Vector Group Ltd.
Q2 2017 Earnings Call Transcript

Published: 4 Aug 2017

[Operator:]

Welcome to Vector Group Ltd’s Second Quarter 2017 Earnings Conference Call. During this call, the terms adjusted revenue, 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 revenues, 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 would 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 and/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 would like to turn the call over to the President and Chief Executive Officer of Vector Group, Howard Lorber.

[Howard Lorber:]

Good morning and thank you for joining us for Vector Group’s second 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 and six months ended June 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 operations continue to performed well in the second quarter. As noted during the first quarter call, we expected to achieve 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 six months of the year. Ron will provide more detail on Liggett’s performance shortly, but sufficed to say we feel good about our position in a discount segment of the market. For the three and six months ended June 30, 2017, Douglas Elliman had approximately $198.7 million and $354.2 million in revenues and adjusted EBITDA of $18.2 million and $20 million. This compared to revenues of $181.7 million and $339.3 million and adjusted EBITDA of $14.8 and $23.9 million in the 2016 period. We continue to believe both our 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 value creation. Vector Group continues to have significant liquidity with cash and cash equivalents of approximately $410.4 million, including approximately $102 million of cash at Douglas Elliman and investment securities and partnership interest with a fair market value of approximately $285.7 million as of June 30, 2017. I will now review our key financials for the three-months and six months ended June 30, 2017. For the three months ended June 30, 2017 Vector Group's revenues were $472 million compared to $438.3 million in the 2016 period. The Company recorded adjusted operating income of $74.3 million in the second quarter compared to $71.5 million in the 2016 period. Second quarter 2017 adjusted net income was $32.7 million or $0.25 per diluted share compared to $24.6 million or $0.19 per diluted share in the 2016 period. For the quarter adjusted EBITDA were at $76.3 million compared to $75.1 million for the year ago period. For the six months ended June 30, 2017 Vector Group’s revenues were $887.2 million, for the six months ended June 30, 2017 compared to $819.1 million in the 2016 period. The Company recorded adjusted operating income of $128.3 million in this six months ended June 30 2017, compared to $136.8 million in the 2016 period. Adjusted net income for the six months ended June 30, 2017 was $51.2 million or $0.38 per diluted share compared to $42.7 million or $0.33 per diluted share in 2016. For the six months ended June 30, 2017 adjusted EBITDA were a $137.6 million compared to $144.7 million for the year ago period. I will now turn the call over to Ron Bernstein, to discuss our tobacco business. Ron.

[Ronald Bernstein:]

Thank you Howard, good morning everyone. As Howard mentioned, we implemented a plan in 2017 to grow cigarette volumes and are pleased with our operating results both in the second quarter and first half of 2017. As noted during 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 segments 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 entering 2016. Those adjustments prove successful as we increase tobacco segment earnings last year and laid the ground work for 2017 volume increases. I will discuss that performance in more detail shortly. With respect to product liabilities 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 105 Engle progeny cases has been resolved by Liggett. As we always cautioned, we may still be subject to periodic adverse verdicts. I will now turn to the tobacco financials. Please note that as always financial reporting for Vector tobacco is combined with Liggett. For the three months and six months and ended June 30, 2017, Liggett revenues were $272.2 million and $529.6 million compared to $255.5 million and $476.5 million for the corresponding period in 2016. The increases in revenues are reflective of year-over-year volume gains and pricing increases. Tobacco adjusted operating income for the three months and six months ended June 30, 2017, was $64.5 million and a $125 million compared to $66 million and a $129.9 million for the corresponding periods in 2016. The decrease in tobacco adjusted operating income during the second quarter is reflective of our investment in and growth of our Eagle 20 [frame] (Ph). Year-to-date decreases are the result of our investment in Eagle 20s and in Q1 2016 MSA cost provision that resulted in $5 million of income in the first quarter of 2016. Excluding the 2016 MSA cost provision first half 2017 tobacco adjusted operating income would have been flat year-over-year despite the investment in Eagle 20’s. Our selling efforts over the past several years have been focused on two core brands, Pyramid the fourth largest U.S. discount brand Eagle 20’s now the fifth largest and fastest growing U.S. discount brand. Recent results clearly affirm that Eagle 20’s is providing an effective long-term compliment to Pyramid while offsetting volume declines in the pyramid and other Liggett brands. Since its launched in 2013, we have built Eagle 20’s in a disciplined manner and are very pleased with our progress. Eagle 20’s is now available in approximately 63000 stores nationwide. We have maintained the competitive price point for Eagle 20’s since its inception and based on the success of our strategy to-date believed that the brand continues to be 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 the business building programs in specifically targeted geographies. Looking at recent industry trends over the course of 2016 and through the second quarter of 2017, we have seen industry volume declines return to historical norms and believe the decline rate is now approaching 4% per year. The industry remains challenging and in recent years to offset declines in their core premium brands we have seen Altria, and Reynolds increase their focus on discounting 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 extension. The price of these premium economy brands is typically well above standard discount products and has had little effect on that 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, overtime targeted deep discount brands continued to emerge in local geographies as smaller competitor search for business. Additionally, while low price product such as [mislabeled] (Ph) pipe tobacco and filtered cigars continue to adversely impact the marketplace, those categories are in decline. Despite the absence of governmental intervention as of yet. Given these factors, we are 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 while overall second quarter industry wholesale shipments were down 2.9% on a year-over-year basis, Liggett’s wholesale shipment increased by 7.1%. As I note during each call, we believe retail shipments are far more reliable indicator of performance due to various factors, including individual company shipment fluctuations the timing of price increases and wholesales buying patterns. For the second quarter Liggett’s year-over-year retail shipments compared favorably to the industry up 5% while the industry was down 5.5% this growth rate is consistent with recent quarterly and according to the data, we were the only nationally focused major cigarette manufacturer to register an increase in shipments during the quarter. Liggett's second quarter retail market share increased by 38 basis points, compared to the prior-year period and now represents more than 3.8% of the total market. We here extremely pleased with our performance to-date and as we look ahead, plan to continue to focus on providing 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 here pleased with our recent performance and continue to believe that Vector Group is well-positioned to drive 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 we here 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] (Ph) 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:]

[Operator Instructions] Our first question will comes from Ian Zaffino, Oppenheimer.

[Mark Breidenbach:]

Hey good morning guys, this is Mark on for Ian, thanks for taking my question. So in regard to real estate was the outperformance in this quarter driven more by meaningful increase in volume are we start to see pricing coming back into the market as well.

[Howard Lorber:]

I think it’s a little bit of both, I think that business in general volume was up. I think that it’s a little bit of different market and that the very ultra high end has been pretty strong and the traditional high end which was let's say between $8 million and $20 million has been softer as most of these reports have better come out from the firms I have shown and under $4 million to $5 million has still maintained its strength. We have also made improvement in our markets, in our new markets, which has helped also in cutting down the losses in those markets.

[Mark Breidenbach:]

Got it, thank you, and I guess like how sustainable these thesis are going forward into the balance of 2017. Thank you.

[Howard Lorber:]

I think it's going to be a good year, I think the balance of the year is going to be good, some of it I guess based on the stock market continuing which is always good for the real estate market and then also the big unknown is tax reform. We believe, we firmly believe that tax reform does happen which some form that should that that will be a boon to the real estate market. Even though there is a couple of may be small negatives in it. I think that all-in-all people feel to have more money in their pocket, they are more rapid to spend money and spend more money in real estate. So pretty bullish for the balance of the year.

[Mark Breidenbach:]

Okay great thank you very much and then I guess just a very quick housekeeping, do you guys have I guess the diluted share count for this quarter?

[Howard Lorber:]

You take it Bryant.

[Bryant Kirkland:]

Yes, it’s about $126.5 million and then shares outstanding at the end of the quarter is about $128.9 million.

[Mark Breidenbach:]

Okay, perfect. Thank you guys very much. Great quarter.

[Operator:]

Thank you. Our next question will come from Karru Martinson, Jefferies.

[Karru Martinson:]

Good morning. So take a step back and look at the kind of the big picture with the FDA announcement. I mean what is the near-term impact and how do you guys see that kind of playing out on a timeline for what will change here given this kind of harm reduction continuum talk that has come out from the FDA?

[Ronald Bernstein:]

So, I mean I would start by saying that has been typically with the FDA since they took over regulation as the industry, there is an extreme lack of clarity and lack of transparency. The short-term, I don’t see any impact, this is a process that even if they were to come to a conclusion that there was some level of nicotine that they were targeting that is going to take years to get to that. They have gone to a long-term type of process in going with the advanced rule making before to the rule making. But the thing that has to be remembered relative to FDA is that its mandated to be a science-based agency and the ability to go in and to determine a target that would have a science-based impact on public health relative to nicotine levels is something that may not be doable. And if it is, it’s going to be something that’s going to be with lots of debate and lots of division and no doubt, losses. So from our perspective, we believe that this is going to be a long process, we are not even clear what it is they are exactly trying to do and we are always going to be in a position to comply with regulations and also as was the case when the FDA went beyond constitutional guidelines with the graphic winning labels we will challenge them in court and I’m sure the rest of the industry will as well if they come up with something that violates our rights. So I mean in the short-term into immediate-term I don’t really see much of an impact at all.

[Karru Martinson:]

Okay. And then just looking at Eagle 20’s, it looks like you added another 2,000 stores to the distribution, I mean it’s still kind of around half of where Pyramid is, is the goal ultimately to bring Eagle 20’s to kind of a Pyramid level or where will that brand kin of top out?

[Ronald Bernstein:]

Well, I think again there is two different issues. There is the market share of the brand and there is the amount of stores and there is little doubt that Eagle will never be in as many stores as Pyramid is; however, we believe that Eagle’s share will certainly approach Pyramid at its peak level. So the brand is growing well, as I said in my comments it’s the fastest growing discount brand in the U.S. and has been for a couple of years now and it continues to maintain its trajectory. So we feel very good about it, Pyramid peaked in volume in 2011 the market six years later is smaller than it was six years ago, so the absolute volume won’t be as large, but we believe that the share will be.

[Karru Martinson:]

Okay, and cash was up nicely in the quarter, but it seems like the real estate portfolio is still the same. So are you still seeing opportunities to liquidate, or harvest that real estate portfolio?

[Howard Lorber:]

The bulk of our portfolio dollar rises in condominium investments. So again that gets liquidated as the building are built and apartments are sold and closed. So yes that is in a liquidation mode. B.K. do you have any other comments on that.

[Bryant Kirkland:]

We did have some monetization during the quarter related to the 10 Madison West project as well as the west Hollywood addition project.

[Howard Lorber:]

And that will continue, we haven’t made a big investment, we have made a couple of small that’s about it.

[Karru Martinson:]

Okay. Thank you very much guys, I appreciate it.

[Operator:]

Our next question will come from Brian Hunt, Wells Fargo.

[David Cook:]

Hi its Dave Cook on from Brian. Just wanted to go back to the FDA announcement, I realize there is some lacks clarity around this where we will ultimately go, but I mean I guess if we are thinking about reduced nicotine levels can you tell us why you think you are on 12 position for kind of the contemplated change in nicotine levels.

[Ronald Bernstein:]

Well there isn’t a contemplating change at this point. So until they prescribed something there is really nothing to comment on. So this is at this point theoretical, they have said that they want to explore this, they will explore it, the industry will explore it and we will determine at the point of time what adjustments if any are necessary, but until there is some indication of what it is that they are even talking about, there is nothing to really speculate about.

[Howard Lorber:]

And then you are going to have comments from the health industry, because what you really have is - look the thinking has been for a quite a while that if you lower nicotine what it does in effect is encourages people to smoke more to get the nicotine. Then what happen is obviously that creates more disease and itself is not good for you and it does have cardiovascular implications, but it doesn’t have the other implications that cigarettes have meaning heart disease and cancer [indiscernible] cancer and so forth. So there will be quite a lot of talk back and forth, does it really make more sense to do it or not to do it.

[David Cook:]

Okay. Then switching over to real estate, I saw the announcement regarding your acquisition of [indiscernible] properties. Just wanted to see if we could get any idea of the scale of that purchase price and how you are thinking about financing that especially using cash on Douglas Elliman’s balance sheet?

[Howard Lorber:]

Yes we are not going to discuss purchase price and we haven’t closed this transaction yet, but it’s going to be financed from our own balance sheet, we have the cash for it.

[David Cook:]

Okay. And then if I look at tobacco dollar sales and your wholesale volume growth it appears that implied pricing, the pricing investment appear to ease sequentially from Q1 to Q2. I want to be right my math and what is that a function of kind of what could we expect for the balance of the year?

[Ronald Bernstein:]

Well I mean obviously the timing of price increases is a major factor and what happened this year was that as I'm sure you know, the first price increase of the year was in the first quarter as appose to the second quarter. So you have an adjustment in terms of when product is bought in from wholesalers and that effects the whole calculation, which is why I was emphasize that its best to track the retail numbers not the wholesale numbers.

[David Cook:]

Okay. And then question for Bryant, if you could provide the secured leverage at the restricted group, do you have that figure?

[Bryant Kirkland:]

Yes. Let me just give you leverage on both the gross and a net basis. On a gross basis the total leverage is five times on a net basis, so total leverage is 2.6 times on a growth basis. The secured leverage is 3.2 times and on a net basis its 1.1 times on secured.

[David Cook:]

Well, thank you very much. That’s all for me.

[Operator:]

Thank you very much. Those are all the questions that we have for today. I would now like to turn the conference back over to Howard Lorber.

[Howard Lorber:]

I would like to thank everyone for participating in this call and as always BK, Ron and myself are available if anyone has any further questions. Thank you very much and everyone please enjoy your weekend. Bye.