Vector Group Ltd (VGR) 2003 Q2 法說會逐字稿

Welcome to Vector Group's 2nd quarter 2003 earnings conference call. Before the call begins, I would like to read the Safe Harbor Statement.

The statements made during this conference call which are not historical facts are forward looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth in or implied by forward looking statements. These risks are described in more detail in the company's Securities and Exchange Commission filings.

Now, I would like to turn the call over to the Chairman and Chief Executive Officer of Vector Group Ltd., Bennett LeBow.

Thank you, operator. Good morning and thank you all for joining us on this difficult day after the power problem last night for Vector's 2nd quarter 2003 earnings conference call. With me today is Ron Bernstein, the President and CEO of Liggett/Vector Brands and Liggett and Howard Lorber, our Chief Operating Officer.

On today's call, I will provide you an update on the launch of our Quest brands and then outline our financial performance. Ron will then give his perspective on our conventional cigarette tobacco business and then we will be available to answer questions.

The news about the cigarette industry continues as previously described; new taxes in various jurisdictions and higher price points are affecting domestic sales, especially premium sales. Industry wide, total domestic sales were down approximately 2 to 3% year over year and the significant shift was seen to third and fourth tier brands.

Despite difficult industry conditions, Liggett's performance continues to be solid. While Liggett's overall second quarter unit volume declined by approximately 408 million units from the prior year period, our core brands sustained substantial growth and the shipment share during the first half of 2003, actually increased over the prior year period. During the same period, all the big four companies lost shipment share of approximately 17 billion units. Ron will review the results in more detail with you later.

Regarding Quest, as you know we launched our Quest product in late January in seven states which accounts for approximately 30% of the domestic cigarette market. This seven state launch was intended to be a substantial test market which will allow us to identify the strengths and weaknesses of the Quest product and prepare us for a national launch.

In terms of Quest's over all performance, while we are generally pleased with the initial response in the seven states, we did identify a product issue that needs to be addressed that we believe has impacted brand performance. Specifically, we found that Quest 3, the nicotine-free version, had a moisture retention issue in the tobacco which tended to reduce the shelf life and resulted in some inconsistent product taste characteristics. The problem has now been addressed and the affected product in the field has been replaced.

As an additional step to ensure quality as we go forward, Quest products have been modified with a new and improved blend to be veiled by the end of October.

In terms of overall performance, although we receive weekly business performance data from sources including MSAI, we now have retail performance data for the 2nd quarter ending June 30th. Given our introduction started in January, this is the first clean read of detailed store by store quarterly performance information from our initial distribution efforts. Based upon this data, we have been able to ascertain that Quest continues to achieve in excess of a 1% market share and those stores are actively reordering.

We have found that beyond traditional high volume stores, stores that are located in higher socioeconomic areas are the primary reordering outlets. These retails include convenience stores, drug and super market chains and this group represents about 8 to 10,000 stores in the seven-state test area.

In addition, data indicates that Quest is gaining particular traction with female smokers that fall into what is considered a semi affluent demographics. The goal, therefore, is to focus our advertising marketing on effectively communicating the emerging Quest brand to these retail outlets and potential customers in the seven states as we increase our distribution.

Current conditions relative to the premium segment of the industry are reflecting unprecedented discountings today. As evidenced by recent quarter reports from the big four companies, particularly RJR and the Carolina Group, earnings from premium brands are being severely strained by competitive activity and we are seeing increased discounting of premium brands at all levels of retail.

Given these market place conditions and the results we have seen to date with Quest, our intent is to take a measured approach to expand the market presence of the brand. We intend now, to introduce a menthol line extension of Quest in the seven-state market in the next few months. In addition, we intend to utilize the information that we have obtained over the past six months on the Quest nonmenthol product and more specifically target our focus in the seven-state market in the coming months.

Based upon those results, the success of the menthol product and market conditions in the premium segment, we will make a determination on the timing of a national launch at a later date. Additionally, working with Dr. Jed Rose of Duke University, we have now petitioned the FDA to supply us with the necessary guidance for a multicenter study to actually prove the effectiveness of the Quest program and the smoking sensation device.

Now, I'll quickly review the key financials for the three and six months ended June 30, 2003 for Vector Group, our conventional cigarette business and our Vector Tobacco potential reduced risk cigarette subsidiary. Our conventional cigarette business includes sales from both Liggett Group cigarettes and our U.S.A. brand cigarettes from the Medallion acquisition.

For the quarter ended June 30, 2003, Vector Group revenues were $131.2 million compared to $140.1 million in the 2002 second quarter. The company recorded operating income of $0.8 million compared to an operating loss of $4.8 million in this 2002 period. Net loss was $4.9 million or 13 cents per diluted common share compared to a net loss of $3.3 million or 10 cents per diluted common share in the 2002 second quarter.

For the six months ended June 30, 2003, Vector Group revenues were $264.3 million compared to $237.2 million in the 2002 period. The company reported operating income of $0.6 million compared to an operating loss of $19.9 million in the 2002 period. Net loss was $9.8 million or 27 cents per diluted common share compared to a net loss of $15.2 million or 44 cents per diluted common share in the 2002 second period.

Now, for performance of our conventional cigarette business. For the three and six months ended June 30, 2003, our conventional cigarettes have revenues of $120.8 million and $245.7 million respectively compared to $138.7 million and $232.8 million for the 2002 periods. Operating income for the three and six months ended June 30, 2003 were $27.6 million and $57.8 million respectively compared to $24.9 and $43.4 million for the 2002 periods.

The 2002 numbers, however, include only three months of earnings from Medallion which was required in April 2002 and include a pretax restructuring charge of $3.5 million from last year. However, our Vector tobacco subsidiary continues to have significant expenditures for items such as R&D, initial advertising and marketing for the Quest launch resulting in an operating loss of approximately $21.2 million for the quarter and $45.5 million for the six months ended June 30, 2003 compared to a loss of $20 million for the 2nd quarter ended June 30, 2003 and a loss of $44.6 million for the six months ended June 30, 2003.

Now, let me turn the call over to Ron Bernstein, the President and CEO of Vector Brands and Liggett who will update you on the performance of the Liggett Group.

Thanks Ben and good morning, everybody.

I am pleased to report that despite the ongoing difficult conditions in the cigarette market place, our conventional cigarette business remains strong. As Ben indicated, the conventional cigarette business did experience a year over year revenue and volume decline of approximately 408 million units. This decline related primarily to year over year purchase timing differences of a major private label customer and, to a lesser extent, to an ongoing consolidation of lower margin discount brands.

As indicated, despite these volume declines, operating income for our conventional cigarette business during the second quarter of 2003 increased by $2.7 million over the 2002 period. Considering performance on a year to date basis, unit volume is up approximately 2% and revenues are up 6%. We were very pleased to gain market share during this six-month period while all of the big four companies were losing shipment share.

I want to reemphasize that we consider the entire market including the non MSAI reporting companies in reporting our share estimates. We strongly believe that that is the appropriate standard for evaluating share performance. I am also very pleased to report that our core conventional brands, Liggett Select and Eve, performed very well in the second quarter. Liggett Select grew at a rate of 30% over the prior year period and at a rate of 20% over the first quarter of 2003.

During the 2nd quarter, we recognized both same store growth and new distribution with several significant new chain accounts agreeing to feature Liggett Select as their primary deep discount brand. We clearly expect these trends to continue throughout the year.

On June 1, 2003, we raised the wholesale carton price of Liggett Select by $1.10 and while we intend to trade a portion of the increase back to retail and trade promotions, we also expect to recognize a margin benefit in the second half of 2003. Importantly, following the last price increase, unit sales continue to be strong on Liggett Select.

Eve's performance was also excellent during the second quarter with year over year growth of almost 45% and quarter over quarter growth of 58%. Over the past several quarters, we have reported that Eve sales had stabilized. Based upon 2nd quarter results and trends in the market place, we believe that Eve is now demonstrating growth at retail and we are optimistic that these trends will continue.

As Ben indicated, during the past quarter, we learned a great deal about Quest that should substantially enhance our sales force focus in the existing seven states, as well as at the time of a national launch. The Quest menthol product, scheduled to ship in the fourth quarter, is a very good product and should further strengthen Quest's positioning in the seven states. We continue to make improvements to Quest and believe that the improved product will meet or exceed consumer expectations. Enthusiasm for Quest does remain strong both within our organization and within the retail community.

Looking at other trends, the situation in the discount segment remains difficult and fourth tier companies do continue to grow, however, we are starting to see the slowing of that growth rate. We were very pleased to see the recent action taken by the State of Minnesota to impose a 35 cent per pack fee on all companies, except those companies, the big four and us, that have a valid settlement with the State of Minnesota.

In addition, 15 states have now passed the allocable share amendment that will force nonMSA accompanies to make escrow payments at the same level as MSA participants. We believe that these actions will continue and grow over the next year and will negatively impact the nonMSA companies. However, we still believe it will take in the range of 18 months to two years to enact the measures necessary to fully level that playing field.

In summary, we believe that Liggett/Vector brands remain well positioned to expand it's profitable discount business and to pursue profitable opportunities with it's differentiated products. Thank you very much for your attention and back to you, Ben.

Thank you, Ron. Before I finish my prepared remarks, I wish to once again reaffirm that our cash dividend policy remains the same. Now, operator, would you please open the call for questions?

Thank you, the floor is now open for questions. If you have a question, please press the number 1 followed by 4 on your touch-tone phone. If at any point your question is answered, you may remove yourself from the queue by pressing the pound key. Questions will be taken in the order that they are received. We do ask that while you pose your question you pick up your hand set to provide the best sound quality. Please hold while we poll for questions.

Thank you. Our first question is coming from Eric Wanger of Jeffries & Company.

Yes, just four financial questions, balance sheet metrics in terms of cash and debt and then also cash flow metrics for depreciation and amortization for the quarter and capital expenditures for the quarter and the guidance going forward?

You want to answer all those?

Yes. The cash is approximately $80.5 million plus another $10 million of restricted cash at Vector and VGR holding level. The next question?

Debt and then depreciation and amortization and capital expenditures for the quarter and going forward.

As far as holding company debt, there is $132.5 at the Vector level, there is $65 million at the VGR holding level. Liggett has approximately $49 million, of that amount $32.6 million is from the revolver and the remaining $16 odd million is from other notes payable for equipment. Total debt current is $53 million which includes New Valley and long-term debt is $302 million including New Valley, without New Valley, the long term debt is $262 million for the company.

If you want to call Brian off line, he would be happy to give you all these numbers, take you through all of them.

As far as EBITDA --.

No, depreciation.

Depreciation was $2.1 million for the quarter for Liggett, for the six months it was $4.2 million for Liggett and for Vector tobacco, it was $1.2 million for the quarter and for the six-months it was $2.4 million and for the entire company, including New Valley, it was $4.4 million for the quarter and $8.6 million for the six-month period. For the entire company, excluding New Valley, it was $4 million for the quarter and $8 million for the 6 month period.

Okay and capital expenditures?

Capital expenditures were $4 million for Liggett for the 6-month period, $2.1 million for Vector Tobacco and for the entire company, it was $6.5 million for the 6-month period. Okay, and when will the Q be filed?

The Q has already been filed and all of this data is in the footnotes of the Q.

The footnote is footnote #11, segment information. And for a point of reference --.

That's enough.

Thank you.

Our next question is from Joel London from APS Financial, please go ahead.

Ben, in terms of the class 10, your comments apparently you are focusing more on a selective market, the more affluent and female smokers?

That's what the data tells us so we are going to focus more on that, yes.

What does that represent in the total market in your estimation?

Ron, you want to help us here?

Yeah, the -- looking at it from the stand point, let me clarify a point, what we have seen is that is where we have seen our greatest position of strength. However, that does not limit the market to only that demographic but that is where we have seen the greatest pocket of strength. What we have seen generally, is that the brand is most successful in areas of greater affluence and within those areas, there is a demographic that is greater relative to the female as opposed to male which was our anticipation going in.

It's only a little bit more pronounced than what we had originally projected. So, in looking at the demographic, obviously your smoking population is -- you have a substantial approximate 50% female orientation and when you bring in the affluence indication, that segment is probably somewhere in the range of 30% or so.

Again, I want to just clarify this, that's not exclusively where the focus is going to be. What we have seen is that it has been indicated that certain types of retail outlets, specifically chain-type outlets, convenience stores, drug stores and super markets have outperformed. There is a broader base than that that we believe is open to the Quest product.

In terms of your reorder, you said that there were like 8,000 to 10,000 stores in kind of the higher economic locations, what does that represent of the total stores out there in the seven states?

That would represent about 10%.

10% of the stores that are there. We are not in every store yet.

That's correct, 10% of that total market place in the seven states market place.

You are not in all the stores, yet?

We are in maybe 50 or 60% at the present time.

In terms of the reorder patterns for the other stores, have those reorder patterns significantly tailed off? Do you see any sort of trends there?

Joel, we have seen a decline in certainly some of the smaller independent stores. What we have seen, just as a reference, Ben referenced 8 to 10 thousand stores that are showing strength. Over the course of the quarter, the total stores reordering is more in the range of 28 to 30,000. So, there is ongoing business, it is just not at the higher core level that we're looking at with the 8 to 10 thousand stores.

Okay, one more question and then I will let other people ask their questions. When do you think you will be at the point whether when you decide to do a national launch? I know you previously said in the third quarter and obviously it's been extended. What kind of time frame do you have now?

The issue we had, the primary issue, as I mentioned, was a moisture issue, how it affected the taste and so forth. We have to get the new product out there and let it flow through the market place to make sure that problem is fixed before we go national. So, it is going to take some time to get that new product out there, get people used to it and make sure that problem is fixed before we commit to a national launch.

Do you have any guesstimate to when that would be?

I don't know, some new products out there now, the new products, Ron, help me a little bit, will be out in October or November, so, you have got to really figure, I would say, at least six months to have the product out there and get some feedback and so forth.

Right.

There are two phases to this and the first phase has already happened which is we corrected the situation that we discovered relative to the loss of moisture with our existing product. At the same time, we were looking at what we could do to further improve the Quest product. We have now been able to both correct that moisture issue and in addition to that, have been able to improve all three brand styles of Quest. So, what we are looking at is in the October time frame, is to start getting the new and improved version of Quest out into retail.

While at the same time we still will have product flowing through that's already out in the system of the corrected product, if you will, that has improved the moisture situation. It will take us a period of certainly months to be able to circulate everything through the system and then evaluate the performance after that.

Okay. Thanks, guys.

You're welcome.

Thank you, our next question comes from the line of Mark McMahon of Wachovia Securities.

Good morning, guys, how are you doing?I have a couple of questions for you, I was wondering if you could go into a little bit more detail on the variance between last second quarter and this on the private labels brand that was attributed to the decline in the quarter?

In terms of the difference, it simply was a buying pattern that related to one customer. If you take that customer and evaluate where they are over the 6 month period, they basically show a slight growth increase over the six-month period but because of their own issues and their own promotions, they had purchased more during the first quarter than they did in the second quarter. So, it's merely a timing difference between the two quarters.

So, you don't anticipate seeing that sort of bump in the quarter we're in now going forward?

No, no. In fact, it tracks above target relative to what our internal projections are. It's right on target and should be smooth through the end of the year. We have different fiscal year ends and they have their considerations to deal with.

Okay, now, if you could explain a little bit of the thinking behind introducing the menthol brand in the 4th quarter of this year on the regular Quest and sort of fixing the problem you have and expanding market share there. Why are you breaking into the menthol market when you are still working on the original?

There are two reasons, the first is consistently since we launched Quest, the market has been asking us for a menthol version. There is very strong inherent demand for the product.

Secondly, we have been working since the launch on the menthol variant and what we have come up with is a product that, we believe, is very strong in terms of product quality. By introducing the menthol version in the latter part of this year, it will create a refreshed look at Quest overall because as we are out dealing with the menthol product, we will also be, at the same time, putting forward the new and improved version in the seven-state area.

The two will support each other and will generate some of what we hope will be a refreshed look at the Quest product. So, A, we think we have a very good product and B, the market demand is already there and C, we believe that we will be able to get some momentum going on both variants.

Menthol is what, 25% of the smoking market?

Yes.

What sort of market share does Quest have with the markets that it is in considering that it is in only 50to 60% of the stores?

I'm sorry, say that again?

What would you guesstimate the Quest market share is currently in seven states.

We haven't given volume share and don't want to at this point. What I would say to you relative to the menthol is that within the seven-state area, you have the highest menthol demographic in the country which is predominantly the Northeast and the larger cities of the Midwest, so we believe that the menthol opportunity is an opportunity of some significance.

The other point is that since this is a no nicotine product, at least Quest 3 is, the menthol helps the taste characteristics very much, okay, it helps mask the fact that there is no nicotine there.

This is a final question regarding the Minnesota issue.

Would it be my correct understanding that that is going to boost your margins considerably in Minnesota and if there is follow-through in the other four states, Texas, Mississippi and so forth, this could be a boon to you or could it take place sooner rather than later or one apparation in Minnesota and not the other four states?

First of all, I don't think it's an apparation and I believe that there is significant opportunity as states are recognizing that they are not recognizing significant revenue that is on the table. If you look at it, in terms of the states, the opportunity in Florida for the State of Florida is an enormous opportunity because of the development of the nonMSA companies in that state. Texas is also significant and Mississippi, on a relative basis, is very significant as well. This is something that will flow through and obviously we aim to to help it any way we can.

As far as the market place itself, there are two things that happen: One is that there is initially going to be a significant opportunity for us to increase market share within the State of Minnesota and secondarily it's going too give us pricing power for the future. What this does is this puts us at the same price effectively as the nonMSA companies and that in any market place have been unable to compete with us at price parody. So, the bottom line is, it gives a significant opportunity to increase our market share and then that inherently gives us an opportunity for pricing in the future.

I actually lied before, one final question. Where do you have Liggett priced in terms of Commonwealth's brand, USA Gold?

The wholesale list price is approximately $1.80 less than USA Gold.

Is that --.

$1.80 per carton.

Maverick is what?

Maverick falls in between. Maverick came in where USA Gold's was price before USA Gold raised their price. So, Maverick is $1 higher, I believe, than Liggett Select per carton and about 80 cents lower than USA Gold?

Is that hurting you guys at all?

Not at this point.

Thank you, our next question is coming from Donald Trott of Jeffries.

Hi, good morning, I have a couple of questions. First one is, you gave us various numerics with respect to Liggett's market share. Could you summarize it, what is the Liggett market share now and what was it a year ago?

Over all?

Yeah. You talked about the degree of increase but you didn't actually quantify what the market share is.

2.6%?

I believe the difference is 2.7 to 2.5.

Thank you very much. Secondly, in terms of the new formulation, new and improved Quest, are you going to advertise the fact that the formulation has indeed been improved?

We are certainly going to promote it, Don. We will offer targeted advertising opportunities but in conjunction with partnerships with our retail customers as well as in vehicles such as FSI's and newspapers.

Okay, and then just one final one. Could you quantify or give us some approximation as to what is your spend to date on advertising on Quest and what is the remainder of the budget for the launch in the seven-state area?

I believe we spent advertising wise. about $15 or $16 million, is that right, Ron?

Yes.

That range so far. We're not anticipating an huge additional expenditures in the seven-states for the rest of the year.

When the menthol comes later this year though, aren't you going to advertise that?

That is not a huge advertising thing.

That will be more of an in store promotion.

Okay. Thank you very much.

You're welcome.

Once again, if you do have a question, please press the number 1 followed by 4 on your touch tone phone.

Thank you. Our next question is from Mitch Pembis of Oppenheimer & Company.

Hello, gentlemen, let's see if I can get this question off accurately. You are showing a drop for the quarterly gross revenues on the operating side. Ron, if I understood correctly, you are saying that most of that was attributable to a drop from one purchaser. I guess that was a private label purchaser?

Correct, it's actually a purchase timing difference, Mitch, between the first and second quarter last year versus this year.

That's what I'm trying to understand.

Mitch, look at the six months, six months is up. It was timing between first quarter and second quarter is what it was.

Was it sort of like inventory loading?

No, not loading, they just had their reasons and purchased ahead for some reason in the first quarter and that skewed first quarter a little bit. If you look for the six months, you will see that things are up.

Okay, I think I understand that then. What was the increase for the six-month percentage wise, I don't have that in front of me?

I think, what, 6% on the revenue, Ron?

2% on revenue and 6%.

Okay. My other question relates to a loss from operations you are showing of 6,384,000 versus roughly 93,000 for the prior year. I am trying to understand, why such a big jump?

Operations where, what operations are you talking about?

I am looking at the loss from operations just above the net loss on the income statement?

I don't have it handy. P.K., do you have that?

I do. Mitch, the primary driver of that is there was a $9 million gain on assets last year at New Valley which comes through on consolidation.

I see.

The gain at New Valley was $8.9 million.

Okay. If I read this correctly then, you are actually gaining market share despite what's happening as a general trend in the market, it is just that the quarter was impacted largely by this one purchaser of yours?

That is correct on the revenue side. I mean, what we have seen in terms of the pick up that we've gained with Liggett Select and Eve has built even with that purchasing difference, we still saw an increase in our operating income, quarter over quarter.

Okay, and where do you see that trend continuing, do you feel like that is sort of burning itself out and the company is leveling off in its growth path?

No, I think that we are going to continue to see growth and what we are seeing right now is Liggett Select is starting to ignite in terms of its growth at major types of chain accounts. For instance, we recently entered into agreements with Exxon Mobile and with Heft and that is volume that has not been seen yet and they are going to be represented in all of their convenience stores as their primary deep discount brand.

So, we are continuing to see growth there and as far as Eve is concerned, we corrected a pricing issue that we had relative to Misty which was corrected back last September and we are generating the benefits of that now as we have regained some of the share that we had previously lost.

Okay, and the last question, I guess, sort of backs into Don Trott's previous question about market share. I think you said Liggett Select is roughly 2.7% nationally now versus.

Overall Liggett.

Oh, overall Liggett and if you added in all the other ancillary brands, do you know where you would be nationally?

That is a national number, that 2.7% is everything.

Oh, it is on everything, well, that answers my question. Where were you a couple years ago? Around 1.5?

1.8 or something like that.

Okay, that's all my questions. Thank you.

Thank you, our next question is from Andy Smith from Emerald Asset Management.

Good morning guys, I have a question regarding the potential FDA that's going right now, talk about the FDA taking over control of the tobacco market and also, what progress and what continued studies are you working on with regards to Omni?

Regarding FDA taking over things, it's good news and could be, you know, difficult news. On the good side, I would think the FDA coming in could put some order to this fourth tier, you know, manufacturers. I think they would have a difficult time meeting FDA standards, whatever they may be.

The potential other news is the devil is in the details, if Congress were to give FDA authority, the whole question is, what does that mean and what kind of regulations and so forth for reduced risk cigarettes and so forth the FDA may require.

As far as where we stand on Omni, we are continuing the research to prove that Omni works in humans. I would say our goals are that sometime next year we will be in a position to know whether Omni works or not and we may have to change it, tweak whatever we have to do it. This is all state-of-the-art stuff and we are doing it with advanced genetics with various institutions we are starting to working with around the country. Hopefully next year we will have some things to report.

Okay. Thank you very much, Ben.

Thank you. I would now like to turn the call back over to Ben LeBow for closing comments.

Thank you everybody and if you have any other questions, please don't hesitate to call either myself or Ron directly and we will try and answer any questions you might have. Thank you very much.

Thank you, this does conclude today's teleconference. Please disconnect your lines and have a wonderful day.