Vector Group Ltd (VGR) 2009 Q3 法說會逐字稿

Welcome to Vector Group's third 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.

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

Good morning. Thank you for joining us on Vector Group's third 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 Group's Chief Financial Officer.

On today's call I will provide an update on our business and review Vector Group's financials for the third quarter and first nine months of 2009. Ron will then discuss the performance of Liggett Group and Vector Tobacco for the periods and provide his perspective on industry developments and the competitive environment. After that we will take your questions.

Let me begin by saying that I cannot be more pleased with our company's overall performance for the first three quarters of 2009. In the face of significant tobacco industry challenges largely created by the April 1, 2009 federal excise tax increase of $6.17 per carton, our conventional tobacco business has managed to provide solid earnings while significantly outperforming the industry from a volume perspective. Bryant will discuss this in more detail shortly.

I'm also pleased to report that we've seen positive signs in a still challenging real estate market. We believe that there is substantial upside in many areas of the marketplace for those with the conviction and wherewithal to act.

Before discussing the financial results, as noted on our previous call, during the third quarter we further enhanced our strong financial position by completing the private placement of $85 million of our 11% senior secured notes due 2015. This followed second-quarter issuance of $50 million of convertible notes to an affiliate of Dr. Phillip Frost, one of our country's most successful entrepreneurs, and the exchange of approximately $100 million of convertible notes. In connection with the convertible debt transactions, we recognized a pretax non-cash charge on extinguishment of debt of approximately $18.4 million for the nine months ended September 30, 2009.

In addition, due primarily to the narrowing of credit spreads in both the US corporate credit markets and the market of the company's debt in 2009, we recognized pretax non-cash charges related to increases in the fair value of derivatives embedded within our convertible debt of $6.1 million and $25.8 million for the three and nine months ended September 30, 2009.

Our liquidity remains strong with cash and cash equivalents of approximately $237.5 million as of September 30, 2009.

In addition, as of September 30, 2009 we held investment securities and partnership interests with a fair market value of approximately $132.1 million.

Now let's turn to the key financials for the three months and nine months ended September 30, 2009 for Vector Group.

In addition to the non-cash charges related to our convertible debt discussed above, our financial results for the nine months ended September 30, 2009 include a pretax gain of $5 million related to the 1999 trademark transaction with Philip Morris, the recognition of a $6.1 million deferred tax asset associated with Vector Tobacco's state net operating loss carry-forwards, pretax impairment charges of $8.5 million on real estate, and pretax restructuring charges of $1 million.

Of our financial results for the three months ended September 30, 2008 include $522,000 in gains from the fair value of derivatives embedded within convertible debt, and pretax impairment charges of $7 million on real estate.

Our financial results for the nine months ended September 30, 2008 include $12 million of pretax income from the St. Regis Hotel, $7.8 million in gains from the fair value of derivatives embedded within convertible debt, and pretax impairment charges of $7 million on real estate.

For the third quarter ended September 30, 2009, Vector Group revenues were $236.7 million compared to $145.6 million in the 2008 third quarter.

The company recorded operating income of $37 million in the 2009 third quarter compared to operating income of $37.5 million in the 2008 third quarter.

Third quarter 2009 net income was $16.2 million or $0.22 per diluted share compared to $14.8 million or $0.20 per diluted share in the 2008 period.

Adjusting for the one-time tax benefit in 2009 and the non-cash charges for the company's convertible debt, previously discussed, third quarter 2009 net income was $13.6 million or $0.19 per diluted share.

Adjusting for the impairment charges and charges to the company's convertible debt previously discussed, third quarter 2008 net income was $18.7 million or $0.25 per diluted share.

For the nine months ended September 30, 2009, Vector Group revenues were $564.7 million, compared to $420.8 million in the first nine months of 2008.

The company recorded operating income of $107 million in the 2009 period compared to operating income of $99.9 million for the 2008 period.

Net income was $11.4 million or $0.16 per diluted share compared to $48.3 million or $0.60 per diluted share in the year-ago period.

Excluding the non-cash charges related to the company's convertible debt previously discussed, the gain on the trademark transaction, the one-time tax benefit, and the impairment losses and restructuring charges in the 2009 period, the company's net income for the first nine months of 2009 was $34.2 million or $0.47 per diluted share.

Excluding the income from the St. Regis Hotel, the impairment charges in 2008, and the non-cash gains related to the company's convertible debt previously discussed, the company's net income for the first nine months of 2008 was $40.7 million or $0.56 per share.

The decline in pro forma income for the three and nine months ended September 30, 2009 was primarily attributable to the effects of the increase in excise taxes, increased net interest expense, and a decline in income from nonconsolidated real estate businesses.

Now I will turn the call over to Ron Bernstein for a review of our tobacco subsidiaries.

Good morning to everybody. As Howard noted, we feel very good about our performance during the first three quarters of 2009. As anticipated, the largest federal excise tax or fee increase on tobacco in history has had an impact on Liggett and the rest of the industry this year. And we expect it to continue to do so going forward.

However, entering 2009 we were well aware of the inevitability of the excise tax increase and had developed a specific plan to position Liggett Vector Brands to perform well in this more challenging environment. This plan involves maintaining strict focus on the efficiency of our operation, investing for growth in key brands, and developing trade programs that reward wholesalers and retailers for actively supporting our core brands.

To date we are very pleased with these programs, which I will elaborate on in a moment. First let me turn to our numbers. Liggett's numbers reflect sales for both Liggett Group cigarettes and conventional cigarette products from Vector Tobacco.

For the three and nine months ended September 30, 2009, our conventional cigarettes generated revenues of $236.3 million and $563.3 million, compared to $144.8 million and $418.8 million for the corresponding periods in 2008. The vast majority of the revenue increase in the quarter and nine-month period is due to the higher tax rates, which explains why the incremental revenue is not dropping to the bottom line.

Operating income for the three and nine months ended September 30, 2009 was $43.4 million and $125.1 million compared to $45.9 million and $127 million for the corresponding 2008 periods.

Included in the nine-month 2009 operating income is the one-time gain of $5 million related to the 1999 trademark transaction with Philip Morris.

Additionally, Liggett's third quarter and nine-month earnings were negatively impacted by $1.6 million and $4.8 million, respectively, compared to the prior-year periods due to 2008 investment losses in Liggett's pension plan.

For the three and nine months ended September 30, 2009, Vector Tobacco's operating losses were $1.7 million and $5.9 million, compared to operating losses of $2.4 million and $6.8 million for the prior-year periods.

Included in the nine-month operating loss for Vector Tobacco in 2009 is a $1 million one-time restructuring charge related to the May 31 shutdown of Vector Tobacco's North Carolina based research operations. We project an overall annual savings of approximately $2 million as a result of this action.

Dr. Tony Albino continues to direct research out of our New York office and will also represent Vector on many complex matters pertaining to FDA regulation and public health.

Turning back to Liggett's numbers, it's important to note that as we predicted, the extraordinary increase in the federal excise tax has resulted in significant shipment declines for the industry. In conjunction with our internal analysis and the analysis of independent industry analysts, we've projected an industry shipment decline of approximately 9% for 2009.

As you may recall, given the uncertainty surrounding such a large one-time tax increase, other manufacturers and industry analysts had estimated declines anywhere from the high single digits to the low double digits. However, through three quarters our 9% decline estimate appears to be on target.

Liggett and all companies that have an MSA grandfathered market share exemption determine the value of that exemption by multiplying their respective share exemption -- percentage by taxable industry shipments. These companies, including us, also increase the value of the exemption by an inflation factor of a minimum of 3%. As a result, the historical 2.5% to 3.0% annual industry decline typically balances with the inflation factor, keeping the value of the MSA exemption fairly stable. However, for each percent that industry shipments decline above 3%, we estimate that we lose approximately $1.8 million of our exemption value.

Given the anticipated extraordinary industry shipment decline of approximately 9% in 2009, Liggett has accrued $2.75 million for the third quarter and $8.25 million year to date to cover the cost of that potential decline.

It is our expectation that industry shipment declines will likely be more in line with historical norms following this year.

Without the effects of the 2009 industry shipment volume decline, our conventional tobacco earnings would be positive compared to the prior year for both the third quarter and year-to-date periods.

The two primary reasons for Liggett's solid performance in the face of industry challenges are increased margin on our Eve, Liggett Select and Grand Prix core brands, and operational efficiencies gained through the growth of our Pyramid brand.

Overall, industry wholesale shipments for the third quarter decreased by 12.6% while Liggett's shipments increased by 6.9% compared to the prior-year periods. I am pleased to report that we were the only company in the top five to report shipment growth for the third quarter.

On a year-to-date basis, the overall industry has declined 8.9% while Liggett has declined only 5.3%. It's important to note that most of that decline came in the turbulent market period immediately before and after the April 1 federal excise tax increase.

Turning to retail data, compared to the third quarter of 2008, industry retail shipments were down 10.8% while Liggett's shipments increased by 6.1%. Compared to the second quarter of '09, industry retail shipments increased by less than 1% and Liggett retail shipments increased by 17.4%.

As mentioned in our previous call, Liggett Vector Brands began shipping newly packaged and priced Pyramid boxes to the market in late April. 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 a highly competitive but sustainable low price point. We've made the strategic decision to price at this level in contrast of a volume renting approach favored by some in the industry. We believe that as market definition continues to develop over the coming months, Pyramid box will offer the trade and consumers the best value proposition available in the marketplace.

We are targeting the growth of Pyramid carefully and are offering Pyramid-focused promotional programs that have provided support to our other core brands. We are pleased with the early growth of the Pyramid box as well as with other initiatives we are undertaking to continue to succeed in a changing tobacco marketplace.

As previously noted, we are also pleased that Congress finally took action to correct a long-standing inequity and equalized the excise tax rates on little cigars and roll-your-own cigarettes to that of manufactured cigarettes. Unfortunately, some of the companies that manufacture and sell these products are seeking to game the system by reclassifying their products. Congressional leaders are aware of the situation. and we are pleased that they appear to be taking action to ensure legal compliance. We will continue to monitor this situation closely.

In conjunction with other congressional initiatives and state budget actions, we believe that Congress and state legislatures continue to consider increasing excise tax rates on smokeless tobacco products, including snuff, chewing tobacco and snus. These products have the same sort of tax advantages formerly enjoyed by little cigars and roll-your-own, and we believe they represent a substantial new source of revenue for federal and state governments to pursue.

As you know, in June the President signed legislation granting the FDA authority to regulate tobacco products. While the FDA bill is certainly complicated and many open issues remain, we remain confident in our ability to fully comply with the legislation.

Clearly there will be costs associated with the implementation of the FDA requirements. Based on our current estimates, which are subject to change as the Secretary issues regulations over the next two years, we expect the cost to be in a manageable range and absorbed over an extended period of time.

We are hopeful that based upon our extensive research activities in the fields of biology and chemistry as well as in smoking cessation, that we will have an opportunity to provide meaningful input to the FDA as this process develops and gains greater clarity.

In any event, we intend to monitor the activities of the FDA and our competitors closely to assure that the process is as fair as possible.

In conclusion, we are pleased with the performance of our conventional tobacco business through the first three quarters of 2009. We have faced numerous market challenges, but we are well prepared for them. I believe that we have maximized our opportunities thus far.

We continue to focus on our long-term strategy of balancing volume growth and profit margins and once again believe that our results validate this approach. We have no doubt that new challenges will arise, but we are confident we are well-positioned to meet them and continue to succeed in the marketplace.

Thanks for your attention. Back to you, Howard.

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 Pindus, Royal Bank of Canada.

I was hoping, Howard, that you could talk a little bit about some of the real estate investments that you've been investing in over the last year or so, including the project out in Palm Springs, what's happening with that; a little about what's happening with Douglas Elliman and the payoff of the notes there, if we've seen anything on that; and just finally, generally, what's happening with some of the partnerships that you've invested in.

On the Douglas Elliman side from the residential real estate brokerage, the market has definitely picked up. Still below the highs, obviously of 2007. And we made significant cuts in overhead when we saw what was going on the end of -- or during 2007 and all the way through recently. And the company is now profitable. So the company is generating cash.

What is our loan down to now?

The loan is down to -- it has a book value of about $7.2 million and a face value of around $7.5 million. That is the total loan to us and Prudential. We have one half of that.

Right. And our projection is that's paid off by the -- at the end of this year?

No. By June of 2010.

2010. Okay. So we would've paid off in total 70 some odd million dollars since we purchased the company.

On some of our real estate investments, one loan that we made to a building downtown, 111th -- the issue there was getting the building a TCO, temporary -- getting a temporary certificate of occupancy, and having close -- closing before September 1 of 2009, or we would've had to offer a recision. I'm pleased to report that we did get the TCO, we've closed one unit, we have -- I think three or four more are being closed this week. So the main negative, or the main disaster scenario there has been averted.

I'm sure there will be some re-trading on pricing and some people dropping out because of financial changes in their lives. But it is a very nice building that we think whatever comes on the market for sale we should be able to sell and should provide a return of our investment and return above that.

The townhouses I think we've covered. We've sold one, we have a contract on another one to sell. We've written that down to a level which I think will do a little bit better on a recovery.

What are they written down to now?

They're written down to $1.2 million.

Yes. So I think we will do somewhat better than that.

California, as I've reported before, we foreclosed in a friendly foreclosure with Lennar, we own it. The golf course is being reopened I think in a few weeks. The clubhouse is just about finished. We are waiting for furniture. There's a lot of excitement.

Interestingly enough, the two people that had lots, that have bought lots and built some models and spec homes, one being Lennar and one being Standard Pacific, put those units on the market, and sales have been pretty good. I haven't gotten an update yet, but they've actually sold quite a few, albeit at lower prices than what they planned originally.

But they had paid I think about $275,000 per lot. Our all-in cost on these lots as of now is about $27,000, and then it would probably cost about $40,000 for the final work that had to be done for a builder to get it ready to build. So we are in at a substantially lower price, which means with the cost of building being down also, we could -- developers could buy these lots and sell and make money with these prices.

Interestingly enough, what we've heard is that all these builders who have gotten out of their land bank, they've sold their land, they've terminated relationships with their land banks to buy land -- now that business has picked up, now they have no -- not much inventory in land, so now they're coming back into the market. In fact, we've heard -- and again, we don't know if it's true or not at this particular point -- that Lennar is considering coming to us to buy lots because they have sold -- they think the market is there now to sell these houses at these prices.

So that's the basic rundown on our real estate.

Anything else?

Yes. Finally, the partnerships, you've invested in a lot of outside business partnerships, i.e., hedge funds, and you've got some money I think outstanding with Icahn in the past. Have you deployed any of that cash forward that you have sitting there in those areas over the last six months or so?

No. Our -- obviously our investments look much better today.

Do you want to give a run-down on those?

Sure. The long-term partnerships are worth roughly -- they were worth around $70 million at the end of September. And they are recorded [on the trial] balance at $51 million.

So they are up about 40%.

Yes. This year.

Okay. So your net cash forward right now is how much?

Just one minute. We had cash and marketable securities of around $300 million at the end of September, and I believe around $237 million of that was cash.

Was that before we paid our taxes or after?

After.

Are there any major cash needs coming up over the next year?

Just our normal taxes and payments. We've spent a lot of time looking at a lot of real estate, a lot of it in South Florida. We think there's tremendous opportunity. There's a few projects we are working on. We think we can get in very cheap, and we think there's a lot of upside. So we're spending a lot of time looking both in New York City and Florida.

And we think we are not quite there yet on anything, but we are getting close.

So would it be unreasonable to expect that cash of $230 million to be significantly invested, deployed over the next year?

Significant -- I don't know what the definition of significant is, but yes, we will be making investments over the next year.

All right. Thanks guys.

Anton Kowalski, Canyon Capital.

I had a question -- cash flow from operations for the quarter seemed like it was quite negative. Can you just walk us through kind of a bridge to normalize cash flow from operations. What -- were there a bunch of one-time charges this quarter?

Yes. The two principal one-time charges were, we made the principle amount of the income tax payment on the Philip Morris transaction in September, and we paid the retirement plan, a one-time retirement plan payment to our former Chairman of $21 million in July.

How much was the tax?

We paid $43 million.

That was a one-time payment from the 1999 brand sale. Philip Morris.

And those were the only two kind of one-time items you think in the quarter?

Yes.

Thanks a lot.

(Operator Instructions). At this time I'm showing no more questions.

Well, thank you all for joining us. As always, Ron Bernstein, BK or myself are available if you have any questions. We are very pleased with our performance this quarter and look forward to continuing in that vein. So thank you all and have a good day.

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