Vector Group Ltd (VGR) 2006 Q3 法說會逐字稿

Ladies and gentlemen, welcome to Vector Group's third-quarter 2006 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 filings.

Now I'd like to turn the conference call over to President and Chief Executive Officer of Vector Group Howard Lorber.

Thank you. Good morning and thank you, everyone, for joining us on Vector Group's third-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 third quarter. Ron will then review the performance of Liggett Group and Vector Tobacco for the quarter and discuss recent industry developments. After that, we will take your questions.

During the third quarter, we continued our successful program of investing for volume growth in our conventional cigarette business. We were very pleased with our performance in that regard compared to the industry and believe that our growth strategy can continue to be successful going forward. Ron will discuss the details of our performance with you shortly.

With respect to Quest, we have recently harvested another low-nicotine blue-cured test crop and are currently in the process of internally testing the new tobacco for taste characteristics and nicotine levels. We will report further on this as we collect and review the additional data.

As we reported during our last call, following our July meeting with the FDA, we have begun a process of evaluation regarding the opportunities and challenges associated with pursuing FDA approval of Quest as a smoking cessation aid. Our valuation was predicated upon our concern that there may be significant time and expense hurdles in pursuing the FDA approval process. The review process is currently ongoing and we will provide more information as soon as possible.

Before discussing the financial results for the quarter, I would like to highlight several important recent corporate developments. First, in July, we entered into a settlement with the Internal Revenue Service regarding the tax treatment of our 1998 brand transaction with Philip Morris. We are very pleased with the settlement, which substantially reflects our long-standing position on the amount and timing of the tax payments.

As a result of the settlement, we have reported reduced income tax expense of $11.5 million in the third quarter due to the reversal of previously established reserves in our financial statements for income taxes payable.

Second, in July, and following the conversion into common equity of $70 million of our 6.25 convertible notes due 2008 in the second quarter, we completed the sale of $110 million of new convertible debentures. These debentures are convertible at $20.48 per share and become redeemable beginning in 2011 and 2012. We have used the proceeds of the offering to call the remaining 62.5% of our 6.25 notes on August 15, 2006, and to pay the IRS settlement. As result of these actions, we have significantly strengthened the Company's balance sheet.

Stockholders' equity increased during 2006 from 29.1 million at December 31, 2005, to $96.9 million at September 30, 2006, due to the conversion of 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 $170 million after giving effect to these transactions.

Finally, on November 9, 2006, we announced that we will restate our financial results for 2004, 2005, and for the quarters ended March 31, 2006, and June 30, 2006. The restatement will correct an error in the computation of the amortization of the discount created by an embedded derivative and the beneficial conversion feature associated with our 5% variable interest senior convertible notes due 2011.

The effect of the restatement will be to decrease our previously reported non-cash expense and to increase previously reported net income by a total of approximately $8 million on a pretax basis during the affected periods. The restatement will have no effect on our previously reported operating income or net reported cash flows for the restated periods.

As a result of the restatement, this previously reported non-cash interest expense of approximately $8 million will be recognized over the remaining term of the convertible debt. We will file an amended Form 10-K for the year ended 2005 and an amended Form 10-Q for the quarters ended March 31, 2006, and June 30, 2006, as promptly as possible. We will speak about this a little bit more in the question-and-answer period.

Now I will review the key financials for the three months and nine months ended September 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 business.

Our conventional cigarette business includes sales for both Liggett Group cigarettes and the conventional cigarette sales from Vector Tobacco. In addition, for comparative purposes, we have excluded the discontinued operations of New Valley's Princeton, New Jersey, office buildings, which were sold for $71.5 million in February 2005.

For the third quarter ended September 30, 2006, Vector Group revenues were $137.7 million compared to $125 million in the 2005 third quarter. The Company recorded operating income of $25.7 million compared to operating income of $20 million in the 2005 third quarter.

Net income from continuing operations was $19.6 million or $0.32 per diluted share in the 2006 third quarter compared to net income from continuing operations of $10 million or $0.21 per diluted share in the 2005 period. The results for the 2006 period included the $11.5 million reduction in tax expense as a result of the IRS settlement.

For the nine months ended September 30, 2006, Vector Group revenues were $368.7 million compared to $342.3 million in the first nine months of 2005. The Company recorded operating profit of $68.4 million compared to $63.0 million for the 2005 period.

Net income from continuing operations was $26.9 million or $0.46 per diluted common share compared to net income of $30.6 million or $0.63 per share in the 2005 nine-month period.

Our results for the nine months ended September 30, 2006, includes non-cash expense of $14.9 million related to the conversion of $70 million of our convertible debt and the $11.5 million reduction in tax expense from the IRS settlement.

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. Ron?

Thanks, Howard. Good morning, everybody. As Howard indicated, we were very pleased with our third-quarter performance, which delivered year-over-year wholesale shipment gains exceeding 14% and even more impressive retail shipment increases exceeding 33%. The volume base of our Company continues to expand at an aggressive pace, and we continue to outperform the market in that regard.

As we have previously noted, the cigarette market, particularly the discount market, has been changing for the past year and a half. These changes have generally been driven by the passage of allocable share legislation in 44 of 46 participating states. As a result, the discount market has seen shifting fortunes for some manufacturers, marked by volume declines for many non-participants of the MSA, and importantly, volume declines for some of the more recent participants of the MSA.

During this period of market transition, our strategy has been to invest to build on our existing base with specific focus on achieving best-in-class volume growth. We believe our strategy is working, and I will provide additional details in a moment. But first, let me turn to the numbers.

For the three months and nine months ended September 30, 2006, our conventional cigarettes generated revenues of $135.9 and $363.3 million compared to $122.7 and $334.6 million for the corresponding periods in 2005. Operating income for the three and nine months ended September 30, 2006, was $34.6 and $95.9 million compared to $31.5 and $97.7 million for the 2005 periods.

The results in 2005 included a special one-time assessment from the United States Department of Agriculture of approximately $5.2 million for losses associated with the sale of the stabilization tobacco inventories related to the tobacco quota buyout program. After adjusting for the one-time charge, operating income for the three and nine months ended September 30, 2005, was $36.6 and $102.8 million, respectively.

For the three months and nine months ended September 30, 2006, Vector Tobacco's operating losses were $2.6 and $8.9 million compared to operating losses of $4.1 and $11.3 million for the prior-year periods.

Let me now return to the discussion of Liggett's third-quarter sales performance and overall industry activity. As I mentioned earlier, for the third quarter 2006, wholesale shipments of our conventional cigarettes increased by 14.2% compared to the year-ago period. Compared to the second quarter, wholesale shipments increased by an even more robust 21.7%.

On the retail side, our results were also notable. Overall third-quarter retail shipments were up by 33.2% compared to the year-ago period and by 11.5% compared to the second quarter. Year over year, our share of the retail market increased by almost three-quarters of a share point and is now at 2.84%.

During this period, retail volume and share percentage growth for the Company substantially outpaced everyone else in the marketplace. In fact, during the third quarter, the only other major manufacturer that showed any shipment growth was Lorillard. Overall, total industry domestic shipments were down 1.6%, which continues to be in the anticipated range of decline. The bulk of our third-quarter growth came from the Grand Prix brand, which we believe 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 have continued to successfully execute that strategy. We are pleased with the brand's growth thus far and believe that Grand Prix will continue to grow throughout this year and beyond. The wholesale price of Grand Prix was raised at the end of the third quarter. And as a result, we anticipate margin improvement on the brand during the fourth quarter.

Liggett Select's performance improved during the third quarter, with wholesale shipments down a modest 4.4% compared to the year-ago period, but up an impressive 29.5% compared to the prior quarter. Liggett Select retail shipments were in a similar range to wholesale shipments, and the brand has continued to strengthen throughout the year after a difficult first quarter. We expect performance to be stable through the remainder of the year and into 2007.

EVE's third-quarter wholesale shipments were down approximately 4.2% compared to the 2005 period, but were up 5.7% compared to the previous quarter. At retail, EVE shipments were down 2.7% over the prior year, but up 1.5% compared to the prior quarter.

The partner brand relationships that we established during 2005 continue to perform well, with all brands reflecting shipment growth at both wholesale and retail.

As the year has progressed, the market has continued to stabilize, and this has enabled us to benefit from the growth programs that we put in place in early 2006. The market leaders have reduced the aggressive promotions that they had earlier in the year, and the smaller companies continue to decline.

Significantly, for the third quarter 2006, shipments of all other manufacturers, which includes nonparticipating manufacturers and small subsequent participating manufacturers, are down over 18%. And over the past four sequential quarters, these companies have declined almost 20%. These declining trends have been ongoing now for almost two years and we expect them to continue.

Relative to pricing, I noted earlier that we recently raised prices on Grand Prix, and we expect that action to improve our margins in the fourth quarter. It is also important to note that there is a general MSA cost increase effective January 1, 2007, in the range of $0.70 per carton, including inflation adjustment. As a result, because of the benefits of our MSA market cap, notwithstanding unanticipated competitive activity, we would expect this to positively impact margins in 2007.

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 20 of 21 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 obviously support the position that has been taken by the participating manufacturers. Several state court rulings are pending.

One other legal development during the third quarter to note -- in August, the U.S. District Court for the District of Columbia issued its long-awaited decision in the Department of Justice's case versus the industry, including Liggett. In that ruling, Judge Kessler ruled that the tobacco company defendants had violated federal racketeering laws by defrauding the public on the dangers of tobacco.

The judge ordered the companies to make corrective statements on the dangers of smoking, to stop labeling cigarettes as low tar or light or natural, and further ordered the companies to begin an advertising campaign in newspapers and on television networks on the adverse health effects of smoking.

Importantly, the judge concluded that Liggett had withdrawn from any conspiracy and that Liggett demonstrated no reasonable likelihood of future violations. Accordingly, the court specifically excluded Liggett from all remedies ordered.

In the ruling, the court commended Liggett's past cooperation with government and public health officials and applauded Liggett's independent actions over the years. Clearly, we are pleased with this outcome.

In conclusion, I would like to say that we are very pleased with the way our performance has developed in 2006. Our growth program is working. We expect it to continue to work, and look forward to building our bottom line off a substantially higher volume base.

Thanks for your attention and 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.

Before we take comments, because I'm sure there will be questions -- I'm sure there will be questions regarding the restatement -- I would just like to say that this restatement sort of -- let me tell you how it came about.

You know, convertible bonds is a very technical way of determining what the interest expense is because of the variable interest in the convertible bonds. And it is sort of accounted for like, as I understand it, like a derivative. We did the work on it, and then we had PricewaterhouseCoopers, our accountants, review it, check it, charge us $140,000 and come to the conclusion that it was done perfectly correct.

Now, two years later, approximately two years later, they have now decided that it wasn't correct. And obviously, the position always is that the Company is always the one that is responsible, so even though we did it and had them check it, and paid for them to check it, and relied on them, it becomes our issue as far as they are concerned.

Okay, operator, will you please open the call for questions?

(OPERATOR INSTRUCTIONS). Andrew Shapiro, Lawndale Capital Management.

Regarding this DoJ ruling, the judge excluding Vector from the suit and damages, the ruling itself is getting appealed. Does the appeal, in your mind, provide the risk that Vector would be brought back in, or that's not really the matter upon which people are appealing?

The basic appeal -- well, there's a couple of things. Anything is possible. But the way it was worded as it relates to us not having been involved in any of this activity, which is true -- I mean, again, look, what they're going for is they are going for sort of injunctive relief to stop the companies from doing things that are false. And we did those things many years ago voluntarily like, for instance, we basically have on our cigarettes, nicotine is addictive.

So it would be hard to imagine that anything that would happen would affect us at this particular time. But of course, in litigation, anything is possible.

A few other -- on the last call, B.K. mentioned that the 2006 dividend was then expected to be entirely taxable -- actually, it was two calls ago. What are your estimates now -- here we are in the ninth month, actually the 11th month, with nine-month numbers -- what are your estimates regarding the taxability of this year's dividends, and if a portion is going to be non-taxable, how quickly do you anticipate being able to finalize those numbers for us this year?

B.K.?

Right now, the numbers -- we think it is going to be partially taxable this year, largely because of the IRS settlement. Right now, if I had to guess, I would say between 80% and 90% taxable or 10% to 20% non-taxable. Obviously, we will work as hard as we can to distribute the numbers. But we are -- this is contingent on the receipt of [K1s] from some of the partnerships we are invested in.

And are the processes and procedures changed at some of these partnerships such that you will get your K1 soon enough and not have to file a Vector tax extension again?

We certainly hope so, but we can't guarantee. Last year, as you know, there was one partnership, and we have put processes and procedures into that -- into the preparation of that K1. But every year is different, as you know.

With respect to that entity, which is an entity that is kind of considered off balance sheet, this is the Douglas Elliman -- what is your stake in Douglas Elliman, on Vector's books here as of the end of September, net of debt? And if I recall, I think your trailing EBITDA in this investment of Douglas Elliman is like $33 million. So what is it on your books for? And am I correct in that the trailing EBITDA is $33 million or so?

B.K.?

Just a minute, Howard. Let me first answer the trailing EBITDA.

I am in the range there?

You are, but just one minute. I have the trailing EBITDA as $32.3 million.

So trailing EBITDA is $32.3, and it is presently on your books net of debt for how much?

I'll have to get back to you with that number. Our total nonconsolidated -- investments and nonconsolidated real estate businesses are $29.3 million.

So assuming Douglas Elliman is all of it, which would be the most conservative assumption, it is on your books right now for less than one times EBITDA, right?

That is correct.

And presumably, this EBITDA of Douglas Elliman, which is in excess of one times what it is on your books for, is being used to pay down Douglas Elliman's debt. Or is it now beginning to be repatriated and Vector is beginning to get and receive the cash flow from its share of Douglas Elliman?

We have received cash distributions from Douglas Elliman in the form of tax sharing payments. And as you know, we have net operating losses, which those -- dependably, we get the tax cash free on that distribution. We also receive payments on the $9.5 million that we lent them in 2003, both in the form of interest and debt service payments.

So in general, about how much in '06 here is Vector receiving from Douglas Elliman?

I will have to get back with you on that.

Lastly, can you give us an update on how much you're asking for -- I know it is on appeal right now -- but how much you're asking for with respect to the NASA lawsuit -- again, another asset that was brought over from New Valley -- the [West Tire] lawsuit that is seeking damages from NASA for the failure to launch? What is the amount you are seeking under the damage claim?

I don't have a precise number for you on that.

Is there a range? What is it that you are -- if you are going to go to trial on it and you are seeking an amount, they are seeking to pay you a lower amount. But what are you guys seeking?

I don't know that -- I don't have an answer for you on what that number is precisely.

Mark McMahon, Wachovia Securities.

Congratulations on a good quarter. I had two questions on the Liggett side. One, on the MSA benefit that comes into play next year of $0.70 per carton, are you planning on taking that whole price increase down to your existing volumes? Or are you going to look to capture some additional market share with that? I wasn't clear on what your intentions were.

And the reason for that, Mark, is because I wasn't clear about what our intentions are with that. Our intention is that we will generate earnings off of that. However, we are going to, as always, deal with what the competitive realities and opportunities are in the marketplace.

So as I have pointed out, over the last couple of quarters, the market is in transition right now. And we're seeing an evolution from the first five years of this century, which were dominated by the growth of the so-called renegade companies, and now has turned to the decline of those companies.

And we are aggressively looking to pick up share during this period. And that is what we have been doing. And we're going to continue to pursue that while looking to increase our earnings as we go.

So somewhere you are going to have sort of a mix here in terms of maybe not taking the whole amount, depending on what the renegades are doing or what the majors are doing in price promotions -- that sort of thing?

That is correct.

And lastly, you mentioned that you increased the price on Grand Prix starting in the quarter. Are you able to give an idea of how much of an increase you did, because if I recall correctly, that is a brand that currently sells around $9.99?

We increased the wholesale list by $1.

(OPERATOR INSTRUCTIONS). Gentlemen, at this time, there are no further questions, Mr. Lorber.

I want to thank everyone for being on the call and look forward to speaking with you next quarter. As always, if any of you have any questions, please feel free to call any of us. Thank you and have a good day.

Thank you. This call is now concluded. You may now disconnect.