Vector Group Ltd (VGR) 2003 Q3 法說會逐字稿

Welcome to Vector Group's third quarter 2003 earnings conference call. Before the call begins, I'd like to read a 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 or implied by forward looking statements.

These risks are described in more detail in the company's Securities and Exchange Commission filings. Now I'd like to turn the call over to the President and Chief Operating Officer of Vector Group, Howard Lorber. Sir, you may begin.

Good morning, and thank you for joining us on Vector's third quarter 2003 earnings conference call. With me today is Ron Bernstein, the President and CEO of Liggett Vector Brands and Liggett. Ben is feeling a little under the weather today, and will not be joining us for the call.

On today's call, I will first provide an update on our Quest brand and the test results we announced this quarter, then outline our financial performance for the period. Ron will then give his perspective on our conventional cigarette business and update you on recent steps we've taken to reduce excess production capacity and improve the profitability of our tobacco business. We will then be available to answer your 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 in premium sales.

Industry wide, total domestic shipments were down approximately 3.5% year-over-year, and a significant shift was seen through third and fourth tier brands. Despite difficult conditions, Liggett's performance continues to be solid. Liggett's overall third quarter unit volume was 2.6 billion cigarettes, a 7% increase over the prior quarter and effectively flat over the prior year period. In his presentation, Ron will review these results in more detail with you.

Regarding Quest, this quarter we announced extremely encouraging news regarding Quest cigarettes. Dr. Jed Rose, Director of Duke University Medical Center's Nicotine Research Program and co-inventor of the Nicotine Patch, conducted a study on Quest to provide us with preliminary evaluation of the use of the Quest technology as a smoking cessation aid. In his 18-week study, Dr. Rose found that 33% of Quest 3 smokers were able to achieve four-week continuous abstinence, which is a standard threshold for smoking cessation. And of those participants who smoked Quest 3 exclusively, after week 13, 54% succeeded in quitting.

We were also pleased to see in the results of this study that subjects who succeeded in quitting experienced very few withdrawal symptoms and did not experience the usual cravings upon quitting. Dr. Rose's belief is that Quest cigarettes address the habit component of smoking, which is not currently addressed by cessation products on the market, including nicotine patches.

We have asked the FDA to supply us with guidance as to the additional research and regulatory filings necessary so that we may eventually market Quest as a smoking cessation product. The news of Dr. Rose's study received broad pickup in the media, including a National Associated Press story and over 100 mentions in television and radio broadcasts throughout the country. This media attention helps raise awareness for the brand and generated nationwide consumer interest through our toll-free hot line and website.

Regarding our existing Quest business, as you probably know, Quest and now the new Quest Menthol, are available in seven states, which account for approximately 30% of the domestic cigarette market. Quest Menthol, which started to hit store shelves this month, is expected to be in over 20,000 retail outlets by the end of December. The 7-state brand expansion is expected to build upon the extensive experience of the initial Quest introduction and better prepare us for a national launch.

We remain pleased with the initial response in the seven states; but given the challenges facing the premium cigarette market, we will continue to take a measured approach to expanding the market presence of Quest. We plan to introduce Quest and Quest Menthol into an expansion market in Arizona beginning January 2004. Quest will be available in Tucson and Phoenix, which account for approximately 1% of the industry volume nationwide.

The launch will be supported with significant advertising weight in regional issues of national magazines such as Time, News Week, and People, and in local newspapers and magazines. We also intend to provide substantial targeted media support in the existing seven-state region beginning in January. Based upon retail performance data for the third quarter ending September 30th, we have been able to ascertain that Quest is currently achieving approximately .7% market share in the brand's core retail universe.

This universe is composed primarily of convenience stores, supermarkets, and high volume tobacco stores, and totals about 8,000 outlets. Further for the quarter, Quest held a 0.3% share of the total industry volume that is sourced from approximately 100,000 retail outlets in the original seven states, with only three SKUs. This share has remained stable without significant advertising support.

Now I will quickly review the key financials for the three and nine months ended September 30, 2003, for Vector Group, our conventional cigarette business, and our Vector Tobacco New Technology cigarette subsidiary. Our conventional cigarette business includes sales for both Liggett group cigarettes and our USA brand cigarette from the Medallion acquisition. For the quarter ending September 30th, 2003, Vector Group revenues were $142.9 million compared to $141.7 million in the 2002 third quarter.

The company recorded an operating loss of $8.3 million compared to operating income of $300,000 in the 2002 period. During the third quarter of 2003, the company recognized pre-tax restructuring and impairment charges of $20.1 million, in connection with our plans to move production of Quest and the other Vector tobacco products to Liggett's' methane manufacturing facility, which Ron Bernstein will discuss in a few minutes. [INAUDIBLE] for the restructuring and impairment charges, the company's operating income for the 2003 third quarter was $11.8 million, an increase from operating income of $300,000 in the 2002 period.

Net loss was $9.4 million or 24 cents per diluted common share, compared to a net loss of $8.2 million or 22 cents per diluted common share in the 2002 third quarter. For the nine months ended September 30th, 2003, Vector Group revenues were $407.2 million compared to $378.9 million in the 2002 period. The company recorded an operating loss of $7.7 million, compared to an operating loss of $19.6 million in the 2002 period.

Again, adjusting for the $20.1 million of pretax charges in 2003 and a pretax restructuring charge of $3.5 million in 2002, operating income for the first nine months of 2003 was $12.4 million compared to a loss -- an operating loss for the 2002 period of $16.1 million. Net loss was $19.2 million, or 50 cents per diluted common share compared to a net loss of $23.4 million or 64 cents per diluted common share in the first nine months of 2002.

Now for the performance of our conventional cigarette business. For the three and nine months ending September 30th, 2003 our conventional cigarette business had revenues of $135.7 million and $381.4 million, respectively, compared to $139 million and $372.7 million for the 2002 period. Operating income for the three and nine months ending September 30, 2003 was $31.3 million and $89.1 million, respectively, compared to $27.3 million and $70.7 million for 2002 periods.

The 2002 numbers, however, include only six months of earnings for Medallion,, which was acquired in April 2002, and include the pretax restructuring charges of $3.5 million.

Our Vector tobacco subsidiary continues to incur significant expenditures for items such as R&D and initial advertising and marketing for the Quest launch, resulting in an operating loss of $34.5 million for the quarter and $80 million for the nine months ending September 30th, compared to a loss of $20.2 million for the third quarter ending September 30th, 2002, and a loss of $64.9 million for the nine months ended September 30, 2002.

The 2003 numbers include the pretax restructuring and impairment charges of $20.1 million. Adjusting for these charges, Vector tobacco's operating loss for the third quarter of 2003 was $14.4 million, a decrease from the $20.2 million lost in the prior year period.

For nine months ended September 30th, 2003, Vector tobacco's operating loss would would have been $59.9 million versus $64.9 million for the same period in 2002. Now let me turn the call over to Ron Bernstein, the President and CEO of Liggett Vector Brands and Liggett, who will now update you on the performance of Liggett Group. Ron?

Thanks, Howard, and good morning everybody. As Howard indicated, industry marketplace conditions remain difficult. The big core companies continue to discount at substantial levels; and despite increased legislative and legal pressure, the small non-MSA participating companies continue to continue to force prices and margins lower.

In the face of this pressure, I'm pleased to report that our conventional cigarette business remains strong and profitable, with continued growth in our core brands. Liggett Select continues to be the growth star of our portfolio, with third quarter growth in excess of 26% over the prior year period, as well as 2003 year to date growth of 26% over the prior year.

As you may recall, we raised the price of Liggett Select by $1.10 per carton, effective June 1st, 2003. I'm pleased to report despite the price increase, we still generated third quarter growth in excess of 4% over the second quarter's strong performance. Trends for Liggett Select remain strong and we anticipate continued growth in the fourth quarter and beyond.

We continue to add major new chain accounts to our Liggett Select family, with the recent additions of Walgreens, K-Mart, and Speedway, representing a total of over 7,000 stores. In Walgreens and K-Mart, Liggett Select will be the lowest priced brand in the store. And in Speedway, Liggett Select will be priced just above the turning private label brand. The performance of Eve remains strong in face of significant pressure in the marketplace.

Third quarter, Eve 120 grew at a rate of 20% over the prior year period, and year to date sales have increased by 15% over the prior year. Eve's third quarter sales were effectively flat compared to the very strong performance in the second quarter, indicating that we are holding on to the gains made earlier in the year.

As previously mentioned, third quarter overall volume was effectively flat compared to the prior year period. This is primarily reflective of our continuing efforts to eliminate smaller, low-margin brands and maintain our sales force focus on the growth of Liggett Select and Eve.

The success of that strategy is reflect in the volume growth of those brands, as well as in third quarter operating income growth of 15% over the prior year period and year to date operating income growth of 20%. We continue to make progress in our efforts to encourage state legislation to improve enforcement and close loop holes of the Master settlement agreement.

Since the beginning of the third quarter, four additional states passed the Allocable Share Amendment, bringing that total to 19. The legislation closes the most significant MSA loophole. In addition, 31 states have now passed the Complimentary Model Statute Legislation, which significantly enhances the state's ability to enforce MSA escrow compliance among the non-participants.

Similar legislative initiatives are currently pending in ten additional states, and we expect that significant progress will be made in 2004. Along those lines, recently the Michigan state legislature passed out of committee a bill to impose an additional $3.50 per carton fee on non-MSA participants to cover costs associated with pursuing MSA escrow payments.

We believe that the various state measures are having the effect of slowing down the MPM's and will likely lead to their decline in the future. Turning now to the recent announcement concerning the closing of our Ttimberlake plant.

As most of you are aware, on October 8th, we announced that Vector Tobacco would be closing its Timberlake facility and would begin contracting with Liggett Group to manufacture its products effective January 2004.. We currently expect that this action will result in annual cost savings of approximately $23 million beginning in 2004.

The restructuring will result in the elimination of approximately 150 positions at Vector Tobacco. We will take restructuring and impairment charges, which we currently estimate at approximately $21.5 million, during the third and fourth quarters of 2003 and the first quarter of 2004. With most of the charges being recognized during the third quarter.

As a company, this was a difficult but obvious decision for us. We currently have sufficient capacity at our state of the art Liggett facility in Mevin [PHONETIC] to meet the current Vector Tobacco manufacturing requirements and if necessary, with relatively modest modifications we can meet future growth requirements. Given the one-year payback period and our ability to absorb the production at the Liggett facility, this action enables us to create a more efficient operating and economic base to meet the ongoing pressures of the marketplace.

We clearly remain committed to our Vector Tobacco products, as evidenced by the recent introduction of Quest Menthol in the existing seven-state region and our plans to expand the brand's availability to Arizona. As Howard indicate Quest's performance remains stable and the brand retains strong appeal in the core retail outlets. We are very pleased to achieve 100% distribution of Quest Menthol in targeted outlets.

This strongly reflect the retail community's ongoing belief in the Quest product. At the present time, we are not actively marketing our Omni product, but we do continue to fill orders for those customers requesting the brand. As Ben has expressed in previous calls, our research work on Omni is going forward and we anticipate that we will have updated information to provide by the middle of 2004.

Finally, as we prepare for 2004, it's important to note that our organizational planning is focused upon the continued profitable growth of our core conventional and new technology products, increased operating efficiency, and supporting the various efforts to assure that both the MPM's and the soon to be big two and a half, are complying with all applicable laws. Thanks for your attention, and back to you, Howard. Howard?

Thanks, Ron. Now before we open for questions, I'd like to again reaffirm that our cash dividend policy remains the same. 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 in which they are received. We do ask that while you pose your question, that you pick up your handset to provide the best sound quality. Please hold while we poll for questions. Thank you. Our first question is coming from Mitch Pendis of RBC Dane Rousher.

Hi gentlemen, a couple of quick questions. The Engel bonds -- can you talk a little bit about that, because of what's happened recently with the case being basically dismissed, what will happen with that money, and how much was it?

Sure. As you remember, Mitch, we didn't actually post the bond. What we did is we made a payment, okay, which was a smaller amount, which, in theory, was a payment that no matter what happened to the case, we didn't get that money back. And because of that we were able to deduct it, and we thought it made -- uh, tax-wise, and we thought it made sense. Being that there's no class right now, everyone is sort of not sure, and the companies are looking at the position as far as suing to get all the money back. Dick, do you have an update on where that stands?

There's nothing new. We have about $9 million subject to these payments that were made. This will play itself out. I think the expectation is that the Florida Supreme Court, relatively shortly, will determine whether or not they're going to hear an appeal from the Intermediate Appellate Court's decision, and once that is final, that process will start, in terms of dialogue, between the industry and plaintiff's counsel.

What's your feeling on what should happen with that money?

Well, I mean, the fact is, you know, they say it wouldn't come back, it should go to the class, but then again there's no class. And then as it relates to going to lawyers, they basically slammed the lawyers in the reversal, so I can't imagine them letting the lawyers keep it. It's very hard to say. Maybe they'll determine that it should go to smokers, you know, to the State. You know, I guess there's so many potential option, you just don't know. I think we really don't have the feeling for it at this particular time.

Another question. I notice there was about an additional, excuse me, 2.4 million shares outstanding, and I'm wondering -- I know a portion of that has got to be from the 5% stock dividend, but can you tell me what the difference is?

I think that probably -- if it's primary, probably I exercised a million and a half options, so that's probably a million and a half of that. Is that right, Dick?

That was actually in the prior year. The bulk of it, Mitch, relates to the 5% stock dividend which would be about 1,850,000. And then there were some warrants that had been issued to note holders about five years ago that expired, and in conjunction with the expiration, some of those warrants were exercised.

Okay. That makes sense. And my last question relates to a pension charge I noted on the Q. Roughly $4.1 million pension charge. Can you discuss that?

DK, you want to handle it?

Yes, the majority of it relates to one pension plan which is a supplemental executive pension plan. That has been detailed in our prior proxy and last year's financial statement that. That has been an ongoing charge for the last two years.

Okay. That's it. Thanks, guys.

Thanks, Mitch.

Thank you. Our next question is coming from Joel Lutton of APS Financial.

Hi guys. Actually, this question is for Ron. In terms of -- you said that the market share of the Quest in the seven states is 0.3%. What is your definition of a successful product, in terms of if you do a national rollout, what sort of market share are you seeking with that?

Well, Joel, the answer to that is that it depends on a number of factors, including the level of discounting that's required for the brand. We are in the process right now, as we indicated, of opening up a test market in Arizona, where we are going to be looking at certain aspects of what we're doing with Quest. We also will be making some adjustments in the existing seven states.

A 0.3 share nationwide could be a successful product. But that's not -- that's certainly not the level that we're looking for, and it's really dependent upon the level of discounting that's required to be able to support the brand.

Joel, this is Howard. If you look at 0.3%, you're talking about 1.2 billion units. If you were making $50 million a billion, you're talking $60 million.. You could look at that and say, wow, that's great, if you don't have any additional overhead [INAUDIBLE]. As Ron said, we're hoping for bigger than that at this particular point, and especially when we get into the smoking cessation areas we're looking for more than 0.3%.

In Arizona, are you going to price this as a premium product? Is that your goal?

It's priced as a premium product, but as I'm sure you know, premium product are priced all over the board these days, and what we have found from the preliminary research we've done in the seven states is that the price sensitivity of this brand is not consistent with premium products. It's actually -- there's less price sensitivity than there is with premium product. So that's one of the aspects, and I emphasize one of the aspects, that we're going to be measuring over the next few months.

And after that point in time over the next few months, then you make a decision, okay, if we go national, this is how we do it, how we price the product, or is that --.

Correct.

You're essentially going to use Arizona as your kind of case study, I guess?

Well, not exactly. That will be part of it, but the seven states -- we will also be doing some things that will help to enhance our overall understanding of how the brand's operating. So between what goes on in the seven states and in Arizona, we believe that we're going to have a sufficient base to make a decision and if that decision is to take it national, what the parameters of that launch would be.

Okay. And in terms of like Vector Tobacco, your EBITDA, you know, after the restructuring charge seems to be showing a trend towards less, you know, cash burn. Do you expect that in the coming quarters, that that you'll go -- start showing improvements in the EBITDA number?

Yeah, obviously, you know, one of the reasons we've made these restructuring charges, why we've taken these restructuring charges, is the attempt to reduce that cash burn on the Vector Tobacco side and operate more efficiently, so, yeah, we would expect an improvement.

Do you expect a dramatic improvement over the next few quarters or more of a gradual-type improvement?

I think it's going to be substantial but gradual.

Okay. Thanks, guys.

You're welcome.

Thank you. Our next question is coming from Don Trot of Jeffries & Company.

Hi, good morning. I have a couple of questions. First of all, on a quarter by quarter basis, if you look at the new cigarette division, the Vector division, revenues were $5.3 million, in the third quarter, down from $8.6 in the second, and even in the first quarter there was $6.4. Why is that revenue trend such as it is?

Well, I mean, fundamentally, Don, it's the reflection of the amount of cigarettes that were sold in concert with the introduction of the product. And as we've indicated, that the brand did slow down over the course -- the latter part of the second quarter and into the third quarter. However, what we've been pleased to see is over the last couple of months -- and I emphasize the fact that we really have not advertised since June -- that the brand has maintained relative stability at this 0.3 market share level.

So what happened was the initial launch, there was a lot of shipments to fill inventory out in the stores and at wholesale, and then as that has worked through the system, the overall orders have slowed somewhat, but have been stable now for sometime.

And the fourth quarter, do we get the initial pipeline shipments to Arizona for the Arizona launch?

No, if there are any, it would be fairly minimal, and the -- I mean, there will be some right at the end of the fourth quarter.

Right. Okay. And then regarding New Valley, New Valley has a large cash balance. I was wondering if there's any planned uses of that, and in terms of the Douglas Elman acquisition, should we read into that that that's an arena that your company wants to get more involved with?

The Douglas Elman acquisition has proved to be very successful, the company is doing very well, thanks in part to strong market in Manhattan. Yeah, we're absolutely opportunistic. We are looking at other opportunities to grow that business and to make some other acquisitions, and while we're -- we're always lacking at other acquisitions in all sorts of different areas, so we remain to look at New Valley as anything that's opportunistic and makes sense value-wise, we're interested in looking at.

But Douglas [INAUDIBLE] is well and the real estate that we own is doing well, so we're holding on to the cash and waiting for the next time there's a good acquisition.

Thank you.

Thank you we have time for one more question coming from Donald Lipkin of Bear Stearns.

Good morning.

Good morning.

Could you tell me, what is your total market share of the domestic cigarette market?

The total mark share -- and let me qualify this, because when we look at market share, we look at it on an adjusted basis, and that's adjusting for the existence of the fourth tier companies, the renegade companies, if you will.

Sure.

Which is not necessarily the way that the big -- current big four looks at it.

Gotcha.

So looking at from the that standpoint, we represent about 2.54 of the market.

That's excluding the fourth tier?

That's including the fourth tier.

So without them you would be a higher market share?

It would be like 2.76.

So is your market share up?

Our market share is up, yes.

And then about that fourth tier, you know, some of the majors have been saying that their market share is stabilizing. Do you feel that? I know there have been a lot of --.

No, we think it's continuing to grow but growing at a slower level than it was last year.

And what's your view of the total size of the non-participating manufacturer segment?

Yeah, about 6, 7% of the market.

Okay. That's what I was thinking, too. Okay, great, I appreciate the help on this.

Well, thank you everyone for being on this conference call. We're always available for any questions you may have. You can call the office and find us, and thank you very much. Speak to you all after the next quarter. Have a good day.

Thank you. That does conclude this morning's teleconference. You may disconnect your lines and have a wonderful day.