Vector Group Ltd (VGR) 2013 Q4 法說會逐字稿

Welcome to Vector Group Ltd.'s fourth-quarter and full-year 2013 earnings conference call.

During this call, the terms pro forma adjusted revenues, pro forma adjusted operating income, pro forma adjusted net income, pro forma adjusted EBITDA, and tobacco pro forma adjusted operating income will be used. These terms 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 of non-GAAP financial results to the comparable GAAP financial results are contained in the Company's earnings release, which has been posted to the investor relations section of the Company's website located at www.vectorgroupltd.com.

Before the call begins, I'd 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 President and Chief Executive Officer of Vector Group, Howard. Please begin.

Yes, hi, good afternoon. Good afternoon, everyone, and thank you for joining us for Vector Group's fourth-quarter and full-year 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 three months and full year ended December 31, 2013. Ron will then address Liggett's performance for these periods, and provide an update on Company and industry developments. After that, we will be available to answer your questions.

As we noted in our October call, Vector Group and Liggett reached a global settlement relating to the Engle tobacco litigation in Florida. Pursuant to this settlement, more than 4,900 of the approximately 5,300 Engle plaintiffs will dismiss their claims against Vector Group and Liggett. This settlement resolves all federal Engle progeny cases, and all but 400 of the state cases.

This landmark settlement was an important milestone for the Company. We believe it prudently resolves substantially all of the Engle cases pending against us. The Engle cases have been the Company's biggest litigation overhang over the past decade, and this settlement substantially reduces our ongoing litigation risks, as well as related legal expenses.

Turning to our business operations, we are pleased with our 2013 performance, and our year-end balance sheet remains strong. In the real estate business, through New Valley, we are very pleased to have completed the purchase of an additional 20% interest in Douglas Elliman that was previously owned by Prudential, establishing Vector Group's 70% ownership interest in Douglas Elliman. Consequently, after December 30, 2013, the Company consolidates the operations and financial position of the Douglas Elliman realty and its financial statements.

For the 2013 fourth quarter and full year, Douglas Elliman had approximately $121 million and $437 million in pro forma adjusted revenues, respectively, and generated pro forma adjusted EBITDA of $13.8 million and $46.6 million, respectively. Building on Douglas Elliman's strong brand name recognition and best-in-class real estate sales, property management, title and mortgage services, we see many opportunities in New York, South Carolina, Southern California, and other regions of the country to increase market share.

Given Douglas Elliman's position as a leader in the lucrative New York City metropolitan market, as well as being the fourth largest residential real estate brokerage company in the United States, we are excited to acquire meaningful incremental equity interest in this business. This acquisition will strengthen our presence in the New York City real estate market, where we are partners in 10 current developments.

In 2013, we invested approximately $75 million in seven new real estate investments that are primarily focused in the New York City area. There continues to be strong demand for residential real estate in the city, and we've been fortunate to partner with several talented developers on a number of exciting projects.

As we look ahead with respect to both our tobacco and real estate businesses, we will continue to assess new opportunities, and selectively pursue those with the best long-term-value potential. Furthermore, we continue to have significant liquidity, with cash and cash equivalents of $234.5 million, which includes approximately $70 million of cash at Douglas Elliman, and investment securities and partnership interests with a fair market value of $206.3 million as of December 31, 2013.

I will now review the key financials for the three months and full year ended December 31, 2013, for Vector Group. For the fourth quarter ended December 31, 2013, Vector Group's pro forma adjusted revenues were $397.3 million compared to $383.5 million. The increase was primarily due to $22.7 million of revenue from the sale in October of 200 lots at our Escena development in Palm Springs, California, and an increase in Douglas Elliman's revenues of $15.3 million. The decline in revenues in the Company's tobacco business of $24.3 million partially offset these amounts.

The Company recorded pro forma adjusted operating income of $76.3 million in the 2013 fourth quarter, compared to $47.1 million in the 2012 period. The increase was primarily attributable to a $20.2-million gain from the sale of the Escena lots, and improved margins at both Douglas Elliman and our tobacco business. Fourth-quarter 2013 pro forma adjusted net income was $37.2 million, or $0.36 per diluted share, compared to $13 million, or $0.14 per diluted share, in 2012. For the fourth-quarter 2013, pro forma adjusted EBITDA attributed to the Company was $76.8 million, compared to $50.8 million for the year-ago period.

For the full year ended December 31, 2013, Vector Group's pro forma adjusted revenues were $1.474 billion, compared to $1.463 billion in the 2012 period. The increase was primarily due to an increase of $58.8 million in real estate revenue at Douglas Elliman, and $22.7 million of real estate revenue from the Escena lots. The decline in revenues in the tobacco company business of $70.2 million partially offset these amounts. For the full year ended December 31, 2013, pro forma adjusted operating income was $234.8 million, compared to $185.1 million in 2012.

Pro forma adjusted net income for the full year ended December 31, 2013, was $84 million, or $0.89 per diluted share, compared to the 2012 full-year amount of $57.7 million, or $0.64 per diluted share. For the full year ended December 31, 2013, pro forma adjusted EBITDA attributed to the Company was $238.2 million, compared to $195 million for the year-ago period.

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

Thanks, Howard. Good afternoon, everyone. As Howard indicated, we're very pleased with the performance of our tobacco business in 2013. Despite an expected decline in shipments, fourth-quarter adjusted operating income increased by 6.8%, while adjusted full-year operating income increased by 7%. We continue to believe that our tobacco business is well positioned to perform going forward.

This proved to be a very productive year in resolving long-standing disputes with the states related to the MSA NPM adjustment. During the first and second quarters, the participating manufacturers of the MSA, including Liggett and Vector Tobacco, entered into an agreement with 22 of the 52 MSA states and territories to resolve the dispute for years 2003 through 2012.

In the third quarter, the NPM adjustment arbitration panel ruled that 6 of 15 states that did not settle had failed to diligently enforce their MSA obligations in 2003. As a result, Liggett will receive a credit of approximately $6 million against its 2013 MSA payment obligation in April of this year. This resulted in $4 million of additional operating income, and $2 million of interest income in the third quarter.

The six states found non-diligent have filed motions to vacate the arbitration award in their state courts. The NPM adjustment arbitration process will continue with the non-settling states, as we still need to resolve years 2004 through 2012. We would obviously prefer a negotiated solution to this process.

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 months and full year ended December 31, 2013, Liggett revenues were $253.3 million and $1.01 billion compared to $277.6 million and $1.08 billion in the corresponding period in 2012.

Tobacco adjusted operating income for the three months and full year ended December 31, 2013, were $48.9 million and $188.3 million, respectively, compared to $45.8 million and $176 million in 2012. The 6.8% increase in fourth-quarter earnings and 7% increase in full-year earnings were primarily the result of higher margins from price increases, and effective cost and expense controls, partially offset by lower volumes. While we are always focused on brand strength and long-term profit growth, we continue to evaluate short- and long-term opportunities that are designed to pursue incremental volume and margin.

As you may recall, in 2011 and 2012, market conditions led us to pursue higher margins on our brand portfolio, while continuing to build on the national strength of our Pyramid brand. As market conditions changed in late 2012, we determined that the time was right to pursue longer-term volume growth by leveraging our strong position in the deep discount segment. To that end, in January we introduced the new national brand, Eagle 20s. A key goal of Eagles 20s is to stabilize our overall volume trends by offsetting losses in non-core brands, as well as to develop a second brand that's complementary to Pyramid.

The economic climate early in 2013 proved very weak, due in part to the elimination of the payroll tax cut, and high gas and food prices. This resulted in a slower-paced start for the Eagle 20s introduction. However, as the year progressed and the economic climate improved, the brand gained strength, and benefited from the robust distribution base we have built with Pyramid. Eagle 20s has now been accepted in almost 40,000 retail outlets, with more than 13,000 added since the end of the third quarter. Overall, Eagle 20s had a strong 2013, and the brand is well positioned for 2014 and beyond.

There continue to be a variety of growth opportunities for both Pyramid and Eagle 20s, and we have implemented targeted programs that feature an aggressive, tactically oriented approach to marketplace discounting. We're pleased with the results of these programs, which are meeting their objectives to date.

While Pyramid, Eagle 20s, and other conventional cigarettes will clearly remain our primary focus long term, we are also excited to have entered the fast-growing eCigarette category, an estimated $1.5-billion industry in the US at this point, with a national rollout that began in January. As we previously pointed out, while we recognize the potential of this category, we enter it cautiously, as there are many unknown factors that are beyond our control. These include long-term consumer acceptance, taxation, and the impact of likely FDA regulation.

With that in mind, we have developed our eCigarette brand, Zoom, which we believe is a superior disposable eCigarette product. It is available in tobacco and menthol flavors, and in both bold and smooth styles. Zoom was developed together with XEO, a company based in Germany that has significant experience in the eCigarette category, and this approach has allowed us to take advantage of new and emerging technologies while minimizing the cost of developing a new premium-quality product from the ground up.

Zoom is manufactured in China, where several types of eCigarettes have been marketed since 2000, and features our proprietary eLiquid made in the United States. We have drawn on our own industry expertise, German precision engineering, quality US eLiquids developed under the guidance of Liggett tobacco experts, and Chinese manufacturing to create what we believe is the best disposable eCigarette available today. We are very pleased with the early market acceptance of Zoom following its official launch in January. The brand has already received commitments from retailers representing approximately 25,000 retail stores nationwide, the majority of which are key chain accounts.

We will discuss Zoom in more detail, including specifics on our market expansion, in future conference calls. However, if you would like to know more about Zoom now, you can go to our website at www.zoomecigs.com for information. We believe that we've entered the market with an appealing product, and if this category continues to grow, we will succeed with Zoom.

Turning now to conventional cigarettes, in general, the overall market was weaker in the fourth quarter than both the previous quarter and the previous year. This was due in part to trade adjustments and de-loading that occurred following a strong third quarter. Value consumers continue to seek low-cost alternatives, and we have seen consistent growth in mislabeled pipe tobacco throughout the year. As previously mentioned, the failure of Congress and regulators to adequately address the tax evasion and avoidance of companies selling mislabeled pipe tobacco and filtered cigars have made these underregulated and undertaxed products ubiquitous in the market.

The government's failure to properly enforce its tax code in existing laws has led to the loss of billions of dollars of tax revenue, and has adversely impacted the legitimate tax-paying industry. In 2012, 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, continue to support full tax equalization.

As it relates to pipe tobacco, it was somewhat encouraging that the FDA recently sent warning letters to several companies that it believes are marketing roll-your-own tobacco as pipe tobacco to evade taxes. Additionally, 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. But the problem remains generally unconstrained, and we remain hopeful that FDA and TTB will use the existing enforcement authority that they have to properly regulate these mislabeled products, though we have seen little action from them to date.

Additionally, the FDA has indicated that it will soon issue regulations to extend its authority over other tobacco products. We are hopeful that this much-delayed process will be completed shortly, and that appropriate action will finally be taken.

As noted previously, large domestic and international cigarette manufacturers have moved into the deep discount segment, presumably to offset declining premium volumes. Not surprisingly, the big three companies now comprise the majority of this segment, according to Management Science Associates data.

In addition, we continue to see aggressive pricing from certain foreign companies in an attempt to capture volume and share. One company notable in its pricing activity is KT&G, the Korean tobacco company, which has maintained pricing on one of its brands for the past three years that appears to be well below cost. Beyond the low-cost pricing, we have seen no evidence that they are making any effort to build a US business.

Importantly, despite these market pressures, the performance of our Pyramid brand has remained strong. Pyramid has a well-established national presence, and is currently sold in approximately 115,000 stores, with a distribution base that continues to grow. Pyramid recently passed Winston, and is now the sixth largest industry brand, as well as being the third largest discount brand in the United States.

According to Management Science Associates, for the fourth quarter of 2013, overall industry wholesale shipments were down 6.2%, with the top five companies down between 1% and 38%. For the period, Liggett units were down just under 12%. Industry retail shipments declined by 4.6% in the fourth quarter, with the top five companies ranging between flat and a 13% decline. Liggett retail shipments declined by 6.5% during the quarter.

Liggett's retail market share remained essentially flat throughout the year, and compared to the fourth quarter of 2012, and Liggett remains the number four cigarette manufacturer in the United States. While industry taxable shipments declined by under 2% in 2012, we are now estimating that 2013 shipments declined in the range of 4.5%. This is slightly higher than the 4% decline that we had forecast at the beginning of the year. The increased 2013 decline rate is the result of a tough comparison with 2012, market economic conditions that caused value smokers to seek lower-tax products that are not properly counted as cigarettes, and some movement to eCigarettes.

As we move forward in 2014, we will continue to implement our plan to build profitable growth with our Pyramid and Eagle 20s brand, while expanding Zoom distribution nationally. At the same time, we'll work to assure that costs are controlled effectively to maximize profits. We are very pleased with our earnings growth in 2013, as well as our market position. We have programs in place to support our volume base going forward, and are confident in our ability to build upon our long-standing successful performance.

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

Thank you, 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 consistently grown our profit margins in recent 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.

Thank you. At this time, we will open the floor for questions.

(Operator Instructions)

Our first question comes from Ken Bann with Jefferies.

Good afternoon, Howard and Ron. I was wondering on the Escena project, how many more lots do you own in that project, and what is the plan regarding the remaining lots?

The 200 lots we sold were probably among the group of the better lots. We have 667 left. Some are basically attached houses, some are not quite as good of a location, we have a hotel pad. So, I didn't want to imply the fact that all the remaining lots, you multiply it times the same price. I think as time goes on, they're all going to go up in value, but they are somewhat different lots than the ones we sold.

And the lots you sold, there was nothing developed on them? They were just --

No, they were lots that the developer had to get ready to do the finishing work and then build and sell houses.

Okay, and then the tobacco buyout payments that you have been making for many years, that -- those will end later this year, if I'm not correct?

Those end, BK, around the end of this year, right? The end of 2014?

That's correct.

Okay, and those are roughly $40 million per year at this point?

(Multiple speakers) based upon volume, and it's in the $30 million to $35 million range.

Okay, and that will add directly to your earnings from the tobacco side?

Unless the boys in Washington decide it's a good time to do something else with the money and come up with another program, but we're hoping that's not going to happen. We're hoping that most of it, if not all of it, will go to our bottom line.

Is there any movement to renew that program at all in Washington?

No, it is not renewable. It was a 10-year buyout that was contractual. The farmers are now bought out, and I think at this point they can't renew it.

It's not a matter of renewing it, though, it's a matter of them saying, okay, the tobacco companies are now going to make X-amount more, maybe we should raise federal excise taxes or something. That's the concern.

Right. Okay. And then on the tobacco volumes, was the decline mostly in the Pyramid brand or was it in your other brand --?

It was predominantly in our non-core brands.

Okay, and is there any -- you're still going to keep the Eagle 20 at a value price range for the near term, is that correct?

That is correct.

Okay. Okay, great. Thank you very much.

You're welcome.

Thank you.

(Operator Instructions)

Our next question comes from Mitch Pindus with Wells Fargo.

Hi, gentlemen.

Hi, Mitch.

Hi. A couple of questions. You had mentioned earlier during the call that the -- one of the advantages to settling the Engle litigation is that your litigation-related expenses will drop, and I'm just wondering what you approximate that at per year?

Ron, do you have an idea?

Well, I think we've had an ongoing cost of litigation that's ranged in the legal expense of $8 million to $9 million a year. It's hard to quantify exactly what's going to happen and I think that's going to phase down, but obviously, there are less cases out there that are likely going to come to judgment. And in addition to that, we would expect there our legal expense, as we complete this process of the settlement, will go down substantially.

Okay, is it reasonable to expect it to be one-third of that?

I don't think we can quantify it yet, Mitch. I would expect that it's going to go down and it's going to go down in a meaningful amount.

Okay.

Mitch, in all fairness, we didn't really do the deal, it was not propositioned on the fact that our legal fees would go down done a lot. We did it because we thought the right thing for all of us. The byproduct will be that legal fees should be less expensive. Whether it will happen right away, whether they will level out at $6 million or $3 million, we don't know yet.

Okay. My other question is related to the earnings. I really, because it just came out a half an hour ago, I really haven't had a chance to go through them, but one thing that I'd like just a little clarity on is, you'd mentioned a gain on the acquisition of Douglas Elliman was about $60.842 million. Can you just explain how that comes out on your income statement?

BK?

Yes, of course. Good afternoon, Mitch.

Hi, BK.

What happened is, is we paid -- when we bought Douglas Elliman, we paid what was effectively $290 million for the equity of Douglas Elliman. Douglas Elliman had a book value which was less than that. So, we recognized a $60 million gain on our 50% interest in Douglas Elliman.

Okay, so -- all right, I think I understand.

And so as far as pro forma adjustments, we have excluded that from those numbers.

So essentially, it was a book entry?

It's a book entry, that's correct. Where we wrote up the assets and we wrote up -- you'll see on the balance sheet in the 10-K, we wrote up goodwill and other intangible assets associated with Douglas Elliman.

And that's all based upon the amount that you paid for the 20%-plus?

That's correct.

Okay.

Because that established in value to Douglas Elliman of $291 million.

Okay, what are you carrying it on the books for right now, the entire Douglas Elliman position?

We are carrying the entire position at $291 million, and then we reduced that by 29.41%, which is what our partner owns in it.

Perfect.

So, our net number's around $205 million.

Okay, thanks, guys.

Thank you. Our next question comes from [Barry Blake] was [Contone] Research.

This question is for Bryant. Bryant, what do you think the taxable rate of the dividend will be this year? Do you have any parameters?

Sure. Barry, right now we think 30% to 40% will be taxable, so 60% to 70% will be non-taxable.

Okay, and the second question is just a general question. With the legalization of marijuana that's going, pretty much starting to take hold in the country -- all over the country, does the Company have any plans to go into this area if it becomes legal in most states?

Not at this time.

Okay. Thank you very much. Thank you. Our next question comes from [Max November] from Triangle Partners.

Hi guys, quick question. With regard to the 667 lots that you have left in the Escena, can you give us a little bit more color? You said the lots that you sold were of higher quality, maybe just give us a little bit more color on the disparity there?

The lots we sold were single-family lots and they were in a -- very good golf course locations. Okay? A lot of the other lots are -- you would say are maybe not quite as good. There are some that are as good golf course locations, but some of those are basically attached -- detached houses, townhomes and attached houses as opposed to just regular single-family lots.

And then you have some commercial space, then you have a pad for a hotel. They are pretty varied, so it's hard to put a price. What I didn't want to do is, again, is just say that if we sold 200 and we have 600 left, we are going to get the same price for the 600. Look, ultimately we may get more, because we're not the market to sell them now. And we're going to wait a little bit, the market's still going up in that area, and we're going to wait. So, we could ultimately get the same or less.

Thank you. Would you say ex the real estate gain, that Q4 adjusted EBITDA would be?

BK?

Hi, Max, how are you? Excluding the real estate gain, which was $20.2 million, adjusted EBITDA would be $56.6 million, and that compares to $50.8 million from last year. And then for the year it would be $218 million, which compares to $195 million for last year.

Thank you.

You're welcome.

Thank you. Our next question comes from Fred Greenberg with Greenberg Advisors.

Hi, how are you?

Good, thanks.

The Douglas Elliman, can you tell us the growth rate of Douglas Elliman for 2013? The red line and EBITDA?

Good afternoon, Fred, how are you?

I'm good, thanks.

As far as for the quarter, Douglas Elliman grew 14.4%, and for the year it grew 15.5%.

That's the revenues?

Yes. That's the revenues.

And EBITDA?

EBITDA -- just a minute. EBITDA grew from, I'm going to give you the year first, it grew from $31 million to $46.6 million. That's for the year. For the quarter, it grew from $10.2 million to $13.8 million.

So, it's 50% for the year.

Yes.

That's a great asset.

It is. And we also did spend money in beefing up things, which were expensed, so my guess is --

Do you have any -- do you see the tobacco business as, quote, challenging, and you see, at least for now, your real estate business is doing very well, and by moving into other markets it's going to continue to give you upside, I'd think. Do you see any reason to separate these divisions to monetize it more aggressively? It's still mixed, it's a very mixed, the business right now.

Obviously, recently the market sort of likes it, being the stock has had a pretty good run over the last couple of months. Last month, really.

That's because you were able to consolidate it in your numbers, that's why.

Well, just before today, but look, (multiple speakers) the real estate can be part of it, it could be a lot of things. We always are looking at how to increase value for shareholders, and so everything is on the table all the time.

Whether it's -- look, the tobacco business is great for us because of the MSA, okay? So, while it's not a growth business, we know it's going to be consistent earnings and not a question is, how much more could we push it?

The real estate business, we think we have upside going into -- expanding what we have and going into new markets. We just are opening our office in California, we think Southern California -- we don't want to be all over the country. What we want to be is, we want to be in the same places that most of our clients are, and that happens to be where we are now.

New York City, Long Island, the Hamptons, Westchester, Miami to Palm Beach, also Southern California, probably left is Fairfield County, Connecticut. And then we're pretty much finished and then we just build from there. Obviously, the more places we are at, the more opportunities we're going to have as we learn the market and are comfortable with our pricing there, we will have other opportunities to be investors in development projects in those markets.

Just on the -- well, it's a great brand and everyone recognizes that in the market. I also live in the middle of that market in the summertime, so it's a standout brand. When your tobacco sales are down $72 million, have we reached a stress point where you can't really grow cash flow from that anymore?

(Multiple speakers) Fred, I think what's important to know is tobacco EBITDA is up from $186 million to $198 million.

One of the points -- you can't go on forever when your revenue is dropping like that. Unless I misunderstand it?

Let me explain. As I've pointed out, and I point out all the time, is that volume and margin opportunities don't necessarily occur at the same time.

The way to view this is if you are in a football game and the -- when the defense is playing deep you can take short gains, and when they're playing up close, you can go long. And the reality is we look for the opportunities. We don't try to fight the market, we look to take advantage of what we can do in the market at the same time that we position something so that it's working to get us ready for the next stage that we have to be at.

So we've recognized that volumes were going to be challenged and took advantage of margin opportunity, at the same time that we start slowly building another brand that's going to be able to come in and to supplement the volume position that we are giving up. As Howard pointed out, we have this extraordinary benefit with the MSA that gives us a foundation of $165 million. Right now we're making about $190 million, $190 million-plus.

So, we're continuing to build earnings on top of that, and our earnings growth has been consistent over the last four or five years. So -- and during that period, we also had some substantial volume growth and today, our volume is higher than it was in 2008. It's a process. And it's not a straight line where volume and margin are building at the same pace at the same time, but we're constantly managing both of them, and we're optimistic that we can continue to do that.

Thank you.

Ron, our market share is also up one-third since 2008. We were at 2.5% in 2008 and we're at 3.3% now.

3.5%.

3.5%.

Speakers, at this time, we have no other for questions in the queue.

Okay. Well, thank you, everyone, for attending this call. As always, we're all available. If anyone would like to speak with us, please call us directly. And if not, we look forward to speaking to everyone on our next quarterly conference call. Thank you, and have a good evening.

That is all the time that we have for these questions today. Thank you for participating in Vector Group's fourth quarter and full-year 2013 earnings conference call. This concludes today's conference. You may disconnect your lines now.