Vector Group Ltd (VGR) 2013 Q2 法說會逐字稿

Welcome to Vector Group's second-quarter 2013 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 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 and thank you for joining us on Vector Group's second-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 second quarter and the six months ending June 30, 2013. Ron will then address Liggett's performance for the period and provide an update on industry developments. After that, we will answer questions.

As expected, the first half of 2013 has been a challenging period in the cigarette marketplace. Despite market pressures, our goal has been to continue to increase year-over-year profit while maintaining the strength of our core Pyramid brand and we are pleased with our ability to have done that in the first half of this year.

We continued to increase year-over-year profit and despite a decline in Pyramid's volume in the second quarter caused in large part by year-over-year timing differences and price increases, Pyramid remained strong. We will discuss our financial results and operating performance in more detail in a moment, but first, I will briefly update you on the Engle progeny cases in Florida.

The Engle progeny cases remain the primary focus of our litigation activity, with 4300 cases currently pending in both federal and state courts. This represents a decrease of 223 cases from the last quarter.

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 been successful to date.

In March, the Florida Supreme Court upheld the Engle findings in the Douglas case, the case where Liggett is the defendant. This was 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 in defending these cases, there is still considerable risk those 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 $281.7 million as of June 30, 2013. As of June 30, 2013, the Company held investment securities and partnership interests with a fair market value of approximately $164.6 million.

In the real estate business, through New Valley and other affiliates, we have made a number of investments this year and promising real estate development and projects primarily focused in the New York City area. There continues to be strong demand for the multifamily residential and lodging assets in the city and we have been fortunate to partner with several talented developers on various projects. We have continued this process in the second quarter.

During this period, New Valley and our partners closed on the purchase of 101 Murray St., one of the largest remaining development sites in lower Manhattan. We will continue to assess new opportunities and selectively pursue those with the best partners, terms, and long-term value potential.

I will now turn to the key financials for the three and six months ended June 30, 2013 for Vector Group. For the second quarter ended June 30, 2013, Vector Group revenues were $249.1 million in the second quarter compared to $276 million in the 2012 second quarter. The decline in revenues was primarily due to an approximate 14% reduction in cigarette volumes during the period, which was partially offset by higher pricing.

The Company recorded operating income of $44.2 million in the 2013 second quarter compared to operating income of $40.9 million in the corresponding period in 2012, an increase of 8.1%, primarily due to improved margins and the settlement of the long-standing dispute related to the management settlement agreement.

Second-quarter 2013 net income was $13.5 million or $0.15 per diluted share compared to $3.9 million or $0.05 per diluted share in the 2012 period. The second-quarter 2013 results include a pretax non-cash charge of $8.5 million related to amortization of debt discounts and our convertible debt and a pretax gain of $2.5 million from changes in fair value of derivatives embedded within our convertible debt as well as pretax income of $1.3 million from the settlement of the long-standing dispute related to the Master Settlement Agreement.

Adjusting for all these items, second-quarter 2013 adjusted net income was $16.3 million or $0.18 per diluted share.

The second-quarter 2012 results include a pretax loss of $7.9 million related to the conversion of the Company's convertible debt and pretax charges of $6 million from changes in fair value of derivatives embedded within our convertible debt, and $4 million related to the amortization of debt discounts on our convertible debt. Adjusting to these items, second-quarter 2012 adjusted net income was $14.7 million or $0.17 per diluted share.

For the second quarter 2013, EBITDA was $46.2 million compared to $44.3 million for the second quarter 2012. Adjusted EBITDA and adjusted net income are non-GAAP financial measures and should be considered in addition to but not as a substitute for other measures of financial performance prepared in accordance with generally accepted accounting principles.

Reconciliations to adjusted net income and adjusted EBITDA are contained in the Company's earnings release.

For the six months ended June 30, 2013, Vector Group revenues were $489.5 million compared to $534 million in the 2012 six-month period. The decline in revenues was primarily due to an approximate 12.4% reduction in cigarette volumes during the period, which was partially offset by higher pricing.

The Company recorded operating income of $87.3 million in the 2013 six-month period, compared to operating income of 74.4 million in the corresponding period in 2012, an increase of 17.4% primarily due to improved margins and a settlement of a long-standing dispute related to the Master Settlement Agreement.

Year-to-date 2013 net income was $11.8 million or $0.13 per diluted share compared to a loss of $3.8 million or $0.05 per diluted share in the 2012 period. The year-to-date 2013 results included a pretax loss of $21.5 million related to the extinguishment of the Company's 11% senior secured notes due 2015 and pretax non-cash charges of $15.8 million related to amortization of debt discounts on our convertible debt and pretax income of $6.9 million from the settlement of the long-standing dispute with the Master Settlement Agreement as well as $5.5 million from changes in fair value of derivatives embedded within our convertible debt.

Adjusting to these items, year-to-date 2013 adjusted net income was $27.4 million or $0.31 per diluted share.

The six-month 2012 results include pretax charges of $27.1 million from changes in fair value of derivatives embedded within our convertible debt, a pretax loss of $7.9 million related to the conversion of the Company's convertible debt, and pretax non-cash interest expense of $3.8 million related to the amortization of debt discounts on our convertible debt. Adjusting to these items, year-to-date 2012 adjusted net income was $22.4 million or $0.26 per diluted share.

For the six months ended June 30, 2013, adjusted EBITDA was $86.9 million compared to $81.3 million for the six months ended June 30, 2012.

Adjusted EBITDA and adjusted net income are non-GAAP financial measures and should be considered in addition to but not as a substitute for other measures of financial performance prepared in accordance with GAAP. Reconciliations to adjusted net income and adjusted EBITDA are 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. As Howard indicated, given the challenging dynamics of the industry, we are pleased with the second-quarter and first-half 2013 performance of our tobacco business. We are also pleased with our position going forward.

As mentioned in our previous call, during the first quarter, 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 nonparticipating manufacturer adjustment dispute for the years 2003 through 2012. During the second quarter, two additional states joined the settlement. This was a favorable develop 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. While certain nonsettling states filed suit in their home jurisdictions to attempt to vacate the settlement, they have been unsuccessful to date.

The settlement resulted in $5.6 million first quarter and $1.3 million second quarter, increases in pretax income for Liggett and Vector Tobacco. Excluding the income from the settlement of the NPM adjustment claim, our second-quarter operating profit increased by more than 5% over the prior year period. The increased profit was primarily the result of higher margins across all brands and effective cost controls, the benefits of which were partially offset by lower volumes.

Before I elaborate further on performance, let me turn to the financials. Please note that financial reporting for Vector Tobacco is combined with Liggett.

For the three and six months ended June 30, 2013, Liggett revenues were $249.1 million compared to $276.6 million in the corresponding period in 2012. The year-over-year revenue decline, which was partially offset by higher list prices, was as previously mentioned, largely driven by anticipated volume declines due to timing differences and price increases.

Operating income for the three and six months ended June 30, 2013, was $48.3 million and $95.5 million respectively compared to $44.6 million and $82.1 million in 2012. As previously noted, 2013 operating income includes $5.6 million and $1.3 million of MPN settlement income for the first and second quarters respectively.

As we have in the past, 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 while maintaining focus on branch strength and long-term profit growth. Over the past two years, market conditions have warranted that our business emphasis should be to pursue higher margins on our brand portfolio while continuing to build on the national strength of our Pyramid brand.

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

Eagle 20's is continuing its good start and is clearly benefiting from the robust distribution base we have built with Pyramid over almost four years. Through the first half of 2013, the brand gained active distribution in almost 23,000 retail outlets, with more than 13,000 added since the end of the first quarter. Based upon current market conditions, we believe there are a variety of growth opportunities for both Pyramid and Eagle and we are in the process of implementing programs that feature a more aggressive tactically oriented approach to marketplace discounting. We will provide updates as these programs develop.

Overall, the market for the cigarette industry particularly discount cigarettes continues to be quite difficult in the second quarter. As noted by others, the macroeconomic environment remains weak, particularly for lower income consumers who in general have significantly less disposable income. As a result, value consumers continue to search 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 are ubiquitous in the market, offering consumers ready access to low-cost smoking options.

Data from TTB indicates that early 2013 saw very high volumes of mislabeled pipe tobacco. 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. Without revisiting that, it's clear that the government's failure to properly enforce its tax code and existing laws has led to the loss of billions of dollars of tax revenue and has adversely impacted the legitimate tax-paying industry. While some progress was made by Congress last year in passing legislation that classifies retailers making cigarettes in their stores as manufacturers, unfortunately the mislabeled pipe tobacco category appears stronger than ever.

While some federal government entities have expressed interest in addressing the problem, remedying it remains a challenge especially with the current political and regulatory environment.

Another under-taxed product that regulators in 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 recommended that Congress 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 Durbin recently introduced legislation to close existing tobacco loopholes and equalize tax rates on all tobacco products. At this time, the bill's prospects are far from clear.

We are also hopeful that FDA and TTB would use the existing enforcement authority that they have to properly regulate these mislabeled products and a number of states have 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.

As noted previously, large domestic and international cigarette manufacturers have moved into the deep discount segment, an area typically dominated by smaller legitimate and renegade type companies, presumably to offset their declining premium volumes. The big three companies now comprise a majority, over 50% of this segment according to Management Science Associates data.

We are also continuing to see aggressive pricing from foreign companies in an attempt to capture volume and share, particularly KT&G Korea Tobacco on their discount brand, Timeless Time.

Most importantly though, we continue to be pleased with the performance of our Pyramid brand in a challenging period for the industry. Pyramid has a well-established national presence and is currently sold in approximately 115,000 stores with a distribution base that has continued to grow. Pyramid remains the seventh largest brand and third largest discount brand in the United States with a continuing opportunity to further expand the brand's national distribution footprint.

According to Management Science Associates for the second quarter of 2013, overall industry volume shipments declined by just over 6.1% while retail shipments declined by almost 4%. All companies experienced wholesale and retail declines for the quarter, with deep discount-focused companies declining at a greater rate.

Liggett's second-quarter declines in wholesale and retail shipments were 14% and 9.2% respectively versus the year-ago quarter. As mentioned, Liggett was negatively affected by price increased timing differences compared to the prior year period.

For the 2012 year, TTB reported industry taxable shipments declined by less than 2%. For the 2013 year, we are now anticipating that taxable shipments will decline in the 4% range, as cigarette shipments somewhat recover in the second half of the year.

As we look ahead, we will continue to implement our plan to grow Pyramid and Eagle 20's and control costs. We remain confident in our market position and our ability to continue to perform.

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 market share and volumes over the past three years, and we 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.

Good morning, Howard, Ron, and Bryant. I wanted to ask about the potential of a ban on menthol in cigarettes. What do you think of that potential? How quickly might that develop? If it comes about, what impact it might have?

In essence and I will answer the middle part first. We think the process is going to be very, very slow. I think the signal -- pretty much FDA, the way they put this out has created a process that is likely going to last years.

At this point, we continue to believe and certainly others in the industry continue to believe that the scientific data does not support the sense that menthol has any sort of different health effects than non-menthol. So we think that it's going to be a lengthy process as they continue to look at data, request comments. And then even by the time which we expect will take multiple years before FDA comes out with anything conclusive, if they were to do something that was deemed to be unconstitutional, which I expect they would if they did anything, there will then likely be a lengthy court battle about it.

So I don't think anything is happening soon. We don't think the data supports them doing anything material and we expect that it will continue to be a process going forward.

Okay, just could you remind us what sort of percentage of your cigarette sales are menthol cigarettes?

Yes, about 25%, 26%.

Okay, okay, and you -- I think you took a recent price increase in June of this year. Is that correct?

Yes, that is correct. There was a fairly broad -- most companies increased prices in the June timeframe.

Okay and have you seen any further impact on volumes or if everybody else -- was it similar to what everyone else took and is it at therefore not impacting your volume?

In fact, in general the industry had a very strong year-over-year performance in July and we had the same type of trend, so actually volume strengthened in July.

Okay, great. Do you care to comment on how big the Eagle 20's brand is at this point? You said it's in 23,000 stores, but can you comment at all on how big it is in terms of volume?

No, at this point we are looking at building the distribution footprint and we will talk more on volume as things develop. But we are very pleased with the way that it's moving directionally.

Okay, then the increase in investment securities in the quarter, could you comment on what they are invested in, what the money was invested in?

BK?

Yes, we put them in corporate grade bonds during the quarter. We put about $42 million in during the quarter just to try to achieve better interest rates.

Right, okay. These are investment grade corporates? Is that --?

Yes, they are all investment grade corporates. Investment grade corporate and government, excuse me.

Okay, then the 101 Murray St. project, will there be additional investments in that project down the road?

It's hard to tell yet. We haven't put all the financing together as it relates to construction and budgets and so forth. So I really don't expect any additional capital coming, but there always -- from us -- but there's always a possibility.

Okay and then finally, any new developments on the negotiations around the 20% Prudential stake in Douglas Elliman?

Yes, we are having a nonbinding mediation, which is going to be next week and we are hoping that we will settle it in nonbinding mediation so we don't have to go through the arbitration process.

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

Anton Kawalsky, Canyon Capital.

Just wondering if you could comment on overall market share for the quarter?

Yes, market share is in the 3.55 range overall.

I see, it's down slightly versus --.

Yes, from 3.6.

Got it. Okay, thanks very much.

Christian Hoffmann, Thornburg Investment Management.

Good afternoon. Could you remind me of your dividend policy?

Our dividend policy has been for a while now $1.60 a year, $0.40 quarterly, and a 5% stock dividend, which is done in the September 30 quarter.

But is it based on cash flow or earnings or I was just wondering how you -- how the Board thinks about that.

That's just been what it has been for a long time. We managed to have the cash to pay it and we plan on keep doing it.

Okay, can you also remind me about the Florida cases? I know you mentioned maybe trying to elevate that to the Supreme Court. But can you maybe give me an update on what you expect the timing of that to be? I know it could be pretty uncertain but just what you are thinking about and also kind of the range of outcomes?

Yes, basically the question relative to the Supreme Court is whether or not they take the case and that's something that is unknown, but we would be hopeful that there would be a review in the next Supreme Court session. But there is no way to predict either whether they will take it or what the outcome might be if they did take it.

So we basically -- this is an ongoing long-term process and fortunately, it hasn't been a debilitating one for us, so we expect that it will continue the way it is going and are hopeful at some point that legal sense will be made and it will be brought to an end.

All right. Thanks, guys.

Thank you. We have no further questions at this time. Mr. Lorber, do you have any closing remarks?

No, I thank everyone for being on this call and as usual, Ron, BK, and myself are available for any questions you may have. We look forward to speaking to everyone in the next quarter call. Have a nice day.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.