Vector Group Ltd (VGR) 2007 Q2 法說會逐字稿

Welcome to Vector Group's second quarter 2007 earnings 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 risk 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 would like to turn the call over to the President and Chief Executive Officer of Vector Group, Howard Lorber.

Good morning and thank you for joining us on Vector Group's second quarter 2007 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 financials for the second quarter of 2007. Ron will then review the performance of Liggett Group and Vector Tobacco for the quarter 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 we have maintained market momentum during the second quarter, generating substantial earnings and volume growth. Despite operating in a challenging overall environment in which industry wholesale shipments declined by 4.6%, Liggett was able to increase our wholesale shipments by 13.8% during the second quarter. According to Management Science Associates, that shipment growth substantially outpaced all of our industry competition. We will review these results in more detail when we discuss the numbers and during Ron's review of the industry and Liggett's performance.

With respect to Quest, its status is unchanged since our last conference call. As you know, Congress is considering legislation that would grant the FDA authority to regulate tobacco products, including so-called "reduced risk" type products. This legislation has been subject to delays for various reasons throughout the year and now, if it passes both houses, faces the prospect of a presidential veto. As a result, we remain unsure as to what the ultimate outcome will be or what effect it may have on the development of our last Quest brand or on our business in general. We will report back when we have more information.

Before discussing the financial results for the quarter and year, I would like to note that our liquidity remained strong, with cash of approximately $126.4 million at June 30, 2007. In addition, we held investment securities and partnership interest with a fair market value of approximately $112.8 million at June 30, 2007.

Now, I will review the key financials for the three months and six months ended June 30, 2007 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 Group cigarettes and conventional cigarette products from Vector Tobacco. Our financial results for the three and six months ended June 30, 2007 include an $8.1 million pre-tax gain from the exchange of $5 million of notes receivable from Ladenburg Thalmann Financial Services, which had been previously written off, for shares of Ladenburg common stock and $1.7 million cash of accrued interest.

Our financial results for the six months ended June 30, 2007 also included the previously-announced March 2007 settlement between New Valley and the U.S. government under which the Company received $20 million. We recognized a pre-tax gain in the first quarter of '07 of approximately $19.6 million as a result of that settlement. Our financial results for the three and six months ended June 30, 2006 included a non-cash charge of $14.9 million associated with the issuance in June 2006 of additional shares of our common stock in connection with the conversion of $70 million of the Company's 6.25% convertible notes due 2008.

For the second quarter ended June 30, 2007, Vector Group revenues are $140.4 million, compared to $113 million in the 2006 second quarter. The Company recorded operating income of $29.2 million, compared to operating income of $22.5 million in the 2006 second quarter. Net income was $21.4 million, or $0.34 per diluted share, in the 2007 second quarter, compared to a net loss of $2.7 million, or $0.05 per diluted share, in the 2006 period. Excluding the gain on the Ladenburg note exchange, the Company's net income for the 2007 second quarter would have been $16.6 million, or $0.27 per diluted share. Excluding the debt conversion expense, the Company's net income for the 2006 second quarter would have been $12.2 million, or $0.21 per diluted common share.

For the six months ended June 30, 2007, Vector Group revenues were $274.2 million, compared to $231.1 million in the first six months of 2006. The Company recorded operating income of $54.9 million compared to $42.7 million for the 2006 period. Net income was $44.5 million, or $0.71 per diluted common share, compared to net income of $7.3 million, or $0.13 per share, in the 2006 period.

Excluding the Ladenburg note exchange and the gain from the U.S. government lawsuit settlement, the Company's net income for the first six months of 2007 would have been $28.2 million, or $0.45 per diluted share. Excluding the debt conversion expense, net income for the first six months of 2006 would have been $22.2 million, or $0.38 per diluted share.

Now I will return the call over to Ron Bernstein, who will update you on the performance of Liggett Vector brands and Liggett.

Good morning, everybody. As Howard indicated, we continue to be pleased with both our financial and volume performance in 2007. Our success for the quarter and the year thus far is a direct result of the long-term growth and pricing strategy that we developed and began implementing in 2005. In addition to attaining year-over-year wholesale shipments increases of 13.8%, according to Management Science Associates, Liggett also achieved year-over-year retail shipments increases of 4.5%. While the wholesale shipments increase was assisted by an easy comparison to second quarter 2006, the retail increase clearly demonstrates the strength that we are exhibiting in the market.

Overall, industry shipments continue to be relatively weak, with all companies other than Liggett and Lorillard reporting volume declines, according to Management Science Associates. We believe that this weakness is attributable to two primary factors. First, a slow recovery of volume following year-end inventory adjustments by most companies in anticipation of the January 2007 MSA increase. And second, lower industry volumes due to increased pricing caused by rising state excise taxes.

As a result, the market leaders continue to offer substantial discounts at retail to limit volume losses, including buy-some, get-some deals on their premium brands. This does have an effect on the overall market, but to date, we have been holding our own. As we previously reported, the trend of declining shipments for many non-participants of the NASA settlement agreement has continued in 2007 and we do not anticipate it changing anytime soon.

Despite these declines, we continue to see evidence of smaller companies offering prices that appear to be below their cost, assuming that they are paying their MSA obligations as required. Of course, we have our doubts about the behavior of some of these companies. In the past two years, we have seen several companies file bankruptcy after failing to collect sufficient funds to meet their MSA payment requirements, yet the states remain very slow at addressing the situation. We and others in the industry continue to provide the state information regarding potential non-compliant companies and encourage them to limit losses by pursuing them as quickly as possible.

Notwithstanding that issue, we remain committed to success in this market and going forward, our approach will continue to be to strategically invest to build on our existing base, with specific focus on achieving sustainable volume growth. We believe our performance, which I will discuss further in a moment, confirms that our strategy is working, but first, let me turn to the numbers.

For the three months and six months ended June 30, 2007, our conventional cigarette generated revenues of $139.3 million and $272.1 million, compared to $111.6 million and $227.4 million for the corresponding periods in 2006. Operating income for the three and six months ended June 30, 2007 were $37.5 million and $72.9 million, compared to $30.9 million and $61.3 million for the 2006 periods.

For the three months and six months ended June 30, 2007, Vector Tobacco's operating losses were $2.1 million and $4.4 million, compared to operating losses of $2.7 million and $6.3 million for the prior year periods.

Now let me add some detail regarding Liggett's second quarter sales performance and overall industry activity. As previously noted, for the second quarter of 2007 wholesale shipments of our conventional cigarettes increased by 13.8% compared to the prior year and overall retail shipments were up by 4.5%. During the same period, according to Management Science Associates, overall industry wholesale shipments were down 4.6% and industry retail shipments were down 2.7%.

The major portion of the industry decline appears to relate to the slow movement of inventory shipped out of bonded warehouses in late 2006 in anticipation of the higher 2007 MSA payment rates. Additionally, the significant increases in state excise taxes and increased smoking restrictions are, without a doubt, playing a role in slowing down the movement of that inventory.

The bulk of Liggett's shipment growth in the second quarter related to Grand Prix, which grew by 84% at wholesale and 51% in retail shipments, respectively, versus the prior year period. Liggett Select wholesale shipments grew by 6.2% during the second quarter versus the corresponding quarter in 2006, while retail shipments declined by 12.8%. The retail shipment decline reflects difficult year-over-year comparisons versus the second quarter of '06 due to a higher level of Liggett Select retail promotion activity in the year-ago period, the price-positioning of the brand, and the trade-off to Grand Prix business in certain outlets.

Wholesale shipments of Eve effectively flat versus year-ago, while retail shipments declined by 7.5%. Eve's retail decline was reflective of the general industry softness and the price position of the brand.

Of note, our partner brand and private-label business continues to perform well, with Sunoco's Silver Eagle brand and QuickTrip's Bronson brand reflecting growth and Speedway SuperAmerica's Tourney brand remaining stable.

As mentioned in our last call, effective January 1, 2007, the MSA payment rate increased by approximately $0.70 per carton for all cigarette manufacturers and importers. Approximately $0.55 was related to a contractual increase in MSA expense and $0.15 was related to the annual inflationary adjustment. As a result of the increase in MSA cost, most companies raised prices prior to the end of 2006. As the scheduled increase in the payment rate was widely known, both wholesalers and retailers elected to increase on-hand inventory, which led to a substantial trade buy-in of product late in the year. In addition, many manufacturers and importers shipped additional amounts of products to their own field warehouses to hold for 2007 sales. This activity resulted in shipments being pulled forward into 2006, which had the effect of increasing the value of the MSA-grandfathered share for those companies which have a share for the full year 2006 and reducing the value of MSA-grandfathered share in 2007.

For Liggett, as we have previously stated, the effect of the increased industry shipments was approximately $2 million of additional earnings in 2006 and will also result in a corresponding industry shipment-related earnings reduction in 2007. We realized approximately $500,000 of that decline during the second quarter.

In terms of the competitive landscape, the market leaders continued to pursue aggressive and often conflicting trade programs and Reynolds American continues to vigorously promote both premium and discount products at retail. This trend has continued during the second quarter, as the market leaders attempt to address their declining sales.

On the litigation front, in the dispute involving the non-participating manufacturer adjustment provisions of the MSA for 2003, 44 of 45 state courts have now ruled that the MSA clearly provides that arbitration, rather than litigation, is the correct way to resolve the NPM Adjustment dispute and 24 of these decisions are now final. We're pleased of these rulings, which clearly support the position that has been taken by us all along with the other participating manufacturers. Additionally, the economic consulting firm used to determine that the MSA was a significant factor contributing to the loss of market share of the participating manufacturers for '03 made a similar determination for '04.

On the legislative front, many of you are aware that both the House and the Senate have proposed a significant increase to the federal excise tax to pay for a portion of the State Children's Health Insurance Program. The house has proposed raising the FET by $4.50 per carton and the Senate has proposed a hike of $6.10 per carton. The current FET rate is $3.90 per carton, so the industry is looking at a potential increase between 115% and 156%. The president has threatened to veto to the SCHIP legislation, but we believe that there may be sufficient bipartisan support to override his veto. So while we believe that the proposed levels of an increase are excessive and inappropriate, we are preparing for the possibility an FET increase will occur.

The effect of such a large increase on a market already impacted by large increases in state excise taxes is unclear, but it could lead to incremental, possibly substantial, industry declines in 2008. Any decline in overall industry volume greater than the core inflation rate will result in a decline in the value of Liggett's MSA-grandfathered share.

Having said that, it is our belief that we are well-positioned to deal with market changes that may arise from a substantial FET increase. We believe that the actions that we've taken over the past few years to change our cost structure and to properly position our brands should enable us to maximize our performance in this market environment.

In conclusion, I would like to say that we are obviously pleased with the results of the first half of 2007 and continue to look for opportunities to build upon our recent performance. We are also watching legislative and market developments closely and are preparing ourselves to address any changes that may occur.

Thank you for your attention and back to you, Howard.

Thank you, Ron. 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) Mitch [Pendant], Royal Bank of Canada Capital.

Nice couple of quarters. Actually my questions relate basically to that. I'm looking at some of the numbers, for example the drop in the total assets that you have on the balance sheet from 637 -- excuse me to 620 from 637. Can you explain that to me?

Assets decreased largely because of the reduction in the deferred income taxes of $18.9 million, which was caused by the utilization of net operating losses during the first six months and also inventories decreased by $10.3 million due to a decline in finished goods inventory, which had been increase in December 2006 in anticipation of the higher master settlement agreement rate than 2007, and this was offset by an increase in cash and investment securities available for sale of $11.3 million.

So then let's segue over to the cash side. It looks like you had a drop from 155 to roughly $126 million in cash equivalents.

Right, and the decrease in cash -- and this is defined in the cash flow statement on page five of the 10-Q -- of $20 million was largely due to the net payment of long-term debt of $20 million, which was primarily the result of retiring the final $35 million in debt associated with the Medallion acquisition, offset by an increase in Liggett's revolver.

Okay, that makes sense. It all makes sense. Let's move on, then, to the Douglas Elliman transaction and the balance sheet there, in terms of how much debt you still have outstanding, the note balance, what has been paid down, and some of the cash flow numbers on that, if you could?

Sure. I believe it is on page 42, it is in note 12 of the 10-Q. Douglas Elliman's debt net of discount to Prudential and New Valley at June 30, 2007 was $36.4 million and of that amount, $18.4 million was associated with the senior secured debt, which was incurred with the acquisition of Douglas Elliman, and the remaining $18.1 million was associated with the subordinated debt to Prudential and New Valley.

So how much was paid down this quarter and year-to-date?

Approximately $3.8 million was paid down during the quarter and $6.8 million was paid down year-to-date.

So you're, give or take, about a year and a half away from paying off the note entirely?

That sounds reasonably. Howard?

Douglas Elliman is doing very well and I am sure that is probably true.

So just -- if we sit here and we work out the numbers, Douglas Elliman is probably throwing off in the range of about $0.20 per share in cash-flow? Does that sound about right?

As far as earnings, Mitch, Douglas Elliman threw off about $0.105 for the six-month period and $0.065 for the three-month period. And that compared to last year of $0.125 a share.

Okay, that makes sense to me, too. My last question is actually for Ron. Ron, you are anticipating an increase coming up in January in the MSA?

No, the federal excise tax.

Would be unreasonable, then, to anticipate some inventory loading at the retail level going into the third and fourth quarters?

No, and the reason being that, first of all, the FET increase will almost certainly be January of '08 and there will likely be a floor tax assessed on inventory at both retail and wholesale, so to the contrary, it is likely that wholesalers and retailers will want to have as low levels as possible of inventory because they will be assessed for that almost immediately. And also, they have to go through the pain of actually counting and doing the inventory, which is something that both wholesalers and retailers hate.

But I always thought that if the consumer knows that a carton of cigarettes is going to increase by three or four or $5.00 or even six, as we are talking about here, that they will go out and they'll make purchases, they will load up their own personal inventory (multiple speakers) to those increases. Is that not correct?

No, Mitch, typically the consumer is the last to know and most of the activity that you typically see in terms of increased shipments around an event like an MSA increase or an FET is increase is the result of wholesalers and retailers making the decisions to invest in product. So, no, it's not -- consumers typically don't think that way and they're typically playing on limited budgets, so the average cigarette smoker really can afford to go too long in their cigarettes.

I thought that was my last question, but another one just popped into my head. The converts, the convertible bonds you have outstanding, you have two different issues. They are both nicely in the money. You have about a $17.60 price conversion on the 5% and other ones are about $20.50. And I am just wondering neither one of them is currently callable, is there any advantage to you to start entering into negotiations to force the conversion or to offer the conversion?

We haven't yet at this particular point. As you know, we've done that in the past and I guess when we think the time is right, we will consider it.

All right. Thank you, guys. Nice quarter.

Mark [McMann], TM Wealth Management.

Good morning, guys. Congratulations on a great quarter. Actually, I had a couple of questions that were answered by Mitch, but I have a follow-up on what he was supposing regarding the proposed increase in the federal taxes. Last week, I happened to be in an outlet store where they said in anticipation of this passing, they had already raised their prices by $6.00 dollars per carton and I went to four other places to verify that and everybody had already raise their per-carton price by $6.00 and your brands were all included in that mix. What do you guys see as a nationwide trend in terms of volumes as a result of that? That took place last Tuesday.

We are not seen that on a nationwide basis at all, Mark. There are pockets and what typically happens is you get somebody who takes the action in a local community and a few other stores follow along because they don't want to miss the opportunity. But there has not been -- to this point, we have not seen any trends relative to increases of that magnitude, nor have we seen an effect relative to volumes at this point.

I live near a couple of different borders and it was in multiple states that all had raised prices by $6.00 a carton, so at first, I actually thought that the tax was already signed into law because of the fact that it was in three different states that this took place in, but you're saying nationwide, you haven't seen a trend?

No, in fact, it is a fairly risky thing because the cost is not fair at this point and all it takes is a retailer or two to keep their prices down and they're going to pull a lot of foot traffic over to themselves.

There is a little bit of confusion in regards to the proposed FDA oversight bill and I was wondering if you guys could clarify your position in terms of whether or not you are supporting the current version going through Congress or have you taken an opposing view along the same aisle as RJR and those guys?

Our position really remains the same as to what it has been. We generally support the bill. We always remain concerned about the details of the bill and we are watching it closely, but in general, we think that defining the provisions of how the industry operates is a productive thing. But again, our biggest concerned, as most concerns of everybody other than Philip Morris, is that Philip Morris gets to write the regulations in a way that will benefit them and hurt everybody else.

What we hear is that there is a lot of conflicting views within the Congress and that the -- particularly the pharmaceutical industry has expressed a lot of concern relative to FDA being able to maintain their mandate while having to deal with tobacco products. So there is a lot to be defined and what the final bills look like will determine whether or not we are finally supportive, but generally, we are.

Lastly, you guys haven't discussed recently amicable quarters of all about your efforts in the Vector Tobacco segment of the previous Omni brand. Any updates in terms of how the studies are progressing, what sort of developments might have taken place over the last year or so?

No, we continue to do work, Mark, but we're not ready to talk about anything publicly at this point.

Okay. Thanks a lot, guys. Congrats on the quarter, again.

Andrew Shapiro, Lawndale Capital.

Good morning. A question for Ron and then I have a few others here on Douglas Elliman and such. You had great Liggett results benefiting, it sounds like, from reduced promotional pricing and good volume. Is there any volume here that was one-time in nature, a new large customer, or was it all organic?

No, it is all organic.

On the pricing front, was this more of a rollback from deep discounts to moderate discounts or eliminating the discounts and normal pricing? How much more pricing latitude might you have to enhance results going forward?

We have been able, obviously, as the MSA rates increase, the portion of cigarettes that we sell that are not covered by the MSA, which is about 7 billion a year, we pick up margin on that segment. And I think that, given the level of tax increases that we're seeing and the potential of this FET increase, that there will be limited opportunities, but opportunities going forward and what we try to do is to position the brand in the most advantageous place for us from both a margin and volume standpoint. And what we are able to do is we're generating more and more margin on our Liggett Select brands as the prices have gone up and also we will pick up margin on Grand Prix over time, as well as in the contractual arrangements we have with our partner brand partners.

Okay. A few Douglas Elliman questions. Can you characterize the strength at Douglas Elliman? Has the New York market been broad in volume in price or were the results due to narrowing real estate strength?

You know, like they say, real estate is local. There is probably only five or six really good markets in the country and I guess from our perspective, the good news is we're in two of them -- the city and the Hamptons are very strong and we have a big presence in both of those and pretty big market share in both of those. Even within those markets, the high-end is pretty much outperforming the bottom and the middle. But it is pretty broad-based.

So what contingencies do you have in place should the New York markets follow the rest of the country, you know, as the subprime mortgage becomes more of a financial services problem?

There is really not much you can do. The good news about the businesses is the fact that the biggest cost is variable, and that is the brokers and salespeople (technical difficulty) commissions. So, you know, a big variable. And obviously, you have to watch your expenses, which we do anyway, as far as your marketing and advertising and so forth. We have tried not to really increase our expenses during this boom, other than commission expenses, which, obviously, is tied to revenue, and let the money come to the bottom line. I think we are set up pretty well.

Speaking of that, money has been coming to the bottom line and cash has been building up at Douglas Elliman. Is there a likelihood of another cash distribution coming up into New Valley and remind us of the terms of duration of the note that New Valley has with Douglas Elliman in terms of when and how that's supposed to be paid back?

During the quarter, we received about $4.6 million in cash and for the year, it was about $4.9 million for the six-month period. That was largely due to income tax distributions, as well as interest payments. As far as the note, I believe the notes are due in 2013 and there is a mechanism every year to pay the notes down for excess cash flow. However, one of the deductions for excess cash flow is the payments on the senior debt to Prudential, which as we said earlier, was about $18.4 million at June 30.

And then Douglas Elliman has -- or is becoming a pretty sizable business inside of Vector, even relative to the cigarette business. What day-to-day involvement or influence, if any, do you have here at Vector in the business in terms of buying out Prudential or being bought out by Prudential.

Prudential itself is not in the business, they are only a franchise company. They don't own anything.

I think they offered to sell you their portion at one point.

The finance company at Prudential, which financed the purchase for us. At one time we talked with them about buying their 20%. We still talk. It is not that important, but if we can get it for the right price, we would buy it. There is no ongoing conversations at this point.

Okay. In terms of this, since it is becoming more sizable, it's still below the line because of the way the consolidation and ownership rules operate, is there any thought on the part of Vector of monetizing it since it would obviously have a very substantial cash flow benefit and gain to Vector from this?

We think about it everyday.

Can you update us on the status of the Hawaiian hotel development and the St. Regis development?

It is pretty much status quo, there is really nothing new to report at this particular time. The renovation is going on on St. Regis, going along well. Look, I think that my overall feeling on the real estate is, especially on the hotel market, we are at the very top of the market. Okay? Obviously the way I view real estate is everything is for sale at the right price, so we played around with speaking to some people and if something came across that was what I felt was a high priced for either of those assets, we would be a seller.

A few questions that maybe BK-related. I noticed for the quarter ended June from March, cash has dropped and receivable from litigation settlement -- but on the liability side, I was wondering if you could explain the sizable drop in what is called settlement accruals in your current liabilities, it about $30 million sequential quarterly drop. Is that a bankruptcy settlement, is that a tobacco litigation settlement?

That is all the payment of the master settlement agreement expense in April of 2007.

What happens with that? That over time builds up and then it gets paid down in a once-a-year, twice-a-year payment?

You are correct.

And the other liability side had a very sizable jump, as well, not as meaningful to the total balance sheet, but still sizable, went from $8 million up to $13.5 million. What is that indicative of?

Can you repeat that please, Andy?

In your longer-term liabilities, the line item is called other liabilities. I believe it went up from $7.995 million to $13.5 million, a sizable jump.

That is right and actually, if you look, also, other current liabilities decreased from $18 million to $16 million and that increase was largely due to the decrease in other current liabilities.

Okay, reclassification. Last two. The 2006 corporate tax return is necessary to finalize your return on capital calculations. When do you anticipate that filing getting filed and the return on capital numbers being locked down for the '06 tax year?

We are still awaiting one significant K-1. Whenever we receive that, we think we will be a ready to go around September 1.

September 1. With just that one last K-1 left, has your return on capital numbers and ranges narrowed or changed at all?

They are still the same that we've been saying for sometime.

With respect to '07, this tax year, now with six months in bag, you're already in the middle of your third quarter, you've had sizable gains, is it your estimate that there should be no return of capital issues here in the '07 dividends we have received to date and are expected to receive?

We believe they will be 100% taxable as of June 30.

Excellent. That is all I have.

(OPERATOR INSTRUCTIONS) Mitch Pendant, Royal Bank of Canada Capital.

A follow-up question to the cash question I asked earlier. We were talking about roughly $126 million I think it was in cash and equivalents.

Yes.

The question is do you have any exposure -- with everything that has been going on lately, do you have any exposure to the mortgage-backeds in anyway?

We have no mortgage-backed securities.

That's all I had. Thanks, guys.

Mr. Lorber, at this time, there are no further questions.

I would like to think you all for participating in today's conference call. As always, Ron, myself, BK are always available to answer any questions you may have. We look forward to speaking to you on the third quarter conference call. Have a good day.

This concludes today's teleconference. You may now disconnect.