PYYX 10-Q Quarter ended Sept. 30, 2011

Alliance One International, Inc. and Subsidiaries
CONDENSED STATEMENTS OF CONSOLIDATED STOCKHOLDERS’ EQUITY
(Unaudited)
	Attributable to Alliance One International, Inc.
				Accumulated Other Comprehensive Loss
(in thousands )		Common Stock	Retained Deficit	Currency Translation Adjustment	Pensions, Net of Tax	Noncontrolling Interests	Total Equity
Balance, March 31, 2010		$ 460,971	$   (49,242)	$  (3,691)	$ (17,638)	$ 4,522	$ 394,922
Net income (loss)		-	34,101	-	-	(207)	33,894
Restricted stock surrendered		(538)	-	-	-	-	(538)
Exercise of employee stock options		106	-	-	-	-	106
Stock-based compensation		865	-	-	-	-	865
Shares purchased		(9,042)	-	-	-	-	(9,042)
Purchase of additional investment in subsidiary		21	-	-	-	(234)	(213)
Conversion of foreign currency financial statements		-	-	837	-	(17)	820
Balance, September 30, 2010		$ 452,383	$   (15,141)	$  (2,854)	$ (17,638)	$ 4,064	$ 420,814
Balance, March 31, 2011		$ 455,409	$ (120,793)	$  (1,376)	$ (20,427)	$ 3,199	$ 316,012
Net loss		-	(2,400)	-	-	(101)	(2,501)
Restricted stock surrendered		(98)	-	-	-	-	(98)
Stock-based compensation		1,782	-	-	-	-	1,782
Conversion of foreign currency financial statements		-	-	(1,127)	-	-	(1,127)
Adjustment in pensions		-	-	-	931	-	931
Balance, September 30, 2011		$ 457,093	$ (123,193)	$  (2,503)	$ (19,496)	$ 3,098	$ 314,999
See notes to condensed consolidated financial statements

Alliance One International, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands)

1.  BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of financial position, results of operation and cash flows at the dates and for the periods presented have been included.  The unaudited information included in 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, 2011.

Taxes Collected from Customers

Certain subsidiaries are subject to value added taxes on local sales.  These amounts have been included in sales and were $3,042 and $11,016 for the three months ended September 30, 2011 and 2010, respectively and $8,614 and $18,670 for the six months ended September 30, 2011 and 2010, respectively.

Other Deferred Charges

Other deferred charges are primarily deferred financing costs that are amortized over the life of the debt.

New Accounting Standards

Recently Adopted Accounting Pronouncements

On April 1, 2011 the Company adopted new accounting guidance on accounting for multiple-deliverable revenue arrangements. The objective of this accounting guidance is to address the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. The Company adopted this new accounting guidance with no material impact on its financial condition or results of operations.

On April 1, 2011, the Company adopted new accounting guidance on fair value measurements and disclosures. This guidance requires reporting entities to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. It also requires reporting entities to present separately information about purchases, sales, issuances, and settlements in their Level 3 fair value reconciliations.  The Company adopted these new disclosure requirements with no material impact on its financial condition or results of operations.  See Note 17 “Fair Value Measurements” for further details.

Recent Accounting Pronouncements Not Yet Adopted

In May 2011, the FASB issued new accounting guidance on fair value measurements and disclosures. The objective of this accounting guidance is to provide consistent common fair value measurement and disclosure requirements in U.S. GAAP and IFRS such as clarifying how existing fair value measurement requirements should be applied, changing particular principles and requirements for measuring fair value and fair value measurement disclosures.   This accounting guidance will be effective for the Company on January 1, 2012. The Company does not expect the impact of this new accounting guidance to have a material impact on its financial condition or results of operations.

In June 2011, the FASB issued new accounting guidance on comprehensive income. The objective of this accounting guidance is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income.  The guidance eliminates the option to present components of other comprehensive income as part of the statement of stockholders’ equity and requires them to be presented in the statement of comprehensive income instead.  This accounting guidance will be effective for the Company on April 1, 2012. The Company does not expect the impact of this new accounting guidance to have a material impact on its financial condition or results of operations.

In September 2011, the FASB issued new accounting guidance on testing goodwill for impairment. The primary objective of this accounting guidance is to reduce complexity and costs by allowing an entity to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit.  If, after assessing qualitative factors, an entity determines that it is not more likely than not (a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, then the two-step goodwill impairment test is unnecessary.  This accounting guidance is effective for the Company in fiscal 2012 but early adoption is permitted.  Therefore, the Company plans to adopt this guidance on January 1, 2012 which is the date of its fiscal 2012 annual goodwill testing.  The Company does not expect the impact of this new accounting guidance to have a material impact on its financial condition or results of operations.

Alliance One International, Inc. and Subsidiaries

2.  INCOME TAXES

Accounting for Uncertainty in Income Taxes

As of September 30, 2011, the Company’s unrecognized tax benefits totaled $8,733, all of which would impact the Company’s effective tax rate if recognized.

The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense.  As of September 30, 2011, accrued interest and penalties totaled $7,903 and $1,376 respectively.

The Company expects to continue accruing interest expense related to the unrecognized tax benefits described above.  Additionally, the Company may be subject to fluctuations in the unrecognized tax liability due to currency exchange rate movements.

Other than the expiration of an applicable statute of limitations pertaining to an international unrecognized tax benefit of $1,420, interest of $6,725, and penalties of $476, the Company does not foresee any reasonably possible changes in the unrecognized tax benefits in the next twelve months but must acknowledge circumstances can change due to unexpected developments in the law.  In certain jurisdictions, tax authorities have challenged positions that the Company has taken that resulted in recognizing benefits that are material to its financial statements.  The Company believes it is more likely than not that it will prevail in these situations and accordingly have not recorded liabilities for these positions.  The Company expects the challenged positions to be settled at a time greater than twelve months from its balance sheet date.

The Company and its subsidiaries file a U.S. federal consolidated income tax return as well as returns in several U.S. states and a number of foreign jurisdictions.  As of September 30, 2011, the Company’s earliest open tax year for U.S. federal income tax purposes was its fiscal year ended March 31, 2008.  Open tax years in state and foreign jurisdictions generally range from three to six years.

Provision for the Six Months Ended September 30, 2011

The effective tax rate used for the six months ended September 30, 2011 was 134.3% compared to 11.6% for the six months ended September 30, 2010.  The effective tax rates for these periods are based on the current estimate of full year results including the effect of taxes related to specific events which are recorded in the interim period in which they occur.  The Company expects the tax rate for the year ended March 31, 2012 to be 25.8% after absorption of discrete items.

For the six months ended September 30, 2011, the Company recorded a specific event adjustment expense of $13,437, bringing the effective tax rate estimated for the six months of 8.9% to 134.3%.  This specific event adjustment expense relates primarily to net exchange losses on income tax accounts and additional income tax, interest, and exchange gains related to liabilities for unrecognized tax benefits.   For the six months ended September 30, 2010, the Company recorded a specific event adjustment benefit of $2,873, bringing the effective tax rate estimated for the six months of 19.4% to 11.6%.  This specific event adjustment expense relates primarily to additional income tax, interest, and exchange losses related to liabilities for unrecognized tax benefits and net exchange gains on income tax accounts.  The significant difference in the estimated effective tax rate for the six months ended September 30, 2011 from the statutory rate is primarily due to net exchange losses on income tax accounts and foreign income tax rates lower than the U.S. rate.

3.  GUARANTEES

The Company and certain of its foreign subsidiaries guarantee bank loans to suppliers to finance their crops.  Under longer-term arrangements, the Company may also guarantee financing on suppliers’ construction of curing barns or other tobacco production assets.  The Company also guarantees bank loans to certain tobacco cooperatives to assist with the financing of their suppliers’ crops.  Guaranteed loans are generally repaid concurrent with the delivery of tobacco to the Company.  The Company is obligated to repay any guaranteed loan should the supplier or tobacco cooperative default.  If default occurs, the Company has recourse against the supplier or cooperative.  The Company also guarantees bank loans of certain unconsolidated subsidiaries in Asia and Zimbabwe.  The following table summarizes amounts guaranteed and the fair value of those guarantees:

	September 30, 2011		September 30, 2010		March 31, 2011
Amounts guaranteed (not to exceed)	$   152,653		$   114,422		$   119,114
Amounts outstanding under guarantee	111,418		110,762		102,550
Fair value of guarantees	5,005		4,830		4,575

Of the guarantees outstanding at September 30, 2011 approximately 88% expire within one year and the remainder within five years.  The fair value of guarantees is recorded in Accrued Expenses and Other Current Liabilities in the condensed consolidated balance sheets and included in crop costs.

In Brazil, some suppliers obtain government subsidized rural credit financing from local banks that is guaranteed by the Company. The Company withholds amounts owed to suppliers related to the rural credit financing of the supplier upon delivery of tobacco to the Company. The Company remits payments to the local banks on behalf of the guaranteed suppliers. Terms of rural credit financing are such that repayment is due to local banks based on contractual due dates. As of September 30, 2011 and 2010 and March 31, 2011, respectively, the Company had balances of $3,447, $1,007 and $27,750 that were due to local banks on behalf of suppliers. These amounts are included in Accounts Payable in the condensed consolidated balance sheets.

Alliance One International, Inc. and Subsidiaries

4.  RESTRUCTURING CHARGES

In response to shifting supply and demand balances and the changing business models of the Company’s customers, the Company began implementing several strategic initiatives during the third quarter of fiscal 2011.  The initiatives will continue over the coming quarters as the Company continues to define and execute the necessary changes to support core business functions. The following table summarizes the restructuring charges recorded in the Company’s reporting segments during the three months and six months ended September 30, 2011:

	Three Months	Six Months
	Ended	Ended
Restructuring Charges	September 30, 2011	September 30, 2011
Employee separation and other cash charges:
Beginning balance	$ 5,220	$  6,193
Period charges:
Severance charges (recovery)	(13)	725
Other cash charges	-	31
Total period charges	(13)	756
Payments through September 30	(1,414)	(3,156)
Ending balance September 30	$ 3,793	$  3,793
Non-current asset impairment	760	760
Total restructuring charges for the period	$    747	$  1,516

Non-current asset impairments are primarily for non-tobacco internally developed software intangible assets and real property in Macedonia.

The following table summarizes the employee separation and other cash charges recorded in the Company’s South America and Other Regions segments during the three months and six months ended September 30, 2011:

		Three Months		Six Months
		Ended		Ended
	Employee Separation and Other Cash Charges		September 30, 2011		September 30, 2011
Beginning balance:		$  5,220		$  6,193
South America		993		1,073
Other regions		4,227		5,120
Period charges:		$ (13)		$ 756
South America		419		419
Other regions		(432)		337
Payments through September 30:		$ (1,414)		$ (3,156)
South America		(867)		(947)
Other regions		(547)		(2,209)
Ending balance September 30:		$  3,793		$  3,793
South America		545		545
Other regions		3,248		3,248

5.  GOODWILL AND INTANGIBLES

Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired businesses.  Goodwill is not subject to systematic amortization, but rather is tested for impairment annually or whenever events and circumstances indicate that an impairment may have occurred.  The Company has chosen the first day of the last quarter of its fiscal year as the date to perform its annual goodwill impairment test.

Alliance One International, Inc. and Subsidiaries

5.  GOODWILL AND INTANGIBLES (continued)

The Company has no intangible assets with indefinite useful lives.  It does have other intangible assets which are being amortized.  The following table summarizes the changes in the Company’s goodwill and other intangibles for the three months and six months September 30, 2011 and 2010:

The following table summarizes the estimated intangible asset amortization expense for the next five years and beyond:

*  Estimated amortization expense for the internally developed software is based on costs accumulated as of September 30, 2011.  These estimates will change as new costs are incurred and until the software is placed into service in all locations.

6.  VARIABLE INTEREST ENTITIES

Consolidated Variable Interest Entities

The Company held a variable interest in one joint venture in which the Company was the primary beneficiary because of its power to direct activities that most significantly impacted the economic performance of the entity.  The joint venture was an enterprise that served as a dedicated inventory supply source in Asia and the Company’s variable interest in this joint venture related to working capital advances and guarantees of the joint venture’s borrowings.  The Company terminated its relationship with this entity during the three months ended June 30, 2011 with no material impact on its financial condition or results of operations.

Alliance One International, Inc. and Subsidiaries

6.  VARIABLE INTEREST ENTITIES (continued)

Consolidated Variable Interest Entities (continued)

As the primary beneficiary of this VIE, the entity’s material assets, liabilities and results of operations were previously included in the Company’s consolidated financial statements. The following table summarizes the material carrying amounts of the entity’s assets, all of which are restricted, and liabilities included in the Company’s consolidated balance sheets.

Assets of Consolidated VIE		September 30, 2010		March 31, 2011
Inventory		$ 5,635		$ 5,195
Advances to suppliers		5,755		1,770
Liabilities of Consolidated VIE
Notes payable to banks		1,386		-

Amounts presented in the table above as restricted assets relating to the consolidated VIE are adjusted for intercompany eliminations.

Nonconsolidated Variable Interest Entities

The Company holds variable interests in four joint ventures that are accounted for under the equity method of accounting. These joint ventures procure inventory on behalf of the Company and the other joint venture partners. The variable interests relate to equity investments and advances made by the Company to the joint ventures.  In addition, the Company also guarantees one of its joint venture’s borrowings which also represent a variable interest in that joint venture.  The Company is not the primary beneficiary, as it does not have the power to direct the activities that most significantly impact the economic performance of the entities as a result of the entities’ management and board of directors structure. Therefore, these entities are not consolidated. At September 30, 2011 and 2010, and March 31, 2011, the Company’s investment in these joint ventures was $25,927, $24,072 and $24,753, respectively and is classified as Investments in Unconsolidated Affiliates in the condensed consolidated balance sheets. The Company’s advances to these joint ventures were $9,317, $9,039 and $36 at September 30, 2011 and 2010, and March 31, 2011, respectively and are classified as Accounts Receivable, Related Parties in the condensed consolidated balance sheets.  The Company guaranteed an amount to a joint venture not to exceed $17,661, $17,175 and $16,982 at September 30, 2011 and 2010, and March 31, 2011, respectively.  The investments, advances and guarantee in these joint ventures represent the Company’s maximum exposure to loss.

7.  SEGMENT INFORMATION

The Company purchases, processes, sells and stores leaf tobacco.  Tobacco is purchased in more than 45 countries and shipped to more than 90 countries.  The sales, logistics and billing functions of the Company are primarily concentrated in service centers outside of the producing areas to facilitate access to its major customers.  Within certain quality and grade constraints, tobacco is fungible and, subject to these constraints, customers may choose to fulfill their needs from any of the areas where the Company purchases tobacco.

Selling, logistics, billing, and administrative overhead, including depreciation, which originates primarily from the Company’s corporate and sales offices are allocated to the segments based upon segment operating income.  The Company reviews performance data from purchase through sale based on the source of the product and all intercompany transactions are allocated to the region that either purchases or processes the tobacco.

The following table presents the summary segment information for the three months and six months ended September 30, 2011 and 2010:

	Three Months Ended				Six Months Ended
	September 30,				September 30,
	2011		2010		2011		2010
Sales and other operating revenues:
South America	$  222,880		$   230,276		$  378,725		$    494,154
Other regions	291,651		328,973		497,370		556,051
Total revenue	$  514,531		$   559,249		$  876,095		$ 1,050,205
Operating income:
South America	$    12,252		$     30,768		$    26,574		$      49,917
Other regions	24,740		15,221		34,172		40,418
Total operating income	36,992		45,989		60,746		90,335
Debt retirement expense	-		2,511		-		3,443
Interest expense	27,027		27,089		52,803		53,825
Interest income	1,286		1,936		2,777		3,919
Income before income taxes and other items	$    11,251		$     18,325		$    10,720		$      36,986

Alliance One International, Inc. and Subsidiaries

7. SEGMENT INFORMATION (continued)

8.  EARNINGS PER SHARE

The weighted average number of common shares outstanding is reported as the weighted average of the total shares of common stock outstanding net of shares of common stock held by a wholly owned subsidiary.  Shares of common stock owned by the subsidiary were 7,853 at September 30, 2011 and 2010.  This subsidiary waives its right to receive dividends and it does not have the right to vote.

Certain potentially dilutive options were not included in the computation of earnings per diluted share because their exercise prices were greater than the average market price of the shares of common stock during the period and their effect would be antidilutive.  These shares totaled 4,229 at a weighted average exercise price of $7.02 per share at September 30, 2011 and 1,527 at a weighted average exercise price of $7.00 per share at September 30, 2010.

In connection with the offering of the Company’s 5 ½% Convertible Senior Subordinated Notes due 2014, issued on July 2, 2009 (the “Convertible Notes”), the Company entered into privately negotiated convertible note hedge transactions (the “convertible note hedge transactions”) equal to the number of shares that underlie the Company’s Convertible Notes.  These convertible note hedge transactions are expected to reduce the potential dilution of the Company’s common stock upon conversion of the Convertible Notes in the event that the value per share of common stock exceeds the initial conversion price of $5.0280 per share.  These shares were not included in the computation of earnings per diluted share because their inclusion would be antidilutive.

On July 28, 2010, the Company’s board of directors authorized the purchase up to $40,000 of its common stock through June 30, 2012.  As of September 30, 2011, the Company had purchased 2,380 shares of its common stock at a weighted average price paid per share of $3.78.  At September 30, 2011, the Company did not achieve the necessary fixed charge coverage ratio under the indenture governing the Company’s 10% Senior Notes due 2016 to access the restricted payments basket for the purchase of common stock.

The following table summarizes the computation of earnings per share for the three months and six months ended September 30, 2011 and 2010, respectively.

Alliance One International, Inc. and Subsidiaries

9.  COMPREHENSIVE INCOME

The components of comprehensive income were as follows:

10.  STOCK-BASED COMPENSATION

The Company recorded stock-based compensation expense related to stock-based awards granted under its various employee and non-employee stock incentive plans of $850 and $371 for the three months ended September 30, 2011 and 2010, respectively, and $1,868 and $865 for the six months ended September 30, 2011 and 2010, respectively.

The Company’s shareholders amended the 2007 Incentive Plan (the “2007 Plan”) at its Annual Meeting of Shareholders on August 6, 2009.  The 2007 Plan is an omnibus plan that provides the flexibility to grant a variety of equity awards including stock options, stock appreciation rights, stock awards, stock units, performance awards and incentive awards to officers, directors and employees of the Company.

During the three months and six months ended September 30, 2011 and 2010, respectively, the Company made the following stock-based compensation awards:

	Three Months Ended September 30,		Six Months Ended September 30,
	2011	2010	2011	2010
Restricted Stock
Number Granted	146	143	146	143
Grant Date Fair Value	$ 3.27	$ 3.34	$ 3.27	$ 3.34

Under the terms of both the Performance Shares and Performance Based Restricted Stock Units, shares ultimately issued will be contingent upon specified business performance goals.  If minimum standards are not attained, compensation paid under these awards will be zero.  Alternatively, if the maximum performance levels described by the plan are attained, the awards may be 150% of the stated award.

11.  CONTINGENCIES AND OTHER INFORMATION

Non-Income Tax

The government in the Brazilian State of Parana (“Parana”) issued a tax assessment on October 26, 2007 with respect to local intrastate trade tax credits that result primarily from tobacco transferred between states within Brazil.  The assessment for intrastate trade tax credits taken is $7,105 and the total assessment including penalties and interest through September 30, 2011 is $16,453.  The Company believes it has properly complied with Brazilian law and will contest any assessment through the judicial process.  Should the Company lose in the judicial process, the loss of the intrastate trade tax credits would have a material impact on the financial statements of the Company.

The Company also has local intrastate trade tax credits in the Brazil State of Rio Grande do Sul and the State of Santa Catarina.  These jurisdictions permit the sale or transfer of excess credits to third parties, however approval must be obtained from the tax authorities.  The Company has agreements with the state governments regarding the amounts and timing of credits that can be sold.  The tax credits have a carrying value of $38,336, which is net of impairment charges based on management’s expectations about future realization. The intrastate trade tax credits will continue to be monitored for impairment in future periods based on market conditions and the Company’s ability to use or sell the tax credits.

In 2001, the Company’s subsidiary in Brazil won a claim related to certain excise taxes (“IPI credit bonus”) for the years 1983 through 1990.  The Company used this IPI credit bonus to offset federal income and other taxes until January 2005 when it received a Judicial Order to suspend the IPI compensation.  In addition, the Company received an assessment in 2006 for federal income taxes that were offset by the IPI credit bonus.  The assessment is valued at $26,221 at September 30, 2011.  The Company appealed the assessment and believes it has properly utilized the IPI credit bonus.  No benefit for the utilization of the IPI credit bonus has been recognized as it has been recorded in Pension, Postretirement and Other Long-Term Liabilities. On September 9, 2011, the Court affirmed the Company’s position regarding the IPI credit bonus which is subject to appeal.  The Company does not expect resolution in the near future, which would directly impact the outcome of the Company’s appeal of the tax assessment as well as its utilization of its remaining IPI credit bonus.  No benefit for any potential future utilization of IPI credit bonus has been recognized.

Alliance One International, Inc. and Subsidiaries

11.  CONTINGENCIES AND OTHER INFORMATION (continued)

Other

In October 2001, the Directorate General for Competition (“DGCOMP”) of the European Commission (“EC”) began an administrative investigation into certain tobacco buying and selling practices alleged to have occurred within the leaf tobacco industry in some countries within the European Union, including Spain and Italy.  In respect of the investigation into practices in Spain, in 2004 the EC fined the Company and its Spanish subsidiaries € 4.4 million (US $5,641).  In respect of the investigation into practices in Italy, in October 2005 the EC announced that the Company and its Italian subsidiaries were assessed fines in the aggregate amount of € 24.0 million (US $28,800).  With respect to both the Spanish and Italian investigations, the fines imposed on the Company and its predecessors and subsidiaries were part of fines assessed on several participants in the applicable industry.  The Company, along with its applicable subsidiaries, lodged several appeals to the European courts against the EC decisions. These cases are currently at various stages of appeal.  The outcome of the appeals is uncertain as to both timing and results.  The Company has fully recognized the impact of each of the fines set forth above and has paid all of such fines as part of the appeal process.

Mindo, S.r.l. has asserted claims against a subsidiary of the Company arising out of the 2004 sale of the Company’s former Italian subsidiary, Dimon Italia, S.r.l., in an action filed before the Court of Rome on April 12, 2007.  The claim, allegedly arising from a guaranty letter issued by a consolidated subsidiary of the Company in connection with the sale transaction, seeks the recovery of € 7.4 million (US $10,031) plus interest and costs.  A hearing for the disposition of this matter is scheduled for December 2011.  No amounts have been reserved with respect to such claim.

On June 6, 2008, the Company’s Brazilian subsidiary and a number of other tobacco processors were notified of a class action initiated by the ALPAG - Associação Lourenciana de Pequenos Agricultrores ("Association of Small Farmers of São Lourenço”). The class action’s focus is a review of tobacco supplier contracts and business practices, specifically aiming to prohibit processors from notifying the national credit agency of producers in debt, prohibiting processors from deducting tobacco suppliers’ debt from payments for tobacco, and seeking the modification of other contractual terms historically used in the purchase of tobacco.  The case is currently before the 2nd civil court of São Lourenço do Sul.  The Company’s motion to dismiss the class action is currently pending.  The Company believes this claim to be without merit and is vigorously defending it. Ultimate exposure if an unfavorable outcome is received is not determinable.

In accordance with generally accepted accounting principles, the Company records all known asset retirement obligations (“ARO”) for which the liability can be reasonably estimated. Currently, it has identified an ARO associated with one of its facilities that requires it to restore the land to its initial condition upon vacating the facility. The Company has not recognized a liability under generally accepted accounting principles for this ARO because the fair value of restoring the land at this site cannot be reasonably estimated since the settlement date is unknown at this time. The settlement date is unknown because the land restoration is not required until title is returned to the government, and the Company has no current or future plans to return the title. The Company will recognize a liability in the period in which sufficient information is available to reasonably estimate its fair value.  The Company has no additional material AROs.

12.  DEBT ARRANGEMENTS

Senior Secured Credit Facility

Fourth Amendment. On November 3, 2011, the Company closed the Fourth Amendment to the Credit Agreement.  See Note 19 “Subsequent Event” to the “Notes to Condensed Consolidated Financial Statements” for further information.

Senior Notes

At September 30, 2011, the Company did not achieve the ratio of consolidated EBITDA to fixed charges of at least 2.0 to 1.0 under the indenture governing the 10% Senior Notes due 2016 necessary to access the restricted payments basket for the purchase of common stock, payment of dividends and other actions under that basket.  The Company from time to time may not satisfy this ratio.

13.  DERIVATIVE FINANCIAL INSTRUMENTS

Fair Value of Derivative Financial Instruments

The Company recognizes all derivative financial instruments, such as interest rate swap contracts and foreign exchange contracts at fair value.  Changes in the fair value of derivative financial instruments are either recognized periodically in income or in shareholders’ equity as a component of other comprehensive income depending on whether the derivative financial instrument qualifies for hedge accounting, and if so, whether it qualifies as a fair value hedge or a cash flow hedge.  Changes in fair values of derivatives accounted for as fair value hedges are recorded in income along with the portions of the changes in the fair values of the hedged items that relate to the hedged risk(s).  Changes in fair values of derivatives accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in other comprehensive income net of deferred taxes.  Changes in fair values of derivatives not qualifying as hedges are reported in income.  During the three months and six months ended September 30, 2011 and 2010, there were no qualified cash flow or fair value hedges.  Estimates of fair value were determined in accordance with generally accepted accounting principles.

Alliance One International, Inc. and Subsidiaries

13.  DERIVATIVE FINANCIAL INSTRUMENTS (continued)

Fair Value of Derivative Financial Instruments (continued)

The following table summarizes the fair value of the Company’s derivatives by type at September 30, 2011 and 2010, and March 31, 2011.

Earnings Effects of Derivatives

Foreign Currency Contracts

The Company periodically enters into forward or option currency contracts to protect against volatility associated with certain non-U.S. dollar denominated forecasted transactions.  When these derivatives qualify for hedge accounting treatment, they are accounted for as cash flow hedges and are recorded in other comprehensive income, net of deferred taxes.

The Company has entered into forward currency contracts to hedge cash outflows in foreign currencies around the world for green tobacco purchases and processing costs as well as selling, administrative and general costs as the Company deems necessary. These contracts do not meet the requirements for hedge accounting treatment under generally accepted accounting principles, and as such, all changes in fair value are reported in income.

The following table summarizes the earnings effects of derivatives in the condensed consolidated statements of operations for the three months and six months ended September 30, 2011 and 2010.

Credit Risk

Financial instruments, including derivatives, expose the Company to credit loss in the event of non-performance by counterparties.  The Company manages its exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties, and procedures to monitor concentrations of credit risk.  If a counterparty fails to meet the terms of an arrangement, the Company’s exposure is limited to the net amount that would have been received, if any, over the arrangement’s remaining life.  The Company does not anticipate non-performance by the counterparties and no material loss would be expected from non-performance by any one of such counterparties.

14.  PENSION AND POSTRETIREMENT BENEFITS

The Company has a defined benefit plan that provides retirement benefits for substantially all U.S. salaried personnel based on years of service rendered, age and compensation.  The Company also maintains various other Excess Benefit and Supplemental Plans that provide additional benefits to (1) certain individuals whose compensation and the resulting benefits that would have actually been paid are limited by regulations imposed by the Internal Revenue Code and (2) certain individuals in key positions.  The Company funds these plans in amounts consistent with the funding requirements of federal law and regulations.

Additional non-U.S. defined benefit plans sponsored by certain subsidiaries cover certain full-time employees located in Germany, Turkey, and the United Kingdom.  In the quarter ended June 30, 2011, Malawi enacted legislation that terminated the statutorily required defined benefit plan and replaced it with a defined contribution plan.  This terminated defined benefit plan resulted in a curtailment gain of $4,989.  The new statutorily required defined contribution plan will be integrated with the Company’s existing defined contribution plan which resulted in an additional liability of $4,172 at June 30, 2011.

Alliance One International, Inc. and Subsidiaries

14.  PENSION AND POSTRETIREMENT BENEFITS (continued)

Components of Net Periodic Benefit Cost

Net periodic pension cost for continuing operations consisted of the following:

		Three Months Ended September 30,				Six Months Ended September 30,
		2011		2010		2011			2010
Service cost		$    526		$     805		$  1,140			$  1,611
Interest expense		2,049		2,192		4,189			4,385
Expected return on plan assets		(1,637)		(1,428)		(3,274)			(2,856)
Amortization of prior service cost		26		6		53			11
Actuarial loss		287		335		593			669
Curtailment gain recognized	-			-		(4,989)			-
Net periodic pension cost	$ 1,251			$  1,910		$ (2,288)			$  3,820

Employer Contributions

The Company’s investment objectives are to generate consistent total investment return to pay anticipated plan benefits, while minimizing long-term costs.  Financial objectives underlying this policy include maintaining plan contributions at a reasonable level relative to benefits provided and assuring that unfunded obligations do not grow to a level to adversely affect the Company’s financial health.  As of September 30, 2011, contributions of $7,275 were made to pension plans for fiscal 2012.  Additional contributions to pension plans of approximately $5,425 are expected during the remainder of fiscal 2012.  However, this amount is subject to change, due primarily to asset performance significantly above or below the assumed long-term rate of return on pension assets and significant changes in interest rates.

Postretirement Health and Life Insurance Benefits

The Company also provides certain health and life insurance benefits to retired employees, and their eligible dependents, who meet specified age and service requirements.  As of September 30, 2011, contributions of $365 were made to the plans for fiscal 2012.  Additional contributions of $640 to the plans are expected during the rest of fiscal 2012.  The Company retains the right, subject to existing agreements, to modify or eliminate the postretirement medical benefits.

Components of Net Periodic Benefit Cost

Net periodic benefit cost for postretirement health and life insurance benefit plans consisted of the following:

	Three Months Ended September 30,				Six Months Ended September 30,
	2011		2010		2011		2010
Service cost	$      18		$     20		$     37		$     40
Interest expense	167		166		333		332
Amortization of prior service cost	(411)		(410)		(822)		(821)
Actuarial loss	101		108		202		217
Net periodic pension cost (benefit)	$  (125)		$ (116)		$ (250)		$ (232)

15.  INVENTORIES

The following table summarizes the Company’s costs in inventory:

	September 30, 2011	September 30, 2010	March 31, 2011
Processed tobacco	$    760,648	$    765,024	$   525,759
Unprocessed tobacco	263,061	202,108	230,831
Other	38,140	41,145	43,775
	$ 1,061,849	$ 1,008,277	$   800,365

Alliance One International, Inc. and Subsidiaries

16.  SALE OF RECEIVABLES

The Company sells trade receivables to unaffiliated financial institutions under two accounts receivable securitization programs.

Under the first program, the Company continuously sells a designated pool of trade receivables to a special purpose entity, which in turn sells 100% of the receivables to an unaffiliated financial institution. This program allows the Company to receive a cash payment and a deferred purchase price receivable for sold receivables. Following the sale and transfer of the receivables to the special purpose entity, the receivables are isolated from the Company and its affiliates, and upon the sale and transfer of the receivables from the special purpose entity to the unaffiliated financial institutions effective control of the receivables is passed to the unaffiliated financial institution, which has all rights, including the right to pledge or sell the receivables. The investment limit with this financial institution is $125,000 and requires a minimum level of deferred purchase price to be retained by the Company in connection with the sales. The Company continues to service, administer and collect the receivables on behalf of the special purpose entity and receives a servicing fee of .5% of serviced receivables per annum. As the Company estimates the fee it receives in return for its obligation to service these receivables is at fair value, no servicing assets or liabilities are recognized. Servicing fees recognized during the three months and six months ended September 30, 2011 and 2010 were not material and are recorded as a reduction of Selling, Administrative and General Expenses within the Condensed Consolidated Statements of Operations.

The agreement for the second securitization program was executed on September 28, 2011 between the Company and an unaffiliated financial institution. This program also allows the Company to receive a cash payment and a deferred purchase price receivable for sold receivables. This is an uncommitted program, whereby the Company offers receivables for sale to the unaffiliated financial institution, which are then subject to acceptance by the unaffiliated financial institution. Following the sale and transfer of the receivables to the unaffiliated financial institution, the receivables are isolated from the Company and its affiliates, and effective control of the receivables is passed to the unaffiliated financial institution, which has all rights, including the right to pledge or sell the receivables. The investment limit with this financial institution is $35,000. The Company receives no servicing fee from the unaffiliated financial institution and as a result, has established a servicing liability based upon unobservable inputs, primarily discounted cash flow. This liability is recorded in Accrued Expenses and Other Liabilities in the Condensed Consolidated Balance Sheets.

Under both programs, all of the receivables sold to the unaffiliated financial institutions for cash are removed from the Condensed Consolidated Balance Sheet and the net cash proceeds received by the Company are included as cash provided by operating activities in the Condensed Consolidated Statements of Cash Flows. A portion of the purchase price for the receivables is paid by the unaffiliated financial institutions in cash and the balance is a deferred purchase price receivable, which is paid as payments on the receivables are collected from account debtors. The deferred purchase price receivable represents a continuing involvement and a beneficial interest in the transferred financial assets and is recognized at fair value as part of the sale transaction. The deferred purchase price receivables are included in accounts receivable in the Condensed Consolidated Balance Sheets and are valued using unobservable inputs (i.e., level three inputs), primarily discounted cash flow.

The difference between the carrying amount of the receivables sold under these programs and the sum of the cash and fair value of the other assets received at the time of transfer is recognized as a loss on sale of the related receivables and recorded in Other Income in the Condensed Consolidated Statements of Operations.

The following table summarizes the Company’s accounts receivable securitization information as of the dates shown:

Alliance One International, Inc. and Subsidiaries

17.  FAIR VALUE MEASUREMENTS

The Company follows the current accounting guidance for fair value measurements for financial and non-financial assets and liabilities.  The financial assets and liabilities measured at fair value include derivative instruments, securitized beneficial interests and guarantees.  The non-financial assets and liabilities measured at fair value primarily include assessments of investments in subsidiaries, goodwill and other intangible assets and long-lived assets for potential impairment.  The carrying value and estimated fair value of the Company’s long-term debt are shown in the table below.

	September 30, 2011	September 30, 2010	March 31, 2011
Long-term debt
Carrying value	$ 878,835	$ 742,909	$ 885,155
Estimated fair value	767,865	808,662	905,330

A three-level valuation hierarchy is used to determine fair value as follows:

·

Level 1 – Quoted prices for identical assets or liabilities in active markets.

·

Level 2 – Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

·

Level 3 – Significant inputs to the valuation model are unobservable.

The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis:

The following tables present the changes in Level 3 instruments measured on a recurring basis:

	Three Months Ended September 30, 2011		Six Months Ended September 30, 2011
	Beneficial Interest in Securitized Receivables	Guarantees	Beneficial Interest in Securitized Receivables	Guarantees
Beginning Balance	$ 13,972	$ 2,950	$  15,797	$  4,575
Issuance of guarantees/sales of receivables	66,867	3,306	101,960	4,599
Settlements	(50,799)	(1,420)	(87,073)	(3,818)
Changes in anticipated loss rate	-	169	-	(351)
Losses recognized in earnings	(1,614)	-	(2,258)	-
Ending Balance September 30, 2011	$ 28,426	$ 5,005	$  28,426	$  5,005

Alliance One International, Inc. and Subsidiaries

17. FAIR VALUE MEASUREMENTS (continued)

	Three Months Ended September 30, 2010		Six Months Ended September 30, 2010
	Beneficial Interest in Securitized Receivables	Guarantees	Beneficial Interest in Securitized Receivables	Guarantees
Beginning Balance	$ 13,188	$ 8,933	$ 25,125	$ 13,478
Issuance of guarantees/sales of receivables	83,650	2,924	91,286	5,279
Settlements	(70,593)	(7,027)	(89,936)	(13,927)
Changes in anticipated loss rate	-	-	-	-
Losses recognized in earnings	(717)	-	(947)	-
Ending Balance September 30, 2010	$ 25,528	$ 4,830	$ 25,528	$   4,830

The amount of unrealized losses relating to assets still held September 30, 2011 and  2010, and  March 31, 2011 was $861, $363 and $288, respectively, all relating to securitized beneficial interests.  Gains and losses included in earnings are reported in Other Income in the Condensed Consolidated Statements of Operations.

Valuation methodologies

The fair value of derivative financial instruments is based on third-party market maker valuation models including amounts related to the Company’s own credit risk and counterparty credit risk.  The fair value of securitized beneficial interests is based upon a valuation model that calculates the present value of future expected cash flows using key assumptions based on the Company’s historical experience, market trends and anticipated performance relative to the particular assets securitized.  The fair value of guarantees is based upon the premium the Company would require to issue the same guarantee in a stand-alone arm’s-length transaction with an unrelated party based upon internally developed models. Internally developed models utilize historical loss data for similar guarantees to develop an estimate of future losses under the guarantees outstanding at the measurement date.

18.  RELATED PARTY TRANSACTIONS

The Company’s operating subsidiaries engage in transactions with related parties in the normal course of business. The following is a summary of balances and transactions with related parties of the Company:

	September 30, 2011	September 30, 2010	March 31, 2011
Balances:
Accounts receivable	$ 50,523	$ 67,134	$ 61,981
Accounts payable	31,295	9,192	38,937

	Three Months Ended September 30,			Six Months Ended September 30,
	2011	2010		2011	2010
Transactions:
Purchases	$ 47,068	$ 36,049		$ 77,793	$ 48,765

The Company’s operating subsidiaries have entered into transactions with affiliates of the Company for the purpose of procuring inventory.

The Company’s balances due to and from related parties are primarily with its deconsolidated Zimbabwe subsidiary.  The remaining related party balances and transactions relate to the Company’s equity basis investments in companies located in Asia which purchase and process tobacco.  The balance due from the Zimbabwe subsidiary includes a $16,657 pledge to a bank, which has been recorded in notes payable to banks.

19.  SUBSEQUENT EVENT

On November 3, 2011, the Company entered into the Fourth Amendment to Credit Agreement (the “Fourth Amendment”), which amended the Credit Agreement.  The Fourth Amendment permits the exclusion of specified levels of restructuring and impairment charges from the financial covenants impacted by the Company’s EBIT for fiscal quarters ending on or prior to March 31, 2012.  The Fourth Amendment also permits the exclusion of specified levels of costs and expenses associated with the commercialization, sale or dissolution of the Company’s Alert business, which offers to third parties automated systems for the enforcement of food safety and quality policies, from the financial covenants impacted by the Company’s EBIT for fiscal quarters ending on or prior to December 31, 2011.  In addition, the Fourth Amendment extends to April 30, 2012 the period in which the Company is permitted to form one or more subsidiaries for a specified business purpose to be funded by up to $1,000 in equity and $30,000 in subordinated note investments by the Company, provided the subsidiary or subsidiaries receive revolving credit financing of up to $200,000 from third parties and issue subordinated notes for an aggregate of up to $100,000.

Alliance One International, Inc. and Subsidiaries

Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations

EXECUTIVE OVERVIEW

The following executive overview is intended to provide significant highlights of the discussion and analysis that follows.

Financial Results

Sales and other operating revenues for the quarter were again negatively impacted as expected by Philip Morris International, Inc.’s (“PMI”) vertical integration initiatives in the prior year.  Decreased revenues were also due to lower green costs for the current crop that have been passed on to our customers and transportation shortages in Africa creating shipping delays.  However, gross margin and gross margin as a percentage of revenues increased slightly due to product mix and the positive exchange rate impact on foreign denominated operating costs.  Operating income and pretax income were down this quarter compared to the prior year primarily due to the prior year gains from the sale of Brazilian tobacco supplier contracts and other assets to PMI that were partially offset by decreased compensation costs in selling, administrative and general expenses this year.  Decreased pretax income this year compared to last year is in line with our expectations and not indicative of our anticipated results for fiscal 2012.  Our effective tax rate for the current quarter is 144.7% primarily related to a specific event adjustment expense related to net exchange losses on income tax accounts.

Liquidity

Our liquidity requirements are affected by crop seasonality, foreign currency and interest rates, green tobacco prices, crop size and quality, as well as other factors. We monitor and adjust funding sources that include cash from operations and various types of financings based on a number of industry, business, and financial market dynamics. Movement and changes between these various funding sources provides flexibility to help maximize various business opportunities, while minimizing associated costs where possible. We continue monitoring turbulence in the capital markets as a result of the European debt crisis, and believe that we are well positioned with no major long-term debt maturities in the next twelve months, good availability to crop lines globally, and appropriate levels of cash on hand. As of September 30, 2011, available credit lines and cash were $728.7 million, comprised of $139.6 million in cash and $589.1 million of credit lines, of which $8.9 million was exclusively for letters of credit.

Outlook

We continue to make changes in our operations to deal effectively with changing market conditions.  The global oversupply did not materialize to the extent we first expected.  For next year’s crop in several countries, we anticipate reduced crop sizes resulting in less export supply.  We have adjusted our marketing focus in response to recent customer vertical integration efforts.  As a result, our sales patterns and timing of shipments are shifting from larger volumes shipping in the first part of our fiscal year to the back end of the fiscal year.  Our restructuring plan is helping us gain factory efficiencies, productivity and volume gains and will continue to be implemented fully as we finish processing this year’s crop.  Our total U.S. volumes have increased.  Although Hurricane Irene caused significant damage to the U.S. tobacco crop, we have secured sufficient additional volumes to partially mitigate the impact of the storm losses.  We are experiencing delays in shipping in some of our African operations due to a shortage of containers and trucks that have been diverted to delivery of food aid to famine stricken Somalia.  However, our outlook for this fiscal year remains in line with our expectations and we remain committed to the restructuring and repositioning of the business model.

RESULTS OF OPERATIONS: