Vector Group Ltd (VGR) 2013 Q1 法說會逐字稿

Welcome to the Vector Group's first-quarter 2013 earnings conference call. Before the call begins, I would like to read the safe harbor statement.

The statements made during this conference call that are not historical facts are forward-looking statements and 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 and Exchange Commission filings.

Now I would 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 first-quarter 2013 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.

I will provide an update on our business and review Vector Group's financials for the first quarter ending March 31, 2013. Bryant will then address Liggett's performance for the period and provide an update on industry developments. After that we will answer your questions.

As we began 2013, we recognized that numerous challenges exist in the cigarette marketplace yet we entered the year committed to maintaining the strength of our core Pyramid brand while again increasing year-over-year profit. I am pleased to report that we have achieved both of those goals for the first quarter and we remain optimistic about the remainder of the year despite ongoing challenges.

We will discuss our financial results and operating performance in more detail in a moment, but first I will briefly update you on tobacco litigation and specifically the Engle progeny cases in Florida. The Engle progeny cases remain the primary focus of our litigation activity with 4,523 cases currently pending in both federal and state court. Although we and the other industry defendants continue to believe that the Engle process is materially flawed and unconstitutional, appellate efforts to overturn the Engle findings have not yet been successful.

In March, the Florida Supreme Court upheld the Engle findings in the Douglas case, a case where Liggett is a defendant. This is the first Engle progeny case reviewed by the Florida Supreme Court. The industry intends to seek review from the United States Supreme Court.

Overall, while we continue to believe we have strong arguments, there is still considerable risk as these cases go to trial and we remain subject to the ongoing process and periodic negative judgments.

Turning now to Vector's balance sheet, I am pleased to report that we've recently completed a series of debt financings which have put in place a capital structure with significant extended maturities providing the flexibly to enable the continued growth of our businesses --- growth of our business in coming years.

In February, the Company successfully refinanced our senior secured notes to gain the benefit of lower interest rates and longer maturities. We issued $450 million of new 7.75% senior secured notes due 2021 in a private offering. As previously disclosed, we used the proceeds from the offering to retire the Company's 11% senior secured notes which mature in 2015 and related expenses.

Our liquidity remains strong with cash and cash equivalents of approximately $352 million as of March 31, 2013. Additionally as of March 31, 2013, the Company held investment securities and partnership interest with a fair market value of approximately $108.7 million.

As we mentioned on our last call, the past several months where an active period for New Valley as we invented in attractive real estate development projects in Miami, New York City, and Long Island City.

Let me now turn to the key financials for the three months ended March 31, 2013, for Vector Group. For the first quarter ended March 31, 2013, Vector Group revenues were $240.4 million compared to $257.6 million in the 2012 first quarter. The decline in revenues was primarily due to an approximate 10.7% reduction in cigarette volumes during the period, which was partially offset by higher pricing.

The Company recorded operating income of $43.1 million in the 2013 first quarter compared to operating income of $33.4 million in the corresponding period in 2012, an increase of 28.9% primarily due to improve margins. First-quarter 2013 net loss was $1.7 million, or $0.02 per diluted share, compared to a net loss of $7.7 million, or $0.09 per diluted share, in the 2012 period.

The first-quarter 2013 results included pretax charge of $21.5 million related to the early retirement of the Company's 11% senior secured notes due 2015. That was offset by a pretax gain of $3 million from changes in fair value of derivatives embedded within our convertible debt and $5.6 million of pretax income resulting from the settlement of a long-standing dispute relating to the master settlement agreement, which Ron will discuss in more detail.

Adjusting for these items first-quarter 2013 net income was $6.6 million, or $0.07 per diluted share. First-quarter 2012 net income included pretax charges of $21.1 million of changes in fair value of derivatives embedded within our convertible debt. Adjusting for this item, first-quarter 2012 net income was $5.4 million, or $0.06 per diluted share.

For the first quarter 2013, adjusted EBITDA was $40.7 million compared to $37 million for the first quarter 2012. Adjusted EBITDA is a non-GAAP financial measure and should be considered in addition to, but not as a substitute for, other measures of financial performance prepared in accordance with GAAP. A reconciliation of net income to adjusted EBITDA is contained in the Company's earnings release.

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

Thanks, Howard. Good morning, everyone. As Howard indicated, given the challenging dynamics of the industry, we are pleased with the first-quarter 2013 performance of our tobacco business and our positioning going forward.

As you may be aware, recently the participating manufacturers of the Master Settlement Agreement, including Liggett and Vector Tobacco, entered into an agreement with 20 of the 52 MSA states and territories to settle the long-standing non-participating manufacturer adjustment dispute for the years 2003 through 2012. This was a favorable development for us.

We have long held that the states failed to diligently enforce their MSA statutes and, as a result, our MSA payment obligations, as calculated by the independent auditor, have been overstated. We were pleased that in the face of an arbitration proceeding 20 states decided to settle the claim. While certain non-settling states filed suit in their home jurisdictions to attempt to vacate the settlement, they have been unsuccessful to date.

The settlement resulted in a $5.6 million increase in first-quarter pretax income for Liggett and Vector Tobacco. I'm very pleased to report that excluding the income from the settlement of the NPM adjustment claim, our first-quarter operating profit increased by 11% over the prior-year period. The increased profit was primarily the result of higher margins across all brands, partially offset by lower volumes on non-Pyramid brands and effective cost controls.

We were also pleased to generate year-over-year shipment growth on our core Pyramid brand while holding its retail share essentially flat. Before I elaborate further on our performance, let me turn to the financials. Please note that financial reporting for Vector Tobacco is combined with Liggett.

For the three months ended March 31, 2013, Liggett revenues were $240.4 million compared to $257.6 million in the corresponding period in 2012. The year-over-year revenue decline was primarily caused by anticipated volume declines in our non-Pyramid brands and the effective two fewer shipping days in the first quarter of 2013.

Operating income for the three months ended March 31, 2013 was $47.2 million compared to $37.5 million in 2012. As noted, 2013 operating income includes $5.6 million of NPM settlement income. Adjusting for that, first-quarter operating income was $41.6 million, an 11% increase over the year-ago first quarter.

We continue to maintain a balanced approach to pursuing volume and margin opportunities in the market. In essence, we work to maximize short-term opportunities on maintaining focus on branch trends and long-term profit growth. Since the second half of 2011, market conditions have warranted that a core focus of ours has been pursuing higher margins on our brand portfolio while continuing to build our Pyramid brand nationally.

In addition to that emphasis, entering this year we determined that the time was right to further leverage our solid position in the deep discount segment of the market. To that end, in January we introduced a new national brand, Eagle 20s. Part of the strategic role of Eagle 20s is to stabilize our overall volume trends by offsetting losses in our non-core brands, as well as to develop a second brand that is complementary to Pyramid.

Eagle 20s is off to a good start and is clearly benefiting from the robust distribution base we've built with Pyramid over almost 4 years. In the first quarter of 2013, the brand gained active distribution in over 9,000 retail outlets and we expect that number to more than double in the second quarter.

Overall, the market for the cigarette industry, particularly discount cigarettes, was quite difficult in the first quarter. As noted by others in the industry, the macroeconomic environment deteriorated in the first quarter, particularly for lower income consumers, as energy prices increased and the payroll tax cut was eliminated, resulting in less disposable income. As a result, valued consumers were left searching for other low-cost alternatives.

Unfortunately, due to the failure of Congress and regulators to adequately address the tax evasion and avoidance of companies selling mislabeled pipe tobacco and filtered cigars, these under regulated and under taxed products have become ubiquitous in the market with consumers having ready access to them as low-cost alternatives.

Data from TTB indicates that January 2013 was the highest volume mislabeled pipe tobacco month in history and the daily shipping rate held steady in February. We now estimate that volume will exceed 24 billion cigarette equivalents, over 8% of the market this year.

In previous calls I have noted the genesis of the mislabeled pipe tobacco situation and will not repeat it here. Suffice to say, the failure of the government to profitably enforce its tax code and laws has resulted in the loss of billions of dollars of tax revenue and has served to disrupt the legitimate taxpaying industry.

While some progress was made by Congress last year in passing legislation that classifies retailers making cigarettes in their stores as manufacturers, the mislabeled pipe tobacco category, unfortunately, appears stronger than ever. From various discussions and recent actions, it appears that TTB, the FDA, the government accountability office, and many members of Congress recognize the issue. However, remedying this problem remains a challenge, especially within the current political and regulatory environment.

Another under taxed product that regulators and Congress have failed to address is filtered cigars, cigarette equivalents that are currently sold under an unintended tax loophole. While these products are not generally as popular as mislabeled pipe tobacco, we believe that they currently comprise approximately 8 billion cigarette equivalents or almost 3% of the total cigarette market. And their appeal in the current economic climate continues to grow.

The GAO has recommended that Congress should consider equalizing tax rates on roll-your-own and pipe tobacco, and in consultation with Treasury, consider options for reducing tax avoidance due to tax differentials between small and large cigars. We, of course, support full tax equalization.

To that end, Senator Richard Durbin of Illinois has introduced legislation to close existing tobacco loopholes. Importantly, the bill would equalize tax rates on all tobacco products including pipe tobacco, cigars, and smokeless tobacco. We are also hopeful that FDA and TTB will use the existing enforcement authority that they have to properly regulate these mislabeled products.

Some members of Congress are strongly encouraging the agencies to do exactly that and we have seen some positive guidance from TTB. Of note, a number of states have recently taken legislative or regulatory actions to address aspects of the mislabeled pipe tobacco problem, a trend that we hope continues and extends to filtered cigars.

Another market change since 2009 federal excise tax increase has been the movement of large domestic and international cigarette manufacturers into the deep discount segment, an area typically dominated by smaller, legitimate, and renegade type companies to offset declining premium volumes. According to Management Science Associates data, the big three companies now comprise a majority, over 80%, of this segment.

Reynolds continues to lead the way with its Pall Mall brand, Altria has grown volume with L&M, and Lorillard continues to support Maverick. We are also continuing to see aggressive pricing from foreign companies like Japan Tobacco and particularly aggressive activity from KT&G, Korea Tobacco, on their discount brand, Timeless TIME.

Importantly, we were pleased with the performance of our Pyramid brand in the first quarter despite these industry dynamics and increased pricing. Pyramid has a well-established national presence and is currently sold in over 100,000 stores with a distribution base that has continued to grow. Pyramid remains the seventh-largest brand and third-largest discount brand in the US with a continuing opportunity to further expand the brand's national distribution footprint.

According to Management Science Associates, for the first quarter of 2013 overall industry wholesale shipments declined by just over 6.1% while retail shipments declined by 4.8%. First-quarter 2013 declines were driven by a number of factors including trade deloading, traditional seasonality declines, particularly poor weather conditions across much of the US, a shift in volume to mislabeled pipe and other low-priced alternatives, and two fewer shipping days.

All companies experienced wholesale and retail declines for the quarter with deep discount-focused companies declining at a greater rate. Liggett's first-quarter declines in wholesale and retail shipments were 10.6% and 11.6%, respectively, versus the year-ago quarter. Adjusting for the two fewer shipping days in the 2013 first quarter, wholesale shipments declines were 7.7%.

For the 2012 year, TTB reported industry taxable shipments declined by less than 2%. Despite the industry's early performance this year, we expect that taxable shipments will decline in the 3% range in 2013 as cigarette shipments recovery.

Thanks for your attention and back to you, Howard.

Thanks, Ron. As I noted at the start of the call, we are pleased with our recent 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 favorable 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.

(Operator Instructions) Ken Bann, Jefferies.

Was just wondering, the -- could you talk about the status of your discussions with Prudential over the 20% Douglas Elliman stake that you are looking to purchase?

Sure. It's subject to an arbitration which would be we pick an appraisal, they pick an appraisal, and then I think there is a third appraiser pick, and they come out with a ruling. We've agreed with them to go to non-binding mediation, because I think both sides feel that we can come to some conclusion, and I believe the original -- the date is now scheduled for the first week in August 2 go through that, the non-binding mediation, to try to resolve the purchase price.

Okay. So we could see a purchase of that probably in the third quarter, is that ---?

Well, if the non-binding mediation works, great. If not, I would imagine it will be before the end of the year.

Right, okay. Then on the Eagle 20 brand, obviously you are getting pretty good distribution on that. What is your hopes for this brand down the road? Is this something that will become bigger than the other brands, all except the Pyramid brand, do you hope? Or do you think it could even continue to grow like the Pyramid brand has grown over the last several years?

Without giving specifics about where we expect it to go, what I would say is that we believe that the brand is strategically positioned to offset declines in our non-Pyramid brands, as well as to give us a long-term prospect of growth. I would not classify whether it was going to be at the level of Pyramid or not, but the brand is well-positioned from a price standpoint to build volume over the long term and that's what we are looking at.

Okay. Where is price now? I presume the margin on that brand is still pretty low at this point. Is that correct?

That would be a good assumption.

Okay. Then is there potential for other settlements on the MSA issues with the other states at this point?

Yes, there are. I think that there continues to be a process going on, a dialogue. We can't predict what they will do. There were several states that as the deadline came down for this settlement, who were thinking about getting in but had I think internal state type issues that they were dealing with. So while we don't know for sure, we are at least hopeful that the process will continue and the rest will get resolved over some reasonable period of time.

Of course, the arbitration decision could have a big factor or the pending arbitration could have --- play a big factor in their decision to come forward and settle.

Okay. Obama recently, in his budget, was proposing some significant increases on cigarette taxes. Could you comment on what your thoughts are on that, whether it really has any chance of going through or being approved, and what impact you would expect that would have on your sales and volumes?

I think -- first, I don't like to predict what Congress will do because it's very hard to do and they tend to do things to surprise you. I would tell you that it seems unlikely to me that there would be an agreement on a tax increase at the level that has been proposed given the current structure of Congress. Which is not to say it's impossible, it's certainly possible, but I think it's unlikely.

We are hopeful that what will come out of this is that the areas that are also included in the legislation and the modifications that were made in Senator Durbin's proposed legislation will address the issues that have been outstanding and not been addressed over the last four years, like mislabeled pipe tobacco and filtered cigars, in some of the other areas. And that will provide a significant amount of revenue and enable them to maybe chop off the cigarette tax.

Which I think cigarettes -- the tax on cigarettes and smokeless are the two things that will be most difficult for them to get through. The others may have a better chance.

Right. Do you think there's a real chance that equalization of taxes goes through this year, or do you think it's really at best a possibility next year?

I can't really say. Obviously, we are hopeful that it will be this year. We are also hopeful that if and when the deeming regulation that FDA has prepared and promised to put out on April 1, if and when it eventually comes out that it will address a couple of these issues in a meaningful way, which they have the authority to do right now.

Right, okay. Great, thank you very much.

[Mitch Tendin], Wells Fargo.

Good morning, gentlemen. Question is actually related to the Douglas Elliman as it relates to Prudential, now that the agreement is up. Can you ballpark me what the amount of money paid on royalties was to Prudential?

Yes, basically it was a little over --- it was probably about a little over 2% of gross commissions, BK?

Yes, it was about $6 million a year for the last three years.

Okay. So I assume that stopped as of mid-March?

No. No, we took the position that they acknowledged that our agreement was finished around I think November 1. Was that the date, BK?

Yes.

Yes, November 1. Because they sold their whole franchise network and we felt that we had the right to get out at that particular point and we used that date to speed it up a little bit. And that's the date they have acknowledged in the valuation, the date to be used for the year ending November 1.

I see. Switching gears, then; now that you have essentially refinanced some of your debt, can you tell me what the reduction of interest expense will be going forward?

Yes, purely from the 11% being refinanced, it's going to be about a $10.8 million reduction a year. And that's just on the [senior] debt. Obviously we will have additional interest expense with the issuance of the $230 million of convertible debt in November.

That's all I have. Thanks, gentlemen.

(Operator Instructions) Anton Kawalsky, Canyon Capital.

Just wondering about market share, Pyramid and overall market share for the quarter.

Right. The overall share was 3.6% and Pyramid's share was about 2.4%.

So basically unchanged from Q4?

Yes, pretty much the same.

Great, thanks a lot.

(Operator Instructions) At this time I'm showing there are no further questions.

Okay. Well, thanks, everyone, for participating in this call. As always, myself, Ron Bernstein, and BK are available to answer any questions you may have and look forward to speaking with you all after the next quarter is complete. Thank you very much and have a good day.

This concludes today's conference call. You may now disconnect.