Vector Group Ltd

NYSE:VGR

Earnings Call Transcript 2021-Q4

[Operator]

Welcome to Vector Group Ltd's Fourth Quarter and Full Year 2021 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 to 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. 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 details 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.

[Howard Lorber, President & Chief Executive Officer]

Good afternoon, and thank you for joining us on our fourth quarter 2021 earnings conference call. With me today are Richard Lampen, our Chief Operating Officer; Bryant Kirkland, our Chief Financial Officer; and Nick Anson, President and Chief Operating Officer of Liggett Vector Brands. Ron Bernstein, Senior Advisor to Liggett Vector Brands will join us during the Q&A. During this call, I will review Vector Group's consolidated financial results for the fourth quarter. Nick will then summarize the performance of our tobacco business. I will then provide closing comments and open the call for questions. Before reviewing Vector Group's consolidated financial results, please note as a result of the spin-off, Douglas Elliman's financial results have been presented as discontinued operations in our consolidated financial statements and are not included in the discussion of adjusted results. Now, turning to Vector Group's consolidated balance sheet. At December 31, 2021, our balance sheet remains strong. We maintained significant liquidity with cash and cash equivalents of approximately $193 million, including cash of $15 million at Liggett. We also held investment securities and investment partnership interest with a fair market value of approximately $200 million at December 31, 2021. Turning to Vector Group's consolidated results from operations for the three months ended December 31, 2021 Vector Group's revenues were $313.7 million, compared to $287.1 million in the 2020 period. The increase in revenues was primarily driven by a $20.5 million increase in tobacco revenues. Net income attributed to Vector Group was $45.3 million, or $0.29 per diluted common share compared to $32.3 million or $0.21 per diluted common share in the fourth quarter of 2020. Net income from continuing operations attributed to Vector Group was $30.7 million or $0.20 per diluted common share, compared to $21.8 million or $0.14 per diluted common share in the fourth quarter of 2020. The Company recorded adjusted EBITDA from continuing operations of $84.3 million compared to $76.7 million in the prior year period. Adjusted net income from continuing operations was $41.4 million, or $0.26 per diluted share compared to $22.1 million, or $0.14 per diluted share in the 2020 period. Moving on to results for the year ended December 31, 2021 Vector Group's revenues were $1.22 billion compared to $1.23 billion in the 2020 period. Net income attributed to Vector Group was $219.5 million, or $1.40 per share – diluted share compared to $92.9 million or $0.60 per diluted common share in the 2020 period. Net income from continuing operations attributed to Vector Group, was $147.2 million or $0.94 per diluted common share compared to $126.9 million, or $0.83 per diluted common share in the 2020 period. The Company recorded adjusted EBITDA from continuing operations of $349.9 million compared to $311.4 million in the prior year. Adjusted net income from continuing operations was $174.8 million or $1.12 per diluted share compared to $129.9 million or $0.85 per diluted share in the 2020 period. I will now turn it over to Nick to discuss our tobacco operations. Nick?

[Nick Anson]

Thank you, Howard, and good afternoon, everyone. Liggett continued its strong performance during the fourth quarter delivering an increase in both retail market share and operating income. Our long-term business strategy continues to prove successful in a competitive marketplace with Eagle 20's delivering significantly higher margins and Pyramid continue to deliver both substantial profit and market presence to the Company. We are also pleased with the performance of our price sliding brand Montego, as we expand distribution of the brand into additional geographies across the country. Inflation continued to rise during the fourth quarter, increasing financial pressure on many cigarette smokers. As a result, we saw a continued shift to the discount segment as consumers search for value with their cigarette purchases. Based on Management Science Associates data for the three months ended December 31, 2021, the discount category represented 27.3% of the total market compared to 26.5% for the same period a year. Within the discount category, we continue to see momentum and growth for brands priced at the low-end of the value chain. For the fourth quarter, we estimate the low end or the deep discount segment comprised approximately 38% of the total discount category compared to 31% in the same period a year ago. It is important to note that there is a great deal of pricing disparity within the discount segment. Discount brands such as Pall Mall, L&M, Chesterfield and Lucky Strikes are priced in an average national retail price range of $5.40 to $6.90 per pack while deep discount brands such as Montego, LD, Montclair, Sonoma and this range from $3.80 to $4.30 per pack. As the deep discount segment continues to offer a more attractive value -- for consumers, we expect consumer down trading will continue for the foreseeable future. As such, we remain confident that our value-focused brand portfolio and broad national distribution position us well to meet evolving market demands. In December, we received news that KT&G was suspending its US cigarette operations. While the suddenness of the announcement came as a surprise, we along with others have been engaged in efforts for some time to highlight relevant authorities KT&G's being activity of dumping excessively cheap cigarettes in the US. As a reminder, in December 2020, the Department of Commerce announced it had determined KT&G to be illegally dumping cigarettes into the US. With a market share of 2.8%, KT&G's exit from the US offers us a significant opportunity. Our time and expansion of Montego in 2021 along with the strong capabilities of our sales organization ensure we are well positioned to capitalize on KT&G's exit. I will now turn to the combined tobacco financials for Liggett Group and Vector Tobacco. For the three months and year ended December 31, 2021 revenues were $306.6 million and $1.2 billion respectively compared to $286.1 million and $1.2 billion for the corresponding 2020 periods. Tobacco operating income for the three months and year ended December 31, 2021 was $83.8 million and $360.3 million compared to $79.7 million and $319.5 million for the corresponding periods in 2020. Tobacco adjusted operating income for the three months and year ended December 31, 2020 was $84 million and $357.8 million compared to $80 million and $320.2 million for the corresponding period a year ago. As noted on previous calls in the second half of 2018, we adjusted the focus of our Eagle 20's brand from volume to margin growth. This has enabled us to significantly increase earnings over the past two years while continuing to maintain strong market presence. Specifically, we have increased tobacco operating income by $98 million over our 2019 tobacco operating income of approximately $262 million. This represents a compounded annual EBIT growth rate of about 17% over the two year period. Liggett's fourth quarter earnings increase was primarily the result of higher gross profit margins associated with higher volumes increased pricing and promotional spending efficiencies offset by higher master settlement agreement expense associated with an increased inflation escalator. While our business has not been immune from the effects of increased inflation, our operational cost base remains stable. As a reminder, with respect to our MSA costs, the inflation impact is mitigated by the fact that nearly 50% of our current volumes are exempt from payment due to our perpetual MSA grandfathered market share. Liggett's retail shipments for the three months ended December 31, 2020 declined 3% from the year ago period, while industry retail shipments decreased 6.7% during the same period. As a result, Liggett's fourth quarter retail share increased to 4.37% from 4.2% in the corresponding period a year ago. Sequentially, Liggett's retail share increased by 16 basis points in the fourth quarter over the third quarter. For the full year, Liggett experienced a small decline in retail market share which was anticipated based on the execution of our income growth strategy with Eagle 20's and the timing of the expansion of Montego distribution. As discussed during previous calls with the expansion of Montego, we expected the temporary loss of market share to abate and that retail share would emerge in the second half of 2021. At this point, we remain pleased with the retail response to Montego. The brand's presence has expanded to approximately 50,000 stores, a 36% increase over the third quarter. Montego is competitively priced in the growing deep discount segment and we continue to expand the brand's market presence. We estimate Montego's retail share of the deep discount segment in the fourth quarter was approximately 10% compared to 4% in the same period a year ago. Our strategy with Montego is consistent with our long-term objective of optimizing profit through the effective management of volume, pricing and market share growth. Regarding the current regulatory environment recently the FDA indicated they remain on track to issue a preliminary ruling in the spring regarding the use of menthol as a characterizing flavor in cigarettes. For the year ended December of 2021, menthol cigarettes represented 19% of Liggett's total retail sales volume compared to 36% of the total industry. As we have previously noted this issue has been considered by the FDA since 2009. And by statute the agency is required to apply a scientific approach to their ruling and any question involving public health. They also required to evaluate potential unintended consequences of any decision. There are many open issues and conflicting scientific data regarding menthol in cigarettes and we believe it will likely take years before this complex issue is resolved. In summary, we remain pleased with the operational and financial performance of our tobacco business. Our full year 2021 and fourth quarter results continue to validate our strategy and reflect the competitive strength we have in the discount segment including our broad-base of distribution, consumer-focused programs and the scope and capabilities of our sales force. Finally, while we are always subject to industry, regulatory and general market risks, we remain confident that we have effective programs and infrastructure in place to keep our business operating efficiently and delivering both market share and long-term profit growth from our value-based brand portfolio. Thanks for your attention. And back to you, Howard.

[Howard Lorber, President & Chief Executive Officer]

Thank you, Nick. Vector Group had an outstanding fourth quarter and 2021 underscored by a successful tax-free spin-off of Douglas Elliman and record operating income in our Tobacco segment. We have strong cash reserves and have consistently increased our tobacco market share and profits over the long-term. We are pleased with our long-standing history of paying a quarterly cash dividend. It remains an important component of our capital allocation strategy and it is our expectation that our policy will continue into the future. Now operator, please open the call for questions.

[Operator]

Thank you. At this time, we will open the floor for questions. [Operator Instructions] Our first question comes from Karru Martinson with Jefferies.

[Karru Martinson, Jefferies]

Good afternoon. Just start with housekeeping. What was the -- sorry, apologies, if I missed it, secured debt and total debt here?

[Howard Lorber, President & Chief Executive Officer]

B.K.

[Bryant Kirkland, Chief Financial Officer]

Yes. Hi. Good morning, Karru. How are you? Good afternoon.

[Karru Martinson, Jefferies]

Doing well.

[Bryant Kirkland, Chief Financial Officer]

Total debt is $1.43 billion. Secured debt is $875 million.

[Karru Martinson, Jefferies]

Okay. Thank you very much. And when you look at the pricing, as you stated, the inflationary pressures on the consumer, are you seeing any move down Lucky Strike and others from that $5.40 to $6.90 more into your range to try to pick up market share, or is it still a margin game for them?

[Howard Lorber, President & Chief Executive Officer]

No. As I mentioned in the remarks there, we are certainly seeing down trading from the premium segment into the discount segment. And within that discount segment itself, moving between kind of the mid-tier down to the low end. So we feel very, very good about where Montego is positioned at the moment to take advantage of these movements going on in the discount segment and the down trading to the low end. So the expansion last year to more states and at the end of 2021 to about $0.35 -- 35 states has positioned the brand well to take advantage of that down trading.

[Karru Martinson, Jefferies]

And just on the -- I think I heard KT&G exit from the U.S. market, the 2%. What's the timetable for securing those slots at the doors? And how should we think about that flowing in through the course of the year?

[Howard Lorber, President & Chief Executive Officer]

Sure. Well, I don't want to go into too much specifics on the numbers. But, again, they exited the market at the end of December. There was some pretty significant wholesale and retail inventories. So they've started to burn off over the course of January and February. And now we're starting to see some significant movement to other low end brands. I think and our Montego brand, specifically, at the price that it is and the distribution at that -- that it is at the moment is very well placed to take advantage of that particular opportunity that's opened up in the low end. That's -- that movement to other brands is happening now.

[Karru Martinson, Jefferies]

Thank you very much. Appreciate it.

[Operator]

And our next question comes from Pallav Mittal with Barclays.

[Pallav Mittal, Barclays]

Hi. I just wanted to check, so Vector has generally built volume first on any new brand launches and then maximize profit, as you also spoke on Eagle right now. So is it fair to believe that the strategy remains the same with Montego, or because of the higher pricing environment in the industry, will that change rather quickly compared to Pyramid and Eagle in terms of profit maximization?

[Howard Lorber, President & Chief Executive Officer]

Sure. Yes, absolutely. Look, we've certainly employed this strategy before. Absolutely. We don't have any other brand launches planned outside of Montego. That's our price fighter at the moment. That's our focus on the low end. And as we -- I talked about in my prepared remarks, we continue to focus on income strategy with Eagles to support Eagle from a volume perspective in the low end with Montego. And again, we're taking advantage of what we're seeing is both kind of macro opportunities with general down trading into the low end and into the discount segment. And, obviously, on a more micro level within the low end, the KT&G opportunity is tremendous for us, not just from a kind of volume perspective, but also within leading the market. We're certainly hoping for a more rational pricing environment down there and that will obviously help us in the long-term from a profitability perspective.

[Ron Bernstein, Senior Advisor to Liggett Vector Brands]

This is Ron. I just want to add, over the course of the last, really, 20 years, we've launched four different brands into the deep discount segment. The circumstances around each of those brands or the circumstances in the market were always different. But the underlying strategy of the Company is always the same, which is, to use the brands, to support one another, to build up a volume base and ultimately to grow the profit base.

[Pallav Mittal, Barclays]

Sure. That did help. Can you also please talk about the minimum price ruling in Colorado? At what stage is the case right now? I very recently saw that the first appeal was denied by the judge. So where are we in that case right now?

[Howard Lorber, President & Chief Executive Officer]

Yeah. There's no real uptake from the last quarter with respect to that. I mean, we're continuing our litigation efforts in the state as we've talked about before. We still believe the legislation to be both anticompetitive and unconstitutional. But the litigation itself is moving slowly through the courts and the federal case there the state moved to dismiss the case. And we're still awaiting a ruling on that. But in the interim though, we're navigating the legislation and have done for the last year in the marketplace. And despite the challenging environment, very pleased with our performance over the course of this last year, specifically as it relates to our Pyramid high-margin brand.

[Pallav Mittal, Barclays]

So because this came into effect on 1st Jan, so right now there is no business in Colorado for Vector at the moment?

[Howard Lorber, President & Chief Executive Officer]

No, no. We're still operating in Colorado. This was simply a minimum price but it -- which essentially raised the price of cigarettes to a minimum of $7 per pack. We can still operate there. What -- what the effect was that our lower end brands like Pyramid and Eagle 20's were raised to that price. So we are still operating in the state of -- Colorado and our business is continuing to do well there.

[Pallav Mittal, Barclays]

Sure. Thank you.

[Operator]

And our next question comes from David Levine with Mid-Ocean Credit Partners.

[David Levine, Mid-Ocean Credit Partners]

Hi. Thank for taking my questions. First question, just around gross margin, I noticed that the gross margin rate was down a couple of hundred basis points, just given better revenue and raising price I would have thought maybe it would be a little better. Can you kind of just speak to the drivers of why the gross margin rate might have been down?

[Howard Lorber, President & Chief Executive Officer]

Nick?

[Nick Anson]

Sure. That we expected and that -- that was in line with the drive to expand Montego. Montego is a lower-priced brand. It is the -- as we expand that brand obviously that will impact the mix on our gross profit margins. But this is a strategy that we've employed before. But again, ultimately, the long-term objective here is to optimize our profit and we do that through balancing both, pricing, volume, and share. So even though we might be seeing a temporary decline in our margins ultimately the strategy as we proved successful with the four brand launches that Ron alluded to earlier, we certainly anticipate ultimately growing profits [Technical Difficulty] for the long-term based on this -- based on this strategy.

[David Levine, Mid-Ocean Credit Partners]

Yeah. That's helpful. Is the gross margin rate in this quarter like the right way to think about it with the Montego mix or probably not because Montego is going to become a larger percent of the share? So they're probably expected to be -- to moderate a little more?

[Howard Lorber, President & Chief Executive Officer]

It would moderate. And I would also point out that certainly the margins this quarter for the fourth quarter were kind of hit this report and disproportionately by the MSA effect, by the inflation that we had to adjust for the end of this year versus actually favorable MSA expense at the end of last year. So the margins at the end of this year in the fourth quarter are certainly impacted kind of by this one-time event in the MSA expense cost.

[David Levine, Mid-Ocean Credit Partners]

Got you, got you. That makes sense. Around price increases for this year, do you guys feel comfortable continuing to take price this year despite some of the trade down so you're probably taking share? But just wanted your thoughts around the typical kind of two or three price increases that -- that one would think, you'd expect for the year?

[Howard Lorber, President & Chief Executive Officer]

Yeah. So I would say for the last few years as industry volumes have declined we've seen more frequent and higher industry price increases PM, Philip Morris and Reynolds have clearly indicated that they plan to continue significantly investing in their reduced risk products. So -- and they're using their conventional cigarette businesses to fund these ventures. So certainly for the foreseeable future we don't see a change in this approach. But I think it's important to note that with respect to Liggett, it's important to understand that we don't necessarily take pricing on our entire brand portfolio. The decisions take pricing depends on a number of several factors including where our brand is in its life cycle and price gaps to key competitors. So -- and even brands that we take pricing we may trade back some of that increase based on specific geographic market dynamics. But -- so the bottom line is our pricing actions are consistent with our objective to maximize long-term profit through not only pricing but volume and share. And we are constantly evaluating those and balancing those value drivers and we'll continue to do that over the course of this year.

[David Levine, Mid-Ocean Credit Partners]

That’s great. And then just last one for me. Is there a point where like gas prices get so high where it becomes a headwind for everybody like even a deep discount where folks might just say I'm not even making the trip? And do you have any kind of perspective around that?

[Howard Lorber, President & Chief Executive Officer]

Well, I mean, certainly the increase in gas prices and well not only gas prices but energy and fuel prices are impacting the adult smoker and that's what's driving the -- certainly a big driver to down trading in the moment. But I mean we don't see a point at the moment where that's going to stop, but we'll obviously continue to keep an eye on that.

[David Levine, Mid-Ocean Credit Partners]

Okay. Thanks a lot. Appreciate it.

[Operator]

Ladies and gentlemen, those are all the questions that we have for today. Thank you for joining us on Vector Group's fourth quarter and full year 2021 earnings conference call. This will conclude our call. On behalf of all of us at Vector Group and Liggett we hope that everyone remains healthy and well. Thank you all for your participation and you may now disconnect.