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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 JUNE 30, 2004
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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
incorporation or organization) Identification No.)
100 S.E. SECOND STREET
MIAMI, FLORIDA 33131
305/579-8000
(Address, including zip code and telephone number, including area code,
of the principal executive offices)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days. [ X ]
Yes [ ] No
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 August 6, 2004, Vector Group Ltd. had 39,659,510 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 (Unaudited):
Vector Group Ltd. Consolidated Balance Sheets as of June 30, 2004 and
December 31, 2003.......................................................................... 2
Vector Group Ltd. Consolidated Statements of Operations for the three and six
months ended June 30, 2004 and June 30, 2003............................................... 3
Vector Group Ltd. Consolidated Statement of Stockholders' Equity (Deficit) for the six
months ended June 30, 2004................................................................. 4
Vector Group Ltd. Consolidated Statements of Cash Flows for the six months
ended June 30, 2004 and June 30, 2003...................................................... 5
Notes to Consolidated Financial Statements.................................................... 6
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................................... 34
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................... 54
Item 4. Controls and Procedures....................................................................... 54
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................. 55
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.............. 55
Item 4. Submission of Matters to a Vote of Security Holders........................................... 55
Item 6. Exhibits and Reports on Form 8-K.............................................................. 56
SIGNATURE ............................................................................................. 58
-1-
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
June 30, December 31,
2004 2003
------------ ------------
ASSETS:
Current assets:
Cash and cash equivalents .................................................... $ 80,397 $ 74,808
Investment securities available for sale ..................................... 19,031 67,521
Accounts receivable - trade .................................................. 10,339 10,425
Other receivables ............................................................ 2,046 2,605
Inventories .................................................................. 81,872 127,351
Restricted assets ............................................................ 633 771
Deferred income taxes ........................................................ 28,789 19,328
Other current assets ......................................................... 13,667 12,568
------------ ------------
Total current assets ....................................................... 236,774 315,377
Property, plant and equipment, net ............................................. 122,385 143,596
Assets held for sale ........................................................... 25,800 9,438
Long-term investments, net ..................................................... 2,266 2,431
Investments in non-consolidated real estate businesses ......................... 25,268 18,718
Restricted assets .............................................................. 5,489 5,571
Deferred income taxes .......................................................... 14,326 13,200
Intangible asset ............................................................... 107,511 107,511
Other assets ................................................................... 11,685 12,370
------------ ------------
Total assets ............................................................... $ 551,504 $ 628,212
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Current portion of notes payable and long-term debt .......................... $ 21,421 $ 10,762
Accounts payable ............................................................. 9,567 8,635
Accrued promotional expenses ................................................. 19,803 22,203
Accrued taxes payable, net ................................................... 41,580 48,577
Settlement accruals .......................................................... 10,428 52,650
Deferred income taxes ........................................................ 4,002 4,000
Accrued interest ............................................................. 7,004 7,004
Other accrued liabilities .................................................... 17,735 19,255
------------ ------------
Total current liabilities .................................................. 131,540 173,086
Notes payable, long-term debt and other obligations, less current portion ...... 297,573 299,977
Noncurrent employee benefits ................................................... 15,206 13,438
Deferred income taxes .......................................................... 143,201 139,927
Other liabilities .............................................................. 5,219 4,781
Minority interests ............................................................. 45,387 43,478
Commitments and contingencies .................................................. -- --
Stockholders' equity (deficit):
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 42,900,379 and 42,103,276 shares and outstanding
39,651,210 and 39,021,189 shares ........................................... 3,965 3,902
Additional paid-in capital ................................................... 228,894 251,239
Deficit ...................................................................... (292,873) (280,598)
Accumulated other comprehensive loss ......................................... (10,351) (9,335)
Less: 3,249,169 and 3,082,087 shares of common stock in treasury, at cost ... (16,257) (11,683)
------------ ------------
Total stockholders' equity (deficit) ..................................... (86,622) (46,475)
------------ ------------
Total liabilities and stockholders' equity (deficit) ..................... $ 551,504 $ 628,212
============ ============
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 Six Months Ended
------------------------------ -----------------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Revenues:
Tobacco* .................................................... $ 120,045 $ 129,400 $ 246,618 $ 260,743
Real estate leasing ......................................... 1,811 1,777 3,592 3,576
------------- ------------- ------------- -------------
Total revenues ............................................ 121,856 131,177 250,210 264,319
Expenses:
Cost of goods sold, excluding inventory impairment* ......... 69,828 86,010 143,928 169,801
Inventory impairment ........................................ 37,000 -- 37,000 --
Operating, selling, administrative and general expenses ..... 37,631 44,344 77,468 93,895
Restructuring and impairment charges ........................ 2,359 -- 3,012 --
------------- ------------- ------------- -------------
Operating income (loss) ................................... (24,962) 823 (11,198) 623
Other income (expenses):
Interest and dividend income ................................ 531 1,127 1,226 2,572
Interest expense ............................................ (6,491) (8,516) (12,913) (15,665)
Gain on sale of investments, net ............................ 5,335 332 5,586 270
Equity income (loss) from non-consolidated New Valley real
estate businesses ......................................... 4,642 (174) 5,288 (891)
Other, net .................................................. (4) 24 (9) 17
------------- ------------- ------------- -------------
Loss from operations before benefit for income taxes
and minority interests .................................... (20,949) (6,384) (12,020) (13,074)
Benefit for income taxes .................................... (7,181) (649) (2,493) (1,242)
Minority interests .......................................... (3,134) 805 (2,748) 2,053
------------- ------------- ------------- -------------
Net loss ........................................................ $ (16,902) $ (4,930) $ (12,275) $ (9,779)
============= ============= ============= =============
Per basic common share:
Net loss applicable to common shares ........................ $ (0.43) $ (0.13) $ (0.31) $ (0.25)
============= ============= ============= =============
Basic weighted average common shares outstanding ................ 39,213,205 38,811,880 39,138,102 38,623,285
============= ============= ============= =============
Per diluted common share:
Net loss applicable to common shares ........................ $ (0.43) $ (0.13) $ (0.31) $ (0.25)
============= ============= ============= =============
Diluted weighted average common shares outstanding .............. 39,213,205 38,811,880 39,138,102 38,623,285
============= ============= ============= =============
- --------
* Revenues and Cost of goods sold include excise taxes of $43,933, $48,519,
$90,103 and $98,336, respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
-3-
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
Accumulated
Additional Other
Common Stock Paid-In Treasury Comprehensive
Shares Amount Capital Deficit Stock Loss Total
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 2003 ............... 39,021,189 $ 3,902 $ 251,239 $ (280,598) $ (11,683) $ (9,335) $ (46,475)
Net loss ................................. -- -- -- (12,275) -- -- (12,275)
Unrealized loss on investment
securities ............................ -- -- -- -- -- (1,016) (1,016)
----------
Total other comprehensive loss .. -- -- -- -- -- -- (1,016)
----------
Total comprehensive loss ................. -- -- -- -- -- -- (13,291)
----------
Distributions on common stock ............ -- -- (31,495) -- -- -- (31,495)
Exercise of options ...................... 590,021 59 6,153 -- (4,574) -- 1,638
Restricted stock grants .................. 40,000 4 (4) -- -- -- --
Tax benefit of options exercised ......... -- -- 2,839 -- -- -- 2,839
Amortization of deferred
compensation, net ...................... -- -- 162 -- -- -- 162
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, June 30, 2004 ................... 39,651,210 $ 3,965 $ 228,894 $ (292,873) $ (16,257) $ (10,351) $ (86,622)
========== ========== ========== ========== ========== ========== ==========
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)
Six Months Ended
----------------------------
June 30, June 30,
2004 2003
------------ ------------
Net cash used in operating activities: ..................... $ (19,212) $ (23,181)
---------- ------------
Cash flows from investing activities:
Proceeds from sale of assets, net ........................ 2,657 910
Sale or maturity of investment securities ................ 63,108 79,391
Purchase of investment securities ........................ (12,253) (37,061)
Sale of long-term investments ............................ 278 830
Investments in non-consolidated real estate businesses ... (2,500) (9,500)
Decrease (increase) in restricted assets ................. 114 (11,010)
Payment of prepetition claims ............................ -- (18)
New Valley repurchase of common shares ................... -- (1,346)
Capital expenditures ..................................... (1,132) (6,503)
---------- ------------
Net cash provided by investing activities .................. 47,615 14,783
---------- ------------
Cash flows from financing activities:
Repayments of debt ....................................... (7,063) (17,836)
Borrowings under revolver ................................ 276,606 332,181
Repayments on revolver ................................... (262,586) (299,559)
Distributions on common stock ............................ (31,495) (29,565)
Proceeds from exercise of options and warrants ........... 1,724 623
---------- ------------
Net cash used in financing activities ...................... (22,814) (14,156)
---------- ------------
Net increase in cash and cash equivalents .................. 5,589 (22,554)
Cash and cash equivalents, beginning of period ............. 74,808 100,027
---------- ------------
Cash and cash equivalents, end of period ................... $ 80,397 $ 77,473
========= ============
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"), Liggett Group Inc. ("Liggett"), Vector Tobacco Inc.
("Vector Tobacco"), Liggett Vector Brands Inc. ("Liggett Vector
Brands"), New Valley Corporation ("New Valley") and other less
significant subsidiaries. The Company owned 58.1% of the common
shares of New Valley at June 30, 2004. All significant intercompany
balances and transactions have been eliminated.
Liggett is engaged in the manufacture and sale of cigarettes in the
United States. Vector Tobacco is engaged in the development and
marketing of low nicotine and nicotine-free cigarette products and
the development of reduced risk cigarette products. New Valley is
currently engaged in the real estate business and is seeking to
acquire additional operating companies.
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, 2003, 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 restructuring and impairment
charges, 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.
(c) Reclassifications:
Certain amounts in the 2003 consolidated financial statements have
been reclassified to conform to the 2004 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 29, 2003. In connection with the 5% dividend, the
Company increased the number of outstanding stock options by 5% and
-6-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
reduced the exercise prices accordingly. All share amounts have been
presented as if the stock dividends had occurred on January 1, 2003.
Basic net income per share is computed by dividing net income by the
weighted-average number of shares outstanding. Diluted net income
per share includes the dilutive effect of stock options, vested
restricted stock grants and warrants.
The Company had a net loss for the three and six months ended June
30, 2004 and for the three and six months ended June 30, 2003.
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 antidilutive. Potentially
dilutive shares that were not included in the diluted loss per share
calculations were 1,826,880 and 1,864,901 for the three and six
months ended June 30, 2004 and 1,108,930 and 1,223,783 for the three
and six months ended June 30, 2003, which shares were issuable upon
the exercise of stock options, vested restricted stock grants and
warrants, assuming the treasury stock method.
(e) Comprehensive Loss:
Other comprehensive loss is a component of stockholders' equity
(deficit) and includes such items as the unrealized gains and losses
on investment securities available for sale and minimum pension
liability adjustments. Total comprehensive loss was $13,291 for the
six months ended June 30, 2004 and $7,435 for the six months ended
June 30, 2003.
(f) New Accounting Pronouncements:
In March 2004, the Financial Accounting Standards Board (the "FASB")
reached a consensus on Emerging Issues Task Force Issue 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" ("EITF 03-1"). EITF 03-1 provides guidance for
determining when an investment is impaired and whether the impairment
is other than temporary. EITF 03-1 also incorporates into its
consensus the required disclosures about unrealized losses on
investments announced by the EITF in late 2003 and adds new
disclosure requirements relating to cost-method investments. The
impairment accounting guidance is effective for reporting periods
beginning after June 15, 2004 and the new disclosure requirements for
annual reporting periods ending after June 15, 2004. The Company does
not expect the adoption of the impairment guidance contained in EITF
03-1 to have a material impact on its financial position or results
of operations.
In December 2003, the FASB issued Statement on Financial Accounting
Standards ("SFAS") No. 132(R), which replaces SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement
Benefits." SFAS No. 132(R) does not change the measurement and
recognition provisions of SFAS No. 87, SFAS No. 88, "Employers
Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits," and SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other Than
Pensions," however, it includes additional disclosure provisions for
annual reporting, including detailed plan asset information by
category, expanded benefit obligation disclosure and key assumptions.
In addition, interim disclosures related to the individual elements
of plan costs and employer's current year contributions are required.
(See Note 6.)
-7-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
2. RESTRUCTURING
On October 8, 2003, the Company announced that it would close Vector
Tobacco's Timberlake, North Carolina cigarette manufacturing
facility in order to reduce excess tobacco production capacity and
improve operating efficiencies company-wide. Production of the QUEST
line of low nicotine and nicotine-free cigarettes, as well as
production of Vector Tobacco's other cigarette brands, has been
moved to Liggett's state-of-the-art manufacturing facility in
Mebane, North Carolina.
The Mebane facility currently produces in excess of 9 billion units
per year, but maintains the capacity to produce 16 billion units per
year. Vector Tobacco has contracted with Liggett Group to produce
its cigarettes and has transitioned production from Timberlake to
Mebane. All production ceased at Timberlake by December 31, 2003. As
part of the transition, Vector eliminated approximately 150
positions.
As a result of these actions, the Company recognized pre-tax
restructuring and impairment charges of $21,521, of which $21,300
was taken in 2003 and the remaining $221 was taken in the first
quarter of 2004. Machinery and equipment to be disposed of was
reduced to estimated fair value less costs to sell during 2003 and
is being carried on the accompanying consolidated balance sheets as
assets held for sale. The asset impairment charges are based on
management's current estimates of the values the Company will be
able to realize on sales of the excess machinery and equipment, and
may be adjusted in future periods based on the actual amounts
realized.
On June 4, 2004, a wholly-owned subsidiary of Vector Tobacco entered
into an agreement to sell the Timberlake facility, along with all
equipment, which sale closed on July 13, 2004. (Refer to Note 4.) The
Company decreased the asset impairment accrual as of June 30, 2004 to
reflect the actual amounts to be realized from the Timberlake sale
and to reduce the values of other excess Vector Tobacco machinery and
equipment in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." The Company further
adjusted the previously recorded restructuring accrual as of June 30,
2004 to reflect additional employee severance and benefits, contract
termination, and associated costs resulting from the Timberlake sale.
No charge to operations resulted from these adjustments as there was
no change to the total impairment and restructuring accruals
previously recognized.
In addition to the $221 recorded in the first quarter, Liggett Vector
Brands, as part of the continuing effort to adjust the cost structure
of the Company's tobacco business and improve operating efficiency,
eliminated 83 positions during April 2004, sublet its New York office
space in July 2004 and relocated several employees. As a result of
these actions, the Company recognized additional pre-tax
restructuring charges of $2,791 in the first half of 2004, including
$824 relating to employee severance and benefit costs and $1,967 for
contract termination and other associated costs. Approximately $518
of these charges represent non-cash items. The Company recognized
$432 of these pre-tax restructuring charges in the first quarter of
2004, and $2,359 in the second quarter of 2004.
Annual cost savings related to the restructuring and impairment
charges are currently expected to be at least $23,000 beginning in
2004. Management is currently reviewing opportunities for additional
cost savings as a result of these restructuring activities at Vector
Tobacco and Liggett Vector Brands.
-8-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
The components of the pre-tax restructuring and impairment charges
for 2003 and the six months ended June 30, 2004 are as follows:
Employee Non-Cash Contract
Severance Asset Termination/
and Benefits Impairment Exit Costs Total
------------ ---------- ----------- ----------
Balance, December 31, 2002 ............. $ -- $ -- $ -- $ --
Original charges ....................... 2,045 18,752 503 21,300
Utilized in 2003 ....................... (182) (18,752) (54) (18,988)
---------- ---------- ---------- ----------
Balance, December 31, 2003 ............. 1,863 -- 449 2,312
Restructuring and impairment charges ... 824 518 1,670 3,012
Adjustments/reclassifications in 2004 .. 507 (871) 364 --
Utilized/recoveries in 2004, net........ (2,432) 388 (1,532) (3,576)
---------- ---------- ---------- ----------
Balance, June 30, 2004 ................. $ 762 $ 35 $ 951 $ 1,748
========== ========== ========== ==========
The Company has recorded the sublease of the New York office space in
accordance with SFAS No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities," reducing future minimum lease payments
by estimated sublease rentals. The charge of $967 has been included
in the $3,012 charge for the six months ended June 30, 2004; $752
has been recorded in other long-term liabilities and the remainder in
other accrued liabilities. These amounts are not included in the
$1,748 balance at June 30, 2004.
3. INVENTORIES
Inventories consist of:
June 30, December 31,
2004 2003
------------ ------------
Leaf tobacco ........................... $ 39,857 $ 80,239
Other raw materials .................... 2,690 3,060
Work-in-process ........................ 1,291 1,609
Finished goods ......................... 41,049 42,825
Replacement parts and supplies ......... -- 636
------------ ------------
Inventories at current cost ............ 84,887 128,369
LIFO adjustments ....................... (3,015) (1,018)
------------ ------------
$ 81,872 $ 127,351
============ ============
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 June 30, 2004,
Liggett had leaf tobacco purchase commitments of approximately
$4,106 and Vector Tobacco had leaf tobacco purchase commitments of
approximately $1,624.
Included in the above table is approximately $3,226 at June 30, 2004
and $44,220 at December 31, 2003 of inventory associated with Vector
Tobacco's QUEST product. During the second quarter of 2004, based on
an analysis of the market data obtained since the introduction of
the QUEST product, the Company determined to postpone indefinitely
the national launch of QUEST and, accordingly, the Company
recognized a non-cash charge of $37,000 to adjust the carrying value
of excess leaf
-9-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
tobacco inventory for the QUEST product, based on estimated future
demand and market conditions. If actual demand for the product or
market conditions are less favorable than those estimated,
additional inventory write-downs may be required.
LIFO inventories represent approximately 91.9% and 53.8% of total
inventories at June 30, 2004 and December 31, 2003, respectively.
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
June 30 December 31,
2004 2003
------------ ------------
Land and improvements .......... $ 9,339 $ 10,019
Buildings ...................... 64,828 74,326
Machinery and equipment ........ 99,620 105,032
Leasehold improvements ......... 1,029 1,023
Construction-in-progress ....... 1,583 1,554
------------ ------------
176,399 191,954
Less accumulated depreciation .. (54,014) (48,358)
------------ ------------
$ 122,385 $ 143,596
============ ============
The table above includes real estate assets and accumulated
depreciation owned and operated by New Valley in the amounts of
$54,258 and $1,843 as of June 30, 2004 and $54,258 and $1,246 as of
December 31, 2003. (Refer to Note 9.)
Depreciation and amortization expense for the three and six months
ended June 30, 2004 was $3,531 and $7,056. Future machinery and
equipment purchase commitments at Liggett are $4,266 as of June 30,
2004.
In July 2003, Liggett granted an unaffiliated third party an option
to purchase Liggett's former manufacturing facility and other excess
real estate in Durham, North Carolina with a net book value at June
30, 2004 of approximately $2,313. The option agreement permits the
purchaser to acquire the property during a period of up to two
years, at a purchase price of $14,000 if the closing occurs by
August 23, 2004 and $15,000 if the closing occurs thereafter during
the term of the option. Liggett has received option fees of $1,000,
of which $250 is refundable if the purchaser terminates the
agreement prior to August 23, 2004. Liggett will be entitled to
receive additional option fees of up to $500 during the remaining
option period. The option fees will generally be creditable against
the purchase price. The purchaser is currently seeking financing for
the transaction, and there can be no assurance the sale of the
property will occur.
The Company recorded an $18,752 non-cash asset impairment charge
during the third quarter of 2003 in conjunction with the closing of
Vector Tobacco's Timberlake, North Carolina facility of which
$17,968 relates to machinery and equipment. (See Note 2.)
On June 4, 2004, a wholly-owned subsidiary of Vector Tobacco entered
into an asset purchase agreement to sell its Timberlake, North
Carolina manufacturing facility along with all equipment to an
affiliate of the Flue-Cured Tobacco Cooperative Stabilization
Corporation for $25,800. The Timberlake sale closed on July 13,
2004. In connection with the closing, the subsidiary of Vector
Tobacco entered into a consulting agreement to provide certain
services to the buyer for $400. (See Notes 2 and 5.)
-10-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
During 2003, Liggett entered into sale-leaseback transactions in
which equipment with a book value of $4,483 was sold and leased back
from a third party as operating leases. Liggett received cash of
$2,386, and no gain or loss was recognized on these transactions.
5. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
June 30 December 31,
2004 2003
------------ ------------
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 $5,381 and $6,675 .................... 64,619 63,325
Liggett:
Revolving credit facility ....................................... 14,020 --
Term loan under credit facility ................................. 4,881 5,190
Equipment loans ................................................. 8,001 9,758
Vector Tobacco:
Note payables ................................................... 5,194 5,999
Note payables - Medallion acquisition ........................... 35,000 38,125
V.T. Aviation:
Note payable .................................................... 10,015 10,496
VGR Aviation:
Note payable .................................................... 5,229 5,346
New Valley:
Note payable - operating real estate ............................ 39,535 39,910
Other ........................................................... -- 90
------------ ------------
Total notes payable, long-term debt and other obligations ....... 318,994 310,739
Less:
Current maturities ........................................ (21,421) (10,762)
------------ ------------
Amount due after one year ....................................... $ 297,573 $ 299,977
============ ============
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. The conversion price, which was $26.71 per share at June 30,
2004, 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 June 30, 2004.
Vector may redeem the notes, in whole or in part, at a price of
103.125% in the year beginning July 15, 2004, 102.083% in the year
beginning July 15, 2005, 101.042% in the year beginning July 15,
2006 and 100% in the year beginning July 15, 2007, together with
accrued interest. If a change of control occurs, Vector will be
required to offer to repurchase the notes at 101% of their principal
amount, plus accrued interest and, under certain circumstances, a
"make whole" payment.
-11-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
10% Senior Secured Notes Due March 31, 2006 - VGR Holding:
In May 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. In April 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, Liggett Vector
Brands, 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 the
Company is in compliance with at June 30, 2004. Among other things,
the covenants limit the ability of VGR Holding to make distributions
to the Company to 50% of VGR Holding's net income, unless VGR
Holding holds an amount in cash equal to the then principal amount
of the notes outstanding ($70,000 at June 30, 2004) after giving
effect to the payment of the distribution, and limit additional
indebtedness of VGR Holding, Liggett, Vector Tobacco and Liggett
Vector Brands to 250% of EBITDA (as defined in the purchase
agreements) for the trailing 12 months. 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 August 2004, in connection
with an amendment to the note purchase agreement, VGR Holding
repurchased $7,000 of the notes at a price of 100% of the principal
amount plus accrued interest. The Company will recognize a loss of
approximately $639 in the third quarter of 2004 on the early
extinguishment of debt.
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
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. 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:
On April 14, 2004, Liggett entered into an Amended and Restated Loan
and Security Agreement with Congress Financial Corporation, as
lender. The $50,000 credit facility replaces Liggett's previous
$40,000 facility with Congress, under which $14,020 was outstanding
at June 30, 2004. Availability as determined under the facility was
approximately $20,900 based on eligible collateral at June 30, 2004.
The facility is collateralized by all inventories and receivables of
Liggett. Borrowings under the facility bear interest at a rate equal
to 1.0% above the prime rate of Wachovia Bank, N.A. (the indirect
parent of Congress). The facility requires Liggett's compliance with
certain financial and other covenants including a restriction on
Liggett's ability to pay cash dividends unless Liggett's borrowing
-12-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
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 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 June 30, 2004, Liggett was in compliance with all
covenants under the credit facility; Liggett's adjusted net worth
was $63,755 and net working capital was $52,995, as computed in
accordance with the agreement.
100 Maple LLC, a company formed by Liggett in 1999 to purchase its
Mebane, North Carolina manufacturing plant, has a term loan of
$4,881 outstanding under Liggett's credit facility at June 30, 2004.
The remaining balance of the term loan is payable in monthly
installments of $77 with a final payment on June 1, 2006 of $3,033.
Interest is charged at the same rate as applicable to Liggett's
credit facility, and the outstanding balance of the term loan
reduces the maximum availability under the credit facility. Liggett
has guaranteed the term loan, and a first mortgage on the Mebane
property and manufacturing equipment collateralizes the term loan
and Liggett's credit facility.
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 was collateralized by a
mortgage and a letter of credit of $1,750, was 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 was payable in 30 monthly installments of
$39 plus accrued interest, with an annual interest rate of LIBOR
plus 5.12%. These loans were repaid on July 13, 2004 with a portion
of proceeds from the sale of the Timberlake property. (See Note 4.)
-13-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
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 have been repaid with the final quarterly
principal payment of $3,125 made on March 31, 2004. The remaining
$35,000 of notes bear interest at 6.5% per year, payable
semiannually, and mature on April 1, 2007.
Note 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
119 monthly installments of $125, including annual interest of 2.31%
above the 30-day commercial paper rate, with a final payment of
$1,420, based on current interest rates.
Note Payable - VGR Aviation:
In February 2002, V.T. Aviation purchased an airplane for $6,575 and
borrowed $5,800 to fund the purchase. The loan is guaranteed by the
Company. The loan is payable in 119 monthly installments of $40,
including annual interest of 2.75% above the 30-day average
commercial paper rate, with a final payment of $2,793, based on
current interest rates. During the fourth quarter of 2003, this
airplane was transferred to the Company's direct subsidiary, VGR
Aviation LLC, which has assumed the debt.
Note Payable - New Valley:
In December 2002, New Valley financed a portion of its purchase of
two office buildings in Princeton, New Jersey 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 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.
-14-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
6. EMPLOYEE BENEFITS
Net periodic benefit cost for the Company's pension and other
postretirement benefit plans for the three and six months ended June
30, 2004 and 2003 consists of the following:
Pension Benefits Pension Benefits
----------------------- -----------------------
Three Months Ended Six Months Ended
----------------------- -----------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
---------- ---------- ---------- ----------
Service cost - benefits earned
during the period ................... $ 1,248 $ 981 $ 2,496 $ 1,962
Interest cost on projected benefit
obligation .......................... 2,240 2,390 4,480 4,780
Expected return on plan assets ......... (3,027) (2,950) (6,054) (5,900)
Amortization of net loss ............... 506 414 1,012 828
---------- ---------- ---------- ----------
Net expense ................... $ 967 $ 835 $ 1,934 $ 1,670
========== ========== ========== ==========
Other Other
Postretirement Benefits Postretirement Benefits
----------------------- -----------------------
Three Months Ended Six Months Ended
----------------------- -----------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
---------- ---------- ---------- ----------
Service cost - benefits earned
during the period ................... $ 8 $ 20 $ 16 $ 40
Interest cost on projected benefit
obligation .......................... 157 169 314 338
Expected return on plan assets ......... -- -- -- --
Amortization of net (gain) loss ........ 5 (32) 10 (64)
---------- ---------- ---------- ----------
Net expense ................... $ 170 $ 157 $ 340 $ 314
========== ========== ========== ==========
The Company did not make contributions to its pension benefits plans
for the six months ended June 30, 2004 and does not anticipate
making any contributions to such plans in 2004. The Company
anticipates paying approximately $550 in other postretirement
benefits in 2004.
7. CONTINGENCIES
SMOKING-RELATED LITIGATION:
Overview. Since 1954, Liggett and other United States cigarette
manufacturers have been named as defendants in numerous direct and
third-party actions predicated on the theory that cigarette
manufacturers should be liable for damages alleged to have been
caused by cigarette smoking or by exposure to secondary smoke from
cigarettes. These cases are reported here as though having been
commenced against Liggett (without regard to whether such cases were
actually commenced against Brooke Group Holding Inc., the Company's
predecessor and a wholly-owned subsidiary of VGR Holding, or
Liggett). There has been a noteworthy increase in the number of
cases
-15-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
commenced against Liggett and the other cigarette manufacturers in
recent years. The cases generally fall into the following
categories: (i) smoking and health cases alleging injury brought on
behalf of individual plaintiffs ("Individual Actions"); (ii) smoking
and health cases alleging injury and purporting to be brought on
behalf of a class of individual plaintiffs ("Class Actions"); (iii)
health care cost recovery actions brought by various foreign and
domestic governmental entities ("Governmental Actions"); and (iv)
health care cost recovery actions brought by third-party payors
including insurance companies, union health and welfare trust funds,
asbestos manufacturers and others ("Third-Party Payor Actions"). As
new cases are commenced, defense costs and the risks attendant to
the inherent unpredictability of litigation continue to increase.
The future financial impact of the risks and expenses of litigation
and the effects of the tobacco litigation settlements discussed
below are not quantifiable at this time. For the six months ended
June 30, 2004, Liggett incurred legal fees and other litigation
costs totaling approximately $2,553 compared to $2,232 for the six
months ended June 30, 2003.
Individual Actions. As of June 30, 2004, there were approximately
382 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, 108 were pending in
Maryland, 94 in Florida, 51 in New York, 34 in Mississippi and 21 in
California. The balance of the individual cases were pending in 23
states. In addition to these cases, an action against cigarette
manufacturers involving approximately 1,000 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 currently scheduled for March
2005.
There are eight individual cases pending where Liggett is the only
named defendant. In April 2004, in one of these cases, Beverly Davis
v. Liggett Group Inc., a jury in a Florida state court action
awarded compensatory damages of $540 against Liggett. Liggett
believes there are a number of grounds to challenge the verdict and
intends to pursue all post-trial and appellate relief.
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 various states 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. Liggett is not a party to these actions. The
following is a brief description of various of these matters:
-16-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
o In February, 1999, in Henley v. Philip Morris, a California
state court jury awarded $1,500 in compensatory damages and
$50,000 in punitive damages. The trial court reduced the
punitive damages award to $25,000. In September 2003, the
California Court of Appeals reduced the punitive damages award
to $9,000 based on the United States Supreme Court's 2003
opinion in State Farm, limiting punitive damages. The defendant
has appealed to the California Supreme Court.
o In March 1999, an Oregon state court jury found in favor of the
plaintiff in Williams v. Philip Morris. The jury awarded $800 in
compensatory damages and $79,500 in punitive damages. The trial
court reduced the punitive damages award to $32,000. In June
2002, the Oregon Court of Appeals reinstated the $79,500
punitive damages award. In October 2003, the United States
Supreme Court set aside the Oregon appellate court's ruling and
directed the Oregon court to reconsider the case in light of the
State Farm decision. In June 2004, the Oregon appellate court
reinstated the original jury verdict. The defendant has
appealed.
o In March 2000, a California state court jury found in favor of
the plaintiff in Whiteley v. Raybestos-Manhattan, Inc., et al.
The jury awarded the plaintiff $1,720 in compensatory damages
and $20,000 in punitive damages. In April 2004, the California
Court of Appeals reversed the judgment and remanded the case for
a new trial.
o During 2001, as a result of a Florida Supreme Court decision
upholding the award, in Carter v. Brown and Williamson Tobacco
Corp., the defendant 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.
o In June 2001, a California state court jury found in favor of
the plaintiff in Boeken v. Philip Morris and awarded $5,500 in
compensatory damages and $3,000,000 in punitive damages. In
August 2001, the trial court reduced the punitive damages award
to $100,000. The parties have appealed.
o In December 2001, in Kenyon v. R.J. Reynolds Tobacco Co., a jury
awarded the plaintiff $165 in compensatory damages, but no
punitive damages. In May 2003, the Florida Court of Appeals
affirmed per curiam (that is, without an opinion) the trial
court's final judgment in favor of the plaintiffs. The defendant
paid the amount of the judgment plus accrued interest ($196)
after exhausting all appeals.
o In February 2002, in Burton v. R.J. Reynolds Tobacco Co., et al,
a federal district court jury in Kansas awarded the plaintiff
$198 in compensatory damages, and determined that the plaintiff
was entitled to punitive damages. In June 2002, the trial court
awarded the plaintiff $15,000 in punitive damages. The defendant
has appealed.
o In March 2002, an Oregon state court jury found in favor of the
plaintiff in Schwarz v. Philip Morris and awarded $169 in
compensatory damages and $150,000 in punitive damages. In May
2002, the trial court reduced the punitive damages award to
$100,000. The parties have appealed.
o In October 2002, a California state court jury found in favor of
the plaintiff in Bullock v. Philip Morris and awarded $850 in
compensatory damages and $28,000,000 in punitive damages. In
December 2002, the trial court reduced the punitive damages
award to $28,000. The parties have appealed.
-17-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
o In April 2003, in Eastman v. Brown & Williamson Tobacco Corp.,
et al, a Florida state court jury awarded $6,500 in compensatory
damages. In May 2004, the Florida Court of Appeals affirmed the
verdict in a per curiam opinion. The defendants will seek
further appellate review.
o In May 2003, in Boerner v. Brown & Williamson Tobacco Corp., a
federal district court jury in Arkansas awarded $4,000 in
compensatory damages and $15,000 in punitive damages. The
defendant has appealed.
o In November 2003, in Thompson v. Brown & Williamson Tobacco
Corp., et al., a Missouri state court jury awarded $1,100 in
compensatory damages. The defendants have appealed.
o In December 2003, in Frankson v. Brown & Williamson Tobacco
Corp., et al., a New York state court jury awarded $350 in
compensatory damages. In January 2004, the jury awarded $20,000
in punitive damages. The deceased smoker was found to be 50% at
fault. In June 2004, the court increased the compensatory
damages to $500 and decreased the punitive damages to $5,000.
Post-trial motions are pending.
One of the states in which cases are pending against Liggett is
Mississippi. During 2003, the Mississippi Supreme Court ruled that
the Mississippi Product Liability Act "precludes all tobacco cases
that are based on product liability." Based on this ruling, Liggett
is seeking, or intends to seek, dismissal of each of the
approximately 34 cases pending against it in Mississippi.
Class Actions. As June 30, 2004, there were approximately 33 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 an "addiction-as-injury" class action that
covered only citizens in the state. In May 2004, the jury returned a
verdict in the amount of $591,000, plus prejudgment interest, on the
class's claim for a smoking cessation program. Post-trial motions are
pending. Two other class actions, Broin and Engle, were certified in
state court in Florida prior to the Fifth Circuit's decision. In
April 2001, the Brown case was certified as a class action in
California.
In May 1994, an action entitled Engle, et al. v. R.J. Reynolds
Tobacco Company, et al., Circuit Court, Eleventh Judicial Circuit,
Miami-Dade County, Florida, was filed against Liggett and others.
The class consists of all Florida residents and citizens, and their
survivors, who have suffered, presently suffer or have died from
diseases and medical conditions caused by their addiction to
cigarettes that contain nicotine. Phase I of the trial commenced in
July 1998 and in July 1999, the jury returned the Phase I verdict.
The Phase I verdict concerned certain issues determined by the trial
court to be "common" to the causes of action of the plaintiff class.
Among other things, the jury found that: smoking cigarettes causes
20 diseases or medical conditions, cigarettes are addictive or
dependence producing, defective and unreasonably dangerous,
defendants made materially false statements with the intention of
misleading smokers, defendants concealed or omitted material
information concerning the health effects and/or the addictive
nature of smoking cigarettes and
-18-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
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. Phase III of the trial was to 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. 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 provided 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 appealed the court's order.
In May 2003, Florida's Third District Court of Appeals decertified
the Engle class and set aside the jury's decision in the case
against Liggett and the other cigarette makers, including the
$145,000,000 punitive damages award. The intermediate appellate
court ruled that there were multiple legal bases why the class
action trial, including the punitive damages award, could not be
sustained. The court found that the class failed to meet the legal
requirements for class certification and that class members needed
to pursue their claims on an individualized basis. The court also
ruled that the trial plan violated Florida law and the appellate
court's 1996 certification decision, and was unconstitutional. The
court further found that the proceedings were irretrievably tainted
by class counsel's misconduct and that the punitive damages award
was bankrupting under Florida law.
In October 2003, the Third District Court of Appeals denied class
counsel's motions seeking, among other things, a rehearing by the
court. Class counsel filed a motion with the Florida Supreme Court
to invoke discretionary review on the basis that the Third District
Court of Appeals decision construes the due process provisions of
the state and federal constitutions and conflicts with other
appellate and supreme court decisions. In May 2004, the Florida
Supreme Court agreed to review the case. Oral argument is scheduled
for November 3, 2004. If the Third District Court's ruling is not
upheld on further appeal, it will have a material adverse effect on
the Company.
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. In November 2000,
Liggett filed the $3,450 bond required by the Florida law in order
to stay execution of the Engle judgment, pending appeal. Legislation
limiting the amount of bonds required to file an appeal of an
adverse judgment has also been enacted in Arkansas, California,
Colorado, Georgia, Idaho, Indiana, Kansas, Kentucky, Louisiana,
Michigan, Minnesota, Mississippi, Missouri, Nevada, New Jersey,
North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South
Carolina, South Dakota, Tennessee, Texas, Virginia, West Virginia
and Wisconsin.
In May 2001, Liggett, along with Philip Morris and Lorillard Tobacco
Co., reached an agreement with the class in the Engle case, which
provided 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
-19-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
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, assured that the
stay of execution, in effect pursuant to the Florida bonding
statute, would 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 fell below
$33,781 (as determined in accordance with generally accepted
accounting principles in effect as of July 14, 2000), the agreement
provided that 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. In March 2003, the court reduced the amount of the
compensatory damages to $25,100. 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 were stayed pending resolution of the appeal of
the Engle verdict. The Lukacs verdict, which was subject to the
outcome of the Engle appeal, has been overturned as a result of the
appellate court's ruling. As discussed above, class counsel in Engle
is pursuing various appellate remedies seeking reversal of the
appellate court's decision.
Class certification motions are pending in a number of putative
class actions. Classes remain certified against Liggett in West
Virginia (Blankenship), in California (Brown), in New York (Simon),
in Kansas (Smith) and in New Mexico (Romero). 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 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 other
defendants. In May 2004, the West Virginia Supreme Court affirmed
the defense jury verdict. In June 2004, plaintiff's motion for
rehearing was denied.
In April 2001, the California state court in the case of Brown v.
The American Tobacco Company, Inc., et al., granted in part
plaintiff's motion for class certification and certified a class
comprised of adult residents of California who smoked at least one
of defendants' cigarettes "during the applicable time period" and
who were exposed to defendants' marketing and advertising activities
in California. Certification was granted as to plaintiff's claims
that defendants violated California's unfair business practices
statute. The court subsequently defined "the applicable class
period" for plaintiff's claims, pursuant to a stipulation submitted
by the parties, as June 10, 1993 through April 23, 2001. The
California Court of Appeals denied defendants' writ application,
which sought review of the trial court's class certification orders.
Defendants filed a petition for review with the California Supreme
Court, which was subsequently denied. The defendants' summary
judgment motions are pending before the court. 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 February 2003, the Second
Circuit agreed to review the district court's class certification
decision, and oral argument was held in November 2003.
-20-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
Class action suits have been filed in a number of states against
individual cigarette manufacturers, alleging that the use of the
terms "lights" and "ultralights" constitutes unfair and deceptive
trade practices. One such suit (McLaughlin v. Philip Morris USA,
Inc., et al.), pending in federal court in New York against the
cigarette manufacturers, seeks to create a nationwide class of
"light" cigarette smokers and includes Liggett as a defendant.
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 $7,100,500 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 appealed the verdict.
Approximately 38 purported state and federal class action complaints
were filed against the cigarette manufacturers, including Liggett,
for alleged antitrust violations. 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 were
consolidated and, in July 2000, plaintiffs filed a single
consolidated complaint that did not name Liggett as a defendant,
although Liggett complied with discovery requests. In July 2002, the
court granted defendants' motion for summary judgment in the
consolidated federal cases, which decision was affirmed on appeal by
the United States Court of Appeals for the Eleventh Circuit. All
state court cases on behalf of indirect purchasers have been
dismissed, except for two cases pending in Kansas and New Mexico. A
Kansas state court, in the case of Smith v. Philip Morris Companies
Inc., et al., granted class certification in November 2001. In April
2003, plaintiffs' motion for class certification was granted in
Romero v. Philip Morris Companies Inc., a case pending in New Mexico
state court, which decision has been appealed. Liggett is one of the
defendants in the Kansas and New Mexico cases.
Governmental Actions. As of June 30, 2004, there were approximately
13 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 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.
In August 2003, following the refusal by the Florida Supreme Court
to hear the appeal of the Republic of Venezuela in connection with
the dismissal of its health care cost recovery action (which
decision plaintiff has appealed to the United States Supreme Court),
the trial court hearing the health care cost recovery actions
brought in Florida by the Republic of Tajikistan and the Brazilian
State of Tocantins granted defendants' motions to dismiss the cases.
Subsequently, plaintiffs voluntarily dismissed additional heath care
cost recovery cases brought in Florida by various foreign
governmental entities.
-21-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
Third-Party Payor Actions. As of June 30, 2004, there were
approximately six 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. Nine
United States Circuit Courts of Appeal have ruled that Third-Party
Payors did not have standing to bring lawsuits against the cigarette
manufacturers. 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. In September
2003, the United States Court of Appeals for the Second Circuit
certified two questions relating to plaintiff's direct claims of
deceptive business practices to the New York Court of Appeals, which
has agreed to review the certified questions. The Second Circuit
reversed the portion of the judgment relating to the verdict
returned against defendants under plaintiff's subrogation claim, and
deferred its ruling on defendants' appeal of the attorneys' fees
award until such time as the New York Court of Appeals rules on the
certified questions.
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 major
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 asserted 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 September 2000, the
court dismissed the government's claims based on MCRA and MSP,
reaffirming its decision in July 2001. In the September 2000
decision, the court also determined not to dismiss the government's
RICO claims, 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 May 2003, the court denied the industry's motion
which sought partial summary judgment as to the government's
advertising, marketing, promotion and warning claims on the basis
that these claims are within the exclusive jurisdiction of the
Federal Trade Commission. In January 2004, the court granted one of
the government's pending motions and dismissed certain equitable
defenses of defendants. In April 2004, the court denied Liggett's
motion to be dismissed from the case. In May 2004, the court denied
the defendants' motion for
-22-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
summary judgment to dismiss the government's disgorgement claim and,
in June 2004, certified that decision for interlocutory appeal to
the United States Court of Appeals for the District of Columbia,
which has agreed to hear the appeal. Oral argument is scheduled for
November 19, 2004.
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. 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.
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 received final judicial
approval in each settling jurisdiction.
The MSA restricts tobacco product advertising and marketing within
the Settling States and otherwise restricts the activities of
Participating Manufacturers. Among other things, the MSA prohibits
the targeting of youth in the advertising, promotion or marketing of
tobacco products; bans the use of cartoon characters in all tobacco
advertising and promotion; limits each Participating Manufacturer to
one tobacco brand name sponsorship during any 12-month period; bans
all outdoor advertising, with the exception of signs, 14 square feet
or less, at retail establishments that sell tobacco products;
prohibits payments for tobacco product placement in various media;
bans gift offers based on the purchase of tobacco products without
sufficient proof that the intended recipient is an adult; prohibits
Participating Manufacturers from licensing third parties to
advertise tobacco brand names in any manner prohibited under the
MSA; prohibits Participating Manufacturers from using as a tobacco
product brand name any nationally recognized non-tobacco brand or
trade name or the names of sports teams, entertainment groups or
individual celebrities; and prohibits Participating Manufacturers
from selling packs containing fewer than 20 cigarettes.
The MSA also requires Participating Manufacturers to affirm
corporate principles to comply with the MSA and to reduce underage
usage of tobacco products and imposes requirements applicable to
lobbying activities conducted on behalf of Participating
Manufacturers.
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 in April
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
-23-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
United States. During 1999 and 2000, Liggett's market share did not
exceed the base amount. According to data from Management Science
Associates, Inc., domestic shipments by Liggett and Vector Tobacco
accounted for approximately 2.2% of the total cigarettes shipped in
the United States during 2001, 2.5% during 2002 and 2.7% during
2003. On April 15 of any year following a year in which Liggett's
and/or Vector Tobacco's market shares exceed their base shares,
Liggett and/or 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. At that time, funds were held back based
on Liggett's and Vector Tobacco's belief that their MSA payments for
2002 should be reduced as a result of market share loss to
non-participating manufacturers. In June 2003, Liggett and Vector
Tobacco reached a settlement with the jurisdictions party to the MSA
whereby Liggett and Vector Tobacco agreed to pay $2,478 in April
2004 to resolve these claims. In April 2004, Liggett and Vector
Tobacco paid a total of $50,322 for their 2003 MSA obligations.
Liggett and Vector Tobacco have expensed $8,391 for their estimated
MSA obligations for the first six months of 2004 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
---- ------
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 four 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,
other than a $100 a year payment to Minnesota starting in 2003, to
be paid any year cigarettes manufactured by Liggett are sold in the
state. 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.
Copies of the various settlement agreements are filed as exhibits to
the Company's Annual Report on Form 10-K and the discussion herein
is qualified in its entirety by reference thereto.
-24-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
Trials. Cases currently scheduled for trial during the next six
months include two individual actions in Florida state court
scheduled for trial in September 2004. Liggett is the sole defendant
in each of these cases. Trial in the United States government action
is scheduled for September 2004 in federal court in the District of
Columbia. 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. In May 2003, a Florida intermediate
appellate court overturned a $790,000 punitive damages award against
Liggett and decertified the Engle smoking and health class action.
In May 2004, the Florida Supreme Court agreed to review the case.
Oral argument is scheduled for November 3, 2004. If the intermediate
appellate court's ruling is not upheld on further appeal, it will
have a material adverse effect on the Company. In November 2000,
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 provided assurance to Liggett that
the stay of execution, in effect pursuant to the Florida bonding
statute, would 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, which was subject to the outcome of the Engle appeal,
has been overturned as a result of the appellate court's ruling. In
April 2004, a jury in a Florida state court action awarded
compensatory damages of approximately $540 against Liggett in an
individual action. Liggett intends to appeal the verdict. It is
possible that additional cases could be decided unfavorably and that
there could be further adverse developments in the Engle case.
Liggett may enter into discussions in an attempt to settle
particular cases if it believes it is appropriate to do so.
Management cannot predict the cash requirements related to any
future settlements and judgments, including cash required to bond
any appeals, and there is a risk that those requirements will not be
able to be met. An unfavorable outcome of a pending smoking and
health case could encourage the commencement of additional similar
litigation. Management is unable to make a meaningful estimate with
respect to the amount or range of loss that could result from an
unfavorable outcome of the cases pending against Brooke Group
Holding or Liggett or the costs of defending such cases. The
complaints filed in these cases rarely detail alleged damages.
Typically, the claims set forth in an individual's complaint against
the tobacco industry pray for money damages in an amount to be
determined by a jury, plus punitive damages and costs. These damage
claims are typically stated as being for the minimum necessary to
invoke the jurisdiction of the court.
It is possible that the Company's consolidated financial position,
results of operations or cash flows could be materially adversely
affected by an unfavorable outcome in any such smoking-related
litigation.
Liggett's 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.
-25-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
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:
Many cities and states have recently enacted legislation banning
smoking in public places including offices, restaurants, public
buildings and bars. Efforts to limit smoking in public places could
have a material adverse effect on the Company and Liggett.
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 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 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
-26-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
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. In July 2004, the Senate
passed a bill providing for FDA regulation of tobacco products and
the elimination of the federal tobacco quota system. The Senate bill
would impose assessments on manufacturers of tobacco products to
compensate tobacco growers and quota holders for the elimination of
their quota rights. The ultimate outcome of these proposals cannot
be predicted, but FDA regulation of tobacco products could have a
material adverse effect on the Company and Liggett.
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 2002, the United States Court of Appeals for 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. Liggett began voluntarily complying with this
legislation in December 1997 by providing ingredient information to
the Massachusetts Department of Public Health and, notwithstanding
the appellate court's ruling, has continued to provide ingredient
disclosure. Liggett also provides ingredient information annually,
as required by law, to the states of Texas and Minnesota. Several
other states are considering ingredient disclosure legislation and
the Senate bill providing for FDA regulation also calls for, among
other things, ingredient disclosure.
Cigarettes are subject to substantial and increasing federal, state
and local excise taxes. 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 exceed $4.00 per
pack. Proposed further tax increases in various jurisdictions are
currently under consideration or pending. In 2003, 15 states and the
District of Columbia enacted increases in excise taxes. Congress has
considered significant increases in the federal excise tax or other
payments from tobacco manufacturers, and several states have pending
legislation proposing further state excise tax increases. In 2004,
five states increased the excise tax rate and several other states
are likely to impose additional taxes on cigarettes. In the opinion
of the Company, increases in excise and similar taxes have had an
adverse impact on sales of cigarettes.
Various state governments have adopted or are considering adopting
legislation establishing ignition propensity standards for
cigarettes. Compliance with this legislation could be burdensome and
costly. In June 2000, the New York State legislature passed
legislation charging the state's Office of Fire Prevention and
Control, referred to as the "OFPC," with developing standards for
"fire-safe" or self-extinguishing cigarettes. All cigarettes
manufactured for sale in New York state must be manufactured to
certain self-extinguishment standards set out in the regulations.
Liggett and Vector Tobacco have not historically provided products
that would be compliant under these new OFPC regulations, and
certain design and manufacturing changes have been necessary for
cigarettes manufactured for sale in New York to comply with the
standards. Inventories of cigarettes existing in the wholesale and
retail trade as of June 28, 2004 that do not comply with the
standards, may continue to be sold provided New York tax stamps have
been affixed and such inventories have been purchased in comparable
quantities to the same period in the previous year. Liggett and
Vector Tobacco have complied with these New York regulatory
requirements. Similar legislation is being
-27-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
considered by other state governments and at the federal level.
Compliance with such legislation could harm the business of Liggett
and Vector Tobacco, particularly if there are varying standards from
state to state.
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. Various concerns regarding
Vector Tobacco's advertising practices have been expressed to Vector
Tobacco by certain state attorneys general. Vector Tobacco has
engaged in discussions in an effort to resolve these concerns and
Vector Tobacco has recently agreed to suspend all print advertising
for its Quest brand while discussions are pending. 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
governmental 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,
advertising 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 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. 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 or legislation.
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) Ltd., which was then an indirect
subsidiary of Brooke Group Holding, in January 1997 constituted a
self-dealing transaction which involved the payment of excessive
consideration by New Valley. The plaintiff seeks a declaration that
New Valley's directors breached their fiduciary duties and Brooke
Group Holding aided and abetted such breaches and that damages be
awarded to New Valley. In December 1999, another stockholder of New
Valley commenced an action in Delaware Chancery Court substantially
similar to the March 1997 action. This stockholder alleges, among
other things, that the 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
-28-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
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 is ongoing. Recently, on motion of the defendants, one of the
plaintiff stockholders was dismissed from the proceeding for lack of
standing.
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 and filed a motion for
summary judgment on the remaining three claims.
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 June 30, 2004, New Valley had $600 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.
8. EQUITY
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 loss for the three and six months ended June
30, 2004 and June 30, 2003 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:
-29-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
Three Months Ended Six Months Ended
---------------------------- ----------------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net loss .................................... $ (16,902) $ (4,930) $ (12,275) $ (9,779)
Add: stock option employee compensation
expense included in reported net loss,
net of related tax effects .............. 52 1,365 84 2,719
Deduct: total stock option employee
compensation expense determined
under the fair value method for all
awards, net of related tax effects ...... (408) (2,254) (956) (4,487)
------------ ------------ ------------ ------------
Pro forma net loss .......................... $ (17,258) $ (5,819) $ (13,147) $ (11,547)
============ ============ ============ ============
Loss per share:
Basic - as reported ..................... $ (0.43) $ (0.13) $ (0.31) $ (0.25)
Diluted - as reported ................... $ (0.43) $ (0.13) $ (0.31) $ (0.25)
Basic - pro forma ....................... $ (0.44) $ (0.15) $ (0.34) $ (0.30)
Diluted - pro forma ..................... $ (0.44) $ (0.15) $ (0.34) $ (0.30)
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 six months ended June 30, 2004, 922,043 options,
exercisable at prices ranging from $3.92 to $15.44 per share, were
exercised for $1,638 in cash and the delivery to the Company of
332,022 shares of common stock with a fair market value of $5,346 or
$16.10 per share at the date of exercise.
On June 1, 2004, the Company granted 10,000 restricted shares of the
Company's common stock to each of its four outside directors which
will vest over a period of three years. The Company will recognize
$644 of expense over the vesting period.
9. NEW VALLEY CORPORATION
Acquisition of Real Estate. In December 2002, New Valley purchased
two office buildings in Princeton, New Jersey. 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). (Refer to Note 5.)
-30-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
Also in December 2002, New Valley and the other owners of Prudential
Douglas Elliman Real Estate, formerly known as Prudential Long
Island Realty, contributed their interests in Prudential Douglas
Elliman Real Estate to Douglas Elliman Realty, LLC, formerly known
as Montauk Battery Realty LLC, a newly formed entity. New Valley
acquired a 50% ownership interest in Douglas Elliman Realty, LLC, an
increase from its previous 37.2% interest in Prudential Douglas
Elliman Real Estate as a result of an additional investment of
$1,413 by New Valley and the redemption by Prudential Douglas
Elliman Real Estate of various ownership interests.
In March 2003, Douglas Elliman Realty, LLC purchased the leading New
York City-based residential brokerage firm, Douglas Elliman, LLC,
formerly known as 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 Douglas Elliman
Realty, LLC to help fund the acquisition. The subordinated debt,
which has a principal amount of $9,500, bears interest at 12% per
annum and is due in March 2013.
New Valley accounts for its 50% interest in Douglas Elliman Realty
LLC and in Koa Investors LLC on the equity method. Koa Investors
owns the former Kona Surf Hotel in Kailua-Kona,Hawaii. Following a
major renovation, the property is scheduled to reopen in late 2004
as a four star Sheraton resort with approximately 525 rooms.
LTS. In March 2004, New Valley and the other holder of the
convertible notes of Ladenburg Thalmann Financial Services Inc.
("LTS") entered into a debt conversion agreement with LTS. New
Valley and the other holder agreed to convert their notes, with an
aggregate principal amount of $18,010, together with the accrued
interest, into common stock of LTS. Pursuant to the conversion
agreement, the conversion price of the note held by New Valley will
be reduced from the current conversion price of approximately $2.08
to $1.10 per share.
The note conversion transaction is subject to approval by the LTS
shareholders and to other conditions, including the absence of any
material adverse change. New Valley, several shareholders of LTS
affiliated with New Valley and the other holder of the convertible
notes have committed to vote their shares of common stock of LTS at
its shareholder meeting in accordance with the vote of a majority of
votes cast at the meeting excluding the shares held by such parties.
At the closing, New Valley's note, representing approximately $9,470
of principal and accrued interest, would be converted into
approximately 8,610,000 shares of LTS common stock. New Valley
currently intends to distribute to its stockholders shares of LTS
common stock issued to New Valley pursuant to the conversion
agreement.
On July 20, 2004, LTS announced that it is currently re-examining
its capital needs to support its liquidity and capital base for the
near term. LTS's 2004 annual shareholder meeting, where the debt
conversion agreement was to have been presented for shareholder
approval, has been delayed until LTS can determine its capital
needs. Upon completion of this determination, LTS will proceed with
its shareholder meeting and the debt conversion agreement as
management deems appropriate.
Other. In October 1999, New Valley's Board of Directors authorized
the repurchase of up to 2,000,000 common shares from time to time on
the open market or in privately negotiated transactions depending on
market conditions. As of June 30, 2004, New Valley had repurchased
1,185,615 shares for approximately $4,695. At June 30, 2004, the
Company owned 58.1% of New Valley's common shares.
10. INCOME TAXES
The effective tax rates for the three and six months ended June 30,
2004 and June 30, 2003 do not bear a customary relationship to
pre-tax income principally as a consequence of non-deductible
expenses and state income taxes.
-31-
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)-(CONTINUED)
(UNAUDITED)
The consolidated balance sheets of the Company 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
June 30, 2004, the Company's deferred income tax liabilities
exceeded its deferred income tax assets by $104,088. The largest
component of the Company's deferred tax liabilities exists because
of differences that resulted from a 1998 and 1999 transaction with
Philip Morris Incorporated in which a subsidiary of Liggett
contributed three of its premium cigarette 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 for a 90-day period commencing in December 2008, and
the Company has an option to require Philip Morris to purchase the
remaining interest for a 90-day period commencing in March 2010. For
additional information concerning the Philip Morris brand
transaction, see Note 19 to the consolidated financial statements
included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2003.
In connection with the transaction, the Company recognized in 1999 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 during the 90-day periods
commencing in December 2008 or in March 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. In connection with an examination of the Company's 1998 and
1999 federal income tax returns, the Internal Revenue Service issued
to the Company in September 2003 a notice of proposed adjustment.
The notice asserts that, for tax reporting purposes, the entire gain
should have been recognized in 1998 and in 1999 in the additional
amounts of $150,000 and $129,900, respectively, rather than upon the
exercise of the options during the 90-day periods commencing in
December 2008 or in March 2010. If the Internal Revenue Service were
to ultimately prevail with the proposed adjustment, it would result
in the potential acceleration of tax payments of approximately
$119,000, including interest, net of tax benefits, through June 30,
2004. These amounts have been previously recognized in the Company's
consolidated financial statements as tax liabilities. As of June 30,
2004, the Company believes amounts potentially due have been fully
provided for in its consolidated statements of operations.
The Company believes the positions reflected on its income tax
returns are correct and intends to vigorously oppose any proposed
adjustments to its returns. The Company has filed a protest with the
Appeals Division of the Internal Revenue Service. No payment is due
with respect to these matters during the appeal process. Interest
currently is accruing on the disputed amounts at a rate of 7%, with
the rate adjusted quarterly based on rates published by the U.S.
Treasury Department. If taxing authorities were to ultimately
prevail in their assertion that the Company incurred a tax
obligation prior to the exercise dates of these options and it was
required to make such tax payments prior to 2009 or 2010, and if any
necessary financing were not available to the Company, its liquidity
could be adversely affected.
11. SEGMENT INFORMATION
The Company's significant business segments for the six months ended
June 30, 2004 and 2003 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 the low nicotine and nicotine-free cigarette products
as well as the development of reduced risk cigarette products and,
for segment reporting purposes, excludes the operations of
Medallion.
-32-
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 interests for the three and six months ended June 30,
2004 and 2003 follows:
Vector Real Corporate
Liggett Tobacco Estate and Other TOTAL
------------ ------------ ------------ ---------- ------------
Three Months Ended June 30, 2004:
Revenues .......................... $ 115,551 $ 4,494 $ 1,811 $ -- $ 121,856
Operating income (loss) ........... 25,368(1) (44,441)(1) 937 (6,826) (24,962)(1)
Depreciation and amortization ..... 2,013 543 325 650 3,531
Three Months Ended June 30, 2003:
Revenues .......................... $ 120,767 $ 8,633 $ 1,777 $ -- $ 131,177
Operating income (loss) ........... 27,587 (21,167) 984 (6,581) 823
Depreciation and amortization ..... 2,130 1,241 321 690 4,382
Six Months Ended June 30, 2004:
Revenues .......................... $ 237,772 $ 8,846 $ 3,592 $ -- $ 250,210
Operating income (loss) ........... 53,151(2) (53,147)(2) 1,858 (13,060) (11,198)(2)
Identifiable assets ............... 281,667 32,876 80,240 156,721 551,504
Depreciation and amortization ..... 4,010 1,135 646 1,265 7,056
Capital expenditures .............. 1,097 35 -- -- 1,132
Six Months Ended June 30, 2003:
Revenues .......................... $ 245,682 $ 15,061 $ 3,576 $ -- $ 264,319
Operating income (loss) ........... 57,849 (45,506) 1,920 (13,640) 623
Identifiable assets ............... 294,588 93,455 72,261 224,435 684,739
Depreciation and amortization ..... 4,169 2,398 642 1,368 8,577
Capital expenditures .............. 4,020 2,134 -- 349 6,503
- --------------------
(1) Includes restructuring and impairment charges in the three months
ended June 30, 2004 of $1,963 at Liggett and $396 at Vector Tobacco
and a $37,000 inventory charge at Vector Tobacco in the 2004 period.
(2) Includes restructuring and impairment charges in the six months
ended June 30, 2004 of $2,352 at Liggett and $660 at Vector Tobacco
and a $37,000 inventory charge at Vector Tobacco in the 2004 period.
-33-
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 manufacture and sale of cigarettes in the United States
through our subsidiary Liggett Group Inc., and
o the development and marketing of the low nicotine and
nicotine-free QUEST cigarette products and the development of
reduced risk cigarette products through our subsidiary Vector
Tobacco Inc.
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 our tobacco operations. With
the combined resources of Liggett and Vector Tobacco, Liggett Vector Brands has
enhanced distribution and marketing capabilities.
In October 2003, we announced that we would close Vector Tobacco's
Timberlake, North Carolina cigarette manufacturing facility in order to reduce
excess cigarette production capacity and improve operating efficiencies
company-wide. Production of QUEST and Vector Tobacco's other cigarette brands
has been transferred to Liggett's state-of-the-art manufacturing facility in
Mebane, North Carolina. In July 2004, we completed the sale of the Timberlake
facility and equipment.
All of Liggett's unit volume in the first half of 2004 was in the
discount segment, which Liggett's management believes has been the primary
growth segment in the industry for over a decade. The significant discounting
of premium cigarettes in recent years has led to brands, such as EVE, that were
traditionally considered premium brands to become more appropriately
categorized as discount, despite their premium list price. Effective February
1, 2004, Liggett reduced the list prices for EVE and JADE from the premium
price level to the branded discount level, in the case of EVE, and the deep
discount level, in the case of JADE.
Liggett's cigarettes are produced in approximately 220 combinations
of length, style and packaging. Liggett's current brand portfolio includes:
o LIGGETT SELECT - the second largest brand in the deep discount
category;
o EVE - a leading brand of 120 millimeter cigarettes in the branded
discount category;
o JADE - the industry's newest free-standing deep discount menthol
brand;
o PYRAMID - the industry's first deep discount product with a brand
identity; and
o USA and various control and private label brands.
In 1999, Liggett introduced LIGGETT SELECT, one of the fastest
growing brands in the deep discount category. LIGGETT SELECT is now the largest
seller in Liggett's family of brands, comprising 54% of Liggett's unit volume
in the first half of 2004 and 50.9% of Liggett's unit volume for the year ended
December 31, 2003.
-34-
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, New Jersey and increased its ownership to 50% in Douglas Elliman
Realty, LLC, which operates the largest residential brokerage company in the
New York metropolitan area.
RECENT DEVELOPMENTS
Reynolds America. In July 2004, RJR Tobacco and Brown & Williamson,
the second and third largest cigarette manufacturers, completed the combination
of their United States tobacco businesses. This transaction will further
consolidate the dominance of the domestic cigarette market by Philip Morris and
the newly created Reynolds America, who will have a combined market share of
approximately 76%. This concentration of United States market share could make
it more difficult for Liggett and Vector Tobacco to compete for shelf space in
retail outlets and could impact price competition in the market, either of
which could have a material adverse affect on their sales volume, operating
income and cash flows.
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 both menthol and non-menthol styles. Each
QUEST style offers three different packagings, 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. All six QUEST varieties are being sold in box style packs and are
priced comparably to other premium brands.
QUEST was 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. A multi-million
dollar advertising and marketing campaign, with advertisements running in
magazines and regional newspapers, supported the product launch. The brand
continues to be supported by significant point-of-purchase awareness campaigns
and other store-related promotions.
The premium segment of the industry is currently experiencing
intense competitive activity, with increased discounting of premium brands at
all levels of retail. Given these marketplace conditions, and the results that
we have seen to date with QUEST, we have taken a measured approach to expanding
the market presence of the brand. In November 2003, Vector Tobacco introduced
three menthol varieties of QUEST in the seven state market. In January 2004,
QUEST and QUEST Menthol were introduced into an expansion market in Arizona,
which accounts for approximately 1% of the industry volume nationwide.
During the second quarter 2004, based on an analysis of the market
data obtained since the introduction of the QUEST product, we determined to
postpone indefinitely the national launch of QUEST. Vector Tobacco continues to
explore potential opportunities to expand the market for the brand on a more
limited basis. Any determination as to future expansion of the market presence
of QUEST will be based on the ongoing and projected demand for the product,
market conditions in the premium segment and the prevailing regulatory
environment, including any restrictions on the advertising of the product.
During the three months ended June 30, 2004, we recognized a
non-cash charge of $37,000 to adjust the carrying value of excess leaf tobacco
inventory for the QUEST product, based on estimates of future demand and market
conditions. If actual demand for the product or
-35-
market conditions are less favorable than those estimated, additional inventory
write-downs may be required.
QUEST brand cigarettes are currently marketed solely to permit adult
smokers, who wish to continue smoking, to gradually reduce their intake of
nicotine. The products are not labeled or advertised for smoking cessation or
as a safer form of smoking.
In October 2003, we announced that Jed E. Rose, Ph.D., Director of
Duke University Medical Center's Nicotine Research Program and co-inventor of
the nicotine patch, had conducted a study at Duke University Medical Center to
provide preliminary evaluation of the use of the QUEST technology as a smoking
cessation aid. In the preliminary study on QUEST, 33% of QUEST 3 smokers were
able to achieve four-week continuous abstinence, a standard threshold for
smoking cessation. Management believes these results show real promise for the
QUEST technology as a smoking cessation aid. We have asked the Food and Drug
Administration to supply us with guidance as to the additional research and
regulatory filings necessary to market QUEST as a smoking cessation product.
Management believes that obtaining the Food and Drug Administration's approval
to market QUEST as a smoking cessation product will be an important factor in
the long-term commercial success of the QUEST brand. No assurance can be given
that such approval can be obtained or as to the timing of any such approval if
received.
Timberlake Sale. On June 4, 2004, a wholly-owned subsidiary of
Vector Tobacco entered into an asset purchase agreement to sell its Timberlake,
North Carolina manufacturing facility along with all equipment to an affiliate
of the Flue-Cured Tobacco Cooperative Stabilization Corporation for $25,800.
The Timberlake sale closed on July 13, 2004. In connection with the closing,
the subsidiary of Vector Tobacco entered into a consulting agreement to provide
certain services to the buyer for $400. Approximately $5,200 of the proceeds
from the sale were used to retire debt secured by the Timberlake property.
Repurchase of Notes. In connection with an amendment to the note
purchase agreement for VGR Holding's 10% senior secured notes due March 31,
2006, proceeds from the Timberlake sale were used to repurchase $7,000 of the
notes in August 2004, at a price of 100% of the principal amount plus accrued
interest. We will recognize a loss of approximately $639 in the third quarter
of 2004 on the early extinguishment of debt.
Restructuring. In October 2003, we announced that we would close
Vector Tobacco's Timberlake, North Carolina cigarette manufacturing facility in
order to reduce excess cigarette production capacity and improve operating
efficiencies company-wide. Production of the QUEST line of low nicotine and
nicotine-free cigarettes, as well as production of Vector Tobacco's other
cigarette brands, has been moved to Liggett's state-of-the-art manufacturing
facility in Mebane, North Carolina.
The Mebane facility currently produces in excess of 9 billion units
per year, but maintains the capacity to produce approximately 16 billion units
per year. Vector Tobacco has contracted with Liggett to produce its cigarettes
and has transitioned production from Timberlake to Mebane. All production
ceased at Timberlake by December 31, 2003. As part of the transition, we
eliminated approximately 150 positions.
As a result of these actions, we recognized pre-tax restructuring
and impairment charges of $21,300 in 2003, and additional charges of $221 were
taken in the first quarter 2004. Approximately $2,045 relate to employee
severance and benefit costs, $724 to contract termination and exit and moving
costs, and $18,752 to non-cash asset impairment charges. Machinery and
equipment to be disposed of was reduced to fair value less costs to sell during
2003. The asset impairment charges are based on management's current estimates
of the
-36-
values we will be able to realize on sales of excess machinery and equipment,
and may be adjusted in future periods based on the actual amounts realized.
We decreased the asset impairment accrual as of June 30, 2004 to
reflect the actual amounts to be realized from the Timberlake sale and to reduce
the values of other excess Vector Tobacco machinery and equipment in accordance
with SFAS No. 144. We also adjusted the previously recorded restructuring
accrual as of June 30, 2004 to reflect additional employee severance and
benefits, contract termination and associated costs resulting from the
Timberlake sale. No charge to operations resulted from these adjustments as
there was no change to the total impairment and restructuring charges previously
recognized.
In addition to the $221 recognized in the first quarter 2004, Liggett
Vector Brands, as part of the continuing effort to adjust the cost structure of
our tobacco business and improve operating efficiency, eliminated 83 positions
during April 2004, sublet its New York office space in July 2004 and relocated
several employees. As a result of these actions, we recognized additional
pre-tax restructuring charges of $2,791 in the first half of 2004, including
$824 relating to employee severance and benefit costs and $1,967 for contract
termination and other associated costs. Approximately $518 of these charges
represent non-cash items. We recognized $432 of these pre-tax restructuring
charges in the first quarter of 2004 and $2,359 in the second quarter of 2004.
Annual cost savings related to the restructuring and impairment
charges are currently expected to be at least $23,000 beginning in 2004.
Management is currently reviewing opportunities for additional cost savings as
a result of these restructuring activities at Vector Tobacco and Liggett Vector
Brands.
Amended Liggett Credit Facility. On April 14, 2004, Liggett entered
into an Amended and Restated Loan and Security Agreement with Congress
Financial Corporation, as lender. The $50,000 credit facility replaces
Liggett's current $40,000 facility with Congress. The facility is
collateralized by all inventories and receivables of Liggett and a first
mortgage on the Mebane, North Carolina plant and manufacturing equipment.
Tax Matters. In connection with the 1998 and 1999 transaction with
Philip Morris Incorporated in which a subsidiary of Liggett contributed three
of its premium cigarette brands to Trademarks LLC, a newly-formed limited
liability company, 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. In such transaction, Philip Morris acquired an
option to purchase the remaining interest in Trademarks for a 90-day period
commencing in December 2008, and we have an option to require Philip Morris to
purchase the remaining interest for a 90-day period commencing in March 2010.
Upon exercise of the options during the 90-day periods commencing in December
2008 or in March 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. In
connection with an examination of our 1998 and 1999 federal income tax returns,
the Internal Revenue Service issued to us in September 2003 a notice of
proposed adjustment. The notice asserts that, for tax reporting purposes, the
entire gain should have been recognized in 1998 and in 1999 in the additional
amounts of $150,000 and $129,900, respectively, rather than upon the exercise
of the options during the 90-day periods commencing in December 2008 or in
March 2010. If the Internal Revenue Service were to ultimately prevail with the
proposed adjustment, it would result in the potential acceleration of tax
payments of approximately $119,000, including interest, net of tax benefits,
through June 30, 2004. These amounts have been previously recognized in our
consolidated financial statements as tax liabilities. As of June 30, 2004, we
believe amounts potentially due have been fully provided for in our
consolidated statements of operations.
We believe the positions reflected on our income tax returns are
correct and intend to vigorously oppose any proposed adjustments to our
returns. We have filed a protest with the Appeals Division of the Internal
Revenue Service. No payment is due with respect to these
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matters during the appeals process. Interest currently is accruing on the
disputed amounts at a rate of 7%, with the rate adjusted quarterly based on
rates published by the U.S. Treasury Department. If taxing authorities were to
ultimately prevail in their assertion that we incurred a tax obligation prior
to the exercise dates of these options and we were required to make such tax
payments prior to 2009 or 2010, and if any necessary financing were not
available to us, our liquidity could be adversely affected.
Real Estate Acquisitions. In December 2002, New Valley purchased two
office buildings in Princeton, New Jersey 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
Douglas Elliman Real Estate, formerly known as Prudential Long Island Realty,
contributed their interests in Prudential Douglas Elliman Real Estate to
Douglas Elliman Realty, formerly known as Montauk Battery Realty LLC, a newly
formed entity. New Valley acquired a 50% ownership interest in Douglas Elliman
Realty, an increase from its previous 37.2% interest in Prudential Douglas
Elliman Real Estate as a result of an additional investment of $1,413 by New
Valley and the redemption by Prudential Douglas Elliman Real Estate of various
ownership interests.
In March 2003, Douglas Elliman Realty purchased the leading New York
City-based residential brokerage firm, Douglas Elliman, LLC, formerly known as
Insignia Douglas Elliman, and an affiliated property management company for
$71,250. With that acquisition, the combination of Prudential Douglas Elliman
Real Estate 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 Douglas Elliman Realty to help fund
the acquisition. The subordinated debt, which has a principal amount of $9,500,
bears interest at 12% per annum and is due in March 2013.
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 June 30, 2004, there were approximately 382 individual
suits, 33 purported class actions and 19 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, in 2000, an action against cigarette manufacturers involving
approximately 1,000 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. In January 2002, the court severed Liggett from the
trial of the consolidated action. Approximately 38 purported class action
complaints have been filed against the cigarette manufacturers for alleged
antitrust violations. As new cases are commenced, the costs associated with
defending these cases and the risks relating to the inherent unpredictability
of litigation continue to increase.
There are eight individual actions where Liggett is the only
defendant, with two of these cases currently scheduled for trial in September
2004. In April 2004, in one of these cases, a jury
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in a Florida state court action awarded compensatory damages of $540 against
Liggett. Liggett believes there are a number of grounds to challenge the
verdict and intends to pursue all post-trial and appellate relief.
In May 2003, a Florida intermediate appellate court overturned a
$790,000 punitive damages award against Liggett and decertified the Engle
smoking and health class action. In May 2004, the Florida Supreme Court agreed
to review the case. Oral argument is scheduled for November 3, 2004. If the
intermediate appellate court's ruling is not upheld on further appeal, it will
have a material adverse effect on us. In November 2000, 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 provided assurance to Liggett
that the stay of execution, in effect under the Florida bonding statute, would
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, which is subject to the outcome of the Engle appeal, has
been overturned as a result of the appellate court's ruling discussed above. It
is possible that additional cases could be decided unfavorably and that there
could be further adverse developments in the Engle case. Liggett may enter into
discussions in an attempt to settle particular cases if it believes it is
appropriate to do so. 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.
Federal or state regulators may object to Vector Tobacco's low
nicotine and nicotine-free cigarette products and reduced risk cigarette
products it may develop 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. Various concerns regarding
Vector Tobacco's advertising practices have been expressed to Vector Tobacco by
certain state attorneys general. Vector Tobacco has engaged in discussions in
an effort to resolve these concerns and Vector Tobacco has recently agreed to
suspend all print advertising for its QUEST brand while discussions are
pending. 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.
In recent years, there have been a number of restrictive regulatory
actions from various Federal administrative bodies, including the United States
Environmental Protection Agency and the Food and Drug Administration. There
have also been adverse political decisions and other unfavorable developments
concerning cigarette smoking and the tobacco industry, including the
commencement and certification of class actions and the commencement of
third-party payor actions. These developments generally receive widespread
media attention. We are not able to evaluate the effect of these developing
matters on pending litigation or the possible commencement of additional
litigation, but our consolidated financial position, results of operations or
cash flows could be materially adversely affected by an unfavorable outcome in
any smoking-related litigation. See Note 7 to our consolidated financial
statements for a description of legislation, regulation and litigation.
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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 restructuring
and impairment charges, 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, litigation and defense costs,
increased tobacco costs or reductions in the selling price of cigarettes in the
near term.
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.
Impairment of Long-Lived Assets. We evaluate our long-lived assets
for possible impairment whenever events or changes in circumstances indicate
that the carrying value of the asset, or related group of assets, may not be
fully recoverable. Examples of such events or changes in circumstances include
a significant adverse charge in the manner in which a long-lived asset, or
group of assets, is being used or a current expectation that, more likely than
not, a long-lived asset, or group of assets, will be disposed of before the end
of its estimated useful life.
In October 2003, we announced that we would close Vector Tobacco's
Timberlake, North Carolina cigarette manufacturing facility and produce its
cigarette products at Liggett's Mebane, North Carolina facility. We have
evaluated the net realizable value of the long-lived assets located at the
Timberlake facility which will no longer be used in operations. Based on
management's estimates of the values we initially recognized non-cash asset
impairment charges of $18,752 in the third quarter of 2003 on machinery and
equipment. As of June 30, 2004, we decreased the asset impairment accrual to
reflect the actual amounts to be realized from the Timberlake sale and to reduce
values of other excess machinery and equipment in accordance with SFAS No. 144.
The estimate of fair value of these long-lived assets is based on the best
information available, including prices for similar assets and the results of
using other valuation techniques. Such asset impairment charges may be further
adjusted in future periods based on the actual amounts realized. Since judgment
is involved in determining the fair value of long-lived assets, there is a risk
that the carrying value of our long-lived assets may be overstated or
understated.
Contingencies. We record Liggett's product liability legal expenses
and other litigation costs as operating, selling, general and administrative
expenses as those costs are incurred. As
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discussed in Note 7 of our consolidated financial statements and above under
the heading "Recent Developments in Legislation, Regulation and Litigation",
legal proceedings covering a wide range of matters are pending or threatened in
various jurisdictions against Liggett. Management is unable to make a
meaningful estimate with respect to the amount or range of loss that could
result from an unfavorable outcome of pending smoking-related litigation or the
costs of defending such cases, and we have not provided any amounts in our
consolidated financial statements for unfavorable outcomes, if any. Litigation
is subject to many uncertainties, and it is possible that our consolidated
financial position, results of operations or cash flows could be materially
adversely affected by an unfavorable outcome in any such smoking-related
litigation.
Settlement Agreements. As discussed in Note 7 to our consolidated
financial statements, Liggett and Vector Tobacco are participants in the Master
Settlement Agreement, the 1998 agreement to settle governmental healthcare cost
recovery actions brought by various states. Liggett and Vector Tobacco have no
payment obligations under the Master Settlement Agreement except to the extent
their market shares exceed approximately 1.65% and 0.28%, respectively, of
total cigarettes sold in the United States. Their obligations, and the related
expense charges under the Master Settlement Agreement, are subject to
adjustments based upon, among other things, the volume of cigarettes sold by
Liggett and Vector Tobacco, their relative market shares and inflation. Since
relative market shares are based on cigarette shipments, the best estimate of
the allocation of charges under the Master Settlement Agreement is recorded in
cost of goods sold as the products are shipped. Settlement expenses under the
Master Settlement Agreement recorded in the accompanying consolidated
statements of operations were $8,391 for the six months ended June 30, 2004 and
$14,332 for the comparable period in 2003. Adjustments to these estimates are
recorded in the period that the change becomes probable and the amount can be
reasonably estimated.
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. At June
30, 2004, approximately $3,226 of our inventory was associated with Vector
Tobacco's QUEST product. During the three months ended June 30, 2004, we
recognized a non-cash charge of $37,000 to adjust the carrying value of excess
leaf tobacco inventory for the QUEST product, based on estimates of future
demand and market conditions. If actual demand for the product or market
conditions 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.
Net pension expense for defined benefit pension plans and other
postretirement benefit expense aggregated approximately $4,100 for 2003, and we
currently anticipate such expense will be approximately $4,550 for 2004. In
contrast, our funding obligations under the pension plans are
-41-
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, 2004 and ending
on December 31, 2004. 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 June 30, 2004.
For purposes of this discussion and other consolidated financial
reporting, our significant business segments for the six months ended June 30,
2004 and 2003 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 and nicotine-free cigarettes as well as the development of
reduced risk cigarette products and, for segment reporting purposes, excludes
the operations of Medallion.
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenues:
Liggett ........................... $ 115,551 $ 120,767 $ 237,772 $ 245,682
Vector Tobacco .................... 4,494 8,633 8,846 15,061
------------ ------------ ------------ ------------
Total tobacco .................. 120,045 129,400 246,618 260,743
Real estate ....................... 1,811 1,777 3,592 3,576
------------ ------------ ------------ ------------
Total revenues ................. $ 121,856 $ 131,177 $ 250,210 $ 264,319
============ ============ ============ ============
Operating income (loss):
Liggett ........................... $ 25,368(1) $ 27,587 $ 53,151(2) $ 57,849
Vector Tobacco .................... (44,441)(1) (21,167) (53,147)(2) (45,506)
------------ ------------ ------------ ------------
Total tobacco .................. (19,073) 6,420 4 12,343
Real estate ....................... 937 984 1,858 1,920
Corporate and other ............... (6,826) (6,581) (13,060) (13,640)
------------ ------------ ------------ ------------
Total operating income (loss) .. $ (24,962)(1) $ 823 $ (11,198)(2) $ 623
============ ============ ============ ============
- ----------------
(1) Includes restructuring and impairment charges in the three months ended
June 30, 2004 of $1,963 at Liggett and $396 at Vector Tobacco and a
$37,000 inventory charge at Vector Tobacco in the 2004 period.
(2) Includes restructuring and impairment charges in the six months ended June
30, 2004 of $2,352 at Liggett and $660 at Vector Tobacco and a $37,000
inventory charge at Vector Tobacco in the 2004 period.
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Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003
Revenues. Total revenues were $121,856 for the three months ended
June 30, 2004 compared to $131,177 for the three months ended June 30, 2003.
This $9,321 (7.1%) decrease in revenues was due to a $5,216 (4.3%) decrease in
revenues at Liggett and a $4,139 (47.9%) decrease in revenues at Vector Tobacco
offset by an increase of $34 in real estate revenues at New Valley.
Tobacco Revenues. In February 2003, Liggett increased its net sales
price for selected discount brands by $.80 per carton. In May 2003, Liggett
increased its list price on USA by $.50 per carton. In June 2003, Liggett
increased its list price for LIGGETT SELECT by $1.10 per carton. In September
2003, Liggett increased its net sales price for PYRAMID by $.95 per carton. In
December 2003, Liggett increased its list price on a leading private label
brand by $.85 per carton. In August 2004, Liggett increased its list price on
LIGGETT SELECT by $1.00 per carton.
Effective February 1, 2004, Liggett reduced the list prices for EVE
and JADE from the premium price level to the branded discount level, in the
case of EVE, and the deep discount level, in the case of JADE. During 2003, EVE
product had been subject to promotional buy-downs at the retail level and was
effectively promoted to consumers at a level that is fully reflected in the new
reduced list price. During 2003, the net list price for JADE was at the deep
discount level after giving effect to off-invoice promotional spending. In
August 2004, the list price for JADE was increased by $1.35 per carton.
All of Liggett's sales for the first half of 2004 were in the
discount category (comprising the brand categories of branded discount, private
label, control label, generic and contract manufacturing). For the three months
ended June 30, 2004, net sales at Liggett totaled $115,551, compared to $120,767
for the three months ended June 30, 2003. Revenues decreased by 4.3% ($5,216)
due to a 7.7% decrease in sales volume (approximately 183.8 million units)
accounting for $9,288 in unfavorable volume variance and an unfavorable sales
mix of $14 offset by a net favorable price variance of $4,086 primarily
attributable to price increases subsequent to March 31, 2003 as discussed above.
The favorable price variances are after adjustment for certain changes in
promotional spending and approximately $1,400 of costs incurred in the six
months ended June 30, 2004, associated with buying down all unpromoted EVE
inventory at retail due to the list price reduction described above. Net
revenues of the LIGGETT SELECT brand increased $660 for the second quarter of
2004 over net revenues for the second quarter of 2003, and its unit volume
decreased 3.8% in the 2004 period compared to 2003.
Revenues at Vector Tobacco for the three months ended June 30, 2004
were $4,494 compared to $8,633 for the three months ended June 30, 2003 due to
decreased sales volume. Vector Tobacco's sales in both periods related primarily
to sales of QUEST.
Tobacco Gross Profit. Tobacco gross profit was $50,066 for the three
months ended June 30, 2004 excluding the inventory write-down of $37,000 taken
by Vector Tobacco to adjust the carrying value of excess leaf tobacco inventory
for the QUEST product, compared to $43,390 for the three months ended June 30,
2003, an increase of $6,676 or 15.4% when compared to the same period last
year. The increase is due to price increases discussed above at Liggett,
recognition of lower Master Settlement Agreement expense at Liggett and Vector
Tobacco, and reduced costs associated with the operations of Vector Tobacco.
Excluding the inventory write-down, Liggett's brands contributed 96.7% to our
gross profit, and Vector Tobacco contributed 3.3% for the three months ended
June 30, 2004. Over the same period in 2003, Liggett brands contributed 107.2%
to our gross profit and Vector Tobacco cost 7.2%.
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Liggett's gross profit of $48,418 for the three months ended June
30, 2004 increased $1,913 from gross profit of $46,505 for the three months
ended June 30, 2003. As a percent of revenues (excluding federal excise taxes),
gross profit at Liggett increased to 67.0% for the three months ended June 30,
2004 compared to 62.7% for the same period in 2003. This increase in Liggett's
gross profit in the 2004 period was attributable to the items discussed above.
Excluding the $37,000 inventory write-down taken by Vector Tobacco
in the 2004 period, Vector Tobacco had gross profit of $1,649 for the three
months ended June 30, 2004 compared to negative gross profit of $3,115 in the
same period in 2003. This increase in gross profit reflects cost savings
realized with the closing of Vector Tobacco's Timberlake facility and the
transfer of production, commencing January 1, 2004, to Liggett's facility in
Mebane, as well as decreased promotional expense. The negative gross profit in
2003 reflected significant initial promotional costs associated with the QUEST
launch, costs associated with excess manufacturing capacity at the Timberlake
facility, and various inventory charges in 2003. As a percent of revenues
(excluding federal excise taxes), gross profit at Vector Tobacco excluding the
inventory charge was 46.9% for the three months ended June 30, 2004.
Real Estate Revenues. New Valley's real estate revenues were $1,811
for the three months ended June 30, 2004 compared to revenues of $1,777 from
real estate activities for the three months ended June 30, 2003.
Expenses. Operating, selling, general and administrative expenses
were $37,631 for the three months ended June 30, 2004 compared to $44,344 for
the same period last year. Expenses at Liggett were $21,086 for the three months
ended June 30, 2004 compared to $18,918 for the same period in the prior year,
an increase of $2,168 due primarily to increased selling, marketing and
administrative expenses allocated from Liggett Vector Brands. Operating expenses
at Liggett include Liggett's product liability legal expenses and other
litigation costs of $990 in the three months ended June 30, 2004 compared with
$1,119 for the same period in the prior year. Expenses at Vector Tobacco for the
three months ended June 30, 2004 were $8,695 compared to expenses of $18,052 for
the three months ended June 30, 2003, a decrease of $9,357 due to lower direct
marketing and advertising costs and decreased selling and administrative
expenses allocated from Liggett Vector Brands. Effective January 1, 2004, we
modified the allocations of the selling, marketing and administrative expenses
of Liggett Vector Brands to Liggett and Vector Tobacco based on a review of
relative business activities. Accordingly, for the three months ended June 30,
2004, the selling, marketing and administrative expenses allocated to Liggett
increased by $3,080 with a corresponding decrease in such expenses to Vector
Tobacco, as compared to the allocation of these expenses between the segments
during the three months ended June 30, 2003. These modifications did not effect
the consolidated financial statements.
Restructuring and impairment charges for the three months ended June
30, 2004 were $2,359 and relate to the closing of the Timberlake facility, sales
force reductions and the loss on the sublease of Liggett Vector Brands' New York
office space.
New Valley's expenses for real estate operations were $874 for the
three months ended June 30, 2004 compared to $795 for the same period in 2003.
For the three months ended June 30, 2004, Liggett's operating income
decreased to $25,368 compared to $27,587 for the prior year period. For the
three months ended June 30, 2004, Vector Tobacco's operating loss, excluding
the inventory write-down of $37,000, decreased to $7,441 compared to $21,167
for the prior year period.
Other Income (Expenses). For the three months ended June 30, 2004,
other income was $4,013 compared to expense of $7,207 for the three months
ended June 30, 2003. For the three months ended June 30, 2004, interest and
dividend income of $531, gains on sales of investments of $5,335 and equity
income from non-consolidated New Valley real estate businesses of $4,642 were
primarily offset by interest expense of $6,491. For the three months
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ended June 30, 2003, interest expense of $8,516 was offset primarily by
interest and dividend income of $1,127 and gains on sales of investments of
$332.
Interest expense was $6,491 for the three months ended June 30, 2004
compared to $8,516 for the same period last year, primarily due to repurchases
of VGR Holding's 10% secured notes during 2003.
Income (Loss) from Operations. The loss from operations before
income taxes and minority interests for the three months ended June 30, 2004
was $20,949 compared to a loss of $6,384 for the three months ended June 30,
2003. Income tax benefit was $7,181 and minority interests in earnings of
subsidiaries were $3,134 for the three months ended June 30, 2004. This
compared to an income tax benefit of $649 and minority interests in losses of
subsidiaries of $805 for the three months ended June 30, 2003. The effective
tax rates for the three months ended June 30, 2004 and June 30, 2003 do not
bear a customary relationship to pre-tax accounting income principally as a
consequence of non-deductible expenses and state income taxes.
Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003
Revenues. Total revenues were $250,210 for the six months ended June
30, 2004 compared to $264,319 for the six months ended June 30, 2003. This
$14,109 (5.3%) decrease in revenues was due to a $7,910 (3.2%) decrease in
revenues at Liggett, a decrease of $6,215 (41.3%) in revenues at Vector Tobacco
and an increase of $16 in real estate revenues at New Valley.
Tobacco Revenues. In February 2003, Liggett increased its net sales
price for selected discount brands by $.80 per carton. In May 2003, Liggett
increased its list price on USA by $.50 per carton. In June 2003, Liggett
increased its list price for LIGGETT SELECT by $1.10 per carton. In September
2003, Liggett increased its net sales price for PYRAMID by $.95 per carton. In
December 2003, Liggett increased the list price on a leading private label
brand by $.85 per carton. In August 2004, Liggett increased its list price on
LIGGETT SELECT by $1.00 per carton.
Effective February 1, 2004, Liggett reduced the list prices for EVE
and JADE from the premium price level to the branded discount level, in the
case of EVE, and the deep discount level, in the case of JADE. During 2003, EVE
product had been subject to promotional buy-downs at the retail level and was
effectively promoted to consumers at a level that is fully reflected in the new
reduced list price. During 2003, the net list price for JADE was at the deep
discount level after giving effect to off-invoice promotional spending. In
August 2004, the list price for JADE was increased by $1.35 per carton.
All of Liggett's sales for the first half of 2004 were in the
discount category. For the six months ended June 30, 2004, net sales at Liggett
totaled $237,772, compared to $245,682 for the first half of 2003. Revenues
decreased by 3.2% ($7,910) due to a 6.4% decrease in unit sales volume
(approximately 311.1 million units) accounting for $15,794 in unfavorable
volume variance and $590 in unfavorable sales mix, partially offset by a
combination of list price increases and reduced promotional spending of $8,474.
The favorable price variances for the 2004 period are after approximately
$1,400 of costs associated with the buy down of unpromoted EVE inventory at
retail discussed above. Net revenues of the Liggett SELECT brand increased
$8,410 for the six months ended June 30, 2004 compared to the same period in
2003, and its unit volume increased 1.4% in the 2004 period compared to 2003.
Revenues at Vector Tobacco were $8,846 for the six months ended June
30, 2004 compared to $15,061 for the six months ended June 30, 2003 due to
decreased sales volume. Vector Tobacco's revenues in 2003 and 2004 relate
primarily to sales of QUEST.
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Tobacco Gross Profit. Tobacco gross profit, excluding the inventory
write-down of $37,000, was $102,388 for the six months ended June 30, 2004
compared to $90,942 for the six months ended June 30, 2003, an increase of
$11,446 or 12.6% when compared to the same period last year, due primarily to
the price increases discussed above at Liggett and lower Master Settlement
Agreement expense at Liggett and Vector Tobacco. In the six months ended June
30, 2003, volume and price increases at Liggett were offset by costs associated
with the launch of QUEST at Vector Tobacco. Liggett's brands contributed 96.4%
to our gross profit and Vector Tobacco contributed 3.6% for the six months
ended June 30, 2004. Over the same period in 2003, Liggett's brands contributed
105.4% to tobacco gross profit and Vector Tobacco cost 5.4%.
Liggett's gross profit of $98,725 for the six months ended June 30,
2004 increased $2,875 from gross profit of $95,850 for the six months ended
June 30, 2003. As a percent of revenues (excluding federal excise taxes), gross
profit at Liggett increased to 66.4% for the six months ended June 30, 2004
compared to 63.4% for the same period in 2003. This increase in Liggett's gross
profit in the 2004 period was attributable to the items discussed above.
Vector Tobacco's gross profit, excluding the inventory write-down,
was $3,663 for the six months ended June 30, 2004 compared to negative gross
profit of $4,908 for the same period in 2003. The increase was due to the cost
savings realized with the closing of Vector Tobacco's Timberlake facility and
the transfer or production, commencing January 1, 2004, to Liggett's facility
in Mebane, as well as decreased promotional expense.
Real Estate Revenues. New Valley's real estate revenues were $3,592
for the six months ended June 30, 2004. This compares to revenues of $3,576
from real estate activities for the six months ended June 30, 2003.
Expenses. Operating, selling, general and administrative expenses were
$77,468 for the six months ended June 30, 2004 compared to $93,895 for the same
period last year. The decrease of $16,427 was due primarily to lower expense at
Vector Tobacco of approximately $21,447, partially offset by higher expense at
Liggett of $5,221. Expenses at Liggett were $43,222, for the six months ended
June 30, 2004 compared to $38,001 for the same period last year, an increase of
$5,221 due primarily to increased selling, marketing and administrative expenses
allocated from Liggett Vector Brands. Operating expenses at Liggett include
Liggett's product liability legal expenses and other litigation costs of $2,553
for the six months ended June 30, 2004 compared to $2,232 for the same period in
the prior year. Expenses at Vector Tobacco for the six months ended June 30,
2004 were $19,151, excluding the $37,000 inventory charge and restructuring and
impairment charges of $660, compared to expenses of $40,598 for the six months
ended June 30, 2003 due to lower direct marketing and advertising costs and
decreased selling and administrative expenses allocated from Liggett Vector
Brands. Effective January 1, 2004, we modified the allocations of the selling,
marketing and administrative expenses of Liggett Vector Brands to Liggett and
Vector Tobacco based on a review of relative business activities. Accordingly,
for the six months ended June 30, 2004, the selling, marketing and
administrative expenses allocated to Liggett increased by $6,429 with a
corresponding decrease in such expenses to Vector Tobacco, as compared to the
allocation of these expenses between the segments during the six months ended
June 30, 2003. These modifications did not effect the consolidated financial
statements.
Restructuring and impairment charges for the six months ended June
30, 2004 were $3,012 and relate to the closing of the Timberlake facility,
sales force reductions and the loss on the sublease of Liggett Vector Brands'
New York office space.
For the six months ended June 30, 2004, Liggett's operating income
decreased to $53,151 compared to $57,849 for the prior year period. For the six
months ended June 30, 2004,
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Vector Tobacco's operating loss was $53,147 compared to a loss of $45,506 in the
prior year period. Excluding the non-cash inventory charge of $37,000, Vector
Tobacco's operating loss decreased to $16,147 for the six months ended June 30,
2004, primarily as a result of the cost savings from the closing of the
Timberlake facility and decreased promotional expense.
Other Income (Expenses). For the six months ended June 30, 2004,
other expense was $822 compared to other expense of $13,697 for the six months
ended June 30, 2003. For the six months ended June 30, 2004, interest expense of
$12,913 was partially offset by interest and dividend income of $1,226, a gain
on investments of $5,586 and equity from income from non-consolidated New Valley
real estate businesses of $5,288. For the six months ended June 30, 2003,
interest expense of $15,665 and an equity loss from non-consolidated real estate
businesses of $891 were offset primarily by interest and dividend income of
$2,572 and a gain on investments of $270.
Interest expense decreased to $12,913 for the six months ended June
30, 2004 compared to $15,665 for the same period in 2003, primarily due to
repurchases of VGR Holding's 10% senior secured notes during 2003.
Income (Loss) from Operations. The loss from operations before
income taxes and minority interests for the six months ended June 30, 2004 was
$12,020 compared to a loss of $13,074 for the six months ended June 30, 2003.
Income tax benefit was $2,493 and minority interests in earnings of
subsidiaries was $2,748 for the six months ended June 30, 2004. This compared
to tax benefit of $1,242 and minority interests in losses of subsidiaries of
$2,053 for the six months ended June 30, 2003. The effective tax rates for the
six months ended June 30, 2004 do not bear a customary relationship to pre-tax
accounting income principally as a consequence of non-deductible expenses and
state income taxes.
CAPITAL RESOURCES AND LIQUIDITY
Net cash and cash equivalents increased $5,589 for the six months
ended June 30, 2004 and decreased $22,554 for the six months ended June 30,
2003.
Net cash used in operations for the six months ended June 30, 2004
was $19,212 compared to net cash used in operations of $23,181 for the
comparable period of 2003. Cash used in operations for the 2004 period resulted
primarily from the payment of the Master Settlement Agreement expense for 2003
in March and April of 2004, the non-cash unrealized gain on investment
securities and the non-cash gain in equity income from non-consolidated real
estate businesses offset primarily by the non-cash charge on the inventory
write-down at Vector Tobacco and depreciation and amortization expense. Cash
used in operations in 2003 resulted primarily from an increase in accounts
receivable and inventories, an increase in other assets and a decrease in
current liabilities offset by the non-cash impact of depreciation and
amortization, deferred finance charges and minority interest as well as a change
in current taxes payable.
Cash provided by investing activities was $47,615 in 2004 compared to
cash provided of $14,783 in 2003. In the six months ended June 30, 2004, cash
was provided primarily through the sale or maturity of investment securities for
$63,108 offset primarily by the purchase of investment securities for $12,253,
investment in non-consolidated real estate businesses at New Valley of $2,500
and capital expenditures of $1,132. In the six months ended June 30, 2003, cash
was provided through the sale or maturity of investment securities for $79,391
offset primarily by the purchase of investment securities for $37,061 and the
investment in non-consolidated real estate businesses at New Valley for $9,500,
an increase in restricted assets of $11,010 and capital expenditures of $6,503.
Cash used in financing activities was $22,814 in 2004 compared to
cash used of $14,156 in 2003. In the six months ended June 30, 2004, cash was
used for dividends of $31,475 and repayments on debt of $7,063. These were
offset by net borrowings under the revolver of $14,020 and proceeds from the
exercise of options of $1,724. In the six months ended June 30, 2003,
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cash was used primarily for dividends of $29,565 and repayments of debt of
$17,836 offset by net borrowings of $32,622 under the revolver and proceeds from
the exercise of warrants and options of $623.
Liggett. On April 14, 2004, Liggett entered into an Amended and
Restated Loan and Security Agreement with Congress Financial Corporation, as
lender. The $50,000 credit facility replaces Liggett's previous $40,000 facility
with Congress, under which $14,020 was outstanding at June 30, 2004.
Availability as determined under the facility was approximately $20,900 based on
eligible collateral at June 30, 2004. The facility is collateralized by all
inventories and receivables of Liggett. Borrowings under the facility bear
interest at a rate equal to 1.0% above the prime rate of Wachovia Bank, N.A.
(the indirect parent of Congress). The facility requires Liggett's compliance
with certain financial and other covenants including a restriction on Liggett's
ability to pay 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
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 June 30, 2004, Liggett was in compliance with all covenants under
the credit facility; Liggett's adjusted net worth was $63,755 and net working
capital was $52,995, as computed in accordance with the agreement.
100 Maple LLC, a company formed by Liggett in 1999 to purchase its
Mebane, North Carolina manufacturing plant, has a term loan of $4,881
outstanding as of June 30, 2004 under Liggett's credit facility. The remaining
balance of the term loan is payable in monthly installments of $77 with a final
payment on June 1, 2006 of $3,033. Interest is charged at the same rate as
applicable to Liggett's credit facility, and the outstanding balance of the
term loan reduces the maximum availability under the credit facility. Liggett
has guaranteed the term loan, and a first mortgage on the Mebane property and
manufacturing equipment collateralizes the term loan and Liggett's credit
facility.
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%.
During 2003, Liggett leased two 100 millimeter box packers, which
will allow Liggett to meet the growing demand for this cigarette style, and a
new filter maker to improve product quality and capacity. These operating lease
agreements provide for payments totaling approximately $4,500.
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In July 2003, Liggett granted an unaffiliated third party an option
to purchase Liggett's former manufacturing facility and other excess real
estate in Durham, North Carolina with a net book value at June 30, 2004 of
approximately $2,313. The option agreement permits the purchaser to acquire the
property during a period of up to two years, at a purchase price of $14,000 if
the closing occurs by August 23, 2004 and $15,000 if the closing occurs
thereafter during the term of the option. Liggett has received option fees of
$1,000, of which $250 is refundable if the purchaser terminates the agreement
prior to August 23, 2004. Liggett will be entitled to receive additional option
fees of up to $500 during the remaining option period. The option fees will
generally be creditable against the purchase price. The purchaser is currently
seeking financing for the transaction, and there can be no assurance the sale
of the property will occur.
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. In May 2003, a Florida
intermediate appellate court overturned a $790,000 punitive damages award
against Liggett and decertified the Engle smoking and health class action. In
May 2004, the Florida Supreme Court agreed to review the case. Oral argument is
scheduled for November 3, 2004. If the intermediate appellate court's ruling is
not upheld on further appeal, it will have a material adverse effect on us. In
November 2000, 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
provided assurance to Liggett that the stay of execution, in effect pursuant to
the Florida bonding statute, would 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, which was subject to the outcome
of the Engle appeal, has been overturned as a result of the appellate court's
ruling discussed above. In April 2004, a jury in a Florida state court action
awarded compensatory damages of $540 against Liggett in an individual action.
Liggett intends to appeal the verdict. It is possible that additional cases
could be decided unfavorably and that there could be further adverse
developments in the Engle case. Liggett may enter into discussions in an
attempt to settle particular cases if it believes it is appropriate to do so.
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 7 to our
consolidated financial statements.
Management is unable to make a meaningful estimate of the amount or
range of loss that could result from an unfavorable outcome of the cases
pending against Brooke Group Holding or Liggett or the costs of defending such
cases. It is possible that our consolidated financial
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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 119 monthly installments of $125
including annual interest of 2.31% above the 30-day commercial paper rate, with
a final payment of $1,420, based on current interest rates.
VGR Aviation. In February 2002, V.T. Aviation purchased an airplane
for $6,575 and borrowed $5,800 to fund the purchase. The loan is guaranteed by
us. The loan is payable in 119 monthly installments of $40, including annual
interest at 2.75% above the 30-day commercial paper rate, with a final payment
of $2,793, based on current interest rates. During the fourth quarter of 2003,
this airplane was transferred to our direct subsidiary, VGR Aviation LLC, which
has assumed the debt.
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 was 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 was 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 was payable in 30 monthly
installments of $39 plus accrued interest, with an annual interest rate of
LIBOR plus 5.12%. These loans were repaid on July 13, 2004 with a portion of
the proceeds from the sale of the Timberlake property.
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 have been repaid
with the final quarterly principal payment of $3,125 made on March 31, 2004.
The remaining $35,000 of notes bear interest at 6.5% per year, payable
semiannually, and mature on April 1, 2007.
VGR Holding. In May 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. In April 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 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, Liggett Vector Brands, 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 the
Company is in compliance with at June 30, 2004. Among other things, the
covenants limit the ability of VGR Holding to make distributions to us to 50%
of VGR Holding's net income, unless VGR Holding holds an amount in cash equal
to the then principal amount of the notes outstanding ($70,000 at June 30,
2004) after giving effect to the payment of the distribution, and limit
additional indebtedness of VGR Holding, Liggett, Vector Tobacco and Liggett
Vector Brands to 250% of EBITDA (as defined in the purchase agreements) for the
trailing 12 months. The
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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 August 2004, in connection with an amendment to the
note purchase agreement, VGR Holding repurchased $7,000 of the notes at a price
of 100% of the principal amount plus accrued interest. The Company will
recognize a loss of approximately $639 in the third quarter of 2004 on the
early extinguishment of debt.
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. 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, New Jersey 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
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, 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 2004, 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 June
30, 2004, VGR Holding was generally not permitted to pay distributions to us
except for approximately $15,000 of dividends and 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 $14,600, dividends on our outstanding shares (currently at an
annual rate of approximately $64,200) and corporate expenses. We anticipate
funding our expenditures for current operations with available cash resources,
proceeds from public and/or private debt and equity financing, management fees
from subsidiaries and tax sharing and other payments from Liggett or New
Valley. New Valley may acquire or seek to acquire additional operating
businesses through merger, purchase of assets, stock acquisition or other
means, or to make other investments, which may limit its ability to make such
distributions.
In July 2001, we completed the sale of $172,500 (net proceeds of
approximately $166,400) of our 6.25% convertible subordinated notes due 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 $26.71 at June 30, 2004,
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 June 30, 2004.
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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 June 30, 2004, our deferred income tax liabilities
exceeded our deferred income tax assets by $104,088. The largest component of
our deferred tax liabilities exists because of differences that resulted from a
1998 and 1999 transaction with Philip Morris Incorporated in which 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 for a
90-day period commencing in December 2008, and we have an option to require
Philip Morris to purchase the remaining interest commencing in March 2010. For
additional information concerning the Philip Morris brand transaction, see Note
19 to our consolidated financial statements in our Annual Report on Form 10-K
for the year ended December 31, 2003.
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 during the 90-day periods commencing in December 2008 or in March 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. In connection with an
examination of our 1998 and 1999 federal income tax returns, the Internal
Revenue Service issued to us in September 2003 a notice of proposed adjustment.
The notice asserts that, for tax reporting purposes, the entire gain should
have been recognized in 1998 and in 1999 in the additional amounts of $150,000
and $129,900, respectively, rather than upon the exercise of the options during
the 90-day periods commencing in December 2008 or in March 2010. If the
Internal Revenue Service were to ultimately prevail with the proposed
adjustment, it would result in the potential acceleration of tax payments of
approximately $119,000, including interest, net of tax benefits, through June
30, 2004. These amounts have been previously recognized in our consolidated
financial statements as tax liabilities. As of June 30, 2004, we believe
amounts potentially due have been fully provided for in our consolidated
statements of operations.
We believe the positions reflected on our income tax returns are
correct and intend to vigorously oppose any proposed adjustments to our
returns. We have filed a protest with the Appeals Division of the Internal
Revenue Service. No payment is due with respect to these matters during the
appeal process. Interest currently is accruing on the disputed amounts at a
rate of 7%, with the rate adjust quarterly based on rates published by the U.S.
Treasury Department. If taxing authorities were to ultimately prevail in their
assertion that we incurred a tax obligation prior to the exercise dates of
these options and we were required to make such tax payments prior to 2009 or
2010, and if any necessary financing were not available to us, our liquidity
could be adversely affected.
OFF-BALANCE SHEET ARRANGEMENTS
We have various agreements in which we may be obligated to indemnify
the other party with respect to certain matters. Generally, these
indemnification clauses are included in contracts arising in the normal course
of business under which we customarily agree to hold the other party harmless
against losses arising from a breach of representations related to such matters
as title to assets sold and licensed or certain intellectual property rights.
Payment by us under such indemnification clauses is generally conditioned on
the other party making a claim that is subject to challenge by us and dispute
resolution procedures specified in the particular contract. Further, our
obligations under these arrangements may be limited in terms of time and/or
amount, and in some instances, we may have recourse against third parties for
certain payments made by us. It is not possible to predict the maximum
potential amount of future payments under these indemnification agreements due
to the conditional nature of our obligations and the unique facts of each
particular agreement. Historically, payments made by us under these agreements
have not been material. As of June 30, 2004, we were not aware of any
indemnification agreements
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that would or are reasonably expected to have a current or future material
adverse impact on our financial position, results of operations or cash flows.
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. We believe that the fair
value of Eve's guarantee was negligible at June 30, 2004.
At June 30, 2004, we had outstanding approximately $5,283 of letters
of credit, collateralized by certificates of deposit. The letters of credit
have been issued as security deposits for leases of office space, to secure the
performance of our subsidiaries under various insurance programs and to provide
collateral for various subsidiary borrowing and capital lease arrangements.
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 June 30, 2004, approximately $68,849 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 June 30, 2004, 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 $842.
We held investment securities available for sale totaling $19,031 at
June 30, 2004. 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 March 2004, the FASB reached a consensus on Emerging Issues Task
Force Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" ("EITF 03-1"). EITF 03-1 provides guidance
for determining when an investment is impaired and whether the impairment is
other than temporary. EITF 03-1 also incorporates into its consensus the
required disclosures about unrealized losses on investments announced by the
EITF in late 2003 and adds new disclosure requirements relating to cost-method
investments. The impairment accounting guidance is effective for reporting
periods beginning after June 15, 2004 and the new disclosure requirements for
annual reporting periods ending after June 15, 2004. We do not expect the
adoption of the impairment guidance contained in EITF 03-1 to have a material
impact on our financial position or results of operations.
In December 2003, the FASB issued SFAS No. 132(R), which replaces
SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits." SFAS No. 132(R) does not change the measurement and recognition
provisions of SFAS No. 87, SFAS No. 88,
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"Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits," and SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions," however, it
includes additional disclosure provisions for annual reporting, including
detailed plan asset information by category, expanded benefit obligation
disclosure and key assumptions. In addition, interim disclosures related to the
individual elements of plan costs and employer's current year contributions are
required. (See Note 6 to 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 Litigation 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 Litigation Reform Act, we have identified
under "Risk Factors" in Item 1 above 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 our disclosure controls and procedures as
of the end of the period covered by this 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 control over financial reporting during the
period covered by this report that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
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 7, 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 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 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, Use of Proceeds and Issuer Purchases of
Equity Securities
Securities of ours which were not registered under the Securities
Act of 1933 have been issued or sold by us during the three
months ended June 30, 2004, except for the grant of a total of
40,000 restricted shares of our common stock to our four
non-employee directors on June 1, 2004. The grant of restricted
shares was effected in reliance on the exemption from
registration afforded by Section 4(2) of the Securities Act of
1933.
Our purchases of our equity securities during the three months
ended June 30, 2004 were as follows:
Total Number Maximum Number
of Shares of Shares that
Total Purchased as May Yet Be
Number of Average Part of Publicly Purchased Under
Shares Price Paid Announced Plans the Plans
Period Purchased per Share or Programs or Programs
------ ------------ ------------ ---------------- ---------------
April 1 to April 30, 2004 .... -- $ -- -- --
May 1 to May 31, 2004 ........ -- -- -- --
June 1 to June 30, 2004 ...... 332,022(1) 16.10 -- --
------------ ------------ ------------ ------------
Total ........................ 332,022 $ 16.10 -- --
============ ============ ============ ============
- ----------------------------
(1) Delivery of shares to us in payment of exercise price in connection with
exercises of a total of 758,079 employee stock options on June 21, 2004.
Item 4. Submission of Matters to a Vote of Security Holders
We held our 2004 annual meeting of stockholders on May 24, 2004. There
were 39,112,553 shares of our common stock entitled to be voted on the
April 19, 2004 record date for the meeting. The matters submitted to
our stockholders for a vote at the annual meeting were to elect the
following seven director nominees to serve for the ensuing year and
until their successors are elected and to approve the Vector Group
Ltd. Amended and Restated 1999 Long-Term Incentive Plan. The votes
cast and withheld for such matters were as follows:
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ELECTION OF DIRECTORS:
NOMINEE FOR WITHHELD
------- --- --------
Bennett S. LeBow 34,574,455 1,331,865
Howard M. Lorber 34,605,425 1,300,895
Ronald J. Bernstein 34,939,654 966,666
Henry C. Beinstein 34,530,646 375,674
Robert J. Eide 35,041,318 865,002
Jeffrey S. Podell 35,564,044 342,276
Jean E. Sharpe 34,495,248 1,411,072
APPROVAL OF AMENDED INCENTIVE PLAN:
BROKER
FOR AGAINST ABSTAIN NON-VOTES
--- ------- ------- ---------
18,187,654 2,776,998 78,705 14,862,963
Based on these voting results, each of the directors nominated was
elected and the amended plan was approved.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
4.1 Sixth Amendment to the Note Purchase Agreement, dated as
of July 29, 2004, 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.,
AIMCO CDO, Series 2000-A and TCW Shared Opportunity Fund
II, L.P., relating to the 10% Senior Secured Notes due
March 31, 2006.
*10.1 Asset Purchase Agreement, dated June 4, 2004, by and
between VT Roxboro LLC and Flue-Cured Tobacco
Cooperative Stabilization Corporation (incorporated by
reference to Exhibit 10.1 in Vector's Form 8-K dated
June 4, 2004).
31.1 Certification of Chief Executive Officer, Pursuant to
Exchange Act Rule 13a-14(a), as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer, Pursuant to
Exchange Act Rule 13a-14(a), as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 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.
32.2 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.
99 Material Legal Proceedings.
- -----------------
* Incorporated by reference
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(b) Reports on Form 8-K
We filed the following Reports on Form 8-K during the second quarter of
2004:
FINANCIAL
DATE ITEMS STATEMENTS
---- ----- ----------
April 14, 2004 5, 7 None
May 11,2004 7, 12 None
June 4, 2004 5, 7 None
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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: August 9, 2004
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