Vector Group Ltd.
Q3 2014 Earnings Call Transcript

Published: 1 Nov 2014

[Operator:]

Welcome to Vector Group Ltd. Third 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 Web site 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. 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 on Vector Group's third 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 third quarter and nine months ended September 30, 2014. Ron will then address Liggett's performance for these periods and provide an update on company and industry developments. After that, we will be available to answer your questions. Turning to our business, we continue to be pleased with the performance of both of our core tobacco and real estate operations in 2014 and our balance sheet remains strong. As previously noted, we consolidated the operations and financial position of Douglas Elliman in our financial statements following the increase of our ownership interest in Douglas Elliman to 70% in late 2013. For the third quarter and nine months ended September 30, 2014, Douglas Elliman had approximately got $153.2 million and $398.7 million in pro forma adjusted revenues and generated pro forma adjusted EBITDA of approximately $20.1 million and $42..8 million. This compared to pro forma adjusted revenues of $133.4 million and $333.1 million and pro forma adjusted EBITDA of $18.4 million and $32.5 million in the 2013 period. Additionally, our ownership of Douglas Elliman strengthens our presence in the New York City real estate market where we are partners in 12 current developments. In the third quarter of 2014 we recognized income of $5 million from one of these investments, which represents approximately 40% of our anticipated profit from that investment. There continues to be strong demand for residential real estate and we have 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. Furthermore, we continue to have significant liquidity with cash and cash equivalents of $380.4 million which includes approximately $96.4 million of cash at Douglas Elliman and investment securities and partnership interest with a fair market value of $385.7 million as of September 30, 2014. I will now review the key financials for the three-months and nine-months ended September 30, 2014 for Vector Group. For the third quarter ended September 30, 2014, Vector Group's pro forma adjusted revenues were $419.9 million compared to $405.5 million in the 2013 third quarter. The increase was primarily due to an increase of $19.8 million of pro form adjusted revenues from Douglas Elliman. The company recorded pro forma adjusted operating income of $65 million in the 2014 third quarter compared to $63.9 million in the 2013 period. Third quarter 2014 pro forma adjusted net income was $21.7 million or $0.20 per diluted share compared to $17.9 million or $0.18 per diluted share in 2013. For the third quarter 2014 pro forma adjusted EBITDA attributed to the company was $65 million compared to $63 million for the year ago period. For the nine months ended September 30, 2014, Vector Group pro forma adjusted revenues were $1.18 billion compared to $1.1 billion in the 2013 period. The increase was primarily due to an increase of approximately $67.6 million in real estate revenue at Douglas Elliman. For the nine months ended September 30, 2014, pro forma adjusted operating income was $173.2 million compared to $156.7 million in 2013. Pro forma adjusted net income for the nine months ended September 30, 2014 was $52.4 million or $0.50 per diluted share compared to $46.8 million or $0.47 per diluted share in 2013. For the nine months ended September 30, 2014, pro forma adjusted EBITDA attributed to the company was $174.4 million compared to $160.1 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 indicated, our tobacco business performed well during the first nine months of 2014. Liggett's market performance was strong in the third quarter and despite a tough year-over-year comparison, we continued to our trend of earnings growth with adjusted operating income increases of more than 3% for the third quarter and 5.5% for the first nine months of the year. As previously noted, early in 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 the next 14 years. This settlement resolved all but approximately 330 state court cases. While we are pleased with this outcome and continue to work to resolve the remaining cases, we note that we might still be subject to periodic adverse verdicts. As you know, earlier in the year Reynolds announced an agreement to acquire Lorillard and to sell certain assets to Imperial Tobacco. As expected, the FTC is reviewing the transaction and many expect that potential anti-competitive aspects of the announced deal will come under additional scrutiny in the coming weeks and months. 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 and nine months ended September 30, 2014, Liggett revenues were $264.5 million and $748.5 million respectively compared to $271.5 million and $761 million for the corresponding period in 2013. Tobacco adjusted operating income for the three and nine months ended September 30, 2014 were $53.2 million and $147.7 million compared to $51.5 million and $140 million in 2013. The increases in third quarter and nine months earnings were primarily the result of higher margins from price increases, product mix and continued controls on cost and expenses, partially offset by expected decline in volumes. While we remain focused on brand strength and long-term profit growth, we continue to evaluate opportunities to pursue incremental volume and margin. Accordingly, our January 2013 introduction of Eagle 20's was designed to provide a long-term complement to Pyramid, the third largest United States discount brand and sixth largest overall brand, and to offset declines in our non-focus brands. We have been focused on building Eagle 20's in a disciplined way to ensure that we grow the brand across the country while minimizing cannibalization on Pyramid. We have been successful to date. Our Eagle 20 brand is now available on over 40,000 stores nationwide with only limited impact on Pyramid. We believe the price point for Eagle 20's is both competitive and sustainable and that the brand is positioned to continue to grow over the long-term. Importantly, there continues to be opportunities to support Eagle 20's growth while minimizing declines on Pyramid. To that end, we have implemented market specific programs that feature an aggressive pricing approach in select geographies. Despite marketplace challenges that I will discuss in a moment, we are pleased with the results of these efforts to date. While Pyramid, Eagle 20's and our other conventional cigarettes remain our primary long-term focus, early this year we began the national rollout of our ZOOM e-cigarette brand. As we have stated, while there is clearly potential in the e-cigarette and vapor category, we have entered it carefully as there are many unknown factors. In addition to questions regarding taxation and regulation, it remains unclear how consumers will react to these products over the long-term. In fact, we have seen rapid changes in the e-cigarette market over a short period of time. Disposable e-cigs that dominated the market as recently as last year are now in significant and rapid decline. And rechargeable products that rose quickly to seemingly provide a more affordable options for loyal e-cigarette users, now appear to be stagnant at best. Meanwhile, open system vapor products that feature refillable tanks and use low-cost flavored liquid, have shown recent growth. These products are largely being sold outside of traditional cigarette outlets and are difficult to measure in terms of volume and profit potential at this point. Additionally, we believe these currently unregulated open system vapor products are of great concern to Congress and regulators and are likely to draw quickest action in terms of regulation. With that in mind, we remain judicious in the development and rollout of our ZOOM product. While we continue to build distribution strategically, our primary focus is now on developing name recognition and being prepared to pursue opportunities if and when the market becomes better defined. Turning back to the general market. The trends of the past few years continued in the third quarter of 2014. Despite a recent price increase, the Korea Tobacco Company continues to sell a brand in the U.S. at a level that appears to be substantially below its own cost. That brand is apparently supported by profits generated by other geographic segments of their tobacco business. Low priced products such mislabeled pipe tobacco and filtered cigars that have been evading excise tax payments, remain a force in the market with significant combined market share of more than 8% nationwide. As previously noted, we were pleased that the Senate finance committee finally held a hearing on this issues and that I had the opportunity to testify before the committee. We are hopeful that this will lead to meaningful action on properly taxing these products. The failure to date of Congress and regulators to act to address violations of existing laws has resulted in the loss of billions of dollars in tax revenues, inadequate consumer and marketing control and a free for all in the marketplace. The long awaited deeming regulation intended to address many of these long standing issues was released earlier this year. And while it does propose to put e-cigarettes, pipe tobacco and filtered cigars under FDA jurisdiction. It appears that final approval and implementation of the regulation could take years. Amidst this backdrop, we remain pleased with the strong market resilience of our Pyramid brand and we continue to build on its well established national presence. Pyramid is currently sold in over 116,000 stores, a substantial national distribution footprint. According to Management Science Associates, for the third quarter of 2014, overall industry wholesale shipments were down 2.3% with the top five companies down between 1.9% and 7.3%. For the period, Liggett shipments were down 5.4%. Liggett's third quarter retail market share remained essentially flat at just under 3.5% compared to the prior year period. We remain the fourth largest cigarette manufacturer in the United States. As we move forward in the balance of 2014, we will continue to focus on building profitable growth with our Pyramid and Eagle 20's brands while selectively expanding ZOOM distribution. At the same time, we will work to assure that costs are controlled effectively to maximize profits. We are very pleased with our operational and financial performance in the first nine months of the year as well as with our market position. We have effective programs in place to support our volume base and we look forward to continuing to build upon our long-standing success. Thanks for your attention and back to your 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, have consistently grown our profit margins in recent years and will continue to benefit for our favorable terms under the MSA. Additionally, we are very proud of the company's uninterrupted track record of paying a regular quarterly cash dividend since 1995 and 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 will come from Ken Bann with Jefferies & Company.

[Ken Bann:]

Could you tell me, in the volume decline, was that mostly in Pyramid or could you give us some context about the decline in Pyramid and some of your other brands during the quarter?

[Ron Bernstein:]

Yes. The largest percentage decline comes from our non-focus brands like Liggett Select and Grand Prix. Those are brands that we have been taking margin on for some time and sit at price points that are going to lead to declines over the long term. They continue to deliver significant profit to the company so we are satisfied with it. In addition to that, our partner brands are -- several of the partner brands declined at rates that were more significant than our core brands, and that’s where the bulk came from.

[Ken Bann:]

Okay. And can you give us any information on how Eagle 20's is growing in terms of volume? It seems like it's about the same number of stores as last quarter but is the volume picking up?

[Ron Bernstein:]

Yes. The volume is picking up and we expect to pretty much double volume year-over-year this year and it's continuing to grow at a rapid pace. The point that I made in my comments is that the price point that it's at is both attractive and sustainable, and the sustainable part of that is the most important.

[Ken Bann:]

Right. Great. And on the real estate side, were there any other investments made in individual projects on the real estate side during the quarter?

[Howard Lorber:]

BK, you have that list?

[Bryant Kirkland:]

Yes. We made about $20 million in investments during the quarter. The most significant new investments -- most of those were add-on investments -- the most significant new investment was the [125 Grannet Street] (ph), which is a joint venture with BC and [Michael Shroud](ph).

[Ken Bann:]

Okay. And I missed the number you said of, what's the cash at Douglas Elliman?

[Bryant Kirkland:]

$96 million.

[Ken Bann:]

96?

[Bryant Kirkland:]

Yes.

[Operator:]

Our next question will from Ian Zaffino with Oppenheimer and Company.

[Ian Zaffino:]

Just focusing on DE for a minute. Can you just go through how you feel about margins here? Where do you think margins can go to? It seems like you're starting to see some leverage in the model. So if you can just kind of talk about the potential margins and also what new markets you might be entering. Thanks.

[Howard Lorber:]

So the margins, actually our margins are pretty good. What tends to happen, I think as the prices get higher, the market gets stronger, as what you see is that the better brokers do more of the business. So what happens then when you look at a tiered commission payout based on how much production they do. Our average commission payout creeps up a little bit. So sometimes that affects it. But the market has been quite strong. Probably a little quiet after Labor Day this year with holidays, Jewish holidays, and I think that that has changed. And other than the weak, the very bad market a few weeks ago, I think showings are up, traffic is up in our new projects. So it's going pretty much in the right direction at this particular point. I think as far as new markets, what we have spoken about is entering -- we are in L.A. already and we are moving pretty well there, recruiting brokers and also trying to do new projects there which is very exciting. We just signed up one. We are both going to do the sales and then invest in a project with Ian Schrager in Hollywood, which will be a hotel and condominiums on top which is sort of his model. Very excited about that. And the margins on new development projects are better than the margins -- from the brokerage side are better than regular resale brokerage. So that will help our California operation. We will probably open in Aspen before the end of the year. Aspen is not the type of market you can make a lot of money in on resale. It's a small market. But there are new projects in the works in Aspen and it just sort of is where our customer base tends to circulate. And that’s sort of where we are picking where to be. We will be opening in [Greenwich] (ph), I think that we have just signed or about to be signed. And then when you look at, again when you look at the map, we are in city, we are in the boroughs, we are in Long Island, we are in the Hampton. We are in South Florida from Miami, Fort Lauderdale, Boca Raton, Palm Beach, L.A., Aspen, Fairfield County. And that sort of is pretty much it as to where we feel the same customers to tend to congregate. We may consider something in New Jersey in the Bergen County area, Saddle River, Alpine, around there where again there is a lot of the same customers.

[Operator:]

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