Vector Group Ltd (VGR) 2009 Q4 法說會逐字稿

Hello and welcome to Vector Group's fourth-quarter and full-year 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'd now like to turn the call over to President and Chief Executive Officer of Vector Group, Howard Lorber. You may begin.

Thank you. Good morning and thank you all for joining us on Vector Group's fourth-quarter and full-year 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 fourth quarter and full year of 2009. Ron will then discuss the performance of Liggett Group and Vector Tobacco for those periods, and then provide his perspective on industry developments and the competitive environment. After that, we will take your questions.

Let me begin by saying that I am very pleased with our Company's overall performance for 2009. We entered 2009 recognizing that we would be facing one of the most challenging economic and industry environments in history. However, we also entered 2009 with a well-constructed plan that we believed would enable us to grow the share of our cigarette business despite overall industry declines driven by the April 1 federal excise tax increase that increased industry cigarette prices by an average of approximately 25%.

I'm pleased to report that our 2009 plan proved sound, and we were in fact able to grow our market share by 74 basis points during the year. At the same time, we were able to increase tobacco-related earnings exclusive of certain items that we believe to be one-time expenses. Ron will provide more detail on this in a moment.

With respect to real estate, we continue to see positive signs in what remains a challenging market. We are pleased that we were able to capitalize on the unique opportunity to enhance our business at Prudential Douglas Elliman as reflected in the recent announcement of our acquisition of Bellmarc Property Management, one of the premiere New York City property management companies.

Before discussing the financial results, it's worth recapping that during 2009 we further enhanced our strong financial position by completing the private placement of $85 million of our 11% senior secured notes due 2015; issuing $50 million of convertible notes to an affiliate of Dr. Phillip Frost, one of our country's most successful entrepreneurs; and exchanging and extending the maturities of approximately $100 million of convertible notes.

In connection with the convertible-debt transactions, we recognized a pretax non-cash charge for extinguishment of debt of approximately $129,000 and $18.6 million for the three and 12 months ended December 31, 2009. In addition, due primarily to the narrowing of credit spreads in both the U.S. 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 values of derivatives embedded within our convertible debt of $10.1 million and $35.9 million for the three and 12 months ended December 31, 2009.

Our liquidity remains strong with cash and cash equivalents of approximately $209.5 million as of December 31, 2009. Additionally as of December 31, 2009, we held investment securities and partnership interests with a fair market value of approximately $121.7 million.

Now, let's turn to the key financials for the three months and full-year ended December 31, 2009, for Vector Group. In addition to the $10.1 million of non-cash charges related to our convertible debt, our financial results for the three months ended December 31, 2009, include a pretax gain of $2.1 million from our investment in the St. Regis Hotel.

In addition to the $54.5 million of non-cash charges related to our convertible debt discussed previously, our financial results for the full year ended December 31, 2009, include a pretax gain of $5 million related to the 1999 trademark transaction with Philip Morris, pretax income of $2.1 million related to the St. Regis Hotel, the recognition of a $6.2 million deferred tax asset associated with Vector Tobacco's state net operating loss carryforwards, pretax impairment charges of $8.5 million on real estate, and pretax restructuring charges of $900,000.

Our financial results for the three months ended December 31, 2008, include $583,000 of pretax income from the Company's investment in the St. Regis Hotel, a gain of $16.5 million from the fair value of derivatives embedded within convertible debt, and pretax impairment charges of $25.4 million on long-term investments, real estate, and investment securities available for sale.

Our financial results for the full year ended December 31, 2008, include $12.6 million of pretax income from the St. Regis Hotel, $24.3 million in gains from the fair value of derivatives embedded within convertible debt, and pretax impairment charges of $32.4 million from long-term investments, real estate, and investment securities available for sale. I hope everyone listened to all that very closely because we're going to test everyone afterwards.

For the fourth quarter ended December 31, 2009, Vector Group revenues were $236.7 million, compared to $144.4 million in the 2008 fourth quarter. The Company recorded operating income of $36.2 million in the 2009 fourth quarter, compared to operating income of $35.4 million in the 2008 fourth quarter.

Fourth-quarter 2009 net income was $13.4 million, or $0.19 per diluted share, compared to $12.2 million, or $0.08 per diluted share, in the 2008 period. Adjusting for the non-cash charges to the Company's convertible debt and gain from the investment in the St. Regis Hotel, fourth-quarter 2009 net income was $18.2 million, or $0.25 per diluted share. Adjusting for the impairment charges and the gains related to the Company's convertible debt and the St. Regis Hotel previously discussed, fourth-quarter 2008 net income was $17.2 million, or $0.24 per diluted share.

For the full year ended December 31, 2009, Vector Group revenues were $801.5 million, compared to $565.2 million in the full year of 2008. The Company recorded operating income of $143.2 million in the 2009 period, compared to operating income of $135.3 million for the 2008 period.

Net income was $24.8 million, or $0.34 per diluted share, compared to $60.5 million, or $0.76 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, the impairment losses and restructuring charges in the 2009 period, and income from our investment in the St. Regis Hotel, the Company's net income for 2009 was $52.4 million, or $0.72 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 2008 was $57.8 million, or $0.81 per diluted share.

The decline in pro forma income for the three and 12 months ended December 31, 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.

Thanks, Howard. Good morning, everybody. In overview, we feel very good about our performance in 2009 and that we achieved all of our key objectives for the year. We are also pleased with our positioning for 2010.

As anticipated, the $6.17 per carton excise tax increase that became effective April 1, 2009, had a significant impact on Liggett and the rest of the industry in 2009, and we expect it will continue to do so going forward. The increase, the largest federal tax or fee increase on tobacco in history, resulted in an average industry retail price increase of approximately 25%.

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 outperform the market in this more challenging environment. Our plan involved 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, these programs are working well and I will elaborate on them 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 months and full year ended December 31, 2009, our conventional cigarettes generated revenues of $236.7 million and $800 million, compared to $143.8 million and $562.7 million for the corresponding periods in 2008. The vast majority of the revenue increase in the quarter and full-year period is due to the higher tax rates, which explains why the incremental revenue is not dropping down to the bottom line.

Operating income for the three months and full year ended December 31, 2009, was $42.9 million and $168 million, compared to $43.2 million and $170.2 million for the corresponding 2008 periods. Included in the full-year 2009 operating income is the one-time gain of $5 million related to the 1999 trademark transaction with Philip Morris.

Additionally, Liggett's fourth-quarter and full-year earnings were negatively impacted by $1.6 million and $6.4 million, respectively, compared to the prior-year periods due to 2008 investment losses in Liggett's pension plan.

For the three months and full year ended December 31, 2009, Vector Tobacco's operating losses were $1.2 million and $7.1 million, compared to operating losses of $1.6 million and $8.3 million for the prior-year periods. Included in the full-year operating loss for Vector Tobacco in 2009 is a $900,000 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 and overall improved results at Vector Tobacco going forward.

Turning back to Liggett's numbers, to put it plainly we were able to buck the industry trend and increase retail shipments in 2009, a year where the industry underwent significant contraction. So let me provide you with some additional context. As a result of the excise tax increase, based upon our internal analysis and the opinion of independent industry analysts, we 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 estimated declines anywhere from the high single digits to the low double digits.

While we do not yet have final numbers from the government, based upon 11-month data our 9% industry-decline estimate appears to be right 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% 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 $2.57 million for the fourth quarter and $10.7 million for the full year to cover the cost of that potential decline.

Looking ahead for a moment, early estimates for 2010 project industry shipment declines in the range of 4%, which would be more in line with the historical norms. So, if we look at our 2009 earnings performance by adjusting for likely one-time items and eliminate the effect of the $5 million Philip Morris transaction gain and the grandfathered market share exemption decline of $10.7 million, our conventional tobacco earnings would have increased by $3.5 million from 2008.

This is particularly noteworthy given our decision to invest in the growth of our Pyramid brand and several of our partner brands. The positive results of that investment are clearly reflected in the 1.7% growth of our year-over-year retail shipments compared to the approximate 9% industry decline. This resulted in an increase of almost three-quarters of a share point in our retail market share.

Specifically, as of December 31, 2009, our fourth-quarter retail market share was 3.34%. This marks the first time that our market share has exceeded 3% in 17 years.

The two primary reasons for Liggett's performance in the face of industry challenges and amidst to our investment for brand growth are increased margin on our Eve, Liggett Select, and Grand Prix core brands; and increased manufacturing efficiencies.

Overall, industry wholesale shipments for the fourth quarter decreased by 7.4%, while Liggett shipments increased by 14% compared to the prior-year period. Notably, we were the only company in the top five to report fourth-quarter shipment growth.

For the full-year period, overall industry wholesale shipments declined by 8.6%, while Liggett shipments were effectively flat.

Turning to retail data, according to Management Science Associates, compared to the fourth quarter of 2008 industry retail shipments decreased by 11.1% while Liggett shipments increased by 14.5%. Again, for the full-year period, industry retail shipments declined 8.7% while Liggett retail shipments increased 1.7%.

The primary driver for Liggett's strong volume growth was the introduction of our newly packaged and priced Pyramid box brand in late April 2009. Pyramid's new box styles are being offered at a highly competitive but sustainable low price point. As we've previously indicated, we made the strategic decision to price at this level in contrast to 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 also provide support to our other core brands. We are pleased with the growth of Pyramid box thus far and we are progressing well with other initiatives that we are undertaking to continue to succeed in the changing tobacco marketplace.

As we've noted, we were pleased 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. Unfortunately, failure to also equalize the pipe tobacco tax rate to that of cigarettes has enabled some companies that sell these products to game the system by reclassifying roll-your-own tobacco to pipe tobacco and pay approximately 10% of the proper tax rate. This has led to an absurd 131% increase in the sale of pipe tobacco in a seven-month period, despite no reports of an increase in the sale of pipes.

Additionally, some little cigar manufacturers have added a small amount of weight to their products and are now classifying them as large cigars. Congressional leaders and regulators are well aware of both of these situations and hopefully will be taking action quickly to address the situation. We think it's important for the government to close this large loophole.

In the meantime, substantial tax payments are being lost by the federal government while both tax and master settlement agreement payments are being lost by the states.

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 not just cigarettes but smokeless tobacco products, including snuff, chewing tobacco, and snus as well. 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 regulations are issued over the next two years, we expect the costs 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 ensure that the process is as fair as possible.

In conclusion, I am very pleased with the performance of our conventional tobacco business in 2009. Through a concerted team effort, we met numerous challenges this past year, making the most of opportunities and managing to improve our overall position in the marketplace. We'll 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. There is no doubt that new challenges will arise, but I'm confident that we are well positioned to meet them and continue to succeed.

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). Ken Bann, Jeffries & Company.

Good morning and congratulations on a good year in a tough environment. I was just wondering, could you give us some insight into what you expect between the different brands? Should we expect Liggett Select and Grand Prix volumes to continue to decline while Pyramid grows or -- and how are you going to balance that with your need to maintain decent gross margins on the tobacco side?

Ron?

Yes. What you said is exactly right. We anticipate that Liggett Select and Grand Prix will continue to decline and that Pyramid will continue to grow, along with some of our other partner brands.

We -- as I said in the prepared comments, we have for some time been working very carefully to balance margin opportunities and volume opportunities. The FET increase created an environment where we could pursue both simultaneously, and that's exactly what we're doing. We believe that Grand Prix will continue to decline somewhere around the general market rate and that Liggett Select will probably, as a higher-priced midprice brand, will decline somewhat greater.

However, we are leveraging off of the growth of Pyramid to maintain distribution with Liggett Select and Grand Prix and to take advantage of those margin opportunities. So, our expectation is that we are investing for growth right now. But we believe that that investment for growth will pay back very quickly.

Has -- are you still getting increased placements of Pyramid in more retail locations? Is that continuing to grow?

Yes. It's growing and growing pretty rapidly. We are -- we've been increasing Pyramid distribution at about 250 stores a week and have just recently gained some inroads into some major chain retail stores.

So, yes, Pyramid is growing. It's growing well. We only went nationwide with it effective January 1. Up until that point, we were only operating in about two-thirds of the country, so we are now nationwide. The brand is growing and doing very well.

Okay, and then, could you also talk about investments in other areas outside of tobacco and real estate? You have mentioned that the Company was looking at certain opportunities, maybe in Florida. You've obviously had some investments in real estate out in California. What are you looking at now and what other possibilities might there be for other investments?

Well, yes, we've been looking at Florida for the past year. And it bounced a little bit off the bottom, and we were below the market, to some degree, and so we didn't buy anything in Florida. We don't think it's going straight up, so we're just going to sit and wait a little bit.

I think California was obviously a long-term investment where we now own it. We're in on a very cheap price on a per-building lot basis, probably about 85% discounted from where they sold lots originally when they started the project. The golf course has been reopened. It's in business. So we view that as a very good asset which will be worth a lot of money as time goes by, and we are constantly in the market looking.

We have two investments in New York real estate, one was this townhouse project that we had to take over, which we've written down and probably will hope to recover more than we thought.

And then, we have one which was a loan on a project in Manhattan, 111th Avenue, which we are now selling. It's -- there were presales when we made the loan. It looks like we'll have a nice profit on that. In fact, I think we picked up -- BK, we picked up some little bit of income.

$1.5 million in the fourth quarter.

Yes, on that. And we're looking -- we have a couple of proposals out on a couple of projects and we're just waiting for the right deal.

And the investments, most of them will be in the real estate side, is that correct? Or is there anything outside of real estate?

No, it's pretty much real estate related. We've looked at -- we're looking at a couple of other things but most of it's real estate related.

Mitch Pindus, RBC Wealth Management.

A question for you -- first off, I guess, for Ron. Ron, you shut down the research facility last year. You came up with some very interesting innovative products over the years, including the nicotine free. I'm just wondering, with that shut down, do you still see a competitive advantage in the marketplace without that source of new product?

Yes. Mitch, I think the environment has really changed, and with the advent of FDA regulation and the definition of what needs to be done to get a product approved as a so-called reduced risk type product, the -- it appears from what we're seeing that it's very unlikely that the FDA is ever going to really go forward and approve products on that basis and in effect sanction a cigarette as being acceptable for consumers.

What I think they're going to do -- I suspect, and I don't know this for sure, is that they're going to, over the course of time, change the specifications and standards for cigarettes. Now, the research and work that we've done has enabled us, we believe, to comply with any standard or specification that the FDA comes up with.

So, I think it's unlikely that anybody is going to gain an advantage in the so-called reduced risk marketplace. Just as things have evolved and with the experience that we've had, it just appears clear to us that FDA will never sanction a cigarette.

Having said that, I think we retain all of the capability that we have and what's happened is -- and we still have -- Dr. Albino is still affiliated with us and is still working for us. But we've transferred a lot of the expertise to the more conventional research operation we have at Liggett. So we have the expertise, we have the ability, and if the opportunity were to present itself, we would be able to come to market with something. So, that's where things stand at this point.

Okay, well, thank you for that. I guess my next question goes to BK. The Douglas Elliman balance on the loan, can you tell me what was paid and what's left?

Yes, Mitch. There's -- first of all, we did receive a payment yesterday of $1.2 million, so Douglas Elliman has, in total, left another $1.4 million to us and $1.4 million to Prudential. It will be paid off at that point.

As far as last year, they paid down $9.5 million of debt in 2009.

So at that point, any dividends forthcoming will go straight to your bottom line?

No, the dividends go to our bottom line because we recognize income in Douglas Elliman. What happens is when we receive the dividends, we reduce our investment in Douglas Elliman. When Douglas Elliman earns money, we recognize the income.

Okay, I'm with you. Thank you. My last question is now that you are over the cap on the MSA exemption, can you tell me what happens to your bottom line for every 1% in market share increase? I know 1% is a big number, but I'm just curious if we can quantify it that way.

I mean, what you're looking at is that if you look at 1 billion units of growth, that should equate to -- and again, it depends upon what your pricing capability is, but for each dollar, at 1 billion units you're talking about $5 million to the bottom line.

And 1 billion units is how much in percentage of MSA?

Well, the total market is -- we project to be about 300 million -- 300 billion units this year.

So 1 billion would be roughly one-third of a percent?

Correct.

Right.

Okay. So for every -- all right, I'm with you. Thank you very much.

(Operator Instructions). Speakers, at this time I'm showing no more questions. Mr. Lorber, do you have any more closing remarks?

Yes, thank you. I'd like to thank everyone for being on this call, and as always, BK, Ron, myself are available anytime anyone would like to speak to us, and we look forward to a good 2010. Thank you, everyone.