in an undersupply position. We are pleased with the ongoing progress we are making to integrate our plant-based ingredients platform, and we continue to execute on our strategy to invest in and expand the platform’s capabilities for future growth in existing and new products. For the quarter ended June 30, 2023, the platform faced soft demand, due to high customer inventory levels, and our earnings for the platform were below our expectations. We believe that many of our customers are continuing to draw down on their raw materials inventories after building inventories to protect against prior supply chain uncertainties. These inventory challenges have been more extensive and persistent in duration than we had forecasted. In addition, the expansion of the platform’s capabilities has added to our costs, while a sharp drop in certain new crop raw material prices resulted in inventory write-downs in the quarter ended June 30, 2023. We continue to believe the inventory challenges are temporary and expect excess inventory levels held by our customers to eventually work down. One of the main objectives of our current investments in our plant-based ingredients platform is to expand our portfolio to include more value-added products for our customers. We believe that we are well-positioned to capitalize on demand from our customers, and that with the investments we are making, we are a stronger partner for current and future customers due to the expanded range of capabilities and products that we can offer them. We are encouraged by ongoing customer engagements regarding existing business and new business opportunities. Our costs, notably interest costs and prices for green leaf tobacco, remained high in the quarter ended June 30, 2023, compared to the quarter ended June 30, 2022. Interest costs were more than double on higher interest rates in the first quarter of fiscal year 2024, compared to the same quarter in fiscal year 2023. Our debt balances, the sum of notes payable and overdrafts and long-term obligations, were relatively flat in the quarter ended June 30, 2023, compared to the same quarter in the prior fiscal year, as working capital requirements to fund larger tobacco crops and higher green tobacco prices were partially offset by increased customer deposits. We continue to make transparency around our sustainability efforts and goals a priority. We recently completed our annual 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 continue to work with third parties to verify our emissions and establish our pathway to net zero through the identification and prioritization of high-impact projects throughout our footprint. FINANCIAL HIGHLIGHTS Three Months Ended June 30, Change (in millions of dollars, except per share data) 2023 2022 $ % Consolidated Results Sales and other operating revenue $ 517.7 $ 429.8 $ 87.9 20 % Cost of goods sold $ 431.2 $ 350.1 $ 81.1 23 % Gross Profit Margin 16.7 % 18.5 % -183 bps Selling, general and administrative expenses $ 75.5 $ 66.5 $ 9.0 14 % Operating income (loss) $ 11.0 $ 13.3 $ (2.2) (17) % Diluted earnings (loss) per share (as reported) $ (0.08) $ 0.27 $ (0.35) (130) % Adjusted diluted earnings (loss) per share (non-GAAP)* $ (0.08) $ 0.25 $ (0.33) (132) % Segment Results Tobacco operations sales and other operating revenues $ 443.9 $ 348.1 $ 95.8 28 % Tobacco operations operating income $ 8.9 $ 8.1 $ 0.8 9 % Ingredients operations sales and other operating revenues $ 73.8 $ 81.8 $ (7.9) (10) % Ingredient operations operating income (loss) $ (2.0) $ 4.6 $ (6.6) (144) % *See Reconciliation of Certain Non-GAAP Financial Measures in Other Items below. Net loss for the quarter ended June 30, 2023, was $(2.1) million, or $(0.08) per diluted share, compared with net income of $6.8 million, or $0.27 per diluted share, for the quarter ended June 30, 2022. Excluding certain other non-recurring items, detailed in Other Items below, net income and diluted earnings per share decreased by $8.2 million and $0.33, respectively, for the quarter ended June 30, 2023, compared to the quarter ended June 30, 2022. Operating income of $11.0 million for the quarter 26 ended June 30, 2023, decreased by $2.2 million, compared to operating income of $13.3 million for the quarter ended June 30, 2022. Consolidated revenues increased by $87.9 million to $517.7 million for the three months ended June 30, 2023, compared to the same period in fiscal year 2023, on higher tobacco sales prices and a favorable product and geographic mix in our Tobacco Operations segment. Tobacco Operations The first fiscal quarter is historically a slow quarter for our tobacco businesses. Operating income for the Tobacco Operations segment increased by $0.8 million to $8.9 million for the quarter ended June 30, 2023, compared with the quarter ended June 30, 2022. Although tobacco sales volumes were down, Tobacco Operations segment operating income was up largely on a more favorable product and geographic mix in the quarter ended June 30, 2023, compared to the same quarter in the prior fiscal year, when a large amount of carryover tobacco crops were shipped. Prices for green leaf tobacco in the quarter ended June 30, 2023, were also higher than in the quarter ended June 30, 2022. Carryover crop shipments were significantly lower in Brazil in the quarter ended June 30, 2023, compared to the quarter ended June 30, 2022. In Europe, sales volumes and revenues were up due to shipment timing and a favorable product mix in the quarter ended June 30, 2023, compared to the same quarter in the prior fiscal year. Carryover crop shipments were up in North America due to shipment timing in the quarter ended June 30, 2023, compared to the quarter ended June 30, 2022. Results for our oriental tobacco joint venture were down significantly in the quarter ended June 30, 2023, compared to the quarter ended June 30, 2022, on unfavorable foreign currency comparisons and higher interest expenses. Selling, general, and administrative expenses for the Tobacco Operations segment were higher in the quarter ended June 30, 2023, compared to June 30, 2022, primarily on higher compensation costs and higher provisions on advances to suppliers following adverse weather conditions in Africa. Revenues for the Tobacco Operations segment of $443.9 million for the quarter ended June 30, 2023, were up $95.8 million, compared to the same period in the prior fiscal year, on higher tobacco sales prices and a favorable product and geographic mix. Ingredients Operations Operating loss for the Ingredients Operations segment was $(2.0) million for the quarter ended June 30, 2023, compared to operating income of $4.6 million for the quarter ended June 30, 2022. Sales for all of our businesses in this segment were down in the quarter ended June 30, 2023, compared to the quarter ended June 30, 2022, on lower demand due to our customers continuing to carry high inventory levels. Prices for some key raw materials were down in the quarter ended June 30, 2023, compared to the quarter ended June 30, 2022. Inventory write-downs for the Ingredients Operations segment were higher in the quarter ended June 30, 2023, compared to the same quarter in the prior fiscal year, on the changes in customer demand and new crop raw material prices. Selling, general, and administrative expenses for this segment increased in the quarter ended June 30, 2023, compared to the same quarter in the prior fiscal year, largely on higher labor costs and investments in product development capabilities. Revenues for the Ingredients Operations segment of $73.8 million for the quarter ended June 30, 2023, were down $7.9 million compared to the quarter ended June 30, 2022, largely on lower sales volumes. Other Items Cost of goods sold in the quarter ended June 30, 2023, increased by 23% to $431.2 million, compared with the same period in the prior fiscal year, largely due to higher green tobacco costs. Selling, general, and administrative costs for the quarter ended June 30, 2023, increased by $9.0 million to $75.5 million, compared to the same period in the prior fiscal year, primarily on weakening of the U.S. dollar, increased compensation costs, and higher provisions on advances to suppliers. Interest expense for the quarter ended June 30, 2023, increased by $8.8 million to $15.5 million on increased costs from higher interest rates. For the three months ended June 30, 2023, our consolidated effective income tax rate on pre-tax loss was a benefit of 21.6%. For the three months ended June 30, 2022, our 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 idled 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 idled Tanzania operations resulted in a $1.8 million reduction to consolidated interest expense related to an uncertain tax position. 27 Reconciliation of Certain Non-GAAP Financial Measures The following table sets 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: Adjusted Net Income (Loss) and Adjusted Diluted Earnings (Loss) Per Share Reconciliation (in thousands) Three Months Ended June 30, 2023 2022 As Reported: Net income (loss) available to Universal Corporation $ (2,064) $ 6,830 Interest expense reversal on uncertain tax position and income tax from sale of operations in Tanzania — (1,816) Total of Non-GAAP adjustments to income (loss) before income taxes $ — $ (1,816) Non-GAAP adjustments to income taxes Income tax expense from sale of operations in Tanzania — 1,132 Total of income tax impacts for Non-GAAP adjustments to income (loss) before income taxes and Non-GAAP adjustment to income taxes — 1,132 As adjusted: Net income (loss) attributable to Universal Corporation (Non-GAAP) $ (2,064) $ 6,146 As reported: Diluted earnings (loss) per share $ (0.08) $ 0.27 As adjusted: Diluted earnings (loss) per share $ (0.08) $ 0.25 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, 2023, using a combination of cash on hand, short-term borrowings, customer advances, and operating cash flows. Tobacco 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 sizes, 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. Operating Activities Net cash used by our operations was $103.9 million during the quarter ended June 30, 2023. That amount was $121.9 million lower than during the same period in fiscal year 2023. Our working capital needs to fund our operations in the quarter ended June 30, 2023, were lower, compared to the quarter ended June 30, 2022, primarily on higher customer advances and deposits partially offset by increased tobacco purchase volumes and higher green tobacco prices. Customer advances and deposits were up $84.0 million in the first quarter of fiscal year 2024, compared to the same period of fiscal year 2023, due to a customer arrangement providing for a higher amount of advances on tobacco purchases in fiscal year 2024. Tobacco inventory levels increased by $266.8 million from March 31, 2023 levels to $1.1 billion at June 30, 2023, on seasonal leaf purchases of larger tobacco crops. Tobacco inventory levels were $20.4 million above June 30, 2022 levels. 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, 2023, our uncommitted tobacco inventories 28 were $175.2 million, or about 16% of total tobacco inventory, compared to $91.1 million, or about 11% of our March 31, 2023 tobacco inventory, and $164.3 million, or about 15% of our June 30, 2022 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, 2023, on deliveries of tobacco crops by farmers in both South America and Africa. Accounts receivable decreased by $26.5 million from March 31, 2023 levels, as we used collections on receivables to fund seasonal working capital needs. Advances to suppliers were $111.2 million at June 30, 2023, a reduction of $59.6 million from March 31, 2023, as tobacco crops were delivered in payment on some of those balances, net of new advances on upcoming tobacco crops. Accounts receivable—unconsolidated affiliates were up $61.1 million in the three months ended June 30, 2023, on the timing of tobacco crop purchases and shipments. Notes payable and overdrafts were up $164.3 million from March 31, 2023 levels, on seasonal working capital needs. Customer advances and deposits increased by $100.4 million in the three months ended June 30, 2023, due to a customer arrangement providing for a higher amount of advances on tobacco crop purchases in fiscal year 2024. Accounts receivable were up $56.5 million for the quarter ended June 30, 2023, compared to the same quarter in the prior fiscal year, on larger tobacco crops and the timing of tobacco crop shipments. Accounts receivable—unconsolidated affiliates were up $24.8 million in the three months ended June 30, 2023, on larger tobacco crop sizes. Notes payable and overdrafts were down $94.8 million compared to June 30, 2022 levels, in part due to higher customer advances available to fund working capital needs. Accounts payable were down $33.3 million for the quarter ended June 30, 2023 compared to the quarter ended June 30, 2022, primarily on the timing tobacco purchases in fiscal year 2023. 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; 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 quarter ended June 30, 2023 and 2022, we invested about $18.0 million and $15.1 million, respectively, in our property, plant and equipment. Depreciation expense was approximately $11.9 million and $10.9 million for the quarter ended June 30, 2023 and 2022, 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, invest in sustainability projects, add value for our customers, and position ourselves for future growth. We currently expect to spend approximately $65 to $75 million over the next twelve months on capital projects for maintenance of our facilities and other investments, including significant investments in our plant-based ingredients platform, to grow and improve our businesses. Our Board of Directors approved our current share repurchase program in November 2022. The program authorizes the purchase of up to $100 million of our common stock through November 15, 2024. Under the program, 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, 2023, we did not purchase any shares of common stock. As of June 30, 2023, approximately 24.6 million shares of our common stock were outstanding, and our available authorization under our current share repurchase program was $100 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 42% at June 30, 2023, up slightly from the June 30, 2022 level of approximately 41%, primarily on higher working capital requirements, and up from the March 31, 2023 level of approximately 35%. As of June 30, 2023, we had $80.5 million in cash and cash equivalents, our short-term debt totaled $359.8 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. 29 As of June 30, 2023, we had $480 million available under the committed revolving credit facility that will mature in December 2027, and we had about $59 million in available, 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 2028. 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, 2023, the fair value of our outstanding interest rate swap agreements was an asset of about $5.8 million, and the notional amount swapped was $310 million. We entered into these agreements to eliminate the variability of cash flows in the interest 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, 2023, the fair value of our open hedges was a net asset of about $0.6 million. Critical Accounting Estimates A summary of our critical accounting policies is included in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the period ended March 31, 2023. Our critical accounting policies have not changed from those reported in the 2023 Annual Report on Form 10-K. 30