Vector Group Ltd (VGR) 2006 Q2 法說會逐字稿

Excuse me ladies and gentlemen. Thank you for your patience in holding and welcome to Vector Group's second quarter 2006 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 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'd like to turn the call over to the President and Chief Executive Officer of Vector Group, Howard Lorber.

Thank you. Good morning and thank all of you for joining us on Vector Group's second quarter 2006 earnings conference call. With me today is Ron Bernstein, the President and CEO of Liggett Vector Brands and Liggett.

On today's call, I will provide an overview of our business and review Vector Group's performance for the second quarter. Ron will then review the performance of Liggett Group and Vector Tobacco for the quarter and discuss recent industry developments. After that, we'll take your questions.

Our conventional cigarette business performance was mixed during the second quarter with 8% year-over-year wholesale shipment gains but an operating profit decline of 10.2%. The bulk of the shipment gains related to the continued growth of our Grand Prix brand, while the profit decline was primarily the result of ongoing investment in Grand Prix and year-over-year decline in Liggett select wholesale shipments. Ron will discuss these trends in detail later.

The industry dynamic shifted again during the course of the second quarter of 2006. Early in the quarter, we continued to see significant promotional activity by the two market leaders in the form of large discounts on selected discount brands and significantly increased free product promotions at retail. However, as the quarter progressed, the number of these promotions diminished and the market began to stabilize, which contributed to improved performance on our brands.

Further, it appeared that macroeconomic issues, particularly higher gas prices and higher interest rates, continue to affect infect consumer purchasing habits. Following the trend that developed in the first quarter, some consumers clearly moved from carton to pack purchases. While this shift inherently benefits the big three companies because of their dominance in pack outlets, we did see movement back to more traditional discount outlets as the quarter progressed and some consumers appear to be adjusting to the reality of less disposable income.

Looking at the industry as a whole, total domestic wholesale shipments for the second quarter were down approximately 3.3% compared to the same quarter in '05. This decline reflects difficult year-over-year comparisons for the big three companies due to strong shipment activity during the second quarter of 2005. Looking at the past four quarters, wholesale shipments decreased by 2.5%, which is more typical of historical performance.

With respect to Quest, we expect to harvest another low nicotine flue-cured test crop and to begin internally testing the new tobacco for taste characteristics and nicotine levels this fall. If successful, commercial quantities of this new tobacco could be available for production by the end of '07. As previously noted, we are generally pleased with the improvements obtained from the first test crop of low nicotine flue-cured tobacco and believe the new variety could work well with our existing barley tobacco.

As has been reported, we recently concluded a multi-center Phase II clinical trial that was designed with input from the FDA to pursue the opportunity to eventually market Quest as a smoking cessation product. Although we believe that the results of the trial justify the continued development of Quest as a smoking cessation aid, during the course of our discussions with the FDA, it became clear that there are both challenges and opportunities associated with this process. And we are currently refining and evaluating the commercial and clinical development strategies for this project. We will comment further once we have completed this review, which will likely be by the end of this year.

Before discussing the financial results for the quarter, I would like to highlight several important recent corporate developments. In July, we entered into a settlement with the IRS regarding the tax treatment of our 1998 brands transaction with Philip Morris. We're very pleased with this settlement, which extensively substantially reflects our long-standing position on the amount and timing of the tax payments. As a result of this settlement, we will recognize a gain of approximately 11.5 million in the third quarter due to the reversal of previously established reserves in our financial statements for income taxes payable.

During June, we negotiated a conversion into common equity of $70 million of our 6.25% convertible notes due 2008. In July, we completed the sale of our 110 million of new convertible debentures. These debentures are convertible at 21.50 per share and become redeemable beginning 2011 and in 2012. We will use the proceeds of the offering to call the remaining 62.5 million of our 6.25 notes on August 14th, 2006 and to pay the IRS settlement. As a result of these actions, we have significantly strengthened the Company's balance sheet.

Stockholders equity increased during the second quarter from 22.2 million to 77.9 million due to the conversion of the debt, and we have lengthened the maturities of our liabilities through the issuance of the new debt with higher conversion prices. Our liquidity remains strong with cash and marketable securities of approximately 175 million after giving effect to these transactions.

Now, I will review the key financials for the three months and six months ended June 30, 2006 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 Liggett cigarettes and the conventional cigarette sales from Vector Tobacco. In addition, for comparative purposes, we excluded the discontinued operations of New Valley's Princeton, New Jersey office buildings which was sold for 71.5 million in February 2005.

For the second quarter ended June 30th, 2006, Vector Group revenues were 113.4 million compared to 113.1 million in the 2005 second quarter. The Company recorded operating income of 22.5 million compared to operating income of 24.4 million in the 2005 second quarter. Net loss from continuing operations was 3.3 million of our $0.07 per diluted share in the 2006 second quarter compared to net income from continuing operations of 10.3 million or $0.22 per diluted share in the '05 period.

Our second quarter results for 2006 include non-cash expense of 14.9 million related to the conversion of 70 million of our convertible debt. Adjusting for the debt conversion expense, the Company had net income of 11.5 million or $0.21 per diluted share in the second quarter 2006.

For the six months ended June 30th, 2006, Vector Group revenues were 23.1 million -- excuse me, 231.1 million compared to 217.3 million in the first six months of 2005. The Company recorded operating profit of 42.7 million compared to 43 million for the '05 period. Net income from continuing operations was 5.9 million or $0.11 per diluted common share compared to net income of 18.7 million or $0.47 per share in the 2005 six month period.

Our results for the six months ended June 30th, 2006 included the 14.9 million of non-cash debt conversion expense. Adjusted for this item, the Company's net income from continuing operations for the 2006 six month period was 20.8 million or $0.38 per diluted common share.

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

Thanks Howard, and good morning everybody. As Howard indicated, our second quarter performance produced mixed results. That said, we were very pleased with the directional development of the Company during the period and the results that we generated at retail. I'll discuss this in more detail shortly.

We continue to realize benefits from the changes we made to our business model in 2004, which has provided our organization greater flexibility to adapt to changing market conditions. This flexibility was particularly important during the first half of this year, as promotional activity by the two market leaders increased substantially at retail. These actions included an expansion of free product promotions on their leading premium brands, as well as increased and aggressive discounting on so-called mid-tier brands.

These volume driving tactics appeared to moderate as the second quarter progress and the market leaders adjusted their focus back to driving margins. While pricing and bonus product promotions remain in the market, they currently appear to be more consistent with historical levels.

Turning now to the numbers. For the three months and six months ended June 30th, 2006, our conventional cigarettes generated revenues of 111.6 and 227.4 million compared to 110.2 and 211.9 million for the corresponding periods in 2005. Operating income for the three and six months ended June 30th, 2006 was 30.9 and 61.3 million compared to 34.3 and 66.2 million for the 2005 periods. For the three months and six months ended June 30th, 2006, Vector Tobacco's operating losses were 2.7 and 6.3 million compared to operating losses of 2.7 and 7.2 million for the prior year periods.

Let me now return to the discussion of Liggett's second quarter sales performance and overall industry activity. Overall, our conventional cigarette second quarter 2006 wholesale shipments increased by 8% compared to the year ago period. In comparison to the first quarter, total shipments to wholesale were essentially flat.

However, on the retail side, our results were far more impressive. Overall second-quarter retail shipments were up by 18% compared to the year ago period and by 12% compared to the first quarter. Year-over-year, our share of the retail market increased by almost 0.5%, and both retail volume and share growth for the Company substantially outpaced everyone else in the marketplace.

The bulk of this growth came from our Grand Prix brand, which to the best of our knowledge continues to be the fastest-growing brand in the country. As previously indicated, we developed a long-term strategy for Grand Prix at its inception, and we have continued to execute that strategy. Accordingly, we believe that the brand will continue to grow throughout this year and beyond.

Liggett Select wholesale shipments declined during the second quarter, with decreases of 25% compared to the year ago period and 22% compared to the prior quarter. Wholesale inventory levels declined slower than expected due primarily to the early quarter competitive activity discussed previously, which slowed our retail velocity. As a result, despite LVB wholesale promotional programs, Liggett select product did not flow through the system as quickly as we anticipated.

However, during this same period, Liggett Select retail shipments performed better, declining approximately 8% compared to the year ago period and generating growth in excess of 7% compared to the prior quarter. As a result, Liggett Select actually had a modest increase in retail market share during the quarter.

As noted previously, the trend of both retail and wholesale performance improved throughout the quarter. Based upon that improvement and relatively strong retail results, we are optimistic about Liggett Select's performance for the remainder of the year.

Eve's performance was also affected by the industry's competitive activity, but to a much lesser degree. Eve's second quarter wholesale shipments were down approximately 4% compared to the 2005 period and were down just over 7% compared to the previous quarter. However, at retail, Eve shipments reflected growth in excess of 4% over the prior year and almost 12% compared to the prior quarter. The partner brand relationships that we established during 2005 continue to perform well, with all brands reflecting shipment growth of both wholesale and retail.

As previously mentioned, second quarter year-over-year operating profit declined by 10.2%. In addition to the slower than anticipated wholesale shipments that I referenced a moment ago, continued investment in the growth of Grand Prix contributed to the decline in operating profit. Compared to the first quarter of 2006, however, operating income increased by 1.4%. And as LVB is continuing to benefit from the recent expense and business model adjustments, we were able to adjust to current market conditions and still deliver greater profit than prior to implementing these changes in late 2004. While year-over-year profits for the second quarter declined by 10.2%, 2006 profits were still almost 13% improved compared to the 2004 second quarter.

While we have seen increased deep discount competition from the market leaders, we also continue to see a general decline in sales from the nonparticipating manufacturers to the Master Settlement Agreement. Reported shipment declines of approximately 18% over the prior year first quarter likely understate the actual decline of the NPMs, as much of their business is not go through MSAi reporting [outcomes]. Over the past four quarters, NPM shipment declines are reported in excess of 18% and are probably markedly greater than that.

Outside of the market leader activity earlier this year and despite NPM activity in localized markets, we continued to see a stabilizing effect due to the ongoing implementation of the allocable share legislation along with the tobacco quota buyout that went into effect in January of last year. We expect that these trends will continue and that margin considerations will drive the two market leaders' pricing policies going forward.

We also note that both Philip Morris USA and Reynolds American have recently confirmed entry into the smokeless tobacco market, with test projects on [snooze and] pouches and Reynolds' $3.5 billion acquisition of Conwood. Our belief has not changed that the market for these products, while profitable, remains fairly limited. We're watching the market leaders' activities carefully, but suspect that these products will simply add diversification to their tobacco product portfolios.

On the litigation front, the only recent activity in lawsuits filed by various MSA states regarding the nonparticipating manufacturer adjustment provisions of the MSA for 2003 involves rulings in 9 of 10 states in addition to previous rulings in New York and Connecticut on the same issue, that arbitration rather than litigation is the correct way to resolve the dispute. These rulings support the position has been taken by the participating manufacturers. Several court rulings remain pending.

In conclusion, I'd like to say that while we expect 2006 to be a challenging year, we do feel very good about Liggett's retail performance and continue to believe that Liggett remains well positioned to maximize performance in this dynamic marketplace. Thanks for your attention. Back to you, Howard.

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

(OPERATOR INSTRUCTIONS). [Mitch Pendis], Royal Bank of Canada.

I'm just curious, because I understand that we got a large balloon payment coming up on the Medallion acquisition. Since that was made several years ago, could you discuss a little bit about how that has worked out with the MSA exemption bump that you received?

Ron, you want to take this?

Sure. I mean, fundamentally it provides us with about 1 billion units a year that we don't have to pay on the MSA, and that equates to additional earning support in excess of $20 million a year. So fundamentally, the -- it's -- from a financial standpoint, it's obviously been a very positive transaction for us. But what it's done is it's given us more flexibility to fight in the market during this period while the renegades grew.

And now that we're entering into a period of decline for the renegade companies, it continues to give us the ability to do two things. One is obviously to increase our margin levels, but also to continue to have fighting flexibility in the market to gain share. So I think that the acquisition of Medallion along with the cost-cutting moves that we made in late 2004 have positioned us to give us a lot of flexibility to withstand the changes that occur in the marketplace, increase earnings on an overall basis, and to build share as the market is re-establishing itself.

Okay. I follow. And that balloon payment comes up -- when is that?

Is it next March? B.K. do you have that?

It's April 1st of next year.

Okay. Okay thank you. And I guess my other question relates to something I noticed in the -- in your numbers. It appears that the weighted average price of the stock option has dropped between this year and last from about 27 plus to somewhere around $10.50 or so for this year. Is that due to an option re-pricing or what is that?

No. We didn't re-price anything.

This is Bryant Kirkland. Let me take that question. Mitch, what it is -- what happened is that when there is a loss per -- when there's a loss for the quarter, you cannot include any of the options outstanding in the computation. And therefore all of the options outstanding were not included this quarter which have a weighted average price of $10.55 versus last quarter. Only those options with which were out of the money were excluded, and those options had a $27.55 weighted average price.

Therefore, there was no change in the -- there was no material change in the amount of the average price on the options. It's just the way the computation works.

Okay. That makes a lot of sense. All right. Thank you guys.

Andrew Shapiro, Lawndale Capital Management.

This is Daniel for Andy. I just had a couple of questions here. In the last couple of years you benefited profitability wise from various cost reduction initiatives. And it seems like cutting through all the various moving parts and the competitive environment (inaudible) somewhat alleviating here. I was just wondering if you could kind of highlight for us what you see as the drivers of profitability going forward from here.

It sounds like maybe the pricing stabilized. Obviously volume is moving around in different products, but if you could just highlight how profitability goes forward.

Sure. The first thing I would note is that from a strategic standpoint, our orientation as we enter this -- as we've entered this period which, if you go back from basically 2000, 2001 until 2005, that period was completely defined by the growth of the so-called renegade companies. As they started to decline in late '04 and accelerated that decline substantially in '05 and that decline has continued, there's a substantial amount of volume that comes into play in the marketplace.

And our strategy, which is a pretty obvious one, is to position ourselves to acquire as much as that volume as we can. And we're using the resources that we have to do that and to stay within profit ranges that are acceptable. As we go forward, and as the market continues to stabilize, there's really not any other vehicles out there for entry into the market on a price competitive basis.

The basic costs associated with the excise taxes and the MSA costs as well as product costs really inhibit anybody that comes in that doesn't have the advantages that we have under the MSA. So from a strategic standpoint, we're using our growth brand Grand Prix as well as partner brands that we have developed in order to build volume over time, and obviously to gain margin over time as the market continues to stabilize.

The other thing is that we will reap an inherent benefit next year because there is an MSA cost increase that goes across the whole market of approximately $0.45 per carton. Obviously, and adding to the question that was asked before, the benefit of the approximate 7.3 billion units that we don't pay MSA on, we get the benefit of that in profitability, which equates to a number north of $20 million. So the MSA cost increases, as well as our volume growth and ultimate margin increases, are what will drive profit over the coming years.

Okay. Now on Quest, you mentioned that him you talked to the FDA and all that good stuff. I was wondering if you could just talk about -- when will you go for Phase III? You have to redefine your strategy here and then go for Phase III, or how do you see the hurdles playing out?

Going for Phase III is really our option. What we're doing right now is we are evaluating all of the feedback and information that we have received, and determining the processes that we would need to go through in order to satisfy the FDA -- or what we anticipate the FDA requirements to be, and just evaluating that on the basis of how we could best structure and what the relative costs and benefits are of doing that. So --

Just to add something, I think we can get there. The question is what do we have to work on is to make sure we get there and we have a product that is commercially viable, depending on what they want and how they want it to market and how they want it packaged, and should it be with patches, without patches. So the work at this point also us to come up with a somewhat of a marketing scheme that we think works commercially and go back to them. And then we can do the Phase III and then we're home.

And how long does the Phase III typically take to do?

Well the Phase III itself would take less than a year. It's -- the time that we're looking at right now is what needs to be done to get ourselves adequately prepared for that Phase III.

In the best case, we figure how it works and we believe it works by the end of this year, and we finish by the end of next year, and we're in the markets the beginning of the following year. So it would be an '08 real product launch if we could put all the -- get all the ducks lined up properly.

One final thing and while back out. Relative to the New Valley acquisition, can you talk a little bit about Douglas Elliman. The revenue growth there continues to be up. I was just wondering to what extent that was organic versus the acquisitions you have been kind of making.

We haven't really made any acquisitions speak of. The growth pretty much is organic. Look, the city and the Hamptons are pretty strong. The suburbs, which to us is Nassau County and Western Suffolk, are down. That is actually holding back on our growth a little bit right now. And that is pretty much endemic to the whole country. Really what you're seeing is the suburbs -- suburban markets are tough.

But we really have made no major acquisitions, a couple of little things. No major acquisitions on the Douglas Elliman side, nor do we intend to at this particular point. And we built a big organization. We have 3300 salespeople, 60 offices or 61 offices. And I think as the market starts to pickup again, which hopefully will be next year, I think we're in a great position to really take off.

And trailing 12 months it did what -- 35 million-ish in EBITDA. How does that get paid out to or upstream to Vector?

Basically what we do in effect is, in our confidence in our loan on the money we borrowed from Prudential Realty, basically we pay down -- we make tax payments and we pay down debt. So the only -- and there is little bit of cash flow that comes, but most of it has been used to pay down debt and pay tax payments.

Right. So should -- when would that start coming back up to you guys?

Now we're talking now about maybe restructuring the debt so we could take on more cash, but really, paying down the debt is not so bad. And it depends. It depends. If we change -- if we could get a change in the covenants and maybe just use a typical bond type of covenant where we could dividend 50%, then we would do that. But we're in the early stages of discussing that.

All right. I'll back out and come back to one or two more questions.

(OPERATOR INSTRUCTIONS). [Tom Koch], [Turnaround Capital].

I was wondering if you could help reconcile for us the future cash tax liabilities versus -- is there any source of cash from the expiration of the Philip Morris option?

B.K.?

Essentially, Philip -- excuse me, essentially Trademarks LLC, which is the entity which holds the trademarks -- Liggett subsidiary used to own, has borrowed $134.9 million. There is a $5 million differential in the put and the call price, but essentially we could receive $5 million if Philip Morris exercises their option in 2008. And the remainder of the amount that will be paid to us would be used to pay off the loan debt Trademarks LLC has borrowed.

Okay. So those proceeds would go to pay off that loan, and then you would still have a tax liability of 103 -- (multiple speakers) million dollars?

The tax liability would be the tax rates in effect when we -- when Philip Morris exercises the option on 192 million of income.

And you have a reserve right now -- you are expecting that is going to be a $92 million amount? It was 103 and it was reduced by $11 million.

No. There's -- there are adjustments which relate to deferred taxes. It is more than just the 103. There are adjustments to deferred taxes which I'll be happy to reconcile with you off-line.

I am just trying to get a ballpark number of what is the tax liability going to be in cash. When that --

If you use a 38% tax rate, it would be $73 million. If you use a 40% tax rate, it would be $77 million.

Okay. And then you also said that could be potentially offset by any NOLs?

There are no operating losses.

Okay. Thank you.

Excuse me; we do not anticipate we'll have any net operating losses in 2008.

[Paul Norris], [Paul Norris Investment Company].

Yes, I'd like to ask you if the stock dividend -- the annual stock dividend that you paid will continue.

We haven't had a board meeting yet to discuss it, but we've pretty much been very positive that the stock dividend has been good for the shareholders, so I don't -- I wouldn't expect a change, but obviously we have not -- it's up to the board. It's a board decision. And we have not had a board meeting yet to discuss it. It will happen -- the board will meet shortly to decide on that.

Thank you.

There are no further questions in the queue at this point.

Thank you. I'd like to thank everyone for being on this call. And obviously as always, if anyone has any questions they can call Ron Bernstein, Bryant Kirkland or myself and we look forward to speaking with you on the next call. Thank you and have a good day.

Thank you. This does conclude today's teleconference. If our speakers would stay connected, the rest of you may disconnect. Thank you.