Vector Group Ltd (VGR) 2017 Q3 法說會逐字稿

Welcome to Vector Group Limited Third Quarter 2017 Earnings Conference Call. During this call, the terms adjusted operator 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 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 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'd like to turn the call over to President and Chief Executive Officer of Vector Group, Howard Lorber. Sir, please begin.

Good morning, and thank you for joining us for Vector Group's Third 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 Chief Financial Officer.

I will provide an update on our business and review Vector Group's performance for the 3 and 9 months ended September 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 businesses have performed well so far this year and we are pleased with our third quarter results. As noted during previous calls, we anticipated 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 9 months of the year. Ron will provide more detail on Liggett's performance shortly, but we continue to believe we are well positioned in the discount segment of the market.

For the 3 and 9 months ended September 30, 2017, Douglas Elliman had approximately $190.4 million and $544.6 million in revenues and adjusted EBITDA of $3.8 million and $23.8 million, respectively. This compared to revenues of $184.5 million and $523.8 million and adjusted EBITDA of $13.3 million and $37.2 million in the comparable 2016 3- and 9-month periods.

We continue to believe Altria 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 maintained significant liquidity with cash and cash equivalents of approximately $397 million, including approximately $101 million of cash at Douglas Elliman and $88 million cash at Liggett. We also had investment securities and partnership interest with a fair market value of approximately $296 million as of September 30, 2017.

I will now review our key financials for the 3 and 9 months ended September 30, 2017. For the 3 months ended September 30, 2017, Vector Group's third quarter 2017 revenues were $484.6 million compared to $459.1 million in the 2016 period. The company recorded adjusted operating income of $59.4 million in the third quarter compared to $71.1 million in the 2016 period. Third quarter 2017 adjusted net income was $22.1 million or $0.16 per diluted share compared to $24.3 million or $0.18 per diluted share in the 2016 period.

Third quarter 2017 adjusted EBITDA was $64.9 million compared to $75.1 million for the year ago. For the 9 months ended September 30, 2017, Vector Group's revenues were $1.37 billion for the 9 months compared to $1.28 billion in the 2016 period. The company recorded adjusted operating income of $187.7 million in the 9 months ended September 30, 2017 compared to $207.9 million in the 2016 period. Adjusted net income for the 9 months ended June 30, 2017, was $73.3 million or $0.52 per diluted share compared to $67.1 million or $0.50 per diluted share in 2016. For the 9 months ended September 30, 2017, adjusted EBITDA was $202.5 million compared to $219.8 million for the year ago period.

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

Thanks, Howard, and good morning, everyone. As Howard mentioned, in 2017 our plan has been to pursue growth in our cigarette volumes and we could not be more pleased with our results through the first 9 months of the year. As noted on 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 beginning in 2016. Those adjustments proved successful as we increased Tobacco segment earnings last year and laid the groundwork for 2017 (inaudible). 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 80 Engle progeny cases have been resolved by Liggett. Despite that, 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 and 9 months ended September 30, 2017, Liggett revenues were $294.2 million and $823.9 million respectively, compared to $274.2 million and $750.7 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 9 months ended September 30, 2017, was $64 million and $189 million, respectively, compared to $66.6 million and $196.5 million for the corresponding periods in 2016. The decrease in tobacco adjusted operating income during the third quarter is primarily the result of our investment in and the growth of our Eagle 20s brand. Year-to-date decreases are the result of our investment in Eagle 20s and in Q1 2016 MSA cost revision, that resulted in $5 million of income in the first quarter of 2016. Excluding the 2016 MSA cost revision, 2017 tobacco adjusted operating income for the 9-month period would've been lower by approximately $2.5 million compared to the corresponding 2016 period, despite our substantial investment in Eagle 20s.

Our selling efforts over the past several years have been focused on 2 core brands: Eagle 20s, now the third largest and fastest growing U.S. discount brand and PYRAMID, the fifth largest U.S. discount brand. Recent results clearly confirm 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 have built Eagle 20s in a disciplined manner and are very pleased with our success. Eagle 20s is now available in approximately 64,000 stores nationwide. We continue to maintain a competitive price point for Eagle 20s and believe the brand remains 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 third quarter of 2017, we have seen industry volume declines return to historical norms and believe the decline rate is now in the range of 4% a 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 discounted line 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 little effect on the discount 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 brands, which has proven beneficial to us. However, over time targeted deep discount brands continue to emerge in various geographies, as smaller competitors search for growth opportunities. 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 thus far of government intervention. 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, Liggett's wholesale shipments increased by 9.7% on a year-over-year basis. While overall, third quarter industry wholesale shipments were down 3.3%. 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 third quarter, Liggett's year-over-year retail shipments increased 5.8% compared to a 2.9% decline across the industry. This growth rate is consistent with recent quarters and we were once again the only nationally-focused major cigarette manufacturer to register an increase in shipments during the quarter. Liggett's third quarter retail market share increased by 32 basis points compared to the prior year period and now represents more than 3.9% of the total market. We are extremely pleased with our performance to date and as we look ahead, plan to continue to focus on generating operating 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 our 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 generate 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 are pleased with the prospects for our growing real estate business. We are 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 comes from Ian Zaffino from Oppenheimer.

This is Mark on for Ian. I just wanted to quickly ask on a couple of your key businesses policy. So for tobacco, either, I guess any additional investments on Eagle 20s going forward that we'll -- that we could - we'll see a material impact for balance of 2017 as well as 2018? I guess we'll just start with that one.

Yes, we are in the process of investing for volume growth. As I've pointed out over the years, we look at the marketplace and make determinations all the time as to whether the market is conducive for volume growth or margin growth. Sometimes they happen at the same time, sometimes they don't. Right now, we believe that we have a significant opportunity, which I think is borne out by the significant increase in our volume and our share over the course of the last year and a half. So at this point, we are continuing to invest and will continue to evaluate the market and determine when it's a good opportunity for us to -- or when we can change course or should change course. So at this point, we feel very comfortable with where we are and are pleased with the volume growth and expect it to continue.

Okay, guys, so maybe continue the investments going forward. Okay, great. And then, are there any other, I guess, material impact on the tobacco margins going forward, besides the investments on Eagle 20s?

I mean, obviously, there's nothing that I'm anticipating, but we -- our base is very stable. Our earnings base is very stable. And when you look at where we are relative to the investment we've made, we've invested far more than the marginal decline in income reflects.

Got it, got it, perfect. And then, I guess another one, are you guys -- what's your view on the potential impact of the house bill on tax reforms going forward?

Well to your -- go ahead, Howard.

Yes, from the real estate side or the tobacco side?

Yes, yes. Yes, more on the real estate but potential tobacco as well.

Well on the real estate side, we really don't know yet because we don't know what the final bill is going to look like. Obviously, people are concerned about the loss of the deductions of state income taxes and real estate taxes to a large degree. But obviously, if the economy -- if it gets the economy going, it may have a little bit of a lapse or a slow down for a short period of time. But as the economy goes -- I mean, ultimately people are going to feel better. The economy is going to go better, it's going to grow quicker. And chances are the housing market's going to do pretty well. I guess the states, obviously, that hurt the most of a high-tax states to begin with, which is basically New York, Florida, New Jersey, I guess. So hard to say because we don't know the final form at this particular point.

And Rick, relative to tobacco, I think there's no tobacco tax change that's anticipated. And frankly, the biggest indicator we see that affects the cigarette market are oil prices rather than income taxes.

Yes. And relative to the corporation, the bottom line is we think the tax bill will have a limited effect. We would lose some deductions primarily, some of our interest expense, but we will also pay tax at a lower rate. When we looked at 2016 tax liability, we would have paid about -- we will pay about $2 million less a year under this bill.

Got you, got you. Great. Thank you. And just a couple of quick, I guess, housekeeping. So the real estate, I guess, our performance was, I guess, more impacted on -- during the quarter was impacted on marketing and opening expenses, I'm guessing?

No, there wasn't too much on that. It was some of the high-margin business, the new development, there were more closings in '16 than '17, quite a bit more. It's a higher-margin business for us. And you know that business, obviously, like real estate in general is somewhat cyclical. But the business remained strong. We -- very low-end is very strong, the middle is sort of little quiet and the very high end is pretty strong. So that's how we see it and that's why our volume was up.

Okay, got it. And then, finally, just a quick one on the diluted share count for the quarter, as Bryant has it?

Just a minute.

Sure.

Diluted is 130.7 million, I believe, but let me check. 132.8 million.

Our next question comes from Brian Hunt of Wells Fargo.

It's Dave Cook on for Brian. Let me first touch on menthol cigarettes. There's been couple of headlines out there about restrictions around menthol cigarettes, where they're going to be sold. Just curious if you've disclosed what percentage of your stick volumes are menthol cigarettes?

I'm not sure if we disclosed it or not, but it's about the same as the general marketplace, which is between 25% and 30%.

Okay. And it seems like a bunch of the industry themes you touched on were fairly consistent with prior periods. Has there been any change in promotional activity or in your competitive behavior in the industry? I guess, especially given the BAT Reynolds acquisition?

No, I'm -- the BAT acquisition of Reynolds really hasn't changed anything, as I'm sure you know. They already had owned 42% of Reynolds, and I'm sure we're intimately involved with everything that was going on. I think that the -- I think it's more of a global issue than a domestic one for BAT. No, generally speaking, the market trends are what they've been. There are always adjustments that occur during the course of the quarter or year. And we're constantly making adjustments to compensate for anything that changes so. But generally speaking, the market trends have been pretty consistent over the last couple of years since the mergers.

Got you. And then on the mid-single digit retail shipment growth, how should we think about breaking that out between increased velocity versus distribution gains?

Well, it's both. And Eagle 20s is building up a very substantial base. As you'll note from the numbers, it's sold in a lot less stores than PYRAMID is. But the velocity in those stores is much stronger. And we're continuing to see both gains in distribution as well as in velocity.

Our next question comes from Karru Martinson of Jeffries.

When you guys talked about maintaining a competitive price point for the Eagle 20s versus the discount, what's the gap between your product and your competitors?

Well, number one, I'm not going to get into the specifics of the gaps because we manage that very carefully, and it's also managed market by market, sometimes store by store. We are -- our objective with Eagle is to provide the best value proposition we can in each marketplace. And so we've positioned the brand where we believe it'll be most competitive. As noted, we're investing in the growth of Eagle 20s. We have kept it at a competitive price point, either at par or below with other brands that we are targeting. So where it's -- it varies across and I really don't want to get into the specifics of what we target.

Understood. And when you look at the big players who have that kind of premium economy, why haven't they kind of accepted the -- or gone after the discount market channel? Why have they kind of tried to keep above that?

Because the biggest damage they would do would be to themselves. If you look, just to use Marlboro as an example, if Marlboro Special Blend, which is permanently discounted at about $7 a carton less than base Marlboro, represents now 25% of Marlboro sales, or at least the last time I noticed. And that represents 10% of the market. They would much rather see their smokers trade down to a lower price Marlboro than to take them down further because the margin loss they would take by going down into the deep discount segment would destroy their profit base. And it just doesn't make any sense. So their strategy, I mean, I think is a good strategy for them. It's fortunately a strategy that's not having a big impact on us.

Okay. And then, when we look at just the real estate side, certainly parts of the market feeling a little bit of softness in the middle there. Should we kind of expect the real estate trends here to kind of continue at this level going forward? Or how should we think about the real estate side of the business?

I -- look, I think the real estate, obviously, like many other industries, is somewhat cyclical. But I think we're in a pretty good place. We have a substantial company with big market shares in most of the markets we're in. We think that our growth will continue. We want to watch our expenses, obviously, that's important. So we try to trim them where we can. New development is probably a little bit more cyclical than the regular resale business. But -- so there's not a lot of maybe new projects right now that are still on the drawing boards, but we have a big backlog of potential new products. And we also pick up projects from other companies that haven't been able to sell them for whatever reason. We probably pick up 5 or 6 in the last 6 months of projects on the market being built where the sales was slow and we took them over. So I think that, all in all, it's a solid business. Having said that, we're in the best markets, probably, in the country. Although couple of those markets may get hurt because of the tax bill to pass as it is. But we're pretty diversified, and we have a low-end business, middle-end business and a high-end business. So we're pretty diversified. So we should be okay.

Those are all the questions we have for today. Thank you for joining us on Vector Group's earnings conference call. That will conclude our call. Thank you for your participation. You may now disconnect.

Thank you, everyone.