Vector Group Ltd (VGR) 2009 Q1 法說會逐字稿

Hello and welcome to Vector Group's first-quarter 2009 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.

I would now like to turn the call over to the President and Chief Executive Officer of Vector Group, Howard Lorber.

Good morning. Thank you for joining us on Vector Group's first-quarter 2009 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 first quarter of 2009. Ron will then discuss the performance of Liggett Group and Vector Tobacco for the period and provide an update on industry developments and the competitive environment. After that we will take your questions.

Let me begin by noting that as expected, the federal excise tax increase of $6.17 per carton to fund the State Children's Health Insurance, or SCHIP legislation, as it is known, became effective on April 1, 2009. As anticipated, this extraordinary tax increase had an impact on our first-quarter performance as it did on all other industry participants and will likely impact our conventional tobacco business performance throughout the balance of the year and beyond.

Importantly, we believe that this changing landscape presents some interesting opportunities for us, which Ron will cover in more detail following my review of Vector Group's financial results.

Before discussing the financial results for the quarter -- I am very pleased with yesterday's announced completion of a $50 million private placement of our convertible notes due November 2014. The purchaser is an affiliate of Dr. Phillip Frost, one of our country's most successful entrepreneurs. The proceeds of the offering will further add to our strong liquidity position and will be available for general corporate purposes.

Our liquidity remains strong with cash and cash equivalents of approximately $202.3 million as of March 31, 2009. In addition, as of March 31, 2009 we held investment securities and partnership interests with a fair market value of approximately $79.2 million.

Now let's turn to the key financials for the three months ended March 31, 2009 for Vector Group.

Our financial results for the 2009 period include a pretax gain of $5 million related to the 1999 trademark transaction with Philip Morris, which was offset by a pretax impairment charge of $8.5 million on real estate, and pretax restructuring charges of $1 million.

Our financial results from the 2008 period include $12 million of pretax income from the St. Regis Hotel sale.

For the first quarter ended March 31, 2009, Vector Group revenues were $121.2 million compared to $132.2 million in the 2008 first quarter.

The company recorded operating income of $31.2 million in the 2009 first quarter compared to operating income of $28 million in the 2008 first quarter.

First quarter 2000 net income was $3.1 million or $0.04 per diluted share compared to net income of $14.3 million or $0.21 per diluted share in the 2008 period.

Excluding the gain on the trademark transaction and the impairment losses and restructuring charges in the 2009 period, the company's net income for the 2009 first quarter was $5.7 million or $0.08 per diluted share.

Excluding the $12 million income from the St. Regis Hotel sale, the company's net income for the 2008 first quarter was $7.2 million or $0.11 per diluted share.

Now I will turn the call over to Ron Bernstein for a review of our tobacco subsidiaries. Liggett's numbers reflect sales for both Liggett Group cigarettes and conventional cigarette products from Vector Tobacco. Ron?

Thanks Howard. And good morning everyone.

As Howard noted, on April 1, 2009 a $6.17 per carton federal excise tax increase on cigarettes became effective. As it is the largest federal tax or fee increase on tobacco in history, it significantly impacted Liggett and the industry during the quarter and will continue to do so going forward.

On February 9 the industry leader announced a price increase of $0.90 per carton on its major brands. This was then followed with a $7.10 per carton increase on March 9. The remainder of the big three followed suit shortly thereafter, and by March 31 the rest of the industry had all increased prices by at least $6.17 per carton.

Initially, because of the early march timing of FET-related price increases by the large manufacturers, there was a great deal of confusion among trade wholesalers and retailers, with many believing that another large price increase would occur on April 1, the effective date of the tax increase. This resulted in significant trade loading both before and after the big three announcements.

As it became clear to the trade that another increase was unlikely, it also became clear to wholesalers and retailers that they would be responsible for paying a $6.17 per carton floor tax to the federal government on all their inventories as of March 31. Since prices had already been increased by the manufacturers to recover the additional tax expense, wholesalers and retailers would be forced to pay out of their own pockets the additional $6.17 per carton for any inventory they held as of March 31. This led to an unprecedented de-load of trade inventory at the end of the first quarter.

As a result, and in order to comply with the trade programs of the big three, programs that we had long believed to be anti-competitive, as the industry de-load took place, wholesalers and retailers first attempted to assure that they had sufficient inventory to meet their big-three program requirements and aggressively reduced all other inventory.

No one was spared from this de-load activity including the big three, but we believe that we and other smaller manufacturers were disproportionately impacted. With that in mind, let me now review the numbers.

For the three months ended March 31, 2009, our conventional cigarettes generated revenues of $120.9 million compared to $131.6 million for the corresponding period in 2008.

Operating income for the three months ended March 31, 2009 was $38.4 million compared to $37.3 million for the corresponding 2008 period. Included in the March 31, '09 operating income is the one-time gain of $5 million related to the 1999 trademark transaction with Philip Morris. Additionally, Liggett's first-quarter earnings were negatively impacted by $1.6 million compared to the prior-year period due to 2008 investment losses in the Liggett pension plan.

For the three months ended March 31, 2009, Vector Tobacco's operating losses were $2.8 million compared to operating losses of $2.4 million for the prior-year period. Included in the March 31, 2009 operating loss for Vector Tobacco is a $1 million, one-time restructuring charge related to the planned shutdown of Vector Tobacco's North Carolina-based research operation effective May 31. We project an overall annual savings of approximately $2 million as a result of this action.

Dr. Tony Albino and a small staff will continue to direct research out of our New York office and will also represent Vector on matters pertaining to FDA regulation and public health.

As mentioned in previous calls, since 2004 we have executed a strategy that strikes a balance between earnings and volume growth. And we believe our results over the past several years have validated that approach.

While current market visibility is limited, we believe that continuing our approach is prudent. In addition, we believe that the current dynamic of the marketplace, absorbing a significant tax increase, presents volume growth opportunities for Liggett in the discount segment. And we are proceeding accordingly.

As previously noted, first-quarter wholesale shipments were significantly affected by activities related to the April 1 tax increase and are not a true indicator of Liggett's performance. Overall industry wholesale shipments for the first quarter were down 10.4%, and Liggett shipments were down 16.2%. Industry retail shipments during the same period were down 2.7% with Liggett shipments down 6.3%.

Our Grand Prix brand continued to perform well in this difficult environment with retail shipments down only 1.8%.

Liggett Select declined at a rate of 12.4% while EVE retail shipments declined by 4.1%.

In terms of new initiatives, on April 1 Liggett Vector Brands announced the launch of Pyramid box and began shipments to wholesale on April 24. As some of you may recall, Pyramid was introduced to the market as the first deep discount branded cigarette in 1988, and at the time the launch was considered one of the most successful in history.

Pyramid's new box styles are being offered at highly competitive but sustainable low pricing. We believe that as market definition develops over the coming months, Pyramid box will offer the trade and consumers the best value proposition available in the market. We are targeting the projected growth of Pyramid carefully and are offering Pyramid-focused promotional programs that we believe will also support our other core brands.

We are excited about the Pyramid box launch, and we will update you in future calls on this and other initiatives that we are undertaking to succeed in a changing tobacco marketplace.

Relative to 2009 earnings, and as indicated during our year-end call, economists and industry analysts who reviewed the potential impact of an FET increase of this magnitude estimated that industry volume would decline by approximately 8% in the 12-month period following enactment of such legislation.

Recently there have been volume estimates by other manufacturers and industry analysts that range from the high single digits to the low double digits. There are many variables at play in determining an accurate rate of elasticity for cigarettes in the current economic environment. And we are not making any independents predictions.

With that said, we believe the estimated range of decline previously referenced is realistic, and our plans have been developed accordingly.

It is also important to reiterate what we said on the last call, that any industry volume decline greater than 3% will result in a decline in Liggett and Vector Tobacco's MSA cap benefit. We estimate that the earnings impact to us will be approximately $1.8 million for each percent of industry volume decline above 3%.

Additionally, despite operating in the discount segment, we are not immune from an overall industry volume decline. Thus, we expect to see some short-term earnings pressure related to volume declines and also anticipate a shift to lower margin brands.

One positive aspect to the SCHIP legislation is that Congress finally took action to correct a long-standing inequity and equalize the excise tax rates on little cigars and roll-your-own cigarettes to that of manufactured cigarettes. As I've stated before, those two categories have grown by over 8 billion cigarette unit equivalents, over 90%, during the past five years, while manufactured cigarettes have been declining in the general range of 2.5% to 3.0% per year during the same period.

The primary reason for the growth of little cigars and RYO cigarettes has been the extraordinary and we believe unfair tax advantages that they previously enjoyed on the federal and state levels. They have been paying approximately 10% of the FET rate and on average 33% of the state excise tax rate paid by cigarette manufacturers. Had the FET rate not been equalized, the companies selling such products would have enjoyed an approximate $9.00 per carton advantage on the federal tax rate alone. Thankfully this was not the case and the new legislation should help level the playing field on a national level.

However since the April 1 tax increase, we have noted that some manufacturers of little cigars are attempting to evade the new tax rate by classifying their virtually identical products as large cigars, which enjoy a lower tax rate. It's our belief that the public health community and federal regulators will clearly see through this and correctly assess the correct tax rate for these products.

While most state tax rates have not yet been equalized, there is proposed legislation pending in several states, and we believe that revenue-starved states will quickly follow the federal government's lead.

Another area that we believe is being looked at by the federal and state governments is smokeless tobacco products such as snuff, chewing tobacco, and snus. These products enjoy the same sort of tax advantages that little cigars and RYO formally did, and it seems clear that PM's acquisition of UST, and Reynolds acquisition of Conwood at least in part relate to the profit and growth opportunities created by the lower, more favorable tax rates enjoyed by these products.

We will keep you posted on any significant legislative developments in the smokeless market. We intend to watch all of these developments carefully and take action as necessary to ensure the fairest possible marketplace for all of our products.

Additionally on the legislation front, the House recently passed legislation that would grant the FDA authority to regulate tobacco products. The Senate is currently scheduled to take up the FDA bill in May, and the expectation is that it is likely to pass a version similar to the House bill.

In the past we have generally been supportive of FDA legislation but have been concerned that the final version might end up providing an unfair advantage to the market leader. We still have that concern and are also troubled that current language gives a short-term exemption on certain compliance issues to companies smaller than us. Many of the companies that would benefit from this exemption are the companies that have avoided and evaded provision of the MSA and other state regulations in the past.

We are continuing to review the bill and meet with appropriate congressional leaders to ensure that the bill is fair and that the playing field is level.

In conclusion, while the large federal excise tax increase has created an environment of market uncertainty, we have spent a great deal of time preparing for this event and believe that we are well-positioned to take advantage of the opportunities created by it and to maximize our performance in this challenging environment.

Thanks 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 [Hindis], Royal Bank of Canada.

I'm looking at a couple of things, specifically some of the outside investments other than the tobacco business, and there have been some significant write-downs in that. I was wondering if you could address that and tell us what you see happening going forward with some of those investments?

Well, I think most of the investments, the write-downs were in the real estate side. Is that correct B. K.?

That's correct Howard.

I think the biggest ones were in this property that was -- we had bought a defaulted note on a project in Palm Springs, California, called Escena, E-s-c-e-n-a. We had paid originally about $21 million, $22 million for the note. The property at the time we bought it, I think was appraised in the mid-30s. Subsequent to that, as the real estate market weakened, the appraisal kept coming down.

And we actually sort of benefited by the fact that it came down because there was a completion guarantee by Lennar. And the way the law works in California anyway is that you can't -- basically if the value is more than we own the note for, we couldn't sue them for money under the completions guarantee. So as the value came down below what we paid the note for, the appraisal came down below what we paid the note for -- what we've paid for the note -- we were able to enter into a settlement agreement with Lennar, who put up I think about a $9 million letter of credit -- B. K. (multiple speakers)

That is correct. It's $8.5 million, Howard.

Made out letters of credit to finish the clubhouse, get the golf course in shape and do some other work, and basically where we ended up now -- and I guess we are all-in or about, what, $23 million? $24 million?

We have a project which will be ready to go as the market picks up with about 900 lots. The original lots were sold -- the first 200 lots were sold for about $250,000 per lot, so we're going to be in for $30,000 a lot by the time we are finished, and we're going to start having some meetings with home builders out there. There's also a pad for a hotel. There is also a piece for possible seniors housing. So we think it's a very exciting project where we think there is a tremendous amount of value.

So that's a typical example of a write-down where we think now that we own the property -- the foreclosure sale took place, we own the property -- we think there is tremendous value there.

And then there's a couple of other ones like that which maybe there's not as much value. We had made a loan on some townhouses that were purchased and renovated -- well, of five of them, three of them are completely renovated. We have $10 million in that deal. I think we've written that down to how much, B. K.?

$3 million Howard.

Well, we've written it down to $3 million, and we are signing a contract today on the sale of one of them where we are going to get out of it about -- I guess about $3 million, right? $2.5 million or $3 million.

Yes, right. In excess of mortgage rights.

We still have the other four. So, look, we've done what the accounts have wanted as it related to the write-downs. But we still believe in that case we should figure a way to at least get our money out.

Escena I believe we will make a lot of money on. So the write-downs are really real estate market related.

And if I read right, you are now -- you've now taken over the management of the townhomes?

Yes, correct.

And what about Oaktree?

That's the Chelsea deal, Howard.

Oaktree is which? Chelsea?

The Chelsea, right.

That was a loan that we made where we basically took out all the economics from the developer. He was underwater. He was over budget. It was 80% sold at a very high price. The big risk at the time was the curtain wall, the facade of the building. It was a very fancy design by architect Jean Nouvel, and it was being fabricated in China, and the big concern was, will it ever show up?

Well actually, it did show up. The bulk of it is hung already. There's a few more pieces that are still on the water on the way over.

And the bigger risk now as the market deteriorated is, will the people that have up these big deposits close? Most of them have deposits up at 15% or 20%. But they paid a pretty high price, so we will lose some. I'm sure we will lose some deals, but we feel pretty confident about making a very good return on our investment on that project.

Okay. So it seems like that's the case with a lot of the outside projects.

Exactly.

And the partnerships? Are you still in the hedge funds with Carl Icahn, etc.?

We are still in them. We didn't get out last year, which I guess is good news, as we all know. I think Icahn is up for the year about 8 or 9. I think he is up in May. I spoke to him yesterday, I think you're up another 5 so far in May, so we got back about 14.

We had another small one that we had invested $5 million. That was down to about $3 million and change. They were up I think 30% in April -- B. K.?

Right. The value at the end of April of the hedge funds was roughly $57 million.

Compared to -- what was our cost on them all? (multiple speakers) I'll tell you exactly what it was. It was $65 million, right?

$65 -- $67 million.

$67 million, yes.

Okay. And on the tobacco side, you addressed what's happened in the first quarter. I'm just wondering if you are seeing any volume pick-up in April and this quarter?

The market is still unclear, Mitch. The -- there is a lot of movement going on in the marketplace, and what you had in April was a reload that sort of artificially affected the market again. So we're not going to have a clear handle I don't think until it gets later on.

We have seen our volumes stabilize. So we are optimistic, but there's going to be a lot of fits and starts as various companies make different moves in the marketplace. So I think it's going to take a little while before it really stabilizes.

My final question relates to the cash. As you mentioned, Howard, cash is king, but at 0.25% or 0.50%, and you take into account what you are paying on that money, it becomes significantly -- it is dilutive to your earnings. And my question relates to why raise an additional $50 million when the only major cash need that I see this year is related to a retirement benefit payout?

No, that's not really true. The converts -- the series of converts that were -- what were they, at a rate of five -- they were 5%?

But due 2011.

2011 -- had a put feature. Well first of all, we have to buy back about $20 million of those under the indenture this year. And in addition to that, there was a put provision. Now, no one ever thought about the put provision -- or we didn't think about it as it being a potential issue until the stock came down when the market came down, because the bonds were trading -- if you go back, they were trading 130, 140 I think. The stock was way above the conversion price, and it was never an issue.

So as the markets deteriorated in the last six, eight months, we became concerned, although we had the money to pay them back, but obviously it would be a big chunk of money if all 120 million bonds were put to us. So --

And we also have a tax payment due, the final tax payment in conjunction with the Philip Morris brand transaction from 1999. That payment is due in the second half of 2009, so there was -- and go through this in considerable detail in the filings, but there were -- certainly those were the two large, potential liquidity calls during 2009, the potential put of the balance of the notes as well as that tax payment, all of which has been accrued, etc., but the time now where it's due is going to be approaching.

Mitch, I think I mentioned on the last call, you never used to think -- or we didn't really think much about worrying that bonds became due, whatever, that you just go out and raise more money. But you know, as the markets deteriorated and there was no way up until a month ago to raise money, we thought it was a prudent thing to do, is to do the deal that we did on these bonds.

Okay. So you're -- let's go back to the fact that you had $200 million as of the end of the -- of March. So now you're at 250 let's say, plus the investments. It's a lot of cash to keep on hand. Where do you see yourself deploying it even after paying off some of these obligations?

Well again, if you want to go through the numbers, you're going to have a tax -- significant tax payment. How much will the tax payment be, B. K.?

$75 million, $76 million.

$75 million. You have a $20 million in [LaBose] deferred comp, which we own. There's $95 million. You have at least $20 million in bonds. So $115 million. So you know, a lot of the cash could be deployed. And then obviously that's without the put. So now, in addition if you bring in a lot of bonds you know from the put, you know, it could use up the bulk of your cash.

So we are obviously not going to do anything which jeopardizes our liquidity, and obviously it's very important for us to continue paying dividends, as I said. And we've basically run the company to pay dividends for many years now, and that's what we think is the right thing for the shareholders, and that's what we want to do.

Thomas Jones, [Sarlo Management].

I just wanted to ask, when you think about the cigarette business sort of in the long term, how do you think about your conventional cigarette business in terms of it -- do you see it stabilizing at some point or do see it more as a gradual decline? Just curious how you think about that when you look at your portfolio of assets?

Well, when -- the industry typically has been in a decline for many years, but they've done a very good job of managing profits by raising prices. So again, we are not the market leader so we follow. But Philip Morris has done a very good job.

And even this decline now, we all knew when the SCHIP passed that there would be a decline, and what they did is they raised the prices more than was necessary for the SCHIP with the thought that they are looking again to manage profits. So right now you have volumes in a substantial decline, but if you go by past history, whenever anything like this has happened, what happens is by the next year volume is stabilized, still declining 2.5%, 3%, but you raise prices and your profits, you maintain your profits or you actually increased your profits. So I think that's the way we look at the business.

(Operator Instructions). [Ajay Guidans], GoldenTree.

My questions have all been answered. Thank you.

(Operator Instructions). Ken Bann, Jefferies & Company.

This is actually Erin Mazzoni calling in for Ken Bann. Just a quick question on the real estate front. I was wondering if you could talk a little bit more about your Douglas Elliman operations. They are obviously down pretty significantly during the order, so I was wondering if you could give any more color on that and any kind of more current trend you're seeing in the second quarter.

Yes. The market -- and if we talk about Manhattan, the market in number of transactions, we're probably down between 50% and 60%, depending on which company you look at. But overall, the number of transactions, we're down 50% to 60% first quarter this year to first quarter of last year.

That trend has started to reverse, probably about -- just about the time the market stabilized. The stock market, the psychology of people is that when the stock market was going down 200 or 300 points every day and that's all they saw on CNBC, the phones stopped ringing. And then as it stabilized and started picking up, all of a sudden traffic picked up, phones were ringing, people were looking, and that has not translated into sales.

So the trend as of right now is definitely on the upswing. I wouldn't say -- again, we all like to point to 2007 as the base year, and I don't think 2007 was the base year. It was sort of crazy in the other direction. But I think that what we've seen now is a stabilization and people coming back into the market thinking this is a good time to purchase homes. So the market has definitely picked up in the last month or so.

(Operator Instructions). Ajay Guidans, GoldenTree.

I just had a quick one I forgot to -- before. Do you still expect to receive about $8 million of dividends from your minority investments?

B. K.?

Ajay, we received $1.4 million in the first quarter from Douglas Elliman. There were no other distributions from our minority investments during the quarter.

Thank you. Well speakers, at this time we have no further questions in the queue.

Okay. Well thank you, and we will hope to speak to you all again on our next quarter call. As always, Ron Bernstein, myself, and B. K. are always available to answer any questions that you may have. Please feel free to call us at any time.

Thank you and have a good day.

Thank you very much ladies and gentlemen. At this time the conference is now ended. You may disconnect your lines. And have a great rest of the week.