Vector Group Management Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 1.13 | About: Vector Group (VGR)

Vector Group (NYSE:VGR)

Q2 2013 Earnings Call

August 01, 2013 11:00 am ET

Executives

Howard M. Lorber - Chief Executive Officer, President, Director and Member of Executive Committee

Ronald J. Bernstein - Director, Chief Executive Officer of Liggett Group LLC, Chief Executive Officer of Liggett Vector Brands, President of Liggett Group LLC, President of Liggett Vector Brands and Director of VGR Holding

J. Bryant Kirkland - Chief Financial Officer, Principal Accounting Officer, Vice President and Treasurer

Analysts

Kenneth P. Bann - Jefferies LLC, Fixed Income Research

Anton Kawalsky

Christian Hoffmann

Operator

Welcome to Vector Group's Second Quarter 2013 Earnings Conference Call.

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 the President and Chief Executive Officer of Vector Group, Howard Lorber.

Howard M. 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 6 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 always 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 continue 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 remains strong. We'll 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 4,300 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, our 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, a case were Liggett is a 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 as 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 investments, 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, in promising real estate development projects primarily focused in the New York City area. There continues to be strong demand for the multi-family, residential and lodging assets in this city and we've 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 Street, 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 3 and 6 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 million -- 8.1%, primarily due to improved margins and the settlement of the long-standing dispute related to the Master 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 -- tax noncash charge of $8.5 million related to amortization of debt discount on 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 discount on our convertible debt. Adjusting for 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 to net income and adjusted EBITDA are contained in the company's earnings release.

For the 6 months ended June 30, 2013, Vector Group revenues were $489.5 million, compared to $534 million in the 2012 6-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 6-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 the 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 noncash charges of $15.8 million related to amortization of debt discount 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 for these items, year-to-date 2013 adjusted net income was $27.4 million or $0.31 per diluted share.

The 6-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 noncash interest expense of $3.8 million related to the amortization of debt discount on our convertible debt. Adjusting for these items, year-to-date 2012 adjusted net income was $22.4 million or $0.26 per diluted share.

For the 6 months ended June 30, 2013, adjusted EBITDA was $86.9 million, compared to $81.3 million for the 6 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?

Ronald J. Bernstein

Thanks, Howard, and good morning.

As Howard indicated, given the challenging dynamics of the industry, we're pleased with the second quarter and first half 2013 performance of our Tobacco business. We're 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, 2 additional states joined the settlement. This was a favorable development for us. We've 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 non-settling states filed suit in their home jurisdictions to attempt to vacate the settlement, they have been unsuccessful to date.

The settlement resulted in $5.6 million, first quarter, and $1.3 million, second quarter increases in pretax income for Liggett and Vector Tobacco. Excluding the income from 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 3 and 6 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 3 and 6 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 NPM 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 brand strength and long-term profit growth.

Over the past 2 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 20s.

Part of the strategic role of Eagle 20s is to stabilize our overall volume trends by offsetting losses in our non-core brands, as well as to develop a second brand that is complementary to PYRAMID. Eagle 20s is continuing its good start and is clearly benefiting from the robust distribution base we have built with PYRAMID over almost 4 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 undertaxed 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've 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 undertaxed 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 helpful that FDA and TTB will 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 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 3 companies now comprise a majority, over 50% of the 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 increase 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 20s and control cost. We remain confident in our market position and in our ability to continue to perform.

Thanks for your attention and back to you, Howard.

Howard M. Lorber

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 our market share and volumes over the past 3 years, and we'll 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?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Ken Bann from Jefferies.

Kenneth P. Bann - Jefferies LLC, Fixed Income Research

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? And if it comes to that, what impact it might have?

Ronald J. Bernstein

Yes. In essence, I'll 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 effect 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 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.

Kenneth P. Bann - Jefferies LLC, Fixed Income Research

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

Ronald J. Bernstein

Yes, about 25%, 26%.

Kenneth P. Bann - Jefferies LLC, Fixed Income Research

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

Ronald J. Bernstein

Yes, that is correct. There was a fairly broad -- most companies increase prices in the June time frame.

Kenneth P. Bann - Jefferies LLC, Fixed Income Research

Okay. Have you seen any further impact on volumes? Or if everybody else is -- was it similar to what everybody else took? And is it therefore not impacting your volumes?

Ronald J. Bernstein

No. In fact, in general, the industry had a very strong year-over-year performance in July and we had the same type of trends. So actually, volume strengthened in July.

Kenneth P. Bann - Jefferies LLC, Fixed Income Research

Okay, okay. Great. And do you care to comment on how big the Eagle 2s brand is at this point? You said it's in 23,000 stores. But can you tell me at all on how big it is in terms of volume?

Ronald J. Bernstein

At this point, we're looking at building the distribution footprint and we'll talk more on volume as things develop. But we're very pleased with the way that it's moving directionally.

Kenneth P. Bann - Jefferies LLC, Fixed Income Research

Okay. And then the increase in investment securities in the quarter, could you comment on what they're invested in? What the money was invested in?

Howard M. Lorber

B.K.?

J. Bryant Kirkland

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

Kenneth P. Bann - Jefferies LLC, Fixed Income Research

Right. And these are investment-grade? Corporate, you said?

J. Bryant Kirkland

Yes, they are all investment-grade corporates. [indiscernible], excuse me.

Kenneth P. Bann - Jefferies LLC, Fixed Income Research

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

Howard M. Lorber

Well, if I could tell you, 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's always -- from us. But there's always a possibility.

Kenneth P. Bann - Jefferies LLC, Fixed Income Research

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

Howard M. Lorber

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

Operator

Our next question comes from Anton Kawalsky with Canyon Capital.

Anton Kawalsky

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

Ronald J. Bernstein

Yes, market share is in 3.5%, 5% range overall.

Anton Kawalsky

It's down slightly...

Ronald J. Bernstein

Yes, from 3.6%.

Operator

Our next question comes from Christian Hoffmann with Thornburg Investment Management.

Christian Hoffmann

Could you remind me of your dividend policy?

Howard M. Lorber

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.

Christian Hoffmann

But is it based on cash flow or earnings? I was just wondering how you -- kind of the board thinks about that?

J. Bryant Kirkland

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

Christian Hoffmann

Okay. Can you also remind me about the Florida cases? I know you mentioned that you're 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 can be pretty uncertain but just what you're thinking about? Then also, kind of the range of outcomes?

Howard M. Lorber

Ron?

Ronald J. Bernstein

Yes, basically, the question relative to the Supreme Court is whether or not they take the case. And that's something that's 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'll take it or what the outcome might be if they did take it. So we basically are -- 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's going and are hopeful, at some point, that legal sense will be made and it will be brought to an end.

Operator

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

Howard M. Lorber

I'd like to thank everyone for being on this call. And as usual, Ron, B.K. and myself are available for any questions you may have, and we look forward to speaking to everyone on the next quarter call. Have a nice day.

Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.

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