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Edited Transcript of VGR earnings conference call or presentation 7-Aug-18 12:30pm GMT

Q2 2018 Vector Group Ltd Earnings Call

MIAMI Aug 17, 2018 (Thomson StreetEvents) -- Edited Transcript of Vector Group Ltd earnings conference call or presentation Tuesday, August 7, 2018 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Howard M. Lorber

Vector Group Ltd. - President, CEO & Director

* James Bryant Kirkland

Vector Group Ltd. - Senior VP, CFO & Treasurer

* Ronald J. Bernstein

Vector Group Ltd. - President & CEO of Liggett and Director

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Conference Call Participants

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* Karru Martinson

Jefferies LLC, Research Division - Analyst

* Mark Zhang

Oppenheimer & Co. Inc., Research Division - Associate

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Presentation

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Operator [1]

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Welcome to Vector Group Ltd.'s Second Quarter 2018 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 operator income (sic) [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'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'd like to turn the call over to the President and Chief Executive Officer of Vector Group, Howard Lorber.

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Howard M. Lorber, Vector Group Ltd. - President, CEO & Director [2]

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Good morning, and thank you for joining us for Vector Group's Second Quarter 2018 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 Chief Financial Officer.

I will provide an update on our business and review Vector Group's performance for the 3 and 6 months ended June 30, 2018. Vector's financial performance includes the company's adoption of several new accounting standards in 2018 that are discussed in the company's press release issued this morning. 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.

Vector Group maintained significant liquidity, with cash and cash equivalents of approximately $322 million, which include cash of $81 million at Douglas Elliman and $54 million at Liggett. We also had investment securities and investment partnership interest with a fair market value of approximately $304 million as of June 30, 2018.

Now let's turn to Vector Group's key financials. For the 3 months ended June 30, 2018, Vector Group's revenues were $481.5 million compared to $472 million in the 2017 period. The company recorded adjusted EBITDA of $65.1 million compared to $76.8 million in the 2017 period. Adjusted net income was $26.4 million or $0.19 per diluted share compared to $32.7 million or $0.24 per diluted share in the 2017 period. The company recorded adjusted operating income of $60 million compared to $74.8 million in the 2017 period.

For the 3 months ended June 30, 2018, Douglas Elliman reported approximately $205.6 million in revenues and adjusted EBITDA of $8.4 million. This compared to revenues of $198.7 million and adjusted EBITDA of $18.2 million in the comparable 2017 period.

Vector Group's revenues for the June 30, 2018, period were $910.5 million compared to $887.2 million in the 2017 period. For the 6 months ended June 30, 2017, adjusted EBITDA was $118 million compared to $138.6 million for the year-ago period -- I think that's a mistake. It's -- that's 6 months, June 30, 2018, adjusted EBITDA was $118 million compared to $138.6 million for the year-ago period.

Adjusted net income for the 6 months ended June 30, 2018, was $34.4 million or $0.23 per diluted share compared to $51.2 million or $0.36 per diluted share in 2017. The company recorded adjusted operating income of $102.5 million in the 6 months ended June 30, 2018, compared to $129.3 million in the 2017 period.

For the 6 months ended June 30, 2018, Douglas Elliman reported approximately $365 million in revenue and an adjusted EBITDA loss of $200,000. This compared to $354.2 million and adjusted EBITDA of $20 million in the comparable 2017 period.

I will now turn the call over to Ron to discuss our tobacco business. Ron?

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Ronald J. Bernstein, Vector Group Ltd. - President & CEO of Liggett and Director [3]

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Thanks, Howard. Good morning, everyone. I'm pleased to report that Liggett continued its trend of volume and share growth during the second quarter and first half of 2018. As previously noted, over the past few years, based upon changes occurring in the industry, we made a commitment to invest for volume growth. As 2018 has progressed, we've maintained that commitment, and we continue to see further growth opportunities in the cigarette market. We're very pleased with the results achieved thus far in 2018.

With respect to product liability litigation, although Liggett has resolved all but approximately 75 Engle progeny cases and 25 non-Engle individual actions, as we always caution, we may still be subject to periodic adverse verdicts.

I'll now turn to the combined tobacco financials for Liggett and Vector Tobacco. For the 3 and 6 months ended June 30, 2018, Liggett revenues were $274.8 million and $541.9 million compared to $272.2 million and $529.6 million for the corresponding periods in 2017. Tobacco adjusted operating income for the 3 and 6 months ending June 30, 2018, was $60.2 million and $120.2 million compared to $64.4 million and $124.7 million for the corresponding periods in 2017. The quarterly and year-to-date decrease in tobacco adjusted operating income is primarily the result of timing issues related to MSA expense accruals, which will reverse in the second half of the year and an increased year-over-year industry decline estimate.

Our selling efforts continue to be focused on 2 core brands: Eagle 20s, now the third-largest and still the fastest-growing national discount brand, and PYRAMID, the fifth-largest national discount brand. Eagle 20s continues to provide an effective long-term complement to PYRAMID while offsetting volume declines in PYRAMID and other Liggett brands. Eagle 20s' growth is represented nationwide, and the brand is now sold in over 67,000 stores. Though we've increased prices on Eagle 20s, the brand continues to grow and remains well positioned for continued expansion. Likewise, despite anticipated volume declines, we're 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 110,000 stores.

Regarding recent industry shipment trends. Following robust industry shipment performance in 2015, industry-wide declines returned to historical norms over the past 2 years, and we anticipate that shipments will decline in the range of 4.5% to 5% in 2018. The industry remains challenging, and in recent years, to offset declines in their core premium brands, we've seen Altria and Reynolds increase their focus on discounted line extensions of those brands. This has resulted in the development of a premium economy price segment, including brands such as Marlboro Special Blend, Newport Red and various Camel extensions. The price of these premium economy brands is typically above standard discount products and has had little effect on the discount segment to date.

Regarding smaller discount-focused companies. The cumulative effect of price increases has generally slowed the growth of many brands, which has proven beneficial to us. However, over time, targeted deep-discount brands continue to emerge in various geographies as smaller competitors search for growth opportunities. Additionally, while low-priced products such as mislabeled pipe tobacco and filtered cigars continue to adversely impact the marketplace, those categories have been in decline for the past few years. Recently, there has been a lot of noise about vapor and other noncombustible products. However, to date, we have seen little to no impact on the discount combustible segment of the market.

According to Management Science Associates, Liggett's wholesale shipments in the second quarter increased by over 0.5% on a year-over-year basis, while overall industry wholesale shipments decreased by 8.2%. While I'm pleased that Liggett's wholesale shipments have significantly outperformed our major national competitors, I'll remind you, as I do each quarter, that we believe retail shipments are a more reliable indicator of performance. This is due to individual company shipment fluctuations, the timing of price increases and wholesaler buying patterns, among other things.

And I'm pleased to report that Liggett's year-over-year retail shipments increased by 4.3% in the second quarter compared to an overall industry decline of 2.7%. We were once again the only nationally focused major cigarette manufacturer to register an increase in retail shipments during the quarter. As a result, Liggett's second quarter retail market share increased by 26 basis points compared to the prior year period, and our share is now 4.1% of the total market.

We're pleased with our performance. And as we look ahead, we plan to continue to focus on generating operating income from the strong sales and distribution base of PYRAMID while delivering volume share and profit growth from Eagle 20s. We remain subject to regulatory and marketplace risks but are confident that we have effective programs in place to support our market share and continue to grow profit.

Thanks for your attention, and back to you, Howard.

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Howard M. Lorber, Vector Group Ltd. - President, CEO & Director [4]

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Thank you, Ron. As I noted at the start of the call, we continue to believe that Vector Group is well positioned to generate long-term value for shareholders. We have strong cash returns, have consistently increased our tobacco profit margins and sales volumes in recent years and continue to benefit from favorable terms under the MSA, and our Real Estate business continues to be well positioned for success.

We are 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?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Karru Martinson of Jefferies.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [2]

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When I look at the tobacco side on the margin front, EBITDA margin, I think was down about 180 basis points. Could you possibly break out how much of that was the kind of the investments for the further growth and how much was kind of those MSA expense accruals that will reverse in the second half?

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Ronald J. Bernstein, Vector Group Ltd. - President & CEO of Liggett and Director [3]

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Yes. Virtually all of it was the MSA accrual issue. Basically, just to explain that, the estimate that we make at the beginning of the year relative to volume is what the MSA accrual is based on. And last year, we outperformed our original estimate from the beginning of the year. So as a result, in the first half of the year, we underaccrued, and then we compensated for that in the second year (sic) [half]. So on a year-over-year basis, the accrual this year is much greater in the first half than it was in the first half last year because we're running at a rate that is comparable to what we did last year. So that will reverse. And the other part of it is that as industry volume declines greater than 3-some-odd percent, we then -- it takes a hit to industry volume, which affects our calculation, which would reduce earnings by probably -- if volume were to come in -- if the industry were to decline 5% this year, it would cost us about $1.8 million of cap value.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [4]

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Okay. And just on the real estate side, just trying to understand, sales are up, EBITDA down sharply on that front. I mean, as a commission-based business, what's driving the step-up in costs there?

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Howard M. Lorber, Vector Group Ltd. - President, CEO & Director [5]

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Well, one area is the lack of really much revenue on the new development side. We do expect more of that starting this quarter, third quarter. But also, it's a little bit misleading from the point of view is that the increases in volume have happened for 2 reasons basically. Number one, Florida is just stronger, okay, but Florida is a lower-margin place to do business than New York City. And California now includes the acquisition of Teles, which adds to the volume. So it's not that the great -- you have to really look at the details of it. I know also that California is also a low stake. The place where the bulk of the money is made traditionally has always been in New York.

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Karru Martinson, Jefferies LLC, Research Division - Analyst [6]

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And then I think last quarter, we talked about seeing prices perhaps coming down 10% to 15%, kind of resetting the market, realigning sellers and buyers. Where are we today on that realignment?

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Howard M. Lorber, Vector Group Ltd. - President, CEO & Director [7]

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It really hasn't happened on an overall basis, although there are individual situations; all the brokers talk about where they are getting their clients to reduce the prices that are (inaudible) selling. They're putting on prices maybe even a little too low, and then all of a sudden there's bidding wars. So it's hard to really put a date, a timing on when's it going to happen, but I would imagine, by the end of this year, it would start to -- start cleaning out, and we go into a better year next year or sometime during next year. Look, we're -- this is -- the one thing about the real estate business and the brokerage business, especially in a real estate business, is it's a cyclical business. And we've had big run-offs, and now this is the adjustment phase. There is no financial crisis. It's nothing obviously like that. There are still big sales being made. You'll see sales being made at every price point. It's just a matter of a readjustment of the run-offs that we've had.

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Operator [8]

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Our next question comes from Ian Zaffino of Oppenheimer.

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Mark Zhang, Oppenheimer & Co. Inc., Research Division - Associate [9]

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This is Mark Zhang for Ian. Just to start off, just going back to tobacco quickly, do you guys expect additional investments in the Eagles? And is this something that we could see impacting margins going forward?

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Ronald J. Bernstein, Vector Group Ltd. - President & CEO of Liggett and Director [10]

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The marketplace has been pretty receptive to growth opportunities for us. And as I always say, when the market is offering opportunities, you need to take them. So we are, in a measured way, looking at opportunities to continue to grow Eagle. And our expectation is that during the second half of the year, we will have some of those opportunities. So we're going to be making selective investments. And our objective is continuing to build the brand, and that may incorporate some additional spending during the second half of the year.

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Mark Zhang, Oppenheimer & Co. Inc., Research Division - Associate [11]

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Okay, great. That's fair. And then in terms of, I guess, like price increases, the next price increase should come during the third quarter?

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Ronald J. Bernstein, Vector Group Ltd. - President & CEO of Liggett and Director [12]

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Typically, that's the case. Obviously, we don't operate in a vacuum, so we have to evaluate what's going on in the market. But typically, we've been over -- the last many years now, we've seen price increases twice a year, typically in March or April and then September-October time frame.

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Mark Zhang, Oppenheimer & Co. Inc., Research Division - Associate [13]

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Got it, got it. Okay, that's terrific. Okay, and then in terms of -- on Douglas Elliman, can you guys just provide an EBITDA walk there just in terms of the puts and takes for the quarter there?

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Howard M. Lorber, Vector Group Ltd. - President, CEO & Director [14]

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B.K., you want to walk through that?

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James Bryant Kirkland, Vector Group Ltd. - Senior VP, CFO & Treasurer [15]

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Okay. Mark, let's take quarter first. So EBITDA declined from $18.3 million to $8.4 million. And the one point I want to make very clear is under the revenue recognition standards that existed prior to 2018, Elliman would have reported an additional $2.9 million of EBITDA for the 3 months ended June 30, 2018, so we would have been at $11.25 million. As far as of the reconciliation of the decline in EBITDA, using the 2018 gross margin percentages, our increased commission revenues increased gross margin by about $1.8 million, but then we had a $7.2 million decline associated in the lower margins, which reflected the shift in elements business sales mix from New York City to Florida and California. Expenses are up about $4.5 million for the quarter, but that -- and that's on a net basis. And those are attributed to both expansion markets as well as inflation. As far as year-to-date, EBITDA declined from $20 million to a net loss of $200,000. Similar to the second quarter explanation, under the revenue recognition standards that existed prior to 2018, Elliman would have reported an additional $5.1 million of EBITDA for the 6 months ended June 30, 2018. So we would have had $4.9 million of EBITDA under the old recognition standards -- revenue recognition standards. As far as the change in EBITDA, the reconciliation of the $20 million difference is as follows. Using the 2018 gross margin percentages, increased commissions added about $2.8 million of gross margin for the 6-month period, but that was offset by a shift of about $14 million associated with lower margins, which, again, reflects the shift of Elliman's commission mix to lower margin profit -- lower-margin markets such as Florida and California. And then net expenses increased about $9 million, and that includes increases for both expansion markets like California as well as inflationary.

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Mark Zhang, Oppenheimer & Co. Inc., Research Division - Associate [16]

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Okay, great. That was very helpful. Okay, got it. And then just in terms of on real estate, I guess like is there anything on the monetization front that you guys could share, anything in the investment pipeline coming online in the near term?

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Howard M. Lorber, Vector Group Ltd. - President, CEO & Director [17]

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Yes, there's a few things. We have a couple of things. One thing on the contract to sell, which will provide that profit. I don't know the exact numbers yet. We really haven't made any new investment in the last quarter. Have we, B.K.?

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James Bryant Kirkland, Vector Group Ltd. - Senior VP, CFO & Treasurer [18]

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No. We -- Howard, we've been in the monetization mode.

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Howard M. Lorber, Vector Group Ltd. - President, CEO & Director [19]

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Yes.

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James Bryant Kirkland, Vector Group Ltd. - Senior VP, CFO & Treasurer [20]

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For the 6 months, we had net monetizations of $31 million.

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Howard M. Lorber, Vector Group Ltd. - President, CEO & Director [21]

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Right.

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James Bryant Kirkland, Vector Group Ltd. - Senior VP, CFO & Treasurer [22]

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$27 million of that was from the 20 Times Square project where we received the first payment. We received $4.3 million for The Marquand on 68th Street in Manhattan, $2.9 million from the 215 Chrystie or PUBLIC Hotel project and $1 million from the Dutch project. The only investments we've made have been in the Witkoff GP of about $4.5 million.

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Mark Zhang, Oppenheimer & Co. Inc., Research Division - Associate [23]

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Okay, terrific. That's very helpful. And then Bryant...

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Howard M. Lorber, Vector Group Ltd. - President, CEO & Director [24]

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There are other parts of the portfolio which are maturing, and we expect money pretty much every quarter. And we're not making any investments but will have positives because we still have leftover condos in our condo projects that we're selling, things like that. So we will have further cash distributions to us.

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Mark Zhang, Oppenheimer & Co. Inc., Research Division - Associate [25]

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Okay, great. That makes sense. And then, Bryant, just a couple of quick housekeeping questions. Can you just provide your shares outstanding and the tax rate and maybe interest expense expectations for the balance of '18?

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James Bryant Kirkland, Vector Group Ltd. - Senior VP, CFO & Treasurer [26]

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Okay. Let's take shares outstanding first. Fully diluted for computing EPS are 133 million shares, and fully diluted for computing equity are 136.2 million shares. Not included in those shares are 15.9 million associated with convertible debt that is due in January 2019, and there's a $14.50 conversion price on that, and 11.6 million associated with convertible debt that's due in April 2020, which has a $22.35 conversion price. Your next question was tax rate?

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Mark Zhang, Oppenheimer & Co. Inc., Research Division - Associate [27]

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Yes, correct.

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James Bryant Kirkland, Vector Group Ltd. - Senior VP, CFO & Treasurer [28]

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Okay. So for the quarter -- excuse me, for the 6 months, our tax rate was about 40%, and that was lowered by some cash benefits we received on taxes related to some of our real estate investments. Going out for the next 2 quarters, I'd expect the tax rate of around 46% but certainly in the 45% to 50% range. And as we've discussed on the previous several conference calls, the income tax rate is increased from the marginal rate of about 27.5% to the 46% because of a nondeductible interest expense that relates to interest expense in excess of 30% of our EBITDA. We're continuing to evaluate the guidance as issued under the 2017 act. New guidance is expected, and we'll adjust that as necessary going forward.

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Operator [29]

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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 all for your participation, and you may now disconnect.

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Howard M. Lorber, Vector Group Ltd. - President, CEO & Director [30]

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Thank you, everyone.