Vector Group Ltd (VGR) 2010 Q1 法說會逐字稿

Welcome to Vector Group's First Quarter 2010 Earnings Conference Call. Before the call begins, I'd like to read a safe harbor statement.

Statements made during this conference call which are not historical facts are forward-looking statements that are subject to risk and uncertainties that could cause actual results to differ materially from those set forth and/or implied by forward-looking statements. These risks are described in more detail in the Company's Securities and Exchange Commission filings.

Now I'd 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 First Quarter 2010 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 first quarter of 2010. Ron will then discuss the performance of Liggett for the period 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 am very pleased that the strong performance and volume growth trends our Company experienced in the second half of 2009 have continued in the first quarter of 2010. Last year, confronted with the challenges created by legislation enacted by Congress that increased the federal excise tax on cigarettes by $6.17 per carton and granted the Food and Drug Administration regulatory authority of tobacco products, we made the decision to strategically invest in the growth of our tobacco business.

Sustainable volume growth is a priority for us, and Ron will provide more detail on that in a moment, but we are very encouraged with the early results and believe that our performance in 2009 and the first quarter of 2010 validates the strategy that we put in place.

With respect to real estate, we continue to see positive signs in a challenging market environment and improvement in our performance at New Valley and Douglas Elliman. We continue to believe that there are good investment opportunities in this market, and we plan to make appropriate investments when the opportunities meet our criteria.

Before discussing the financial results, I am also pleased to report that, in April, 2010, we enhanced our strong financial position by completing a private placement of $75 million of our 11% senior secured notes due 2015. Our liquidity remains strong, with cash and cash equivalents of approximately $203 million as of March 31, 2010, or $276 million after adjusting for the notes offering.

Additionally, as of March 31, 2010, we held investment securities and partnership interests with a fair market value of approximately $132.6 million.

Now let's turn to the key financials for the three months ended March 31, 2010 for Vector Group.

For the first quarter ended March 31, 2010, Vector Group revenues were $222.1 million, compared to $121.2 million in the 2009 first quarter. The increase in revenues in 2010 was primarily due to higher prices related to the increase in federal excise taxes, which became effective on April 1, 2009.

The Company reported operating income of $31 million in the 2010 first quarter, compared to the operating income of $31.2 million in the 2009 first quarter. First quarter 2010 net income was $11.9 million, or $0.15 per diluted share, compared to $3.1 million, or $0.04 per diluted share in the 2009 period. Our financial results for the three months ended March 31, 2009 included pretax gain of $5 million related to the 1999 trademark transaction with Philip Morris, pretax impairment charges of $8.5 million on real estate, and pretax restructuring charges of $1 million. Adjusting for these items, our net income for 2009 would have been $5.7 million, or $0.08 per diluted common share.

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

Thank you, Howard, and good morning to everybody.

As Howard mentioned, and as we've discussed in previous calls, prior to the implementation of the 2009 federal excise tax increase, we believed that the largest fee or tax increase in tobacco product history would create both new challenges and opportunities in the marketplace. To take advantage of those opportunities, we implemented a business strategy to aggressively, but prudently, invest in the evolving market and position Liggett to achieve meaningful long-term volume growth.

Through the first quarter of 2010, we feel very good about the results of our strategy, and continue to see positive trends for Liggett going forward.

On the yearend conference call, I mentioned that our company had surpassed 3% share of the cigarette market for the first time since 1992. I'm pleased to report that Liggett has continued to grow its market share through the first quarter of 2010. I will elaborate more on our performance in a moment, but, first, let me turn to the financials.

In 2009, as we have told you, we restructured operations at Vector Tobacco and have ceased most of Vector Tobacco's research activities. Accordingly, we have determined to combine financial reporting for Vector Tobacco into Liggett. As a result, comparisons to 2009 performance are adjusted to reflect the combination of Vector Tobacco and Liggett.

For the three months ended March 31, 2010, Liggett revenues were $221.1 million, compared to $121.2 million for the corresponding period in 2009. As Howard mentioned, the great majority of the revenue increase in the quarter is due to the higher federal excise tax rate, which explains why the incremental revenue is not dropping down to the bottom line.

Operating income for the three months ended March 31, 2010 was $34.9 million, compared to $35.6 million for the corresponding period in 2009. Included in the year-ago period's operating income is the one-time gain of $5 million related to the 1999 trademark transaction with Philip Morris and restructuring charges of $1 million.

Overall, according to Management Science Associates, first quarter retail shipments for the industry declined by 9.3%. During the same period, Liggett's retail shipments increased by almost 19%. All of the larger competitors suffered significant declines in retail shipments, except for Lorillard, which data indicates had a modest increase of less than 1%.

Liggett's first quarter retail growth has increased our industry market share to 3.4%, an eight-tenths of an industry share point increase over the prior-year period. This is the highest market share we have had since 1991.

As you may recall, in anticipation of the April 1, 2009 federal excise tax increase, there was a de-loading of industry inventory at both wholesale and retail. By far, the greater impact was at wholesale, where higher inventory levels are maintained. Under any circumstances, retail shipments tend to be more stable and, we believe, serve as a better indicator of Company performance.

Having said that, overall industry wholesale shipments declined by 2.4% in the first quarter of 2010 compared to the 2009 period. Liggett also significantly outperformed the market during the first quarter, with wholesale shipments increasing by 26.8% over the prior year.

The primary driver for Liggett's volume growth at both retail and wholesale has been the performance of our Pyramid box brand, which was newly packaged and introduced to the market about one year ago, in late April 2009. Pyramid's new box styles continue to be offered at a highly competitive but sustainable low price point. As indicated in prior calls, we made the strategic decision to price at a level that makes economic sense for us in contrast to a volume-renting approach favored by some in the industry. We believe that, as market definition has developed, Pyramid box is offering the trade and consumers the best value proposition available in the market.

Effective January 1, 2010, Pyramid was made available nationwide, following the regional rollout we implemented last year. We continue to provide Pyramid-focused promotional programs to the trade that also provide support to our other core brands. We are very pleased with the growth of Pyramid box thus far and are progressing well with other initiatives that we are undertaking to continue to succeed in the changing tobacco marketplace.

Since 2005, Liggett has carefully balanced its approach to pursuing volume and margin opportunities in the market. That continues to be the case. As we have invested in the growth of Pyramid box, we have also improved profit margins on our other core brands - Liggett Select, Grand Prix, and Eve. The margin increases we achieved in other brands have helped to mitigate the impact of the first quarter investment in Pyramid, enabling us to improve operating income year over year when adjusting for last year's Philip Morris transaction.

However, it is important to note that, as the year progresses and we continue to invest in the growth of Pyramid, we do expect to see some earnings contraction compared to 2009. We are managing the situation carefully and will make adjustments to assure that we stay in an acceptable range of profitability.

In 2009, Liggett projected industry wholesale shipments to decline in the range of 9% as a result of the previously discussed excise tax increase. The final number came in at a decline of 8.6%. As we've previously explained, 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 relatively 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 extraordinary industry shipment decline of 8.6% in 2009, Liggett suffered a decline of $10.7 million in its MSA exemption, which was reflected in 2009 earnings. As noted, this decline was within the range that we had anticipated.

At this point, estimates for 2010 project industry shipment declines in the range of 4% to 5%, which would be more in line with historical norms. But, as mentioned, any decline above 3% will result in further declines in the value of Liggett's MSA exemption.

As you know, in June 2009, the President signed legislation granting the FDA authority to regulate tobacco products. There continues to be a great deal of uncertainty regarding the FDA bill, and many open issues remain. However, we remain confident that we will be able 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 expertise and experience 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.

On the legal front, most of the historical litigation focus has been narrowed to the state of Florida and the Engle progeny cases. There are approximately 8,500 plaintiffs and 7,160 cases pending in federal and state court that comprise Engle, and they are moving very slowly through an over-burdened Florida legal system. The federal cases are all currently stayed. Since last year when trials commenced in these Engle progeny cases in state court, adverse verdicts for compensatory damages have been rendered against Liggett in four cases, with punitive damages being assessed against Liggett in only one of these cases. These verdicts will be appealed. We, along with the other defendants, believe that the entire Engle process is legally flawed and is unconstitutional. We have no choice but to go through the process but continue to expect there to be a reasonable resolution to the situation.

In conclusion, I'm very pleased with Liggett's first quarter 2010 performance. Through a concerted team effort, we have continued to meet the challenges of a difficult marketplace and continue to pursue opportunities that we believe will enhance the long-term strength and profitability of Liggett. There is no doubt that, as the year progresses, new challenges will arise, but I am confident that Liggett is 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). [Mitch Pindus], RBC Wealth Management.

I really just am asking the same question I've asked in the past. You have a great amount of cash on your balance sheet right now you're not utilizing, or you haven't utilized it to date. And then to issue another $75 million at 11% when you're getting very little on the interest side-- I'm just wondering if you could shed a little more light on what you're seeing out there in terms of opportunities-- what opportunities you've taken or purchases you've made over the last quarter that will shed some light as to where we're going with this.

Well, Mitch, I know you've asked me for it. What we basically said is that we look at a few things. Money isn't always there to borrow when you need it. And I'm surely happier today that we borrowed it than maybe I was thinking about it a month ago as the markets change.

The fact is-- There's a few things. Number one, we continue to believe that there are tremendous opportunities that are going to happen in the next two years on the real estate side, on the commercial end and the residential end of the real estate business. We have looked at numerous things. We have bid on numerous things. We have spent very little money doing anything yet. But that's because there's been a standoff between the developers and the banks, generally speaking. But now that is changing. That landscape is changing. Banks are doing foreclosures, presenting opportunities. We are seeing more and more situations with what we think are very substantial opportunities.

Number two is that there are certain of our bonds, which over the near term become-- there are puts on them. Look, when the stock-- These are the converts. When the stocks are-- stock is where it is, generally, the bonds are trading above par, and there's no way that there's going to be a put exercised. But, as we saw yesterday, the market changes. And the stocks come way down, there's a possibility that a certain amount of bonds are put to us. And we want to have that liquidity and still have the money to pursue other opportunities.

Those, I would say, are the basic reasons.

Okay. Can you give us a rundown of some of the investments you made over the last couple of years and where they stand right now?

Sure. On the real estate side, we purchased a defaulted note that was a Lennar project in California; basically, right across from the Palm Springs airport. And they originally sold lots-- I don't remember how many, but probably about 100-some lots at an average price of about $265,000 per lot. We did a friendly foreclosure, ultimately. There's golf courses completed; the clubhouse is now completed, all paid for by Lennar. Golf course is in operation. The builders that had built some spec houses, which include Lennar, on the property started selling and are selling the houses. We're left with probably 800-someodd lots where our average price is about $26,000. Of course, there's some more infrastructure to make them buildable. But, even if we rack $50,000 or $60,000 per lot, we think that that's very cheap. Very cheap.

And what's happening now in that business is that the-- Who gets interested? The people that got rid of the property before Lennar come back and are interested in buying lots. This is what's happening in that marketplace.

So we think that's a great investment. We're probably in for about $25 million or $26 million, all cash - no mortgage. And we have 800-someodd lots and a hotel site and a golf course and the clubhouse in Palm Springs. So we think that's a very good investment long term for us.

We invested in a mortgage in a building at 100 11th Avenue in Manhattan before the building was finished and before the offering plan was declared effective by the attorney general. We made the closings that we had to do. It's now a condominium. Obviously, there are people that default on contracts because of their own circumstances that have changed during the financial crisis. And we try to get out-- work on keeping as much of those deposits as possible and then reselling the apartment. As an example, we just basically kept most of the deposit on one apartment, then sold the apartment for a few dollars more than the other buyer was going to pay. So that's a work in progress, but that's going fine at this particular time.

The townhouses that we took over - basically, where we wrote off a substantial amount-- B.K., what did we write those down to?

We wrote them from $10 million to $3 million.

Right. We've recovered how much already - about $3.5 million?

We've recovered about $3 million right now.

About $3 million? And we have three of them left. And we think there will be more recovery there. That was not such a good deal. That was done earlier on, before the real meltdown happened.

We continue to look. We continue to bid on properties. A couple of things we're working on now, which I don't want to mention. As you probably have seen, at one point, we filed a 13-D on a hotel company, where our average price in the stock was at $1.38. We've liquidated a substantial portion of that already at prices around $5 a share. We still have shares left, which we will continue to liquidate at the right time. So that was a good use of some capital because we thought it was cheap at the time.

And those are the type of things we're looking at, Mitch.

And can you just discuss very quickly-- This is my last question-- some of the businesses that you bought into along with Phil Frost?

Yes. Well, we've done a few with him. I guess the most substantial one is OPKO, which has some great patents, which you know Phil is a genius in this, with finding these blockbuster type of situations. Probably our average price on OPKO is about $1.50, B.K.?

That's about right.

$1.50. And how many shares do we have now?

It's actually-- Howard, we have 10,057,000 shares.

Okay. So we probably invested about--

-- about $11 million. It's actually (inaudible).

The stock is $2. It was higher. We think it's-- He's very keen on it. We think it has some great patents. And it's one of these situations that could be fantastic. Those are really smaller investments, and you're investing based on the knowledge of Phil Frost.

Okay. Any thoughts about spinning off some of these shareholdings as you've done in the past?

Yes. We think about it. At the right time, we would consider it.

Okay. Thanks, guys.

Ken Bann, Jefferies & Company.

On the cigarette side, your volume shipments were up 26.8%. It was something like 482 million cigarettes. Are those numbers right?

You're asking me how much the volume increased?

Right.

Yes; I'd say that's in the range.

Okay. And could you give us some idea about how the-- somewhat of the split between increases at Pyramid versus declines at the Liggett Select and Grand Prix?

Yes. All of the increases were related to Pyramid. And they offset declines that were in the kind of range as we were looking at in the general market, in the single-digit to low, double-digit kind of range.

Okay. And what--? As you were saying, or alluding, that earnings may come down as Pyramid continues to grow, what's sort of the difference in the gross profit margin that you're making on a Pyramid versus the Liggett Select or the Grand Prix?

The difference is probably somewhere in the range of-- and it varies based upon the brand-- but somewhere in the range of $3 to $5 a carton.

Okay. And do you sort of expect these kind of--? Well, versus last year, was there--? Wasn't there sort of a destocking of inventories as people didn't want to hold a lot inventory prior to the tax increase?

Yes. And I guess, if you look at it from the standpoint-- That's why we focused a little bit more heavily on the changes that occurred at retail, because, while they were also affected by the de-loading, they weren't affected as much. But, looking at it on the wholesale shipment side, the overall industry was down about 2.5% for the first quarter, and we were up 27%. So, irrespective of the de-loading effect, there was significant growth relative to our growth program with Pyramid.

Right. Okay. But I would guess expecting that kind of growth in the next few quarters-- Is that realistic, or is that--?

We are continuing to invest for growth, and we anticipate that we will continue to grow.

Okay. All right. Great. Thank you very much.

(Operator instructions). [Victor Rajesh, VGSA Partners].

Looking at the 10-q, Douglas Elliman revenues have rebounded very nicely. So could you just comment on what trends you're seeing in that business? And, if you will, what's the run rate revenue line you see in '10 and '11?

Sure. What typically happens at the time that the market slows down, your overhead is the highest. So we were not that much different. We made substantial cuts in all areas. And then our business has rebounded. In fact, volumes are very strong. Prices, probably, in Manhattan are down maybe 10% to 15%, but the volume is starting to approach the highs that we saw in '06/'07.

So it's hard to say. I mean, generally when people ask me what's going to happen with the real estate market, I tell them - Tell me what's going to happen with the stock market, and I'll tell you what's going to happen with the real estate market. The fact is the Manhattan real estate market, at the very least, is really directly related to how the market is based on how people are feeling. On a day like yesterday, I doubt there were too many people that were very encouraged about going and making a bid on an apartment, unless they had to do it. So, if the market continued that way, my guess is things would start slowing a little bit again.

But I think the basic psychology has again changed to where people are not worried about a major financial meltdown. At least, they weren't until yesterday. Again, now it looks like in the US-- now all of a sudden everyone's thinking - Well, maybe we're in better shape than the rest of the world. So it's hard to say how it will affect it.

But, as of now, the markets are still strong. Lots of activities at all price levels. And we see it maybe slowing back down in a little bit but not substantially at this point.

I see. And then, switching gears, in the long-term investment category, could you just give a little bit more detail on these partnerships that are listed here?

You mean the investment partnerships?

That's correct. Yes. There's about $50 million, which is fairly valued at about $71 million. I'm just curious about the details.

I don't think that's right. I don't think the $50 million is valued $71 million. We had invested in Icon Enterprise fund. And I think we put in $25 million and then put in another $25 million. And I think that total is probably a little bit less than $50 million now. Is that correct, B.K.?

That is correct.

Right. We had another small fund that we put $5 million in, which is probably at around $6 million or $7 million now.

That's right.

And we had another one that we put $10 million in, which is probably still at a loss. It's probably at around $8 million. Those are three, what I call, hedge fund investments or partnerships that we're in.

(Inaudible) carrying them on the books at $50 million because we wrote down the impairment charges.

Okay.

So the fair value is correct, which is about $71 million, which is what you have in footnote 3.

That's correct.

Okay. Thank you. Thanks, guys.

(Operator instructions). Okay, sir, at this time, there are no further questions in the queue. So, Mr. Lorber, I'll turn it back to you for closing remarks.

Thank you, operator. Well, we thank everyone for being on this conference call today. As always, Ron Bernstein, B.K., and myself are available to answer any questions at any time. And we look forward to our next conference call in August. Thank you very much.

This now concludes our teleconference. You may disconnect your lines.