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Securities And Exchange Commission
Washington, D.C. 20549
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FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
VECTOR GROUP LTD.
(Exact name of registrant as specified in its charter)
DELAWARE 1-5759 65-0949535
(State or other jurisdiction of Commission File Number (I.R.S. Employer
incorporation or organization) Identification No.)
100 S.E. SECOND STREET
MIAMI, FLORIDA 33131
305/579-8000
(Address, including zip code and telephone number, including area code,
of the principal executive offices)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
[X] Yes [ ] No
At November 13, 2002, Vector Group Ltd. had 34,919,903 shares of common
stock outstanding.
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VECTOR GROUP LTD.
FORM 10-Q
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. VECTOR GROUP LTD. CONSOLIDATED FINANCIAL STATEMENTS:
Vector Group Ltd. Consolidated Balance Sheets as of September 30, 2002 and
December 31, 2001............................................................................. 2
Vector Group Ltd. Consolidated Statements of Operations for the three and nine months
ended September 30, 2002 and September 30, 2001............................................... 3
Vector Group Ltd. Consolidated Statement of Stockholders' Equity for the nine
months ended September 30, 2002............................................................... 4
Vector Group Ltd. Consolidated Statements of Cash Flows for the nine months ended
September 30, 2002 and September 30, 2001..................................................... 5
Notes to Consolidated Financial Statements.......................................................... 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................... 30
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................................... 44
Item 4. CONTROLS AND PROCEDURES........................................................................ 44
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.............................................................................. 46
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS...................................................... 46
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................................................... 46
SIGNATURE.............................................................................................. 48
CERTIFICATIONS......................................................................................... 49
- 1 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
September 30, December 31,
2002 2001
------------- ------------
ASSETS:
Current assets:
Cash and cash equivalents.................................................... $109,227 $217,761
Investment securities available for sale..................................... 145,395 173,697
Accounts receivable - trade.................................................. 11,790 34,380
Other receivables............................................................ 3,433 1,234
Inventories.................................................................. 94,109 53,194
Restricted assets............................................................ - 20,054
Deferred income taxes........................................................ 8,213 6,294
Other current assets......................................................... 12,419 9,113
-------- ---------
Total current assets..................................................... 384,586 515,727
Property, plant and equipment, net............................................. 128,779 102,185
Long-term investments, net..................................................... 11,138 10,044
Restricted assets.............................................................. 1,875 1,881
Deferred income taxes.......................................................... 11,215 9,778
Intangible asset............................................................... 107,511 -
Pension assets................................................................. 21,070 17,920
Other assets................................................................... 8,913 31,368
------- --------
Total assets............................................................. $675,087 $688,903
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Current portion of notes payable and long-term debt and other obligations.... $ 19,369 $ 4,808
Accounts payable............................................................. 15,871 16,192
Accrued promotional expenses................................................. 21,368 20,634
Accrued taxes payable, net................................................... 14,439 33,992
Settlement accruals.......................................................... 32,322 29,299
Deferred income taxes........................................................ 4,817 759
Accrued interest............................................................. 3,600 6,799
Prepetition claims and restructuring accruals................................ 675 2,700
Other accrued liabilities.................................................... 17,114 26,362
-------- --------
Total current liabilities................................................ 129,575 141,545
Notes payable, long-term debt and other obligations, less current portion...... 289,285 214,273
Noncurrent employee benefits................................................... 13,230 14,749
Deferred income taxes.......................................................... 138,696 132,528
Other liabilities.............................................................. 4,814 16,294
Minority interests............................................................. 47,884 56,156
Commitments and contingencies..................................................
Stockholders' equity:
Preferred stock, par value $1.00 per share, authorized 10,000,000 shares.....
Common stock, par value $0.10 per share, authorized 100,000,000
shares, issued 39,530,924 and outstanding 34,919,903....................... 3,491 3,317
Additional paid-in capital................................................... 297,641 309,849
Deficit...................................................................... (228,295) (182,645)
Accumulated other comprehensive income....................................... (2,901) 1,170
Less: 4,611,021 shares of common stock in treasury, at cost................. (18,333) (18,333)
-------- --------
Total stockholders' equity............................................... 51,603 113,358
-------- -------
Total liabilities and stockholders' equity............................... $675,087 $688,903
======= =======
The accompanying notes are an integral part
of the consolidated financial statements.
- 2 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenues:
Tobacco* ................................................ $ 141,714 $ 120,228 $ 378,285 $ 302,922
Real estate leasing ..................................... -- 2,538 661 7,604
------------ ------------ ------------ ------------
Total revenues ........................................ 141,714 122,766 378,946 310,526
Expenses:
Cost of goods sold* ..................................... 100,442 72,199 262,617 173,605
Operating, selling, administrative and general expenses . 40,958 33,511 136,718 89,509
Settlement charges ...................................... -- 56 (807) 9,853
------------ ------------ ------------ ------------
Operating income (loss) ............................... 314 17,000 (19,582) 37,559
Other income (expenses):
Interest and dividend income ............................ 2,342 3,537 7,743 7,777
Interest expense ........................................ (7,112) (5,824) (19,417) (9,134)
(Loss) gain on sale of investments, net ................. (62) (804) 1,715 (51)
Gain on sale of assets .................................. 345 415 9,029 2,187
Provision for uncollectibility of notes receivable ...... (13,198) -- (13,198) --
Other, net .............................................. 757 (305) 206 (428)
------------ ------------ ------------ ------------
(Loss) income from continuing operations before provision for
income taxes and minority interests ................... (16,614) 14,019 (33,504) 37,910
(Benefit) provision for income taxes .................... (1,972) 6,753 (5,643) 17,235
Minority interests ...................................... (6,476) (1,210) (4,490) (1,992)
------------ ------------ ------------ ------------
(Loss) income from continuing operations .................... (8,166) 8,476 (23,371) 22,667
------------ ------------ ------------ ------------
Discontinued operations:
Loss from discontinued operations ........................... -- (1,107) -- (2,231)
Gain on disposal of discontinued operations, net of
minority interests .................................... -- -- -- 1,283
------------ ------------ ------------ ------------
Loss from discontinued operations ........................... -- (1,107) -- (948)
------------ ------------ ------------ ------------
Net (loss) income ........................................... $ (8,166) $ 7,369 $ (23,371) $ 21,719
============ ============ ============ ============
Per basic common share:
(Loss) income from continuing operations ................ $ (0.23) $ 0.26 $ (0.67) $ 0.75
============ ============ ============ ============
Loss from discontinued operations ....................... $ -- $ (0.03) $ -- $ (0.03)
============ ============ ============ ============
Net (loss) income applicable to common shares ........... $ (0.23) $ 0.23 $ (0.67) $ 0.72
============ ============ ============ ============
Basic weighted average common shares outstanding ............ 34,920,140 32,520,237 34,915,109 30,123,183
============ ============ ============ ============
Per diluted common share:
(Loss) income from continuing operations ................ $ (0.23) $ 0.22 $ (0.67) $ 0.62
============ ============ ============ ============
Loss from discontinued operations ....................... $ -- $ (0.03) $ -- $ (0.03)
============ ============ ============ ============
Net (loss) income applicable to common shares ........... $ (0.23) $ 0.19 $ (0.67) $ 0.59
============ ============ ============ ============
Diluted weighted average common shares outstanding .......... 34,920,140 38,293,602 34,915,109 36,422,931
============ ============ ============ ============
- -------------
* Revenues and Cost of goods sold include excise taxes of $51,668, $41,496,
$144,858 and $105,806, respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
- 3 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Accumulated
Common Stock Additional Other
---------------------- Paid-In Treasury Comprehensive
Shares Amount Capital Deficit Stock Income (Loss) Total
---------- ---------- ---------- ---------- ---------- ------------- ----------
Balance, December 31, 2001 ............... 33,171,847 $ 3,317 $ 309,849 $ (182,645) $ (18,333) $ 1,170 $ 113,358
Net loss ................................. -- -- -- (23,371) -- -- (23,371)
Unrealized loss on investment securities -- -- -- -- -- (2,564) (2,564)
----------
Total other comprehensive loss ..... -- -- -- -- -- -- (2,564)
----------
Total comprehensive loss ................. -- -- -- -- -- -- (25,935)
----------
Distributions on common stock ............ -- -- (39,906) -- -- -- (39,906)
Effect of stock dividend ................. 1,662,619 166 22,113 (22,279) -- -- --
Exercise of options ...................... 85,437 8 1,188 -- -- -- 1,196
Tax benefit of options exercised ......... -- -- 526 -- -- -- 526
Amortization of deferred compensation, net -- -- 2,364 -- -- -- 2,364
Other, net ............................... -- -- 1,507 -- -- (1,507) --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, September 30, 2002 .............. 34,919,903 $ 3,491 $ 297,641 $ (228,295) $ (18,333) $ (2,901) $ 51,603
========== ========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part
of the consolidated financial statements.
- 4 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Nine Months Ended
-------------------------
Sept. 30, Sept. 30,
2002 2001
--------- ---------
Net cash (used in) provided by operating activities: $(35,602) $ 20,425
-------- ----------
Cash flows from investing activities:
Proceeds from sale of businesses and assets, net.. 2,642 8,599
Sale or maturity of investment securities ........ 70,161 10,634
Purchase of investment securities ................ (46,024) (159,381)
Purchase of long-term investments ................ (50,103) (5,747)
Sale or liquidation of long-term investments ..... -- 1,133
Purchase of real estate .......................... -- (1,213)
Sale of real estate .............................. 20,461 10,172
Increase in restricted assets..................... -- 1,306
Issuance of notes receivable, net................. (4,000)
Payment of prepetition claims .................... (2,025) (2,634)
Cash acquired in acquisition of LTS .............. -- 8,010
New Valley purchase of common shares ............. -- (274)
Purchase by New Valley of subsidiary common stock -- (3,945)
Capital expenditures ............................. (39,284) (47,357)
--------- ---------
Net cash used in investing activities .............. (48,172) (180,697)
-------- ---------
Cash flows from financing activities:
Proceeds from debt ............................... 37,635 255,167
Repayments of debt ............................... (10,355) (21,933)
Borrowings under revolver ........................ 467,016 358,330
Repayments on revolver ........................... (467,016) (377,704)
Deferred financing charges ....................... (930) (9,201)
Decrease in margin loan payable .................. -- (2,028)
Issuance of common stock ......................... -- 50,000
Distributions on common stock .................... (39,906) (34,024)
Proceeds from participating loan ................. -- 2,478
Repayment of participating loan................... (12,400) --
Proceeds from exercise of options and warrants ... 1,196 16,042
-------- ---------
Net cash (used in) provided by financing activities (24,760) 237,127
-------- ---------
Net cash provided by discontinued operations ....... -- 139
Net (decrease) increase in cash and cash equivalents (108,534) 76,994
Cash and cash equivalents, beginning of period ..... 217,761 157,513
--------- ---------
Cash and cash equivalents, end of period ........... $ 109,227 $ 234,507
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
- 5 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BASIS OF PRESENTATION:
The consolidated financial statements of Vector Group Ltd. (the
"Company" or "Vector") include the accounts of VGR Holding Inc. ("VGR
Holding"), Vector Tobacco Inc. ("Vector Tobacco"), Liggett Group Inc.
("Liggett"), New Valley Corporation ("New Valley") and other less
significant subsidiaries. The Company owned 56.2% of New Valley's
common shares at September 30, 2002. All significant intercompany
balances and transactions have been eliminated.
Vector Tobacco is engaged in the development and marketing of reduced
carcinogen and low nicotine and nicotine-free cigarette products.
Liggett is engaged primarily in the manufacture and sale of
cigarettes, principally in the United States. New Valley is currently
engaged in the real estate business through its New Valley Realty
division and is seeking to acquire additional operating companies.
As discussed in Note 3, a subsidiary of the Company acquired The
Medallion Company, Inc. on April 1, 2002.
As discussed in Note 9, New Valley's former broker-dealer operations
are presented for 2001 as discontinued operations.
The interim consolidated financial statements of the Company are
unaudited and, in the opinion of management, reflect all adjustments
necessary (which are normal and recurring) to present fairly the
Company's consolidated financial position, results of operations and
cash flows. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2001, as filed with the Securities and
Exchange Commission. The consolidated results of operations for
interim periods should not be regarded as necessarily indicative of
the results that may be expected for the entire year.
(b) ESTIMATES AND ASSUMPTIONS:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities and the reported amounts of revenues and
expenses. Significant estimates subject to material changes in the
near term include deferred tax assets, allowance for doubtful
accounts, promotional accruals, sales returns and allowances,
actuarial assumptions of pension plans, settlement accruals and
litigation and defense costs. Actual results could differ from those
estimates.
- 6 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
(c) RECLASSIFICATIONS:
Certain amounts in the 2001 consolidated financial statements have
been reclassified to conform to the 2002 presentation.
(d) EARNINGS PER SHARE:
Information concerning the Company's common stock has been adjusted
to give effect to the 5% stock dividends paid to Company stockholders
on September 28, 2001 and September 27, 2002. In connection with each
of the 5% dividends, the Company increased the number of warrants and
stock options by 5% and reduced the exercise prices accordingly. All
share amounts have been presented as if the stock dividends had
occurred on January 1, 2001.
The Company had a net loss for the three and nine months ending
September 30, 2002. Therefore, the effect of the common stock
equivalents and convertible securities is excluded from the
computation of diluted net loss per share since the effect is
anti-dilutive for the three and nine months ended September 30, 2002.
(e) COMPREHENSIVE INCOME:
Comprehensive income is a component of stockholders' equity and
includes such items as the Company's proportionate interest in New
Valley's capital transactions, unrealized gains and losses on
investment securities and minimum pension liability adjustments.
Total comprehensive loss was $25,935 for the nine months ended
September 30, 2002 and total comprehensive income was $20,938 for the
nine months ended September 30, 2001.
(f) NEW ACCOUNTING PRONOUNCEMENTS:
During 2000, the Emerging Issues Task Force issued EITF No. 00-14,
"Accounting for Certain Sales Incentives". EITF Issue No. 00-14
addresses the recognition, measurement and statement of operations
classification for certain sales incentives and became effective in
the first quarter of 2002. As a result, certain items previously
included in operating, selling, general and administrative expense in
the consolidated statement of operations have been recorded as a
reduction of operating revenues. The Company has determined that the
impact of adoption and subsequent application of EITF Issue No. 00-14
did not have a material effect on its consolidated financial position
or results of operations. Upon adoption, prior period amounts, which
were not significant, have been reclassified to conform to the new
requirements.
In April 2001, the EITF reached a consensus on Issue No. 00-25,
"Vendor Income Statement Characterization of Consideration Paid to a
Reseller of the Vendor's Products." EITF Issue No. 00-25 requires
that certain expenses included in operating, selling, administrative
and general expenses be recorded as a reduction of operating revenues
and was effective in the first quarter of 2002. The financial
statements reflect adoption of this accounting treatment. For
comparative purposes, prior period amounts have been
- 7 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
reclassified from operating, selling, administrative and general
expenses to a reduction of revenues. The adoption of EITF 00-25 did
not impact the Company's consolidated financial position, operating
income or net income.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations"
and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No.
141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001, establishes
specific criteria for the recognition of intangible assets separately
from goodwill and requires unallocated negative goodwill to be
written off. SFAS No. 142 primarily addresses the accounting for
goodwill and intangible assets subsequent to their acquisition. SFAS
No. 141 is effective for all business combinations initiated after
June 30, 2001, and SFAS No. 142 is effective for fiscal years
beginning after December 15, 2001.
In October 2001, FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 supersedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of", and requires (i) the
recognition and measurement of the impairment of long-lived assets to
be held and used and (ii) the measurement of long-lived assets to be
disposed of by sale. SFAS No. 144 is effective for fiscal years
beginning after December 15, 2001. The adoption of this statement did
not have any impact on the Company's consolidated financial
statements.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies EITF 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS
146 requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred as
opposed to EITF 94-3, which allowed a cost to be recognized when a
commitment to an exit plan was made. The provisions of this SFAS are
effective for exit or disposal activities that are initiated after
December 31, 2002. The Company will apply this statement
prospectively upon adoption.
2. LIGGETT VECTOR BRANDS
In March 2002, the Company announced that the sales and marketing
functions, along with certain support functions, of its Liggett and Vector
Tobacco subsidiaries would be combined into a new entity, Liggett Vector
Brands Inc. The newly formed company will coordinate and execute the sales
and marketing efforts for all of the Company's tobacco operations. As of
September 30, 2002, this reorganization was essentially complete. With the
combined resources of Liggett and Vector Tobacco, Liggett Vector Brands
has approximately 425 salespersons, and enhanced distribution and
marketing capabilities. Final reorganization matters are being completed
in the fourth quarter of 2002. In connection with the creation of the new
Liggett Vector Brands entity, the Company took a charge of $3,460 in
- 8 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
the first quarter of 2002, related to the reorganization of its business.
As of September 30, 2002, the Company's reorganization accrual has been
reduced by payments of $730 and the remaining balance was $2,730.
3. MEDALLION ACQUISITION
On April 1, 2002, a subsidiary of the Company acquired 100% of the stock
of The Medallion Company, Inc. ("Medallion"), and related assets from
Medallion's principal stockholder. The total purchase price consisted of
$50,000 in cash and $60,000 in notes, with the notes guaranteed by the
Company and Liggett. Medallion, a discount cigarette manufacturer
headquartered in Richmond, Virginia, is a participant in the Master
Settlement Agreement between the state Attorneys General and the tobacco
industry. Medallion has no payment obligations under the Master Settlement
Agreement except to the extent its market share exceeds approximately
0.28% of total cigarettes sold in the United States (approximately 1.15
billion units in 2001). The results of operations of Medallion are
included in the Company's financial statements beginning April 1, 2002.
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition.
AT APRIL 1, 2002
----------------
Receivable from seller...................... $ 3,189
Inventory................................... 1,019
Property, plant and equipment............... 2,181
Intangible asset............................ 107,511
-------
Total assets acquired................... 113,900
-------
Accrued merger costs........................ 300
Allowance for sales returns................. 500
Accrued MSA liability....................... 3,100
---------
Total liabilities assumed............... 3,900
---------
Net assets acquired..................... $ 110,000
=========
The $107,511 intangible asset, which is not subject to amortization,
relates to Medallion's exemption under the Master Settlement Agreement and
has been included with the Liggett segment for segment reporting purposes.
The following table presents unaudited pro forma results of operations as
if the Medallion acquisition had occurred immediately prior to January 1,
2001. These pro forma results have been prepared for comparative purposes
only and do not purport to be indicative of what would have occurred had
these transactions been consummated as of such date.
- 9 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
Three Months Ended Nine Months Ended
------------------------- --------------------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2002 2001 2002 2001
---------- ---------- ---------- -----------
Revenues .......................... $141,714 $ 134,960 $393,807 $ 339,725
======== ========== ======== ===========
Net (loss) income ................. (8,166) $ 8,139 (24,535) $ 23,491
======== ========== ======== ===========
Net (loss) income per common share:
Basic ......................... $ (0.23) $ 0.25 $ (0.70) $ 0.78
======== ========== ======== ===========
Diluted ....................... $ (0.23) $ 0.21 $ (0.70) $ 0.64
======== ========== ======== ===========
4. INVENTORIES
Inventories consist of:
September 30, December 31,
2002 2001
------------- ------------
Leaf tobacco ................. $ 52,150 $ 26,364
Other raw materials .......... 5,978 6,764
Work-in-process .............. 2,922 2,263
Finished goods ............... 29,881 15,317
Replacement parts and supplies 4,617 3,040
-------- --------
Inventories at current cost .. 95,548 53,748
LIFO adjustments ............. (1,439) (554)
-------- --------
$ 94,109 $ 53,194
======== ========
At September 30, 2002, Liggett had leaf tobacco purchase commitments of
approximately $21,800 and Vector Tobacco had leaf tobacco purchase
commitments of approximately $11,330.
- 10 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
September 30, December 31,
2002 2001
------------- -----------
Land and improvements ....... $ 2,383 $ 2,252
Buildings ................... 26,165 23,035
Machinery and equipment ..... 128,046 81,396
Leasehold improvements ...... 1,668 1,451
Construction-in-progress .... 10,101 27,464
--------- ---------
168,363 135,598
Less accumulated depreciation (39,584) (33,413)
--------- ---------
$ 128,779 $ 102,185
========= =========
6. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
September 30, December 31,
2002 2001
------------- ------------
Vector:
6.25% Convertible Subordinated Notes due 2008 ............ $ 132,500 $ 132,500
VGR Holding:
10% Senior Secured Notes due 2006, net of
unamortized discount of $12,485 and $9,242 ............ 77,515 50,758
Liggett:
Revolving credit facility ................................ -- --
Term loan under credit facility .......................... 5,190 5,865
Other notes payable ...................................... 14,072 7,748
Vector Research:
Equipment loans .......................................... 17,551 12,724
Vector Tobacco:
Note payable ............................................. 6,918 8,847
Equipment loans .......................................... 1,158 389
Notes for Medallion acquisition .......................... 53,750 --
Other .................................................... -- 250
--------- ---------
Total notes payable, long-term debt and other obligations 308,654 219,081
Less:
Current maturities ................................. (19,369) (4,808)
--------- ---------
Amount due after one year ................................ $ 289,285 $ 214,273
========= =========
- 11 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
6.25% CONVERTIBLE SUBORDINATED NOTES DUE JULY 15, 2008 - VECTOR:
In July 2001, Vector completed the sale of $172,500 (net proceeds of
approximately $166,400) of its 6.25% convertible subordinated notes due
2008 through a private offering to qualified institutional investors in
accordance with Rule 144A under the Securities Act of 1933. The notes pay
interest at 6.25% per annum and are convertible into Vector's common
stock, at the option of the holder, at a conversion price of $30.91 per
share at September 30, 2002. The conversion price is subject to adjustment
for various events, and any cash distribution on Vector's common stock
will result in a corresponding decrease in the conversion price. Following
the conversion of $40,000 principal amount of the convertible notes in
December 2001, $132,500 principal amount of the convertible notes were
outstanding.
The notes may be redeemed by Vector, in whole or in part, between July 15,
2003 and July 15, 2004, if the closing price of Vector's common stock
exceeds 150% of the conversion price then in effect for a period of at
least 20 trading days in any consecutive 30 day trading period, at a price
equal to 100% of the principal amount, plus accrued interest and a "make
whole" payment. Vector may redeem the notes, in whole or in part, at a
price of 103.125% in the year beginning July 15, 2004, 102.083% in the
year beginning July 15, 2005, 101.042% in the year beginning July 15, 2006
and 100% in the year beginning July 15, 2007, together with accrued
interest. If a change of control occurs, Vector will be required to offer
to repurchase the notes at 101% of their principal amount, plus accrued
interest and, under certain circumstances, a "make whole" payment.
10% SENIOR SECURED NOTES DUE MARCH 31, 2006 - VGR HOLDING:
On May 14, 2001, VGR Holding issued at a discount $60,000 principal amount
of 10% senior secured notes due March 31, 2006 in a private placement. VGR
Holding received net proceeds from the placement of approximately $46,500.
On April 30, 2002, VGR Holding issued at a discount an additional $30,000
principal amount of 10% senior secured notes due March 31, 2006 in a
private placement and received net proceeds of approximately $25,000. The
notes were priced to provide the purchasers with a 15.75% yield to
maturity. The new notes are on the same terms as the $60,000 principal
amount of senior secured notes previously issued. All $90,000 principal
amount of the notes have been guaranteed by the Company and by Liggett.
The notes are collateralized by substantially all of VGR Holding's assets,
including a pledge of VGR Holding's equity interests in its direct
subsidiaries, including Brooke Group Holding, Brooke (Overseas) Ltd.,
Vector Tobacco and New Valley Holdings, Inc., as well as a pledge of the
shares of Liggett and all of the New Valley securities held by VGR Holding
and New Valley Holdings. The purchase agreement for the notes contains
covenants, which among other things, limit the ability of VGR Holding to
make distributions to Vector to 50% of VGR Holding's net income, unless
VGR Holding holds $75,000 in cash after giving effect to the payment of
the distribution, and limit additional indebtedness of VGR Holding,
Liggett and Vector Tobacco to 250% of EBITDA (as defined in the purchase
agreements) for the trailing 12 months plus an additional amount of up to
$75,000 during the period commencing on April 1, 2002 and ending on
September 29, 2002, $115,000 during the period commencing on September 30,
2002 and ending on December 30, 2002 and $100,000 during the period
commencing on December 31, 2002 and ending on March 31, 2003. The
covenants also restrict transactions with affiliates subject to exceptions
which include payments to Vector not to exceed $9,500 per year for
permitted operating expenses, and limit the ability of VGR Holding to
merge, consolidate or sell certain assets. In November 2002, in connection
with an amendment to the note purchase
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
agreement, VGR Holding repurchased $8,000 of the notes at a price of 100%
of the principal amount plus accrued interest. VGR Holding will recognize
a loss of approximately $1,300 in the fourth quarter 2002 on the early
extinguishment of debt.
Prior to May 14, 2003, VGR Holding may redeem up to $31,500 of the notes
at a redemption price of 100% of the principal amount with proceeds from
one or more equity offerings. VGR Holding may redeem the notes, in whole
or in part, at a redemption price of 100% of the principal amount
beginning May 14, 2003. During the term of the notes, VGR Holding is
required to offer to repurchase all the notes at a purchase price of 101%
of the principal amount, in the event of a change of control, and to offer
to repurchase notes, at 100% of the principal amount, with the proceeds of
material asset sales.
REVOLVING CREDIT FACILITY - LIGGETT:
Liggett has a $40,000 credit facility, under which $0 was outstanding at
September 30, 2002. Availability under the credit facility was
approximately $34,633 based on eligible collateral at September 30, 2002.
The facility is collateralized by all inventories and receivables of
Liggett. Borrowings under the facility, whose interest is calculated at a
rate equal to 1.0% above Philadelphia National Bank's (the indirect parent
of Congress Financial Corporation, the lead lender) prime rate, bore a
rate of 5.75% at September 30, 2002. The facility requires Liggett's
compliance with certain financial and other covenants including a
restriction on the payment of cash dividends unless Liggett's borrowing
availability under the facility for the 30-day period prior to the payment
of the dividend, and after giving effect to the dividend, is at least
$5,000. In addition, the facility, as amended, imposes requirements with
respect to Liggett's adjusted net worth (not to fall below $8,000 as
computed in accordance with the agreement) and working capital (not to
fall below a deficit of $17,000 as computed in accordance with the
agreement). At September 30, 2002, Liggett was in compliance with all
covenants under the credit facility; Liggett's adjusted net worth was
$22,353 and net working capital was $2,643, as computed in accordance with
the agreement. The facility expires on March 8, 2003 subject to automatic
renewal for an additional year unless a notice of termination is given by
the lender at least 60 days prior to the anniversary date.
In November 1999, 100 Maple LLC, a new company formed by Liggett to
purchase its Mebane, North Carolina facility, borrowed $5,040 from the
lender under Liggett's credit facility. In July 2001, Maple borrowed an
additional $2,340 under the loan, and a total of $5,190 was outstanding at
September 30, 2002. In addition, the lender extended the term of the loan
so that it is payable in 59 monthly installments of $75 with a final
payment of $1,875. In September 2002, the lender agreed that no further
regularly scheduled principal payments would be due under the Maple loan
until March 1, 2004. Interest is charged at the same rate as applicable
to Liggett's credit facility, and borrowings under the Maple loan reduce
the maximum availability under the credit facility. Liggett has guaranteed
the loan, and a first mortgage on the Mebane property collateralizes the
Maple loan and Liggett's credit facility.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
EQUIPMENT LOANS - LIGGETT:
In March 2000, Liggett purchased equipment for $1,000 under a capital
lease which is payable in 60 monthly installments of $21 with an effective
annual interest rate of 10.14%. In April 2000, Liggett purchased equipment
for $1,071 under two capital leases which are payable in 60 monthly
installments of $22 with an effective interest rate of 10.20%.
In October and December 2001, Liggett purchased equipment for $3,204 and
$3,200, respectively, through capital lease arrangements guaranteed by the
Company, each payable in 60 monthly installments of $61 with interest
calculated at the prime rate.
In March 2002, Liggett purchased equipment for $3,023 through the issuance
of a note, payable in 30 monthly installments of $62 and then 30 monthly
installments of $51 with an effective annual interest rate of 4.68%.
In May 2002, Liggett purchased equipment for $2,871 through the issuance
of a note, payable in 30 monthly installments of $59 and then 30 monthly
installments of $48 with an effective annual interest rate of 4.64%.
In September 2002, Liggett purchased equipment for $1,573 through a note
guaranteed by the Company, payable in 58 monthly installments of $26 and a
final payment of $345 with an effective annual interest rate of 6.20%.
EQUIPMENT LOANS - VECTOR RESEARCH:
In February 2001, a subsidiary of Vector Research purchased equipment
for $15,500 and borrowed $13,175 to fund the purchase. The loan, which is
collateralized by the equipment and a letter of credit from the Company
for $775, is guaranteed by Vector Research, VGR Holding and the Company.
The loan is payable in 120 monthly installments of $125, including annual
interest of 2.31% above the 30-day commercial paper rate with a final
payment of $6,125.
In February 2002, the Vector Research subsidiary purchased equipment for
$6,575 and borrowed $6,150 to fund the purchase. The loan, which is
collateralized by the equipment, is guaranteed by Vector Research and the
Company. The loan is payable in 120 monthly installments of $44, including
annual interest of 2.75% above the 30-day commercial paper rate.
NOTE PAYABLE - VECTOR TOBACCO:
In June 2001, Vector Tobacco purchased for $8,400 an industrial facility
in Timberlake, North Carolina. Vector Tobacco financed the purchase with
an $8,200 loan, payable in 60 monthly installments of $85, including
annual interest at 4.85% above LIBOR with a final payment of approximately
$3,160. The loan, which is collateralized by a mortgage and a letter of
credit of $1,750, is guaranteed by VGR Holding and Vector.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
During December 2001, Vector Tobacco executed a second promissory note
with the same lender for approximately $1,159 to finance building
improvements. The second promissory note is payable in 30 monthly
installments of $39 plus accrued interest, with an annual interest rate of
LIBOR plus 5.12%.
NOTES FOR MEDALLION ACQUISITION - VECTOR TOBACCO:
The purchase price for the acquisition of Medallion included $60,000 in
notes of Vector Tobacco, guaranteed by the Company and Liggett. Of the
notes, $25,000 bear interest at a 9.0% annual rate and mature $3,125 per
quarter commencing June 30, 2002 and continuing through March 31, 2004.
The remaining $35,000 of notes bear interest at 6.5% per year and mature
on April 1, 2007.
7. CONTINGENCIES
SMOKING-RELATED LITIGATION:
OVERVIEW. Since 1954, Liggett and other United States cigarette
manufacturers have been named as defendants in numerous direct and
third-party actions predicated on the theory that cigarette manufacturers
should be liable for damages alleged to have been caused by cigarette
smoking or by exposure to secondary smoke from cigarettes. These cases are
reported here as though having been commenced against Liggett (without
regard to whether such cases were actually commenced against Brooke Group
Holding Inc., the Company's predecessor and a wholly-owned subsidiary of
VGR Holding, or Liggett). There has been a noteworthy increase in the
number of cases commenced against Liggett and the other cigarette
manufacturers in recent years. The cases generally fall into the following
categories: (i) smoking and health cases alleging injury brought on behalf
of individual plaintiffs ("Individual Actions"); (ii) smoking and health
cases alleging injury and purporting to be brought on behalf of a class of
individual plaintiffs ("Class Actions"); (iii) health care cost recovery
actions brought by various foreign and domestic governmental entities
("Governmental Actions"); and (iv) health care cost recovery actions
brought by third-party payors including insurance companies, union health
and welfare trust funds, asbestos manufacturers and others ("Third-Party
Payor Actions"). As new cases are commenced, defense costs and the risks
attendant to the inherent unpredictability of litigation continue to
increase. The future financial impact of the risks and expenses of
litigation and the effects of the tobacco litigation settlements discussed
below are not quantifiable at this time. For the nine months ended
September 30, 2002, Liggett incurred counsel fees and costs totaling
approximately $4,103 compared to $4,911 for the nine months ended
September 30, 2001.
INDIVIDUAL ACTIONS. As of September 30, 2002, there were approximately 338
cases pending against Liggett, and in most cases the other tobacco
companies, where one or more individual plaintiffs allege injury resulting
from cigarette smoking, addiction to cigarette smoking or exposure to
secondary smoke and seek compensatory and, in some cases, punitive
damages. Of these, 90 were pending in New York, 76 in Florida, 47 in
Maryland, 25 in Mississippi and 19 in California. The balance of the
individual cases were pending in 21 states. There are four individual
cases pending where Liggett is the only named defendant. In addition to
these cases, an action against cigarette manufacturers involving
approximately 1,250 named individual plaintiffs has been consolidated
before a single West Virginia state
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
court. Liggett is a defendant in most of the cases pending in West
Virginia. In January 2002, the court severed Liggett from the trial of the
consolidated action, which is scheduled to begin in June 2003.
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence,
gross negligence, breach of special duty, strict liability, fraud,
misrepresentation, design defect, failure to warn, breach of express and
implied warranties, conspiracy, aiding and abetting, concert of action,
unjust enrichment, common law public nuisance, property damage, invasion
of privacy, mental anguish, emotional distress, disability, shock,
indemnity and violations of deceptive trade practice laws, the Federal
Racketeer Influenced and Corrupt Organization Act ("RICO"), state RICO
statutes and antitrust statutes. In many of these cases, in addition to
compensatory damages, plaintiffs also seek other forms of relief including
treble/multiple damages, medical monitoring, disgorgement of profits and
punitive damages. Defenses raised by defendants in these cases include
lack of proximate cause, assumption of the risk, comparative fault and/or
contributory negligence, lack of design defect, statute of limitations,
equitable defenses such as "unclean hands" and lack of benefit, failure to
state a claim and federal preemption.
Jury awards in California and Oregon have been entered against other
cigarette manufacturers. The awards in these individual actions are for
both compensatory and punitive damages and represent a material amount of
damages. In 1999, a jury awarded $800 in compensatory damages and $79,500
in punitive damages in an Oregon state court case involving Philip Morris.
The trial court later determined that the punitive damage award was
excessive and reduced it to $32,000. In June 2002, an Oregon intermediate
appellate court reinstated the jury's punitive damages award. Philip
Morris has appealed the decision to the Oregon Supreme Court. In June
2001, a jury awarded $5,500 in compensatory damages and $3,000,000 in
punitive damages in a California state court case involving Philip Morris.
In March 2002, a jury awarded $169 in compensatory damages and $150,000 in
punitive damages in an Oregon state court case also involving Philip
Morris. The punitive damages awards in both the California and Oregon
actions were subsequently reduced to $100,000 by the trial courts. In
September 2002, a jury awarded $850 in compensatory damages and
$28,000,000 in punitive damages in a California state court case involving
Philip Morris. Both the verdict and damage awards in these cases are being
appealed. In November 2001, in another case, a $25,000 punitive damages
judgment against Philip Morris was affirmed by a California intermediate
appellate court. In October 2002, the California Supreme Court vacated the
decision and remanded the case to the intermediate appellate court for
reconsideration in light of its August 2002 ruling that a state statute in
effect from January 1988 to December 1997 conferred immunity to cigarette
manufacturers for conduct during that ten-year period. During 2001, as a
result of a Florida Supreme Court decision upholding the award, another
cigarette manufacturer paid $1,100 in compensatory damages and interest to
a former smoker and his spouse for injuries they allegedly incurred as a
result of smoking. In December 2001, in an individual action involving
another cigarette manufacturer, a Florida jury awarded a smoker $165 in
compensatory damages. The defendant has appealed the verdict. In February
2002, a federal district court jury in Kansas awarded a smoker $198 in
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
compensatory damages from two other cigarette manufacturers and, in June
2002, the trial court assessed punitive damages of $15,000 against one of
the defendants. The defendant has appealed the verdict.
CLASS ACTIONS. As of September 30, 2002, there were approximately 41
actions pending, for which either a class has been certified or plaintiffs
are seeking class certification, where Liggett, among others, was a named
defendant. Many of these actions purport to constitute statewide class
actions and were filed after May 1996 when the Fifth Circuit Court of
Appeals, in the CASTANO case, reversed a Federal district court's
certification of a purported nationwide class action on behalf of persons
who were allegedly "addicted" to tobacco products.
The extent of the impact of the CASTANO decision on smoking-related class
action litigation is still uncertain. The CASTANO decision has had a
limited effect with respect to courts' decisions regarding narrower
smoking-related classes or class actions brought in state rather than
federal court. For example, since the Fifth Circuit's ruling, a court in
Louisiana (Liggett is not a defendant in this proceeding) has certified
"addiction-as-injury" class actions that covered only citizens in those
states. Two other class actions, BROIN and ENGLE, were certified in state
court in Florida prior to the Fifth Circuit's decision. In April 2001, the
BROWN case was certified as a class action in California.
In May 1994, an action entitled ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO
COMPANY, ET AL., Circuit Court, Eleventh Judicial Circuit, Miami-Dade
County, Florida, was filed against Liggett and others. The class consists
of all Florida residents and citizens, and their survivors, who have
suffered, presently suffer or have died from diseases and medical
conditions caused by their addiction to cigarettes that contain nicotine.
Phase I of the trial commenced in July 1998 and in July 1999, the jury
returned the Phase I verdict. The Phase I verdict concerned certain issues
determined by the trial court to be "common" to the causes of action of
the plaintiff class. Among other things, the jury found that: smoking
cigarettes causes 20 diseases or medical conditions, cigarettes are
addictive or dependence producing, defective and unreasonably dangerous,
defendants made materially false statements with the intention of
misleading smokers, defendants concealed or omitted material information
concerning the health effects and/or the addictive nature of smoking
cigarettes and agreed to misrepresent and conceal the health effects
and/or the addictive nature of smoking cigarettes, and defendants were
negligent and engaged in extreme and outrageous conduct or acted with
reckless disregard with the intent to inflict emotional distress. The jury
also found that defendants' conduct "rose to a level that would permit a
potential award or entitlement to punitive damages." The court decided
that Phase II of the trial, which commenced November 1999, would be a
causation and damages trial for three of the class representatives and a
punitive damages trial on a class-wide basis, before the same jury that
returned the verdict in Phase I. In April 2000, the jury awarded
compensatory damages of $12,704 to the three plaintiffs, to be reduced in
proportion to the respective plaintiff's fault. The jury also decided that
the claim of one of the plaintiffs, who was awarded compensatory damages
of $5,831, was not timely filed. In July 2000, the jury awarded
approximately $145,000,000 in the punitive damages portion of Phase II
against all defendants including $790,000 against Liggett. The court
entered a final order of judgment against the defendants in November 2000.
The court's final judgment, which provides for interest at the rate of 10%
per year on the jury's awards, also denied various post-trial motions,
including a motion for new trial and a motion seeking reduction of the
punitive damages award. Liggett intends to pursue all available post-trial
and
- 17 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
appellate remedies. Oral argument before Florida's Third District Court of
Appeals was held on November 6, 2002. If this verdict is not eventually
reversed on appeal, or substantially reduced by the court, it could have a
material adverse effect on the Company. Phase III of the trial will be
conducted before separate juries to address absent class members' claims,
including issues of specific causation and other individual issues
regarding entitlement to compensatory damages.
It is unclear how the ENGLE court's order regarding the determination of
punitive damages will be implemented. The order provides that the punitive
damage amount should be standard as to each class member and acknowledges
that the actual size of the class will not be known until the last case
has withstood appeal. The order does not address whether defendants will
be required to pay the punitive damage award prior to a determination of
claims of all class members, a process that could take years to conclude.
In May 2000, legislation was enacted in Florida that limits the size of
any bond required, pending appeal, to stay execution of a punitive damages
verdict to the lesser of the punitive award plus twice the statutory rate
of interest, $100,000 or 10% of the net worth of the defendant, but the
limitation on the bond does not affect the amount of the underlying
verdict. Liggett has filed the $3,450 bond required by the Florida law in
order to stay execution of the ENGLE judgment. Similar legislation has
been enacted in Georgia, Indiana, Kentucky, Louisiana, Michigan, Nevada,
North Carolina, Ohio, Oklahoma, South Carolina, Virginia and West
Virginia.
In May 2001, Liggett, along with Philip Morris and Lorillard Tobacco Co.,
reached an agreement with the class in the ENGLE case, which will provide
assurance of Liggett's ability to appeal the jury's July 2000 verdict. As
required by the agreement, Liggett paid $6,273 into an escrow account to
be held for the benefit of the ENGLE class, and released, along with
Liggett's existing $3,450 statutory bond, to the court for the benefit of
the class upon completion of the appeals process, regardless of the
outcome of the appeal. As a result, the Company recorded a $9,723 pre-tax
charge to the consolidated statement of operations for the first quarter
of 2001. The agreement, which was approved by the court, assures that the
stay of execution, currently in effect pursuant to the Florida bonding
statute, will not be lifted or limited at any point until completion of
all appeals, including an appeal to the United States Supreme Court. If
Liggett's balance sheet net worth falls below $33,781 (as determined in
accordance with generally accepted accounting principles in effect as of
July 14, 2000), the stay granted in favor of Liggett in the agreement
would terminate and the ENGLE class would be free to challenge the Florida
bonding statute.
In June 2002, the jury in a Florida state court action entitled LUKACS V.
PHILIP MORRIS, ET AL. awarded $37,500 in compensatory damages in a case
involving Liggett and two other tobacco manufacturers. The jury found
Liggett 50% responsible for the damages incurred by the plaintiff. The
LUKACS case was the first individual case to be tried as part of Phase III
of the ENGLE case; the claims of all other individuals who are members of
the class have been stayed pending resolution of the appeal of the ENGLE
verdict. The LUKACS verdict will be subject to the outcome of the ENGLE
appeal, and the plaintiff has agreed not to seek the entry of a final
judgment on the jury verdict until after completion of all review of the
ENGLE final judgment.
Class certification motions are pending in a number of putative class
actions. Classes remain certified against Liggett in Florida (ENGLE), in
West Virginia (BLANKENSHIP) and in California (BROWN) and in New York
(SIMON). A number of class certification denials are on appeal.
- 18 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
In August 2000, in BLANKENSHIP V. PHILIP MORRIS, INC., a West Virginia
state court conditionally certified (only to the extent of medical
monitoring) a class of present or former West Virginia smokers who desire
to participate in a medical monitoring plan. The trial of this case ended
in January 2001, when the judge declared a mistrial. In an order issued in
March 2001, the court reaffirmed class certification of this medical
monitoring action. In July 2001, the court issued an order severing
Liggett from the retrial of the case which began in September 2001. In
November 2001, the jury returned a verdict in favor of the defendants. In
January 2002, the trial court denied plaintiffs' motion for a new trial,
and plaintiffs have appealed.
In April 2001, the California state court in the case of BROWN V. THE
AMERICAN TOBACCO COMPANY, INC., ET AL., granted in part plaintiff's motion
for class certification and certified a class comprised of adult residents
of California who smoked at least one of defendants' cigarettes "during
the applicable time period" and who were exposed to defendants' marketing
and advertising activities in California. Certification was granted as to
plaintiff's claims that defendants violated California's unfair business
practices statute. The court subsequently defined "the applicable class
period" for plaintiff's claims, pursuant to a stipulation submitted by the
parties, as June 10, 1993 through April 23, 2001. The California Court of
Appeals denied defendants' writ application, which sought review of the
trial court's class certification orders. Defendants filed a petition for
review with the California Supreme Court, which was subsequently denied.
Trial is scheduled to begin in March 2003. Liggett is a defendant in the
case.
In September 2002, in IN RE SIMON II LITIGATION, the federal district
court for the Eastern District of New York granted plaintiffs' motion for
certification of a nationwide non-opt-out punitive damages class action
against the tobacco companies, including Liggett. The class is not seeking
compensatory damages, but was created to determine whether smokers across
the country may be entitled to punitive damages. In its order, the court
set a trial date of January 2003, but has since stayed the order pending
the tobacco companies' appeal to the U.S. Court of Appeals for the Second
Circuit.
Approximately 38 purported state and federal class action complaints have
been filed against the cigarette manufacturers for alleged antitrust
violations, including Liggett. The actions allege that the cigarette
manufacturers have engaged in a nationwide and international conspiracy to
fix the price of cigarettes in violation of state and federal antitrust
laws. Plaintiffs allege that defendants' price-fixing conspiracy raised
the price of cigarettes above a competitive level. Plaintiffs in the 31
state actions purport to represent classes of indirect purchasers of
cigarettes in 16 states; plaintiffs in the seven federal actions purport
to represent a nationwide class of wholesalers who purchased cigarettes
directly from the defendants. The federal actions have been consolidated
and, in July 2000, plaintiffs in the federal consolidated action filed a
single consolidated complaint that did not name Liggett as a defendant,
although Liggett has complied with certain discovery requests. The court
granted defendants' motion for summary judgment in the consolidated
federal cases in July 2002. Fourteen California actions have been
consolidated and the consolidated complaint did not name Liggett as a
defendant. In Nevada, an amended complaint was filed that did not name
Liggett as a defendant.
GOVERNMENTAL ACTIONS. As of September 30, 2002, there were approximately
40 Governmental Actions pending against Liggett. In these proceedings,
both foreign and
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
domestic governmental entities seek reimbursement for Medicaid and other
health care expenditures. The claims asserted in these health care cost
recovery actions vary. In most of these cases, plaintiffs assert the
equitable claim that the tobacco industry was "unjustly enriched" by
plaintiffs' payment of health care costs allegedly attributable to smoking
and seek reimbursement of those costs. Other claims made by some but not
all plaintiffs include the equitable claim of indemnity, common law claims
of negligence, strict liability, breach of express and implied warranty,
breach of special duty, fraud, negligent misrepresentation, conspiracy,
public nuisance, claims under state and federal statutes governing
consumer fraud, antitrust, deceptive trade practices and false
advertising, and claims under RICO.
THIRD-PARTY PAYOR ACTIONS. As of September 30, 2002, there were
approximately 7 Third-Party Payor Actions pending against Liggett. The
claims in these cases are similar to those in the Governmental Actions but
have been commenced by insurance companies, union health and welfare trust
funds, asbestos manufacturers and others. Eight United States Circuit
Courts of Appeal have ruled that Third-Party Payors did not have standing
to bring lawsuits against the tobacco companies. The United States Supreme
Court has denied petitions for certiorari in the cases decided by four of
the courts of appeal. However, a number of Third-Party Payor Actions,
including an action brought by 24 Blue Cross/Blue Shield Plans, remain
pending.
In June 2001, a jury in a third party payor action brought by Empire Blue
Cross and Blue Shield in the Eastern District of New York rendered a
verdict awarding the plaintiff $17,800 in damages against the major
tobacco companies. As against Liggett, the jury awarded the plaintiff
damages of $89. In February 2002, the court awarded plaintiff's counsel
$37,800 in attorneys' fees, without allocating the fee award among the
several defendants. Liggett has appealed both the jury verdict and the
attorneys' fee award.
In other Third-Party Payor Actions claimants have set forth several
additional theories of relief sought: funding of corrective public
education campaigns relating to issues of smoking and health; funding for
clinical smoking cessation programs; disgorgement of profits from sales of
cigarettes; restitution; treble damages; and attorneys' fees.
Nevertheless, no specific amounts are provided. It is understood that
requested damages against the tobacco company defendants in these cases
might be in the billions of dollars.
FEDERAL GOVERNMENT ACTION. In September 1999, the United States government
commenced litigation against Liggett and the other tobacco companies in
the United States District Court for the District of Columbia. The action
seeks to recover an unspecified amount of health care costs paid for and
furnished, and to be paid for and furnished, by the Federal Government for
lung cancer, heart disease, emphysema and other smoking-related illnesses
allegedly caused by the fraudulent and tortious conduct of defendants, to
restrain defendants and co-conspirators from engaging in fraud and other
unlawful conduct in the future, and to compel defendants to disgorge the
proceeds of their unlawful conduct. The complaint alleges that such costs
total more than $20,000,000 annually. The action asserts claims under
three federal statutes, the Medical Care Recovery Act ("MCRA"), the
Medicare Secondary Payer provisions of the Social Security Act ("MSP") and
RICO. In December 1999, Liggett filed a motion to dismiss the lawsuit on
numerous grounds, including that the statutes invoked by the government do
not provide the basis for the relief sought. In September 2000, the court
dismissed the government's claims based on MCRA and MSP, and the court
reaffirmed its decision in July 2001. In the September 2000 decision, the
court also determined not to
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
dismiss the government's claims based on RICO, under which the government
continues to seek court relief to restrain the defendant tobacco companies
from allegedly engaging in fraud and other unlawful conduct and to compel
disgorgement.
In June 2001, the United States Attorney General assembled a team of three
Department of Justice ("DOJ") lawyers to work on a possible settlement of
the federal lawsuit. The DOJ lawyers met with representatives of the
tobacco industry, including Liggett, in July 2001. No settlement was
reached, and no further meetings are planned. Discovery in the case has
commenced, and trial has been scheduled for September 2004.
SETTLEMENTS. In March 1996, Brooke Group Holding and Liggett entered into
an agreement, subject to court approval, to settle the CASTANO class
action tobacco litigation. The CASTANO class was subsequently decertified
by the court.
In March 1996, March 1997 and March 1998, Brooke Group Holding and Liggett
entered into settlements of smoking-related litigation with the Attorneys
General of 45 states and territories. The settlements released both Brooke
Group Holding and Liggett from all smoking-related claims, including
claims for health care cost reimbursement and claims concerning sales of
cigarettes to minors.
In November 1998, Philip Morris, Brown & Williamson Tobacco Corporation,
R.J. Reynolds Tobacco Company and Lorillard Tobacco Company (collectively,
the "Original Participating Manufacturers" or "OPMs") and Liggett
(together with the OPMs and any other tobacco product manufacturer that
becomes a signatory, the "Participating Manufacturers") entered into the
Master Settlement Agreement (the "MSA") with 46 states, the District of
Columbia, Puerto Rico, Guam, the United States Virgin Islands, American
Samoa and the Northern Marianas (collectively, the "Settling States") to
settle the asserted and unasserted health care cost recovery and certain
other claims of those Settling States. The MSA has received final judicial
approval in each of the 52 settling jurisdictions.
The MSA restricts tobacco product advertising and marketing within the
Settling States and otherwise restricts the activities of Participating
Manufacturers. Among other things, the MSA prohibits the targeting of
youth in the advertising, promotion or marketing of tobacco products; bans
the use of cartoon characters in all tobacco advertising and promotion;
limits each Participating Manufacturer to one tobacco brand name
sponsorship during any 12-month period; bans all outdoor advertising, with
the exception of signs, 14 square feet or less, at retail establishments
that sell tobacco products; prohibits payments for tobacco product
placement in various media; bans gift offers based on the purchase of
tobacco products without sufficient proof that the intended recipient is
an adult; prohibits Participating Manufacturers from licensing third
parties to advertise tobacco brand names in any manner prohibited under
the MSA; prohibits Participating Manufacturers from using as a tobacco
product brand name any nationally recognized non-tobacco brand or trade
name or the names of sports teams, entertainment groups or individual
celebrities; and prohibits Participating Manufacturers from selling packs
containing fewer than 20 cigarettes.
The MSA also requires Participating Manufacturers to affirm corporate
principles to comply with the MSA and to reduce underage usage of tobacco
products and imposes requirements applicable to lobbying activities
conducted on behalf of Participating Manufacturers.
- 21 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
Liggett has no payment obligations under the MSA except to the extent its
market share exceeds a base share of 125% of its 1997 market share, or
approximately 1.65% of total cigarettes sold in the United States. Liggett
believes, based on published industry sources, that its domestic shipments
accounted for approximately 2.2% of the total cigarettes shipped in the
United States during 2001. On April 15 of any year following a year in
which Liggett's market share exceeds the base share, Liggett will pay on
each excess unit an amount equal (on a per-unit basis) to that due during
the same following year by the OPMs under the annual and strategic
contribution payment provisions of the MSA, subject to applicable
adjustments, offsets and reductions. In April 2002, Liggett and Vector
Tobacco paid a total of $31,130 for their 2001 MSA obligations. Liggett
and Vector Tobacco have expensed $29,037 for their estimated MSA
obligations for the first nine months of 2002 as part of cost of goods
sold. Under the annual and strategic contribution payment provisions of
the MSA, the OPMs (and Liggett to the extent its market share exceeds the
base share) are required to pay the following annual amounts (subject to
certain adjustments):
Year Amount
---- ------
2002 - 2003 $6,500,000
2004 - 2007 $8,000,000
2008 - 2017 $8,139,000
2018 and each $9,000,000
year thereafter
These annual payments will be allocated based on relative unit volume of
domestic cigarette shipments. The payment obligations under the MSA are
the several, and not joint, obligations of each Participating Manufacturer
and are not the responsibility of any parent or affiliate of a
Participating Manufacturer.
The MSA replaces Liggett's prior settlements with all states and
territories except for Florida, Mississippi, Texas and Minnesota. Each of
these states, prior to the effective date of the MSA, negotiated and
executed settlement agreements with each of the other major tobacco
companies separate from those settlements reached previously with Liggett.
Because these states' settlement agreements with Liggett provided for
"most favored nation" protection for both Brooke Group Holding and
Liggett, the payments due these states by Liggett (with certain possible
exceptions) have been eliminated. With respect to all non-economic
obligations under the previous settlements, both Brooke Group Holding and
Liggett are entitled to the most favorable provisions as between the MSA
and each state's respective settlement with the other major tobacco
companies. Therefore, Liggett's non-economic obligations to all states and
territories are now defined by the MSA.
In April 1999, a putative class action was filed on behalf of all firms
that directly buy cigarettes in the United States from defendant tobacco
manufacturers. The complaint alleges violation of antitrust law, based in
part on the MSA. Plaintiffs seek treble damages computed as three times
the difference between current prices and the price plaintiffs would have
paid for cigarettes in the absence of an alleged conspiracy to restrain
and monopolize trade in the domestic cigarette market, together with
attorneys' fees. Plaintiffs also seek injunctive relief against certain
aspects of the MSA.
- 22 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
Copies of the various settlement agreements are filed as exhibits to the
Company's Form 10-K and the discussion herein is qualified in its entirety
by reference thereto.
TRIALS. Cases currently scheduled for trial during the next six months
include two individual actions in Florida state court scheduled for
January 2003 and February 2003, an individual action in New York state
court scheduled for January 2003 and an action consolidating the claims of
three individuals in a Mississippi state court scheduled for May 2003. In
addition, the BROWN case is scheduled for trial in California state court
in March 2003. Trial dates, however, are subject to change.
Management is not able to predict the outcome of the litigation pending
against Brooke Group Holding or Liggett. Litigation is subject to many
uncertainties. An unfavorable verdict was returned in the first phase of
the ENGLE smoking and health class action trial pending in Florida. In
July 2000, the jury awarded $790,000 in punitive damages against Liggett
in the second phase of the trial, and the court has entered an order of
final judgment. Liggett intends to pursue all available post-trial and
appellate remedies. If this verdict is not eventually reversed on appeal,
or substantially reduced by the court, it could have a material adverse
effect on the Company. Liggett has filed the $3,450 bond required under
recent Florida legislation which limits the size of any bond required,
pending appeal, to stay execution of a punitive damages verdict. On May 7,
2001, Liggett reached an agreement with the class in the ENGLE case, which
will provide assurance to Liggett that the stay of execution, currently in
effect pursuant to the bonding statute enacted in 2000 by the Florida
legislature, will not be lifted or limited at any point until completion
of all appeals, including to the United States Supreme Court. As required
by the agreement, Liggett paid $6,273 into an escrow account to be held
for the benefit of the ENGLE class, and released, along with Liggett's
existing $3,450 statutory bond, to the court for the benefit of the class
upon completion of the appeals process, regardless of the outcome of the
appeal. As a result, the Company recorded a $9,723 pre-tax charge to the
consolidated statement of operations for the nine months ended September
30, 2001. In June 2002, the jury in an individual case brought under the
third phase of the ENGLE case awarded $37,500 of compensatory damages
against Liggett and two other defendants and found Liggett 50% responsible
for the damages. The verdict will be subject to the outcome of the ENGLE
appeal. It is possible that additional cases could be decided unfavorably
and that there could be further adverse developments in the ENGLE case.
Management cannot predict the cash requirements related to any future
settlements and judgments, including cash required to bond any appeals,
and there is a risk that those requirements will not be able to be met. An
unfavorable outcome of a pending smoking and health case could encourage
the commencement of additional similar litigation. Management is unable to
make a meaningful estimate with respect to the amount or range of loss
that could result from an unfavorable outcome of the cases pending against
Brooke Group Holding or Liggett or the costs of defending such cases. The
complaints filed in these cases rarely detail alleged damages. Typically,
the claims set forth in an individual's complaint against the tobacco
industry pray for money damages in an amount to be determined by a jury,
plus punitive damages and costs. These damage claims are typically stated
as being for the minimum necessary to invoke the jurisdiction of the
court.
It is possible that the Company's consolidated financial position, results
of operations or cash flows could be materially adversely affected by an
unfavorable outcome in any such smoking-related litigation.
Liggett's management is unaware of any material environmental conditions
affecting its existing facilities. Liggett's management believes that
current operations are conducted in material compliance with all
environmental laws and regulations and other laws and
- 23 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
regulations governing cigarette manufacturers. Compliance with federal,
state and local provisions regulating the discharge of materials into the
environment, or otherwise relating to the protection of the environment,
has not had a material effect on the capital expenditures, earnings or
competitive position of Liggett.
Liggett has been served in two reparations actions brought by descendants
of slaves. Plaintiffs in these actions claim that defendants, including
Liggett, profited from the use of slave labor. Seven additional cases have
been filed in California, Illinois and New York. Liggett is a named
defendant in only one of these additional cases, but has not been served.
There are several other proceedings, lawsuits and claims pending against
the Company and certain of its consolidated subsidiaries unrelated to
smoking or tobacco product liability. Management is of the opinion that
the liabilities, if any, ultimately resulting from such other proceedings,
lawsuits and claims should not materially affect the Company's financial
position, results of operations or cash flows.
LEGISLATION AND REGULATION:
In January 1993, the Environmental Protection Agency ("EPA") released a
report on the respiratory effect of secondary smoke which concludes that
secondary smoke is a known human lung carcinogen in adults and in
children, causes increased respiratory tract disease and middle ear
disorders and increases the severity and frequency of asthma. In June
1993, the two largest of the major domestic cigarette manufacturers,
together with other segments of the tobacco and distribution industries,
commenced a lawsuit against the EPA seeking a determination that the EPA
did not have the statutory authority to regulate secondary smoke, and that
given the current body of scientific evidence and the EPA's failure to
follow its own guidelines in making the determination, the EPA's
classification of secondary smoke was arbitrary and capricious. In July
1998, a federal district court vacated those sections of the report
relating to lung cancer, finding that the EPA may have reached different
conclusions had it complied with relevant statutory requirements. The
federal government has appealed the court's ruling. Whatever the ultimate
outcome of this litigation, issuance of the report may encourage efforts
to limit smoking in public areas.
In February 1996, the United States Trade representative issued an
"advance notice of rule making" concerning how tobacco is imported under a
previously established tobacco rate quota ("TRQ") should be allocated.
Currently, tobacco imported under the TRQ is allocated on a "first-come,
first-served" basis, meaning that entry is allowed on an open basis to
those first requesting entry in the quota year. Others in the cigarette
industry have suggested an "end-
- 24 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
user licensing" system under which the right to import tobacco under the
quota would be initially assigned based on domestic market share. Such an
approach, if adopted, could have a material adverse effect on the Company
and Liggett.
In August 1996, the Food and Drug Administration (the "FDA") filed in the
Federal Register a Final Rule classifying tobacco as a "drug" or "medical
device", asserting jurisdiction over the manufacture and marketing of
tobacco products and imposing restrictions on the sale, advertising and
promotion of tobacco products. Litigation was commenced challenging the
legal authority of the FDA to assert such jurisdiction, as well as
challenging the constitutionality of the rules. In March 2000, the United
States Supreme Court ruled that the FDA does not have the power to
regulate tobacco. Liggett supported the FDA Rule and began to phase in
compliance with certain of the proposed FDA regulations.
Since the Supreme Court decision, various proposals have been made for
federal and state legislation to regulate cigarette manufacturers. In May
2001, a Presidential commission appointed by former President Clinton
issued a final report recommending that the FDA be given authority by
Congress to regulate the manufacture, sale, distribution and labeling of
tobacco products to protect public health. In addition, Congressional
advocates of FDA regulation have introduced such legislation for
consideration by the 107th Congress. The ultimate outcome of these
proposals cannot be predicted.
In August 1996, Massachusetts enacted legislation requiring tobacco
companies to publish information regarding the ingredients in cigarettes
and other tobacco products sold in that state. In December 1997, the
United States District Court for the District of Massachusetts
preliminarily enjoined this legislation from going into effect on the
grounds that it is preempted by federal law. In November 1999, the United
States Court of Appeals for the First Circuit affirmed this ruling. In
September 2000, the federal district court permanently enjoined
enforcement of the law. In October 2001, the First Circuit reversed the
district court's decision, ruling that the ingredients disclosure
provisions are valid. The entire court, however, agreed to re-hear the
appeal, reinstating the district court's injunction in the meantime. Oral
argument before the full court took place on January 7, 2002, and the
court has not yet issued its decision. Notwithstanding the foregoing, in
December 1997, Liggett began complying with this legislation by providing
ingredient information to the Massachusetts Department of Public Health.
Several other states have enacted, or are considering, legislation similar
to that enacted in Massachusetts.
Cigarettes are subject to substantial federal, state and local excise
taxes which, in general, have been increasing. The federal excise tax on
cigarettes is currently $0.39 per pack. State and local sales and excise
taxes vary considerably and, when combined with sales taxes, local taxes
and the current federal excise tax, may currently be as high as $4.10 per
pack. Proposed further tax increases in various jurisdictions are
currently under consideration or pending. Thus far in 2002, 21 states have
passed excise tax increases, ranging from $0.07 per pack in Tennessee to
as much as $1.81 per pack in New York City and New York State combined.
Congress has considered significant increases in the federal excise tax or
other payments from tobacco manufacturers, and significant increases in
excise and other cigarette-related taxes have been proposed or enacted at
the state and local levels. In the opinion of the Company, increases in
excise and similar taxes have had an adverse impact on sales of
cigarettes.
- 25 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
In August 2000, the New York state legislature passed legislation charging
the state's Office of Fire Prevention and Control ("OFPC") with developing
standards for "fire safe" or self-extinguishing cigarettes. The OFPC has
until January 1, 2003 to issue final regulations. Six months from the
issuance of the standards, all cigarettes offered for sale in New York
state will be required to be manufactured to those standards. It is not
possible to predict the impact of this law on the Company until the
standards are published. Similar legislation is being considered by other
state governments and at the federal level.
Federal or state regulators may object to Vector Tobacco's reduced
carcinogen and low nicotine and nicotine-free cigarette products as
unlawful or allege they bear deceptive or unsubstantiated product claims,
and seek the removal of the products from the marketplace, or significant
changes to advertising claims. Allegations by federal or state regulators,
public health organizations and other tobacco manufacturers that Vector
Tobacco's products are unlawful, or that its public statements or
advertising contain misleading or unsubstantiated health claims or product
comparisons, may result in litigation or governmental proceedings. Vector
Tobacco's business may become subject to extensive domestic and
international government regulation. Various proposals have been made for
federal, state and international legislation to regulate cigarette
manufacturers generally, and reduced constituent cigarettes specifically.
It is possible that laws and regulations may be adopted covering issues
like the manufacture, sale, distribution and labeling of tobacco products
as well as any health claims associated with reduced carcinogen and low
nicotine and nicotine-free cigarette products and the use of genetically
modified tobacco. A system of regulation by agencies like the FDA, the
Federal Trade Commission or the United States Department of Agriculture
may be established. In addition, a group of public health organizations
have submitted a petition to the FDA, alleging that the marketing of the
OMNI product is subject to regulation by the FDA under existing law.
Vector Tobacco has filed a response in opposition to the petition. The
Federal Trade Commission has also expressed interest in the regulation of
tobacco products made by tobacco manufacturers, including Vector Tobacco,
which bear reduced carcinogen claims. The ultimate outcome of any of the
foregoing cannot be predicted, but any of the foregoing could have a
material adverse impact on the Company.
In addition to the foregoing, there have been a number of other
restrictive regulatory actions, adverse legislative and political
decisions and other unfavorable developments concerning cigarette smoking
and the tobacco industry, the effects of which, at this time, management
is not able to evaluate. These developments may negatively affect the
perception of potential triers of fact with respect to the tobacco
industry, possibly to the detriment of certain pending litigation, and may
prompt the commencement of additional similar litigation.
OTHER MATTERS:
In March 1997, a stockholder derivative suit was filed in Delaware
Chancery Court against New Valley, as a nominal defendant, its directors
and Brooke Group Holding by a stockholder of New Valley. The suit alleges
that New Valley's purchase of the BrookeMil Ltd. shares from Brooke
(Overseas) in January 1997 constituted a self-dealing transaction which
involved the payment of excessive consideration by New Valley. The
plaintiff seeks a declaration that New Valley's directors breached their
fiduciary duties and Brooke Group Holding aided and abetted such breaches
and that damages be awarded to New Valley. In December 1999, another
stockholder of New Valley commenced an action in Delaware Chancery Court
substantially similar to the March 1997 action. This stockholder alleges,
among other things, that the
- 26 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
consideration paid by New Valley for the BrookeMil shares was excessive,
unfair and wasteful, that the special committee of New Valley's board
lacked independence, and that the appraisal and fairness opinion were
flawed. By order of the court, both actions were consolidated. In January
2001, the court denied a motion to dismiss the consolidated action. Brooke
Group Holding and New Valley believe that the allegations in the case are
without merit. Discovery in the case has commenced.
In July 1999, a purported class action was commenced on behalf of New
Valley's former Class B preferred shareholders against New Valley, Brooke
Group Holding and certain directors and officers of New Valley in Delaware
Chancery Court. The complaint alleges that the recapitalization, approved
by a majority of each class of New Valley's stockholders in May 1999, was
fundamentally unfair to the Class B preferred shareholders, the proxy
statement relating to the recapitalization was materially deficient and
the defendants breached their fiduciary duties to the Class B preferred
shareholders in approving the transaction. The plaintiffs seek class
certification of the action and an award of compensatory damages as well
as all costs and fees. The Court has dismissed six of plaintiff's nine
claims alleging inadequate disclosure in the proxy statement. Brooke Group
Holding and New Valley believe that the remaining allegations are without
merit. Discovery in the case has commenced.
Although there can be no assurances, Brooke Group Holding and New Valley
believe, after consultation with counsel, that the ultimate resolution of
these matters will not have a material adverse effect on the Company's or
New Valley's consolidated financial position, results of operations or
cash flows.
As of September 30, 2002, New Valley had $675 of remaining prepetition
bankruptcy-related claims and restructuring accruals including claims for
lease rejection damages. The remaining claims may be subject to future
adjustments based on potential settlements or decisions of the court. On
August 8, 2002, New Valley paid $2,000 to settle a claim for unclaimed
monies that certain states were seeking on behalf of money transfer
customers, and its restructuring accruals were reduced by a corresponding
amount in the third quarter of 2002.
In May 1999, in connection with the Philip Morris brand transaction, Eve
Holdings Inc., a subsidiary of Liggett, guaranteed a $134,900 bank loan to
Trademarks LLC. The loan is secured by Trademarks' three premium cigarette
brands and Trademarks' interest in the exclusive license of the three
brands by Philip Morris. The license provides for a minimum annual royalty
payment equal to the annual debt service on the loan plus $1,000.
8. NEW VALLEY CORPORATION
On April 30, 2002, New Valley sold the shares of BrookeMil Ltd., a
wholly-owned subsidiary, for approximately $22,000 before closing
expenses. BrookeMil owned the two Kremlin sites in Moscow, which were New
Valley's remaining real estate holdings in Russia. Under the terms of the
Western Realty Repin LLC participating loan to BrookeMil, New Valley
received approximately $7,400 of the net proceeds from the sale and Apollo
Real Estate Investment Fund III, L.P. received approximately $12,400 of
the proceeds. These amounts are subject to adjustment based on final
closing expenses. New Valley recorded a gain on sale of real estate of
$8,484 for the nine months ended September 30, 2002 in connection with the
- 27 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
sale. New Valley also recorded $767 in additional general and
administrative expenses in the second quarter of 2002 related to the
closing of its Russian operations. The expenses consisted principally of
employee severance.
In March 2002, Ladenburg Thalmann Financial Services Inc. ("LTS") borrowed
$2,500 from New Valley. The loan, which bears interest at 1% above the
prime rate, is due on the earlier of December 31, 2003 or the completion
of one or more equity financings where LTS receives at least $5,000 in
total proceeds. In July 2002, LTS borrowed an additional $2,500 from New
Valley on the same terms.
New Valley evaluated its ability to collect the $13,198 of notes and
interest receivable from LTS at September 30, 2002. These notes receivable
include the $5,000 of notes discussed above and a $8,010 convertible note
issued to New Valley in May 2002 in connection with the LTS acquisition.
New Valley determined, based on current trends in the broker-dealer
industry and Ladenburg's operating results and liquidity needs, that a
reserve for uncollectibility should be established against these notes and
interest receivable. As a result, New Valley recorded a charge of $13,198
in the third quarter of 2002.
On October 8, 2002, LTS borrowed an additional $2,000 from New Valley. The
loan, which bears interest at 1% above prime rate, matures the earlier of
December 31, 2002, the date after LTS receives its federal income tax
refund for the fiscal year ended September 30, 2002, or the next business
day after LTS receives a loan from an affiliate of its clearing broker in
connection with the conversion of additional business to this broker.
9. DISCONTINUED OPERATIONS
-----------------------
The consolidated financial statements of the Company have been
reclassified to reflect as discontinued operations New Valley's
broker-dealer operations, which were New Valley's primary source of
revenues since 1995. Accordingly, revenues, costs and expenses, and cash
flows of the discontinued operations have been excluded from the
respective captions in the consolidated statements of operations and
consolidated statements of cash flows. The net operating results of these
entities have been reported, net of minority interests and applicable
income taxes, as "Loss from discontinued operations," and the net cash
flows of these entities have been reported as "Net cash flows provided
from discontinued operations."
On December 20, 2001, New Valley distributed its 53.6% interest
(22,543,158 shares) of LTS common stock to holders of New Valley common
shares through a special dividend. On the same date, Vector distributed
the 12,694,929 shares of LTS common stock that it received from New Valley
to the holders of Vector's common stock as a special dividend.
Summarized operating results of the discontinued broker-dealer operations
for the three and nine months ended September 30, 2001 are as follows:
Three Months Nine Months
Ended Ended
Sept. 30, 2001 Sept. 30, 2001
-------------- --------------
Revenues ..................... $ 18,054 $ 58,376
Expenses ..................... 26,492 70,565
-------- --------
Operating loss before minority
interests and income taxes $ (8,438) $(12,189)
======== ========
- 28 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
10. SEGMENT INFORMATION
The Company's significant business segments for the nine months ended
September 30, 2002 and 2001 were Liggett, Vector Tobacco and real estate.
The Liggett segment consists of the manufacture and sale of conventional
cigarettes and, for segment reporting purposes, includes the operations of
Medallion acquired on April 1, 2002 (which operations are held for legal
purposes as part of Vector Tobacco). The Vector Tobacco segment includes
the development and marketing of new reduced carcinogen and low nicotine
and nicotine-free cigarette products and, for segment reporting purposes,
excludes the operations of Medallion.
Financial information for the Company's continuing operations before taxes
and minority interest for the three and nine months ended September 30,
2002 and 2001 follows:
Vector Real Corporate(1)
Liggett Tobacco Estate and Other Total
--------- --------- --------- ------------ ---------
THREE MONTHS ENDED SEPT. 30, 2002:
Revenues ......................... $ 139,875 $ 1,839 $ -- $ -- $ 141,714
Operating income (loss) .......... 27,255 (20,239) 484 (7,186) 314
Depreciation and amortization .... 1,560 1,327 -- 973 3,860
THREE MONTHS ENDED SEPT. 30, 2001:
Revenues ......................... $ 120,228 $ -- $ 2,538 $ -- $ 122,766
Operating income (loss) .......... 33,592 (10,574) (166) (5,852) 17,000
Depreciation and amortization .... 1,025 533 661 431 2,650
NINE MONTHS ENDED SEPT. 30, 2002:
Revenues ......................... $ 372,688 $ 5,597 $ 661 $ -- $ 378,946
Operating income (loss) .......... 70,650 (64,876) (354) (25,002) (19,582)
Identifiable assets .............. 160,592 208,173 1,514 304,808 675,087
Depreciation and amortization .... 4,281 3,407 191 2,066 9,945
Capital expenditures ............. 16,357 15,624 688 6,615 39,284
NINE MONTHS ENDED SEPT. 30, 2001:
Revenues ......................... $ 302,922 $ -- $ 7,604 $ -- $ 310,526
Operating income (loss) .......... 76,435 (21,790) (796) (16,290) 37,559
Identifiable assets .............. 128,933 53,096 131,993 483,907 797,929
Depreciation and amortization .... 3,463 856 1,989 914 7,222
Capital expenditures ............. 5,266 23,329 1,213 17,549 47,357
- -------------
(1) For 2001, the assets of the discontinued broker-dealer segment are included
in Corporate and Other.
- 29 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
INTRODUCTION
The following discussion provides an assessment of our consolidated
results of operations, capital resources and liquidity and should be read in
conjunction with our consolidated financial statements and related notes
included elsewhere in this report. The consolidated financial statements include
the accounts of VGR Holding Inc., Liggett Group Inc., New Valley Corporation,
Vector Tobacco Inc. and other less significant subsidiaries. As of September 30,
2002, we owned 56.2% of New Valley's common shares.
We are a holding company for a number of businesses. We are engaged
principally in:
o the development and marketing of reduced carcinogen and low
nicotine and nicotine-free cigarette products through our
subsidiary Vector Tobacco, and
o the manufacture and sale of cigarettes in the United States
through our subsidiary Liggett.
Our majority-owned subsidiary, New Valley, completed in December 2001
the distribution to its stockholders of its shares in Ladenburg Thalmann
Financial Services, its former majority-owned subsidiary engaged in the
investment banking and brokerage business. The Ladenburg Thalmann Financial
Services shares received by us were, in turn, distributed to our stockholders.
Following the distribution of the shares, New Valley's broker-dealer operations,
which were its primary source of revenues since 1995, are accounted for as a
discontinued operation. New Valley is currently engaged in the real estate
business and is seeking to acquire additional operating companies.
RECENT DEVELOPMENTS
LIGGETT VECTOR BRANDS. In March 2002, we announced that the sales and
marketing functions, along with certain support functions, of our Liggett and
Vector Tobacco subsidiaries would be combined into a new entity, Liggett Vector
Brands Inc. The newly formed company will coordinate and execute the sales and
marketing efforts for all of our tobacco operations. As of September 30, 2002,
this reorganization was essentially complete. With the combined resources of
Liggett and Vector Tobacco, Liggett Vector Brands has approximately 425
salespersons, and enhanced distribution and marketing capabilities. Final
reorganization matters are being completed in the fourth quarter of 2002. In
connection with the creation of the new Liggett Vector Brands entity, we took a
charge of $3,460 in the first quarter of 2002, related to the reorganization of
our business. As of September 30, 2002, the Company's reorganization accrual has
been reduced by payments of $730 and the remaining balance was $2,730.
ACQUISITION OF MEDALLION. On April 1, 2002, a subsidiary of ours
acquired the stock of The Medallion Company, Inc., and related assets from
Medallion's principal stockholder. The total purchase price consisted of $50,000
in cash and $60,000 in notes, with the notes guaranteed by us and by Liggett.
Medallion, a discount cigarette manufacturer headquartered in Richmond,
Virginia, is a participant in the Master Settlement Agreement between the state
Attorneys General and the tobacco industry. Medallion has no payment obligations
under the Master Settlement Agreement except to the extent its market share
exceeds approximately 0.28% of total cigarettes sold in the United States
(approximately 1.15 billion units in 2001).
- 30 -
VGR HOLDING PRIVATE PLACEMENT. On April 30, 2002, VGR Holding issued at
a discount $30,000 principal amount of 10% senior secured notes due March 31,
2006 in a private placement to institutional investors. VGR Holding received net
proceeds from the placement of approximately $25,000. In November 2002, in
connection with an amendment to the note purchase agreement, VGR Holding
repurchased $8,000 of the notes at a price of 100% of the principal amount plus
accrued interest.
RECENT DEVELOPMENTS IN LEGISLATION, REGULATION AND LITIGATION
The cigarette industry continues to be challenged on numerous fronts.
New cases continue to be commenced against Liggett and other cigarette
manufacturers. As of September 30, 2002, there were approximately 338 individual
suits, 41 purported class actions and 47 governmental and other third-party
payor health care reimbursement actions pending in the United States in which
Liggett was a named defendant. In addition to these cases, an action against
cigarette manufacturers involving approximately 1,250 named individual
plaintiffs has been consolidated before a single West Virginia state court.
Liggett is a defendant in most of the cases pending in West Virginia.
Approximately 38 other purported class action complaints have been filed against
the cigarette manufacturers for alleged antitrust violations. As new cases are
commenced, the costs associated with defending these cases and the risks
relating to the inherent unpredictability of litigation continue to increase.
An unfavorable verdict was returned in the first phase of the ENGLE
smoking and health class action trial pending in Florida. In July 2000, the jury
awarded $790,000 in punitive damages against Liggett in the second phase of the
trial, and the court entered an order of final judgment. Liggett intends to
pursue all available post-trial and appellate remedies. If this verdict is not
eventually reversed on appeal, or substantially reduced by the court, it will
have a material adverse effect on Vector. Liggett has filed the $3,450 bond
required under recent Florida legislation which limits the size of any bond
required, pending appeal, to stay execution of a punitive damages verdict. In
May 2001, Liggett reached an agreement with the class in the ENGLE case, which
will provide assurance to Liggett that the stay of execution, currently in
effect under the Florida bonding statute, will not be lifted or limited at any
point until completion of all appeals, including to the United States Supreme
Court. As required by the agreement, Liggett paid $6,273 into an escrow account
to be held for the benefit of the ENGLE class, and released, along with
Liggett's existing $3,450 statutory bond, to the court for the benefit of the
class upon completion of the appeals process, regardless of the outcome of the
appeal. In June 2002, the jury in an individual case brought under the third
phase of the ENGLE case awarded $37,500 of compensatory damages against Liggett
and two other defendants and found Liggett 50% responsible for the damages. The
verdict will be subject to the outcome of the ENGLE appeal. It is possible that
additional cases could be decided unfavorably and that there could be further
adverse developments in the ENGLE case. Management cannot predict the cash
requirements related to any future settlements and judgments, including cash
required to bond any appeals, and there is a risk that those requirements will
not be able to be met.
In recent years, there have been a number of restrictive regulatory
actions from various Federal administrative bodies, including the United States
Environmental Protection Agency and the Food and Drug Administration. There have
also been adverse political decisions and other unfavorable developments
concerning cigarette smoking and the tobacco industry, including the
commencement and certification of class actions and the commencement of
third-party payor actions. These developments generally receive widespread media
attention. We are not able to evaluate the effect of these developing matters on
pending litigation or the possible commencement of additional litigation, but
our consolidated financial position, results of operations or cash flows could
be materially adversely affected by an unfavorable outcome in any
smoking-related litigation. See Note 7 to our consolidated financial statements
for a description of legislation, regulation and litigation.
- 31 -
CRITICAL ACCOUNTING POLICIES
Financial Reporting Release No. 60, which was recently released by the
Securities and Exchange Commission, requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. The following is a brief discussion of the more
significant accounting policies and methods used by us.
GENERAL. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities and the reported amounts of revenues and expenses. Significant
estimates subject to material changes in the near term include deferred tax
assets, allowance for doubtful accounts, promotional accruals, sales returns and
allowances, actuarial assumptions of pension plans, settlement accruals and
litigation and defense costs. Actual results could differ from those estimates.
REVENUE RECOGNITION. Revenues from sales of cigarettes are recognized
upon the shipment of finished goods to customers. We provide an allowance for
expected sales returns, net of related inventory cost recoveries. Since our
primary line of business is tobacco, our financial position and our results of
operations and cash flows have been and could continue to be materially
adversely effected by significant unit sales volume declines, litigation and
defense costs, increased tobacco costs or reductions in the selling price of
cigarettes in the near term. As discussed in Note 1 to our consolidated
financial statements, effective January 1, 2002, we adopted new required
accounting standards mandating that certain sales incentives previously reported
as operating, selling, general and administrative expenses be shown as a
reduction of operating revenues. As a result, our previously reported revenues
have been reduced by approximately $208,628 for the nine months ended September
30, 2001 and cost of goods sold increased by $7,831. The adoption of the new
accounting standards had no impact on our net earnings or basic or diluted
earnings per share.
MARKETING COSTS. We record marketing costs as an expense in the period
to which such costs relate. We do not defer the recognition of any amounts on
our consolidated balance sheets with respect to marketing costs. We expense
advertising costs as incurred, which is the period in which the related
advertisement initially appears. We record consumer incentive and trade
promotion costs as an expense in the period in which these programs are offered,
based on estimates of utilization and redemption rates that are developed from
historical information. As discussed above under "Revenue Recognition",
beginning January 1, 2002, we have adopted the previously mentioned revenue
recognition accounting standards that mandate that certain costs previously
reported as marketing expense be shown as a reduction of operating revenues. As
a result, previously reported amounts for operating, selling, general and
administrative expenses have been reduced by approximately $216,459 for the nine
months ended September 30, 2001. The adoption of the new accounting standards
had no impact on our net earnings or basic or diluted earnings per share.
CONTINGENCIES. As discussed in Note 7 of our consolidated financial
statements and above under the heading "Recent Developments in Legislation,
Regulation and Litigation", legal proceedings covering a wide range of matters
are pending or threatened in various jurisdictions against Liggett. Management
is unable to make a meaningful estimate with respect to the amount or range of
loss that could result from an unfavorable outcome of pending smoking-related
litigation or the costs of defending such cases, and we have not provided any
amounts in our consolidated financial statements for unfavorable outcomes, if
any. Litigation is subject to many uncertainties, and it is possible that our
consolidated financial position, results of operations or cash flows could be
materially adversely affected by an unfavorable outcome in any such
smoking-related litigation.
- 32 -
EMPLOYEE BENEFIT PLANS. Since 1997, income from our defined benefit
pension plans covering Liggett employees, partially offset by the costs of
postretirement medical benefits, have contributed to our reported operating
income, including approximately $3,200 for 2002. The determination of our net
pension and other postretirement benefit income or expense is dependent on our
selection of certain assumptions used by actuaries in calculating such amounts.
Those assumptions include, among others, the discount rate, expected long-term
rate of return on plan assets and rates of increase in compensation and
healthcare costs. In accordance with accounting principles generally accepted in
the United States of America, actual results that differ from our assumptions
are accumulated and amortized over future periods and therefore, generally
affect our recognized income or expense in such future periods. While we believe
that our assumptions are appropriate, significant differences in our actual
experience or significant changes in our assumptions may materially affect our
future net pension and other postretirement benefit income or expense.
Based on the declines in the securities markets, we anticipate
recording a non-cash charge to stockholders' equity in the fourth quarter of
2002 relating to one of Liggett's defined benefit plans. We currently estimate
the non-cash charge to equity will be approximately $11,000, net of income
taxes; the actual charge may differ materially from this estimate because the
charge will be based on the extent to which our accumulated benefit obligations
under the pension plan on September 30, 2002 exceed the fair value of the
pension plan's assets on that date. We will record this charge in accordance
with Statement of Financial Accounting Standards No. 87, "Employers' Accounting
for Pensions." We also currently anticipate net pension expense for Liggett's
plan and other postretirement benefit expense aggregating approximately $1,000
for 2003. In contrast, our funding obligations under the pension plans are
governed by ERISA. To comply with ERISA's minimum funding requirements, we do
not currently anticipate that we will be required to make any funding to the
pension plans for the pension plan year beginning on January 1, 2003 and ending
on December 31, 2003. Any additional funding obligation that we may have for
subsequent years is contingent on several factors and is not reasonably
estimable at this time.
RESULTS OF OPERATIONS
For purposes of this discussion and other segment reporting, our
significant business segments for the nine months ended September 30, 2002 and
2001 were Liggett, Vector Tobacco and real estate. The Liggett segment consists
of the manufacture and sale of conventional cigarettes and, for segment
reporting purposes, includes the operations of Medallion acquired on April 1,
2002 (which operations are held for legal purposes as part of Vector Tobacco).
The Vector Tobacco segment includes the development and marketing of new reduced
carcinogen and low nicotine and nicotine-free cigarette products and, for
segment reporting purposes, excludes the operations of Medallion.
- 33 -
<Table>
<Caption>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
REVENUES:
Liggett ........................ $ 139,875 $ 120,228 $ 372,688 $ 302,922
Vector Tobacco ................. 1,839 -- 5,597 --
--------- --------- --------- ---------
Total tobacco ............... 141,714 120,228 378,285 302,922
Real estate .................... -- 2,538 661 7,604
--------- --------- --------- ---------
Total revenues .............. $ 141,714 $ 122,766 $ 378,946 $ 310,526
========= ========= ========= =========
OPERATING INCOME (LOSS):
Liggett ........................ $ 27,255 $ 33,592 $ 70,650 $ 76,435
Vector Tobacco ................. (20,239) (10,574) (64,876) (21,790)
--------- --------- --------- ---------
Total tobacco ............... 7,016 23,018 5,774 54,645
Real estate .................... 484 (166) (354) (796)
Corporate and other ............ (7,186) (5,852) (25,002) (16,290)
--------- --------- --------- ---------
Total operating income (loss) $ 314 $ 17,000 $ (19,582) $ 37,559
========= ========= ========= =========
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2001
REVENUES. Total revenues were $141,714 for the three months ended
September 30, 2002 compared to $122,766 for the three months ended September 30,
2001. This 15.4% ($18,948) increase in revenues was due to a $19,647 or 16.3%
increase in revenues at Liggett, and $1,839 in revenues at Vector Tobacco offset
by a decrease of $2,538 in real estate revenues at New Valley.
TOBACCO REVENUES. During 2001, the major cigarette manufacturers,
including Liggett, announced list price increases of $1.90 per carton. On April
2, 2002, the major manufacturers announced list price increases of $1.20 per
carton. Liggett matched the increase on its premium brands only. On July 1,
2002, Liggett announced a list increase of $.60 per carton on LIGGETT SELECT.
Tobacco revenues at Liggett for the three months ended September 30,
2002 totaled $139,875, compared to $120,228 for the same period in 2001.
Revenues grew by 16.3% ($19,647) due to price increases of $17,741 and to a 7.5%
increase in unit sales volume (approximately 182.1 million units) accounting for
$8,957 in positive volume variance, partially offset by $7,051 in unfavorable
sales mix. Tobacco revenues at Vector Tobacco were $1,839 and relate to sales of
OMNI.
Premium sales at Liggett for the third quarter of 2002 amounted to
$14,571 and represented 10.4% of total Liggett sales, compared to $23,766 and
19.8% of total sales for the third quarter of 2001. In the premium segment,
revenues decreased by 38.7% ($9,195) for the three months ended September 30,
2002, compared to the prior year third quarter, due to an unfavorable volume
variance of $9,220, reflecting a 38.8% decrease in unit sales volume
(approximately 96.6 million units), slightly offset by a favorable price
variance of $25.
The decline in Liggett's premium sales revenue during the 2002 period
reflects both the decrease in sales volume of premium-priced cigarettes and
increased promotional spending on
- 34 -
premium brands driven primarily by weak economic conditions, substantial excise
tax increases in many states, and significant promotional and pricing activity
among the major U.S. cigarette manufacturers.
Discount sales at Liggett (comprising the brand categories of branded
discount, private label, control label, generic, international and contract
manufacturing) for the three months ended September 30, 2002 amounted to
$125,304 and represented 89.6% of total Liggett sales, compared to $96,462 and
80.2% of total Liggett sales for the three months ended September 30, 2001. In
the discount segment, revenues grew by 29.9% ($28,842) for the three months
ended September 30, 2002 compared to the prior year period, due to a 12.7% gain
in unit sales volume (approximately 278.7 million units) accounting for $12,247
in positive volume variance and price increases of $17,715, partially offset by
an unfavorable product mix of $1,120.
For the three months ended September 30, 2002, fixed manufacturing
costs at Liggett on a basis comparable to 2001 were $334 higher with costs per
thousand units of $2.11 increasing 6.0% from the previous year's $1.99, with
essentially constant production volume. On a per-thousand unit basis, fixed
payroll expense and indirect labor of $0.99 for the three months ended September
30, 2002 decreased from $1.17 in the prior year period (15.4%), while fixed
non-payroll expenses increased 37.8%.to $1.13 from $0.82 in the prior year
period.
TOBACCO GROSS PROFIT. Tobacco gross profit was $41,272 for the three
months ended September 30, 2002 compared to $47,879 for the three months ended
September 30, 2001, a decrease of $6,607 or 13.8% when compared to the same
period last year, due to inclusion of the higher estimated payment obligations
under the Attorneys General Master Settlement Agreement and to costs associated
with the operations of Vector Tobacco. Liggett's brands contributed 114.3% and
Vector Tobacco's brand cost 14.3% for the three months ended September 30, 2002.
Over the same period in 2001, all the tobacco gross profit related to Liggett's
brands.
Liggett's gross profit of $47,187 for the three months ended September
30, 2002 decreased $692 from gross profit of $47,879 for the three months ended
September 30, 2001. As a percent of revenues (excluding federal excise taxes),
gross profit at Liggett decreased to 53.2% for the three months ended September
30, 2002 compared to 60.8% for the same period in 2001, with gross profit for
the premium segment decreasing to 24.4% for the three months ended September 30,
2002 compared to 73.4% in the same period in 2001 and gross profit for the
discount segment increasing to 57.5% in the three months ended September 30,
2002 from 56.6% in the same period in 2001. The overall decrease in Liggett's
gross profit is due primarily to the inclusion of the higher estimated payment
obligations under the Attorneys General Master Settlement Agreement within cost
of goods sold, the increase in promotional spending on premium brands discussed
above and the disproportionate rise in deep-discount sales, leading to lower
gross margin.
REAL ESTATE REVENUES. New Valley's real estate revenues were $0 for the
three months ended September 30, 2002. This compares to revenues of $2,538 from
real estate activities for the three months ended September 30, 2001, with the
decline primarily due to the absence of rental revenue of $2,067 from Western
Realty Investments, which was sold in December 2001, and rental revenue of $471
from New Valley's remaining shopping center, which was disposed of in May 2002.
EXPENSES. Operating, selling, general and administrative expenses were
$40,958 for the three months ended September 30, 2002 compared to $33,511 for
the same period last year. The increase of $7,447 was due primarily to a $3,743
increase in expenses at Vector Tobacco related to expenses of product
development and marketing for Vector Tobacco's OMNI brand and QUEST, its new low
nicotine and nicotine-free products, scheduled to be introduced at retail in
select markets in the first quarter 2003, and to an increase of $5,701 at
Liggett related to a larger sales force and increased marketing efforts. There
were also increased expenses at corporate offset by lower expenses at New Valley
due to a decrease in professional fees. Expenses at Liggett were $19,932 for the
three
- 35 -
months ended September 30, 2002 compared to $14,287 for the same period last
year. Expenses at Vector Tobacco for the three months ended September 30, 2002
were $14,324, compared to expenses of $10,581 for the three months ended
September 30, 2001.
For the quarter ended September 30, 2001, Liggett's operating income
was reduced by $6,337 to $27,255 compared to $33,592 in the prior year primarily
due to increased expenses related to a larger sales force and increased
marketing efforts. Vector Tobacco's operating loss increased to $20,239 for the
quarter ended September 30, 2002 when compared to the operating loss of $10,574
for the same period in September 30, 2001.
OTHER INCOME (EXPENSES). For the three months ended September 30, 2002,
other income (expenses) was a loss of $16,928 compared to a loss of $2,981 for
the three months ended September 30, 2001. Interest and dividend income were
$2,342 for the 2002 period compared to $3,537 for the 2001 period and were
offset in the 2002 period by a provision for loss on notes receivable of $13,198
established by New Valley and an increase in interest expense of $1,288 for the
three months ended September 30, 2002 over the same period last year. The
increased interest expense was primarily due to the issuance of long-term debt
at the corporate level, increased equipment financing when compared to the prior
period as well as the issuance of the notes relating to the Medallion
acquisition.
(LOSS) INCOME FROM CONTINUING OPERATIONS. The loss from continuing
operations before income taxes and minority interests for the three months ended
September 30, 2002 was $16,614 compared to income of $14,019 for the three
months ended September 30, 2001. Income tax benefit was $1,972 and minority
interests in losses of subsidiaries was $6,476 for the three months ended
September 30, 2002. This compared to tax expense of $6,753 and minority
interests in income of subsidiaries of $1,210 for the three months ended
September 30, 2001. The effective tax rates for the three months ended September
30, 2002 do not bear a customary relationship to pre-tax accounting income
principally as a consequence of non-deductible expenses and state income taxes.
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2001
REVENUES. Total revenues were $378,946 for the nine months ended
September 30, 2002 compared to $310,526 for the nine months ended September 30,
2001. This 22.0% ($68,420) increase in revenues was due to a $69,766 or 23.0%
increase in revenues at Liggett, and $5,597 in revenues at Vector Tobacco offset
by a decrease of $6,943 in real estate revenues at New Valley.
TOBACCO REVENUES. During 2001, the major cigarette manufacturers,
including Liggett, announced list price increases of $1.90 per carton. On April
2, 2002, the major manufacturers announced list price increases of $1.20 per
carton. Liggett matched the increase on its premium brands only. On July 1,
2002, Liggett announced a list price increase of $.60 per carton on LIGGETT
SELECT.
For the nine months ended September 30, 2002, net sales at Liggett
totaled $372,688, compared to $302,922 for the first nine months of 2001.
Revenues increased by 23.0% ($69,766) due to price increases of $32,819 and a
17.7% increase in unit sales volume (approximately 1,110 million units)
accounting for $53,556 in positive volume variance, partially offset by $16,609
in unfavorable sales mix. Tobacco revenues at Vector Tobacco were $5,597 and
relate to sales of OMNI.
Premium sales at Liggett for the nine months ended September 30, 2002
amounted to $37,199 and represented 10.0% of total Liggett sales, compared to
$57,350 and 18.9% of total sales for the same period of 2001. In the premium
segment, revenues decreased by 35.1%
- 36 -
($20,151) for the nine months ended September 30, 2002, compared to the prior
year period, due to an unfavorable price variance of $10,149, primarily
associated with promotional activities and an unfavorable volume variance of
$10,002.
The decline in Liggett's premium sales revenue during the 2002 period
reflects both the decrease in sales volume of premium-priced cigarettes and
increased promotional spending on premium brands driven primarily by weak
economic conditions, substantial excise tax increases in many states, and
significant promotional and pricing activity from the major U.S. cigarette
manufacturers.
Discount sales at Liggett for the nine months ended September 30, 2002
amounted to $335,489 and represented 90.0% of total Liggett sales, compared to
$245,572 and 81.1% of total Liggett sales for the nine months ended September
30, 2001. In the discount segment, revenues grew by 36.6% ($89,917) for the nine
months ended September 30, 2002 compared to the prior year period, due to a
21.0% gain in unit sales volume (approximately 1,200 million units) accounting
for $51,677 in positive volume variance and price increases of $42,968,
partially offset by an unfavorable product mix of $4,728.
For the nine months ended September 30, 2002, fixed manufacturing costs
at Liggett on a basis comparable to 2001 were $498 higher with costs per
thousand units of $1.88 increasing $0.10 (5.6%) from the previous year's $1.78,
concurrent with a 1.3% decrease in production volume. On a per-thousand unit
basis, fixed payroll expense and indirect labor of $1.00 for the nine months
ended September 30, 2002 increased from $0.94 in the prior year period (6.4%),
while fixed non-payroll expenses increased to $0.87 from $0.85 in the prior year
period (2.4%).
TOBACCO GROSS PROFIT. Tobacco gross profit was $115,668 for the nine
months ended September 30, 2002 compared to $128,867 for the nine months ended
September 30, 2001, a decrease of $13,199 or 10.2% when compared to the same
period last year, due primarily to the volume and price increases discussed
above at Liggett offset by costs associated with the operations of Vector
Tobacco. Liggett's brands contributed 111.4% to our gross profit and Vector
Tobacco cost 11.4% for the nine months ended September 30, 2002. Over the same
period in 2001, all of the tobacco gross profit related to Liggett's brands.
Liggett's gross profit of $128,812 for the nine months ended September
30, 2002 decreased $55 from gross profit of $128,867 for the nine months ended
September 30, 2001. As a percent of revenues (excluding federal excise taxes),
gross profit at Liggett decreased to 56.2% for the nine months ended September
30, 2002 compared to 65.4% for the same period in 2001, with gross profit for
the premium segment decreasing to 44.6% for the nine months ended September 30,
2002 compared to 70.4% in the same period in 2001 and gross profit for the
discount segment decreasing to 57.8% in the nine months ended September 30, 2002
from 63.8% in the same period in 2001. This decrease in Liggett's gross profit
is due primarily to the inclusion of the higher estimated payment obligations
under the Attorneys General Master Settlement Agreement within cost of goods
sold, the increase in promotional spending on premium brands discussed above and
the disproportionate rise in deep-discount sales, leading to lower gross margin.
REAL ESTATE REVENUES. New Valley's real estate revenues were $661 for
the nine months ended September 30, 2002. This compares to revenues of $7,604
from real estate activities for the nine months ended September 30, 2001, with
the decline primarily due to the absence of rental revenue of $6,111 from
Western Realty Investments, which was sold in December 2001, and New Valley's
remaining shopping center, which was disposed of in May 2002.
EXPENSES. Operating, selling, general and administrative expenses were
$136,718 for the nine months ended September 30, 2002 compared to $89,509 for
the same period last year. The increase of $47,209 was due primarily to a
$29,939 increase in expenses at Vector Tobacco related
- 37 -
to expenses of product development and marketing for Vector Tobacco's OMNI and
QUEST brands and increased expenses at corporate offset by lower expenses at New
Valley primarily due to a decrease in professional fees. Expenses at Liggett
were $58,969 for the nine months ended September 30, 2002 compared to $42,579
for the same period last year. The increase in operating expense at Liggett was
due primarily to expenses related to a larger sales force, increased marketing
efforts and a $3,460 restructuring charge taken in March 2002 in connection with
the creation of Liggett Vector Brands and used for reorganization of its
business. Expenses at Vector Tobacco for the nine months ended September 30,
2002 were $51,732, compared to expenses of $21,793 for the nine months ended
September 30, 2001.
For the nine months ended September 30, 2002, Liggett's operating
income decreased to $70,650 compared to $76,435 for the prior year period due
primarily to increased expenses related to a larger sales force and increased
marketing efforts. As discussed in Note 7 to our consolidated financial
statements, in May 2001, Liggett reached an agreement with the class in the
ENGLE case, which provides assurance to Liggett that the stay of execution,
currently in effect pursuant to the Florida bonding statute, will not be lifted
or limited at any point until completion of all appeals, including to the
United States Supreme Court. As required by the agreement, Liggett paid $6,273
into an escrow account to be held for the benefit of the ENGLE class, and
released, along with Liggett's existing $3,450 statutory bond, to the court for
the benefit of the class upon completion of the appeals process, regardless of
the outcome of the appeal. As a result, we recorded a $9,723 pre-tax charge to
the consolidated statement of operations for the first quarter of 2001. Vector
Tobacco's operating loss was $64,876 for the nine months ended September 30,
2002 compared to $21,790 in the 2001 period.
OTHER INCOME (EXPENSES). For the nine months ended September 30, 2002,
other income (expenses) was a loss of $13,922 compared to other income of $351
for the nine months ended September 30, 2001. A provision for loss on notes
receivable of $13,198 established by New Valley and increased interest expense
were offset by interest and dividend income of $7,743 and a gain on sale of
assets of $9,029. The gain on sale of assets includes a gain of $8,484 related
to the sale of BrookeMil in April 2002 and a gain of $564 on the disposal of
New Valley's remaining shopping center in May 2002.
Interest expense was $19,417 for the nine months ended September 30,
2002 compared to $9,134 for the same period last year, due to the issuance of
long-term debt at the corporate level and increased equipment financing when
compared to the prior period as well as issuance of the notes relating to the
Medallion acquisition.
(LOSS) INCOME FROM CONTINUING OPERATIONS. The loss from continuing
operations before income taxes and minority interests for the nine months ended
September 30, 2002 was $33,504 compared to income of $37,910 for the nine months
ended September 30, 2001. Income tax benefit was $5,643 and minority interests
in losses of subsidiaries was $4,490 for the nine months ended September 30,
2002. This compared to tax expense of $17,235 and minority interests in income
of subsidiaries of $1,992 for the nine months ended September 30, 2001. The
effective tax rates for the nine months ended September 30, 2002 do not bear a
customary relationship to pre-tax accounting income principally as a consequence
of non-deductible expenses and state income taxes.
CAPITAL RESOURCES AND LIQUIDITY
Net cash and cash equivalents decreased $108,534 for the nine months
ended September 30, 2002 and increased $76,994 for the nine months ended
September 30, 2001.
Net cash used in operations for the nine months ended September 30,
2002 was $35,602 compared to net cash provided by operations of $20,425 for the
comparable period of 2001. Net cash used in operations for the nine months ended
September 30, 2002 resulted primarily from a net loss of $23,371 and an increase
in inventories offset by a decrease in accounts receivable. Net cash provided by
operations for the comparable period in 2001 resulted from net income of
$21,719, an increase in accounts payable and accrued expenses and other current
liabilities offset by an increase in inventories and accounts receivable.
- 38 -
Cash used in investing activities of $48,172 in 2002 compares to cash
used of $180,697 in 2001. In 2002, cash was used principally for the acquisition
of Medallion for $50,000 and for the purchase of machinery and equipment for
$39,284 as well as for the issuance of a note receivable at New Valley for
$4,000. These expenditures were offset primarily by net proceeds received from
the sale by New Valley of BrookeMil for $20,461 and the net sale or maturity of
investment securities of $24,137. In 2001, cash was used primarily for purchase
of investment securities of $159,381, capital expenditures of $47,357, purchase
of long term investments for $5,747 and the purchase by New Valley of common
shares of Ladenburg Thalmann Financial Services for $3,945. These expenditures
were offset primarily by $9,172 of proceeds from the sale of one of New Valley's
shopping centers, sales at Liggett of a warehouse facility and machinery and
equipment, sales or maturity of investment securities of $10,634 and cash
acquired in the acquisition of Ladenburg Thalmann.
Cash used in financing activities was $24,760 for the nine months ended
September 30, 2002 compared to cash provided of $237,127 in 2001. During the
nine months ended September 30, 2002, cash was used primarily for dividends of
$39,906 and repayments of debt of $10,355 offset by proceeds from debt of
$37,635 and proceeds from the exercise of options of $1,196. During the nine
months ended September 30, 2001, cash was provided primarily by the net proceeds
from debt of $255,167, the issuance of common stock for $50,000 and proceeds
from the sale of options and warrants for $16,042. Cash was used primarily for
net repayments on the revolving credit facilities of $19,374 and for dividends
of $34,024.
LIGGETT. Liggett has a $40,000 credit facility under which $0 was
outstanding at September 30, 2002. Availability under the facility was
approximately $34,633 based on eligible collateral at September 30, 2002. The
facility is collateralized by all inventories and receivables of Liggett.
Borrowings under the facility, whose interest is calculated at a rate equal to
1.0% above First Union's (the indirect parent of Congress Financial Corporation,
the lead lender) prime rate, bore a rate of 5.75% at September 30, 2002. The
facility requires Liggett's compliance with certain financial and other
covenants including a restriction on the payment of cash dividends unless
Liggett's borrowing availability under the facility for the 30-day period prior
to the payment of the dividend, and after giving effect to the dividend, is at
least $5,000. In addition, the facility, as amended, imposes requirements with
respect to Liggett's adjusted net worth (not to fall below $8,000 as computed in
accordance with the agreement) and working capital (not to fall below a deficit
of $17,000 as computed in accordance with the agreement). At September 30, 2002,
Liggett was in compliance with all covenants under the credit facility;
Liggett's adjusted net worth was $22,353 and net working capital was $2,643 as
computed in accordance with the agreement. The facility expires on March 8, 2003
subject to automatic renewal for an additional year unless a notice of
termination is given by the lender at least 60 days prior to the anniversary
date.
In November 1999, 100 Maple LLC, a new company formed by Liggett to
purchase an industrial facility in Mebane, North Carolina, borrowed $5,040 from
the lender under Liggett's credit facility. In July 2001, Maple borrowed an
additional $2,340 under the loan, and a total of $5,190 was outstanding at
September 30, 2002. In addition, the lender extended the term of the loan so
that it is payable in 59 monthly installments of $75 including annual interest
at 1% above the prime rate with a final payment of $1,875. In September 2002,
the lender agreed that no further regularly scheduled principal payments would
be due under the Maple loan until March 1, 2004. Interest is charged at the
same rate as applicable to Liggett's credit facility, and borrowings under the
Maple loan reduce the maximum availability under the credit facility. Liggett
has guaranteed the loan, and a first mortgage on the Mebane property and
equipment collateralizes the Maple loan and Liggett's credit facility. Liggett
completed the relocation of its manufacturing operations to this facility in
October 2000.
- 39 -
In March 2000, Liggett purchased equipment for $1,000 under a capital
lease which is payable in 60 monthly installments of $21 with an effective
annual interest rate of 10.14%. In April 2000, Liggett purchased equipment for
$1,071 under two capital leases which are payable in 60 monthly installments of
$22 with an effective interest rate of 10.20%.
Liggett has upgraded the efficiency of its manufacturing operation at
Mebane with the addition of four new state-of-the-art cigarette makers and
packers, as well as related equipment. The total cost of these upgrades was
approximately $22,000. Liggett took delivery of the first two of the new lines
in the fourth quarter of 2001 and financed the purchase price of $6,404 through
capital lease arrangements guaranteed by us and payable in 60 monthly
installments of $61 with interest calculated at the prime rate. In March 2002,
the third line was delivered, and the purchase price of $3,023 was financed
through the issuance of a note, payable in 30 monthly installments of $62 and
then 30 monthly installments of $51 with an effective annual interest rate of
4.68%. In May 2002, the fourth line was delivered, and Liggett financed the
purchase price of $2,871 through the issuance of a note, payable in 30 monthly
installments of $59 and then 30 monthly installments of $48 with an effective
annual interest rate of 4.64%. In September 2002, Liggett purchased additional
equipment for $1,573 through a note guaranteed by us, payable in 58 monthly
installments of $26 with a final payment of $345 with an effective annual
interest rate of 6.20%.
In May 1999, in connection with the Philip Morris brand transaction,
Eve Holdings Inc., a subsidiary of Liggett, guaranteed a $134,900 bank loan to
Trademarks LLC. The loan is secured by Trademarks' three premium cigarette
brands and Trademarks' interest in the exclusive license of the three brands by
Philip Morris. The license provides for a minimum annual royalty payment equal
to the annual debt service on the loan plus $1,000.
Liggett (and, in certain cases, Brooke Group Holding, our predecessor
and a wholly-owned subsidiary of VGR Holding) and other United States cigarette
manufacturers have been named as defendants in a number of direct and
third-party actions (and purported class actions) predicated on the theory that
they should be liable for damages from cancer and other adverse health effects
alleged to have been caused by cigarette smoking or by exposure to so-called
secondary smoke from cigarettes. We believe, and have been so advised by counsel
handling the respective cases, that Brooke Group Holding and Liggett have a
number of valid defenses to claims asserted against them. Litigation is subject
to many uncertainties. An unfavorable verdict was returned in the first phase of
the ENGLE smoking and health class action trial pending in Florida. In July
2000, the jury awarded $790,000 in punitive damages against Liggett in the
second phase of the trial, and the court entered an order of final judgment.
Liggett intends to pursue all available post-trial and appellate remedies. If
this verdict is not eventually reversed on appeal, or substantially reduced by
the court, it will have a material adverse effect on Vector. Liggett has filed
the $3,450 bond required under recent Florida legislation which limits the size
of any bond required, pending appeal, to stay execution of a punitive damages
verdict. In May 2001, Liggett reached an agreement with the class in the ENGLE
case, which will provide assurance to Liggett that the stay of execution,
currently in effect pursuant to the Florida bonding statute, will not be lifted
or limited at any point until completion of all appeals, including to the United
States Supreme Court. As required by the agreement, Liggett paid $6,273 into an
escrow account to be held for the benefit of the ENGLE class, and released,
along with Liggett's existing $3,450 statutory bond, to the court for the
benefit of the class upon completion of the appeals process, regardless of the
outcome of the appeal. In June 2002, the jury in an individual case brought
under the third phase of the ENGLE case awarded $37,500 of compensatory damages
against Liggett and two other defendants and found Liggett 50% responsible for
the damages. The verdict will be subject to the outcome of the ENGLE appeal. It
is possible that additional cases could be decided unfavorably and that there
could be further adverse developments in the ENGLE case. Management cannot
predict the cash requirements related to any future settlements and judgments,
including cash required to bond any appeals, and there is a risk that those
requirements will not be able to be met. An unfavorable outcome of a pending
smoking and health case could encourage the commencement
- 40 -
of additional similar litigation. In recent years, there have been a number of
adverse regulatory, political and other developments concerning cigarette
smoking and the tobacco industry. These developments generally receive
widespread media attention. Neither we nor Liggett are able to evaluate the
effect of these developing matters on pending litigation or the possible
commencement of additional litigation or regulation. See Note 7 to our
consolidated financial statements.
Management is unable to make a meaningful estimate of the amount or
range of loss that could result from an unfavorable outcome of the cases pending
against Brooke Group Holding or Liggett or the costs of defending such cases. It
is possible that our consolidated financial position, results of operations or
cash flows could be materially adversely affected by an unfavorable outcome in
any such tobacco-related litigation.
VECTOR RESEARCH. In February 2001, a subsidiary of Vector Research Ltd.
purchased equipment for $15,500 and borrowed $13,175 to fund the purchase. The
loan, which is collateralized by the equipment and a letter of credit from us
for $775, is guaranteed by Vector Research, VGR Holding and us. The loan is
payable in 120 monthly installments of $125 including annual interest of 2.31%
above the 30-day commercial paper rate with a final payment of $6,125.
In February 2002, the Vector Research subsidiary purchased equipment
for $6,575 and borrowed $6,150 to fund the purchase. The loan, which is
collateralized by the equipment, is guaranteed by Vector Research and us. The
loan is payable in 120 monthly installments of $44, including annual interest at
2.75% above the 30-day commercial paper rate.
VECTOR TOBACCO. In June 2001, Vector Tobacco purchased for $8,400 an
industrial facility in Timberlake, North Carolina. Vector Tobacco financed the
purchase with an $8,200 loan. The loan is payable in 60 monthly installments of
$85, including annual interest at 4.85% above the LIBOR rate, with a final
payment of approximately $3,160. The loan, which is collateralized by a mortgage
and a letter of credit of $1,750, is guaranteed by us and by VGR Holding.
During December 2001, Vector Tobacco executed a second promissory note
with the same lender for approximately $1,159 to finance building improvements.
The second promissory note is payable in 30 monthly installments of $39 plus
accrued interest, with an annual interest rate of LIBOR plus 5.12%.
On April 1, 2002, a subsidiary of ours acquired the stock of The
Medallion Company, Inc., and related assets from Medallion's principal
stockholder. Medallion is a discount cigarette manufacturer headquartered in
Richmond, Virginia.
Following the purchase of the Medallion stock, Vector Tobacco merged
into Medallion and Medallion changed its name to Vector Tobacco Inc. The total
purchase price for the Medallion shares and the related assets consisted of
$50,000 in cash and $60,000 in notes, with the notes guaranteed by us and by
Liggett. Of the notes, $25,000 bear interest at a 9.0% annual rate and mature
$3,125 per quarter commencing June 30, 2002 and continuing through March 31,
2004. The remaining $35,000 of notes bear interest at 6.5% per year and mature
on April 1, 2007.
VGR HOLDING. On May 14, 2001, VGR Holding issued at a discount $60,000
principal amount of 10% senior secured notes due March 31, 2006 in a private
placement. VGR Holding received net proceeds from the offering of approximately
$46,500. On April 30, 2002, VGR Holding issued at a discount an additional
$30,000 principal amount of 10% senior secured notes due March 31, 2006 in a
private placement and received net proceeds of approximately $25,000. The notes
were priced to provide purchasers with a 15.75% yield to maturity. The notes are
on the same terms as the $60,000 principal amount of senior secured notes
previously issued. All $90,000 principal amount of the notes have been
guaranteed by us and by Liggett.
- 41 -
The notes are collateralized by substantially all of VGR Holding's
assets, including a pledge of VGR Holding's equity interests in its direct
subsidiaries, including Brooke Group Holding, Brooke (Overseas) Ltd., Vector
Tobacco and New Valley Holdings, Inc., as well as a pledge of the shares of
Liggett and all of the New Valley securities held by VGR Holding and New Valley
Holdings. The purchase agreement for the notes contains covenants, which among
other things, limit the ability of VGR Holding to make distributions to us to
50% of VGR Holding's net income, unless VGR Holding holds $75,000 in cash after
giving effect to the payment of the distribution, and limit additional
indebtedness of VGR Holding, Liggett and Vector Tobacco to 250% of EBITDA (as
defined in the purchase agreements) for the trailing 12 months plus an
additional amount of up to $75,000 during the period commencing on April 1, 2002
and ending on September 29, 2002, $115,000 during the period commencing on
September 30, 2002 and ending on December 30, 2002 and $100,000 during the
period commencing on December 31, 2002 and ending on March 31, 2003. The
covenants also restrict transactions with affiliates subject to exceptions which
include payments to us not to exceed $9,500 per year for permitted operating
expenses, and limit the ability of VGR Holding to merge, consolidate or sell
certain assets. In November 2002, in connection with an amendment to the note
purchase agreement, VGR Holding repurchased $8,000 of the notes at a price of
100% of the principal amount plus accrued interest. VGR Holding will recognize a
loss of approximately $1,300 in the fourth quarter 2002 on the early
extinguishment of debt.
Prior to May 14, 2003, VGR Holding may redeem up to $31,500 of the
notes at a redemption price of 100% of the principal amount with proceeds from
one or more equity offerings. VGR Holding may redeem the notes, in whole or in
part, at a redemption price of 100% of the principal amount beginning May 14,
2003. During the term of the notes, VGR Holding is required to offer to
repurchase all the notes at a purchase price of 101% of the principal amount, in
the event of a change of control, and to offer to repurchase notes, at 100% of
the principal amount, with the proceeds of material asset sales.
VECTOR. We believe that we will continue to meet our liquidity
requirements through 2002, although the covenants in the purchase agreements for
VGR Holding's notes limit the ability of VGR Holding to make distributions to us
unless certain tests are met. Under the terms of these covenants, at September
30, 2002, VGR Holding was generally not permitted to pay distributions to us
except for tax sharing payments and specified amounts of operating expenses.
Corporate expenditures (exclusive of Liggett, Vector Research, Vector Tobacco
and New Valley) over the next twelve months for current operations include cash
interest expense of approximately $16,500, dividends on our outstanding shares
(currently at an annual rate of approximately $56,000) and corporate expenses.
We anticipate funding our expenditures for current operations with available
cash resources, proceeds from public and/or private debt and equity financing,
management fees from subsidiaries and tax sharing and other payments from
Liggett or New Valley. New Valley may acquire or seek to acquire additional
operating businesses through merger, purchase of assets, stock acquisition or
other means, or to make other investments, which may limit its ability to make
such distributions.
In July 2001, we completed the sale of $172,500 (net proceeds of
approximately $166,400) of our 6.25% convertible subordinated notes due 2008
through a private offering to qualified institutional investors in accordance
with Rule 144A under the Securities Act of 1933. The notes pay interest at 6.25%
per annum and are convertible into our common stock, at the option of the
holder. The conversion price, which was $30.91 at September 30, 2002, is subject
to adjustment for various events, and any cash distribution on our common stock
results in a corresponding decrease in the conversion price. Following the
conversion of $40,000 principal amount of our convertible notes in December
2001, $132,500 principal amount of the convertible notes were outstanding.
- 42 -
MARKET RISK
We are exposed to market risks principally from fluctuations in
interest rates, foreign currency exchange rates and equity prices. We seek to
minimize these risks through our regular operating and financing activities and
our long-term investment strategy.
The market risk management procedures of us and New Valley cover all
market risk sensitive financial instruments. We held investment securities
available for sale totaling $145,395 at September 30, 2002. Adverse market
conditions could have a significant effect on the value of these investments.
New Valley also holds long-term investments in limited partnerships and
limited liability companies. These investments are illiquid, and their ultimate
realization is subject to the performance of the investee entities.
NEW ACCOUNTING PRONOUNCEMENTS
During 2000, the Emerging Issues Task Force issued EITF No. 00-14,
"Accounting for Certain Sales Incentives", EITF Issue No. 00-14 addresses the
recognition, measurement and statement of operations classification for certain
sales incentives and became effective in the first quarter of 2002. As a result,
certain items previously included in operating, selling, general and
administrative expense in the consolidated statement of operations have been
recorded as a reduction of operating revenues. We have determined that the
impact of adoption or subsequent application of EITF Issue No. 00-14 did not
have a material effect on our consolidated financial position or results of
operations. Upon adoption, prior period amounts, which were not significant,
have been reclassified to conform to the new requirements.
In April 2001, the EITF reached a consensus on Issue No. 00-25, "Vendor
Income Statement Characterization of Consideration Paid to a Reseller of the
Vendor's Products." EITF Issue No. 00-25 requires that certain expenses included
in operating, selling, administrative and general expenses be recorded as a
reduction of operating revenues and was effective in the first quarter of 2002.
As discussed above under "Critical Accounting Policies", adoption of EITF Issue
No. 00-25 has resulted in a significant reduction of revenues offset by a
corresponding reduction in operating, selling, administrative and general
expenses. For comparative purposes, prior period amounts have been reclassified
from operating, selling, administrative and general expenses to a reduction of
revenues. The adoption of EITF 00-25 did not impact the Company's consolidated
financial position, operating income or net income.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001, establishes specific criteria for the recognition
of intangible assets separately from goodwill and requires unallocated negative
goodwill to be written off. SFAS No. 142 primarily addresses the accounting for
goodwill and intangible assets subsequent to their acquisition. SFAS No. 141 is
effective for all business combinations initiated after June 30, 2001, and SFAS
No. 142 is effective for fiscal years beginning after December 15, 2001.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of", and requires (i) the recognition and measurement of
the impairment of long-lived assets to be held and used and (ii) the measurement
of long-lived assets to be disposed of by sale. SFAS No. 144 is effective for
fiscal years beginning after December 15, 2001. The adoption of this statement
did not have an impact on our consolidated financial statements.
- 43 -
In June 2002, FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and
nullifies EITF 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." SFAS 146 requires that a liability for a cost associated
with an exit or disposal activity be recognized when the liability is incurred
as opposed to EITF 94-3, which allowed a cost to be recognized when a commitment
to an exit plan was made. The provisions of this SFAS are effective for exit or
disposal activities that are initiated after December 31, 2002. We will apply
this statement prospectively upon adoption.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We and our representatives may from time to time make oral or written
"forward-looking statements" within the meaning of the Private Securities Reform
Act of 1995, including any statements that may be contained in the foregoing
discussion in "Management's Discussion and Analysis of Financial Condition and
Results of Operations", in this report and in other filings with the Securities
and Exchange Commission and in our reports to stockholders, which reflect our
expectations or beliefs with respect to future events and financial performance.
These forward-looking statements are subject to certain risks and uncertainties
and, in connection with the "safe-harbor" provisions of the Private Securities
Reform Act, we have identified under "Risk Factors" in Item 1 of our Form 10-K
for the year ended December 31, 2001 filed with the Securities and Exchange
Commission important factors that could cause actual results to differ
materially from those contained in any forward-looking statement made by or on
behalf of us.
Results actually achieved may differ materially from expected results
included in these forward-looking statements as a result of these or other
factors. Due to such uncertainties and risks, readers are cautioned not to place
undue reliance on such forward-looking statements, which speak only as of the
date on which such statements are made. We do not undertake to update any
forward-looking statement that may be made from time to time by or on behalf of
us.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Market Risk" is incorporated
herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
have evaluated the effectiveness of the design and operation of our disclosure
controls and procedures within 90 days of the filing date of this quarterly
report, and, based on their evaluation, our principal executive officer and
principal financial officer have concluded that these controls and procedures
are effective. There were no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
Disclosure controls and procedures are our controls and other
procedures that are designed to ensure that information required to be disclosed
by us in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commission's rules and forms. Disclosure
- 44 -
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by us in the
reports that we file under the Exchange Act is accumulated and communicated to
our management, including our principal executive officer and principal
financial officer, as appropriate to allow timely decisions regarding
disclosure.
- 45 -
PART II
OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Reference is made to Note 7, incorporated herein by reference, to
our consolidated financial statements included elsewhere in this
Report on Form 10-Q which contains a general description of
certain legal proceedings to which Brooke Group Holding, VGR
Holding, New Valley or their subsidiaries are a party and certain
related matters. Reference is also made to Exhibit 99.1 for
additional information regarding the pending smoking-related
material legal proceedings to which Brooke Group Holding and/or
Liggett are party. A copy of Exhibit 99.1 will be furnished to
holders of our securities and the securities of our subsidiaries
without charge upon written request to us at our principal
executive offices, 100 S.E. Second St., Miami, Florida 33131,
Attn. Investor Relations.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
No securities of ours which were not registered under the
Securities Act of 1933, as amended, have been issued or sold by us
during the three months ended September 30, 2002, except for
grants of stock options to purchase 2,100 shares of our common
stock at prices ranging between $14.23 and $14.95 per share to
employees of us and/or our subsidiaries. The grants of stock
options were effected in reliance on the exemption from
registration afforded by Section 4(2) of the Securities Act of
1933.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
10.1 Third Amendment to Note Purchase Agreement, dated as
of September 30, 2002, between VGR Holding Inc. and
TCW High Income Partners, Ltd., TCW High Income
Partners II, Ltd., Pioneer High Yield Cayman Unit
Trust, TCW Shared Opportunity Fund III, L.P., TCW
Leveraged Income Trust IV, L.P., TCW Leveraged Income
Trust, L.P., TCW Leveraged Income Trust II, L.P., TCW
LINC III CBO Ltd., POWRs 1997-2, Captiva II Finance
Ltd., AIMCO CDO, Series 2000-A and TCW Shared
Opportunity Fund II, L.P., relating to the 10% Senior
Secured Notes due March 31, 2006.
99.1 Material Legal Proceedings.
*99.2 New Valley Corporation's Interim Consolidated
Financial Statements for the quarterly periods ended
September 30, 2002 and 2001 (incorporated by
reference to New Valley's Quarterly Report on Form
10-Q for the quarterly period ended September 30,
2002, Commission File No. 1-2493).
99.3 Certification of Chief Executive Officer, Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.4 Certification of Chief Financial Officer, Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
- -----------------
* Incorporated by reference
- 46 -
(b) REPORTS ON FORM 8-K
The Company filed the following Reports on Form 8-K during the
third quarter of 2002:
Financial
Date Items Statements
---- ----- ----------
September 3, 2002 5 None
- 47 -
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.
VECTOR GROUP LTD.
(REGISTRANT)
By: /s/ Joselynn D. Van Siclen
-------------------------------------
Joselynn D. Van Siclen
Vice President and Chief
Financial Officer
Date: November 14, 2002
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CERTIFICATION
I, Bennett S. LeBow, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Vector Group Ltd.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Bennett S. LeBow
-----------------------------------------
Bennett S. LeBow
Chairman and Chief Executive Officer
- 49 -
CERTIFICATION
I, Joselynn D. Van Siclen, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Vector Group Ltd.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Joselynn D. Van Siclen
-----------------------------------------
Joselynn D. Van Siclen
Vice President and Chief
Financial Officer
- 50 -