Vector Group Ltd (VGR) 2008 Q2 法說會逐字稿

Welcome to the Vector Group's second quarter 2008 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 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 2008 earnings conference call. With me today is Ron Bernstein, the President and CEO of Liggett Vector Brands and Liggett, and Bryant Kirkland, Vector's Chief Financial Officer.

On today's call, I will provide an overview of our business and review Vector Group's financials for the second quarter and first half of 2008. Ron will then review the performance of Liggett Group and Vector Tobacco for the period, discuss recent industry developments, and provide you with an update on the competitive environment. After that, we will take your questions.

Let me start by saying I am very pleased to report that our conventional tobacco business continued its trends of earnings growth during the second quarter of 2008, with operating income for the second quarter increasing by a robust 16.6% over the prior year period. While we feel very good about our performance during the first half of this year and are confident about our prospects going forward, it's important to note that competitive challenges remain in the cigarette marketplace. Ron will discuss these matters in detail shortly, following my review of Vector Group's financial results.

As reported on the last call, New Valley closed the sale of its 50% owned investee, the St. Regis Hotel, in March 2008. In connection with the closing, New Valley received approximately $15.8 million and expects to receive an additional $1.4 million by the end of this year's third quarter. In addition to retaining a 3% interest in the hotel, New Valley anticipates receiving another $5 million in connection with the sale of tax credits from 2009 to 2013. Despite of a challenging real estate market, New Valley's net IRR in this transaction is approximately 30%.

Before discussing the financial results for the quarter and the year, I would also like to note that our liquidity remains strong with cash and cash equivalents of approximately $219.8 million as of June 30, 2008. In addition, as of the June 30, 2008, we held investment securities and partnership interest with a fair market value of approximately $120.8 million.

Now let's turn to the key financials for the three months and six months ended June 30, 2008, for Vector Group. Our financial results for six months ended June 30, 2008, include approximately $12 million of income from our interest in the St. Regis Hotel in Washington, DC. Our financial results for the three and six months ended June 30, 2007, include an $8.1 million pretax 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 of accrued interest.

Our financial results for the six months ended June 30, 2007, also include the previously announced March 2007 settlement between New Valley and the United States government under which the Company received $20 million. We recognized a pretax gain in the first quarter of 2007 of approximately $19.6 million as a result of this settlement.

For the second quarter ended June 30, 2008, Vector Group revenues were $143 million compared to $140.4 million in the 2007 second quarter. The Company recorded operating income of $34.3 million compared to operating income of $29.2 million in the 2007 second quarter. Second quarter 2008 net income was $19.1 million, or $0.25 per diluted share, compared to net income of $21.4 million, or $0.32 per diluted share, in the 2007 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 $0.25 per diluted share.

For the six months ended June 30, 2008, Vector Group's revenues were $275.2 million compared to $274.2 million in the first six months of 2007. The Company recorded operating income of $62.4 million compared to $54.9 million for the 2007 period. Net income was $33.4 million, or $0.51 per diluted common share, compared to net income of $44.5 million, or $0.68 per common share, in the 2007 period. Excluding the income from the St. Regis in 2008, net income was $26.3 million in the first quarter of 2008, or $0.41 per diluted share.

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 $0.43 per diluted share. The decline reflects the increase in interest expense and the decline in the equity income from Douglas Elliman Realty business, offset by non-cash charges related to the accounting for the Company's convertible securities.

Now I will turn the call over to Ron Bernstein, who will review the key financials for our Liggett and Vector Tobacco subsidiaries. Liggett's numbers reflect sales for both Liggett Group cigarettes and conventional cigarette products from Vector Tobacco.

Thanks, Howard, and good morning to everyone. As Howard indicated, we are pleased with our earnings thus far in 2008. We believe that our continued strong performance is the direct result of the long-term growth and pricing strategy that we implemented in 2004 and the adjustments that we have made since to effectively strike a balance between earnings and volume growth. We are particularly pleased that we have been able to sustain earnings growth over the past several years despite operating in challenging industry conditions, and more recently in a negative economic environment.

While we continue to see some generally stabilizing trends in the marketplace, we do also see new risks emerging. Looking at the Big Two, the market leaders have moved away from some of their most aggressive volume-generating programs, but appear to be shifting strategy by continuing to introduce programs that are designed to capitalize on their market dominance. We also continue to see a decline in many of the more established non-participants of the Master settlement agreement.

However, as state excise taxes increase around the country and general economic conditions deteriorate, we are now seeing replacement companies and brands emerge that could lead to market challenges in the future. To that end, Management Science Associates data indicates that if 24 new deep discount brands launched in the first half of 2008, 22 of those brands are manufactured by non-participants of the Master Settlement Agreement. This is something that we are watching closely. Particularly we are seeing significant growth in Native American reservation-related business in states that have lax MSA enforcement, and states that have failed to pass MSA-related legislation.

Given the competitive environment, we have focused our attention in 2008 on maximizing performance on Grand Prix, while pursuing margin opportunities on other brands in our portfolio. Overall, second quarter industry wholesale shipments were down 3.2% compared to the prior year period, while Liggett wholesale shipments declined by 3.9%. This decline includes a 20% decrease in shipments of Tourney to Speedway SuperAmerica, which is in line with the mutually agreed revision to the Tourney shipment schedule for 2008.

We are pleased to note, however, that wholesale shipments of Grand Prix, our growth brand for the past three years, increased by 8.6% compared to the prior year period and by 6.6% compared to the first quarter of 2008. For the second quarter, wholesale shipments of Liggett Select decreased by 9.1%, while shipments of Eve were essentially flat. This performance is consistent with our expectations for these two brands in the current environment.

Turning now to the numbers, for the three- and six-month periods ended June 30, 2008, our conventional cigarettes generated revenues of $142.3 million and $274 million compared to $139.3 million and $272.1 million for the corresponding periods in '07. Operating income for the three and six months ended June 30, 2008, was $43.7 million and $81 million compared to $37.5 million and $72.9 million for the corresponding year-ago periods. For the three and six months ended June 30, 2008, Vector Tobacco's operating losses were $1.9 million and $4.3 million compared to operating losses of $2.1 million and $4.4 million for the prior-year periods.

Turning back to the industry analysis, in addition to the activities of non-participating manufacturers that I mentioned earlier, we continue to see significant growth from other new renegade type threats in the market, particularly from the sellers of little cigars and roll-your-own cigarettes. Since 2003, these two categories have grown by the equivalent of approximately 8 billion cigarettes, a 90% increase, while manufactured cigarettes have declined by approximately 2.5% to 3% annually over the same period.

The reason for this growth is the extraordinary and seemingly indefensible tax advantages enjoyed by little cigar and roll-your-own products. These tobacco categories pay approximately 10% of the federal excise tax rate paid by cigarette manufacturers and on average approximately 25% or less of the state excise tax rate.

We have been working with the U.S. Congress, the public health community, and state authorities to equalize the tax rate on these products to that of manufactured cigarettes. As these companies grow, it is becoming clear to all concerned that they enjoy an unfair advantage in the marketplace and are undermining the efforts of Congress and state legislators.

As previously noted, we introduced Grand Prix snus in the second quarter of 2008 to capitalize on the growing alternative tobacco market. Grand Prix snus is a pouch tobacco products designed for adult smokers who are interested in smokeless tobacco alternatives to cigarettes, as well as for existing adult users of other smokeless products. We have been watching the growth and developing of the U.S. snus category for the past two years and concluded that there may be a strong opportunity to introduce our own snus product as part of the Grand Prix brand family.

Grand Prix snus has recently been introduced into a number of test markets including Portland, Oregon; Kansas City, Missouri; Indianapolis, Indiana; Dallas-Fort Worth; Raleigh, North Carolina; Orlando, Florida; and Columbus, Ohio. Grand Prix snus, which is available in three flavor varieties -- original, spearmint, and wintergreen -- is a premium quality snus product manufactured in and imported from Sweden. As with Grand Prix cigarettes, our market approach is to offer adult snus consumers a high-quality product at an affordable value price point.

As also previously reported, we began shipments of Tourney snus to our long-time market partners, Speedway SuperAmerica, during the second quarter. Speedway launched Tourney snus into all of their 1,588 stores and is making a major commitment to the brand. We are excited about this opportunity and believe the taste and value proposition provided by both Tourney snus and Grand Prix snus may appeal to a wide range of adult consumers. We are generally encouraged by the initial performance of Tourney and Grand Prix snus with strength in some markets but softness in others.

These mixed initial results are consistent with those of our competitors. In markets where Reynold's snus products are performing well, our products are following suit. However, we are also seeing slow initial movements in markets where Camel snus is not performing well. We believe that education about the snus product and time are the keys for evaluating the potential of these products.

From the start we have viewed this as a long-term proposition and planned accordingly. As a result, we have a go-to-market approach, which limits expenditures while allowing us to evaluate the longer term snus opportunity. We look forward to providing further updates as the product develops.

On the litigation front, as expected, pursuant to prior rulings in the now decertified Engel class action in Florida, approximately 2,150 cases have been filed on behalf of approximately 9,570 individual claimants where Liggett, Vector, or both were named as a defendant along with other cigarette manufacturers. Since the deadline for filing claims has passed, the total number of Engel claimants will not increase, but the number of cases will likely increase as the various courts hearing these cases may require multi-plaintiff cases to be severed into individual cases. Although trial dates are subject to change, currently there are nine individual Engel-related actions scheduled for trial in late '08 or early '09.

On the legislative front, federal legislation to fund the State Children's Health Insurance Program, which would have included a $6.10 per cart increase to the federal excise tax, remains on hold. However, it is possible that the legislation may be introduced again prior to the November election, but it is unclear if the likely presidential veto can be overridden. Recently, the U.S. House of Representatives passed legislation to grant the FDA authority to regulate tobacco products.

We understand that there is currently no time allocated in the Senate to debate this bill and as of last counting there are insufficient votes in the Senate to override the promised presidential veto. However, I want to emphasize that given the nature of this election year, the legislative process is fluid and can change at any time.

In conclusion, I would like to say that we are very pleased with our results during the first half of 2008 and continue to look for opportunities to build upon our strong performance. We will continue to watch legislative and market developments closely, and are prepared to address any changes that may occur. 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. Now, operator, would you please open the call for questions?

(Operator Instructions) [Mitch Pendiss.]

A couple of quick questions. The Engel escrow money that was held up after the case was decertified, is that now being utilized eventually if any of these cases get settled as a settlement?

As I understand it -- and Dick, you are on; correct me if I am wrong -- I believe that that money is not being used. Our money was basically more in line of being a fee in order not to have to post a bond.

Okay, so all of the companies, including yourself, are then going to have to forfeit that money. Is that where it is?

The money is going to really for two sources. One portion is being used to pay an attorney's fee and the balance of it is being used to make payments to, I think, 10,000 some odd individuals in Florida who have applied under the procedures set forth by the court. I don't think there is any clarification at this point of whether there would be any offset if those people are also plaintiffs in the individual Engel actions. Although, clearly, the industry would make that argument.

Okay, I actually assumed that was what was happening. I just wanted to get confirmation. Can you address, Howard, some of the partnerships and where they stand, why you are making them, future investment opportunities? I noticed that the cash balance dropped by a bit this quarter and I assume that was because of the Palm Springs investment.

Yes, it could be. I can talk briefly about Palm Springs and the Aberdeen. Palm Springs was basically a community right outside the airport of Palm Springs that originally was -- it's 450 acres, 900 lots. They sold -- Lennar sold, I think, about 200 of the lots prices upwards of about $250,000 a lot. The infrastructure is almost complete. The golf course is complete. The clubhouse is almost complete. Then they decided they weren't going to go forward and defaulted, and we bought the notes.

Assuming we get ownership, there is a second mortgage. Obviously, the second mortgage holder could just take us out and we get a return and that is it. Although, quite honestly, that is not why we went into it; we would like to own it. If we owned it at the note price, we would be in at about 30 -- by the time we get it, maybe $35,000/$40,000 per lot in a project where lots were going in the $200,000s.

So, obviously, it's not something that you could sell today, but we don't own it yet today. So we are hoping, if we get the property and wait it out a little bit and the markets turn to a little bit more normal markets out there, we could stand to make a substantial profit on the project.

Okay, so right now that note is just accruing?

Exactly correct.

Okay. Can you talk about Aberdeen and the healthcare companies and the other investments you have?

Yes, Aberdeen is a company that is buying and renovating townhouses in the city and basically provides services to townhouse buyers. One of the negatives of buying townhouse was who takes care of problems when you have a problem in the townhouse as opposed to an apartment? There is no super. So this is a company that is providing full services to the townhouse buyers. Whatever they need, they call them or e-mail them, and they have people on staff to take care of every need.

They have purchased so far, I think, it's about seven. This was a loan that is due in two years. It's a 15% rate and an equity kicker. I think our analysis and our projections -- we believe that our return would be 25% to 30% in the two years. So the real estate stuff we are doing really has to have those type of rates of returns for us to be interested. We are looking at another loan possibly to make pretty shortly with rates in excess of that.

Okay, and I noticed that you also purchased a healthcare company, a publicly traded health care company.

Dick, you want to mention --? Do you want to talk about that?

Sure, we purchased some additional -- made an additional investment. We have -- we didn't purchase the company. We have a small percentage investment in a public healthcare company called [OpGo]. We think it's some very interesting and potentially exciting products that they have. Without getting into great detail, it's really the first company to take a product to Phase III clinical trials based on the Nobel Prize-winning RNA interference technology. Here it's being applied to trying to deal with macular degeneration. It's a company that focuses on ophthalmology products, so it's an investment that we think is something that had some real potential.

Well, this is out of the ordinary for you. I am assuming that you are piggybacking on Philip Frost's knowledge at that point.

Well, we are, certainly. Phil's involvement is important, but I think when you look at the history of Vector's/New Valley's investments, we have made investments in a number of industries historically.

Okay, I guess that brings me to my next question that is related to the high cash balance you are carrying. I think you mentioned, Howard, $219.8 million in cash. Obviously, that is a negative carry right now at high interest rates and we can all see the markets coming down in various areas. You have always historically loved the real estate.

I am just wondering what types of investments you are looking at. Are you looking at the more financial investments, buying up pools of CMOs or investing in a hedge fund type investment? Or actual physical real estate and what type of things are you looking at? And how fast do you expect to deploy it?

Look, there is a lot of interesting opportunities, but with these opportunities there is all sorts of problems and issues. I must have met with eight or nine different people who are putting together CMO funds and CDO funds and second mortgage funds. And almost in every case, they come out of the companies and ran the companies that made the loans, the bad loans to begin with.

I always have an issue saying, okay, great, so you made these loans at Lehman and now you left Lehman and now you are going to buy those same loads you made at par? Now we combine for $0.40 and you are going to tell me why it's so good. You know, I sort of have a problem with that.

So what we are trying to stick to is nothing esoteric. We are trying to stick to basically real estate via loans, not actual loan to shift but via mezz or very high interest with equity kickers where the markets have really dried up for these type of people. So there are lots of developers that have projects that need money now and we are working on probably six, eight of them at any one time. As I said, we have another one we are getting close to doing, and we have a bunch of them that we continue to look at.

As far as investments go, our big hedge fund investment is basically with Icahn, who historically has done great. He hasn't done great this year, but I have confidence that he will continue to do well. Steel Partners we have been with forever; they have done very well. A couple of smaller new ones, and then as far as some of these small deals with Phil or anyone else, we still believe it's a good idea for us to dabble in these, where a few dollars can turn into big money if they hit.

So that has sort of been our strategy. As I have said many times, we are not going to take $200 million and do one project or one deal. We like to diversify.

I guess the last question relates to one of those bigger investments, the Prudential Elliman relationship, and you have been paying off the debt over time. I wanted to find out a little bit about where you are with that, how Prudential is performing right now.

Okay, as far as how we are performing, '08 so far looks more like an '06 type of year. I was on CNBC couple of weeks ago and they were talking about, wanted to ask about the markets. And I said, '07 we were up some odd 40% from '06. So now transactions are down about 35%, so that sort of brings us back to '06. You know what? If you don't look at '07, you would say, boy, '06 was a pretty good year. Maybe that is more of a normalized year. It's hard to tell in this setting, but maybe that is a more normalized year.

So we are sort of running around the '06 type of numbers. Although just even recently, we have started to see some pickup, which is strange for August. So our performance is okay. It's not going to be an '07 type of year, but we are profitable and we expect to have a pretty decent year. As for as Prudential, the loan has been -- the senior loan is completely paid off and the only thing left now is the sub loan. Is that correct, BK?

It is, and the face value of that is $18.9 million. We will begin receiving payments of about $1.2 million per quarter for the next eight quarters.

The $18.9 million is half ours and half Prudential's.

What was the size of the senior initially?

Was it 50-something, BK?

$52.5 million.

$52.5 million.

If you paid off at $52.5 million in, what is it five years now, I guess, since you have owned Prudential?

That is correct.

That is very nice. So you are going to start cash flowing directly to your holding company at this point?

Yes.

Okay. Thanks, guys. I appreciate it.

Brad Burroughs.

Actually, it's [Fred Burroughs]. Mitch, hogged the lectern here and asked most of my questions, so I will just follow up with have you had any further discussions on acquiring maybe further interest in Douglas Elliman from Prudential? I know you mentioned on the last call you were thinking about talking to them down in the conference down south. I just wanted to see if there has been any further conversations there, if that is something you are still interested in.

Definitely interested in it. Here is the lay of the land. You know, last year was a great year. Their idea of what the value was was way up, but this is not as good a year. I think equally as important or more important, we have now passed a halfway point in our franchise agreement with Prudential. It was originally 10 years. We are five years and a few months into it.

You know, time goes very fast. So they really have a diminishing asset as far as us as a franchisee, because at the end of 10 years we don't have to renew. We are paying them now. BK, what are we paying, about $8 million, $9 million?

Yes, that is correct.

$8 million, $9 million in franchise fees, which if we didn't have to pay them, it's not going to hurt our business at this point. Our name is well-established. The Douglas Elliman name is well-established. You put a cap rate on that, that is worth a lot of money.

So I think what is going to happen is, I think as time goes on, probably sometime if I had to guess within the next year or two, we will have a serious conversation of them selling us their stake at we would consider to be a very good price. And them wanting us to sign an extension to our franchise agreement, which we would consider depending and what we paid for their 20% stake in Douglas Elliman. So I think those two things will happen at some point.

I see. Now, doesn't Dolly Lenz own a fairly significant chunk of the company?

Dolly Lenz owns nothing. Dottie Herman -- Dolly Lenz is a broker.

I am sorry, that is right. Dottie Herman owns a chunk?

Dottie Herman owns about 30%, a little bit less.

30%, and so you guys own 50% right now. Is that right?

We own 50%, approximately. We own 50%, Dottie owns about 30% -- is 80% -- and 20% is owned by Prudential.

Is she interested in selling any portion of hers to you as well or not?

Look, I think, you know, it doesn't really matter at this point. This is her life and whatever. Yes, she probably would like to cash in some, but I would sort of like to do it at the same time, and with that we could buy the other 20%.

Okay, great. Nice quarter. Thanks, you guys.

(Operator Instructions) There are currently no more questions.

Okay, I would like to thank everyone for being on this conference call. We are pleased with the results. I hope everyone agrees with us on that. We are always available for any questions you may have between now and our next conference call. Thank you all for being on the call today.

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