Vector Group Ltd (VGR) 2017 Q2 法說會逐字稿

Welcome to Vector Group Ltd.'s Second Quarter 2017 Earnings Conference Call.

During this call, the terms adjusted revenues, adjusted operating income, adjusted net income, adjusted EBITDA and tobacco-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 to adjusted revenues, adjusted operating income, adjusted net income, adjusted EBITDA and tobacco-adjusted operating income 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'd like to turn the call over to President and Chief Executive Officer of Vector Group, Howard Lorber.

Good morning, and thank you for joining us for the Vector Group's Second Quarter 2017 Earnings Conference Call. With me today are Ron Bernstein, the President and CEO of Liggett Vector Brands and Liggett; and Bryant Kirkland, Vector Group's CFO.

I'll provide an update on our business and review Vector Group's performance for the 3 and 6 months ended June 30, 2017. Ron will then summarize Liggett's performance and provide an update on company and industry developments. After that, we will be available to answer your questions.

The company's core real estate and tobacco operations continued to perform well in the second quarter. As noted during the first quarter call, we expected to achieve volume growth in our tobacco business during 2017, and I'm pleased to report that we have been successful in that effort through the first 6 months of the year. Ron will provide more detail on Liggett's performance shortly, but suffice it to say, we feel good about our position in the discount segment of the market.

For the 3 and 6 months ended June 30, 2017, Douglas Elliman had approximately $198.7 million and $354.2 million in revenues and adjusted EBITDA of $18.2 million and $20 million. This compared to revenues of $181.7 million and $339.3 million and adjusted EBITDA of $14.8 million and $23.9 million in the 2016 period. We continue to believe both our tobacco and real estate businesses are well positioned for success. As always, we will assess new opportunities in our businesses and selectively pursue those with the best long-term potential for value creation.

Vector Group continues to have significant liquidity with cash and cash equivalents of approximately $410.4 million, including approximately $102 million of cash at Douglas Elliman and investment securities and partnership interest with a fair market value of approximately $285.7 million as of June 30, 2017.

I will now review our key financials for the 3 months and 6 months ended June 30, 2017. For the 3 months ended June 30, 2017, Vector Group's revenues were $472 million compared to $438.3 million in the 2016 period. The company recorded adjusted operating income of $74.3 million in the second quarter compared to $71.5 million in the 2016 period. Second quarter 2017 adjusted net income was $32.7 million or $0.25 per diluted share compared to $24.6 million or $0.19 per diluted share in the 2016 period. For the quarter, adjusted EBITDA were $76.3 million compared to $75.1 million for the year ago period.

For the 6 months ended June 30, 2017, Vector Group's revenues were $887.2 million for the 6 months ended June 30, '17, compared to $819.1 million in the 2016 period. The company recorded adjusted operating income of $128.3 million in the 6 months ended June 30, 2017, compared to $136.8 million in the 2016 period. Adjusted net income for the 6 months ended June 30, 2017, was $51.2 million or $0.38 per diluted share compared to $42.7 million or $0.33 per diluted share in 2016. For the 6 months ended June 30, 2017, adjusted EBITDA were $137.6 million compared to $144.7 million for the year ago period.

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

Thank you, Howard. Good morning, everyone. As Howard mentioned, we implemented a plan in 2017 to grow cigarette volumes and are pleased with our operating results, both in the second quarter and first half of 2017. As noted during prior calls, 2016 was a year of transition in the tobacco industry. The Reynolds-Lorillard Imperial transaction brought change to the industry and created both competitive challenges and opportunities for Liggett in the marketplace.

Further, as smaller companies operating in the deep discount segment started to raise prices to curtail losses, we also recognized and acted on growth opportunities in that segment. In anticipation of those changes and to put Liggett in the best position for long-term success, we made structural and market-based adjustments to our tobacco operations entering 2016. Those adjustments proved successful as we increased tobacco segment earnings last year and laid the groundwork for 2017 volume increases. I'll discuss that performance in more detail shortly.

With respect to product liability litigation, we continue to make progress in working to resolve the remaining Engle progeny cases, in which Liggett is a defendant. At this point, all, but approximately 105 Engle progeny cases have been resolved by Liggett. As we always caution, we may still be subject to periodic adverse verdicts.

I'll now turn to the tobacco financials. Please note that as always, financial reporting for Vector tobacco is combined with Liggett. For the 3 months and 6 months ended June 30, 2017, Liggett revenues were $272.2 million and $529.6 million compared to $255.5 million and $476.5 million for the corresponding periods in 2016. The increases in revenues are reflective of year-over-year volume gains and pricing increases.

Tobacco-adjusted operating income for the 3 months and 6 months ended June 30, 2017, was $64.5 million and $125 million compared to $66 million and $129.9 million for the corresponding periods in 2016. The decrease in tobacco-adjusted operating income during the second quarter is reflective of our investment in and growth of our Eagle 20s brand. Year-to-date decreases are the result of our investment in Eagle 20s and a Q1 2016 MSA cost revision that resulted in $5 million of income in the first quarter of 2016. Excluding the 2016 MSA cost revision, first half 2017 tobacco-adjusted operating income would have been flat year-over-year, despite the investment in Eagle 20s.

Our selling efforts over the past several years have been focused on 2 core brands: PYRAMID, the fourth-largest U.S. discount brand; and Eagle 20s, now the fifth-largest and fastest-growing U.S. discount brand. Recent results clearly affirm that Eagle 20s is providing an effective long-term complement to PYRAMID, while offsetting volume declines in PYRAMID and other Liggett brands. Since its launch in 2013, we've built Eagle 20s in a disciplined manner and are very pleased with our progress.

Eagle 20s is now available in approximately 63,000 stores nationwide. We've maintained the competitive price point for Eagle 20s since its inception. And based on the success of our strategy to date, believe that the brand continues to be well positioned for growth. All of the promotional programs for our core brands are designed to develop and maintain price value strength, while delivering long-term profit growth. As a result, we continue to pursue opportunities that we believe will generate incremental volume, including an expansion of business-building programs in specifically targeted geographies.

Looking at recent industry trends over the course of 2016 and through the second quarter of 2017, we've seen industry volume declines to return to historical norms and believe the decline rate is now approaching 4% per year.

The industry remains challenging. And in recent years to offset declines in their core premium brands, we've seen Altria and Reynolds increase their focus on discounting extensions of those brands. This has resulted in the development of a premium economy type of price segment, highlighted by brands such as Marlboro Special Blend, Newport Red and various Camel extensions. The price of these premium economy brands is typically well above standard discount products and has had little effect on that segment to date.

Regarding smaller discount-focused companies, as previously noted, the cumulative effect of price increases has generally slowed the growth of many of their respective bands, which has proven beneficial to us. However, over time, targeted deep discount brands continue to emerge in local geographies as smaller competitors search for business. Additionally, while low-priced products such as mislabeled pipe tobacco and filtered cigars continue to adversely impact the marketplace, those categories are in decline despite the absence of governmental intervention as of yet.

Given these factors, we're pleased with the performance of our PYRAMID brand and continue to focus on supporting its well-established nationwide presence. PYRAMID distribution remains strong, and the brand is currently sold in approximately 112,000 stores, a substantial national distribution footprint. According to Management Science Associates, while overall second quarter industry wholesale shipments were down 2.9% on a year-over-year basis, Liggett's wholesale shipments increased by 7.1%.

As I note during each call, we believe retail shipments are a far more reliable indicator of performance due to various factors, including individual company shipment fluctuations, the timing of price increases and wholesaler buying patterns. For the second quarter, Liggett's year-over-year retail shipments compared favorably to the industry, up 5%, while the industry was down 5.5%. This growth rate is consistent with recent quarters, and according to the data, we were once again, the only nationally-focused major cigarette manufacturer to register an increase in shipments during the quarter. Liggett's second quarter retail market share increased by 38- basis points compared to the prior year period and now represents more than 3.8% of the total market.

We're extremely pleased with our performance to date, and as we look ahead, plan to continue to focus on providing income from the strong sales and distribution base of PYRAMID, while delivering volume and share growth from Eagle 20s. We as always remain subject to regulatory and marketplace risks, including those discussed, but are confident that we have effective programs in place to support our market share and continue to grow profit.

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 to drive long-term value for shareholders. We have strong cash reserves, have consistently increased our tobacco profit margins and sales volumes in recent years and will continue to benefit from favorable terms under the MSA, and we're pleased with the prospects for our real estate business. We're also 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 its cash dividend policy remains the same.

Now operator, would you please open the call for questions?

(Operator Instructions) Our first question will come from Ian Zaffino, Oppenheimer.

This is Mark on for Ian. So in regards to real estate, was the outperformance in this quarter driven more by a meaningful increase in volumes? Or are we starting to see pricing coming back into market as well?

I think it's a little bit of both. I think that business in general, volume was up. I think that it's a little bit of a different market and that the very ultra-high end has been pretty strong and the traditional high end, which was, let's say, between $8 million and $20 million, has been softer as most of these reports have -- that has come out from the firms have shown. And under $5 million -- under $4 million or $5 million has still maintained its strength. We've also made improvement in our markets, in our new markets, which has helped also in cutting down the losses in those markets.

Got it. And I guess, like how do you -- how sustainable do you see this going forward into the balance of 2017?

I think it's going to be a good year. I think the balance of the year is going to be good. So I'm going to guess, based on the market -- the stock market continuing, which is always good for the real estate market. And then also the big unknown is tax reform. We believe -- firmly believe that if tax reform does happen, which some form of it should, that, that will be a boom to the real estate market, even though there's a couple of maybe small negatives in it. I think that all in all, when people feel they have more money in their pocket, they're more apt to spend money and spend more money on real estate. So pretty bullish for the balance of the year.

Okay, great. And then I guess, just a very quick housekeeping. Do you guys have, I guess, the diluted share count for this quarter?

B. K., you have that?

Yes. It's about $126.5 million and then shares outstanding at the end of the quarter is about $128.9 million.

Our next question will come from Karru Martinson, Jefferies.

So taking a step back and looking at the kind of the big picture with the FDA announcement. I mean, what is the near-term impact? And how do you guys see that kind of playing out in a time line for what will change here given this kind of harm reduction continuum talk that has come out from the FDA?

Yes, so -- I mean, I would start by saying that, that has been typical with the FDA since they took over regulation of the industry, there's an extreme lack of clarity and lack of transparency. The short term -- I don't see any impact. This is a process that even if they were to come to a conclusion that there was some level of nicotine that they were targeting that it's going to take years to get to that. They've gone to a long-term type of process and going with the advanced rulemaking before going to the rulemaking. But the thing that has to be remembered relative to FDA is that it is -- it's mandated to be a science-based agency. And the ability to go in and to determine a target that would have a science-based impact on public health relative to nicotine levels is something that may not be doable. And if it is, it's going to be something that's going to be fraught with lots of debate and lots of division and no doubt, lawsuits. So from our perspective, we believe that this is going to be a long process. We're not even clear what it is they're exactly trying to do. And we're always going to be in a position to comply with regulations and also as was the case when the FDA went beyond constitutional guidelines with the graphic warning labels, we will challenge them in court and I'm sure the rest of the industry will as well, if they come up with something that is -- violates our rights. So I mean, in the short term and into medium term, I don't really see much of an impact at all.

Okay. And then just looking at Eagle 20s, it looks you added another 2,000 stores to the distribution still kind of around half of where PYRAMID is. Is the goal ultimately to bring Eagle 20s to kind of a PYRAMID level? Or where will that brand kind of top out?

Well, I think, again, there's 2 different issues, there is the market share of the brand and there is the amount of stores. And there is little doubt that Eagle will not -- never be in as many stores as PYRAMID is. However, we believe that Eagle's share will certainly approach PYRAMID at its peak levels. So the brand is growing well. As I said in my comments, it's the fastest-growing discount brand in the U.S. and has been for a couple of years now, and it continues to maintain its trajectory. So we feel very good about it. We think that brand -- again, the market -- PYRAMID peaked in volume in 2011, the market 6 years later is smaller than it was 6 years ago. So the absolute volume won't be as large, but we believe that the share will be.

Okay. And cash was up nicely in the quarter, but it seems like the real estate portfolio is still the same. So are you still seeing opportunities to liquidate or harvest that real estate portfolio?

The bulk of our portfolio dollar-wise is in condominium investments. So again, that gets liquidated as the buildings are built and apartments are sold and closed. So yes, that is still in a liquidation mode. B. K., do you have any other comments on that?

We did have some monetizations during the quarter related to the 10 Madison West project as well as the West Hollywood Edition project.

And that will continue. We haven't made a lot of investments. We've made a couple of small, that's about it.

Our next question will come from Brian Hunt, Wells Fargo.

It's Dave Cook on for Brian. Just wanted to go back to the FDA announcement. I realize there is some lack of clarity around this, where it will ultimately go. But I mean, I guess, if we're thinking about reduced nicotine levels, can you tell us why you think you are or aren't well-positioned for kind of the contemplated change in nicotine levels?

Well, there isn't it a contemplated change at this point. So until they prescribe something, there's really nothing to comment on. So this is, at this point, theoretical, they've said that they want to explore this, they will explore it, the industry will explore it, and will determine at the point of time what adjustments, if any, are unnecessary. But until there is some indication of what it is that they're even talking about, it's kind of -- there's nothing to really speculate about.

And then you're going to have comments from the health industry, because what you really have is -- look, the thinking has been for quite a while that if you lower nicotine what it does in effect is, it encourages people to smoke more to get the nicotine. Then what happens is, obviously, that creates more disease, in itself it's not good for you and it does have cardiovascular implications. But it doesn't have the other implications that cigarettes have, meaning heart disease and cancer -- excuse me, cancer and so forth. So there'll be quite a lot of talk back and forth, is it really make more sense to do it or not to do it.

Okay. And switching over to real estate. I saw the announcement regarding your acquisition of Teles Properties. Just wanted to see if you could get any idea of the scale of that purchase price? And how you all are thinking about financing that if that's just using cash on Douglas Elliman's balance sheet?

Yes. We're not going to discuss purchase price, and we haven't closed the transaction yet. But it's -- we have -- it's going to be financed on our own balance sheet. We have the cash for it.

Okay. And then if I look at tobacco dollar sales and your wholesale volume growth, it appears that implied pricing, the pricing investment appeared to ease sequentially from Q1 to Q2. One, am I right in my math? And what is that a function of and kind of what could we expect for the balance of the year?

Well, I mean, obviously, the timing of price increases is a major factor and what happened this year was that, as I'm sure you know, the price increase, the first price increase of the year was in the first quarter as opposed to the second quarter. So you have an adjustment in terms of when product is bought in from wholesalers and that affects the whole calculation, which is why I always emphasize that it's best to track the retail numbers not the wholesale numbers.

Okay. And then a question for Bryant, if you could provide the secured leverage at the restricted group, do you have that figure?

Yes. Let me just give you leverage on both the gross and a net basis. On a gross basis, the total leverage is 8.5x. On a net basis, the total leverage is 2.6x. On a gross basis, the secured leverage is 3.2x and on a net basis it's 1.1x, unsecured.

Those are all the questions that we have for today. I would now like to turn the conference back over to Howard Norbert.

I'd like to thank everyone for participating in this call and as always B.K., Ron and myself are available if anyone has any further questions. Thank you very much and everyone, please enjoy your weekend. Bye.