Vector Group Ltd (VGR) 2006 Q4 法說會逐字稿

Ladies and gentlemen, welcome to Vector Group's fourth 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 conference over to the President and Chief Executive Officer of Vector Group, Howard Lorber.

Thank you. Good morning. And thank you all for joining us on Vector Group's fourth 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 fourth quarter and full year of 2006. Ron will then review the performance of Liggett Group and Vector Tobacco for the quarter and full year and will discuss recent industry developments. After that, we will take your questions.

Let me start by saying that I am pleased to report that our previously announced strategy of investing for growth proved successful in 2006. According to Management Science Associates, Liggett Vector Brands' percentage volume growth was the highest in our industry from both a wholesale and retail perspective, and our Grand Prix brand continued to be a growth leader in a challenging market. Ron will discuss the details of our performance with you shortly. With respect to Quest, we reported during the last call that following our July meeting with the FDA, we began a process of evaluation regarding the opportunities and challenges associated with pursuing FDA approval of Quest as a smoking cessation aid. An important part of our evaluation was based upon our concern that there may be significant time and expense hurdles in pursuing the FDA approval process. Based upon this evaluation, we advised in an 8-K that we had determined not to pursue FDA approval of Quest as a smoking cessation aid at the present time. Subsequently, Senator Ted Kennedy and Representative Henry Waxman have introduced legislation in the Senate and House, respectively, to provide the FDA with authority to regulate tobacco products. While we have been and remain a supporter of FDA legislation, we want to ensure that the rules be written in a fair and equitable manner. As such, we are following the progress of this legislation carefully. There does appear to be considerable momentum on the Hill to pass legislation, but the timing is not clear. Currently there is speculation among industry analysts that the earliest that the legislation will be passed is this fall. With that in mind, we are also reviewing the implications and timing of this proposed legislation and what effect, if any, it may have on our decision regarding Quest and the pursuit of FDA approval of Quest as a smoking cessation aid. We will provide additional information on this when appropriate.

Before discussing the financial results for the quarter and the year, I would like to highlight several important corporate developments in 2006. First, in July, 2006, as previously reported, we entered into a settlement with the Internal Revenue Service regarding the tax treatment of our 1998 brand transaction with Phillip Morris. We were very pleased with the settlement which substantially reflected our long-standing position on the amount and timing of the tax payments. As a result of the settlement, we reported reduced income tax expense of 11.5 million in the third quarter due to reversal of previously established reserves and our financial statements for income taxes payable. Second, in July, 2006, and following the conversion into common equity of 70 million of our 6.25% convertible notes that were 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 used the proceeds of the offering to call the remaining 62.5 million of our 6.25 notes on August 4, 2006, and to pay the IRS settlement.

As a result of these actions, we have significantly strengthened our balance sheet. Stockholders equity increased during 2006 from 29.1 million at December 31st, 2005, to 95 million at December 31st, 2006, 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 $147 million at December 31st, 2006. In addition, we held investment securities and partnership interests with a fair market value of approximately 77 million at year-end 2006. Last week, we announced that our New Valley subsidiary had reached a settlement with the United States government under which New Valley will receive $20 million. This settlement relates to litigation commenced by New Valley in 1994 seeking damages from the U.S. government for breach of an agreement to launch one of the Westar satellites owned by New Valley's former Western Union business. We expect to recognize a pre-tax gain for accounting purposes later this year of approximately 19.5 million in connection with this settlement.

Now I will review the key financials for the three months and 12 months ended December 31st, 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 of both Liggett Group cigarettes and conventional cigarette sales from Vector Tobacco. For the fourth quarter ended December 31st, 2006, Vector Group revenues were 137.5 million compared to 136.2 million in the 2005 fourth quarter. The Company recorded operating income of 32.6 million, compared to operating income of 26.1 million in the 2005 fourth quarter. Net income from continuing operations was 15.8 million, or $0.25 per diluted share in the 2006 fourth quarter, compared to a net income from continuing operations of 12 million or $0.23 per diluted share in the 2005 period. For the 12 months ended December 31st, 2006, Vector Group revenues were 506.3 million compared to 478.4 million in the 12 months of '05. The Company recorded operating profit of 101 million compared to 89.1 million for the '05 period. Net income from continuing operations was 42.7 million, or $0.71 per diluted common share, compared to net income of 42.6 million, or $0.86 per share in the 2005 12-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 these companies. Ron?

Thanks, Howard. Good morning, everybody.

As Howard indicated, we were very pleased with our 2006 performance which delivered year-over-year wholesale shipment gains of 8.5%, and even more impressive retail shipment increases of 20.8%, as measured by Management Science Associates. These growth rates were the highest in the industry on a percentage basis. In late September, 2006, we implemented price increases on Grand Prix and promotional spending reductions on our Liggett Select and EVE brands. While we consequent suffered modest shipment declines during the fourth quarter, those declines were consistent with our expectations following an industry-leading pricing action. As we have previously noted, the cigarette market, particularly the discount market, has been changing over the past two years. These changes have generally been driven by the passage of allocable share legislation in all MSA states other than New Jersey and Missouri. As a result, the discount market has seen shifting fortunes for some manufacturers, marked by volume declines for many nonparticipants of the MSA, and importantly volume declines for some of the more recent participants. During this period of market transition, our approach has been to strategically 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 12 months ended December 31st, 2006, our conventional cigarettes generated revenues of 136.2 and 499.5 million, compared to 134.1 and 468.7 million for the corresponding periods in 2005. Operating income for the three and 12 months ended December 31st, 2006, was 44.6 and 140.5 million, compared to 45.7 and 143.4 million for the 2005 periods. The 2006 results include a pre-tax gain on the sale of real estate of $2.5 million, and nonrecurring expense items totaling $1.5 million. The 12 month results in 2005 included a special one-time assessment from the USDA of approximately 5.2 million, a gain on the sale of excess real estate in Durham of 12.7 million, a $114,000 reversal of previously-established restructuring accruals, and approximately 5.25 million of nonrecurring litigation expense at Liggett. For the three months and 12 months ended December 31st, 2006, Vector Tobacco's operating losses were 5 and 14 million, compared to operating losses of 3.7 and 15 million for the prior year periods. Fourth quarter and 12 month results for Vector Tobacco include 2.7 million of restructuring and inventory impairment charges relating to the termination of Vector Tobacco's genetic research operation.

Let me now return to the discussion of Liggett's fourth quarter sales performance and overall industry activity. For 2006, wholesale shipments of our conventional cigarettes increased by 8.5% compared to the prior year, and overall retail shipments were up by a robust 20.8%. Year-over-year, our share of the retail market increased by almost half of a share point and is now at 2.63%. For the year, Liggett shipment and retail share growth percentage substantially outpaced the rest of the industry. Comparing fourth quarter 2006 to the prior year quarter, Liggett wholesale shipments decreased just over 5%, while retail shipments increased by more than 17.4%. As I mentioned earlier, it is important to note that Liggett neither raised prices or reduced promotional spending on its core brands in late September, 2006, in anticipation of the January 1st, 2007 MSA payment rate increase, while the rest of the industry did not raise prices until December. For the full year of 2006, overall industry domestic retail shipments were down by 1.4% for the year. That decrease is less than would have been expected versus historical trends, and was primarily driven by the anticipated increase in the master settlement agreement payment rate. Effective January 1st, the MSA payment rate increased by approximately $0.70 per carton for all cigarette manufacturers and importers. Approximately $0.55 is related to a contractual increase in the MSA expense, and $0.15 is related to the annual inflationary adjustment. In anticipation of this increase, virtually all companies effectively increased prices prior to the end of '06. As the scheduled increase in the payment rate was widely known, both wholesalers and retailers elected to increase on-hand inventories which led to a substantial trade buy-in of product late in the year. In addition, many manufacturers and importers shipped additional amounts of product to their own field warehouses to hold for 2007 sales. Based upon this activity, overall federal tax paid industry shipments, as calculated by the independent auditor under the MSA, appeared to have actually increased year-over-year. However, it is our belief that actual consumer purchases declined in line with the historic trends of 2.5 to 3% and that the reported 2006 shipments were distorted by the various company and trade activities. Since the independent auditor industry shipment estimate is used for determining the participating company's MSA obligations, pulling shipments forward into 2006 has the effect of increasing the value of the MSA grandfathered share for all companies that have such share for that year and reducing the MSA grandfathered share value in the following year. For Liggett, the effect of the artificially inflated industry shipments resulted in approximately $2 million of additional earnings in '06, but will also result in a corresponding industry shipment relating earnings reduction in 2007.

Despite the October 1st, 2006 price increase, our Grand Prix brand continued to perform well in the fourth quarter. Compared to the prior year quarter, wholesale shipments increased 32.5%, while retail shipments increased by almost 240%. Compared to the third quarter, wholesale shipments for Grand Prix increased by 11% while retail shipments were effectively flat. As previously indicated, we developed a long term strategy for Grand Prix at its inception and have continued to successfully execute that plan. We are pleased with the brand's well-paced growth thus far and look forward to strong performance from Grand Prix in the future. Our late September pricing actions and competitive price increases at year-end had more impact on Liggett Select and EVE. Compared to the year ago quarter, Liggett Select and EVE wholesale shipments were down 16.9 and 11.8%, respectively, and compared to the previous quarter, wholesale shipments were down 14.6 and 6.1%. Compared to the year-ago quarter, retail shipments on Liggett Select decreased by 9.3% while EVE shipments decreased by 1.8%. Compared to the previous quarter, Liggett Select and EVE shipments decreased by 9.3 and 5.3%, respectively. While there was certainly some end of the year buying by retailers on competitor products due to their pending price increases, as we had taken our MSA price increases earlier, the forward buying effect on our brands was more limited at retail, making retail a better indicator of brand performance. Our strong private label relationship with Speedway SuperAmerica resulted in a good year for the Tourney brand, and the partner brand relationships that we established during 2005 continued to perform well in 2006. All brands reflected shipment growth, with particularly strong results with Silver Eagle from Sunoco, and Bronson from Quiktrip. Overall, the market stabilized throughout 2006 enabling us to benefit from the growth programs that were put in place earlier in the year. The substantial shipment activity at year end makes the trends more difficult to read, but we believe that the recent volume declines of the nonparticipating manufacturers as as well as the more recent MSA participants are continuing.

Of note, we recently became aware that General Tobacco failed to make a required payment under their separate agreement with the MSA settling states, and based upon our understanding of the agreement, are therefore in default. The states have not yet pursued this apparent default of approximately $15 million by General Tobacco, which occurred in August, despite the existence of a provision in the settlement agreement providing for an automatic acceleration of General Tobacco's full payment obligation of approximately $250 million. Coincidentally, it appears that General Tobacco imported a substantial volume of cigarettes at year end, possibly as much as a full quarter's worth of volume, and held those cigarettes for subsequent sale in 2007. This would, ironically, have the effect of reducing General Tobacco's 2007 MSA payment obligation to the states. We, along with others, have sought clarification from the states regarding the situation. While market leaders continue to reduce the aggressive promotions that they had on certain brands earlier in the year, it appears that they are starting 2007 by initiating similarly-aggressive promotions. In particular, RJ Reynolds appears to be attempting to drive lower price competition out of stores with more aggressive trade program requirements and by trying to shift volume to a higher price discount brand. We believe that these programs may be anti-competitive, and many retailers have indicated that they are troubled with RJR's current demands and past practices.

On the litigation front, in the dispute involving the nonparticipating manufacturer adjustment provisions of the MSA for 2003, 38 of 39 states have now ruled that the MSA clearly provides that arbitration rather than litigation is the correct way to resolve the NPM adjustment dispute. These rulings obviously support the position that has been taken by the participating manufacturers. Several state court rulings are pending. Additionally, the independent economic consulting firm used to determine that the MSA was a significant factor contributing to the loss of market share in 2003 made a similar determination for 2004.

In conclusion, I'd like to say that we're very pleased with the way that our performance developed during 2006. Our growth program is working. We expect it to continue to work, and look forward to building our bottom line from a strategically focused volume base. 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 Pendes], Royal Bank of Canada Capital.

Good morning, gentlemen.

Hey, Mitch.

Good morning. I wanted to ask you about -- a little bit about the Douglas Elliman distributions. I understand that the distributions have been used to pay down the debt from the acquisition over the last few years. Is that true?

I think the bulk of them under our loan agreement because we borrowed the money from an affiliate of Prudential, that pretty much other than tax payments we had to pay down the loans.

Okay. Can you sort of give a little history on that? In other words, how much was the original loan? How much has been paid down? And how much has been left?

Yes, I think the original loans were basically 52 -- I think about 50 million, $52 million senior debt from Prudential, 10 million sub-debt from Prudential, and 10 million sub-debt from New Valley at the time. And I believe the total outstanding -- so it was about 70, I think we paid about $72 million, and I think the total outstanding now, BK, correct me if I'm wrong, is around $40 million.

That's correct.

Okay. And can you tell us how much was paid off last year, for example?

BK, do you have that?

I do not have that, Howard.

Okay. Well, we'll get it for you, Mitch, and we'll get back to you.

Okay. Just trying to get a -- my arms wrapped around that.

Right. We will be filing the Douglas Elliman statements in a 10-KA in the next two weeks, so you'll be able to see full-blown financials for them.

That would be great. Thank you. My other question relates to the Ladenburg Thalmann notes which you had outstanding which you recently converted back into the Ladenburg stock at -- I think it was $1.80 a share.

Right. Correct.

In the past, when you've had similar transactions occur, you've made distributions to shareholders. Is it your intent to do the same thing again? Or is that not decided yet?

The Board -- the Board has not really met and decided on whether to do that. But obviously, in the past, we've done it, and we will consider it, and I guess after that -- after the shareholder approval of that transaction, we will own about what percent of Ladenburg?

We will own about 9 -- 8.5, 9%.

Right.

Okay. That's it for me. Thanks, gentlemen.

Thanks.

[Mark McMahon], Wachovia.

Good morning, guys. Congratulations on the growth last year.

Thanks.

I've got a question regarding the FDA -- the proposed FDA legislation that's been working its way through Congress since the changeover of the House and Senate. I'm unclear -- I understand why Phillip Morris backs it and the others don't and I understand why you guys back it, but what I'm unclear about is what exactly is the framework that they're working under for the reduction of nicotine in cigarettes? How is that supposed to work? And how would that affect Quest going forward?

Well, I don't think that it's clear. And I think that's all part of the -- of the issues. And a lot of that's going to be determined, Mark, in the rule writing phase. So I mean they're passing general parameters as part of the current legislation. But the specifics are going to be left more to the FDA.

One of the problems, Mark -- it's Howard, is that if you had FDA legislation tomorrow passed, it could be years and years until you really have the regulations, until anything really happens.

Yes, especially anything coming out of Washington.

Right. Exactly.

The thing I'm curious about is does anybody have -- what sort of technologies are available out there for other companies for reducing nicotine?

What we see -- the things we basically see are filter technologies.

Just filter.

Well, there could be others, but again the type of tobacco you use, maybe how you grow it, and so forth, but I think the main thrust for all this stuff has been filter technology. Would you agree, Ron?

Yes, well, I think particularly on the reduced risk side, it is.

Right.

And on the nicotine control side, it's been a combination of filter technology and as you say blending. But I think to Mark's point, that a lot of the NPM volume, particularly that which comes in that's imported, will strain a little bit more to meet those types of guidelines.

Which is going to obviously be a big benefit to companies such as yourself.

Well, I mean conceivably. The bottom line is, is that the technology is there for people to use. The question is whether or not importers who are importing from companies all over the world, whether they're going to adjust their production in order to meet the U.S. standards. And that's something that's unknown.

Okay. And along the lines of your traditional cigarette business, which unit volume did you do in Grand Prix and what unit volume did do you in Liggett Select last year?

We don't -- we don't release those specific unit numbers, Mark, as you know, and -- but Grand Prix continues to grow. Liggett Select is declining at a modest rate. And I think both brands are performing within a range of what our expectations are.

What was your total unit sales? You provide that, right?

Our total unit sales were -- were just over 9 billion.

9 billion? Is there -- Liggett Select was your big growth vehicle for a long time, and I understand the strategy behind Grand Prix and what you're thinking is there is with the growth, but what made you decide not to get more aggressive on the Liggett Select to maintain market share? Is it just you're trying to turn some profit off of that brand after the growth that you did enjoy over multiple years and what was the methodology behind the thinking of allow Liggett Select to maintain some of these declines while building up Grand Prix for your overall growth strategy?

Well, Liggett Select, Mark, is a profitable brand and it has an established base of smoker with an identity. Over the years since we introduced Liggett Select, the price on Liggett Select has increased by as much as $4, $5 a carton, and in order to take it down to a growth level, in the current market, you would have to give up far too much margin to justify it. So Liggett's Grand Prix is a growth vehicle because you don't have the established volume base with existing margin.

Do you expect even after the build-up of units at the end of '06 for its growth to continue on this sort of trajectory for 2007?

Well, I don't know that it will continue at the same rate, but I think that we believe that the brand will continue to provide better margin for the Company.

Did you see much of a slowdown in '07 in the first quarter so far in the brand?

No. The brand continues to perform well. Again, the growth rate -- the first quarter has really been somewhat distorted because of all of the activity in the marketplace at the end of the year, but Grand Prix has been pretty solid.

Great. Okay. Thanks a lot, guys.

[OPERATOR INSTRUCTIONS]. Andrew Shapiro, Lawndale Capital Management.

Hi. This is [Daniel Fermette] for Andy. I was wondering a little bit more, you did say that there was a lot of changes at the MSA's, et cetera, at the end of the year, and I think in previous calls, we thought that basically these changes were going to lead to some sort of like pricing umbrella, et cetera. Could you talk a little bit about that, what you're seeing so far this year, and whether any of your shipments are beginning to rebound at all, that had gone off in the fourth quarter?

Yes, the -- what's -- in terms of the MSA action, the entire industry was affected. People made their moves in terms of adjusting their prices, in different ways, and in different times. We made a decision to adjust our rates at the end of September, which was coincidental to an increase that we had planned on Grand Prix in any event. The -- as a result, what happened was there was -- the folks who basically, at the end of the year, made their adjustments, particularly a number of the smaller companies, allowed substantial buy-ins of their products. And so that affected just the general overall market. And we feel pretty comfortable with how our sales are doing in entering the new year, and the brands are consistent with what our expectations are for them.

Okay. And could you talk a little bit about kind of consolidation in the tobacco industry in general, and kind of where you see your guy's place in this evolution over time?

Well, yes, look, I guess, the obvious situation to look at is the Imperial purchase of Commonwealth at a price of -- reportedly about $1.9 billion. Now, I think if you look at Commonwealth's and our -- Commonwealth's numbers and our numbers, they're pretty close, and there are sort of advantages and disadvantages to both companies. On the Commonwealth side, they -- basically, their disadvantage to us is that their cap is much smaller than ours. The advantage they have is they basically don't have any litigation, because they're a relatively new company. So it's sort of a trade-off. I think our earnings are more protected because we have a much bigger cap. And so I think they're more at risk with their earnings. But obviously, on the other hand, if the foreign companies especially are a little bit queasy about the litigation in the United States, so I guess that's how they looked at it. They didn't come to us to buy us, so I mean obviously, that's how they were looking at it. They were willing to give up that cap and the stability, and not be involved in litigation. Having said that, I think, their consolidation is going to continue, and I think that the price they paid for Commonwealth bodes well for our shareholders.

And just to add to that, I think that at the time that the announcement was made of their planned acquisition of Commonwealth, that the conventional wisdom of the industry analyst was that that would now foreclose them going after Altadis. Well, obviously, that's not the case. So what you have is there's a global dynamic taking place right now. And how that's all going to play out remains to be seen. But I think that what Imperial has done is has at least said that the U.S. is now on the table as part of the way that these global companies are looking at the marketplace.

Yes. It looks that way. Just a quick question on Quest. I mean, assuming something did happen in Washington, et cetera, how much do you think it would cost you guys to get that thing back up and running and how much time? I think you let go a bunch of the employees there.

Well, I think that in terms of what -- what we would need to do, and again, we're just at a preliminary phase of evaluating it. What we've decided is that given the advent of FDA legislation, we -- it's prudent for us to take a look at this as it goes. That doesn't mean that we're moving or leaning towards changing the decision that we made, but it's just prudent for us to be looking at it, and we wanted our investors to be aware of that. We don't -- the adjustments that we have made from a research standpoint are fine. We would not need to add significant expense to do anything more there. As far as the selling side is concerned, we can assimilate that pretty well as well. The decision would be, if we determined that there was a viable structure for a product, would be going through the FDA process, because we would still have to get it approved by the FDA, and then determining a marketing strategy for the product if it got that far.

Okay. You guys talked a little bit about Douglas Elliman. Can you at all give us any feel as to whether fourth quarter EBITDA was up year-over-year? I think you did about $5.7 million in EBITDA there lost fourth quarter was around 32, $33 million in annualized EBITDA, was the fourth quarter up or down?

Daniel, it is Bryant. How are you?

Good. And you?

We did -- the fourth quarter EBITDA for Elliman was about 4.6, and for the year it was 31.9.

Okay.

And in -- but in that number was $0.5 million management fee to Vector, so if you look at year-over-year it was about 5.7 to 5.1 if you adjust it for that.

Okay. And I think he said 40 million-ish in debt right now is what you said?

That's an approximate number at the end of March.

And what's -- what's Douglas Elliman on your -- on Vector's books for?

20.5 million.

20.5 million's on the books, for -- you did about 33 million and then you thought about 40 million in debt.

We did -- we did 32 million. 31.9 million for the 12 months.

Okay. And then 10 million of that debt is actually owned by Vector.

Correct. A little bit less. A drop was paid down, a little bit less than 10.

Right. And remember, Daniel, we own 50% of Douglas Elliman, so we would be entitled to half of that 31.9 million.

Okay. One more quick question. What's your thoughts on the taxability of the 2007 dividend stream?

Right now, I believe it will be 100% taxable.

100% taxable.

Now, obviously, we will be adjusting those numbers, and for the 2006, we are still finalizing those numbers, but we believe it will be between 57.5 and 77.5% taxable.

All right. Thanks. I'll back up.

Thank you for your questions, sir. Mr. Lorber, there are no further questions in the queue at this point.

Okay. Thank you. I'd like to again thank everyone for being on the conference call. And as always, all of us, Ron, myself, BK, are always available to answer any questions you might have. Have a great day. Bye.

Thank you. This does conclude today's teleconference. You may now disconnect.