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Vector Group Ltd. (NYSE:VGR)

Q1 2014 Earnings Conference Call

May 13, 2014, 09:00 AM ET

Executives

Howard M. Lorber - President and CEO

Ronald J. Bernstein - President and CEO of Liggett Group LLC and Liggett Vector Brands LLC

J. Bryant Kirkland III - VP, CFO and Treasurer

Analysts

Ken Bann - Jefferies

Mitch Pindus - Wells Fargo

Operator

Hello and welcome to Vector Group Ltd's First Quarter 2014 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 to pro-forma adjusted revenues, pro-forma adjusted operating income, pro-forma adjusted net income, pro-forma adjusted EBITDA and adjusted tobacco 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.

I would now like to turn the call over to President and Chief Executive Officer of Vector Group, Howard Lorber. You may begin.

Howard M. Lorber

Good morning. Thank you for joining us for Vector Group's first quarter 2014 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 ended March 31, 2014. Ron will then address Liggett's performance for this period and provide an update on company and industry developments. After that, we will be available to answer your questions.

Turning to our business performance. We are pleased with the early performance of both our tobacco and real estate operations in 2014 and our balance sheet remains strong. As previously noted, in the fourth quarter of 2013, through New Valley, we completed the purchase of an additional 20% interest in Douglas Elliman that was once owned by Prudential, establishing Vector Group's 70% ownership interest. Consequently, the company now consolidated the operations and financial position of Douglas Elliman in its financial statements.

For the first quarter of 2014, Douglas Elliman had approximately 107.5 million in pro-forma adjusted revenues and generated pro-forma adjusted EBITDA of 7.4 million compared to pro-forma adjusted revenues of 78.2 million and pro-forma adjusted EBITDA of 681,000 in the 2013 period.

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 Florida, Southern California and other regions of the country to increase market share.

Douglas Elliman is widely considered the market leader in the lucrative New York City metropolitan area in addition to its position as the fourth largest residential real estate brokerage company in the United States and we are excited to have acquired the incremental equity interest.

This acquisition strengthens our presence in the New York City real estate market where we are partners in 10 current developments. There continues to be strong demand for residential real estate 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.

The company recently completed two senior note offerings raising approximately $400 million in March and April 2014 for general corporate purposes. There was strong demand for the notes and we are pleased with the success of the offerings.

Furthermore, we continue to have significant liquidity with cash and cash equivalents of 381.5 million, which included approximately 69 million of cash at Douglas Elliman and investment securities and partnership interest with a fair market value of 220.4 million as of March 31, 2014.

I will now review the key financials for the three months ended March 31, 2014 for Vector Group. Vector Group's first quarter pro-forma adjusted revenues were 348.9 million compared to 320.7 million. The increase was primarily due to an increase of 29.4 million of revenues from Douglas Elliman.

The company recorded pro-forma adjusted operating income of 47.6 million in the 2014 first quarter compared to 37.4 million in the 2013 period. First quarter 2014 pro-forma adjusted net income was 14.6 million or $0.15 per diluted share compared to 11.1 million or $0.12 per diluted share in 2013. For the first quarter of 2014, pro-forma adjusted EBITDA attributed to the company was 50.9 million compared to 41.3 million for the year ago period.

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

Ronald J. Bernstein

Thanks, Howard, and good morning, everyone. As Howard indicated, we are pleased with the performance of our tobacco business through the first quarter of 2014. Despite continued aggressive discount pricing nationwide and poor weather conditions in January and February that disrupted wholesale shipments and retail sales, we were able to increase first quarter adjusted operating income by 6.8% while holding our retail share essentially flat.

Additionally, in February 2014, Liggett funded the initial payment of approximately $60 million for the global settlement of the Engle progeny cases. The remaining payments are approximately $3.5 million per year for 14 years. This settlement resolved all but approximately 350 state court cases. While we're pleased with this outcome and continued to work to resolve the remaining cases, we note that we might still be subject to periodic adverse verdicts.

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 ended March 31, 2014, Liggett revenues were 233.4 million compared to 240.4 million in the corresponding period in 2013.

Tobacco adjusted operating income for the three months ended March 31, 2014 was 44.4 million compared to 41.6 million in 2013. The 6.8% increase in year-over-year first quarter earnings was primarily the result of higher margins from price increases and effective cost and expense controls, partially offset by lower volumes.

While we remain focused on brand strength and long-term profit growth, we also continued to evaluate opportunities that are designed to pursue incremental volume and margin. Margin growth has been our primary focus due to market conditions in recent years and we introduced our Eagle 20s brand in early 2013 with a goal of providing a long-term complement to PYRAMID, the third largest U.S. discount brand and sixth largest overall brand and to offset declines in our non-focus brands.

Our strategy has been to build Eagle 20s in a methodical way to ensure its long-term positioning while minimizing declines on PYRAMID. To that end we've been successful. Our Eagle 20s brand is now available in over 40,000 stores nationwide with only modest impact to PYRAMID.

The price point of Eagle 20s in the market is both competitive and sustainable. As a result, we believe the brand is well positioned to build on its performance going forward. There continues to be a variety of growth opportunities for both PYRAMID and Eagle 20s and we have implemented several targeted programs that feature an aggressive tactically-oriented approach to marketplace discounting.

Despite marketplace challenges that I'll discuss in a moment, we're generally pleased with the early results of these programs. While PYRAMID, Eagle 20s and our other conventional cigarettes will clearly remain our primary focus long term, in January we announced the national rollout of our ZOOM e-cigarette brand. We are pleased to have entered into this emerging category which currently represents an estimated $1.5 billion industry in the United States.

As previously noted, while we recognized the potential of the e-cigarette and vapor category, we enter it cautiously as there are many unknown factors including long-term consumer acceptance, taxation and the impact of FDA regulation. I'll comment on the recently proposed FDA regulations in a moment.

With that in mind, we developed ZOOM, a superior disposable e-cigarette together with Germany-based XEO, a company that has significant technical experience in the e-cigarette category. This approach enables 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 and features our proprietary e-liquid that was developed under the guidance of Liggett's tobacco experts and is made in the USA. We have drawn on our own industry expertise, German precision engineering, quality U.S. e-liquids and Chinese manufacturing to create what we believe is the best disposable e-cigarette available today.

Following our launch in January, the brand is currently being sold nationally at stores such as Walmart and Dollar General along with a number of large regional chains. We have already received commitments from customers with over 30,000 retail locations nationwide and we're pleased with the early market acceptance and performance of ZOOM.

We'll discuss ZOOM further in future conference calls, however, if you'd like to know more about ZOOM today you can go to our website at www.zoomecigs.com for information. We believe ZOOM is a best-in-class superior product and if this category continues to grow, we're confident that ZOOM is positioned for future success.

Turning back to conventional cigarettes. In the past we have explained that retail shipments are a better indicator of market activity than wholesale shipments due to individual company shipping anomalies that sometimes occur at the end of quarters and particularly at the end of fiscal years. That pattern was evident with first quarter shipments where according to Management Science Associates data, wholesale shipments declined 2.75% while retail shipments declined by 4.2%.

We believe that first quarter wholesale shipment comparisons were overstated for two primary reasons. First, they do not fully reflect the negative impact of winter storm weather on consumer purchasing at retail. And second, a substantial wholesale de-load of one company last year created a favorable year-over-year comparison in their wholesale numbers which positively impacted wholesale trends for the industry. As a result, we will continue to focus on the more reliable retail shipment data.

The market trends of the past few years continued into the first quarter of 2014. Low price products such as mislabel type tobacco and filtered cigars that have been evading and avoiding excise tax payment remain a force in the market with combined market share over 8%. We continue to see aggressive pricing from certain foreign competitors in an attempt to capture market share, in particular KT&G, the Korean tobacco company has been selling a brand in the U.S. for almost four years at a level that is substantially below its cost and it appears that their sustained losses are supported by profits generated by their Korean and other international sales.

Based on a preliminary review, it appears that KT&G may well be in violation of U.S. antidumping laws. The failure of Congress and regulators, particularly FDA and TTB, that act to address violations of existing regulations and laws has resulted in the loss of substantial tax revenues, inadequate consumer controls and a competitive free-for-all in the market.

The long-awaited deeming regulation intended to address many of these longstanding issues was finally released on April 24 and while it does propose to put e-cigarette, pipe tobacco and filtered cigars, possibly premium cigars under FDA jurisdiction, it appears that final approval and implementation of the regulation could take years. In fact the early reaction by key legislators was disappointment and frustration with the inadequacy of the FDA action. Hopefully that reaction will spur Congress to act aggressively to legislate a fix to these issues. We will continue to monitor the situation closely and contribute to an effective resolution where possible.

Both FDA and TTB have existing enforcement authority to properly regulate mislabeled pipe tobacco in particular and we remain hopeful that they will exercise that authority. The FDA did recently send warning letters to several companies that it believes our marketing roll-your-own tobacco as pipe tobacco to evade taxes and in addition a number of states have taken legislative or regulatory actions to address aspects of the mislabeled pipe tobacco problem. We hope that trend accelerates going forward.

Regardless of these market pressures, the performance of our PYRAMID brand has remained strong as we continue to build on our well established national presence. PYRAMID is currently sold in approximately 115,000 stores, a substantial national distribution base. As mentioned earlier, according to Management Science Associates, for the first quarter of 2014 overall industry retail shipments were down 4.2% with the top five companies down between 2% and 13%. For the period, Liggett retail shipments were down 5.9%. Liggett's retail market share remains essentially flat at 3.5% compared to both the fourth quarter and the prior year period. We remain the fourth largest cigarette manufacturer in the United States.

Industry taxable shipments declined by approximately 4.5% in 2013 and we estimate that 2014 declines will be in the 3.5% to 4.5% range. As we move forward in 2014, we will continue to implement our plan to build profitable growth with our PYRAMID and Eagle 20s brands while expanding ZOOM distribution nationally. At the same time, we will work to ensure that costs are controlled effectively to maximize profits. We're very pleased with our earnings performance in the first quarter of 2014 as well as our market position. We have programs in place to support our volume base going forward and look forward to building upon our longstanding successful performance.

Thanks for your attention and back to you, Howard.

Howard M. Lorber

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 consistently growing our profit margins in recent 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

Thank you very much. (Operator Instructions). Our first question will come from Ken Bann, Jefferies and Company.

Ken Bann - Jefferies

Good morning, Howard and Ron. With the increase in cash that you've raised over the last couple of months, will you be accelerating at all your investments in real estate with that additional cash that you have and do you see the big opportunities out there in the real estate sector?

Howard M. Lorber

I think that there are still some good opportunities. Obviously, New York City is getting a little bit tougher. Things are pricier but the demand is still there from domestic and international buyers, so we do plan on extending – maybe not doing so many more projects but taking bigger equity pieces of some projects we're looking at now. But yes, we do continue to believe that there are opportunities in the same markets that are residential business and which is primarily New York, South Florida and now in California and LA.

Ken Bann - Jefferies

Okay. And then just a run on the cigarette side, your market share has been flat even though you've been raising prices. Is it your goal to keep market share at that level or will you still consider – maybe you might want to be willing to lose market share in order to be able to raise price and margin?

Ronald J. Bernstein

Ken, we always seek to balance on that and obviously our primary goal is to continue to increase earnings, but we're cognizant of the fact that long term our volume base is really important. So, as I said in my comments, we have implemented a number of programs that are oriented to tactically approach volume growth in the marketplace. Certainly at a minimum, we're seeking to maintain our share. We're always looking for opportunities to grow our share but we also are looking to do it in a way where we're not going to cost ourselves undue amounts to do that. So, we feel very comfortable about what our position is right now and our objective is to continue to build our profit base and to maximize our share as much as we can.

Ken Bann - Jefferies

And in e-cigarettes you mentioned that your biggest retail outlets are Walmart and Dollar General, are you making progress in getting the e-cigarettes into the c-stores and the gas stations?

Ronald J. Bernstein

Yes, we have already agreements with Speedway SuperAmerica, with Sheetz, with Kwik Trip and others that are smaller regional pipe chains. But yes, we're getting very good acceptance both relative to the quality of the product and the value because our product typically offers a lot more puffs than the competitive products do, so that the taste characteristics and the value characteristics are very appealing to chains and we've had success pretty much everywhere we've gone with them.

Ken Bann - Jefferies

Okay, great. All right, thanks a lot.

Operator

Thank you very much. Our next question will come from Mitch Pindus Wells Fargo Private Bank.

Mitch Pindus - Wells Fargo

Good morning, gentlemen.

Howard M. Lorber

Hi, Mitch.

Mitch Pindus - Wells Fargo

Hi. So a couple of questions. I think that some of them were just answered, but looking at the e-cig pricing, where do you price now versus competitors? Is the idea, Ron, to price it the same as the others but give you more puffs or is it still cheaper and more puffs?

Ronald J. Bernstein

Mitch, that's something that's going to evolve over time and not to get too much into what our long-term strategy is, but we believe that value is going to be a critical element to the marketplace as it develops. So as we do with our cigarettes, we're going to seek to provide the best value proposition in e-cigarettes and that's a combination of taste and puffs and price. So we expect to be competitively priced. We're obviously in a growth mode right now and pricing ranges are very tight as you probably know in the marketplace. That's not a problem for us right now because of the value aspects of our product. So we're going to look at this from the standpoint of trying to maximize the distribution base over the course of the next couple of years and then adapt a pricing strategy that will provide us with the best long-term returns.

Mitch Pindus - Wells Fargo

Okay. Thank you. Staying on tobacco for a second, I'm showing your current payment due under the MSA of 49,000,919 but last quarter they were 25,000,348 and I'm just wondering how that reconciles given that volumes were down?

J. Bryant Kirkland III

Mitch, this is Bryant. Mitch, that's the accrual for the first quarter MSA. We don't make the fourth quarter 2013 payment until April of 2014, so it would have been due still at March 31.

Mitch Pindus - Wells Fargo

I see. Okay, that makes sense. Really, I guess that's it from me. Thank you.

Operator

Thank you very much. Well, at this time we have no further questions. I would like to turn this conference back over to Howard Lorber.

Howard M. Lorber

Thank you, everyone, for participating in this call and as always Ron, B.K. or myself are available for any questions you may have, just call any of us. Thank you and we'll speak to everyone in the next quarter. Have a good day.

Operator

Thank you very much. Ladies and gentlemen, this conference is now concluded. You may disconnect your phone lines and have a great rest of the week. Thank you.

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