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Vector Group Ltd. (NYSE:VGR)

F1Q08 Earnings Call

May 13, 2008 11:00 am ET

Executives

Howard M. Lorber – President, Chief Executive Officer & Director

J. Bryant Kirkland, III – Chief Financial Officer, Vice President & Treasurer

Ronald J. Bernstein – President & Chief Executive Officer of Liggett; Director

Analysts

Joel Luton - APS Financial Corporation

[Ken Ban] - Jeffries & Co.

Operator

Welcome to Vector Group's first quarter 2008 earnings conference call. Before the call begins I'd like to read a Safe Harbor statement. The statements made during this conference call which 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 & Exchange Commission filings.

Now I'd like to turn the call over to President & Chief Executive Officer of Vector Group, Howard Lorber.

Howard M. Lorber

Thank you everyone for joining us on Vector Group's first quarter 2008 earnings conference call. With me today is Ron Bernstein, President & CEO of Liggett Vector Brands and Liggett, and Bryant Kirkland, Vector's Chief Financial Officer. On today's call I will provide an overview of our business and review Vector Group's financials for the first quarter of 2008. Ron will then review the performance of Liggett Group and Vector Tobacco for the quarter, discuss recent industry developments, and provide you with an update on the competitive environment. After that we will take your questions.

Let me start by saying that I am pleased to report that our conventional tobacco business continued its trend of earnings growth during the first quarter of 2008. As many of you are aware, the big three manufacturers experienced year-over-year declines in operating income during the first quarter, so we are particularly pleased with the 5.3% operating income growth generated by Liggett during the three-month period. However, the first quarter profit performance of the big three indicate the cigarette industry continues to face many challenges. While we continue to perform well and I'm confident in our commercial strategy, we're certainly not immune from the risks of the marketplace. Ron will discuss these matters in detail shortly following my review of Vector Group's financial results.

I am pleased to note that in March 2008 New Valley closed the sale of its 50% owned interest in the St. Regis Hotel. In connection with the closing, New Valley received approximately $15.8 million and expects to receive an additional $1.4 million by the end of the third quarter of 2008. In addition to retaining a 3% interest in the hotel, New Valley anticipates receiving another $5 million in connection with the sale of tax credits from 2009 to 2013. Despite a challenging real estate market, New Valley's net IRR on the transaction is approximately 30%. In the first quarter New Valley purchased a loan secured by a substantial portion of a 450-acre approved master planned community in Palm Springs, California known as Escena, which we view as an opportunistic investment. The loan which is currently in foreclosure was purchased for approximately $21,400,000. The project consists of 867 residential lots with site and public infrastructure, an 18-hole Nicklaus designed golf course, a substantially completed clubhouse, and a 450-room hotel site on seven acres of land.

Before discussing the financial results for the quarter and the year, I would also like to note that our liquidity remains strong with cash and cash equivalents of approximately $218.8 million as of March 31, 2008. In addition, as of March 31, 2008 we held investment securities and partnership interests with a fair market value of approximately $142 million.

Now let's turn to the key financials for the three months ending March 31, 2008 for Vector Group. Our financial results for the first quarter 2008 include approximately $12 million of income from our interest in St. Regis Hotel, Washington, DC. Our financial results for the first quarter of 2007 included approximately $19.6 million of income as a result of a settlement between New Valley and the US Government where we saw damages from the Government for failure to launch one of Western Union's satellites. For the first quarter ended March 31, 2008 Vector Group revenues were $132.2 million compared to $133.9 million in the 2007 first quarter. The Company recorded operating income of $28 million compared to operating income of $25.7 million in the 2007 first quarter. First quarter 2008 net income was $14.3 million or $0.22 per diluted share compared to a net income of $23.1 million or $0.35 per diluted share in the 2007 period. Excluding the income from the St. Regis in 2008 and the lawsuit settlement with the US Government in 2007, net income was $7.2 million in the first quarter of 2008 or $0.11 per diluted share compared to net income of $11.5 million or $0.18 per diluted share in the 2007 period. This decline reflects the increase in interest expense, non-cash charges related to the accounting for the Company's convertible securities, and a decline in equity income from the Douglas Elliman Real Estate business.

Now I will turn the call over to Ron Bernstein who will review the key financials for our Liggett and Vector Tobacco subsidiaries. Liggett's numbers reflect sales for both Liggett Group Cigarettes and conventional cigarette products from Vector Tobacco.

Ronald J. Bernstein

Good morning everybody. As Howard indicated we are pleased with our earnings performance for the first quarter of 2008. It's important to note that we were able to generate this earnings growth despite experiencing year-over-year shipment declines during the period. We believe this favorable performance in a tough market is a direct result of the long-term growth in pricing strategy that we implemented three years ago. As we anticipated during our year-end call the market leaders were negatively affected in the first quarter by the high cost of priced promotions associated with buy-some-get-some deals. It does not appear that they were able to offset the costs of these programs with meaningful shipment growth. As a result it appears at this point that the market leaders have curtailed some of the most aggressive and costly programs as they moved into the second quarter.

During the first quarter Liggett was able to offset the affect of shipment decline with increased margins on our Grand Prix and Partner brand products. Our expectation is that volume trends will improve during the second quarter and that margins should hold or improve as a result of the recent industry pricing actions. According to Management Science Associates overall industry wholesale shipments were down 3.3% for the first quarter of the year while Liggett wholesale shipments declined by 8.4%. This decline includes a 20% decrease in shipments of [Turney] to Speedway Super America which is in line with a mutually agreed revision to the [Turney] shipment schedule for 2008. At the same time industry retail shipments were down 3.8% for the quarter while Liggett's shipments declined by 5%. The retail shipment decline was caused by anticipated reductions in Liggett Select and non-core brands and lower first quarter growth rates on Grand Prix. However, I'm pleased to note that Grand Prix, while basically flat in terms of year-over-year wholesale shipments, continued to grow at retail at a fairly robust rate of 7.7% compared to the year ago period. Compared to the first quarter of 2007 Liggett Select retail shipments declined by 12.8% and wholesale shipments declined by 13.6%. Eve retail shipments declined by 3.1% while wholesale shipments increased by 2.2%. Both of these brands continue to produce margin at or above last year's level due to the effective implementation of our pricing strategy.

Turning now to the numbers. For the three months ended March 31, 2008 our conventional cigarettes generated revenue of $131.6 million compared to $132.8 million for the corresponding period in 2007.

Operating income for the three months ended March 31, 2008 was $37.3 million compared to $35.5 million for the corresponding 2007 period. For the three months ended March 31, 2008 Vector Tobacco's operating loss was $2.4 million compared to an operating loss of $2.3 million for the prior year period. Given the challenging competitive environment and substantial discounting activity we saw in the quarter, we are very pleased with our financial performance. As noted we believe based upon current observations that the market will be more orderly going forward and that recent industry pricing actions reflect that trend.

Also impacting the industry in recent years we have seen the emergence of new renegade type threats in the market particularly from the sellers of little cigars and roll-your-own cigarettes. Since 2003 these two categories have grown by the equivalent of approximately 5.8 billion cigarettes a 67% increase, while manufactured cigarettes have declined by approximately 2.5% to 3% annually over the same period. The reason for this growth is the extraordinary tax advantages enjoyed by little cigar and roll-your-own products. These tobacco categories pay approximately 10% of the federal excise tax rate paid by cigarette manufacturers and on average approximately 25% or less of the state excise tax rate paid by cigarette manufacturers. We've been working with the Congress, the public health community, and state authorities to equalize the tax rate on these products to that of manufactured cigarettes. As these companies grow it's becoming clear to all concerned that they enjoy an unfair advantage in the marketplace and are undermining the efforts of the Congress and state legislators.

To capitalize on the growing alternative tobacco market as discussed in our year-end call, we announced that we will be introducing Grand Prix Snus in the second quarter of 2008. Grand Prix Snus is a pouch tobacco product designed for adult smokers who are interested in smokeless tobacco alternatives to cigarettes as well as for existing adult users of other smokeless products. We've been watching the growth and the development of the US Snus category for the past two years and have concluded that there is a significant opportunity to introduce our own Snus product as part of the Grand Prix brand family. Grand Prix Snus is being introduced into a number of test markets this month including Portland, Kansas City, Indianapolis, Dallas-Fort Worth, Raleigh, Orlando and Columbus, Ohio. Grand Prix Snus which will initially be available in three flavor varieties, original, spearmint and wintergreen, is a premium quality Snus product manufactured in and imported from Sweden. As with Grand Prix cigarettes our market approach will be to offer adult Snus consumers a high-quality product at an affordable value price point.

In addition we're pleased to announce that we have started shipments of [Turney] Snus to our long-time market partner Speedway Super America. Speedway is launching [Turney] Snus into all of their 1,588 stores and is clearly making a major commitment to the brand. We're excited about this opportunity and believe the taste and value proposition provided by both [Turney] Snus and Grand Prix Snus will appeal to a wide range of adult consumers. We look forward to providing updates on the product launch next quarter.

On the litigation front, as expected pursuant to prior rulings in the now decertified Engle Class Action in Florida approximately 1,900 cases have been filed on behalf of approximately 8,150 individual claimants where Liggett, Vector or both were named as a defendant along with other cigarette manufacturers. As of today cases are still filtering through the system but we expect to have final numbers by the end of the month.

On the legislative front, federal legislation to fund the state children's health insurance program, which would have included a $6.10 per carton increase to the federal excise tax, is currently on hold. It appears unlikely that this legislation will go forward during 2008. Recently the US House of Representatives has revived consideration of legislation to grand the FDA Authority to regulate tobacco products. We understand that the schedule to vote on this legislation is no longer clear as various House committees have asserted jurisdiction. As a result it does not currently appear likely that the bill will become law this year.

In conclusion, I'd like to say that we are pleased with our first quarter 2008 results and continue to look for opportunities to build upon our recent performance. We will continue to watch the legislative and market developments closely and are prepared to address any changes that may occur.

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

Howard M. Lorber

Before I finish the prepared remarks, 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) Your first question comes from Joel Luton - APS Financial Corporation.

Joel Luton - APS Financial Corporation

The question I have is, you all did that high yield financing last August I guess and a pretty significant rate on that and you're sitting on a lot of cash here and I'm wondering what you are kind of thinking in terms of putting that cash to work and kind of the time table that you would put that cash to work and in what areas do you think that makes sense? I can't see you raising that money and just sitting on it and paying that stiff coupon.

Howard M. Lorber

Yes, you're right. We had a number of thoughts when we did it. Number one always was, raise it when you can raise it because when you need it you generally can't raise it and I think in retrospect it was probably a good idea because we do have things as deferred taxes on the Philip Morris brand transaction coming up and some other substantial cash outlays. But in the interim we really wanted to be opportunistic and I think this piece of property, this mortgage we bought in Palm Springs is one of those things, we've made some other investments, we are looking at a number of things, there's some potential acquisitions on the real estate side and the real estate brokerage side to expand a little bit geographically, and then there's always the opportunity at the right time and at the right price to buy back some of these older converts. So I think that it was a good move and I think looking back it was a great move because I don't think it's something that could have been done now in this marketplace.

Joel Luton - APS Financial Corporation

And do you expect to be a taxpayer this year?

Howard M. Lorber

Yes, we are. Correct, BK?

J. Bryant Kirkland III

That is correct.

Operator

Your next question comes from [Ken Ban] with Jeffries & Co.

[Ken Ban] - Jeffries & Co.

Could you give us a little bit more details on the Palm Springs transaction? What state is the property in? Are the lots finished? Is there a lot more development work to go in there? How much more money might need to be invested in that project?

Howard M. Lorber

We don't own it yet. We bought the first mortgage which is in foreclosure. A lot of infrastructure has been done, the bulk of it has been done. The golf course has been built, the clubhouse is substantially complete. Actually there were lots that were sold I guess about two to two and a half years ago, Lennar bought some of the lots and another developer bought some of the lots and some of these lots were sold for like $200,000 to $250,000 a lot. At the mortgage amount that we're in for we're going to be in around $25,000 a lot so we think it's a great project, although you know we have a lot of work to do because there's a second and the second can come up and pay us off and in that case we would have gotten a decent return, but that's not really what we're looking for so we're going to look probably to try to work something out with the second, get control of the property and work on developing it.

Ken Ban - Jeffries & Co.

How big is the second?

Howard M. Lorber

The second's big. If I remember correctly it's like -

J. Bryant Kirkland III

$23 million.

Howard M. Lorber

$25 million, $23 million to $25 million.

Ken Ban - Jeffries & Co.

Can you give us any idea as to timeframe as to when you think this might be worked out?

Howard M. Lorber

I think all of this is going to happen within the next couple of months.

Operator

Okay. Mr. Lorber, there are no further questions at this time.

Howard M. Lorber

Well, this is a first, only two questions. Thank you all for being on the call and if anyone has any questions as usual feel free to call myself or Bryant Kirkland and we'll look forward to speaking to you on the next quarter call. Have a good day.

Operator

That concludes today's teleconference. You may disconnect at this time.

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