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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 MARCH 31, 2003
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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 Identification No.)
incorporation or organization)
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)
----------------
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
Indicate by check mark whether the Registrant is an accelerated filer as
defined in Rule 12b-2 of the Exchange Act. [X] Yes [ ] No
At May 14, 2003, Vector Group Ltd. had 36,962,073 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 March 31, 2003 and
December 31, 2002............................................................................. 2
Vector Group Ltd. Consolidated Statements of Operations for the three months
ended March 31, 2003 and March 31, 2002....................................................... 3
Vector Group Ltd. Consolidated Statement of Stockholders' Equity for the three
months ended March 31, 2003................................................................... 4
Vector Group Ltd. Consolidated Statements of Cash Flows for the three months ended
March 31, 2003 and March 31, 2002............................................................. 5
Notes to Consolidated Financial Statements.......................................................... 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations.............................................. 33
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................... 46
Item 4. Controls and Procedures....................................................................... 46
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 48
Item 2. Changes in Securities and Use of Proceeds...................................................... 48
Item 6. Exhibits and Reports on Form 8-K............................................................... 49
SIGNATURE 50
CERTIFICATIONS......................................................................................... 51
- 1 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
March 31, December 31,
2003 2002
---------- ------------
ASSETS:
Current assets:
Cash and cash equivalents.................................................... $ 85,963 $100,027
Investment securities available for sale..................................... 108,183 128,430
Accounts receivable - trade.................................................. 23,929 13,395
Other receivables............................................................ 2,663 3,853
Inventories.................................................................. 129,753 104,649
Restricted assets............................................................ 1,199 -
Deferred income taxes........................................................ 18,089 12,825
Other current assets......................................................... 14,285 17,912
-------- --------
Total current assets....................................................... 384,064 381,091
Property, plant and equipment, net............................................. 179,849 181,972
Long-term investments, net..................................................... 2,588 3,150
Investments in non-consolidated real estate businesses......................... 16,592 7,811
Restricted assets.............................................................. 5,208 4,857
Deferred income taxes.......................................................... 11,820 12,501
Intangible asset............................................................... 107,511 107,511
Pension assets................................................................. 445 1,225
Other assets................................................................... 8,019 8,377
-------- --------
Total assets............................................................... $716,096 $708,495
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Current portion of notes payable and long-term debt.......................... $ 41,697 $ 31,277
Accounts payable............................................................. 22,483 17,046
Accrued promotional expenses................................................. 32,547 24,998
Accrued taxes payable, net................................................... 41,236 39,370
Settlement accruals.......................................................... 50,446 40,528
Deferred income taxes........................................................ 5,277 5,277
Accrued interest............................................................. 3,433 7,556
Prepetition claims and restructuring accruals................................ 657 674
Other accrued liabilities.................................................... 17,384 17,658
-------- --------
Total current liabilities.................................................. 215,160 184,384
Notes payable, long-term debt and other obligations, less current portion...... 304,165 307,028
Noncurrent employee benefits................................................... 10,835 11,121
Deferred income taxes.......................................................... 135,219 134,762
Other liabilities.............................................................. 4,682 4,866
Minority interests............................................................. 41,425 44,037
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 40,053,712 and 39,530,924 and outstanding 36,962,073
and 36,439,285............................................................. 3,696 3,643
Additional paid-in capital................................................... 266,487 279,305
Deficit...................................................................... (241,567) (236,718)
Accumulated other comprehensive income....................................... (11,703) (11,630)
Less: 3,091,639 shares of common stock in treasury, at cost................. (12,303) (12,303)
-------- --------
Total stockholders' equity............................................... 4,610 22,297
-------- --------
Total liabilities and stockholders' equity............................... $716,096 $708,495
======== ========
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
-----------------------------
March 31, March 31,
2003 2002
----------- ------------
Revenues:
Tobacco*...................................................... $ 131,343 $ 96,758
Real estate leasing........................................... 1,799 424
---------- ----------
Total revenues.............................................. 133,142 97,182
Expenses:
Cost of goods sold*........................................... 83,791 61,002
Operating, selling, administrative and general expenses....... 49,580 52,039
Settlement charges............................................ - (807)
---------- ----------
Operating loss.............................................. (229) (15,052)
Other income (expenses):
Interest and dividend income.................................. 1,445 2,820
Interest expense.............................................. (7,149) (5,385)
(Loss) gain on investments, net............................... (62) 1,321
Gain (loss) on sale of assets................................. 29 (344)
Equity loss from non-consolidated New Valley real
estate businesses........................................... (717) -
Other, net.................................................... (7) (157)
---------- ----------
Loss from operations before benefit for income taxes
and minority interests...................................... (6,690) (16,797)
Benefit for income taxes...................................... (593) (4,262)
Minority interests............................................ 1,248 672
---------- ----------
Net loss.......................................................... $ (4,849) $ (11,863)
---------- ----------
Per basic common share:
Net loss applicable to common shares.......................... $(0.13) $(0.34)
========== ==========
Basic weighted average common shares outstanding.................. 36,602,470 34,904,874
========== ==========
Per diluted common share:
Net loss applicable to common shares.......................... $ (0.13) $ (0.34)
========== ==========
Diluted weighted average common shares outstanding................ 36,602,470 34,904,874
========== ==========
- ----------
*Revenues and Cost of goods sold include excise taxes of $49,818 and $38,444 for
the three months ended March 31, 2003 and 2002, 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 Loss Total
------------ -------- ---------- ---------- --------- ------------- ----------
Balance, December 31, 2002.................. 36,439,285 $3,643 $279,305 $(236,718) $(12,303) $(11,630) $ 22,297
Net loss.................................... - - - (4,849) - - (4,849)
Unrealized loss on investment securities.. - - - - - (73) (73)
--------
Total other comprehensive loss........ - - - - - - (73)
--------
Total comprehensive loss.................... - - - - - - (4,922)
--------
Distributions on common stock............... - - (14,794) - - - (14,794)
Exercise of warrants and options............ 522,788 53 454 - - - 507
Tax benefit of options exercised............ - - 1,298 - - - 1,298
Amortization of deferred compensation, net.. - - 149 - - - 149
Effect of New Valley share repurchase....... 75 - - - 75
---------- ------ -------- ---------- ---------- -------- --------
Balance, March 31, 2003..................... 36,962,073 $3,696 $266,487 $(241,567) $(12,303) $(11,703) $ 4,610
========== ====== ======== ========= ======== ======== ========
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)
Three Months Ended
---------------------------
March 31, March 31,
2003 2002
----------- ------------
Net cash used in operating activities................................... $ (12,708) $ (17,995)
--------- ---------
Cash flows from investing activities:
Proceeds from sale of assets, net..................................... 660 1,822
Sale or maturity of investment securities............................. 45,578 3,040
Purchase of investment securities..................................... (27,541) -
Investment in non-consolidated real estate businesses................. (9,500) -
Increase in restricted assets......................................... (4) (6)
Issuance of note receivable, net...................................... - (1,500)
Payment of prepetition claims......................................... (17) (7)
New Valley purchase of subsidiary shares.............................. (1,346) -
Capital expenditures.................................................. (1,804) (22,897)
--------- ---------
Net cash provided by (used in) investing activities..................... 6,026 (19,548)
--------- ---------
Cash flows from financing activities:
Proceeds from debt.................................................... - 9,158
Repayments of debt.................................................... (4,894) (1,704)
Borrowings under revolver............................................. 154,916 141,092
Repayments on revolver................................................ (143,117) (141,092)
Distributions on common stock......................................... (14,794) (13,289)
Proceeds from exercise of warrants and options........................ 507 1,441
--------- ---------
Net cash used in financing activities................................... (7,382) (4,394)
---------- ---------
Net decrease in cash and cash equivalents............................... (14,064) (41,937)
Cash and cash equivalents, beginning of period.......................... 100,027 217,761
--------- ---------
Cash and cash equivalents, end of period................................ $ 85,963 $ 175,824
========= =========
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 58.1% of New Valley's
common shares at March 31, 2003. All significant intercompany
balances and transactions have been eliminated.
Vector Tobacco is engaged in the development and marketing of low
nicotine, nicotine-free and reduced carcinogen 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 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.
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, 2002, 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 inventory valuation, 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 2002 consolidated financial statements have
been reclassified to conform to the 2003 presentation.
(d) Earnings Per Share:
Information concerning the Company's common stock has been adjusted
to give effect to the 5% stock dividend paid to Company stockholders
on September 27, 2002. In connection with the stock dividend, 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 dividend had occurred on January 1, 2002.
The Company had a net loss for the three months ending March 31, 2003
and March 31, 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 months ended March 31, 2003 and March 31,
2002.
(e) Comprehensive Loss:
Comprehensive loss is a component of stockholders' equity and
includes such items as the unrealized gains and losses on investment
securities and minimum pension liability adjustments. Total
comprehensive loss was $4,922 for the three months ended March 31,
2003 and $11,833 for the three months ended March 31, 2002.
(f) New Accounting Pronouncements:
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of
SFAS No. 123." SFAS No. 148 amends SFAS No. 123 to provide
alternative methods of transition for a voluntary change to that
statement's fair value method of accounting for stock-based employee
compensation. SFAS No. 148 also amends the disclosure provisions of
SFAS No. 123 and APB No. 28, "Interim Financial Reporting," to
require disclosure in the summary of significant accounting policies
of the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings
per share in annual and interim financial statements. The transition
and disclosure provisions of this statement are effective for
financial statements for fiscal years ending after December 15, 2002
and for interim financial statements commencing after that date. The
Company has not elected the fair value-based method of accounting for
stock-based compensation under SFAS No. 123, as amended by SFAS No.
148. (See Note 7.)
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
- 7 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
exit plan was made. The provisions of SFAS 146 are effective for exit
or disposal activities that are initiated after December 31, 2002.
The adoption of this statement did not have an impact on the
Company's consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 requires
that upon issuance of a guarantee, the guarantor must recognize a
liability for the fair value of the obligation it assumes under the
guarantee and expanded disclosure of certain guarantees existing at
December 31, 2002. The adoption of this statement did not have an
impact on the Company's consolidated financial statements.
In January 2003, FIN No. 46, "Consolidation of Variable Interest
Entities" was issued. This interpretation clarifies the application
of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," to certain entities in which equity investors do not
have the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from
other parties. FIN No. 46 is effective February 1, 2003 for variable
interest entities created after January 31, 2003, and July 1, 2003
for variable interest entities created prior to February 1, 2003.
The Company does not believe this interpretation will have a
material impact on its consolidated financial statements.
2. LIGGETT VECTOR BRANDS
In 2002, the Company approved a plan to combine the sales and marketing
functions of its Liggett and Vector Tobacco subsidiaries into a new
entity, Liggett Vector Brands Inc., in order to enhance the effectiveness
of the Company's sales and marketing operations. This company coordinates
and executes the sales and marketing efforts for all of the Company's
tobacco operations. As a result of this plan, during the first quarter of
2002, the Company recognized a pre-tax restructuring charge of
approximately $3,460, consisting of approximately $2,000 in involuntary
severance and other exit costs and an impairment charge of approximately
$1,500 related to certain long-lived assets. The Company has substantially
completed all of these restructuring activities as of March 31, 2003. The
Company's restructuring accrual has been reduced by payments of $1,865 and
impairments of $1,450 as of March 31, 2003. At March 31, 2003, the
restructuring accrual of $145 is reflected in other current liabilities in
the accompanying consolidated balance sheet.
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. 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 consisted of $50,000 in
cash and $60,000 in notes, with the notes guaranteed by the Company and
Liggett.
- 8 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
(See Note 6.) Medallion, a discount cigarette manufacturer, 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. 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,
2002. 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.
Three Months Ended
March 31, 2002
------------------
Revenues......................... $112,043
========
Net loss......................... $(13,027)
========
Net loss per common share:
Basic........................ $ (0.37)
========
Diluted...................... $ (0.37)
========
- 9 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
4. INVENTORIES
Inventories consist of:
March 31, December 31,
2003 2002
----------- ------------
Leaf tobacco................................. $ 78,696 $ 63,196
Other raw materials.......................... 3,848 5,438
Work-in-process.............................. 3,027 2,888
Finished goods............................... 41,542 30,014
Replacement parts and supplies............... 5,081 4,878
-------- --------
Inventories at current cost.................. 132,194 106,414
LIFO adjustments............................. (2,441) (1,765)
-------- --------
$129,753 $104,649
======== ========
The Company has a leaf inventory management program whereby, among other
things, it is committed to purchase certain quantities of leaf tobacco.
The purchase commitments are for quantities not in excess of anticipated
requirements and are at prices, including carrying costs, established at
the date of the commitment. At March 31, 2003, Liggett had leaf tobacco
purchase commitments of approximately $16,184 and Vector Tobacco had leaf
tobacco purchase commitments of approximately $1,969.
LIFO inventories represent approximately 62.0% and 61.4% of total
inventories at March 31, 2003 and December 31, 2002, respectively.
Included in the above table is approximately $45,000 and $38,000 at March
31, 2003 and December 31, 2002, respectively, of inventory associated with
Vector Tobacco's new product initiatives.
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
March 31, December 31,
2003 2002
--------- ------------
Land and improvements........................ $ 10,019 $ 10,019
Buildings.................................... 72,616 72,811
Machinery and equipment...................... 138,056 136,738
Leasehold improvements....................... 2,424 2,147
Construction-in-progress..................... 4,344 3,566
-------- --------
227,459 225,281
Less accumulated depreciation................ (47,610) (43,309)
-------- --------
$179,849 $181,972
======== ========
- 10 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
6. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
March 31, December 31,
2003 2002
------------ -----------
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 $10,100 and $10,751............ 71,900 71,249
Liggett:
Revolving credit facility................................. 11,799 --
Term loan under credit facility........................... 5,190 5,190
Other notes payable....................................... 12,349 13,195
Vector Tobacco:
Notes payable............................................. 7,180 7,357
Equipment loans........................................... 166 452
Notes payable - Medallion acquisition..................... 47,500 50,625
V.T. Aviation:
Notes payable............................................. 16,885 17,237
New Valley:
Notes payable - operating real estate..................... 40,393 40,500
------- --------
Total notes payable, long-term debt and other obligations. 345,862 338,305
Less:
Current maturities.................................. (41,697) (31,277)
-------- --------
Amount due after one year................................. $304,165 $307,028
======== ========
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
July 15, 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 $30.11 per share at March 31, 2003. 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. In December 2001, $40,000 of the notes were converted into Vector's
common stock, and $132,500 of the notes were outstanding at March 31,
2003.
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
- 11 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 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 $24,500. 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 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), Vector
Tobacco and New Valley Holdings, Inc. ("NV Holdings"), as well as a pledge
of the shares of Liggett and all of the New Valley securities held by VGR
Holding and NV Holdings. The purchase agreement for the notes contains
covenants, which among other things, limit the ability of VGR Holding to
make distributions to the Company 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, for periods through
December 31, 2003, additional amounts including up to $100,000 during the
period commencing on December 31, 2002 and ending on March 31, 2003,
$115,000 during the period commencing on April 1, 2003 and ending on June
29, 2003, $100,000 during the period commencing on June 30, 2003 and
ending on September 29, 2003 and $50,000 during the period commencing on
September 30, 2003 and ending on December 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 agreement, VGR Holding repurchased $8,000 of the notes
at a price of 100% of the principal amount plus accrued interest. The
Company recognized a loss of $1,320 in the fourth quarter 2002 on the
early extinguishment of debt.
In April 2003, in connection with an additional amendment to the note
purchase agreement, VGR Holding repurchased $4,000 of the notes at a price
of 100% of the principal amount plus accrued interest. VGR Holding also
agreed to repurchase, under certain conditions, an additional $4,000 of
the notes on each of June 30, 2003 and September 30, 2003, at a price of
100% of the principal amount plus accrued interest. The Company will
recognize a loss of approximately $1,250 in the second quarter and $625 in
the third quarter of 2003 on the early extinguishment of debt if VGR
Holding repurchases the $12,000 of the notes.
VGR Holding has the right (which it has not exercised) under the purchase
agreement for the notes to elect to treat Vector Tobacco as a "designated
subsidiary" and exclude the losses of Vector Tobacco in determining the
amount of additional indebtedness permitted to be incurred.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
If VGR Holding were to make this election, future cash needs of Vector
Tobacco would be required to be funded directly by Vector or by
third-party financing as to which neither VGR Holding nor Liggett could
provide any guarantee or credit support.
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 $11,799 was outstanding
at March 31, 2003. Availability under the credit facility was
approximately $23,011 based on eligible collateral at March 31, 2003. 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 Wachovia's (the indirect parent of Congress Financial
Corporation, the lead lender) prime rate, bore a rate of 5.25% at March
31, 2003. 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 March 31, 2003,
Liggett was in compliance with all covenants under the credit facility;
Liggett's adjusted net worth was $33,226 and net working capital was
$15,836, as computed in accordance with the agreement. The facility
expires on March 8, 2004 subject to automatic renewal for an additional
year unless a notice of termination is given by the lender at least 60
days prior to such date or the anniversary of such 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 March 31, 2003. In September 2002, the lender agreed that
no further regularly scheduled principal payments would be due under the
Maple loan until March 1, 2004. Thereafter, the loan is payable in 27
monthly installments of $77 with a final payment of $3,111. 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.
On April 15, 2003, the credit facility was amended to increase the maximum
credit available under the facility to $45,000 for the period through July
15, 2003. Vector has guaranteed $10,000 of borrowings under the facility
and collateralized the guarantee with $10,000 in cash. Vector's guarantee
and the pledge of the cash collateral will terminate July 16, 2003 subject
to satisfaction of various conditions.
- 13 -
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 through the issuance
of a note, 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 through the issuance of notes, 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 the issuance of notes guaranteed by the
Company, each payable in 60 monthly installments of $53 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 the
issuance of a note guaranteed by the Company, payable in 60 monthly
installments of $26 plus interest calculated at LIBOR plus 4.31%.
Notes 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, plus 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.
During December 2001, Vector Tobacco borrowed an additional $1,159 from
the same lender to finance building improvements. This loan 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. At
March 31, 2003, $12,500 of these notes were outstanding. The remaining
$35,000 of notes bear interest at 6.5% per year, payable semiannually, and
mature on April 1, 2007.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Notes Payable - V.T. Aviation:
In February 2001, V.T. Aviation LLC, a subsidiary of Vector Research Ltd.,
purchased an airplane for $15,500 and borrowed $13,175 to fund the
purchase. The loan, which is collateralized by the airplane 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, V.T. Aviation purchased an airplane for $6,575 and
borrowed $6,150 to fund the purchase. The loan 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 average
commercial paper rate.
Note Payable - New Valley:
In December 2002, New Valley financed a portion of its purchase of two
office buildings in Princeton, N.J. with a mortgage loan of $40,500 from
HSBC Realty Credit Corporation (USA). The loan has a term of four years,
bears interest at a floating rate of 2% above LIBOR, and is secured by a
first mortgage on the office buildings, as well as by an assignment of
leases and rents. Principal is amortized to the extent of $54 per month
during the term of the loan. The loan may be prepaid without penalty and
is non-recourse against New Valley, except for various specified
environmental and related matters, misapplications of tenant security
deposits and insurance and condemnation proceeds, and fraud or
misrepresentation by New Valley in connection with the indebtedness.
7. EQUITY
At March 31, 2003, the Company accounts for employee stock compensation
plans under APB Opinion No. 25, "Accounting for Stock Issued to
Employees", with the intrinsic value-based method permitted by SFAS No.
123, "Accounting for Stock-Based Compensation" as amended by SFAS No. 148.
Accordingly, no compensation expense is recognized when the exercise price
is equal to the market price of the underlying common stock on the date of
grant.
Awards under the Company's stock compensation plans generally vest over
periods ranging from four to five years from the date of grant. The
expense related to stock option compensation included in the determination
of net income for the three months ended March 31, 2003 and March 31, 2002
is less than that which would have been recognized if the fair value
method had been applied to all awards since the original effective date of
SFAS No. 123. The following table illustrates the effect on net loss and
loss per share if the Company had applied the fair value provisions of
SFAS No. 123:
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Three Months Ended
----------------------------------
March 31, March 31,
2003 2002
-------- ----------
Net loss........................................ $(4,849) $(11,863)
Add: stock option employee compensation
expense included in reported net loss,
net of related tax effects.................. 1,354 1,328
Deduct: total stock option employee
compensation expense determined
under the fair value method for all
awards, net of related tax effects.......... (2,233) (2,568)
------- --------
Pro forma net loss.............................. $(5,728) $(13,103)
======= ========
Loss per share:
Basic and diluted - as reported............. $(0.13) $(0.34)
Basic and diluted - pro forma............... $(0.16) $(0.38)
For purposes of this pro forma presentation, the fair value of each option
grant was estimated at the date of the grant using the Black-Scholes
option pricing model. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options which
have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions
including expected stock price characteristics which are significantly
different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value
estimate, the existing models do not necessarily provide a reliable single
measure of the fair value of stock-based compensation awards.
During the quarter ended March 31, 2003, 127,331 warrants, exercisable at
$3.98 per share, and 395,457 options, exercisable at $4.93 per share, were
exercised for $507 of cash and the surrender of 225,388 options.
8. 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
- 16 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 three
months ended March 31, 2003, Liggett incurred counsel fees and costs
totaling approximately $1,113 compared to $1,711 for the three months
ended March 31, 2002.
Individual Actions. As of March 31, 2003, there were approximately 310
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, 86 were pending in Florida, 55 in
Maryland, 53 in New York, 29 in Mississippi and 19 in California. The
balance of the individual cases were pending in 20 states. There are
six individual cases pending where Liggett is the only named
defendant. In addition to these cases, an action against cigarette
manufacturers involving approximately 1,260 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. 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
- 17 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
reinstated the jury's punitive damages award. The Oregon Supreme Court
refused to hear Philip Morris' appeal of the appellate court ruling in
December 2002, and Philip Morris has appealed to the United States
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. In
December 2002, the trial court reduced the punitive damages award to
$28,000. 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. In March 2003, the appellate court reaffirmed its
earlier decision approving the jury's verdict, and Philip Morris has
indicated it will appeal to the California Supreme Court. 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 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. In April 2003, in an individual
Florida state court action involving two other cigarette
manufacturers, a jury awarded compensatory damages of $3,250. The
defendants intend to appeal the verdict.
Class Actions. As of March 31, 2003, 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.
- 18 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 appellate remedies. Oral argument before Florida's Third District
Court of Appeals was held in November 2002. An opinion from this
intermediate appellate court is expected in 2003. 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
- 19 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
enacted in Arkansas, Georgia, Idaho, Indiana, Kentucky, Louisiana,
Michigan, Nevada, North Carolina, Ohio, Oklahoma, South Carolina, Virginia
and West Virginia. The Mississippi Supreme Court has also placed limits on
appeal bonds by court rule.
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. In March 2002, the court reduced the amount of the
compensatory damages to $25,100.
Class certification motions are pending in a number of putative class
actions. Classes remain certified against Liggett in Florida (Engle), in
West Virginia (Blankenship), in California (Brown), in New York (Simon)
and in Kansas (Smith). A number of class certification denials are on
appeal.
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
- 20 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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
currently scheduled to begin in September 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. In February 2003, the Second Circuit agreed to review the
district court's class certification decision.
In March 2003, in a class action brought against Philip Morris on behalf
of smokers of light cigarettes, a state court judge in Illinois awarded
$7,100,000 in actual damages to the class members, $3,000,000 in punitive
damages to the State of Illinois (which was not a plaintiff in this
matter), and approximately $1,800,000 in attorney's fees and costs. Entry
of judgment has been stayed. Philip Morris has stated it will appeal the
verdict.
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 class 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 discovery requests. The
court granted defendants' motion for summary judgment in the consolidated
federal cases in July 2002, which decision has been appealed by plaintiffs
to the U.S. Court of Appeals for the Eleventh Circuit. Oral argument is
scheduled for April 2003. State court cases have been dismissed in
Arizona, which is currently on appeal, and in New York and Florida. Class
certification has been denied by courts in Minnesota and Michigan. A
Kansas state court in the case of Smith v. Philip Morris Companies Inc.,
et al. granted class certification in November 2001, and the trial in that
case is currently scheduled to commence in October 2003. Liggett is one of
the defendants in the Kansas case.
Governmental Actions. As of March 31, 2003, there were approximately 40
Governmental Actions pending against Liggett. In these proceedings, both
foreign and 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
- 21 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 March 31, 2003, there were approximately
6 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 five 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. Oral argument before the United States Court of
Appeals for the Second Circuit was held in February 2003.
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. In a January 2003 filing
with the court, the government alleged that disgorgement by defendants of
approximately $289,000,000 is an appropriate remedy in the case. 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.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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.
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. As a
result of the Medallion acquisition on April 1, 2002, Vector Tobacco has
no payment obligations under the MSA except to the extent its market share
exceeds a base amount of approximately 0.28% of total cigarettes sold in
the United States. During 1999 and 2000, Liggett's market share did not
exceed the base amount. Based on published industry sources, domestic
shipments by Liggett and Vector Tobacco accounted for approximately 2.2%
of the total cigarettes shipped in the United States during 2001 and 2.5%
during 2002. On April 15 of any year following a year in which Liggett's
and Vector Tobacco's market shares exceed their base shares, Liggett and
Vector Tobacco 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 March and April
2002, Liggett and Vector Tobacco paid a total of $31,130 for their 2001
MSA obligations. In March and April 2003, Liggett and Vector Tobacco paid
a total of $37,541 for their 2002 MSA obligations. Liggett and Vector
Tobacco have expensed $7,583 for their estimated MSA obligations for the
first three months of 2003 as part of cost of goods sold. Under the annual
and strategic contribution payment provisions of the MSA, the OPMs (and
Liggett and Vector Tobacco to the extent their market shares exceed their
base shares) are required to pay the following annual amounts (subject to
certain adjustments):
Year Amount
- --- ---------
2003................................... $6,500,000
2004 - 2007............................ $8,000,000
2008 - 2017............................ $8,139,000
2018 and each year thereafter......... $9,000,000
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.
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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 June
2003 and July 2003, in both of which Liggett is the only defendant, and an
individual action in New Hampshire state court scheduled for October 2003,
involving Liggett and Philip Morris as defendants. In addition, in
September 2003, the Brown class action is scheduled for trial in
California state court and the Smith antitrust class action is scheduled
in Kansas state court in October 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 will have a material adverse
effect on the Company. Liggett has filed the $3,450 bond required under
the bonding statute enacted in 2000 by the Florida legislature 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 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, the Company recorded a $9,723 pre-tax
charge to the consolidated statement of operations for the first quarter
of 2001. In June 2002, the jury in an individual case brought under the
third phase of the Engle case awarded $37,500 (subsequently reduced by the
court to $25,100) 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.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 and Vector Tobacco's management are unaware of any material
environmental conditions affecting their existing facilities. Liggett's
and Vector Tobacco's management believe that current operations are
conducted in material compliance with all environmental laws and
regulations and other laws and 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, results of operations or competitive
position of Liggett or Vector Tobacco.
Liggett has been served in three 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 appealed the court's ruling. In December 2002, the
United States Court of Appeals for the Fourth Circuit rejected the
industry challenge to the EPA report ruling that it was not subject to
court review. 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 proposed rule making" concerning how tobacco is
imported under a previously established tobacco tariff 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
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
suggested an "end-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 and recommendations
have been made for additional federal and state legislation to regulate
cigarette manufacturers. Congressional advocates of FDA regulations have
introduced legislation that would give the FDA authority to regulate the
manufacture, sale, distribution and labeling of tobacco products to
protect public health, thereby allowing the FDA to reinstate its prior
regulations or adopt new or additional regulations. 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. In
December 2002, the First Circuit ruled that the ingredients disclosure
provisions violated the constitutional prohibition against unlawful
seizure of property by forcing firms to reveal trade secrets. The decision
was not appealed by the state. Notwithstanding the foregoing, in December
1997, Liggett began voluntarily 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. In 2002, 21 states 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. In addition,
since January 1, 2003, seven states and the District of Columbia approved
increases in excise taxes. 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.
- 27 -
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. On December
31, 2002, the OFPC issued proposed standards for public comment. The
public comment period ended on April 15, 2003. Six months from the
issuance of the final 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
final 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. Various concerns regarding Vector Tobacco's
advertising practices have been expressed to Vector Tobacco by certain
state attorneys general. Vector Tobacco is negotiating in an effort to
resolve these concerns. 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 express or implied 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 FTC 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
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 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 March 31, 2003, New Valley had $657 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.
9. NEW VALLEY CORPORATION
In December 2002, New Valley purchased two office buildings in Princeton,
N.J. for a total purchase price of $54,000. New Valley financed a portion
of the purchase price through a borrowing of $40,500 from HSBC Realty
Credit Corporation (USA). (See Note 6.)
Also in December 2002, New Valley and the other owners of Prudential Long
Island Realty contributed their interests in Prudential Long Island Realty
to Montauk Battery Realty LLC, a newly formed entity. New Valley acquired
a 50% ownership interest in Montauk, an increase from its previous 37.2%
interest in Prudential Long Island Realty as a result of an additional
investment of $1,413 by New Valley and the redemption by Prudential Long
Island Realty of various ownership interests.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
On March 14, 2003, Montauk purchased the New York City-based residential
brokerage firm, Insignia Douglas Elliman, and an affiliated property
management company for $71,250. New Valley invested an additional $9,500
in subordinated debt and equity of Montauk to help fund the acquisition.
New Valley accounts for its interest in Montauk on the equity method and
recorded a loss of $577 for the three months ended March 31, 2003
associated with Montauk.
10. PHILIP MORRIS BRAND TRANSACTION
In November 1998, the Company and Liggett granted Philip Morris
Incorporated options to purchase interests in Trademarks LLC which holds
three domestic cigarette brands, L&M, Chesterfield and Lark, formerly held
by Liggett's subsidiary, Eve Holdings Inc.
Under the terms of the Philip Morris agreements, Eve contributed the three
brands to Trademarks, a newly-formed limited liability company, in
exchange for 100% of two classes of Trademarks' interests, the Class A
Voting Interest and the Class B Redeemable Nonvoting Interest. Philip
Morris acquired two options to purchase the interests from Eve. In
December 1998, Philip Morris paid Eve a total of $150,000 for the options,
$5,000 for the option for the Class A interest and $145,000 for the option
for the Class B interest.
The Class A option entitled Philip Morris to purchase the Class A interest
for $10,100. On March 19, 1999, Philip Morris exercised the Class A
option, and the closing occurred on May 24, 1999.
The Class B option entitles Philip Morris to purchase the Class B interest
for $139,900. The Class B option will be exercisable during the 90-day
period beginning on December 2, 2008, with Philip Morris being entitled to
extend the 90-day period for up to an additional six months under certain
circumstances. The Class B interest will also be redeemable by Trademarks
for $139,900 during the same period the Class B option may be exercised.
On May 24, 1999, Trademarks borrowed $134,900 from a lending institution.
The loan is guaranteed by Eve and collateralized by a pledge by Trademarks
of the three brands and Trademarks' interest in the trademark license
agreement (discussed below) and by a pledge by Eve of its Class B
interest. In connection with the closing of the Class A option, Trademarks
distributed the loan proceeds to Eve as the holder of the Class B
interest. The cash exercise price of the Class B option and Trademarks'
redemption price were reduced by the amount distributed to Eve. Upon
Philip Morris' exercise of the Class B option or Trademarks' exercise of
its redemption right, Philip Morris or Trademarks, as relevant, will be
required to obtain Eve's release from its guaranty. The Class B interest
will be entitled to a guaranteed payment of $500 each year with the Class
A interest allocated all remaining income or loss of Trademarks.
Trademarks has granted Philip Morris an exclusive license of the three
brands for an 11-year term expiring May 24, 2010 at an annual royalty
based on sales of cigarettes under the brands, subject to a minimum annual
royalty payment equal to the annual debt service obligation on the loan
plus $1,000.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
If Philip Morris fails to exercise the Class B option, Eve will have an
option to put its Class B interest to Philip Morris, or Philip Morris'
designees, at a put price that is $5,000 less than the exercise price of
the Class B option (and includes Philip Morris' obtaining Eve's release
from its loan guarantee). The Eve put option is exercisable at any time
during the 90-day period beginning March 2, 2010.
If the Class B option, Trademarks' redemption right and the Eve put option
expire unexercised, the holder of the Class B interest will be entitled to
convert the Class B interest, at its election, into a Class A interest
with the same rights to share in future profits and losses, the same
voting power and the same claim to capital as the entire existing
outstanding Class A interest, i.e., a 50% interest in Trademarks.
Upon the closing of the exercise of the Class A option and the
distribution of the loan proceeds on May 24, 1999, Philip Morris obtained
control of Trademarks, and the Company recognized a pre-tax gain of
$294,078 in its consolidated financial statements and established a
deferred tax liability of $103,100 relating to the gain. Upon exercise of
the options in 2009 or 2010, the Company will be required to pay tax in
the amount of the deferred tax liability, which will be offset by the
benefit of any deferred tax assets, including any net operating losses,
available to the Company at that time. The Company's 1998 and 1999 federal
income tax returns are being examined, and, although the Company believes
the positions reflected on its income tax returns are correct, there can
be no assurance that relevant taxing authorities may not challenge certain
positions. If taxing authorities were to assert that the Company incurred
a tax obligation prior to the exercise date of these options and the
Company was required to make such tax payments prior to 2009 or 2010, its
liquidity could be adversely affected.
11. SEGMENT INFORMATION
The Company's significant business segments for the three months ended
March 31, 2003 and 2002 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 low nicotine, nicotine-free and reduced
carcinogen cigarette products and, for segment reporting purposes,
excludes the operations of Medallion.
- 31 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Financial information for the Company's operations before taxes and
minority interest for the three months ended March 31, 2003 and 2002
follows:
Vector Real Corporate
Liggett Tobacco Estate and Other Total
--------- -------- -------- ---------- --------
Three Months Ended March 31, 2003:
Revenues........................ $124,915 $ 6,428 $ 1,799 $ - $133,142
Operating income (loss)......... 30,233 (24,081) (188) (6,193) (229)
Identifiable assets............. 308,127 100,287 72,847 234,835 716,096
Depreciation and amortization... 2,039 1,157 321 678 4,195
Capital expenditures............ 860 733 - 211 1,804
Three Months Ended March 31, 2002:
Revenues........................ $ 94,092 $ 2,666 $ 424 $ - $ 97,182
Operating income (loss)......... 18,478 (24,519) (316) (8,695) (15,052)
Identifiable assets............. 170,180 87,254 12,580 389,680 659,694
Depreciation and amortization... 1,246 967 123 491 2,827
Capital expenditures............ 8,250 9,394 688 4,565 22,897
- 32 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Amounts)
(Unaudited)
INTRODUCTION
We are a holding company for a number of businesses. We are engaged
principally in:
o the development and marketing of the low nicotine and nicotine-free
QUEST cigarette products and the reduced carcinogen OMNI cigarette
products through our subsidiary Vector Tobacco Inc. and
o the manufacture and sale of cigarettes in the United States through our
subsidiary Liggett Group Inc.
Our majority-owned subsidiary, New Valley Corporation, is currently
engaged in the real estate business and is seeking to acquire additional
operating companies. In December 2002, New Valley acquired two office buildings
in Princeton, N.J. and increased its ownership to 50% in Montauk Battery Realty
LLC, which owns the largest residential brokerage company in the New York
metropolitan area.
RECENT DEVELOPMENTS
Quest Introduction. In January 2003, Vector Tobacco introduced QUEST,
its brand of low nicotine and nicotine-free cigarette products. QUEST is
designed for adult smokers who are interested in reducing their levels of
nicotine intake and is available in three different varieties, each with
decreasing amounts of nicotine - QUEST 1, 2 and 3. QUEST 1, the low nicotine
variety, contains 0.6 milligrams of nicotine. QUEST 2, the extra-low nicotine
variety, contains 0.3 milligrams of nicotine. QUEST 3, the nicotine-free
variety, contains only trace levels of nicotine - no more than 0.05 milligrams
of nicotine per cigarette. QUEST cigarettes utilize a proprietary process that
enables the production of nicotine-free tobacco that tastes and smokes like
tobacco in conventional cigarettes.
QUEST is initially available in New York, New Jersey, Pennsylvania,
Ohio, Indiana, Illinois and Michigan. These seven states account for
approximately 30% of all cigarette sales in the United States. Based on the
success of the product in these markets, Vector Tobacco will determine whether
to market QUEST nationwide later in 2003. All three QUEST varieties are being
sold in hard packs and are priced comparable to other premium brands. A
multi-million dollar advertising and marketing campaign, with advertisements
running in magazines and regional newspapers, is supporting the product launch.
The brand is also supported by significant point-of-purchase campaigns.
Liggett Vector Brands. During 2002, the sales and marketing functions,
along with certain support functions, of our Liggett and Vector Tobacco
subsidiaries were combined into a new entity, Liggett Vector Brands Inc. This
company coordinates and executes the sales and marketing efforts for all of our
tobacco operations. With the combined resources of Liggett and Vector Tobacco,
Liggett Vector Brands has approximately 430 salespersons, and enhanced
distribution and marketing capabilities. In connection with the formation of the
new Liggett Vector Brands entity, we took a charge of approximately $3,460 in
the first quarter of 2002, related to the reorganization of our business. As of
March 31, 2003, these restructuring activities were substantially completed and
our reorganization accrual had been reduced by payments and impairments of
$3,315. The remaining balance was $145 at that date.
- 33 -
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 Liggett.
Medallion, a discount cigarette manufacturer, 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 unless its market share exceeds approximately 0.28% of total
cigarettes sold in the United States.
VGR Holding Notes. In April 2003, in connection with an amendment to
the note purchase agreement for VGR Holding's 10% senior secured notes due March
31, 2006, VGR Holding repurchased $4,000 of the notes at a price of 100% of the
principal amount plus accrued interest. VGR Holding also agreed to repurchase,
under certain conditions, an additional $4,000 of the notes on each of June 30,
2003 and September 30, 2003 at a price of 100% of the principal amount plus
accrued interest. We will recognize a loss of approximately $1,250 in the second
quarter and $625 in the third quarter of 2003 if we repurchase the $12,000 of
the notes.
Real Estate Acquisitions. In December 2002, New Valley purchased two
office buildings in Princeton, N.J. for a total purchase price of $54,000. New
Valley financed a portion of the purchase price through a borrowing of $40,500
from HSBC Realty Credit Corporation (USA).
The loan has a term of four years, bears interest at a floating rate of
2% above LIBOR, and is collateralized by a first mortgage on the office
buildings, as well as by an assignment of leases and rents. Principal is
amortized to the extent of $54 per month during the term of the loan. The loan
may be prepaid without penalty and is non-recourse against New Valley, except
for various specified environmental and related matters, misapplications of
tenant security deposits and insurance and condemnation proceeds, and fraud or
misrepresentation by New Valley in connection with the indebtedness.
Also in December 2002, New Valley and the other owners of Prudential
Long Island Realty contributed their interests in Prudential Long Island Realty
to Montauk Battery Realty LLC, a newly formed entity. New Valley acquired a 50%
ownership interest in Montauk, an increase from its previous 37.2% interest in
Prudential Long Island Realty as a result of an additional investment of $1,413
by New Valley and the redemption by Prudential Long Island Realty of various
ownership interests. New Valley accounts for its interest in Montauk on the
equity method.
On March 14, 2003, Montauk purchased the leading New York City-based
residential brokerage firm, Insignia Douglas Elliman, and an affiliated property
management company for $71,250. With that acquisition, the combination of
Prudential Long Island Realty with Douglas Elliman has created the largest
residential brokerage company in the New York metropolitan area. New Valley
invested an additional $9,500 in subordinated debt and equity of Montauk to help
fund the acquisition.
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 March 31, 2003, there were approximately 310 individual
suits, 41 purported class actions and 46 governmental and other third-party
payor health care reimbursement actions pending in the United States in which
Liggett was a named defendant. A civil lawsuit has been filed by the United
States federal government seeking disgorgement of approximately $289,000,000
from various cigarette manufacturers, including Liggett. In addition to these
cases, during 2000, an action against cigarette manufacturers involving
approximately 1,260 named individual plaintiffs was 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
- 34 -
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 filed the $3,450 bond required
under the bonding statute enacted in 2000 by the Florida legislature 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 (subsequently reduced by
the court to $25,100) 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 8 to our consolidated financial statements
for a description of legislation, regulation and litigation.
CRITICAL ACCOUNTING POLICIES
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 inventory
valuation, 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 the customer, there is persuasive
evidence of an arrangement, the sale price is determinable and collectibility is
reasonably assured. 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,
- 35 -
litigation and defense costs, increased tobacco costs or reductions in the
selling price of cigarettes in the near term. 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. The adoption of the new
accounting standards did not have an 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. The
adoption of the new accounting standards did not have an impact on our net
earnings or basic or diluted earnings per share.
Contingencies. As discussed in Note 8 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.
Inventories. Tobacco inventories are stated at lower of cost or market
and are determined primarily by the last-in, first-out (LIFO) method at Liggett
and the first-in, first-out (FIFO) method at Vector Tobacco. Although portions
of leaf tobacco inventories may not be used or sold within one year because of
time required for aging, they are included in current assets, which is common
practice in the industry. We estimate an inventory reserve for excess quantities
and obsolete items based on specific identification and historical write-offs,
taking into account future demand and market conditions. If actual demand or
market conditions in the future are less favorable than those estimated,
additional inventory write-downs may be required.
Employee Benefit Plans. Since 1997, income from our defined benefit
pension plans, partially offset by the costs of postretirement medical and life
insurance benefits, have contributed to our reported operating income up to and
including 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 recorded a non-cash
charge of $11,090 net of tax to stockholders' equity in the fourth quarter of
2002 relating primarily to one of Liggett's defined benefit plans. The charge
was based on the extent to which our accumulated
- 36 -
benefit obligations under the pension plan on September 30, 2002 exceeded the
fair value of the pension plan's assets on that date. We also currently
anticipate net pension expense for defined benefit pension plans and other
postretirement benefit expense aggregating approximately $4,100 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
The following discussion provides an assessment of our 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, Liggett, Vector Tobacco, Liggett Vector Brands, New Valley and
other less significant subsidiaries. Our interest in New Valley's common shares
was 58.1% at March 31, 2003.
For purposes of this discussion and other consolidated financial
reporting, our significant business segments for the three months ended March
31, 2003 and 2002 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
reduced nicotine, nicotine-free and reduced carcinogen cigarette products and,
for segment reporting purposes, excludes the operations of Medallion.
Three Months Ended
March 31,
----------------------
2003 2002
---- ----
Revenues:
Liggett............................... $124,915 $ 94,092
Vector Tobacco........................ 6,428 2,666
--------- -------
Total tobacco...................... 131,343 96,758
Real estate........................... 1,799 424
--------- --------
Total revenues..................... $133,142 $ 97,182
========= ========
Operating loss:
Liggett............................... $ 30,233 $ 18,478
Vector Tobacco........................ (24,081) (24,519)
--------- --------
Total tobacco...................... 6,152 (6,041)
Real estate........................... (188) (316)
Corporate and other................... (6,193) (8,695)
--------- --------
Total operating loss............... $ (229) $(15,052)
========= ========
- 37 -
Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002
Revenues. Total revenues were $133,142 for the three months ended March
31, 2003 compared to $97,182 for the three months ended March 31, 2002. This
37.0% ($35,960) increase in revenues was due to a $30,823 or 32.8% increase in
revenues at Liggett, a $3,762 or 141% increase in revenues at Vector Tobacco and
an increase of $1,375 in real estate revenues at New Valley.
Tobacco Revenues. 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. On December 2, 2002, Liggett announced a list
price increase of $.80 per carton on LIGGETT SELECT. In February 2003, Liggett
increased its net sales price for other selected discount brands by $.80 per
carton.
Tobacco revenues at Liggett for the three months ended March 31, 2003
increased due to a 25.5% ($23,988) gain in unit sales volume (approximately
497.6 million units) and price increases of $7,191, discussed above, offset by
$356 in unfavorable sales mix. Net sales for the 2003 period included $6,996
related to sales of cigarette brands acquired in the April 2002 Medallion
transaction. Tobacco revenues at Vector Tobacco for the three months ended March
31, 2003 were $6,428 and relate primarily to sales of QUEST, introduced in
January 2003.
Premium sales at Liggett for the first quarter of 2003 amounted to
$5,337 and represented 4.3% of total Liggett sales, compared to $10,035 and
10.7% of total sales for the first quarter of 2002. In the premium segment,
revenues decreased by 46.8% ($4,698) for the three months ended March 31, 2003,
compared to the prior year first quarter, due to an unfavorable volume variance
of $4,173, reflecting a 41.6% decrease in unit sales volume (approximately 66.0
million units), coupled with an unfavorable price variance of $525, primarily
associated with promotional activities.
The decline in Liggett's premium sales revenue that has occurred during
2002 and in the first quarter of 2003 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 continued 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 March 31, 2003 amounted to $119,578
and represented 95.7% of total Liggett sales, compared to $84,057 and 89.3% of
total Liggett sales for the three months ended March 31, 2002. In the discount
segment, revenues grew by 42.3% ($35,521) for the three months ended March 31,
2003 compared to the prior year period, due to a 31.4% gain in unit sales volume
(approximately 563.6 million units) accounting for $26,420 in positive volume
variance, price increases of $7,716, and a favorable product mix of $1,385.
Tobacco Gross Profit. Tobacco gross profit was $47,552 for the three
months ended March 31, 2003 compared to $35,756 for the three months ended March
31, 2002, an increase of $11,796 or 33.0% when compared to the same period last
year, due primarily to the volume and price increases discussed above at
Liggett. Liggett's premium brands contributed 4.5% to our gross profit, the
discount segment contributed 99.3% and Vector Tobacco's QUEST and OMNI products
cost 3.8% for the three months ended March 31, 2003. Over the same period in
2002, Liggett's premium brands contributed 14.7%, the discount segment
contributed 92.0% and Vector Tobacco's OMNI product cost 6.7%.
- 38 -
Liggett's gross profit of $49,345 for the three months ended March 31,
2003 increased $11,378 from gross profit of $37,967 for the three months ended
March 31, 2002, due primarily to the price and unit volume increases discussed
above, offset by higher estimated payment obligations under the Attorneys
General Master Settlement Agreement, an increase of $3,416. As a percent of
revenues (excluding federal excise taxes), gross profit at Liggett decreased to
64.1% for the three months ended March 31, 2003 compared to 67.5% for the same
period in 2002, with gross profit for the premium segment decreasing to 60.9%
for the three months ended March 31, 2003 compared to 74.9% in the same period
in 2002 and gross profit for the discount segment decreasing to 64.2% in the
three months ended March 31, 2003 from 66.6% in the same period in 2002. This
decrease is due primarily to the higher estimated payment obligations under the
Attorneys General Master Settlement Agreement within cost of goods sold, the
increase in promotional spending and the disproportionate rise in Liggett's
discount brand sales, offset by the overall growth in sales volume and the 2002
and 2003 price increases.
Real Estate Revenues. New Valley's real estate revenues were $1,799 for
the three months ended March 31, 2003. This compares to revenues of $424 from
real estate activities for the three months ended March 31, 2002, with the
increase primarily due to the additional rental revenue resulting from the two
commercial office buildings in Princeton, N.J. acquired in December 2002, offset
by the absence of rental revenue from a U.S. shopping center disposed of in May
2002.
Expenses. Operating, selling, general and administrative expenses were
$49,580 for the three months ended March 31, 2003 compared to $52,039 for the
same period last year. The decrease of $2,459 was due primarily to the absence
of the restructuring charge taken in the prior year period, offset by increased
costs of a significantly larger sales force. Expenses at Liggett were $19,112
for the three months ended March 31, 2003 compared to $20,296 including a
restructuring charge of $3,460 for the same period last year. Expenses at Vector
Tobacco for the three months ended March 31, 2003 were $22,288, compared to
expenses of $22,158 for the three months ended March 31, 2002.
Other Income (Expenses). For the three months ended March 31, 2003,
other expense was $6,461 compared to other expense of $1,745 for the three
months ended March 31, 2002. Interest and dividend income of $1,445 was offset
primarily by increased interest expense and an equity loss of $717 which
includes a $577 loss from Montauk, one of New Valley's non-consolidated real
estate businesses.
Interest expense was $7,149 for the three months ended March 31, 2003
compared to $5,385 for the same period last year, due to the issuance of
long-term debt in connection with the Medallion acquisition and the New Valley
acquisition of two office buildings in Princeton, N.J.
Loss from Operations. The loss from operations before income taxes and
minority interests for the three months ended March 31, 2003 was $6,690 compared
to a loss of $16,797 for the three months ended March 31, 2002. Income tax
benefit was $593 and minority interests in losses of subsidiaries were $1,248
for the three months ended March 31, 2003. This compared to income tax benefit
of $4,262 and minority interests in losses of subsidiaries of $672 for the three
months ended March 31, 2002. The effective tax rates for the three months ended
March 31, 2003 and March 31, 2002 do not bear a customary relationship to
pre-tax accounting income principally as a consequence of non-deductible
expenses and state income taxes.
- 39 -
CAPITAL RESOURCES AND LIQUIDITY
Net cash and cash equivalents decreased $14,064 for the three months
ended March 31, 2003 and decreased $41,937 for the three months ended March 31,
2002.
Net cash used in operations for the three months ended March 31, 2003
was $12,708 compared to net cash used in operations of $17,995 for the
comparable period of 2002. Cash used in operations in 2003 resulted primarily
from an increase in accounts receivable and inventories offset by an increase in
accounts payable and the non-cash impact of depreciation and amortization. Cash
used in operations in 2002 resulted primarily from the first quarter operating
loss, increased inventories and reduced receivables offset by the non-cash
impact of depreciation and amortization, non-cash stock-based expense, losses on
the sale of assets and minority interests.
Cash provided by investing activities of $6,026 in 2003 compares to
cash used of $19,548 in 2002. In the first quarter of 2003, cash was provided
through the sale or maturity of investment securities and other assets for
$46,238 offset primarily by the purchase of investment securities and the
purchase of the real estate businesses at New Valley for $37,041. In the first
quarter of 2002, cash was used principally for acquisition of machinery and
equipment in the amount of $22,897 and net issuance of a note receivable for
$1,500 at New Valley offset primarily by proceeds received upon sale of
investment securities and other assets of $4,862.
Cash used in financing activities was $7,382 in 2003 compared to cash
used of $4,394 in 2002. In the first quarter of 2003, cash was used for
dividends of $14,794 and repayments on debt of $4,894 offset by net borrowings
of $11,799 under the revolver and proceeds from the exercise of warrants and
options of $507. In the first quarter of 2002, cash was used primarily for
dividends of $13,289 and repayments of debt of $1,704 offset by proceeds from
debt of $9,158 and proceeds from the exercise of options of $1,441.
Liggett. Liggett has a $40,000 credit facility under which $11,799 was
outstanding at March 31, 2003. Availability under the facility was approximately
$23,011 based on eligible collateral at March 31, 2003. 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
Wachovia's (the indirect parent of Congress Financial Corporation, the lead
lender) prime rate, bore a rate of 5.25% at March 31, 2003. 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 March 31, 2003,
Liggett was in compliance with all covenants under the credit facility;
Liggett's adjusted net worth was $33,226 and net working capital was $15,836 as
computed in accordance with the agreement. The facility expires on March 8, 2004
subject to automatic renewal for an additional year unless a notice of
termination is given by the lender at least 60 days prior to such date or the
anniversary of such 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 March
31, 2003. In September 2002, the lender agreed that no further regularly
scheduled principal payments would be due under the Maple loan until March 1,
2004. Thereafter, the loan is payable in 27 monthly installments of $77 with a
final payment of $3,111. 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
- 40 -
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.
On April 15, 2003, the credit facility was amended to increase the
maximum credit available under the facility to $45,000 for the period through
July 15, 2003. We have guaranteed $10,000 of borrowings under the facility and
collateralized the guarantee with $10,000 in cash. Our guarantee and the pledge
of the cash collateral will terminate July 16, 2003 subject to satisfaction of
various conditions.
In March 2000, Liggett purchased equipment for $1,000 through the
issuance of a note, 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 through the issuance of notes, payable in 60 monthly installments of $22
with an effective interest rate of 10.20%.
Beginning in October 2001, Liggett 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 $20,000. 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 the issuance of notes, guaranteed by us and payable in 60
monthly installments of $106 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 the issuance of a note, guaranteed by
us, payable in 60 monthly installments of $26 plus interest rate calculated at
LIBOR plus 4.31%.
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 the bonding statute enacted in 2000 by the
Florida legislature 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
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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 (subsequently reduced by the court to
$25,100) 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. 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 8 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.
V.T. Aviation. In February 2001, V.T. Aviation LLC, a subsidiary of
Vector Research Ltd., purchased an airplane for $15,500 and borrowed $13,175 to
fund the purchase. The loan, which is collateralized by the airplane 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 V.T. Aviation purchased an airplane for $6,575
and borrowed $6,150 to fund the purchase. The loan 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, plus 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 borrowed an additional $1,159 from
the same lender to finance building improvements. This loan 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., a discount cigarette manufacturer, and related assets
from Medallion's principal stockholder. 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. At March 31, 2003, $12,500 of these notes
were outstanding. The remaining $35,000 of notes bear interest at 6.5% per year,
payable semiannually, and mature on April 1, 2007.
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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 of the notes have been guaranteed by us 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 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, for periods
through December 31, 2003, additional amounts including up to $100,000 during
the period commencing on December 31, 2002 and ending on March 31, 2003,
$115,000 during the period commencing on April 1, 2003 and ending on June 29,
2003, $100,000 during the period commencing on June 30, 2003 and ending on
September 29, 2003 and $50,000 during the period commencing on September 30,
2003 and ending on December 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. We recognized a loss of $1,320 in 2002 on the early
extinguishment of debt.
In April 2003, in connection with an additional amendment to the note
purchase agreement, VGR Holding repurchased $4,000 of the notes at a price of
100% of the principal amount plus accrued interest. VGR Holding also agreed to
repurchase, under certain conditions, an additional $4,000 of the notes on each
of June 30, 2003 and September 30, 2003, at a price of 100% of the principal
amount plus accrued interest. We will recognize a loss of approximately $1,250
in the second quarter and $625 in the third quarter of 2003 on the early
extinguishment of debt if we repurchase the $12,000 of the notes.
VGR Holding has the right (which it has not exercised) under the
purchase agreement for the notes to elect to treat Vector Tobacco as a
"designated subsidiary" and exclude the losses of Vector Tobacco in determining
the amount of additional indebtedness permitted to be incurred. If VGR Holding
were to make this election, future cash needs of Vector Tobacco would be
required to be funded directly by us or by third-party financing as to which
neither VGR Holding nor Liggett could provide any guarantee or credit support.
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.
New Valley. In December 2002, New Valley financed a portion of its
purchase of two office buildings in Princeton, N.J. with a $40,500 mortgage loan
from HSBC Realty Credit Corporation (USA). The loan has a term of four years,
bears interest at a floating rate of 2% above LIBOR, and is secured by a first
mortgage on the office buildings, as well as by an assignment of leases and
rents. Principal is amortized to the extent of $54 per month during the
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term of the loan. The loan may be prepaid without penalty and is non-recourse
against New Valley, except for various specified environmental and related
matters, misapplication of tenant security deposits and insurance and
condemnation proceeds, and fraud or misrepresentation by New Valley in
connection with the indebtedness.
Vector. We believe that we will continue to meet our liquidity
requirements through 2003, although the covenants in the purchase agreement 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 March 31,
2003, 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 $60,000) and corporate expenses. In addition,
VGR Holding repurchased in April 2003 $4,000 of the notes at a price of 100% of
the principal amount plus accrued interest. VGR Holding also agreed to
repurchase, under certain conditions, an additional $4,000 of the notes on each
of June 30, 2003 and September 30, 2003. 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 July 15,
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 $30.11 at May 14, 2003, is
subject to adjustment for various events, and any cash distribution on our
common stock results in a corresponding decrease in the conversion price. In
December 2001, $40,000 of the notes were converted into our common stock, and
$132,500 principal amount of the notes were outstanding at March 31, 2003.
Our consolidated balance sheets include deferred income tax assets and
liabilities, which represent temporary differences in the application of
accounting rules established by generally accepted accounting principles and
income tax laws. As of March 31, 2003, our deferred income tax liabilities
exceeded our deferred income tax assets by $110,587. The largest component of
our deferred tax liabilities exists because of differences that resulted from a
transaction with Philip Morris where a subsidiary of Liggett contributed three
of its premium brands to Trademarks LLC, a newly-formed limited liability
company. In such transaction, Philip Morris acquired an option to purchase the
remaining interest in Trademarks commencing in 2009, and we have an option to
require Philip Morris to purchase the remaining interest commencing in 2010. For
additional information concerning the Philip Morris brand transaction, see Note
10 to our consolidated financial statements. In connection with the transaction,
we recognized in 1999 a pre-tax gain of $294,078 in our consolidated financial
statements and established a deferred tax liability of $103,100 relating to the
gain. Upon exercise of the options in 2009 or 2010, we will be required to pay
tax in the amount of the deferred tax liability, which will be offset by the
benefit of any deferred tax assets, including any net operating losses,
available to us at that time. Our 1998 and 1999 federal income tax returns are
being examined, and, although we believe the positions reflected on our income
tax returns are correct, there can be no assurance that relevant taxing
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authorities may not challenge certain positions. If taxing authorities were to
assert that we incurred a tax obligation prior to the exercise date of these
options and we were required to make such tax payments prior to 2009 or 2010,
our liquidity could be adversely affected.
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.
As of March 31, 2003, approximately $87,312 of our outstanding debt had
variable interest rates, which increases the risk of fluctuating interest rates.
Our exposure to market risk includes interest rate fluctuations in connection
with our variable rate borrowings, which could adversely affect our cash flows.
As of March 31, 2003, we had no interest rate caps or swaps. Based on a
hypothetical 100 basis point increase or decrease in interest rates (1%), our
annual interest expense could increase or decrease by approximately $838.
We held investment securities available for sale totaling $108,183 at
March 31, 2003. 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
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No.
123." SFAS No. 148 amends SFAS No. 123 to provide alternative methods of
transition for a voluntary change to that statement's fair value method of
accounting for stock-based employee compensation. SFAS No. 148 also amends the
disclosure provisions of SFAS No. 123 and APB No. 28, "Interim Financial
Reporting," to require disclosure in the summary of significant accounting
policies of the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share
in annual and interim financial statements. The transition and disclosure
provisions of this statement are effective for financial statements for fiscal
years ending after December 15, 2002 and for interim financial statements
commencing after that date. The Company has not elected the fair value-based
method of accounting for stock-based compensation under SFAS No. 123, as amended
by SFAS No. 148. (See Note 7 to our 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 adoption of
this statement did not have an impact on the Company's consolidated financial
statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN No. 45 requires that upon issuance of
a guarantee, the guarantor must recognize a
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liability for the fair value of the obligation it assumes under the guarantee
and expanded disclosure of certain guarantees existing at December 31, 2002. The
adoption of this statement did not have an impact on the Company's consolidated
financial statements.
In January 2003, FIN No. 46, "Consolidation of Variable Interest
Entities", was issued. This interpretation clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN No. 46 is effective February 1, 2003 for
variable interest entities created after January 31, 2003, and July 1, 2003 for
variable interest entities created prior to February 1, 2003. We do not believe
this interpretation will have a material impact on our consolidated financial
statements.
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, 2002 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.
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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 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.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
Reference is made to Note 8, incorporated herein by reference, to
our consolidated financial statements included elsewhere in this
report 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 March 31, 2003, except for grants of
stock options to purchase 15,000 shares of our common stock at
$13.25 per share to employees of us and/or our subsidiaries and
the issuance of 522,788 shares of our common stock upon exercise
of warrants and options as described in Note 7, incorporated
herein, to our consolidated financial statements included
elsewhere in this report. The foregoing transactions were effected
in reliance on the exemption from registration afforded by Section
4(2) of the Securities Act of 1933 or did not involve a sale under
the Securities Act of 1933.
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Fourth Amendment to Note Purchase Agreement,
dated as of March 31, 2003, 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., 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 March 31, 2003 and 2002 (incorporated by
reference to New Valley's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2003,
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
(b) Reports on Form 8-K
No Reports on Form 8-K were filed during the first
quarter of 2003.
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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: May 15, 2003
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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: May 15, 2003
/s/ Bennett S. LeBow
-----------------------------------------
Bennett S. LeBow
Chairman and Chief Executive Officer
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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: May 15, 2003
/s/ Joselynn D. Van Siclen
------------------------------------------------
Joselynn D. Van Siclen
Vice President and Chief Financial Officer
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