Vector Group Ltd.
Q1 2017 Earnings Call Transcript

Published: 5 May 2017

[Operator:]

Good morning and welcome to Vector Group Ltd’s First Quarter 2017 Earnings Conference Call. During this call, the terms 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 operating income, adjusted net income, adjusted EBITDA, and tobacco adjusted operating income are contained in the company’s earnings release, which has been posted on 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. These 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 the 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, Mr. Howard Lorber.

[Howard Lorber:]

Good morning and thank you for joining us today for Vector Group’s first 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 will provide an update on our business, and review Vector Group’s performance for the three months ended March 31, 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 performed well in the first quarter and we continue to be pleased with the performance of our core operations. Notably, our tobacco business grew volume in the first quarter and gained more than 30 basis points of retail market share compared to the prior year quarter. For the three months ended March 31, 2017, Douglas Elliman had approximately $155.5 million in revenues and generated adjusted EBITDA of $1.8 million. This compared to revenues of $157.6 million and adjusted EBITDA of $9.1 million in the 2016 period. We continue to believe both our tobacco and real estate businesses are well positioned for continued success. As always we will assess new opportunities in our businesses and selectively pursue those with the best long-term value creation potential. Additionally, Vector Group continues to have significant liquidity with cash and cash equivalents of approximately $356.7 million, including approximately $88.1 million of cash at Douglas Elliman and investment securities and partnership interest with a fair market value of approximately $284 million as of March 31, 2017. As previously reported, the company refinanced its existing 7.75% senior secured notes due 2021 of 835 million by completing the sale of 850 million aggregate principal amount of 6.125% senior secured notes due 2025. We expect to save approximately 12.6 million per year in cash interest expense as a result of the refinancing. I will now review our key financials for the three-months ended March 31, 2017. Vector Group's first quarter 2017 revenues were $415.2 million, compared to $380.8 million in the 2016 period. The company recorded adjusted operating income of $54.1 million in the first quarter, compared to $65.2 million in the 2016 period. First quarter 2017 adjusted net income was $18.4 million or $0.14 diluted share, compared to $18.1 million or $0.14 per diluted share in the 2016 period. For the quarter, adjusted EBITDA was $61.3 million, compared to $69.6 million for the year ago period. I will now turn the call over to Ron Bernstein to discuss our tobacco business. Ron?

[Ron Bernstein:]

Thank you, Howard. Good morning everyone. As Howard mentioned, we’re pleased with the continued strength in earnings performance of our tobacco business during the first quarter and particularly with our volume and market share growth. As we previously noted, we entered 2016 well positioned to take advantage of market opportunities resulting from the Reynolds Lorillard Imperial tobacco transaction, as well as opportunities relating to developments in the deep discount category. We succeeded at maximizing those opportunities and substantially increased our earnings in 2016, while investing in the continued growth of our Eagle 20's brand. Building on that momentum, our 2017 strategy calls for continued investment in the growth of Eagle 20’s as a long-term complement to our other core brand; Pyramid. I’m pleased to report that our first-quarter results, which I will discuss in more detail shortly, reflect the successful early execution of that plan. 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. In December 2016, we reached a settlement that resolved 124 Engle progeny cases in Florida. In conjunction with that settlement, Liggett paid $14 million and will be an additional 3.65 million in equal quarterly installments in 2018. Our remaining payments for the settlement announced in 2013 are approximately 3.4 million per year for the next 11 years. At this point, all but approximately 115 Engle progeny cases have been resolved by Liggett, but we may still be subject to periodic adverse verdicts. Before I elaborate further on first quarter tobacco performance, let’s turn to the financials. Please note that financial reporting for Vector Tobacco is combined with Liggett. For the three months ended March 31, 2017, Liggett revenues were $257.5 million, compared to $221 million for the corresponding period in 2016. The increase in revenues is reflective of year-over-year volume and pricing increases. Tobacco adjusted operating income for the three months ended March 31, 2017 was $60.5 million, compared to $63.9 million for the corresponding period in 2016. Please note that first quarter 2016 adjusted operating income includes $5 million related to a revision by the independent auditor and Liggett's 2015 MSA cost estimate due to higher industry volume. Excluding this 2016 first quarter MSA cost revision, Q1 2017 earnings increased by approximately 2.5% year-over-year. As previously mentioned, our recent selling efforts have been focused on two core brands; Pyramid, the fourth largest US discount brand and Eagle 20's, the fifth largest US discount brand. Recent results clearly affirm that Eagle 20's is in fact providing an effective long-term complement to Pyramid, while offsetting volume declines in Pyramid and other brands. Since its launch in 2013, we have built Eagle 20’s in a disciplined manner and are pleased with our progress. Eagle 20’s is the fastest growing discount brand in the United States and is now available on over 61,000 stores nationwide. We’ve maintained a competitive price point for Eagle 20's since its inception, and based on the success of our strategy to date believe the brand is well-positioned for continued 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 targeted business building programs in geographies of focus for us. Looking at recent industry trends over the course of 2016 and through the first quarter of 2017, we have seen industry volume declines return to historical norms and believe the decline rate is now in the range of 3% to 4% per year. The industry remains highly competitive and in recent years we’ve seen Altria and Reynolds increase their focus on discounting extensions of core premium 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 remains well above standard discount products and has had little effect on our brand portfolio and performance to date. Regarding smaller discount focus companies, the cumulative effect of price increases has generally slowed the growth of many of their respective brands, which has proven beneficial to us. However, as we have seen over time, targeted deep discount brands continue to emerge in local geographies as smaller competitors search for business. Additionally, while low price products such as mislabeled pipe tobacco and filtered cigars continue to adversely impact the marketplace, those categories continue to be in decline, despite the absence of governmental 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 remained strong and the brand is currently sold in approximately 113,000 stores, a substantial national distribution footprint. According to Management Science Associates, while overall first quarter industry wholesale shipments were down 3.1% on a year-over-year basis, Liggett's wholesale shipments increased by 20.8%. Liggett's year-over-year wholesale shipment increase was aided by timing differences related to price increases in 2015 and 2016. As I note during each call, 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 first quarter, Liggett's year-over-year retail shipments increased 6.2%, compared to the industry, which was down 2.7%. This growth rate is consistent with recent quarters and according to the data we were once again the only nationally focused cigarette manufacturer to register an increase in shipments during the quarter. Liggett's first quarter retail market share increased by 31 basis points, compared to the prior-year period and now represents more than 3.75% of the total market. We’re extremely pleased with our performance to date and as we look ahead, plan to continue to focus on building income from the strong sales and distribution base of pyramid, while delivering volume and share growth from Eagle 20's. 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. Thank you for your attention and back to you Howard.

[Howard Lorber:]

Thank you, Ron. As I noted at the start of the call we're pleased with our recent performance and continue to believe that Vector Group is well-positioned. We have strong cash reserves, have consistently increased our tobacco profit margins and sales volumes in recent years, and continue to benefit from favorable terms under the MSA and we're pleased with the prospects for our real estate business. We were 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:]

Thank you, sir. [Operator Instructions] Our first question comes from Ian Zaffino with Oppenheimer.

[Ian Zaffino:]

Hi, great. Thank you very much. Question would be, I guess for Ron, how much more run rate does Eagle 20 have in your opinion, how long can you take share for or maybe harvest that brand? Thanks.

[Ron Bernstein:]

Hi, we anticipate continued growth on Eagle 20’s. The brand is picking up volume in various geographies and our intent as I indicated is to invest in its growth over the course of the year. So, I would anticipate that we will continue to see growth on the brand throughout the year.

[Ian Zaffino:]

Okay. And then on the real estate side of the equation, can you give us maybe a breakdown of how maybe New York did for Douglas Elliman versus the other areas, you said the results are actually pretty good despite sort of perception that the market might be a little bit weak, so …

[Howard Lorber:]

I mean the difference in New York was there was less new development closings in the first quarter and that’s higher margin business, okay. So that hurt us a little bit on the margin, but as it relates to the other areas South Florida was up a lot, California was up a bunch and Aspen was up a bunch, although Aspen is small, so it doesn't mean that much in dollars, but it was up quite a bit. So, we were strong in those markets, have had a good rebounds and New York was just really less in new development closings and a little bit less resale volume in the first quarter.

[Ian Zaffino:]

Okay, and in the non-New York markets is that, you know the strength there, is that market-related or market share related, company specific?

[Howard Lorber:]

I think it is a little bit of both, I think the market has definitely improved in those markets and I think our market share from picking up new brokers and better brokers has improved also so I think it is a combination of both.

[Ian Zaffino:]

Alright, great, thank you very much.

[Operator:]

Our next question comes from Bryan Hunt with Wells Fargo.

[Dave Cook:]

Good morning it is Dave Cook on for Bryan. On the tobacco side sales they were up 16.5% with unit volumes up 21%, so I guess that implies pricing like 4.5% lower year-over-year, I am just wondering is that due to outsized price investments in Eagle 20’s?

[Ron Bernstein:]

Yes the factors that affected volume in the first quarter, obviously we are continued investment in Eagle 20’s, which takes the net pricing down obviously. And also the timing differences that I reference year-over-year, the price increase on Eagle 20’s at the end of 2016 was earlier than it was in 2015, so there was less anticipatory buying in the wholesale volumes, wholesaler volumes came down earlier so that the first quarter came in stronger.

[Dave Cook:]

Okay. And then I guess do you see any significant wholesale volume swings in the balance of 2017?

[Ron Bernstein:]

You know, as I said wholesaler volumes are contingent on factors that vary. So, it depends on what the wholesalers are doing or what other companies are doing and the timing. So that is why always referenced the fact that retail sales are a much - or shipments are a much more stable indicator because retailers don't have the capacity to hold inventory the way wholesalers do, but I would imagine that the fluctuations would not be as great as it was in the first quarter.

[Dave Cook:]

Okay. And then on those retail shipments, could you, give us some sort of indication as to what’s that retail shipment growth for Eagle 20's versus the balance of the portfolio?

[Ron Bernstein:]

Yes, I mean all of the growth is Eagle 20’s and it offsets some declines in the other brands because all of the other brands are in some level of decline phase, while Eagle 20's is growing substantially.

[Dave Cook:]

Okay. And then, you still have a ton of distribution wide space for Eagle 20’s, I think you said 61,000 units versus you're distributing Pyramid and 113,000 or so, is your plan to roll out Eagle 20’s to all those 113,000?

[Ron Bernstein:]

Not necessarily. Part of the - looking at differences and timing, when Pyramid was introduced, the Reynolds EDLP universe was much more flexible and somewhat smaller than it is today. Eagle 20's is a much more dominant brand in the independent retailer marketplace, whereas Pyramid had a broad base in both the gas station convenience stores, as well as in the Independent. We anticipate that the store count will continue to grow, but probably not to the level that Pyramid reached.

[Dave Cook:]

Okay. And the question for Bryant, I think you had previously mentioned you are planning to manage the business with three 3 to 4 times growth secured leverage, could you just tell me where you are at on that leverage metric at the end of Q1?

[Bryant Kirkland:]

Where we are is we are constantly evaluating our capital structure and we feel good about it right now, as far as we are able to save $12.5 million under recent refinancing.

[Operator:]

[Operator Instructions] Our next question comes from Karru Martinson with Jefferies.

[Karru Martinson:]

Good morning. When we look at the volume gains for the Eagle 20's where are you taking that stair from, is it coming from some of your own portfolio or do you feel that you are replacing guys on the shelf?

[Howard Lorber:]

Well it is broad based and it’s coming I think across the spectrum. It’s coming from - largely from other deep discount brands and companies, but it’s also coming from we believe from ITG and we think that there is modest impact from our own brands because obviously we target things in ways to try to limit the amount of declines that we cause ourselves, but Eagle is a broad enough brand now that it’s going across the board I think.

[Karru Martinson:]

Okay. And when you guys looked at on the real estate side, software New York, does that create opportunities for you to add some assets or are you still kind of just focused on the asset monetization of what you have?

[Howard Lorber:]

Excuse me, would you repeat that?

[Karru Martinson:]

I was just thinking with the software New York market, I mean are there opportunities for you guys to add some assets or is the focus still on monetizing the ones that you have right now are you are in harvest mode?

[Howard Lorber:]

Look, it is a combination of both. I mean if there was something, we are very opportunistic investors. So, if there is something that makes sense that’s an opportunity type of investment or a troubled project where we think we could add value to it. We are interested. And likewise at the same time we're harvesting some of our better projects are coming to fruition like Times Square in a year and some of the big ones. So, I think, next year and the rest of this year will be interesting, I think it will be a little bit of both.

[Karru Martinson:]

Thanks very much guys, appreciate it.

[Operator:]

Thank you. Those are all the questions we have for today. I would now like to turn it back to Mr. Lorber for closing comments.

[Howard Lorber:]

Thank you everyone for being on this call, and as always the management team is always available to answer any questions. Thank you and have a good day.

[Operator:]

Thank you for joining us on Vector Group's earnings conference call. That will conclude our call. Thank you all for your participation and you may now disconnect.