Vector Group Ltd (VGR) 2010 Q4 法說會逐字稿

Welcome to the Vector Group fourth quarter and full-year 2010 earnings conference call.

Before the call begins I would like to read a Safe Harbor statement. The statements made during this conference call that 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 & Exchange Commission filings.

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

Thank you. Good morning, and thank you all for joining us for Vector Group'sfourth quarter and full-year 2010 earnings conference call.

With me is Ron Bernstein, the President and Chief Executive Officer of Liggett Vector Brands and Liggett, and Bryant Kirkland, Vector Group's Chief Financial Officer. On today's call, I will provide an on our business and review Vector Group's financials for the fourth quarter and full-year ending December 31, 2010. Ron will then discuss Liggett's performance and provide views on industry developments in a competitive environment. After that, we will answer your questions.

Let me begin by saying that we are pleased with our Company's overall performance, and particularly with our volume and share growth of 2010. As we have noted, we made the decision to strategically invest in the growth of our tobacco business in advance of the 2009 legislation that increased the federal excise tax on cigarettes by $6.17 per carton, and legislation that ultimately granted the Food and Drug Administration's regulatory authority over tobacco products.

The success of the strategy that we put into place is reflective in LVB's fourth quarter 2010 wholesale shipment growth of almost 17%, compared to the year ago quarter. And for the 2010 full-year, we achieved wholesale shipment growth of almost 25%. Looking longer term, we remain committed to achieving sustainable profitable 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 but improving market environment. We are very pleased with Douglas Elliman's record EBITDA of $43.5 million and net income of $41.5 million for 2010. We continue to believe that there are good investment opportunities in this market and we are pursuing appropriate opportunities that meet our criteria.

Before turning to the financials, I want to briefly address the tobacco litigation environment, and specifically developments with respect to the Engle cases in Florida. As previously noted, the Engle progeny cases are now the primary focus of our litigation activity. There are approximately 6,800 cases pending, with more half of them in federal court and the balance in Florida state court. We along with the other industry defendants continue to believe that the Engle process is materially floored and unconstitutional. While we believe that we have strong arguments as is evidenced by several recent defense verdicts in the state cases and a potentially favorable ruling in federal court that we referenced on previous calls, there are still considerable risks and we remain subject to the ongoing process and periodic negative judgements.

As previously reported in June 2010, we paid $14.4 million to resolve the judgment in [Lupacks] case, which was the first Engle progeny case tried. Although the verdict was rendered years in advance of the Florida Supreme Court's ruling on the Engle case, we (inaudible) certain findings that the jury in Lupacks replied upon in assessing liability the appellate court shows not to review this case. This is the largest judgement against Liggett to date and is the result of what we believe to be unique circumstances.

The federal court ruling from the 11th Circuit Court of Appeals we referenced impacts approximately 3,700 Engle progeny cases pending in federal court. While we continue to believe the Court's rulings will result in restrictions on the ability of plaintiffs in federal count to use Phase I findings determined by the prior Engle jury to meet their burden of proof in trial, a recent appellate decision in the state court ruled that the Federal Appellate Court decision is not persuasive authority in the state court.

Turning now to Vector's balance sheet, our liquidity remains strong with cash and cash equivalents of approximately $300 million as of December 1, 2010. During the 2010 fourth quarter, we saw a strong demand among qualified institutional buyers from Vector Group's 11% senior secured notes due 2015 and thus upside the offering size from $75 million to $90 million. The notes were issued at a premium $103 of face value. At year end 2010, the Company held investment securities and partnership interest with a fair market value of $151 million.

Before we review groups Vector Group's financial performance, there was a press release that was issued which has to be -- which we're sending out a correction, two numbers in the table that was in the release that was given out yesterday. More importantly, these numbers do not change any of the totals, and we will be issuing a correction momentarily. The correct number for the gain on investments securities for the quarter is $8,050,000 and the correct number for the income from non-consolidate real estate business is $5,125,000. We apologize for any confusion.

For the fourth quarter ended December 31, 2010, Vector Group's revenues were $277.6 million, compared to $236.7 million in the 2009 fourth quarter. The increase in revenues in the 2010 period was primarily due to increased cigarette unit volumes. The Company reported operating income of $29.3 million in the 2010 fourth quarter, compared to operating income of $36.2 million in the 2009 fourth quarter.

Fourth quarter 2010 net income was $12 million, or $0.16 per diluted share, compared to $13.4 million, or $0.18 per diluted share in the corresponding 2009 period. Excluding a $1.8 million pre-tax charge for litigation judgment and $1.2 million in pre-tax charges from changes in fair value of derivatives embedded within our convertible debt, fourth quarter 2010 net income was $13.9 million, or $0.18 per diluted share.

Excluding $10.1 million in pre-taxcharges from changes in fair value of derivatives embedded within our convertible debt, which was offset by $2.1 million inpre-tax income from our investment in the St. Regis Hotel, fourth quarter 2009 net income was $18.2 million, or $0.24 per diluted share.

For the full year ended December 31, 2010, Vector Group revenues were $1.063 billion compared to $801.5 million for the full year 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 $111.3 million during the full year of 2010, compared to operating income of $143.2 million for 2009. Excluding $16.2 million pre-tax charges related to litigation judgments and $3.0 million pre-tax settlement charge, operating income was $130.5 million for the full year period. This performance is in line with our expectations given the substantial investments we have made in the growth of our Pyramid brand, which Ron will elaborate on in a moment.

Net income was $54.1 million for the full year of 2010, or $0.71 per diluted share, compared to $24.8 million in the 2009 period, or $0.33 per diluted share. Excluding the litigation judgements, settlement charge, and $11.5 million of pre-tax gains from changes in fair value of derivatives embedded within our convertible debt, net income for the full year period in 2010 was $58.7 million, or $0.77 per diluted share. Our financial results for the full year ended December 31, 2009, include a pre-tax gain of $5 million related to 1999 trademark transaction with Philip Morris. Pre-tax charges of $18.6 million on extinguishment of debt and pre-tax expenses of $35.9 million from changes in fair value of derivatives embedded within our convertible debt.

Pre-tax impairment charges of $8.5 million on real estate and pre-tax restructuring charges of $900,000. Adjusted for these items are net income for 2009 would have been $52.4 million or $0.69 per diluted common share.

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

Thanks, Howard. Good morning, everybody. As Howard mentioned, we're very pleased with the performance and growth of our tobacco operations in 2010. Over the past 21 months, we have substantially increased our product shipments and grown our market share, and we continue to feel positive about the track we're 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 combined financial reporting for Vector Tobacco into Liggett. As a result, comparisons to 2009 performances are adjusted to reflect the combination of Vector Tobacco and Liggett.

For the three months and full year ended December 31, 2010, Liggett revenues were $277.6 million, and $1.063 billion, compared to $236.7 million and $801.5 million for the corresponding periods in 2009. As previously noted, the revenue increased during the 12-month period ended in December 31, 2010, was primarily due to increased unit volumes and the higher federal excise tax rates.

Operating income for the three months and full year ended December 31, 2010, was $33.7 million and $130.2 million, compared to $41.7 million and $160.9 million for the corresponding periods in 2009. Adding back the previously mentioned $16.2 million litigation judgement and the $3 million settlement charge in the third quarter, operating income for the full year was $149.3 million. Included in the 2009 operating income is the one-time gain of $5 million related to the 1999 trademark transaction with Philip Morris and restructuring charges of $900,000.

Turning back to market performance, I'm pleased to report that our trend of market share growth continued in the fourth quarter of 2010. According to Management Science Associates, for the quarter ending December 31, 2010, Liggett's wholesale market share was 3.85%, an increase of almost three-quarters of a share point over the fourth quarter of 2009. At the same time, Liggett's retail share increased to approximately 4.1%, an increase of almost 80 basis points over the prior year period. This marks the highest industry share held by Liggett since 1985.

Overall, fourth quarter retail shipments for the industry declined by 2.3%, while Liggett's retail shipments increased by almost 21%. All major competitors suffered declines in retail shipments for the quarter, except for Lorillard, which data indicates had an increase of 7.3%.

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 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 4.7% in the fourth quarter in 2010 compared to 2009 period. Liggett significantly outperformed the market during the fourth quarter with wholesale shipments growing by almost 17% over the prior year period.

The primary driver for Liggett's volume growth, at both retail and wholesale, continues to be the strong performance of our Pyramid brand, which was redesigned, repackaged, and reintroduced to the market in 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, and we believe that Pyramid box continues to offer the trade and consumers the best value proposition available in the market.

As previously reported, effective January 1, 2010, Pyramid was made available nationwide following the regional rollout we implemented in 2009. We are very pleased with our progress to date. According to Management Science Associates, in the fourth quarter of 2010, Pyramid was the seventh largest brand in the United States in terms of retail shipments, and we saw a strong acceptance of the brand at both the retail and consumer level nationwide.

As a result, we're continuing to go provide Pyramid-focused promotional programs to the trade that also provides support to our other core brands. We're progressing well with other initiatives that we're undertaking to continue to successfully grow the brand in the changing tobacco marketplace.

Since 2005, we've carefully balanced our approach to pursuing volume and margin opportunities in the market. That continues to be the case, and our objective is to achieve sustainable profitable growth in our tobacco business over the long-term.

Throughout the year, estimates for 2010 industry shipment declines were in the range of 4% to 5%, and final year-end data from Management Science Associates reflected that wholesale shipments actually declined by just over 3.8%. However, recently released data from the US Treasury's Alcohol and Tobacco Tax and Trade Bureau, TTB, indicated that the taxable shipment decline was significantly greater at 5.9%.

While we had accrued for a 5% decline, the actual decline resulted in additional expense of $1.5 million, which was booked in the fourth quarter. This type of discrepancy between MSAI and TTB is very unusual and we believe resulted from one or more of the larger companies deloading tax paid inventory at their bonded warehouses and withholding shipments from their factories.

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 have been bearing costs associated with the implementation of the FDA requirements and will continue to do so in the future.

Based on our current estimates, which are subject to change as regulations 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 had been hopeful that based upon our expertise and experience in the fields of biology and chemistry, as well as in smoking cessation, that would have had the opportunity to provide meaningful input to the FDA as the process developed. Regrettably, to this point, that has not been the case and the Tobacco Product Scientific Advisory Committee, TPSAC, appears to have been largely dominated by anti-industry zealots, while knowledgeable industry experts have been shut out for the most part.

It is unclear if the FDA will blindly accept what we fear will be inevitably biased recommendations from TPSAC, or if they will open to discussion to objective scientific data. While we've had meetings and discussions with FDA officials, they have not provided any meaningful guidance on outstanding issues. As a result, we continue to closely monitor the activities of the FDA and its committees, and along with other industry participants, will pursue such remedies as necessary to assure that the process is as fair as possible.

In other industry news, we were pleased when TTB ruled that retailers that sell cigarettes produced by roll-your-own machines in their stores must obtain manufacturing permits and pay applicable federal taxes. The ruling deems stores using such RYO machines as cigarette manufacturers, meaning they must obtain permits from the Tobacco Tax Bureau, comply with record keeping rules, and pay $10.07 for each carton of cigarettes they make. We believe this ruling, when properly enforced, will help level playing field as many of these retailers may now find it cost prohibitive to deploy these machines. Unfortunately, that ruling has been stayed pending appeal. We believe that TTB will ultimately prevail and that their ruling will slow the alarming growth of these machines that typically use so-called pipe tobacco to avoid paying proper excise taxes and fees to federal and state entities.

Let me wrap up my comments by reiterating that we are very pleased with Liggett's 2010 performance. Through a concerted company-wide team effort, we continue to meet the challenges of a difficult marketplace while pursuing opportunities that we believe will enhance the long-term strength and profitability of Liggett. There is no doubt that new challenges will continue to arise, but I'm confident that Liggett is well-positioned to meet them and to succeed.

Thanks for your attention, and back to you, Howard.

Thank you, Ron.

As we begin 2011, we believe that Vector Group is well-positioned. We have strong cash reserves, have significantly grown our market share in the past 18 months, and will continue to benefit from our favorable terms under the management settlement agreement. Additionally, we are very proud of the Company's uninterrupted track record of paying a regular quarterly cash dividend since 1995 and an annual 5% stock dividend since 1999. 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. At this time, we will open the floor up for questions. (Operator Instructions). And we are currently holding for questions. Our first questions comes from Suzanne Franks with Vivid Research.

Good morning. A couple of questions. It seems you're running the business for market share at the expense of margin mainly due to the support of the Pyramid brand. When would you expect, or do you expect to continue this type of support to the Pyramid brand? Or do you expect to revert to running the business for margin at some point as opposed to market share?

As I mentioned in the comments, we've, over the course of the last six years or so, have really focused on both margin and volume opportunities. And with the advent of the federal excise tax increase in 2009, we determined that there was a significant opportunity to grow share and to build the brand. We focused on that and we basically had a structured plan, which we have been operating by, and we invested at a certain level in 2009, reduced that somewhat in 2010, and are no longer investment spending, if you will, on Pyramid. So we are in a process of gradually bringing the brand up to a profitable level and expect that given the volume gains, that it will deliver significant profits in the future.

Okay, so you expect that volume to continue even if you remove the support?

Yes

Okay. What was your free cash flow for 2010?

B.K.?

Are you talking on a corporate level or Liggett's level?

Both.

Okay. Liggett's free cash flow was -- EBITDA was $138.4 million for 2010, or $157.5 million if you add back the litigation judgment and the settlement charges. And as far as the consolidated level, EBITDA was $122.1 million before adding back the two special charges, or $141.3 million after adding back the litigation judgment and the settlement charges.

And capital investments?

Just a minute. Capital investment for 2010 --

For Liggett?

Right. For the Company, it was $23.4 million, and $23.1 million related to Liggett, and the rest related to some real estate projects we have.

Just as a point on CapEx in conjunction with the growth that we've been generating and the switch in the marketplace from a soft-pack oriented product to a box oriented product, we have over the last couple of years been restructuring and adding capacity to our factory. So our expectation is that the number that was last year was a one-year event and that we will come down to closer to historic levels, which are usually at the range or below our depreciation rates.

Right. And in addition to that, approximately $16 million of that was financed.

Okay. Thank you.

The next question comes from Ken Vaughan with Jefferies & Company.

Good morning. I noticed you said in the K that you increased the list price on Pyramid by $1.30 a carton this last January, right?

Yes, by January 1st.

Have you seen any impact on volumes? Did volumes increase before that as people thought the price increase would go into effect? Or have volumes changed --

We put the market on allocation in December to avoid any large buy-in of product, and the brand continues to grow.

Okay. I would presume that most of this price increase will basically flow pretty much to the bottom line. Is that correct?

It will eliminate the investment that we had made in the previous year, and will cover additional costs related to FDA and the MSA.

Right, okay. And your total accruals for MSA payments for 2010 were $140 million? Is that correct?

That's correct.

What was the final total for the prior year?

I don't remember -- B.K., I don't know if you have it in front of you, but it's about $100 million.

Yes.

Okay. And you already paid $96 million of the accrual at the end of last year and you'll pay the other $40 million in April. Is that correct?

Correct. Minus any amount that we determine to withhold.

Okay. Could you comment at all on the -- talk about the potential of trying to eliminate the use of menthol in cigarettes? What do you think that potential is and as that comes about, how that might effect you?

Well, as -- in terms of what our expectation is, is that it's unknown what type of recommendation TPSAC may make, or the Tobacco Product Scientific Advisory Committee, may make to FDA. As I mentioned in our comments, that the folks at TPSAC are anti-industry zealots who could recommend draconian measures such as elimination. I don't think they're going to, but they could. I think it's unlikely that FDA, which is mandated to be a science-based organization and is not required to accept recommendations made by advisory committees, would take that type of a measure. It's possible that they may come up with some gradual declines over a period of time. However, to the best of our knowledge, there is no scientific data that indicates that menthol is in any way more harmful than non-menthol or less harmful. So there is really not a scientific base, and my guess is that FDA will be more measured than TPSAC may be in their recommendations, and further that anything that is not substantiated by good scientific data is likely to end up in litigation. I can't imagine that Lorillard and Reynolds, particularly Lorillard, is going to stand and not fight in the event that something is brought forward and is not appropriate, which we think it would not be appropriate. Our business is about 25% approximately menthol. If menthol were eliminated in a worst-case scenario, I think that you would see some folks switch to non-menthol products. There would clearly be a reduction, but I think that outcome is very unlikely.

Thank you. Our next question comes from [Ajay Ahajan] with (inaudible). (Operator Instructions).

Hey, guys. I have two questions for you. The first was dealing with your cash flow. Could you talk about how you think about using cash flow aside from the dividends and CapEx that you'd mentioned?

Well, we are always looking for opportunities. We made some investments in the real estate brokerage and also, obviously, in ownership of some real estate. A couple of things may be a little too early, but we've managed to work our way out of them, and then a couple of things where we think we're going to do pretty well on, and we're always looking for opportunities. We think this is going to be a good year for that. We also look at other corporate opportunities. There's not a lot because, you know, it's hard to compete with the large private equity firms or even the smaller private equity firms, and we're not buyer of things at high multiples. So right now, most of the looking has been done, the serious looking has been done on the real estate side, and we'll continue that way. If there was a corporate opportunity within the tobacco business, which we don't really see anything there or outside, obviously depending on the size, we would consider it.

Thank you. (Operator Instructions). There are no questions at this time.

Okay. Well, I would like to thank everyone for being on this conference call, and as always, Ron, Bryant Kirkland, and myself are available to answer any questions. Thank you all very much, and have a good weekend. Bye.