Vector Group Ltd (VGR) 2011 Q3 法說會逐字稿

Welcome to Vector Group's third-quarter 2011 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 risk and uncertainties that could cause actual results to differ materially from those set forth in or implied by forward-looking statements. These risks are described in more detail in the Company's Securities and Exchange Commission filings.

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

Good morning and thank you for joining us on Vector Group's third-quarter 2011 earnings conference call. With me today is Ron Bernstein, the President and CEO of Liggett Vector Brands and Liggett; and Bryant Kirkland, Vector Group's Chief Financial Officer.

On today's call I will provide an update on our business and review Vector Group's financials for the third quarter and first nine months of 2011. Ron will then address Liggett's performance for the period and provide his perspective on what continues to be a challenging domestic tobacco market. After that, we will answer your questions.

As we have previously stated, our primary goals for 2011 are to continue growing Liggett's market share by focusing on our Pyramid brand while also generating year-over-year profit growth. I am very pleased to report that year to date we are achieving both of these goals and continued to increase both market share and profits. We will provide more detail when we discuss our financial and tobacco business performance later in the call.

With respect to our non-tobacco operations, we continue to identify and pursue investment opportunities that we believe will enhance the long-term value of Vector Group. We believe there are good opportunities in this market in real estate and elsewhere and we will make appropriate investments when those opportunities meet our criteria.

Before turning to the financials, I want to briefly update you on tobacco litigation and specifically the Engel cases in Florida. As previously noted, the Engel progeny cases are now the primary focus of our litigation activity with 5771 cases pending in both federal and state court. We, along with the other industry defendants, continue to believe that the Engel process is materially flawed and unconstitutional.

That said, appellate efforts to date have not been successful and the Florida Supreme Court has declined to review verdicts against the tobacco industry defendants. While we believe we have strong arguments as evidenced by several defense verdicts in the state cases and the potentially favorable ruling in a federal court referenced on previous calls, there is still considerable risk that these cases go to trial and we remain subject to the ongoing process and periodic negative judgments.

Turning now to Vector's balance sheet, our liquidity remains strong with cash and cash equivalents of approximately $328 million as of September 30, 2011. Additionally, as of September 30, 2011, the Company held investment securities and partnership interest with a fair market value of approximately $85 million.

Now, let's turn to the key financials for the three months and nine months ended September 30, 2011 for Vector Group. For the third quarter ended September 30, 2011, Vector Group revenues were $289 million compared to $295.1 million in the 2010 third quarter. The decline in revenues was primarily due to lower wholesale cigarette shipments in the quarter. Ron will discuss this further in his comments. The Company recorded operating income of $37.9 million in the 2011 third quarter compared to operating income of $29.9 million in the corresponding period in 2010. Third-quarter 2011 net income was $17.5 million or $0.21 per diluted share compared to $10.9 million or $0.14 per diluted share in the 2010 period. Excluding $4.4 million of pre-tax gains from changes in fair value of derivatives embedded within our convertible debt and $2.2 million from the liquidation of long-term investments, third quarter 2011 net income was $13.6 million or $0.17 per share.

Excluding a $3 million pre-tax nonrecurring settlement charge and $1.7 million of pre-tax gains from changes in the fair value of derivatives embedded within our convertible debt, third-quarter 2010 net income was $11.7 million, or $0.15 per diluted share.

For the nine months ended September 30, 2011, Vector Group revenues were $840.6 million compared to $785.7 million in the first nine months of 2010. The increase in revenues was primarily due to increased wholesale cigarette shipments and higher prices during the nine-month period. The Company recorded operating income of $107.3 million in the 2011 nine-month period compared to operating income of $82 million with for the 2010 nine-month period. Excluding a $14.4 million pre-tax charge related to the litigation judgment and $3.0 million of pre-tax non-recurring settlement charges, operating income was $99.3 million for the 2010 nine-month period.

Net income for the nine-month period was $67.2 million or $0.82 per diluted share compared to $42.1 million or $0.52 per diluted share in the corresponding 2010 period.

The 2011 results include pre-tax gains from the liquidation of long-term investments of $25.8 million, changes in fair value of derivatives embedded within our convertible debt of $13.2 million and sales of townhomes of $3.7 million. The amounts were offset by a loss on extinguishment of debt at $1.2 million. Adjusting for these items, net income for the nine-month period in 2011 was $42.6 million or $0.53 per diluted share. Excluding the litigation judgment settlement charges and $12.7 million of pre-tax gains from changes in the fair value of derivatives embedded within our convertible debt, net income to the nine-month period in 2010 was $44.8 million, or $0.56 per diluted share.

I will now turn the call over to Ron Bernstein to discuss our tobacco business. Ron?

Thanks, Howard, and good morning everybody. Despite a challenging market environment, we are very pleased to have increased both market share and operating profit in the third quarter of 2011. As noted in prior calls, we embarked on a growth strategy in conjunction with the April 1, 2009 Federal excise tax increase. We have had significant success in the 2.5 years since we began this initiative and based upon our progress we continue to feel positive about the course we are on. I will elaborate more on our performance in a moment, but first let me turn to the financials. Please note that financial reporting for Vector Tobacco is combined with Liggett.

For the three and nine months ended September 30, 2011, Liggett revenues were $289 million and $840.6 million compared to $295.1 million and $785.7 million for the corresponding periods in 2010. Operating income for the three and nine months ended September 30, 2011 was $42.9 million and $121.5 million compared to $35.5 million and $96.5 million in 2010. Operating income in the third quarter of 2010 included a $3 million pre-tax charge related to a litigation settlement. Operating income for the nine months of 2010 included $17.4 million in litigation judgments and settlements.

Turning to market performance, according to Management Science Associates for the quarter ending September 30, 2011 Liggett's retail market share was over 4%. This represents an increase of 10 basis points over the prior-year period and 18 basis points over the 2011 second quarter. During the third quarter of 2011, Liggett's retail shipments increased by 0.5% while overall retail industry shipments decreased by more than 2%. According to MSAI, Liggett and Lorillard were the only two companies to realize retail gains for the quarter. As noted previously, retail shipments are a far better indicator of performance than wholesale shipments since both manufacturer and wholesaler actions can affect wholesale shipments. The third quarter provided an excellent example of that dynamic.

While industry retail shipments in the quarter declined by approximately 2%, wholesale shipments declined by almost 6.5% compared to the prior-year period. Liggett wholesale shipments declined by just under 6%, in range with the rest of the industry, while our retail shipments outperformed the industry and grew by the previously mentioned 0.5%.

The reason for the discrepancy in hotel -- wholesale and retail sales in the quarter primarily relates to year-over-year timing differences in anticipatory buying and inventory reducing patterns. In 2010, wholesalers anticipating industry price increases added to their inventory at the end of the third quarter. In 2011, industry pricing actions took place early in the third quarter, which in turn led wholesalers to reduce total inventories throughout the balance of the quarter.

Somewhat mitigating the reduced inventory dynamic, Commonwealth Brands actually increased wholesale shipments by 8% during the third quarter while their retail shipments declined by almost 8.5%. The reason for this extraordinary difference in wholesale and retail shipments was Commonwealth's decision to announce in early September that they were raising prices on their core brands effective October 1 and that they would allow the trade to purchase product without limitation prior to that increase. To our knowledge, this was an unprecedented industry buy-in period, and it's worth noting that Commonwealth ended their fiscal year on September 30.

In terms of retail shipments, I'm pleased to say that Liggett remains the fourth-largest manufacturer in the domestic market, up from fifth a year ago. The primary driver for Liggett's volume growth continues to be the strong performance of Pyramid, which was repackaged and reintroduced to the market in April 2009. According to Management Science Associates, through the first nine months of 2011, Pyramid was the sixth-largest brand in the United States in terms of both retail and wholesale shipments. Additionally, it was the second largest discount brand in the country. We continued to see strong acceptance of the brand at the retail and consumer level.

Since reintroduction, we have been focused on building Pyramid as a national brand, rather than a brand with regional strength. To achieve that goal, we defined benchmarks throughout the US to measure our effectiveness over time.

In 2011, we have continued to make excellent progress in building Pyramid nationwide with strong increases in distribution through all channels and all geographies. Pyramid is now sold in more than 70,000 stores across the country and we expect that number to grow as we continue to add new national and regional chains.

As I have discussed previously, since 2005 we have 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 business over the long term. We determined that market conditions in the third quarter presented an appropriate opportunity to increase the price of Pyramid by $1.10 per carton. We announced and implemented the price increase at the end of August, enabling us to add margin to the brand while at the same time continuing to increase market share. It is our belief that Pyramid continues to offer consumers the best value proposition in the marketplace. The brand's growth, along with increasing profits over the first nine months of the year, validates the approach we have taken and reflects Pyramid's strong appeal to adult smokers.

It's important to note that as we build Pyramid, we have also improved profit margins on our other programs -- Liggett Select, Grand Prix, and EVE. As mentioned earlier, overall industry dynamics the third quarter remained difficult and there was significant pricing pressure in the discount category. Over the course of 2011, the deep discount category has come to be dominated by large domestic and international manufacturers rather than the renegade companies that dominated the category in previous years. In fact, based upon these September NSAI data, the big three companies currently comprise over 53% of the lowest price discount segment. While Reynolds has led the way with the Pall Mall brand, Philip Morris USA has recently become an aggressive player at the lower part of that segment with its L&M brand. and Lorillard continues to invest in Maverick. In addition, Japan Tobacco has been aggressive with its Wings brand while Korea Tobacco has recently engaged in what we believe is predatory type pricing with a new brand, Timeless Time.

While JTI and KT&G are growing as a result of their aggressive pricing levels, it's important to note that their volume base is comparatively low. Of course, we are watching these brands and other developments in the discount market closely.

As noted previously, our Pyramid brand continues to be the second-largest brand in the discount category despite the activity of our larger competitors. Additionally, in part to support the growth of their deep discount brands, we continue to believe that the big three cigarette manufacturers are putting stringent and potentially anti-competitive requirements on retailers. This is something we are also closely monitoring.

As discussed previously, a major challenge facing legitimate cigarette manufacturers is the extraordinary growth of companies that we believe are evading federal taxes by knowingly mislabeling roll-your-own tobacco as pipe tobacco. While this appears to be a clear and blatant violation of US tax law, Congress and regulators have been slow to address the problem. As a result of this mislabeling, the sale of pipe tobacco has dramatically increased, up almost fourfold by 380% in the 2.5 years since the federal excise tax increase and it continues to grow at an alarming rate. It now represents approximately 19 billion cigarette equivalents per year as compared to 2.5 billion cigarette equivalents in the year prior to the tax increase.

Importantly, it is our belief that the federal treasury will have been denied more than $2 billion in tax revenue it's expected to collect between April 2009 and December 2011 with over $1 billion of that loss in calendar year 2011 alone.

While these and other competitive activities created real challenges in the third quarter, Pyramid and our profits continued to grow. Going forward, while we expect competitive market pressures to continue, we hope Congress will act at some point to end the pipe tobacco tax evasion. In any event, we remain prepared to meet these challenges head-on in the marketplace as well as the halls of Congress.

As we've previously explained, Liggett and all companies with 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.

In 2009, due to the large federal excise tax increase, the industry suffered a taxable shipment decline of 8.6%. In 2010, the taxable shipment decline was 5.4% which significantly outpaced the wholesale shipment decline of 3.8%. Based upon those numbers, and the projections of others, we continue to estimate that shipments will decline in the range of 3% in 2011.

Through nine months, indications are consistent with that estimate, but it remains subject to change as the year progresses. As you know, the tobacco industry has been subject to the regulatory authority of FDA since June 2009. While the process is still developing, there continues to be a great deal of uncertainty regarding FDA's regulation and many open issues remain. We are closely monitoring FDA's various activities, including that of their advisory committee, and we remain confident that we'll be able to comply with all aspects of the legislation. In June, the FDA revealed the nine pictorial images that are scheduled to be required on cigarette packaging and advertising beginning in the fall of 2012. These images which are very graphic will be required to be posted on the top 50% of the front and back of cigarette packs and cartons and will also be required to be on 20% of any cigarette advertisement. Liggett is taking steps to plan for this change and will be prepared to implement them at the appropriate time. That said, we have also decided to join with Reynolds, Lorillard, Commonwealth, and others to challenge the legality of the FDA's warning label requirement. We have been advised and believe that the prescribed warning labels are in fact a clear violation of our First Amendment rights and we intend to vigorously protect those rights.

Let me wrap up my comments by again saying that we are very pleased with Liggett's performance through the first nine months of 2011. Our entire team remains committed to meeting the challenges of a difficult and competitive marketplace while pursuing opportunities that we believe will enhance the long-term strength and profitability of Liggett. There's no doubt that there will be new challenges, but I remain confident that Liggett is well-positioned to meet them and to continue to succeed. Thanks for your attention and back to you, Howard.

Thanks, Ron. As I mentioned at the start of this call, we are pleased with our performance and continue to believe that Vector Group is well positioned. We have strong cash reserves, have significantly grown our cigarette volumes and market share in the past 30 months and will continue to benefit from our favorable terms under the MSA.

Additionally, we are proud of the Company's uninterrupted track record of paying a regularly 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?

(Operator Instructions). Ken Bann, Jefferies & Company.

On the price increases that you've been putting in place on your various brands, have you seen an impact on sales volumes as a result of those price increases, and what kind of impact has that been?

As far as the price increase on Pyramid, our volume has remained relatively stable. We continue to grow share and we believe that the brand is pretty competitively positioned.

As far as Liggett Select and Grand Prix are concerned, they sit in a price segment that is challenged in the marketplace. It's getting -- approaching the mid-priced tier, and there are pretty significant declines in that segment across all companies. We made the decision that it would be too expensive to try to fight for volume in that segment and instead made decisions to take margin. And, the volume has pretty much held at the same rate of decline that we were looking at previously. So, basically, we've been able to increase our margins without really negatively affecting our volumes.

Okay. And the price increase, the latest one was only in the impact -- in effect for the last month of the quarter. Is that correct?

Yes. The Pyramid price increase occurred at the end of August and we subsequently increased price on the Liggett Select Grand Prix and EVE October 1.

Okay, all right, great. And then, also, on the real estate (multiple speakers)

I'm sorry, November 1.

Okay. On the real estate side, has there been any developments with the Toy Center Building in Manhattan? And do you -- can you tell us how that might be financed and how Vector will be participating in that financing?

Sure. It has been financed. We entered into an agreement with Morgan Stanley and basically Witkoff was our partner in the purchase and us -- basically owned 10% of the deal, but we had a big carried interest. So we are expecting -- you know, it's going to be converted -- the plan is to convert it into condominiums and fully -- pretty much fully financed. And we are working on the plans and we think our returns are going to be very good where the market is now and the deal we have with Morgan Stanley.

So we limited our risk and we limited our capital exposure and I think we have very good chance of some very high returns on it.

So, was that 10% financed with cash coming from Vector? Or --?

Well we put out -- BK, do you have the number exactly how much we have in there?

It's about $5.5 million, is what we have in the investment. We have about $5.489 million.

Okay, great, all right, thank you very much.

(Operator Instructions). Mitch Pindus, Wells Fargo.

A couple of questions actually on also the real estate deals. Can you talk a little bit about this recent Winthrop transaction, the partnership out here in California?

Sure. This was this a group that purchased this portfolio for about $1.5 billion a few years back, and we are in at around 50% off. The loan is cash flowing, it is covering. There's plenty of income to pay. The question they're going to have is -- what happens when the loan comes due in about nine or 10 months from now? One of two things are going to happen. The loans going to get paid off, of which the price we pay the loan will end up with a 30% some odd return, or they will default, in which case we'll try to make a deal and take control of the properties.

Winthrop is an excellent partner to have. They've been doing this for many years. They did all the due diligence on it, which we then reviewed. And, you know at the price we would be in for, it's about $175 a foot which, we think in those markets, it's impossible to replicate. So, we are very excited about the opportunity there.

Okay. And switching gears a little bit, it's been a bit over a year now on the Palm Springs properties. Have there been any developments there or any developing at all actually?

You know what happened, is the initial developers that paid a lot of money for the lot sold some houses. There's a lot of potential activity. I would say the market is probably not quite ready yet to absorb a lot of new product. It is definitely better than when we bought it. There have been sales at lower prices. We are in cheap enough that we can sell and still make money at lower prices. But the way we look at it sort of now is it's sort of a bank account. It's sitting there and we think it becomes more valuable each year. And there will be a time -- we are in constant talks with different developers about buying pieces to develop, buying homes sites to develop and so forth. And my guess is probably these as things -- as the economy strings out a little bit here, if it does, we're hoping that in the next year or two we'll start entering into some sales of pieces of the project.

Is there much development that needs to be done to put it into salable condition?

No, I mean a lot of the lots need finishing, bringing the power and water to them, but the infrastructure is all in. The golf course is open and operating to rave reviews. It's pretty nice. You know, it looks good.

And it's just -- look, we're not going to be putting any substantial money -- we are not developers. We don't want to be a developer, okay? We want to sell the lots to developers. And, for the price we're in, we believe that the lots are worth substantially more, and at the right time, we'll be selling lots to developers, and they'll be building.

All right, thanks guys.

Thank you. And I'll now turn the conference back over to Howard Lorber for closing remarks.

Okay, well I thank everyone for being on our third-quarter call. As always, we appreciate the support of our shareholders and, we look forward to speaking to everyone again after the next quarter. And of course, as always, BK, Bryant Kirkland and myself, are available anytime you like. So, thank you everyone and have a good weekend.

Thank you, ladies and gentlemen, this concludes today's call, you may now disconnect your line.