================================================================================
Securities And Exchange Commission
Washington, D.C. 20549
---------------------
FORM 10-Q
---------------------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
---------------------
VECTOR GROUP LTD.
(Exact name of registrant as specified in its charter)
DELAWARE 1-5759 65-0949535
(State or other jurisdiction of Commission File Number (I.R.S. Employer Identification No.)
incorporation or organization)
</Table>
100 S.E. SECOND STREET
MIAMI, FLORIDA 33131
305/579-8000
(Address, including zip code and telephone number, including area code,
of the principal executive offices)
---------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
[X] Yes [ ] No
Indicate by check mark whether the Registrant is an accelerated filer as
defined in Rule 12b-2 of the Exchange Act.
[X] Yes [ ] No
At November 8, 2004, Vector Group Ltd. had 41,746,026 shares of common
stock outstanding.
================================================================================
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 September 30, 2004 and
December 31, 2003......................................................................... 2
Vector Group Ltd. Consolidated Statements of Operations for the three and nine
months ended September 30, 2004 and September 30, 2003.................................... 3
Vector Group Ltd. Consolidated Statement of Stockholders' Equity (Deficit) for the
nine months ended September 30, 2004...................................................... 4
Vector Group Ltd. Consolidated Statements of Cash Flows for the nine months
ended September 30, 2004 and September 30, 2003........................................... 5
Notes to Consolidated Financial Statements................................................... 6
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS..................................................................... 38
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................... 61
Item 4. CONTROLS AND PROCEDURES...................................................................... 61
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS............................................................................ 63
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.................................. 63
Item 6. EXHIBITS..................................................................................... 63
SIGNATURE................................................................................................. 64
</Table>
- 1 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
September 30, December 31,
2004 2003
------------- ------------
ASSETS:
Current assets:
Cash and cash equivalents ................................................ $ 97,500 $ 74,808
Investment securities available for sale ................................. 17,187 67,521
Accounts receivable - trade .............................................. 4,794 10,425
Other receivables ........................................................ 1,646 2,605
Inventories .............................................................. 82,062 127,351
Restricted assets ........................................................ 577 771
Deferred income taxes .................................................... 20,885 19,328
Other current assets ..................................................... 12,838 12,568
--------- ---------
Total current assets ................................................... 237,489 315,377
Property, plant and equipment, net ......................................... 120,889 143,596
Assets held for sale ....................................................... -- 9,438
Long-term investments, net ................................................. 2,334 2,431
Investments in non-consolidated real estate businesses ..................... 27,602 18,718
Restricted assets .......................................................... 3,739 5,571
Deferred income taxes ...................................................... 16,045 13,200
Intangible asset ........................................................... 107,511 107,511
Other assets ............................................................... 12,438 12,370
--------- ---------
Total assets ........................................................... $ 528,047 $ 628,212
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Current portion of notes payable and long-term debt ...................... $ 21,699 $ 10,762
Accounts payable ......................................................... 8,810 8,635
Accrued promotional expenses ............................................. 14,743 22,203
Accrued taxes payable, net ............................................... 38,771 48,577
Settlement accruals ...................................................... 17,559 52,650
Deferred income taxes .................................................... 4,000 4,000
Accrued interest ......................................................... 3,038 7,004
Other accrued liabilities ................................................ 19,096 19,255
--------- ---------
Total current liabilities .............................................. 127,716 173,086
Notes payable, long-term debt and other obligations, less current portion .. 286,272 299,977
Noncurrent employee benefits ............................................... 15,952 13,438
Deferred income taxes ...................................................... 141,012 139,927
Other liabilities .......................................................... 5,183 4,781
Minority interests ......................................................... 45,633 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 45,128,184 and 42,103,276 shares and outstanding
41,734,407 and 39,021,189 shares ....................................... 4,173 3,902
Additional paid-in capital ............................................... 243,543 251,239
Accumulated deficit ...................................................... (314,475) (280,598)
Accumulated other comprehensive loss ..................................... (10,791) (9,335)
Less: 3,393,777 and 3,082,087 shares of common stock in treasury, at cost (16,171) (11,683)
--------- ---------
Total stockholders' equity (deficit) ................................. (93,721) (46,475)
--------- ---------
Total liabilities and stockholders' equity (deficit) ................. $ 528,047 $ 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 Nine Months Ended
-------------------------------- ------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Revenues:
Tobacco*.................................................. $ 124,251 $ 141,053 $ 370,869 $ 401,796
Real estate leasing....................................... 1,809 1,797 5,401 5,373
---------- ---------- ---------- ----------
Total revenues.......................................... 126,060 142,850 376,270 407,169
Expenses:
Cost of goods sold, excluding inventory impairment*....... 71,117 92,711 215,347 262,512
Inventory impairment...................................... -- -- 37,000 --
Operating, selling, administrative and general expenses... 32,718 38,367 109,884 132,262
Restructuring and impairment charges...................... 4,532 20,079 7,544 20,079
---------- ---------- ---------- ----------
Operating income (loss)................................. 17,693 (8,307) 6,495 (7,684)
Other income (expenses):
Interest and dividend income.............................. 322 844 1,548 3,416
Interest expense.......................................... (6,832) (7,422) (19,745) (23,087)
Gain on sale of investments, net.......................... 302 806 5,888 1,076
Equity income from non-consolidated New Valley
real estate businesses.................................. 4,539 1,527 9,827 636
Other, net................................................ (1) 4 (10) 21
---------- ---------- ---------- ----------
Income (loss) from operations before provision (benefit)
for income taxes and minority interests................. 16,023 (12,548) 4,003 (25,622)
Provision (benefit) for income taxes...................... 6,995 (3,240) 4,502 (4,482)
Minority interests........................................ (962) (72) (3,710) 1,981
---------- ---------- ---------- ----------
Net income (loss)............................................. $ 8,066 $ (9,380) $ (4,209) $ (19,159)
========== ========== ========== ==========
Per basic common share:
Net income (loss) applicable to common shares $ 0.19 $ (0.23) $ (0.10) $ (0.47)
========== ========== ========== ==========
Basic weighted average common shares outstanding 41,669,127 40,787,431 41,287,777 40,633,009
========== ========== ========== ==========
Per diluted common share:
Net income (loss) applicable to common shares $ 0.19 $ (0.23) $ (0.10) $ (0.47)
========== ========== ========== ==========
Diluted weighted average common shares outstanding 43,307,392 40,787,431 41,287,777 40,633,009
========== ========== ========== ==========
</Table>
- --------------
*Revenues and Cost of goods sold include excise taxes of $42,626, $51,132,
$132,729 and $149,468, 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
Common Stock Additional Other
---------------------- Paid-In Accumulated 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 ................................... -- -- -- (4,209) -- -- (4,209)
Unrealized loss on investment securities . -- -- -- -- -- (1,456) (1,456)
----------
Total other comprehensive loss .... -- -- -- -- -- -- (1,456)
----------
Total comprehensive loss ................... -- -- -- -- -- -- (5,665)
Distributions on common stock ($1.14
per share) ............................... -- -- (47,397) -- -- -- (47,397)
Exercise of options ........................ 686,028 69 7,136 -- (4,488) -- 2,717
Stock dividend ............................. 1,987,190 198 29,470 (29,668) -- -- --
Restricted stock grants .................... 40,000 4 (4) -- -- -- --
Tax benefit of options exercised ........... -- -- 2,891 -- -- -- 2,891
Amortization of deferred compensation, net . -- -- 208 -- -- -- 208
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, September 30, 2004 ................ 41,734,407 $ 4,173 $ 243,543 $ (314,475) $ (16,171) $ (10,791) $ (93,721)
========== ========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part
of the consolidated financial statements.
- 4 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Nine Months Ended
----------------------------------
September 30, September 30,
2004 2003
----------------- ----------------
Net cash used in operating activities.................................. $ (3,675) $ (9,660)
-------- ----------
Cash flows from investing activities:
Proceeds from sale of assets, net.................................... 25,821 3,852
Sale or maturity of investment securities............................ 65,454 109,341
Purchase of investment securities.................................... (10,747) (49,127)
Sale of long-term investments........................................ 243 679
Investments in non-consolidated real estate businesses............... (2,500) (9,500)
Distribution from non-consolidated real estate businesses............ -- 670
Decrease (increase) in restricted assets............................. 1,832 (13,691)
New Valley repurchase of common shares............................... (202) (1,346)
Capital expenditures................................................. (3,005) (7,691)
-------- ----------
Net cash provided by investing activities.............................. 76,896 33,187
-------- ----------
Cash flows from financing activities:
Repayments of debt................................................... (20,782) (26,764)
Borrowings under revolver............................................ 411,150 487,105
Repayments on revolver............................................... (395,660) (470,878)
Increase in cash overdraft........................................... -- 183
Distributions on common stock........................................ (47,397) (44,371)
Proceeds from exercise of options and warrants....................... 2,868 1,106
Issuance of note receivable.......................................... (500) --
Deferred financing costs............................................. (208) --
-------- ----------
Net cash used in financing activities.................................. (50,529) (53,619)
-------- ----------
Net increase in cash and cash equivalents.............................. 22,692 (30,092)
Cash and cash equivalents, beginning of period......................... 74,808 100,027
------- ----------
Cash and cash equivalents, end of period............................... $97,500 $ 69,935
======= ==========
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 58.2% of the common
shares of New Valley at September 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 and real estate properties.
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 dividends paid to Company stockholders
on September 29, 2003 and September 29, 2004. In connection with the
5% dividend, the Company increased the number of outstanding stock
options by 5% and reduced the exercise prices accordingly. All share
amounts have been presented as if the stock dividends had occurred on
January 1, 2003.
- 6 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 net income for the three months ended September 30,
2004 and a net loss for the nine months ended September 30, 2004 and
for the three and nine months ended September 30, 2003. 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 1,841,180 for the
nine months ended September 30, 2004 and 1,926,493 and 1,608,809 for
the three and nine months ended September 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 $5,665 for the
nine months ended September 30, 2004 and $16,758 for the nine months
ended September 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 adoption of
the impairment guidance contained in EITF 03-1 did not have a
material impact on the Company's 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
LIGGETT VECTOR BRANDS RESTRUCTURINGS. 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 and relocated several
employees. As a result of these actions, the Company recognized 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.
On October 6, 2004, the Company announced an additional plan to further
restructure the operations of Liggett Vector Brands, its sales, marketing
and distribution agent for its Liggett and Vector Tobacco subsidiaries.
Liggett Vector Brands is realigning its sales force and adjusting its
business model to more efficiently serve its chain and independent
accounts nationwide. In connection with the restructuring, the Company is
eliminating approximately 330 full-time positions and 135 part-time
positions, effective December 15, 2004.
As a result of the actions announced in October 2004, the Company
currently expects to realize annual cost savings of approximately $30,000
beginning in 2005. The Company will recognize pre-tax restructuring
charges currently estimated to total $12,058, of which $4,428 has been
recognized in the third quarter of 2004 and approximately $7,630 will be
taken in the fourth quarter of 2004. Approximately $5,883 of the charges
relate to employee severance and benefit costs and approximately $6,175 to
contract termination and other associated costs. Approximately $2,455 of
these charges represent non-cash items. Additionally, in the fourth
quarter of 2004, the Company will incur other charges for various
compensation and related payments to employees which are related to the
restructuring. These charges will approximate $1,784 and will be included
in selling, general and administrative expenses.
The components of the combined pre-tax restructuring charges relating to
the Liggett Vector Brands restructurings for the nine months ended
September 30, 2004 are as follows:
Employee Non-Cash Contract
Severance Asset Termination/
and Benefits Impairment Exit Costs Total
------------ ---------- ----------- -------
Balance, December 31, 2003 $ -- $ -- $ -- $ --
Original charges .......... 824 518 1,449 2,791
Utilized/reclassifications,
net...................... (752) (483) (1,060) (2,295)
------- ------- ------- -------
Balance, June 30, 2004 .... 72 35 389 496
Change in estimate ........ (26) (15) 41 --
Restructuring charges ..... 4,428 -- (71) 4,357
Utilized/reclassifications,
net...................... (46) (20) (122) (188)
------- ------- ------- -------
Balance, September 30, 2004 $ 4,428 $ -- $ 237 $ 4,665
======= ======= ======= =======
</Table>
- 8 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 recorded during the second
quarter was reduced by $71 during the third quarter 2004 due to a
modification of the sub-lease terms. The future minimum lease payments
liability was $804 at September 30, 2004; $734 of which is recorded in
other long-term liabilities and the balance is recorded in other accrued
liabilities. These amounts are not recorded in the $4,665 balance at
September 30, 2004. The $4,665 balance has also been recorded in other
accrued liabilities.
TIMBERLAKE RESTRUCTURING. In October 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 to produce its cigarettes, and
all production was transitioned from Timberlake to Mebane 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 recognized 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 was carried on the accompanying December 31,
2003 consolidated balance sheets as assets held for sale. The asset
impairment charges were based on management's estimates of the values the
Company would be able to realize on sales of the excess machinery and
equipment, and were adjusted in future periods based on the actual amounts
realized.
In June 2004, a wholly-owned subsidiary of Vector Tobacco entered into an
agreement to sell the Timberlake facility, along with all equipment, which
sale closed in July 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. During the third quarter of 2004, the Company recognized a
restructuring charge of $175 in connection with additional employee
severance and benefit costs relating to the Timberlake sale.
The components of the pre-tax restructuring charge relating to the closing
of Vector Tobacco's Timberlake, North Carolina cigarette manufacturing
facility for the year ended 2003 and the nine months ended September 30,
2004 are as follows:
- 9 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 175 -- 221 396
Adjustments/reclassifications in 2004 507 (871) 364 --
Utilized/recoveries in 2004, net .... (1,888) 871 (900) (1,917)
-------- -------- -------- --------
Balance, September 30, 2004 ......... $ 657 $ -- $ 134 $ 791
======== ======== ======== ========
Annual cost savings related to the Timberlake restructuring and impairment
charges and the actions taken at Liggett Vector Brands in the first half
of 2004 are currently expected to be at least $23,000 beginning in 2004.
Management continues to review opportunities for additional cost savings
in the Company's tobacco business.
3. INVENTORIES
Inventories consist of:
September 30, December 31,
2004 2003
------------- ------------
Leaf tobacco................................. $37,787 $ 80,239
Other raw materials.......................... 3,170 3,060
Work-in-process.............................. 1,275 1,609
Finished goods............................... 43,276 42,825
Replacement parts and supplies............... -- 636
------- --------
Inventories at current cost.................. 85,508 128,369
LIFO adjustments............................. (3,446) (1,018)
------- --------
$82,062 $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 September 30, 2004, Liggett had leaf
tobacco purchase commitments of approximately $523 and Vector Tobacco had
leaf tobacco purchase commitments of approximately $1,595.
Included in the above table is approximately $2,752 at September 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
- 10 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
and, accordingly, the Company recognized a non-cash charge of $37,000 to
adjust the carrying value of excess leaf 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 93.4% and 53.8% of total
inventories at September 30, 2004 and December 31, 2003, respectively.
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
September 30, December 31,
2004 2003
------------- ------------
Land and improvements ....... $ 9,263 $ 10,019
Buildings ................... 63,359 74,326
Machinery and equipment ..... 100,037 105,032
Leasehold improvements ...... 2,828 1,023
Construction-in-progress .... 2,500 1,554
--------- ---------
177,987 191,954
Less accumulated depreciation (57,098) (48,358)
--------- ---------
$ 120,889 $ 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 $2,142 as
of September 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 nine months ended
September 30, 2004 was $3,200 and $10,256, respectively, and for the three
and nine months ended September 2003 was $4,174 and $12,630, respectively.
Future machinery and equipment purchase commitments at Liggett were $4,202
as of September 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 September 30,
2004 of approximately $2,285. The option agreement permits the purchaser
to acquire the property during a period of up to two years, at a purchase
price of $15,000. Liggett has received option fees of $1,250, of which
$250 is refundable if the purchaser terminates the agreement prior to
February 14, 2005. Liggett will be entitled to receive additional option
fees of up to $250 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.)
- 11 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
In July 2004, a wholly-owned subsidiary of Vector Tobacco completed the
sale of its Timberlake, North Carolina manufacturing facility along with
all equipment to an affiliate of the Flue-Cured Tobacco Cooperative
Stabilization Corporation for $25,800. In connection with the sale, the
subsidiary of Vector Tobacco entered into a consulting agreement to
provide certain services to the buyer for $400. Vector Tobacco recognized
$200 as income in the third quarter of 2004. (See Notes 2 and 5.)
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:
September 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 $4,151 and $6,675 ............. 58,849 63,325
Liggett:
Revolving credit facility ................................ 15,490 --
Term loan under credit facility .......................... 4,649 5,190
Equipment loans .......................................... 7,173 9,758
Vector Tobacco:
Notes payable ............................................ -- 5,999
Notes payable - Medallion acquisition .................... 35,000 38,125
V.T. Aviation:
Note payable ............................................. 9,720 10,496
VGR Aviation:
Note payable ............................................. 5,157 5,346
New Valley:
Note payable - operating real estate ..................... 39,374 39,910
Other .................................................... 59 90
--------- ---------
Total notes payable, long-term debt and other obligations 307,971 310,739
Less:
Current maturities ................................. (21,699) (10,762)
--------- ---------
Amount due after one year ................................ $ 286,272 $ 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 $25.06 per share at September 30, 2004, is subject to adjustment
for various events, and any cash distribution on Vector's common stock
will result in a
- 12 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 September 30, 2004. In October 2004, an
additional $8 of the notes were converted into Vector's common stock.
Vector may redeem the notes, in whole or in part, at a price of 103.125%
in the year beginning July 15, 2004, 102.083% in the year beginning July
15, 2005, 101.042% in the year beginning July 15, 2006 and 100% in the
year beginning July 15, 2007, together with accrued interest. If a change
of control occurs, Vector will be required to offer to repurchase the
notes at 101% of their principal amount, plus accrued interest and, under
certain circumstances, a "make whole" payment.
10% SENIOR SECURED NOTES DUE MARCH 31, 2006 - VGR HOLDING:
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 held by Brooke Group Holding 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 September 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
($63,000 at September 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 recognized as additional interest expense a loss of $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.
- 13 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 replaced Liggett's previous $40,000 facility with
Congress, under which $15,490 was outstanding at September 30, 2004.
Availability as determined under the facility was approximately $15,670
based on eligible collateral at September 30, 2004. The facility is
collateralized by all inventories and receivables of Liggett and a
mortgage on its manufacturing facility. 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 and no event of default has occurred under the agreement,
including Liggett's compliance with the covenants in the credit facility,
including an adjusted net worth and working capital requirement. 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 September 30,
2004, Liggett was in compliance with all covenants under the credit
facility; Liggett's adjusted net worth was $52,055 and net working capital
was $41,669, 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 $4,649 outstanding
under Liggett's credit facility at September 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 $3,023. 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.
- 14 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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.)
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 $1,603, 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 $2,948, 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.
- 15 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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.
6. EMPLOYEE BENEFITS
Net periodic benefit cost for the Company's pension and other
postretirement benefit plans for the three and nine months ended September
30, 2004 and 2003 consists of the following:
Pension Benefits Pension Benefits
----------------------- -----------------------
Three Months Ended Nine Months Ended
----------------------- -----------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2004 2003 2004 2003
--------- --------- --------- ---------
Service cost - benefits earned
during the period.......................... $ 1,248 $ 981 $ 3,744 $ 2,943
Interest cost on projected benefit
obligation................................. 2,240 2,390 6,720 7,170
Expected return on plan assets................ (3,027) (2,950) (9,081) (8,850)
Amortization of net loss...................... 506 414 1,518 1,242
------- ------- ------- -------
Net expense.......................... $ 967 $ 835 $ 2,901 $ 2,505
======= ======= ======= =======
Other Other
Postretirement Benefits Postretirement Benefits
----------------------- -----------------------
Three Months Ended Nine Months Ended
----------------------- -----------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2004 2003 2004 2003
--------- --------- --------- ---------
Service cost - benefits earned
during the period.......................... $ 8 $ 20 $ 24 $ 60
Interest cost on projected benefit
obligation................................. 157 169 471 507
Expected return on plan assets................ - - - -
Amortization of net loss (gain)............... 5 (32) 15 (96)
---- ---- ---- ----
Net expense.......................... $170 $157 $510 $471
==== ==== ==== ====
</Table>
The Company did not make contributions to its pension benefits plans for
the nine months ended September 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.
- 16 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
7. CONTINGENCIES
SMOKING-RELATED LITIGATION:
OVERVIEW. Since 1954, Liggett and other United States cigarette
manufacturers have been named as defendants in numerous direct and
third-party actions predicated on the theory that cigarette manufacturers
should be liable for damages alleged to have been caused by cigarette
smoking or by exposure to secondary smoke from cigarettes. These cases are
reported here as though having been commenced against Liggett (without
regard to whether such cases were actually commenced against Brooke Group
Holding Inc., the Company's predecessor and a wholly-owned subsidiary of
VGR Holding, or Liggett). There has been a noteworthy increase in the
number of cases commenced against Liggett and the other cigarette
manufacturers in recent years. The cases generally fall into the following
categories: (i) smoking and health cases alleging injury brought on behalf
of individual plaintiffs ("Individual Actions"); (ii) smoking and health
cases alleging injury and purporting to be brought on behalf of a class of
individual plaintiffs ("Class Actions"); (iii) health care cost recovery
actions brought by various foreign and domestic governmental entities
("Governmental Actions"); and (iv) health care cost recovery actions
brought by third-party payors including insurance companies, union health
and welfare trust funds, asbestos manufacturers and others ("Third-Party
Payor Actions"). As new cases are commenced, defense costs and the risks
attendant to the inherent unpredictability of litigation continue to
increase. The future financial impact of the risks and expenses of
litigation and the effects of the tobacco litigation settlements discussed
below are not quantifiable at this time. For the nine months ended
September 30, 2004, Liggett incurred legal fees and other litigation costs
totaling approximately $3,677 compared to $3,373 for the nine months ended
September 30, 2003.
INDIVIDUAL ACTIONS. As of September 30, 2004, there were approximately 384
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, 111 were pending in Maryland, 92 in Florida, 52 in New
York, 45 in Mississippi and 20 in California. The balance of the
individual cases were pending in 16 states. In one of 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.
- 17 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
There are six 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. In addition, plaintiff's counsel is
seeking legal fees of $760. Liggett has appealed the verdict.
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:
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. In September 2004, the California Supreme Court upheld the
$9,000 punitive damages award. The defendant has appealed.
o In March 1999, an Oregon state court jury found in favor of the
plaintiff in WILLIAMS-BRANCH 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.
- 18 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
o In 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. In September 2004, the California Court of Appeals
affirmed the compensatory damages award, but reduced the punitive
damages award to $50,000. In October 2004, the California Court of
Appeals granted the parties' petitions for rehearing and vacated its
decision.
o In December 2001, in KENYON V. R.J. REYNOLDS TOBACCO CO., a Florida
state court 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.
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' motion for
rehearing was denied, and the judgment was paid in October 2004.
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 $2,100 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.
- 19 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
In June 2004, the court increased the compensatory damages to $500
and decreased the punitive damages to $5,000. Post-trial motions are
pending.
o In October 2004, in ARNITZ V. PHILIP MORRIS, a Florida state court
jury awarded $600 in damages but found that the plaintiff was 60% at
fault, thereby reducing the verdict against Philip Morris to $240.
Philip Morris intends to appeal.
One of the states where several individual cases are pending against
Liggett is Mississippi. In 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 45 cases
pending against it in Mississippi.
CLASS ACTIONS. As September 30, 2004, there were approximately 28 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' claim for a smoking cessation
program. The case is on appeal. Two other class actions, BROIN, ET AL., V.
PHILIP MORRIS COMPANIES INC., ET AL., and ENGLE, ET AL., V. R.J. REYNOLDS
TOBACCO COMPANY, ET AL., were certified in state court in Florida prior to
the Fifth Circuit's decision. In April 2001, BROWN, ET AL., V. THE
AMERICAN TOBACCO COMPANY, INC., ET AL., was certified as a class action in
California.
In May 1994, the ENGLE case was filed against Liggett and others in the
Circuit Court, Eleventh Judicial Circuit, Miami-Dade County, Florida. The
class consists of all Florida residents and citizens, and their survivors,
who have suffered, presently suffer or have died from diseases and medical
conditions caused by their addiction to cigarettes that contain nicotine.
Phase I of the trial commenced in July 1998 and in July 1999, the jury
returned the Phase I verdict. The Phase I verdict concerned certain issues
determined by the trial court to be "common" to the causes of action of
the plaintiff class. Among other things, the jury found that: smoking
cigarettes causes 20 diseases or medical conditions, cigarettes are
addictive or dependence producing, defective and unreasonably dangerous,
defendants made materially false statements with the intention of
misleading smokers, defendants concealed or omitted material information
concerning the health effects and/or the addictive nature of smoking
cigarettes and agreed to misrepresent and conceal the health effects
and/or the addictive nature of smoking cigarettes, and defendants were
negligent and engaged in extreme and outrageous conduct or acted with
reckless disregard with the intent to inflict emotional distress. The jury
also found that defendants' conduct "rose to a level that would permit a
potential award or entitlement to punitive damages." The court decided
that Phase II of the trial, which commenced November 1999, would be a
causation and damages trial for three of the class representatives and a
punitive damages trial on a class-wide basis, before the same jury that
returned the verdict in Phase I. Phase III of the trial was to be
conducted before separate juries to
- 20 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 was held on November 3, 2004. If the Third District
Court of Appeal'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 the bond required to file an
appeal of an adverse judgment has been enacted in over 30 states.
In May 2001, Liggett, Philip Morris and Lorillard Tobacco Company 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 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
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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), California (BROWN), New York (SIMON), Kansas (SMITH) and
New Mexico (ROMERO). A number of class certification denials are on
appeal.
In August 2000, in BLANKENSHIP V. PHILIP MORRIS, 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 BROWN 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. In September
2004, the court granted in part and denied in part defendants' motion for
summary judgment. Trial is currently scheduled for March 2005. 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.
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 , ET AL.), pending
in federal court in New York
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 in the
PRICE, ET AL., V. PHILIP Morris case 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, ET AL., granted class certification in November
2001. In April 2003, plaintiffs' motion for class certification was
granted in ROMERO V. PHILIP MORRIS, 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 September 30, 2004, there were approximately
12 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. Trial in the
health care recovery case brought by the City of St. Louis, Missouri,
against the major cigarette manufacturers is scheduled for June 2005.
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.
THIRD-PARTY PAYOR ACTIONS. As of September 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
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 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
cigarette manufacturers. 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 ruled in October 2004 that the plaintiff cannot
use the state consumer protection law to pursue direct claims for the
recovery of medical expenses from cigarette manufacturers. The Second
Circuit had previously reversed the portion of the judgment relating to
the verdict returned against defendants under the 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 summary judgment to dismiss the government's disgorgement claim
and, in June 2004, certified that
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 17, 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 of the case began on September 21,
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, R.J. Reynolds and
Lorillard (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.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Liggett has no payment obligations under the MSA except to the extent its
market share exceeds a base share of 125% of its 1997 market share, or
approximately 1.65% of total cigarettes sold in the United States. 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 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 2.1% of the total cigarettes shipped in the
United States during 2001, 2.4% during 2002 and 2.4% 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
$14,813 for their estimated MSA obligations for the first nine 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.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
On August 30, 2004, the Company announced that Liggett and Vector Tobacco
had notified the Attorneys General of 46 states that they intend to
initiate proceedings against the Attorneys General for violating the terms
of the MSA. The Company's subsidiaries allege that the Attorneys General
violated their rights and the MSA by extending unauthorized favorable
financial terms to Miami based Vibo Corporation d/b/a/ General Tobacco
when, on August 19, 2004, the Attorneys General entered into an agreement
with General Tobacco allowing it to become a Subsequent Participating
Manufacturer under the MSA. General Tobacco imports discount cigarettes
manufactured in Colombia, South America.
In the notice sent to the Attorneys General, the Company's subsidiaries
indicate that they will seek to enforce the terms of the MSA, void the
General Tobacco agreement and enjoin the Settling States and National
Association of Attorneys General from listing General Tobacco as a
Participating Manufacturer on their websites.
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.
TRIALS. Trial in the United States government action began on September
21, 2004 in federal court in the District of Columbia. Cases currently
scheduled for trial during the next six months include two individual
actions in Florida state court, with one of these cases scheduled for
trial in January 2005 and one in early 2005. Liggett is the sole defendant
in each of these cases. In addition, the BROWN class action is scheduled
for trial in California state court in March 2005, two individual actions
involving the major companies as defendants are scheduled for trial in
federal court in Puerto Rico in March 2005 and April 2005, another
individual action is scheduled for trial in Louisiana state court in April
2005 and the CITY OF ST. LOUIS governmental action is scheduled for trial
in June 2005. 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 was held on
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. In addition, plaintiff's counsel
is seeking legal fees of $760. 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
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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.
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
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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
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 October 2004, the
Senate passed a bill providing for FDA regulation of tobacco products. 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 October 2004, federal legislation was enacted which will eliminate the
federal tobacco quota and price support program. Pursuant to the
legislation, manufacturers of tobacco products will be assessed
$10,140,000 over a ten year period to compensate tobacco growers and quota
holders for the elimination of their quota rights. Cigarette manufacturers
will be responsible for 96.3% of the assessment, which will be allocated
based on relative unit volume of domestic cigarette shipments. The three
largest manufacturers will be entitled to a credit of a portion of the
assessment payable by them against certain of their MSA obligations.
Management currently estimates that Liggett's assessment will be
approximately $25,000 for the first year of the program which began
October 1, 2004. The ultimate impact of this legislation cannot be
determined, but there is a risk that smaller manufacturers, such as
Liggett and Vector Tobacco, will be disproportionately affected by the
legislation, which could have a material adverse effect on the Company.
- 29 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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, seven states have increased the excise tax rate and
several other states are likely to impose additional taxes on cigarettes.
Management believes 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 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. If Vector Tobacco is unable to advertise its QUEST brand, it
could have a material adverse effect on sales of QUEST. Allegations by
federal or state regulators, public health organizations and other tobacco
- 30 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 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
- 31 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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
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.
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. The
Company believes that the fair value of Eve's guarantee was negligible at
September 30, 2004.
In February 2004, Liggett Vector Brands and another cigarette manufacturer
entered into a five year agreement with a subsidiary of the American
Wholesale Marketers Association to support a program to permit tobacco
distributors to secure, on reasonable terms, tax stamp bonds required by
state and local governments for the distribution of cigarettes. Under the
agreement, Liggett Vector Brands has agreed to pay a portion of losses, if
any, incurred by the surety under the bond program, with a maximum loss
exposure of $500 for Liggett Vector Brands. To secure its potential
obligations under the agreement, Liggett Vector Brands has delivered to
the subsidiary of the Association a $100 letter of credit and a demand
note for $400. Liggett Vector Brands has incurred no losses to date under
this agreement, and the Company believes the fair value of Liggett Vector
Brands' obligation under the agreement was immaterial at September 30,
2004.
As of September 30, 2004, New Valley had $600 of remaining prepetition
bankruptcy-related claims. 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 income (loss) for the three and nine months ended September 30,
2004 and September 30, 2003 is less than that which would have been
recognized if the fair value method had been applied to all
- 32 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
awards since the original effective date of SFAS No. 123. The following
table illustrates the effect on net income (loss) and income (loss) per
share if the Company had applied the fair value provisions of SFAS No.
123:
Three Months Ended Nine Months Ended
---------------------- ---------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2004 2003 2004 2003
--------- --------- --------- ---------
Net income (loss)............................... $8,066 $ (9,380) $(4,209) $(19,159)
Add: stock option employee compensation
expense included in reported net income (loss),
net of related tax effects.................. 42 1,396 126 4,146
Deduct: total stock option employee
compensation expense determined
under the fair value method for all
awards, net of related tax effects.......... (432) (2,294) (1,388) (6,811)
------ -------- ------- --------
Pro forma net income (loss)..................... $7,676 $(10,278) $(5,471) $(21,824)
====== ======== ======= ========
Income (loss) per share:
Basic - as reported......................... $ 0.19 $ (0.23) $ (0.10) $ (0.47)
Diluted - as reported....................... $ 0.19 $ (0.23) $ (0.10) $ (0.47)
Basic - pro forma........................... $ 0.18 $ (0.25) $ (0.13) $ (0.54)
Diluted - pro forma......................... $ 0.18 $ (0.25) $ (0.13) $ (0.54)
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 nine months ended September 30, 2004, 1,068,953 options,
exercisable at prices ranging from $3.73 to $14.70 per share, were
exercised for $2,708 in cash and the delivery to the Company of 348,623
shares of common stock with a fair market value of $5,346 or $15.33 per
share at the date of exercise.
On June 1, 2004, the Company granted 10,500 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.
- 33 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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.)
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 had an initial 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 Sheraton
Keauhou Bay Resort & Spa in Kailua-Kona, Hawaii. Following a major
renovation, the property is reopening in the fourth quarter 2004 as a four
star 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 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 $9,620 of principal and accrued interest, will be converted
into approximately 8,745,000 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.
In July 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.
- 34 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 September 30, 2004, New Valley had repurchased 1,229,515
shares for approximately $4,895. At September 30, 2004, the Company owned
58.2% of New Valley's common shares.
10. INCOME TAXES
The effective tax rates for the three and nine months ended September 30,
2004 and September 30, 2003 do not bear a customary relationship to
pre-tax income principally as a consequence of non-deductible expenses and
state income taxes.
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 September 30, 2004, the
Company's deferred income tax liabilities exceeded its deferred income tax
assets by $108,082. 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 $120,000,
including interest, net of tax benefits, through September 30, 2004. These
amounts have been previously recognized in the Company's consolidated
financial statements as tax liabilities. As of September 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
- 35 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 materially adversely affected.
11. SEGMENT INFORMATION
The Company's significant business segments for the nine months ended
September 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.
Financial information for the Company's operations before taxes and
minority interests for the three and nine months ended September 30, 2004
and 2003 follows:
- 36 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Vector Real Corporate
Liggett Tobacco Estate and Other Total
------- ------- ------ --------- -----
THREE MONTHS ENDED SEPT. 30, 2004:
Revenues........................ $120,793 $ 3,458 $ 1,809 $ -- $126,060
Operating income (loss)......... 27,228(1) (3,623)(1) 978 (6,890) 17,693(1)
Depreciation and amortization... 1,906 350 323 621 3,200
THREE MONTHS ENDED SEPT. 30, 2003:
Revenues........................ $135,716 $ 5,337 $ 1,797 $ -- $142,850
Operating income (loss)......... 31,295 (34,474)(3) 959 (6,087) (8,307)(3)
Depreciation and amortization... 1,649 1,572 320 633 4,174
NINE MONTHS ENDED SEPT. 30, 2004:
Revenues........................ $358,565 $ 12,304 $ 5,401 $ -- $376,270
Operating income (loss)......... 80,379(2) (56,770)(2) 2,836 (19,950) 6,495(2)
Identifiable assets............. 266,214 21,061 82,652 158,120 528,047
Depreciation and amortization... 5,916 1,485 969 1,886 10,256
Capital expenditures............ 2,704 62 - 239 3,005
NINE MONTHS ENDED SEPT. 30, 2003:
Revenues........................ $381,398 $ 20,398 $ 5,373 $ -- $407,169
Operating income (loss)......... 89,145 (79,980)(3) 2,867 (19,716) (7,684)(3)
Identifiable assets............. 292,263 79,324 73,298 187,500 632,385
Depreciation and amortization... 5,409 4,380 962 1,879 12,630
Capital expenditures............ 4,600 2,288 - 803 7,691
- ---------------
(1) Includes restructuring charges in the three months ended September 30,
2004 of $3,968 at Liggett and $564 at Vector Tobacco.
(2) Includes restructuring and impairment charges in the nine months ended
September 30, 2004 of $6,320 at Liggett and $1,224 at Vector Tobacco
and a $37,000 inventory impairment charge at Vector Tobacco in the 2004
period.
(3) Includes restructuring and impairment charges in 2003 of $20,079 at
Vector Tobacco.
- 37 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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.
In recent years, we have undertaken a number of initiatives to
streamline the cost structure of our tobacco business and improve operating
efficiency and long-term earnings. 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.
Effective year-end 2003, we closed 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 was 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.
In April 2004, we eliminated a number of positions in our tobacco
operations and subleased excess office space. In October 2004, we announced a
plan to restructure the operations of Liggett Vector Brands. Liggett Vector
Brands is realigning its sales force and adjusting its business model to more
efficiently serve its chain and independent accounts nationwide. In connection
with the restructuring, we are eliminating approximately 330 full-time positions
and 135 part-time positions effective December 15, 2004.
We may consider various additional opportunities to further improve
efficiencies and reduce costs. These prior and current initiatives have involved
material restructuring and impairment charges, and any further actions taken are
likely to involve material charges as well. Although management may estimate
that substantial cost savings will be associated with these restructuring
actions, there is a risk that these actions could have a serious negative impact
on our tobacco operations and that any estimated increases in profitability
cannot be achieved.
Our majority-owned subsidiary, New Valley Corporation, is currently
engaged in the real estate business and is seeking to acquire additional
operating companies and real estate properties. 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.
All of Liggett's unit volume in the first nine months 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,
- 38 -
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 55.5% of Liggett's unit volume in the
first nine months of 2004 and 50.9% of Liggett's unit volume for the year ended
December 31, 2003.
We believe that Liggett has gained a sustainable cost advantage over
its competitors through its various settlement agreements. Under the Master
Settlement Agreement reached in November 1998 with 46 state attorneys general
and various territories, the three largest cigarette manufacturers must make
settlement payments to the states and territories based on how many cigarettes
they sell annually. Liggett, however, is not required to make any payments
unless its market share exceeds approximately 1.65% of the U.S. cigarette
market. Additionally, as a result of the Medallion acquisition, Vector Tobacco
likewise has no payment obligation unless its market share exceeds approximately
0.28% of the U.S. market.
In recent years, the domestic tobacco business has experienced the
following trends:
o Declining unit volumes due to health considerations,
diminishing social acceptance of smoking, legislative
limitations on smoking in public places, federal and state
excise tax increases and settlement-related expenses which
have augmented cigarette prices,
o Narrower price spreads between the premium and all discount
segments resulting from aggressive premium price promotions by
larger competitors including Philip Morris and Reynolds
American, while price spreads between the traditional discount
and the deep discount markets have been maintained due to the
continued influx of smaller companies producing or importing
low quality, deep discount cigarettes, and
o Loss of market share for discount cigarettes such as those
sold by Liggett due to a continued increase in market share by
the smaller cigarette companies producing low quality, deep
discount cigarettes.
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
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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 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 2% 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 second quarter 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.
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.
In November 2001, Vector Tobacco launched nationwide OMNI, the first
reduced carcinogen cigarette that tastes, smokes and burns like other premium
cigarettes. The OMNI cigarettes are produced using a patent pending process
developed by Vector Tobacco. In comparison to comparable styles of the leading
U.S. cigarette brand, OMNI cigarettes produce significantly lower levels of many
of the recognized carcinogens and toxins that the medical community has
identified as major contributors to lung cancer and other diseases in smokers.
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During 2002, acceptance of OMNI in the marketplace was limited, with revenues of
approximately $5,100 on sales of 70.7 million units. During 2003, OMNI sales
activity was minimal as Vector Tobacco has not been actively marketing the OMNI
product, and the product is not currently being distributed. Vector Tobacco was
unable to achieve the anticipated breadth of distribution and sales of the OMNI
product, due in part, to the lack of success of its advertising and marketing
efforts in differentiating OMNI with consumers through the "reduced carcinogen"
message. Over the next several years, our in-house research program, together
with third-party collaborators, plans to conduct appropriate studies as to the
human effects of OMNI's reduction of carcinogens and, based on these studies,
management will review the marketing and positioning of the OMNI brand in order
to formulate a strategy for its long-term success.
RECENT DEVELOPMENTS
TOBACCO QUOTA ELIMINATION. In October 2004, federal legislation was
enacted which will eliminate the federal tobacco quota and price support
program. Pursuant to the legislation, manufacturers of tobacco products will be
assessed $10,140,000 over a ten year period to compensate tobacco growers and
quota holders for the elimination of their quota rights. Cigarette
manufacturers will be responsible for 96.3% of the assessment, which will be
allocated based on relative unit volume of domestic cigarette shipments. The
three largest manufacturers will be entitled to a credit of a portion of the
assessment payable by them against certain of their MSA obligations. Management
currently estimates that Liggett's assessment will be approximately $25,000 for
the first year of the program which began October 1, 2004. The ultimate impact
of this legislation cannot be determined, but there is a risk that smaller
manufacturers, such as Liggett and Vector Tobacco, will be disproportionately
affected by the legislation, which could have a material adverse effect on us.
Effective October 22, 2004, Liggett increased the list price of all its
brands by $.65 per carton. The increase was taken due to the recently passed
federal tobacco buyout legislation.
REYNOLDS AMERICAN. 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 American, 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.
TIMBERLAKE SALE. In July 2004, a wholly-owned subsidiary of Vector
Tobacco completed the sale of its Timberlake, North Carolina manufacturing
facility along with all equipment to an affiliate of the Flue-Cured Tobacco
Cooperative Stabilization Corporation for $25,800. In connection with the sale,
the subsidiary of Vector Tobacco entered into a consulting agreement to provide
certain services to the buyer for $400; $200 of this amount was recognized as
income in the third quarter of 2004. 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 recognized as additional interest expense a loss of $639 in the
third quarter of 2004 on the early extinguishment of debt.
LIGGETT VECTOR BRANDS RESTRUCTURINGS. 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 and relocated several employees. As a result of these
actions, we recognized pre-tax restructuring charges of $2,791
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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.
On October 6, 2004, we announced an additional plan to restructure the
operations of Liggett Vector Brands, our sales, marketing and distribution agent
for our Liggett and Vector Tobacco subsidiaries. Liggett Vector Brands is
realigning its sales force and adjusting its business model to more efficiently
serve its chain and independent accounts nationwide. In connection with the
restructuring, we are eliminating approximately 330 full-time positions and 135
part-time positions, effective December 15, 2004.
As a result of the actions announced in October 2004, we currently
expect to realize annual cost savings of approximately $30,000 beginning in
2005. We will recognize pre-tax restructuring charges currently estimated to
total $12,058, of which $4,428 has been recognized in the third quarter of 2004
and approximately $7,630 will be recognized in the fourth quarter of 2004.
Approximately $5,883 of the charges relate to employee severance and benefit
costs and approximately $6,175 to contract termination and other associated
costs. Approximately $2,455 of these charges represent non-cash items.
Additionally, in the fourth quarter of 2004, we will incur other charges for
various compensation and related payments to employees which are related to the
restructuring. These charges will be $1,784 and will be included in operating,
selling, administrative and general expenses.
TIMBERLAKE 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
all production was transitioned from Timberlake to Mebane 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 $21,521, of which $21,300 was taken in 2003 and $221 was
taken in the first quarter 2004. Machinery and equipment to be disposed of was
reduced to estimated fair value less costs to sell during 2003. The asset
impairment charges were based on management's estimates of the values we would
be able to realize on sales of excess machinery and equipment, and were 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 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 charges previously
recognized. During the third quarter of 2004, we recognized a restructuring
charge of $175 in connection with additional employee severance and benefit
costs relating to the Timberlake sale.
Annual cost savings related to the Timberlake restructuring and
impairment charges and the actions taken at Liggett Vector Brands in the first
half of 2004 are currently expected to be at least $23,000
- 42 -
beginning in 2004. Management will continue to review opportunities for
additional cost savings in our tobacco business.
AMENDED LIGGETT CREDIT FACILITY. In April 2004, Liggett entered into an
Amended and Restated Loan and Security Agreement with Congress Financial
Corporation, as lender. The $50,000 credit facility replaced Liggett's previous
$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 $120,000, including interest, net of tax benefits, through
September 30, 2004. These amounts have been previously recognized in our
consolidated financial statements as tax liabilities. As of September 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 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 materially
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.
- 43 -
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 had an initial principal amount of
$9,500, bears interest at 12% per annum and is due in March 2013.
New Valley holds a 50% interest in Koa Investors LLC, the owner of the
Sheraton Keauhou Bay Resort & Spa in Kailua-Kona, Hawaii. Following a major
renovation, the property is reopening in the fourth quarter 2004 as a four star
resort with approximately 525 rooms.
INDUSTRY DATA. The source of industry data in this report is Management
Science Associates, Inc., an independent third-party database management
organization that collects wholesale shipment data from various cigarette
manufacturers and provides analysis of market share, unit sales volume and
premium versus discount mix for individual companies and the industry as a
whole. Effective June 2004, Management Science Associates made three changes in
the information it reports as noted below and these changes are reflected in the
information presented herein:
o Management Science Associates is now reporting actual units
shipped by Commonwealth Brands, Inc.
o Management Science Associates has implemented a new model for
estimating unit sales volume for certain of the smaller,
primarily deep discount cigarette manufacturers.
o Management Science Associates has restated volume and the
resulting effects on share of market from January 2001
forward.
The effects of these changes are that total industry volume increased
based on new smaller manufacturer estimates and actual reported volume for
Commonwealth and, based on the revised industry volume number, market shares for
the major tobacco companies, including Liggett, have been restated from January
2001 forward and will be lower. Under Management Science Associates' new method
for computing market share, Liggett and Vector Tobacco accounted for
approximately 2.2% of the total cigarettes shipped in the United States during
2001, 2.4% during 2002 and 2.5% during 2003, as compared to 2.2% during 2001,
2.5% during 2002 and 2.7% during 2003 under the past method. Liggett management
continues to believe that the volume and market share information published by
Management Science Associates for smaller manufacturers is understated and,
correspondingly, share information for the larger manufacturers, including
Liggett, is overstated by Management Science Associates.
RECENT DEVELOPMENTS IN LEGISLATION, REGULATION AND LITIGATION
The cigarette industry continues to be challenged on numerous fronts.
New cases continue to be commenced against Liggett and other cigarette
manufacturers. As of September 30, 2004, there were approximately 384 individual
suits, 28 purported class actions
- 44 -
and 18 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. Trial of the case began on September 21, 2004. In one of
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 six individual actions where Liggett is the only defendant,
with one of these cases currently scheduled for trial in January 2005 and one in
early 2005. In April 2004, in one of these cases, a jury in a Florida state
court action awarded compensatory damages of $540 against Liggett. In addition,
plaintiff's counsel is seeking legal fees of $760. Liggett has appealed the
verdict.
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 was held on 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. If Vector
Tobacco is unable to advertise its QUEST brand, it could have a material adverse
effect on sales of QUEST. 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.
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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.
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 as a reduction in revenue in the period in which these
programs are offered, based on estimates of utilization and redemption rates
that are developed from historical information.
RESTRUCTURING AND ASSET IMPAIRMENT CHARGES. We have recorded charges
related to employee severance and benefits, asset impairments, contract
termination and other associated exit costs during 2002, 2003 and 2004. The
calculation of severance pay requires management to identify employees to be
terminated and the timing of their severance from employment. The calculation of
benefits charges requires actuarial assumptions including determination of
discount rates. As discussed further below, the asset impairments were recorded
in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," which requires management to estimate the fair value of
assets to be disposed of. On January 1, 2003, we adopted SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." Charges
related to restructuring activities initiated after this date were recorded when
incurred. Prior to this date, charges were recorded at the date of an entity's
commitment to an exit plan in accordance with EITF 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." These restructuring
charges are based on management's best estimate at the time of restructuring.
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The status of the restructuring activities is reviewed on a quarterly basis and
any adjustments to the reserve, which could differ materially from previous
estimates, are recorded as an adjustment to operating income.
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 evaluated
the net realizable value of the long-lived assets located at the Timberlake
facility which is no longer 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 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 $14,813 for the nine months ended September 30, 2004 and $27,567 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
- 47 -
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 September 30, 2004, approximately $2,752 of our inventory
was associated with Vector Tobacco's QUEST product. During the second quarter of
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 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 58.2% at September 30, 2004.
For purposes of this discussion and other consolidated financial
reporting, our significant business segments for the nine months ended September
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.
- 48 -
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
REVENUES:
Liggett ........................ $ 120,793 $ 135,716 $ 358,565 $ 381,398
Vector Tobacco ................. 3,458 5,337 12,304 20,398
--------- --------- --------- ---------
Total tobacco ............... 124,251 141,053 370,869 401,796
Real estate .................... 1,809 1,797 5,401 5,373
--------- --------- --------- ---------
Total revenues .............. $ 126,060 $ 142,850 376,270 $ 407,169
========= ========= ========= =========
OPERATING INCOME (LOSS):
Liggett ........................ $ 27,228(1) $ 31,295 $ 80,379(2) $ 89,145
Vector Tobacco ................. (3,623)(1) (34,474)(3) (56,770)(2) (79,980)(3)
--------- --------- --------- ---------
Total tobacco ............... 23,605 (3,179) 23,609 9,165
Real estate .................... 978 959 2,836 2,867
Corporate and other ............ (6,890) (6,087) (19,950) (19,716)
--------- --------- --------- ---------
Total operating income (loss) $ 17,693(1) $ (8,307)(3) $ 6,495(2) $ (7,684)(3)
========= ========= ========= =========
- --------------
(1) Includes restructuring charges of $3,968 at Liggett and $564 at Vector
Tobacco for the three months ended September 30, 2004.
(2) Includes restructuring and impairment charges of $6,320 at Liggett and
$1,224 at Vector Tobacco and a $37,000 inventory impairment charge at
Vector Tobacco for the nine months ended September 30, 2004.
(3) Includes restructuring and impairment charges of $20,079 at Vector
Tobacco in 2003.
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2003
REVENUES. Total revenues were $126,060 for the three months ended
September 30, 2004 compared to $142,850 for the three months ended September 30,
2003. This $16,790 (11.8%) decrease in revenues was due to a $14,923 or 11.0%
decrease in revenues at Liggett, a decrease of $1,879 in revenues at Vector
Tobacco and an increase of $12 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. In October 2004, Liggett increased the list price of
all its brands by $.65 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.
- 49 -
All of Liggett's sales for the first nine months of 2004 were in the
discount category. For the three months ended September 30, 2004, net sales at
Liggett totaled $120,793, compared to $135,716 for the three months ended
September 30, 2003. Revenues decreased by 11.0% ($14,923) due to a 16.0%
decrease in unit sales volume (approximately 410.5 million units) accounting for
$21,765 in unfavorable volume variance and $330 in unfavorable sales mix,
partially offset by a combination of list price increases and reduced
promotional spending of $7,172. Net revenues of the LIGGETT SELECT brand
decreased $940 for the three months ended September 30, 2004 compared to the
same period in 2003, and its unit volume decreased 7.8% in the 2004 period
compared to 2003. In anticipation of the planned October restructuring and
related trade pricing adjustments, Liggett wholesale inventory levels were
allowed to decline compared to the prior year period. This adjustment in
wholesale inventories was a contributing factor in the declines in LIGGETT
SELECT unit volume and overall unit volume during the 2004 quarter.
Revenues at Vector Tobacco were $3,458 for the three months ended
September 30, 2004 compared to $5,337 for the three months ended September 30,
2003 due to decreased sales volume. Vector Tobacco's revenues in 2003 and 2004
relate primarily to sales of QUEST.
TOBACCO GROSS PROFIT. Tobacco gross profit was $53,134 for the three
months ended September 30, 2004 compared to $48,342 for the three months ended
September 30, 2003, an increase of $4,792 or 10.0% when compared to the same
period last year, due primarily to the price increases discussed above at
Liggett and lower estimated Master Settlement Agreement expense at Liggett and
Vector Tobacco. In the three months ended September 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 98.6% to our gross profit and
Vector Tobacco contributed 1.4% for the three months ended September 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 $52,393 for the three months ended September
30, 2004 increased $1,463 from gross profit of $50,930 for the three months
ended September 30, 2003. As a percent of revenues (excluding federal excise
taxes), gross profit at Liggett increased to 66.7% for the three months ended
September 30, 2004 compared to 59.3% 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 was $741 for the three months ended
September 30, 2004 compared to negative gross profit of $2,588 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 of 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 $1,809 for
the three months ended September 30, 2004. This compares to revenues of $1,797
from real estate activities for the three months ended September 30, 2003.
EXPENSES. Operating, selling, general and administrative expenses were
$32,718 for the three months ended September 30, 2004 compared to $38,367. These
expenses are net of restructuring charges of $4,532 in the three months ended
September 30, 2004 and restructuring and impairment charges of $20,979 for the
same period last year. The decrease of $5,649 was due primarily to lower expense
at Vector Tobacco of approximately $7,738, partially offset by higher expense at
Liggett of $1,562. Expenses at Liggett excluding the Liggett Vector Brands'
restructuring costs were $21,197 for the three months ended September 30, 2004
compared to $19,635 for the same period last year, 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 $1,124 for the three months ended
September 30, 2004 compared to $1,141 for the same period in the prior year.
Expenses at Vector Tobacco for the three months ended September 30, 2004 were
$3,800 compared to expenses of $11,538 for the three months ended September 30,
2003, excluding the
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restructuring and impairment charges of $20,079, 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 September 30, 2004,
the selling, marketing and administrative expenses allocated to Liggett
increased by $2,881 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 September 30, 2003. These modifications did not
effect the consolidated financial statements.
Restructuring charges for the three months ended September 30, 2004
were $3,968 at Liggett and $564 at Vector Tobacco and relate to the
restructuring of Liggett Vector Brands. Restructuring and impairment charges for
the three months ended September 30, 2003 were $20,079 and relate to the closing
of Vector Tobacco's Timberlake facility.
New Valley's expenses for real estate operations for the three months
ended September 30, 2004 were $831 compared to $838 for the same period in 2003.
For the three months ended September 30, 2004, Liggett's operating
income decreased $4,067 to $27,228 compared to $31,295 for the prior year
period. For the three months ended September 30, 2004, Vector Tobacco's
operating loss was $3,623 compared to a loss of $34,474 in the prior year
period. The $30,851 decrease in Vector Tobacco's operating loss was primarily
the result of the 2003 restructuring and impairment charge of $20,079 related to
the closing of the Timberlake facility and lower selling, general, operating,
general and administrative expenses in 2004 as discussed above.
OTHER INCOME (EXPENSES). For the three months ended September 30, 2004,
other expense was $1,670 compared to other expense of $4,241 for the three
months ended September 30, 2003. For the three months ended September 30, 2004,
interest expense of $6,832 was partially offset by equity income from
non-consolidated New Valley real estate businesses of $4,539, interest and
dividend income of $322 and a gain on investments of $302. For the three months
ended September 30, 2003, interest expense of $7,422 was partially offset by
equity income from non-consolidated real estate businesses of $1,527, interest
and dividend income of $844 and a gain on investments of $806.
Interest expense decreased to $6,832 for the three months ended
September 30, 2004 compared to $7,422 for the same period in 2003, primarily due
to repurchases of VGR Holding's 10% senior secured notes during 2003 and 2004.
INCOME (LOSS) FROM OPERATIONS. Income from operations before income
taxes and minority interests for the three months ended September 30, 2004 was
$16,023 compared to a loss of $12,548 for the three months ended September 30,
2003. The income tax provision was $6,995 and minority interests in income of
subsidiaries was $962 for the three months ended September 30, 2004. This
compared to tax benefit of $3,240 and minority interests in income of
subsidiaries of $72 for the three months ended September 30, 2003. The effective
tax rates for the three months ended September 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.
- 51 -
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2003
REVENUES. Total revenues were $376,270 for the nine months ended
September 30, 2004 compared to $407,169 for the nine months ended September 30,
2003. This 7.6% ($30,899) decrease in revenues was due to a $22,833 or 6.0%
decrease in revenues at Liggett, an $8,094 decrease in revenues at Vector
Tobacco and an increase of $28 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 net sales 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 net sales
price of LIGGETT SELECT by $1.00 per carton. In October 2004, Liggett increased
the list price of all its brands by $.65 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 nine months were in the discount
category. For the nine months ended September 30, 2004, net sales at Liggett
totaled $358,565, compared to $381,398 for the first nine months of 2003.
Revenues decreased by 6.0% ($22,833) due to a 9.8% decrease in unit sales volume
(approximately 721.5 million units) accounting for $37,197 in unfavorable volume
variance and $915 in unfavorable sales mix partially offset by a combination of
list price increases and reduced promotional spending of $15,279. 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 due to the
price reduction discussed above. Net revenues of the LIGGETT SELECT brand
increased $7,470 for the nine months ended September 30, 2004 compared to the
same period in 2003, and its unit volume decreased 1.9% in the 2004 period
compared to 2003.
Revenues at Vector Tobacco were $12,304 for the nine months ended
September 30, 2004 compared to $20,398 for the nine months ended September 30,
2003 due to decreased sales volume. Vector Tobacco's revenues in 2003 and 2004
relate primarily to sales of QUEST.
TOBACCO GROSS PROFIT. Tobacco gross profit excluding the inventory
write-down at Vector Tobacco of $37,000 in the second quarter was $155,522 for
the nine months ended September 30, 2004 compared to $139,284 for the nine
months ended September 30, 2003, an increase of $16,238 or 11.7% when compared
to the same period last year, due primarily to the reduction in promotional
spending, price increases discussed above at Liggett and lower estimated Master
Settlement Agreement expense at Liggett and Vector Tobacco. Liggett's brands
contributed 97.2% to our tobacco gross profit and Vector Tobacco contributed
2.8% for the nine months ended September 30, 2004. Over the same period in 2003,
Liggett brands contributed 105.4% to our gross profit and Vector Tobacco's
brands cost 5.4%.
Liggett's gross profit of $151,118 for the nine months ended September
30, 2004 increased $4,337 from gross profit of $146,781 for the nine months
ended September 30, 2003. As a percent of revenues (excluding federal excise
taxes), gross profit at Liggett increased to 66.5% for the nine months ended
September 30, 2004 compared to 61.9% for the same period in 2003. This increase
in Liggett's gross profit in the 2004 period was attributable to the items
discussed above.
- 52 -
Vector Tobacco's gross profit, excluding the inventory write-down, was
$4,404 for the nine months ended September 30, 2004 compared to negative gross
profit of $7,497 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 of 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 $5,401 for
the nine months ended September 30, 2004. This compares to revenues of $5,373
from real estate activities for the nine months ended September 30, 2003.
EXPENSES. Operating, selling, general and administrative expenses were
$109,884 for the nine months ended September 30, 2004 compared to $132,262 for
the same period in 2003. These expenses are net of restructuring charges of
$1,224 and the inventory impairment charge of $37,000 recognized at Vector
Tobacco and restructuring charges of $6,320 recognized at Liggett during the
nine months ended September 30, 2004 and the restructuring and impairment
charges of $20,079 recognized by Vector Tobacco during the 2003 period. Expenses
at Liggett excluding the restructuring costs were $64,419 for the nine months
ended September 30, 2004 compared to $57,636, an increase of $6,783 over the
same period in 2003 due primarily to increased selling, marketing and
administrative expenses allocated from Liggett Vector Brands. Operating expenses
at Liggett also include Liggett's product liability legal expenses and other
litigation costs of $3,677 for the nine months ended September 30, 2004 compared
to $3,373 for the nine months ended September 30, 2003. Excluding the
restructuring and inventory charges, expenses at Vector Tobacco for the nine
months ended September 30, 2004 were $22,950 compared to expenses of $52,136 for
the nine months ended September 30, 2003, a decrease of $29,186, due to the
closing and sale of the Timberlake facility, related reduction in headcount and
reduced expense allocation 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 nine months ended
September 30, 2004, the selling, marketing and administrative expenses allocated
to Liggett increased by $9,310 with a corresponding decrease in such expenses to
Vector Tobacco, as compared to the allocation of these expenses between the
segments during the nine months ended September 30, 2003. These modifications
did not effect the consolidated financial statements.
Restructuring and impairment charges for the nine months ended
September 30, 2004 were $7,544 and relate to the closing of the Timberlake
facility, the loss on the sublease of Liggett Vector Brands' New York office
space and the Liggett Vector Brands' restructurings. Restructuring and
impairment charges for the nine months ended September 30, 2003 were $20,079 and
relate to the closing of Vector Tobacco's Timberlake facility.
New Valley's expenses for real estate operations were $2,565 in the
2004 period compared to $2,506 for the same period in 2003.
For the nine months ended September 30, 2004, Liggett's operating
income decreased to $80,379 compared to $89,145 for the prior year period due
primarily to lower sales volume and a restructuring charge of $6,320 related to
the Liggett Vector Brands restructurings during the nine months ended September
30, 2004. Vector Tobacco's operating loss which includes the second quarter
inventory impairment charge of $37,000 and restructuring charges of $1,224 was
$56,770 for the 2004 period compared to a loss of $79,980 for the 2003 period
which included the restructuring charge of $20,079 for the closing of the
Timberlake facility.
OTHER INCOME (EXPENSES). For the nine months ended September 30, 2004,
other income (expenses) was a loss of $2,492 compared to a loss of $17,938 for
the nine months
- 53 -
ended September 30, 2003. In the 2004 period, interest expense of $19,745 was
offset by equity income from non-consolidated New Valley real estate businesses
of $9,827, a gain on sale of investments of $5,888 and interest and dividend
income of $1,548. In the 2003 period, interest expense of $23,087 was offset by
interest and dividend income of $3,416, a gain on sale of investments of $1,076
and equity income from non-consolidated real estate businesses of $636.
INCOME (LOSS) FROM OPERATIONS. The income from operations before income
taxes and minority interests for the nine months ended September 30, 2004 was
$4,003 compared to a loss of $25,622 for the nine months ended September 30,
2003. Income tax provision was $4,502 and minority interests in income of
subsidiaries was $3,710 for the nine months ended September 30, 2004. This
compared to tax benefit of $4,482 and minority interests in losses of
subsidiaries of $1,981 for the nine months ended September 30, 2003. The
effective tax rates for the nine months ended September 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 $22,692 for the nine months
ended September 30, 2004 and decreased $30,092 for the nine months ended
September 30, 2003.
Net cash used in operations for the nine months ended September 30,
2004 was $3,675 compared to net cash used in operations of $9,660 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, a decrease in current liabilities, the non-cash gain
on investment securities and 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 a net loss of $19,159 and an increase
in inventories, offset by the non-cash impact of restructuring charges and
depreciation and amortization.
Cash provided by investing activities was $76,896 in 2004 compared to
$33,187 in 2003. In the nine months ended September 30, 2004, cash was provided
primarily through the sale or maturity of investment securities for $65,454, the
sale of assets for $25,821 and the decrease in restricted cash of $1,832. This
was partially offset primarily by the purchase of investment securities for
$10,747, investment in non-consolidated real estate businesses at New Valley of
$2,500 and capital expenditures of $3,005. In the nine months ended September
30, 2003, cash was provided primarily through the sale or maturity of investment
securities of $109,341 and the sale of long-term investments and other assets
for $4,531 offset primarily by the purchase of investment securities for
$49,127, the purchase of an investment in real estate businesses at New Valley
for $9,500, an increase in restricted assets of $13,691 and capital expenditures
of $7,691.
Cash used in financing activities was $50,529 in 2004 compared to cash
used of $53,619 in 2003. In the nine months ended September 30, 2004, cash was
used for dividends of $47,397 and repayments on debt of $20,782. These were
offset by net borrowings under the revolver of $15,490 and proceeds from the
exercise of options of $2,868. In the nine months ended September 30, 2003, cash
was used primarily for dividends of $44,371 and repayments of debt of $26,764
offset by net borrowings of $16,227 under the revolver and proceeds from the
exercise of warrants and options of $1,106.
LIGGETT. In April 2004, Liggett entered into an Amended and Restated
Loan and Security Agreement with Congress Financial Corporation, as lender. The
$50,000 credit facility replaced Liggett's previous $40,000 facility with
Congress, under which $15,490 was outstanding at September 30, 2004.
Availability as determined under the facility was approximately $15,670
- 54 -
based on eligible collateral at September 30, 2004. The facility is
collateralized by all inventories and receivables of Liggett and a mortgage on
its manufacturing facility. 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 and no event of default has occurred
under the agreement, including Liggett's compliance with the covenants in the
credit facility, including an adjusted net worth and working capital
requirement. 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 September 30, 2004, Liggett
was in compliance with all covenants under the credit facility; Liggett's
adjusted net worth was $52,055 and net working capital was $41,669, 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 $4,649
outstanding as of September 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 $3,023. 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.
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 September 30, 2004 of
approximately $2,285. The option agreement permits the purchaser to acquire the
property during a period of up to two years, at a purchase price of $15,000.
Liggett has received option fees of $1,250, of which $250 is refundable if the
purchaser terminates the agreement prior to February 14, 2005. Liggett will be
entitled to receive additional option fees of up to $250 during the remaining
option period. The option fees will generally be
- 55 -
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 was held on 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. In addition, plaintiff's
counsel is seeking legal fees of $760. Liggett has appealed 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 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
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including annual interest of 2.31% above the 30-day commercial paper rate, with
a final payment of $1,603, 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 $2,948, 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, was 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 held by Brooke Group Holding 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 September 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
($63,000 at September 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 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. We recognized as additional interest expense a loss of $639 in
the third quarter of 2004 on the early extinguishment of debt.
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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 over the next 12 months, 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 September 30, 2004, VGR Holding was generally not permitted to pay
distributions to us except for approximately $5,800 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 $67,610) 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 $25.06 at September 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 September 30, 2004.
In October 2004, $8 of the notes were converted.
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 September 30, 2004, our deferred income tax liabilities
exceeded our deferred income tax assets by $108,082. 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
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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
$120,000, including interest, net of tax benefits, through September 30, 2004.
These amounts have been previously recognized in our consolidated financial
statements as tax liabilities. As of September 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 materially
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 September 30, 2004, we were not aware of any
indemnification agreements 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
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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 September 30,
2004.
In February 2004, Liggett Vector Brands and another cigarette
manufacturer entered into a five year agreement with a subsidiary of the
American Wholesale Marketers Association to support a program to permit tobacco
distributors to secure, on reasonable terms, tax stamp bonds required by state
and local governments for the distribution of cigarettes. Under the agreement,
Liggett Vector Brands has agreed to pay a portion of losses, if any, incurred by
the surety under the bond program, with a maximum loss exposure of $500 for
Liggett Vector Brands. To secure its potential obligations under the agreement,
Liggett Vector Brands has delivered to the subsidiary of the Association a $100
letter of credit and a demand note for $400. Liggett Vector Brands has incurred
no losses to date under this agreement, and we believe the fair value of Liggett
Vector Brands' obligation under the agreement was immaterial at September 30,
2004.
At September 30, 2004, we had outstanding approximately $3,533 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 September 30, 2004, approximately $78,110 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 September 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
$942.
We held investment securities available for sale totaling $17,187 at
September 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
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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, "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
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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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
No 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 September 30, 2004. No securities of ours were
repurchased by us or our affiliated purchasers during the three
months ended September 30, 2004.
Item 6. EXHIBITS
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.
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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: November 9, 2004
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