Vector Group Ltd (VGR) 2012 Q1 法說會逐字稿

Welcome to The Vector Group's first quarter 2012 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 applied by forward-looking statements. These risks are described in more detail in the Company's Securities and Exchange Commission filings. Now I would like to turn the call over to the President and Chief Executive Officer of Vector Group, Howard Lorber.

Good morning. Thank you for joining us on Vector Group's first quarter 2012 earnings conference call. With me today is Ron Bernstein, the President and CEO of Liggett Vector brand 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 ending March 31, 2012. Ron will address Liggett's performance for the period, and provide an update on industry developments. After that we will answer your questions.

Our focus is 2012 is to continue to build volume and share growth on our Pyramid brand, and to drive year-over-year profit growth. We are pleased to have achieved both of those goals in the first quarter, especially given the challenges in today's tobacco market. As we look ahead, we are confident that our business is heading in the right direction. We will discuss our financial results in tobacco performance in more detail in a moment.

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. Before turning to the financials, I want to briefly update you on the tobacco litigation and specifically the Angle cases in Florida. The Angle progeny cases remain the primary focus of our litigation activity, with 5,727 cases pending in both federal and state court. We along with the other industry defendants continue to believe that the Angle process is materially flawed and unconstitutional.

That said, Appellate Courts 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 a recently Appellate decision certifying the constitutionally of the application of the Angle findings as a question of great public importance, there is still considerable risk as these cases go to trial and we remain subject to the ongoing process and periodic negative judgements.

Turning now to Vector's balance sheet, our liquidity remains strong with cash and cash equivalents of approximately $219.6 million as of March 31, 2012. Additionally, as of March 31, 2012, the Company held investment securities and partnership interests with a fair market value of approximately $97.1 million.

Turning to the key financials for the months ended March 31, 2012 for Vector Group. The first quarter ended March 31, 2012, Vector Group revenues were $257.6 million, compared to $260.4 million in the first quarter. The Company recorded operating income of $33.4 million in the 2012 first quarter compared to operating income of $31.5 million in the corresponding period in 2011. First quarter 2012 net loss was $7.7 million, or $0.10 per diluted share compared to net income of $19.4 million, or $0.24 per diluted share in the 2011 period.

Excluding $21.1 million in fair market value of pretax charges from changes in fair market value of derivatives embedded within our convertible debt, first quarter 2012 net income was $5.4 million or $0.07 per diluted share. First quarter 2011 net income included pretax gains of $4.1 million from the liquidation of long-term investments, and $3.1 million from the sale of a townhome that was offset by $575,000 of pretax charges from changes in the fair value of derivatives embedded within our convertible debt. Adjusting for those items first quarter 2011 net income was $15.3 million or $0.20 perdiluted share.

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

Thanks Howard. Good morning everyone. As Howard indicated, we are pleased to have increased year-over-year operating in the first quarter despite challenging market conditions. We also continue to generate volume growth on our Pyramid brand during the quarter consistent with our plan. We have had significant success with the growth strategy we initiated at the time of the 2009 federal excise tax increase, and we remain positive about the course that we are on. Before I elaborate more on performance, let's turn to the financials.

Please note that financial reporting for Vector Tobacco is combined with Liggett. For the three months ended March 31 2012 Liggett revenues were $257.6 million compared to $260.4 million for the corresponding period in 2011. Operating income for the three months ended March 31 2012, was $37.5 million, compared to $36.4 million in 2011. For some time, we have maintained a balanced approach to pursuing volume and margin opportunities in the market.

In essence, we work to maximize short-term opportunities while maintaining focus on our strategic objectives and key brand expansion and long-term profit growth. On the year end call, we noted that during the second half of 2011 Liggett subtly shifted its emphasis from overall volume growth to pursuing higher margins on our brand portfolio. Since the excise tax increase in 2009, the cigarette marketplace has changed in some notable ways. There are two primary drivers for these changes. The first and most significant driver has been the extraordinary growth of mislabeled pipe tobacco. This growth has adversely affected the entire legitimate cigarette marketplace, with the most direct impact on the discount segment of the industry.

As a reminder, there was a substantial increase on the federal excise tax on cigarettes, roll your own tobacco, and small cigars in April 2009. Unfortunately, Congress neglected to also increase the tax rate on pipe tobacco to the same level as roll your own. That opened the door for some companies to game the system by mislabeling roll your own tobacco as pipe tobacco, enabling them to evade payment of a substantial portion of excise taxes and other tobacco related fees.

Shortly thereafter manufacturing machines that produced a carton of cigarettes in approximately eight minutes, started being sold to retail stores. By using mislabeled pipe tobacco, stores with their own manufacturing machines are able to sell consumers a carton of cigarettes at 50% to 75% less than a carton of legitimate manufacturer made cigarettes. The result of this is that the so-called pipe tobacco category has grown over 425% since December 2008. From 2.6 billion cigarette equivalents to over 17.5 billion in 2011. During the same period, roll your own has declined 76% from 10.7 billion to 2.6 billion cigaretteequivalents.

Amazingly, according to Centers for Disease Control and Prevention statistics, we calculate that close 3 million people are currently smoking mislabeled pipe tobacco as cigarettes. Based on tobacco tax and Trade Bureau data, the Federal government has failed to collect over $1 billion in taxes owed to it over the course of the past three years, and based upon current projections that number may exceed $1 billion in 2012 alone. From various discussions, it appears that the Tobacco Tax and Trade Bureau, the FDA, the government accountability office, and many members of Congress generally agree with this analysis.

However, government processes are cumbersome by nature and our political parties seem to disagree on most everything, including the collection of taxes legitimately owed to them. Regardless, we believe that the level of support for addressing this inequitable situation is growing rapidly as the revenue being lost by both federal and state governments continues to increase. Recently we have seen a number of individual states take legislative or regulatory actions to address some or all at aspects of the mislabeled pipe tobacco situation, and we are hopeful that the federal government will take action to finally end this tax evasion.

The second market change since the excise tax increase has been the significant movement of large domestic and international cigarette manufacturers into the deep discount segment, in an attempt to offset declining premium brand volumes. Whereas the deep discount segment was previously dominated by smaller legitimate and renegade companies, according to first quarter MSAI data, the big three companies now comprise a majority over 53% of this segment. Reynolds has led the way with its Pall Mall brand, in the past 12 months Altria has become more and more aggressive in building volume with its L&M brand, and Lorillard continues to support its Maverick brand. We have also seen hyper-aggressive pricing from foreign companies like Japan Tobacco and KT&G Korea tobacco on their discount brands.

Despite the industry changes, we were quite pleased to be able to grow our Pyramid brand by over 11% in the first quarter compared to the prior year period. Pyramid has a clear and national presence and is currently sold in over 84,000 stores, with a distribution base that grows daily. While substantial opportunity remains in building its national footprint, Pyramid is now the seven largest brand and third largest discount brand in the United States.

In fact, I am excited to report that we have recently added North Carolina-based Family Dollar stores, and the Wisconsin based Quick Trip convenience store chain to our Pyramid family, as well as a large number of other regional chains and independent stores. These retail chain accounts which are very important in their respective markets represent over 5,000 stores that will offer excellent new growth potential for Pyramid. According to Management Science Associates, during the first quarter of 2012, overall industry wholesale shipments declined by 4%, while retail shipments declined by 2.8%.

All major manufacturers suffered declines in shipments during the quarter. Liggett's overall declines were 4.3% and 3% respectively, generally in line with the rest of the industry. Accordingly Liggett was able to maintain both its retail and wholesale share compared to the first quarter of 2011. In 2011, industry taxable shipments declined by 3% which was in line with our projections. Initial indications are that declines for 2012 should be in a similar range.

As you know, the tobacco industry has been subject to the regulatory authority of FDA since June of 2009. While the process has developed over the past three years, there is still a great deal of uncertainty regarding FDA's regulation and enforcement. As an example, in August, 2011, along with Reynolds, Lorillard, Commonwealth and Santa Fe, we filed suit to challenge the legality of the FDA's graphic images in Federal District Court in Washington, DC. In February of 2012, the District Court granted the industry's motion for summary judgment, indicating that the FDA had violated the industry's constitutional rights. The FDA appealed the District Court's decision and oral arguments were held in April at the US Court of Appeals for the DC Circuit.

We continue to work closely with the FDA to seek mutually acceptable solutions to complex issues raised by the statute and regulatory issues. We also continue to monitor FDA developments and we remain confident that we will be able to comply with all aspects of the legislation.

Let me wrap up my comments with again saying that we are pleased with Liggett's early performance in 2012. Our entire team is committed to meeting the demands of the challenge marketplace while pursuing opportunities that we believe will enhance our long-term strength and profitability. I remain confident that Liggett is well-positioned to continue to succeed.

Thanks for your attention, and back to you Howard.

Thank you, Ron. As I mentioned we're 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 in market share over the past three years, and will continue to benefit from our favorite terms under the MSA. Additionally we are 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. (Operator Instructions). Our first question comes from Mitch Pindus from Wells Fargo Private Bank.

Good morning, gentlemen.

Good morning Mitch.

A couple of questions, the Chelsea I noticed that was sold, can you talk about the ROI on that, it has been in the portfolio for a bit?

Yes, well, it is not finalized. We still have some ongoing litigation. We are suing one of the bonding companies on construction issues, but I believe it looks like it will end up anywhere between 18% and 20%. Is that correct?.

Right now Howard it is 18.45%.

That is cash on cash?

Right, as of now.

IRR.

IRR. Better, yes.

IRR. Okay. Alright. Can you talk a little about the projects that you have started over the last couple of years, the Palm Springs project, for example?

Palm Springs, as I told everyone when we purchased the note and then did a consensual disclosure from the owner, which was Lennar, that this was sort of a long-term hold. It is like a bank account. You can't get much money in the bank. We actually owned the lots for probably under $30,000 a lot. At the peak of the market, in 2003, 2004, 2005, out there, these lots were being sold to builders at $250,000 to $275,000 a lot.

The clubhouse is complete and open. It has a very successful restaurant in it. The golf course has developed into a great golf course. Voted one of the top public golf courses in California by a couple of magazines. And it is just a matter now for the velocity to pick up, and then we will, and we are talking to developers, obviously, about selling lots to developers. So we think it is going pretty well.

Would you characterize the project as self-financing at this point with the operations that are up and running?

I think we have been putting in a few hundred thousand dollars a year. Now I think our budget, we will probably be closer to breakeven. Is that correct, BK?

Right. I believe we lost about $1 million on it last year. During the first quarter, we actually made a couple hundred thousand because of the golf course season.

Right.

Okay. Your cash from operations has changed significantly from about $500,000 to something north of $40 million. Can you discuss that a little bit?

BK?

Sure, Mitch. The change in cash from operations related to we had some increased operating income in 2012, and then we had a reduction of Accounts Receivable in 2012, for December 31 2011 balance and then in 2011 Accounts Receivable increased. The 2011 Accounts Receivable increase related to the extension of terms on Pyramid by five days. And that was about $15 million. That was the primary driver of it. In 2012, it was timing of collections of Receivables and Accounts Receivable werelower by about $14 million at March 31 compared to December 31, 2011. We had some favorable swings on inventory changes, and that essentially explains it.

Okay. So my last question relates to the embedded derivatives. It has significantly impacted the appearance of your statements. Can you discuss that a little bit and why it was so big this quarter.

BK? It is pretty similar. When the bonds go up,we get additional charge. I think it is pretty much as simple as that, is that correct BK?

Right, yes. That is exactly right. The way it works, Mitch, is the interest rate is competed by comparing the yield on our 11% senior secured notes. To the comparable Treasury rates, and then also comparing the changes in unsecured and subordinated debt during the quarter. What happened during the quarter was the prices on our 11% notes increased from like 103 to 105.5. The duration of that note also declined by three months. So what happened was the yield to worst call which is what we use, went from 9.3% to 5.6%. And that was a major driver in taking the discount rate used to complete that derivative from 12.5% to 8.25% in March. At year end we were at 12.5%. And almost the entire charge related to the 3.875% notes, and that charge was $21.7 million. And what is a little bit quirky about it, is if you take the book value of those notes and you add the embedded derivative to it, you get $122.2 million. But yet that debt at a face value is only $99 million at March 31st.

Right.

So it doesn't seem to make sense.

It is the way it has to be done, the accounting standards, but the fact is, it is like the better we do, and the stronger we are, the worse the numbers look, because the value of the derivative has to change.

Right. So when is the next call feature, or something on the bonds that might affect this?

So the next call feature, which bonds? The 11%?

Sure.

The 11% right now they could be called at 105.5. In August that call will be reduced to 103.67. And then in 2013 it drops to 101.8, and then 2014 and 2015 it is at par.

Okay. Alright. Thanks, gentlemen.

You are welcome.

Thank you. Our next question from Ken Bann at Jefferies & Company.

Good morning. I was wondering if you could talk about any plans on price increases on your various brands, cigarette brands over the next year?

Sure. Obviously, for competitive reasons, we wouldn't discuss what we are planning to do specifically, but what I would say is that we are constantly evaluating the market and determining when we have an opportunity to increase prices and margins. There has not been any sort of industry pricing action this year thus far. And it is impossible to say when or if the big three will take action. And obviously, the discount segment is a different factor all together. So we continue as I said in my comments, that we are constantly looking at balancing our volume growth opportunities and margin increase opportunities, and we will continue to do that.

Okay. And the Liggett Select and Grand Prix brands, are they being most hurt by stronger market share by the big three in the discount category, or--?

Yes. Yes. I think the price point that Liggett Select and Grand Prix are in, and it would be the same thing for say Commonwealth, USA Gold and Sonoma, it is a very difficult price point. We have made the decision that we were not going to defend volume on those brands, but rather have taken opportunities over the last two years to increase the margin base while we are continuing to build our Pyramid and some of our partner brands.

Okay. And should we, with the new stores in which Pyramid will be distributed in over the next couple of quarters, hopefully should we see an increase, further increases in volume with the Pyramid because of that extra distribution?

We are optimistically anticipating that volume will continue to increase on Pyramid.

Okay. Great. Thank you very much.

Thank you. Our next question comes from Phil Dumas from Geode Capital.

Good morning. Question on to BK. the 3.875% notes are putable and callable in June. Most likely, as you know, not going to be put, do you have any plans to call those bond and convert them out?

We have not announced any such plans.

Okay. Can you give me a sense of what you may think will happen there? Probably not, right?

No.

No.

Alright. Thanks, guys.

Thank you. (Operator Instructions). Our next question comes from Greg Matthews, investor.

Hello, Howard, Ron, everyone on the call.

Hi, Greg.

Hello.

I have been a retail investor since the BGL days, and I would jut like to make a comment and a question. My comment is long overdue, I think, on these calls. I think that everyone, not just the Board, but everyone at Vector should be congratulated for maintaining such a strong dividend throughout the years. I can't tell you how it has bailed us out many, many times. So thanks to one and all.

You are welcome.

You are welcome.

Also. My question goes to Ron. Ron, you've commented in the past about preps products and about don't quote me on the time frame on this, but a about 1.5 years ago one of the analysts asked you a question about preps products.

I am sorry, what kind of products are you saying?

Preps. Potential reduced --

Okay.

Right. And your response was very direct, and I can quote that word for word.

Okay.

You said that if an opportunity presented itself that Vector would be ready. So can you give us an update on that and what you meant by that comment?

Well, I don't specifically recall the comment, but what I would say is that we are constantly looking at every development that occurs in the marketplace, and we evaluate where we believe that there are opportunities. We, as you know being a long-term investor, we were first to the market with products that had potentially reduced risk factors, and we introduced the first non-nicotine cigarette with Quest. We have learned a lot about the marketplace. We were also involved with the smokeless Snus product, and we have learned a lot about the marketplace and how it responds to those things. So we are constantly evaluating and looking at opportunities, and when we see an opportunity that makes sense for us, we are prepared to act on it.

I think, this is Howard. The key really is what we have learnedmore than anything else, it is possible to have reduced risks. We believe reduced risk products. But until the FDA comes out and says what we can say, there is really no way to market them. If you can't say even something like this product may reduce the risk of certain diseases, which right now they try to stop you if you say that, or the Attorneys General tried, there really is nothing that you can say that is going to help in marketing the product, and therefore no one is going to buy the product, and therefore it doesn't make any sense commercially. Right.

And I understand it that. Like I said, I was quoting Ron from a prior conference call that Vector would be ready, which led me to believe that work was going on?

Again we have done a lot of work as I said over the years in understanding that marketplace and the potential. And if an opportunity ever did present itself, we were and we are prepared to act on it. I was not insinuating that we had anything specific that was in place, other than the stuff that we have publicly reported in the past.

I understand. And if I could ask just one last question.

Sure.

Several years ago, Vector came out with Snus. And I have seen nothing regarding that in the reports, so could you give us the status on that if you are marketing that product or not?

No. We did report that what happened with Snus was that the marketplace had a lot of activity with Phillip Morris and Reynolds in particular. And that we came to market in a very measured way with a Snus product that we hoped to offer at a discount to their products. Unfortunately, they really couldn't sell their products, and pretty much have had to give them away. And the Snus market has not developed so we have been out of that for some time now.

Okay. Appreciate the feedback.

Okay.

You are welcome.

Once again, I am done with my questions. I just wanted to say thanks again to each and every Vector employee for maintaining such a strong dividend over the years.

You are welcome. And that is a very key driver for us. We are all stockholders in this Company. And it benefits us all. We are all lined up on this, and we really plan on just continuing it as long as we financially can.

I appreciate that. And thanks again.

Thank you. Gentlemen, there are no further questions in the queue at this time.

Okay, well, thank you all for being on this first quarter conference call. We appreciate your support in the future, as you have supported us in the past. As always, myself, BK, Ron Bernstein, are always available if you need us you know where to reach us. Thank you very much, and we will speak at the end of the next quarter. Have a nice weekend.

Thank you. This does conclude our teleconference for the day, you may now disconnect.