Vector Group Ltd.
Q3 2015 Earnings Call Transcript

Published: 3 Nov 2015

[Operator:]

Welcome to Vector Group Limited's Third Quarter 2015 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 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 tobacco adjusted 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 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, Howard Lorber. Sir, please begin.

[Howard Lorber:]

Thank you. Good morning, and thank you all for joining us for Vector Group's third quarter 2015 earnings conference call. With me today is Ron Bernstein, 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 and nine months ended September 30, 2015. Ron will then address Liggett's performance and provide an update on company and industry developments. After that, we will be available to answer your questions. Turning to our businesses, we are very pleased with the strong performance of both our core tobacco and real estate operations. Additionally, our balance sheet remained strong. As you may know, in early October, we made some operational adjustments to best position our tobacco business to continue its success over the long-term. Ron will provide some details on those adjustments during his update. Our 70% ownership of Douglas Elliman, the largest residential real estate brokerage in the New York metropolitan area complements our strong presence in the metropolitan real estate market, where we have invested in 14 projects through our New Valley subsidiary. The New York City market remains robust, particularly as it relates to residential real estate. Douglas Elliman has been gaining market share and posting strong revenue increases in 2015. During the quarter, we continued to make strategic investments in our development marketing division by increasing advertising and marketing initiatives to build on our recent success and strengthen the long-term value of the Douglas Elliman brand. For the three and nine months ended September 30, 2015, Douglas Elliman had approximately $185.5 million and $475.8 million respectively in pro forma adjusted revenues and generated pro forma adjusted EBITDA of approximately $16.3 million and $29.9 million reflecting the impact of the aforementioned marketing initiatives. This compares to pro forma adjusted revenues of $153.2 million and $398.7 million respectively and pro forma adjusted EBITDA of $21.4 million and $44.5 million respectively in the 2014 periods. Looking forward, we feel positive about both our tobacco and real estate businesses, and we'll continue to assess new opportunities and selectively pursue those with the highest potential to build long-term value for stockholders. Additionally, Vector Group continues to have significant liquidity, with cash and cash equivalents of approximately $246 million, which includes approximately $120 million of cash at Douglas Elliman, and investment securities and partnership interests with a fair market value of approximately $347 million as of September 30, 2015. I will now review our key financials for the three and nine months ended September 30, 2015. For the third quarter ended September 30, Vector Group's pro forma adjusted revenues were $450.4 million compared to $419.9 million in the 2014 third quarter. The increase was primarily due to an increase of $32 million of pro forma adjusted revenues from our real estate segment. The company recorded pro forma adjusted operating income of $71.1 million in the 2015 third quarter, compared to $65 million in the 2014 period. Third quarter 2015 pro forma adjusted net income was $12.8 million or $0.11 per diluted share, compared to $22 million or $0.20 per diluted share in 2014. For the quarter, pro forma adjusted EBITDA attributed to the company was $72.7 million, compared to $65 million for the year-ago period. For the nine months ended September 30, 2015 Vector Group’s pro forma adjusted revenues were $1.228 billion compared to $1.175 billion in the 2014 period. The increase was primarily due to an increase of $63 million of pro forma adjusted revenues from our real estate segment. The company recorded pro forma adjusted operating income of $178.5 million in the 2015 nine month period compared to $173.2 million in the 2014 period. Pro forma adjusted net income for the nine months ended September 30, 2015 was $55.8 million or $0.46 per diluted share, compared to $52.1 million or $0.47 per diluted share in 2014. For the nine month 2015 period pro forma adjusted EBITDA attributed to the company was $188.3 million compared to $174.3 million for the year-ago period. I will now turn the call over to Ron Bernstein to discuss our tobacco business. Ron?

[Ron Bernstein:]

Thanks, Howard, and good morning, everyone. As Howard noted, we're very pleased with the continued strong performance of our tobacco business in the third quarter and first nine months of the year. Liggett’s year-over-year operating income grew almost 19% for the quarter and is up 17% year-to-date. This continues the long-term trend of operating income growth for Liggett, which we believe is a significant achievement in a contracting and challenging cigarette marketplace. On October 5th, we commenced a restructuring of the Liggett Tobacco operations and Liggett Vector Brands, which we believe will help strengthen our market position. We realigned the Liggett Vector Brands salesforce and made adjustments to our business model to serve our chain and independent accounts more effectively nationwide. In connection with this initiative, the total workforce of our tobacco segment is being reduced by approximately 95 full-time employees, approximately 17% of our workforce by the end of 2015. As a result, we expect to recognize up to $6 million of pre-tax restructuring charges during the third and fourth quarters and we expect approximately two-thirds of that to be non-cash pension benefit related costs. We expect to achieve approximately $10 million of annual cost savings from the restructuring and we plan to reinvest the entire amount of savings into business development initiatives for our tobacco brands as we go forward. As I've discussed in the past, we continuously analyze the market to assess risks and opportunities. To that end, we believe that recent industry changes relating to Reynolds acquisition of Lorillard will likely result in an aggressive expansion of Reynolds’ so-called everyday low price program, a program that we believe to be anticompetitive and that could impact market dynamics. Conversely, we believe that the Reynolds’ brand divestitures and other industry developments may result in new market opportunities. The organizational changes that we have made are designed to put us in the best possible position to maximize potential opportunities while minimizing risk. As previously noted, Liggett has settled all but approximately 285 of the state Engle Progeny cases and our remaining payments for the settled cases are approximately $3.4 million per year for the next 13 years. While we're pleased with this outcome and continue to work to resolve the remaining cases, we note that we may still be subject to periodic adverse verdicts. Before I elaborate further on performance, let's turn to the financials. Please note that financial reporting for Vector Tobacco is combined with Liggett. For the three months and nine months ended September 30, 2015, Liggett revenues were $264.2 million and $747.1 million compared to $264.5 million and $748.5 million for the corresponding periods in 2014. Tobacco adjusted operating income for the three months and nine months ended September 30, 2015 was $63.2 million and $172.8 million compared to $53.2 million and $147.7 million in 2014. The increases in third quarter and nine months operating income were primarily the result of higher margins from strategic price increases and the elimination of the tobacco quota buyout program, offset by anticipated modest decreases in unit volumes. As always, we remain focused on establishing and maintaining brand strength and driving long-term profit growth. To pursue incremental volume opportunities, we are continuing to expand tactical business building programs in several geographies and we are encouraged by the results. As we've previously noted, our selling efforts are focused on two primary bands, Pyramid, the third-largest US discount brand and seventh-largest overall brand in the country and Eagle 20’s, which was brought to market nationwide in 2013 and provides an effective long-term complement to Pyramid, while offsetting declines in our non-focused brands. We've continued to build Eagle 20’s in a disciplined manner and are pleased with our progress to date. Eagle 20’s is the fastest-growing discount brand in the US and is now available in about 51,000 stores nationwide. Importantly, Eagle 20’s is showing good year-over-year same-store sales growth and doing so with limited impact on Pyramid. The price point for Eagle 20’s remains both competitive and sustainable and based on the consistent volume growth we've had since 2013, we believe that the brand is well positioned to continue to grow over the long-term. Almost two years since the launch of our Zoom E cigarette brand, we're pleased that we entered the category cautiously and with limited expense. The uncertainties regarding E-cigarettes that we recognized at launch are significantly greater today than they were a year ago and appear to be increasing. We do not believe the trend lines predict a bright future for this product category. Given this backdrop, our primary focus for Zoom is to remain prepared to pursue sustainable opportunities should they occur. Turning back to the conventional business, while the trends of the past few years generally continue, the market has shown considerably more volume strength over the past year, in addition to other developments that have been beneficial for us. For example, recent price increases have slowed the growth of Korea Tobacco's Timeless Time brand that sells in the US at a level that continues to appear to be below cost. Perhaps, recent large cigarette excise tax and other developments in Korea have put pricing pressure on KT&G in the US. Additionally while low-priced products such as mislabeled pipe tobacco and filtered cigars continue to meaningfully impact the marketplace, those categories are no longer growing. We're still hopeful that focus from the Senate Finance Committee will lead to appropriate taxation of these products, but this is far from certain. Amidst this environment, we are pleased with the market resilience of our Pyramid brand and we continue to focus on building on its well-established nationwide presence. Pyramid distribution has grown further in 2015 and the brand is currently sold in more than 118,000 stores, which represents a substantial national distribution footprint. According to management science associates, for the third quarter of 2015, overall industry wholesale shipments were down 2.2%. Liggett’s wholesale shipments decreased in line with the industry. For the third quarter, retail shipments for the four nationally focused cigarette manufacturers ranged from a decline of 1.2% to a decline of 5.7%. During this period, Liggett retail shipments decreased by 2.2%. Liggett’s third quarter retail market share remained stable at just over 3.4%. As we look ahead, we're focused on building on the successful growth of our Eagle 20’s brand and driving increased margins from the strong sales and distribution base of Pyramid. Additionally, we expect to continue to see enhanced margins across our portfolio as a result of the elimination of the federal tobacco quota buyout program, also known as the TTPP. Notably, our operational and financial performance in the third quarter of 2015 were stronger than at any point in our recent history. While as always, we remain subject to regulatory and market place risks, including those discussed, we believe we have effective programs in place, both 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 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 will 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.

[Operator:]

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

[Ian Zaffino:]

Very good quarter. Ron, great job on the tobacco side.

[Ron Bernstein:]

Thank you.

[Ian Zaffino:]

I wanted to focus maybe more on the element side, revenues were very strong, gross profit year-over-year was relatively unchanged. Can you guys maybe give us a bridge on the puts and takes of what’s there and what we should expect going forward?

[Howard Lorber:]

Sure. Well, the major investments were in the overall growth of the brand in new markets that we’ve entered and over the last couple of years, basically we went to West Coast to LA and then and [indiscernible] and now Connecticut and Glen Ridge Those are three new markets which again takes a while. We struggled with Florida when we first opened for a while but that’s really doing well now and we have 700 sales people I think in the Florida region. In addition, the new development business is a business that requires lots of money upfront to pay for the people to do the work. And then what happens with all these projects, well, I would have thought that this year there would have been a lot of money coming in because of two projects that we did the sales on and everyone has contractors, developers all have it, regions wide, but the winter was bad, the jobs are behind and while we started closing these buildings, there will be very few closings this year and the rest of the closings will be in the first and second quarter of 2016. So that’s just sort of pushed forward as it relates to that. We have a very good backlog and new development sales projects coming online. The market is holding up. It’s actually doing pretty well on the resale business. In the last quarter 50%, about 52% of listing sold at the asking price or above asking price. So that just shows you how the market is as far as how people are viewing buying in New York City.

[Ian Zaffino:]

Okay. And then as far as your geographic footprint, are you happy where you are - so are we going to see maybe margin expansion as these investments subside or are we going to see ongoing investments where we are going to - let’s wait a little while for the margins to ramp.

[Howard Lorber:]

I think the big margin issue was really more related to marketing, the new development marketing. So I don't really think it’s not as much to go into a new region. And the only other places, we’ve considered a couple of new place. One on - another one on the West Coast and maybe want someplace else, but nothing eminent at this particular time. And even if we did it would be small expenditure compared to the money we expected. We’re starting to bring in on the new developments to the marketing side. That’s where most of the money has gone. And obviously not just due to the marketing, but the overall marketing of the company and the brand to help us get these projects and also to help us build the markets we’re in.

[Ian Zaffino:]

Okay, great. Thank you very much.

[Howard Lorber:]

You are welcome.

[Operator:]

Thank you. Our next question comes from Ken Bann from Jefferies & Company.

[Ken Bann:]

Good morning, Howard and Ron. Ron, you were talking about the Lorillard transaction and that gives you some opportunities as they divest the product lines. Can you talk about them and are you looking at buying any of those or are there other opportunities outside of that?

[Ron Bernstein:]

No, I mean we're not looking at buying any of them. I don’t know that any of them are for sale. But I think that what you have is you have disruption in the marketplace and you have a - as I mentioned, as Reynolds aggressively moved to expand their EDLP program outside of the EDLP universe, there are a lot of other dynamics that are developing and those are things that we are looking to exploit and we believe that there's opportunities that will result from it. And without going into specifics of what we're targeting, but I think that there's good opportunity for us in the marketplace. And obviously it’s an area that we have a lot of experience working in and recognize that you have to constantly be adapting and adjusting to whatever the circumstances are at that time.

[Ken Bann:]

Okay. And then could you tell us how much did the reduction in the tobacco transfer tax save you this quarter versus last year?

[Howard Lorber:]

Yeah, it's about $6 million.

[Ken Bann:]

$6 million.

[Howard Lorber:]

For the quarter.

[Ken Bann:]

Okay. And, where any of - all the restructuring activities that you announced none of that had any impact on this quarter in terms of cost savings and will those savings at all show up in the fourth quarter or they mostly next year?

[Howard Lorber:]

Mostly next year, there will be some that will accrue to the fourth quarter.

[Ken Bann:]

Okay. And then, Howard where there any real estate investments in the quarter?

[Howard Lorber:]

BK?

[Bryant Kirkland:]

None. [Technical Difficulty] investments.

[Ken Bann:]

All right, okay. And I guess there were not much in the way of sales since things have been delayed a bit is that -

[Howard Lorber:]

You mean sales and the projects that we are an investor in?

[Ken Bann:]

Right.

[Howard Lorber:]

That's correct, I mean we get pretty well updated on those, but we haven't got, let me say it in another way, on a cash basis, we haven't gotten any of the returns, we've gotten returns of capital in a few of the projects but the big profits are going to should start coming in I think we're figuring in first half of ‘16, right BK.

[Bryant Kirkland:]

That's correct, and also the Marquand, which is the 11 East 68TH Street did have one sale of a unit during the quarter, but it was de minimis.

[Ken Bann:]

Okay, great. Okay, thank you very much.

[Operator:]

Thank you, our next question comes from [indiscernible].

[Unidentified Analyst:]

What is the size of your participation in the 20 Times Square project and why has the website removed the size of the participation in the various investments?

[Howard Lorber:]

BK.

[Bryant Kirkland:]

All right, sure. First of all, the size of the investment will be disclosed in Form 10-Q, they were disclosed in last quarter's 10-Q and as far as the 20 Times Square, we have 11.5% interest.

[Howard Lorber:]

But just to qualify that that's somewhat misleading because we also participate in the promote, so am I correct BK?

[Bryant Kirkland:]

Correct, [Technical Difficulty].

[Howard Lorber:]

Our potential profit is substantially more than just 11.5% of the profit of the project.

[Unidentified Analyst:]

Thank you.

[Operator:]

Thank you. Our next question comes from Dustin Henderson from Eagle Asset.

[Dustin Henderson:]

Good morning Howard, Ron, Brian. Thanks for taking the call. I was just looking down the income statement, just a quick, the thing that caught my eye might have thrown off some people that were publishing estimates and there is an impairment on investment securities and that's just one of your publicly traded slight Ladenburg Thalmann or something like that traded lower during the quarter right?

[Bryant Kirkland:]

Yes, the big one was Morgan's, which were a 13D file on, and on the board and that's been a tough one but we’re working on it and hopefully the investment will come back.

[Dustin Henderson:]

Okay, no change in thesis or anything like that for the holding or any of the other holdings?

[Howard Lorber:]

Nor at this particular time.

[Dustin Henderson:]

Alright, thanks very much for taking the question.

[Operator:]

[Operator Instructions] Our next question comes from Christian Hoffmann from Thornburg.

[Christian Hoffmann:]

Good morning, not to beat the dead horse here but in your prepared comments you talked about, at least you sounded like risk and threat of the EDLP from rentals and then in the Q&A you kind of said an opportunity in moving parts. Can you just kind of can give me little more color on what you're actually seeing and what makes positive or negative?

[Howard Lorber:]

Look as we expected, Reynolds is using Newport as a sledgehammer in the marketplace to try to induce more retailers to go on the EDLP program. That was fully expected and we developed a strategy part of which was the realignment that we did in our salesforce and organization in order to pursue opportunities around that and even through that. So, it’s - there is always a measure of risks and opportunities in the marketplace and what you know the EDLP situation, if it's less unchecked is something that creates risks in the marketplace. But as other brands are divested - were invested out of Reynolds and Lorillard, those create opportunities in the marketplace as well and we are well experienced that working in the retail community and making sure that our brands are in the best position to complement whatever programs that are operating out there. So what I was doing was highlighting the fact that there are risks associated with it but at the same time we also believe and in fact we are pursuing opportunities that we think will be beneficial for the long-term for us.

[Operator:]

Thank you. Those are all the questions that we have for today. Thank you for joining us on Vector Group earnings conference call. That will conclude our call. Thank you for your participation, you may now disconnect.

[Howard Lorber:]

Thank you everyone.