Vector Group Ltd (VGR) 2005 Q2 法說會逐字稿

Welcome to the Vector Group's second quarter 2005 earnings conference call. Before the call begins, I would 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 in, or implied by, forward-looking statements. These risks are described in more detail in the Company's Securities and Exchange Commission's filings. Now I would like to turn the call over to the President and Chief Operating Officer of Vector Group, Howard Lorber.

Good morning, and thank you for joining us on Vector's second quarter 2005 earnings conference call. With me today is Ronald Bernstein, the President and CEO of Liggett Vector Brands and Liggett.

On today's call I will provide an overview of our business and Vector Group's performance for the second quarter. Ron will then review the performance of Liggett Group and Vector Tobacco for the quarter, and provide you a detailed update regarding the progress and results we are seeing from our new business model. After that we will be happy to take your questions.

Let me first way that Vector Group had a very strong quarter operationally, and translated that performance into a significantly improved bottom line. Despite continuing industry challenges, which we will elaborate on shortly, we generated solid revenues during the quarter as we continued to reduce costs. As a result we were able to increase the operating income at our conventional tobacco business by 26% on an apples-to-apples basis. We're confident that the recent restructuring steps we have undertaken are the right thing for our business, and we're beginning to see the positive impact of those actions.

As noted, industry conditions have remained challenging but continued to show signs of stabilizing during the second quarter. Additional pricing actions by Philip Morris and Reynolds American in the form of reduced consumer buy downs occurred during the second quarter, which seems to reflect growing confidence in premium pricing power among the Big Three companies. A major factor in that confidence is that 43 of the 46 MSA states have now passed allocable share legislation, closing a major MSA loophole that the nonparticipating companies have exploited over the last four years.

Currently North Carolina, Missouri and New Jersey are the only participating states that have not enacted allocable share legislation. The legislation recently passed the North Carolina Legislature and is scheduled to become effective January 1, 2006.

The allocable share legislation, along with the tobacco quota buyout which went into effect earlier this year, has generally lead to price increases from the smaller manufacturers and importers. These small manufacturer price increases have reduced price gaps between premium and discount cigarettes to a point where we believe the Big Three are relatively comfortable with price differentials. And a net effect of all of this seems to be growing stability at retail.

The two market leaders are continuing to aggressively promote their retail trade programs. And we continue to be concerned about potential anti-competitive elements to these programs. However, due to an apparent lack of consistent application by Reynolds, we cannot yet fully measure the effect of their program with retail customers. We will continue to monitor these programs closely. And if they do prove to be anti-competitive we intend to seek appropriate remedies.

Industrywide total domestic wholesale shipments for the 12 months ending June 30, 2005 declined by 2.2% over the prior 12 month period, while second quarter 2005 wholesale shipments fell by approximately 2.6% compared to the same quarter last year. It appears that shipment declines continue to run in the historical range for the industry.

In this environment we were very pleased with the financial results of our conventional cigarette business during the second quarter as we rebounded from first quarter transition issues, and began to gain position traction from a number of steps we have taken to improve performance. Ron will provide a more detailed update shortly.

With respect to Quest, we continue to work on the development of a flue-cured tobacco without nicotine, although we do not anticipate growing another flue-cured test crop until the spring of next year. Therefore the earliest we would be in a position to grow commercial quantities will likely be the spring of 2007.

As I had indicated during the last call we were pleased with the improvements in taste characteristics obtained from the first test crop of low-nicotine flue-cured tobacco, and believe the new the new variety works well with our no nicotine Burley tobacco. However, we still have more work to do, and we will provide further updates as we proceed.

In addition, we continue to work with the FDA and are in the process of doing the required research and the regulatory filings necessary to eventually market Quest as a smoking cessation product. We're optimistic about this process, and believe that we will complete the FDA approved Phase II clinical trial by the end of the first quarter of 2006. At that point we expect to be in a position to provide a more comprehensive update on our findings and expectations.

Now I will review the key financials for the three and six months ended June 30, 2005 for Vector Group. And Ron will then review the key financials for our conventional cigarette business and our Vector Tobacco new technology cigarette subsidiary. Our conventional cigarette business includes sales for both the original Liggett Group cigarette and our USA brand cigarettes from the Medallion acquisition. In addition, for comparative purposes we have excluded the discounted operations of New Valley Princeton New Jersey office buildings which were sold for 71.5 million in February 2005.

For the second quarter ended June 30, 2005 Vector Group revenues were 113.1 million compared to 120 billion (ph) in the 2004 second quarter. The Company recorded operating income of 24.4 million, compared to an operating loss of 25.9 million in the 2004 second quarter. Our quarterly results in 2004 included a pretax non-cash charge of 37 million related to the write-down of our Quest tobacco leaf inventory, and restructuring charges of 2.4 million. Adjusting for the inventory and restructuring charges, the Company's operating income in the 2004 second quarter was 13.5 million. Therefore the results from the 2005 period represented an increase of 10.9 million of operating income from the adjusted amount for the 2004 period. That is improvement of 81% year-over-year.

Net income from continuing operations was 10 million, or $0.23 per diluted share, in the 2005 second quarter compared to a net loss of 17 million, or $0.41 per diluted share, in the 2004 period. For the six months ended June 30, 2005 Vector Group revenues were 217.3 million compared to 246.6 million in the first half of 2004. The Company recorded operating income of 43 million compared to an operating loss of 13.1 million for the 2004 period.

Adjusting for the inventory charge of 37 million, and pretax restructuring charges of 3 million, the Company's operating income for the six months ended June 30, 2004 was 27 million. Therefore operating income for the six months ended June 30, 2005 increased 16 million, or 59.3%, from the adjusted amount for the 2004 period. Net income from continuing operations was 18.3 million, or $0.42 per diluted common share, compared to a net loss of 12.5 million, or $0.31 per diluted common share, in the 2004 six-month period.

Now I will turn the call over to Ron Bernstein, the President and CEO of Liggett Vector Brands and Liggett, who will update you on the performance of the operating companies.

Good morning everyone. First, I would like to echo Howard's comments on the quarter. Following a challenging restructuring we were pleased to generate solid sequential growth in our wholesale shipments, significantly improved profits at our conventional tobacco business, and substantially reduced losses at Vector Tobacco. And importantly, we're confident that our strategy is working, and that our business is on the right track for the future.

For the three and six months ended June 30, 2005 our conventional cigarette generated revenues of 110.2 and 211.9 million compared to 115.6 and 237.8 million for the corresponding periods a year ago. Operating income for the three and six months ended June 30, 2005 was 34.3 and 66.2 million compared to 25.4 and 53.2 million for the 2004 period. The quarterly and six months results in 2004 included pretax restructuring charges of 2 million and 2.4 million respectively.

For the three and six months ended June 30, 2005 Vector Tobacco's operating losses were 2.7 and 7.2 million, compared to operating losses of 44.4 and 53.1 million for the prior year period. The quarterly and six months results for Vector Tobacco in 2004 included pretax inventory impairment and restructuring charges of 37.4 million and 37.7 million respectively.

Let me now turn to Liggett's second quarter sales performance and the ongoing results of our new business model. As a reminder, during the fourth quarter of 2004 Vector Group announced the restructuring of Liggett Vector Brands, our sales and marketing and distribution subsidiary. This cost-saving restructuring involved adjustment to LVB's business model and a major realignment of its sales force. This resulted in the elimination of approximately 330 full-time positions and 135 part-time positions that became effective December 15, 2004.

Having now worked through the post restructuring issues that we discussed during the previous call, I'm pleased to report that we're starting to realize the positive results that we anticipated from the changes to our business model, and I would discus those further in a moment.

As previously mentioned, the passage of allocable share legislation in 43 states has generally led to increased consumer prices in the discount segment. However, it is important to remember that deep discount segment prices vary significantly on a state by state basis, and are subject to volatility based upon the actions of nonparticipants and participants to the MSA.

During the previous call I indicated that an established MSA participant, Commonwealth Brands, had taken a very aggressive national pricing posture on a deep discount brand. Based on the simple costs of doing business and expenses, such as federal excise tax, the Master Settlement Agreement, tobacco quota buy out, and manufacturing costs, we believed and continue to believe that they have been selling cigarette substantially below costs, and could not sustain this price level indefinitely. Commonwealth did maintain these pricing levels through the second quarter, but there are now widespread indications that the levels of their buy down spending has recently been reduced, thereby increasing prices at the store level.

Aggressive pricing actions of this nature can certainly have an impact on our performance, as well as that of the discount segment in general, as margins get strained and volume is pressured. However, despite this recent activity in the discount segment, as well as the usual challenges we face, I'm pleased to report that Liggett Vector Brands' wholesale shipments improved substantially during the second quarter from the first quarter of 2005. Overall, second quarter 2005 wholesale shipments increased by 11.3% compared to the first quarter 2005 shipments with Liggett Select shipments increasing by 22% during this period, and Eve shipments increasing by almost 10%.

On a year-over-year basis, second quarter 2005 wholesale shipments declined by 15.7% compared to the prior year period. This level of decline is generally consistent with our initial post restructuring expectations, and compares favorably to the 28% decline we experienced during the first quarter of 2005. Operating earnings at Liggett for the second quarter increased by 25.6%, or $7 million, over the prior year period, as adjusted for the $2 million restructuring charge in 2004. An important component of this earnings improvement was a 44.8% or a $9.4 million decrease in SG&A expense at Liggett for the second quarter 2005 versus the prior year.

For the six month period, we have reduced SG&A expense by 43.8% or 18.9 million, compared to the first six months of last year. Importantly, the adjustments that we made last year have given us the financial flexibility to meet competitive market pricing requirements, while still substantially improving our financial results. That was one of the key goals of our restructuring. And we are pleased with our progress in improving competitive effectiveness.

Liggett Select's performance continued to strengthen during the second quarter among our core independent accounts and new major retail chains. We anticipate that Liggett Select's sales will continue to improve as the year progresses.

Our core Eve brand performed relatively well during the transition, and has consistently built strength since. We remain optimistic regarding Eve's potential for continued growth through the remainder of the year.

On the last call I announced that we had reached agreement with Speedway SuperAmerica, our long-time private label partner on the Tourney brand, to extend our relationship on a multiyear basis. We subsequently executed that agreement with Speedway, and are currently working closely with the Speedway organization to further develop and grow the Tourney brand family.

An important component of our revised business plan was the development of the partner brand category. As a reference, partner brands are long-term contractual relationships with major retail chains that provide our partners pricing guarantees on proprietary brands over an extended period of time. As you may recall, Montego was the first brand to be launched in our new partner brand category. Our partner with Montego is Couche-Tard, the parent company of Circle K and Mac's Stores. This launch has progressed well, and both parties are looking forward to continuing to build the Montego brand franchise.

Today I'm pleased to announce that we have recently reached a multiyear agreement with another premier gas convenience retail chain, with retail outlets in over 20 states to provide them a proprietary partner brand. We currently in development with this product, and anticipate that it will be launched early in the fourth quarter 2005. We are delighted to be working with this chain. And we will make further announcements in conjunction with the launch.

In addition, we have entered into several new relationships with powerful regional retailers such as Safeway and Murphy Oil for nonproprietary brands. As this program progresses, we believe that it will build momentum and provide long-term benefits to both Liggett and our partners.

While the market, particularly in the discount segments, is still volatile and risks remain, we continue to see signs of increasing marketplace stability, and believe that Liggett is well positioned to benefit from that stability. As our base of core independent and chain accounts continues to grow, and our partner brand category builds, we expect to generate both profit and volume growth over time. We remain very excited about our Company's prospects for 2005 and beyond.

Thanks for your attention, and I will send it back to you, Howard.

Before I finish the prepared remarks, the Company once again reaffirms that our cash dividend policy remains the same. Now operator, would you please open the call for questions.

(OPERATOR INSTRUCTIONS). Donald Lipkin of Bear Stearns.

Could I ask you -- I am not sure if you said it or I just missed it -- what were the shipments -- cigarette shipments for the second quarter and for the first half of the year?

We didn't announce the actual shipments. We just gave you the percentages.

So they declined -- on a year-over-year basis they declined 15% in the second quarter, did you say, and 22% in the first quarter, or did I get that wrong?

They increased -- Liggett Select shipments increased by 22% in the second quarter over the first quarter.

Right, but I mean like on a year-over-year basis?

On a year-over-year basis -- the Liggett Select shipments or overall shipments?

I am just thinking overall really.

Overall shipments were down -- I believe it is 15%.

What is causing that kind of decline?

The decline was reflective of the business model that we put in place. You may recall that in the first quarter we had a substantial -- about a 28% decline year-over-year compared to the prior year first quarter. And that was reflective of a couple of things.

First, the issues that we went through in transition, along with the competitive activity in the market in the first quarter. And then, as we came into the second quarter our sales had stabilized. In fact overall sales increased by 12% from the first quarter. Liggett Select up 22%. And the base of the decline that we are experiencing on a year-over-year basis is reflective of the decrease of 330 sales people.

I got you. Right, okay. And then I have a question about the issue of the nonparticipating manufacturer adjustment. Were you one of the manufacturers that decided to put some of your MSA payment into escrow to take a nonparticipating payment (indiscernible) adjustment for the --?

Yes, we did.

How do you expect back to play out over time?

This has been an ongoing debate with the states for the last four years. And there was -- in 2000 -- after 2002 there was a settlement on everything that had occurred prior to -- for 2002 and prior. Since then in 2003 and 2004 we, and virtually all of the other participating manufacturers, including now the Big Three companies, have claimed an NPM adjustment.

And it is something that is either going to be arbitrated, or there will be some sort of an agreement reached. But on our side of the ledger, we think it is a pretty clear issue relative to what the MSA says. And we expect to realize fully all of that we have claimed on the NPM adjustment.

One of the things that I think your --. Well, first of all, did you think it becomes a mote point in the future in terms of future years, given what you and the major companies are saying about when the states have passed allocable share release amendments that competitive threat really seems to have diminished.

I think that that remains to be seen, because it is an issue of how effectively the states enforce their laws. And one of the big problems, and the reasons why we got into this situation in the first place, is because there appeared to be an inadequacy of enforcement, certainly in the early years relative to the model statute.

I think on a going forward basis our expectation is that the states are much more focused on the issue now than they ever have been before. And also, we believe that last year the states lost somewhere in the range of $1 billion because of issues related to NPM activity. And that has got gotten their attention. So we think they are serious about the allocable share. But on a state by state basis there's no telling how effectively they're going to enforce.

Does that happen by arbitration state by state, or do you think it happens through legal action in the courts?

That is an interesting debate. We have to two different rulings. New York issued an initial ruling that it should be litigation. Connecticut, in what appears to be a much more reasoned decision, just came out with a decision saying that it should be arbitrated.

Oh, really?

Yes. So we think arbitration is the correct vehicle, but that remains to be seen.

Right.

And just answering that last question, it was 15.7% on a year-over-year basis.

Okay, so then -- and I guess that you're right to put money into a disputed payments account, so then you work out I guess state by state. The issue I guess would have to be a state by state issue, I would think.

No, under the MSA there will likely -- what will likely happen is that there will be some sort of global agreement or decision ultimately. If each state is coming up with different judgments it is going to be completely chaotic. So I think ultimately it will get consolidated and be resolved that way.

I see. Very good. I appreciate the help on this. That's it.

(OPERATOR INSTRUCTIONS) Mark McManus of Wachovia Securities.

I guess a little bit of a follow-up on the previous call. I know what you guys have been saying about the allocable share legislation for the last couple of years. But what you're talking about in regards to Commonwealth easing back perhaps, what is the strategy for the Company in terms of your pricing war marketing of the Liggett Select brand and trying to leverage that into either higher profits or growing the brand a little bit more aggressively? Can you explain if you guys have put together sort of a plan for the future, if indeed you do have more pricing flexibility?

We do have a plan for the future. And I will give you some general indications on that. Obviously, when we're speaking publicly, we're speaking to our competitors as well, so we're not going to get too detailed. We have a very strong commitment in -- certainly in the near term to maintaining price stability with our brands. And we have said that to the marketplace, and we are absolutely committed to it.

We took the cost-cutting actions that we did last year so that we could maintain the maximum flexibility to be very competitive on a pricing basis and still increased our earnings. And that is exactly what we've done. So at the end of the day I think that we're going to be very measured in the marketplace and only take actions that are going to lead to a combination of volume growth and profitability.

Would you be able to tell me what your average list price for a carton of Liggett Select is versus, say, the average list price for Commonwealth's USA Gold?

The list price for the Liggett Select is $14.64. And for the USA Gold it is $14.94. Then you have buy down issues which differ substantially.

That seems like it has come down a bit from where it would have been -- I am talking about USA Gold where it would have been like say two years ago?

No.

(multiple speakers) a wider --?

Their pricing has been pretty stable from a list price basis.

But I thought Liggett Select was considerably cheaper than USA Gold, but at least more than $0.30 on the average price.

Liggett Select has increased more -- there is more buy down activity on Liggett Select than there is on USA Gold. That is correct.

I guess follow-up is you guys haven't talked too much about Arizona and the Quest roll out there. It is been quite long time. And I know you have seen sort of comparable results there in terms of marketshare as you did in the original states. But in terms of pricing, do you still have that priced as an above premium price --?

We have gone to consistent pricing on both of them. We brought down the discounting in the seven states.

In all fairness though, it is probably not a big enough test. We're sort of just in the standstill mode until we see if we get this FDA approval for a smoking cessation. (multiple speakers) It is not like we're doing any big promotions, is my point.

No, we're not. And I think at this stage, we found out what we wanted to find out in Arizona. And as Howard said, we're just simply in a maintenance mode at this point.

Do you guys truly feel that an FDA approved smoking cessation devise designation for Quest would have a meaningful impact on the sales, or would just going national and having that a sort of a boost would help marginally make it a national brand? I'm not quite sure what the strategy is going national with FDA or without?

I would say that obviously it would be the first time the FDA approved anything as it related to smoking -- cigarettes. So I think it definitely helps. The question is how does it get approved? How is it packaged? Is it the 1, 2, 3 approach? Is it just the nicotine free with the patch? How long is the program, because obviously if the programs are very successful, the people only smoke it for short periods of time. And we are just too early to tell you -- we believe there is a definite market and a definite commercially viable market, that we will make money in it once we're approved by the FDA. We just can't tell you how big it is going to be yet.

(OPERATOR INSTRUCTIONS). Andrew Shapiro of Lawndale Capital.

This is Daniel Penn here on behalf of Andy. I had a question regarding New Valley. The cash levels, if you deconsolidate New Valley I guess is $74 million at the Vector level and $89 million at New Valley. And I was wondering if you could maybe characterize the kind of relative quality and depth of the investment opportunities you are seeing at this stage to redeploy the cash at the New Valley level please?

Obviously, you know, and we have done a significant number of transactions, real estate transactions. And it is getting tougher and tougher to buy anything. We have been a seller, yet on the other hand, as you may have seen, and we just actually -- we just closed on the purchase of the St. Regis Hotel in Washington D.C. yesterday with Brickman Associates, which is the same group that we did the Hawaii project with.

So we thought that was a great hotel in a great marketplace. It is going to be renovated. And it is something that is probably a hold for a number of years and then maybe a conversion into a condominium. You have to pick your places. New York City we have bid on some things, but the prices are just astronomical. We really haven't purchased anything. We are always looking.

And as it relates to Hawaii, we're actually just taking some cash out. We did a refinancing, and I think we took out half our cash that we have had in. It is now out and we will see. We may sell it. We may do it a joint venture with someone on it. We're looking at different opportunities for the Hawaii project.

Is Hawaii operating at a full capacity at this stage?

It is open. I can't tell you what -- the full occupancy. I think the occupancy is a little bit less than we had projected originally. But the numbers are okay. And obviously if -- today I just happened to read an article in the Wall Street Journal about Blackstone and Blackstone's view on the hotel market. They really think there's a lot of upside there. The hotel market is pretty good right now. So we think we are going to do well.

Regarding the St. Regis investment, is the $10 million the extent of the equity (multiple speakers).

No, I think that the total -- our total equity investment could go up to $12 million. I think we funded about 6, 7 million so far. And the total equity that we may put in is 12.

And the construction will be completed when?

I don't have the time schedule yet for the construction.

And just one final question. Regarding the NASA suit, it think it was completed in August of '04. And I guess to haven't heard back from (multiple speakers).

I haven't heard back and now the judge has changed. Now there is going to be a new judge. And this case is -- its life expectancy just keeps going longer and longer and longer and longer.

Is this one of these ones where the judge kind of goes away and then come back whenever they want?

Yes, exactly. And now the judge is out of this case, or the judge is retiring. It is just horrendous. This is the judicial system at its worst. I guess this case is now -- , how old is this case? Is this case 20 years old almost?

It is about -- yes.

It is like 18 years old this case. Hard to believe.

Our final question is a follow-up coming from Donald Lipkin of Bear Stearns.

Just a quick follow-up. Could you tell me, do you know the name of the case that -- in Connecticut where the arbitration was -- the outcome?

It was a case -- I don't know the name, but it was instituted by Commonwealth Brands.

And it is in federal -- or that would be state court do you know?

That would be state court.

State court. Okay, I will search for it. Thank you so much.

There appears to be no further questions. I would like to turn the floor back to Howard Lorber for any closing remarks.

Thank you all for participating in our conference call today. And obviously if anyone has any questions, they can always call Ron or myself. We are always available. Thank you very much. And have a nice day.

The call is now over. Please disconnect your lines at this time. And have a wonderful day.