Vector Group Ltd (VGR) 2010 Q2 法說會逐字稿

Welcome to Vector Group's second quarter 2010 earnings conference call. Before the call begins, I'd 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 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 President and Chief Executive Officer of Vector Group, Howard Lorber.

Thank you. Good morning and thank you for joining us on Vector Group's second 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 second quarter and first half 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 we are very pleased with our Company's continued strong performance and volume growth trends during the second quarter of 2010. As we have previously noted in anticipation of the April 2009 legislation that increased the federal excise tax on cigarettes by $6.17 per carton and pending legislation that ultimately granted the Food and Drug Administration regulatory authority over tobacco products, we made the decision to strategically invest in the growth of our tobacco business.

The success of the strategy that we put into place is reflected in Liggett Vector Brands second quarter 2010 wholesale shipment growth in excess of 30%, while the overall industry declined by over 7%. Beyond the short-term, we are committed to a program of sustainable growth in our tobacco business and Ron will provide more detail on that in a moment.

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

At this point, I want to briefly address the tobacco litigation environment and especially developments related to the Engle cases. As previously noted, the primary focus of our litigation activity currently is the Engle progeny cases in Florida. There are approximately 7,000 cases pending, with more than half of them in federal court and the rest in Florida state court. We along with the other industry defendants continued to believe that the Engle process is materially flawed and unconstitutional. While we believe we have very strong arguments and have recently received a potentially significant favorable ruling in federal court, there is considerable risk and we remain subject to the ongoing process and periodic negative judgments.

For example, in June we paid $14.4 million to resolve the judgment in the Lukacs case. This is the largest judgment against Liggett to-date and it was the result of what we believe to be unique circumstances. Lukacs was the first Engle progeny case tried and the judgment was entered years in advance of the Florida Supreme Court's ruling on the Engle case. Although the Florida Supreme Court eventually overturned certain findings that the jury in Lukacs relied upon in assessing liability, the appellate court chose not to review this case. Accordingly, Liggett and the two other tobacco company defendants had no further meaningful avenue of appeal and the judgment was paid in the second quarter.

What we recently had well could be very positive news in a ruling from the 11th Circuit Court of Appeals, which impacts the approximately 3,900 Engle progeny cases pending federal court. We believe the court's ruling will likely result in severe restrictions on the ability of plaintiffs in federal court to use Phase 1 findings determined by the prior Engle jury to meet that burden of proof of trial. We agree with the industry leader that this ruling should also provide persuasive authority for Florida state courts that have been allowing plaintiffs to rely on the Engle findings without satisfying the requirements of Florida law or due process. We are encouraged by this recent ruling and believe it could have a very positive impact on the future direction of the Engle cases.

Before discussing the financial results, I am also pleased to remind you that, in April 2010, we enhanced our strong financial position by completing a private placement of an additional $75 million of our 11% senior secured notes through 2015. Our liquidity remains strong, with cash and cash equivalents of approximately $285.5 million as of June 30, 2010. Additionally, as of June 30, 2010, we held investment securities and partnership interests with a fair market value of approximately $143.7 million.

Now let's turn to the key financials for the three months and six months ended June 30, 2010 for Vector Group. For the second quarter ended June 30, 2010, Vector Group revenues were $268.5 million, compared to $206.8 million in the 2009 second quarter. The increase in revenues in 2010 was primarily due to increased volumes.

The Company recorded operating income of $21.1 million in the 2010 second quarter, compared to operating income of $38.8 million in the 2009 second quarter. Excluding the $14.4 million pretax charge related to the litigation judgment, operating income was $35.4 million for the quarter.

Second quarter 2010 net income was $19.2 million, or $0.20 per diluted share, compared to a net loss of $7.9 million, or $0.11 per diluted share, in the corresponding 2009 period. Excluding the charge related to the litigation judgment and $13.8 million of pretax gains from changes in fair value of derivatives embedded with our convertible debt, second quarter 2010 net income was $19.6 million, or $0.27 per diluted share.

Excluding $18.4 million of pretax charges related to the extinguishment of debt in 2009 and $19.5 million of pretax charges from changes in fair value of derivatives embedded with our convertible debt, second quarter 2009 net income was $14.7 million, or $0.20 per diluted share.

For the six months ended June 30, 2010, Vector Group revenues were $490.6 million, compared to $328 million in the first six months of 2009. The increase in revenues in 2010 was primarily due to increased volumes and higher prices related to the federal excise tax increase, which became effective on April 1, 2009.

The Company recorded operating income of $52.1 million during the first six months of 2010, compared to operating income of $70 million for the 2009 six month period. Excluding the $14.4 million pretax charge related to the litigation judgment, operating income was $66.5 million for the six month period. Net income was $31.2 million for the first six months of 2010, or $0.41 per diluted share, compared to a net loss of $4.8 million in the 2009 period, or $0.07 per diluted share.

Excluding the charge related to the litigation judgment and $11.1 million of pretax gains from changes in fair value of derivatives embedded within our convertible debt, net income for the six month period in 2010 was $33.2 million or $0.46 per diluted share.

Our financial results for the six months ended June 30, 2009 include a pretax gain of $5 million, related to the 1999 trademark transaction with Philip Morris, pretax charges of $18.4 million on extinguishment of debt and pretax expenses of $19.8 million from changes in fair value of derivatives embedded within our convertible debt, 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 the 2009 six month period would have been $20.7 million, or $0.29 per diluted common share.

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

Thanks, Howard. Good morning, everybody. As Howard mentioned, we are very pleased with the performance and growth of our tobacco operations. Over the past 15 months, we've seen substantial increases in product shipments and market share and we feel very positive about the track we are on. I will elaborate more on our performance in a moment, but first let me turn to the financials.

As discussed on prior calls, in 2009 we restructured operations at Vector Tobacco and ceased most of Vector Tobacco's research activities. Accordingly, beginning in 2010 we are combining 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 and six months ended June 30, 2010, Liggett revenues were $268.5 million and $490.5 million, compared to $206.8 million and $328 million for the corresponding periods in 2009. As Howard mentioned, the revenue increase during the six month period was due to increased unit volumes and the higher federal excise tax rate.

Operating income for the three and six months ended June 30, 2010, was $26 million and $61 million, compared to $42 million and $77.6 million to the corresponding period in 2009. Adding back the $14.4 million Lukacs settlement previously described, operating income for the three and six month periods of 2010 would be $40.4 million and $75.4 million.

Included in the year ago period's operating income is a one-time gain of $5 million related to the 1999 trademark transaction with Philip Morris and restructuring charges of $1 million.

On our last call, I mentioned that, in 2009, our Company surpassed 3% share of cigarette market for the first time since 1992. I am pleased to report that Liggett has continued to grow its market share through the second quarter of 2010. According to Management Science Associates, as of June 30, 2010, Liggett's wholesale market share was over 3.4%, an increase of 1 full share point versus the second quarter of 2009, while retail share increased to almost 3.7%, marking the highest industry share held by Liggett since 1987. Overall, second quarter retail shipments for the industry declined by less than 1%, while Liggett's retail shipments increased by approximately 34%. All of the larger competitors suffered declines in retail shipments for the quarter except for Lorillard, which, data indicates, had an increase of close to 8%.

As you may recall, following the April 1, 2009 federal excise tax increase, there was a reloading 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 serves as a better indicator of Company performance. Having said that, overall industry wholesale shipments declined by 7.1% in the second quarter of 2010, compared to the 2009 period. Liggett significantly outperformed the market during the second quarter, with wholesale shipments increasing by more than 30% over the prior year.

The primary driver for Liggett's volume growth at both retail and wholesale has been the performance of our Pyramid brand, which was redesigned, repackaged and introduced to the market in late April 2009. Pyramid's new box styles are 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 ranking 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 marketplace.

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 provides support to our other core brands. We continue to be pleased with the growth of Pyramid box, 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 our investment in Pyramid during the first six months of 2010. This has allowed us to improve operating income year-over-year, when adjusting for the second quarter settlement and 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 while continuing to grow the Pyramid brand. 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 as a decline of 8.6%.

As we 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 the 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% for 2009, Liggett suffered a decline of $10.7 million in its MSA exemption, which was reflected in 2009 earnings. As previously noted, this decline was within the range we anticipated. At this point, estimates for 2010 industry volumes project 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. We've been bearing costs associated with the implementation of FDA requirements and we'll continue to do so in the future. Based on our current estimates, which are subject to changes in regulations that are issued over the next two years, we expect the costs to remain in a manageable range and to be 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.

In conclusion, we are very pleased with Liggett's performance during the first half of 2010. Through a concerted companywide 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.

Thanks Ron. Before I finish the prepared remarks, the Company once again reaffirms that our cash dividend policy remains the same.

Now, operator, would you please open the call for questions?

Thank you, sir. (Operator Instructions). Our first question is from Ken Bann with Jefferies & Company.

Good morning. I was wondering if you could talk about the Liggett brand and the Eve brand. Were volumes down in both of those brands in the quarter?

Yes, volumes on Eve were down around 3% and Liggett Select was down in the high teens.

Okay. And you expect that that kind of decline is going to continue, whereas the Pyramid brand, I guess that we still have the same of growth rate, do you expect going forward over the next several quarters versus last year. But, or will it decline in terms of growth rate?

No, well we expect Pyramid to continue to grow. It probably it will not sustain at a level of 30%, but we expect that it will continue to grow at pretty significant levels. We expect that the decline rates, remember in comparison to last year because of the reloading of the industry after the April 1st excise tax increase --?

Right.

That declines are a little bit - they were tough comparisons year-over-year. So, I would expect that the declines on Liggett Select, Grand Prix, and Eve will be --. Eve is running in more or less a flat kind of range, Liggett Select, because of the price point, will decline more for sure, but not at the level that we saw in the second quarter and Grand Prix is declining far less than Liggett Select.

Okay. Do you have an estimate of what would be your MSA payments this year, given your increase in market share?

Well, I mean, we obviously we're not giving guidance in terms of what the ultimate volume would be. But, I would be expect, if you look at last year, that you would be looking at a significant increase year-over-year in terms of MSA payments.

Right, okay. But, do you - some any idea order of magnitude or?

You know, it's going, if you just track through our volume you would anticipate that the MSA payments would probably come close to doubling year-over-year.

Okay. And, then in terms of the cash that you are sitting on, I know you have been looking at various real estate investments. Can you give us any color as to where you see opportunities? Is anything different than what you have looked at before and are you close to anything?

We are working on a number of interesting situations, a few of them in South Florida, a couple in New York. I think it's getting a little bit -- I mean there is a lot of buyers around, but on the other hand there were really no sellers. Now that the banks are basically actually doing foreclosures and taking over projects, we are working with a number of banks. So, I would imagine that we will get something done before the end of the year.

So, does it seem like the opportunities are becoming more realistic in terms of getting transaction done right now, than (inaudible -- multiple speakers) for a while?

Yes. Yes it has, yes this is the first time because their banks are actually biting the bullet and taking back the properties so --

Right, right.

So that's basically what's happened.

Okay, all right great. Thank you very much.

Thank you. At this time, I am showing no further questions. Mr. Howard Lorber, do you have any closing remarks.

No. Thank you all for being on the call of you. Like all of you I think we all are very pleased with what our quarter and the first six months look like and hope to continue. And always, we are always available, BK, myself or Ron are always available to speak to any of you. Well, have a nice weekend everyone. Thank you.

Thank you ladies and gentlemen. This concludes today's conference. You may now disconnect. Have a great weekend.