1
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
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JOINT QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
---------------
BROOKE GROUP LTD.
(Exact name of registrant as specified in its charter)
DELAWARE 1-5759 51-0255124
(State or other jurisdiction of Commission File Number (I.R.S. Employer Identification No.)
incorporation or organization)
BGLS INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-93576 13-3593483
(State or other jurisdiction of Commission File Number (I.R.S. Employer Identification No.)
incorporation or organization)
100 S.E. SECOND STREET
MIAMI, FLORIDA 33131
305/579-8000
(Address, including zip code and telephone number, including area code,
of the principal executive offices)
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Indicate by check mark whether the Registrants (1) have 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 Registrants were required to file such
reports), and (2) have been subject to such filing requirements for the past 90
days. [ X ] Yes [ ] No
At May 14, 1999 Brooke Group Ltd. had 20,943,730 shares of common stock
outstanding, and BGLS Inc. had 100 shares of common stock outstanding, all of
which are held by Brooke Group Ltd.
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BROOKE GROUP LTD.
BGLS INC.
FORM 10-Q
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Brooke Group Ltd./BGLS Inc. Consolidated Financial Statements:
Brooke Group Ltd. Consolidated Balance Sheets as of March 31, 1999 and
December 31, 1998............................................................................. 2
BGLS Inc. Consolidated Balance Sheets as of March 31, 1999 and December 31, 1998.................... 3
Brooke Group Ltd. Consolidated Statements of Operations for the three months ended
March 31, 1999 and March 31, 1998............................................................. 4
BGLS Inc. Consolidated Statements of Operations for the three months ended
March 31, 1999 and March 31, 1998............................................................. 5
Brooke Group Ltd. Consolidated Statement of Stockholders' Equity (Deficit) for the three
months ended March 31, 1999................................................................... 6
BGLS Inc. Consolidated Statement of Stockholder's Equity (Deficit) for the three months
ended March 31, 1999.......................................................................... 7
Brooke Group Ltd. Consolidated Statements of Cash Flows for the three months ended
March 31, 1999 and March 31, 1998............................................................. 8
BGLS Inc. Consolidated Statements of Cash Flows for the three months ended
March 31, 1999 and March 31, 1998............................................................. 9
Notes to Consolidated Financial Statements.......................................................... 10
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations............................................... 32
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................... 42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 43
Item 2. Changes in Securities and Use of Proceeds...................................................... 43
Item 3. Defaults Upon Senior Securities................................................................ 43
Item 6. Exhibits and Reports on Form 8-K............................................................... 43
SIGNATURES............................................................................................. 45
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Item 1. Consolidated Financial Statements
BROOKE GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
-----------------------
March 31, December 31,
1999 1998
--------------------------------
ASSETS:
Current assets:
Cash and cash equivalents ............................................. $ 5,519 $ 7,396
Accounts receivable - trade ........................................... 17,920 15,160
Other receivables ..................................................... 979 924
Inventories ........................................................... 42,740 36,316
Deferred income taxes ................................................. 54,328 59,613
Other current assets .................................................. 4,756 3,151
--------- ---------
Total current assets ............................................ 126,242 122,560
Property, plant and equipment, at cost, less accumulated
depreciation of $35,427 and $33,856 ................................. 108,919 93,504
Intangible assets, at cost, less accumulated amortization
of $21,555 and $21,551 .............................................. 167 171
Other assets ............................................................ 13,017 12,747
--------- ---------
Total assets .................................................... $ 248,345 $ 228,982
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Notes payable and current portion of long-term debt ................... $ 29,077 $ 21,176
Accounts payable ...................................................... 13,552 13,880
Cash overdraft ........................................................ 43 77
Accrued promotional expenses .......................................... 22,117 23,760
Accrued taxes payable ................................................. 12,420 14,854
Accrued interest ...................................................... 7,737 17,189
Proceeds received for options ......................................... 150,000 150,000
Other accrued liabilities ............................................. 32,296 32,505
--------- ---------
Total current liabilities ........................................... 267,242 273,441
Notes payable, long-term debt and other obligations, less current
portion ............................................................... 280,410 262,665
Noncurrent employee benefits ............................................ 20,383 21,701
Other liabilities ....................................................... 60,361 65,350
Commitments and contingencies
Stockholders' equity (deficit):
Preferred Stock, par value $1.00 per share, authorized
10,000,000 shares ...................................................
Series G Preferred Stock, 2,184,834 shares, convertible,
participating, cumulative, each share convertible to 1,000
shares of common stock and cash or stock distribution,
liquidation preference of $1.00 per share ...........................
Common stock, par value $0.10 per share, authorized 100,000,000
and 40,000,000 shares, issued 26,498,043 shares, outstanding
20,943,730 shares ................................................... 2,094 2,094
Additional paid-in capital ............................................ 123,041 124,120
Deficit ............................................................... (503,379) (512,182)
Accumulated other comprehensive income ................................ 30,694 24,774
Other ................................................................. (5,028) (5,508)
Less: 5,554,313 shares of common stock in treasury, at cost .......... (27,473) (27,473)
--------- ---------
Total stockholders' equity (deficit) .............................. (380,051) (394,175)
--------- ---------
Total liabilities and stockholders' equity (deficit) .............. $ 248,345 $ 228,982
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
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Item 1. Consolidated Financial Statements - (Continued)
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
March 31 December 31,
1999 1998
--------------------------------
ASSETS:
Current assets:
Cash and cash equivalents .................................................... $ 5,519 $ 7,396
Accounts receivable - trade .................................................. 17,920 15,160
Other receivables ............................................................ 824 755
Inventories .................................................................. 42,740 36,316
Deferred income taxes ........................................................ 54,328 59,613
Other current assets ......................................................... 4,681 2,946
--------- ---------
Total current assets ..................................................... $ 126,012 122,186
Property, plant and equipment, at cost, less accumulated depreciation of
$35,421 and $33,852 .......................................................... 108,899 93,481
Intangible assets, at cost, less accumulated amortization of $21,555 and
$21,551 ...................................................................... 167 171
Other assets ................................................................... 11,878 11,558
--------- ---------
Total assets ............................................................. $ 246,956 $ 227,396
========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT):
Current liabilities:
Notes payable and current portion of long-term debt .......................... $ 29,037 $ 20,955
Accounts payable ............................................................. 13,427 13,746
Cash overdraft ............................................................... 43 63
Due to parent ................................................................ 32,560 32,394
Accrued promotional expenses ................................................. 22,117 23,760
Accrued taxes payable ........................................................ 12,420 14,854
Accrued interest ............................................................. 7,737 17,188
Proceeds received from options ............................................... 150,000 150,000
Other accrued liabilities .................................................... 31,211 31,556
--------- ---------
Total current liabilities ................................................ 298,552 304,516
Notes payable, long-term debt and other obligations, less current portion ...... 280,410 262,665
Noncurrent employee benefits ................................................... 20,383 21,701
Other liabilities .............................................................. 62,768 69,216
Commitments and contingencies
Stockholder's equity (deficit):
Common stock, par value $0.01 per share; 100 shares authorized,
issued and outstanding
Additional paid-in capital ................................................... 69,789 69,297
Deficit ...................................................................... (515,640) (524,773)
Accumulated other comprehensive income ....................................... 30,694 24,774
--------- ---------
Total stockholder's equity (deficit) ..................................... (415,157) (430,702)
--------- ---------
Total liabilities and stockholder's equity (deficit) ..................... $ 246,956 $ 227,396
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
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Item 1. Consolidated Financial Statements - (Continued)
BROOKE GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended
--------------------------------
March 31, March 31,
1999 1998
--------------------------------
Revenues* .................................................. $ 108,409 $ 84,803
Cost of goods sold* ........................................ 41,427 41,656
------------ ------------
Gross profit ............................................... 66,982 43,147
Operating, selling, administrative and general expenses .... 44,837 35,604
------------ ------------
Operating income ........................................... 22,145 7,543
Other income (expenses):
Interest income ........................................ 60 65
Interest expense ....................................... (14,988) (20,786)
Equity in loss of affiliate ............................ (7,629) (4,187)
Recognition of deferred gain on sale of assets ......... 7,050
Foreign currency gain .................................. 2,270 79
Other, net ............................................. 375 852
------------ ------------
Income (loss) from continuing operations before income
taxes..................................................... 9,283 (16,434)
Provision for income taxes ................................. 1,729 931
------------ ------------
Income (loss) from continuing operations ................... 7,554 (17,365)
------------ ------------
Gain on discontinued operations in equity investee ......... 1,249
------------ ------------
Net income (loss) .......................................... $ 8,803 $ (17,365)
============ ============
Net income (loss) applicable to common shares .............. $ 8,803 $ (17,365)
============ ============
Per basic common share:
Income (loss) from continuing operations ............... $ 0.36 $ (0.89)
============ ============
Income from discontinued operations .................... $ 0.06
============ ============
Net income (loss) applicable to common shares .......... $ 0.42 $ (0.89)
============ ============
Basic weighted average common shares outstanding ........... 20,943,730 19,465,056
============ ============
Per diluted common share:
Income (loss) from continuing operations ............... $ 0.29 $ (0.89)
============ ============
Income from discontinued operations .................... $ 0.05
============ ============
Net income (loss) applicable to common shares .......... $ 0.34 $ (0.89)
============ ============
Diluted weighted average common shares outstanding ......... 26,020,356 19,465,056
============ ============
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* Revenues and Cost of goods sold include federal excise taxes of $14,038
and $17,918 for the three months ended March 31, 1999 and 1998,
respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
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Item 1. Consolidated Financial Statements - (Continued)
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended
--------------------------
March 31, March 31,
1999 1998
--------------------------
Revenues* .................................................. $ 108,409 $ 84,803
Cost of goods sold* ........................................ 41,427 41,656
--------- ---------
Gross profit ............................................... 66,982 43,147
Operating, selling, administrative and general expenses .... 44,435 35,371
--------- ---------
Operating income ........................................... 22,547 7,776
Other income (expenses):
Interest income ......................................... 60 56
Interest expense ........................................ (16,244) (21,824)
Equity in loss of affiliate ............................. (7,629) (4,187)
Recognition of deferred gain on sale of assets .......... 8,264
Foreign currency gain ................................... 2,270 79
Other, net .............................................. 345 849
--------- ---------
Income (loss) from continuing operations before income taxes 9,613 (17,251)
Provision for income taxes ................................. 1,729 931
--------- ---------
Income (loss) from continuing operations ................... 7,884 (18,182)
--------- ---------
Gain on discontinued operations of equity investee ......... 1,249
--------- ---------
Net income (loss) .......................................... $ 9,133 $ (18,182)
========= =========
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*Revenues and Cost of goods sold include federal excise taxes of $14,038 and
$17,918 for the three months ended March 31, 1999 and 1998, respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
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Item 1. Consolidated Financial Statements - (Continued)
BROOKE GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
-----------------------------------------------------------------------------------
Accumulated
Common Stock Additional Other
------------------- Paid-In Treasury Comprehensive
Shares Amount Capital Deficit Stock Other Income Total
---------- ------------------------------------------------------------------------
Balance, December 31, 1998.................. 20,943,730 $2,094 $124,120 $(512,182) $(27,473) $(5,508) $24,774 $(394,175)
Net income.................................. 8,803 8,803
Unrealized holding gain on
investment in New Valley................. 8,159 8,159
Effect of New Valley capital
transactions............................. (2,239) (2,239)
---------
Total other comprehensive income...... 5,920
---------
Total comprehensive income.................. 14,723
---------
Distributions on common stock............... (1,534) (1,534)
Amortization of deferred compensation....... 455 480 935
---------- ------ -------- --------- -------- ------- ------- ----------
Balance, March 31, 1999..................... 20,943,730 $2,094 $123,041 $(503,379) $(27,473) $(5,028) $30,694 $ (380,051)
========== ====== ======== ========= ======== ======= ======= =========
The accompanying notes are an integral part
of the consolidated financial statements.
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Item 1. Consolidated Financial Statements - (Continued)
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
--------------------------------------------------------------------
Accumulated
Common Stock Additional Other
----------------- Paid-In Comprehensive
Shares Amount Capital Deficit Income Total
-------------------------------------------------------------------
Balance, December 31, 1998........................ 100 $ $69,297 $(524,773) $24,774 $(430,702)
Net income........................................ 9,133 9,133
Unrealized holding gain on
investment in New Valley...................... 8,159 8,159
Effect of New Valley capital transactions....... (2,239) (2,239)
---------
Total other comprehensive income.............. 5,920
---------
Total comprehensive income........................ 15,053
---------
Amortization of deferred compensation............. 492 492
------ ------ ------- --------- ------- ---------
Balance, March 31, 1999........................... 100 $ $69,789 $(515,640) $30,694 $(415,157)
====== ====== ======= ========= ======= =========
The accompanying notes are an integral part
of the consolidated financial statements.
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Item 1. Consolidated Financial Statements - (Continued)
BROOKE GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended
------------------------------
March 31, March 31,
1999 1998
------------------------------
Net cash provided by (used in) operating activities ........ $ 2,571 $(25,984)
-------- --------
Cash flows from investing activities:
Proceeds from sale of business and assets ................ 36 1,217
Capital expenditures ..................................... (19,617) (395)
-------- --------
Net cash (used in) provided by investing activities ........ (19,581) 822
-------- --------
Cash flows from financing activities:
Proceeds from debt ....................................... 4,500
Repayments of debt ....................................... (323) (102)
Borrowings under revolver ................................ 83,986 63,961
Repayments on revolver ................................... (71,319) (58,799)
Decrease in cash overdraft ............................... (34) (45)
Distributions on common stock ............................ (1,358) (900)
Proceeds from participating loan ......................... 11,000
Issuance of common stock ................................. 9,796
-------- --------
Net cash provided by financing activities .................. 15,452 24,911
-------- --------
Effect of exchange rate changes on cash and cash equivalents (319) 79
Net decrease in cash and cash equivalents .................. (1,877) (172)
Cash and cash equivalents, beginning of period ............. 7,396 4,749
-------- --------
Cash and cash equivalents, end of period ................... $ 5,519 $ 4,577
======== ========
The accompanying notes are an integral part
of the consolidated financial statements.
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Item 1. Consolidated Financial Statements - (Continued)
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended
--------------------------------
March 31, March 31,
1999 1998
--------------------------------
Net cash provided by (used in) operating activities ........ $ 1,019 $(17,218)
-------- --------
Cash flows from investing activities:
Proceeds from sale of business and assets ................ 36 1,217
Capital expenditures ..................................... (19,617) (395)
-------- --------
Net cash (used in) provided by investing activities ........ (19,581) 822
-------- --------
Cash flows from financing activities:
Proceeds from debt ....................................... 4,500
Repayments of debt ....................................... (143) (102)
Borrowings under revolver ................................ 83,986 63,961
Repayments on revolver ................................... (71,319) (58,799)
Decrease (increase) in cash overdraft .................... (20) 47
Proceeds from participating loan ......................... 11,000
-------- --------
Net cash provided by financing activities .................. 17,004 16,107
-------- --------
Effect of exchange rate changes on cash and cash equivalents (319) 79
Net decrease in cash and cash equivalents .................. (1,877) (210)
Cash and cash equivalents, beginning of period ............. 7,396 4,749
-------- --------
Cash and cash equivalents, end of period ................... $ 5,519 $ 4,539
======== ========
The accompanying notes are an integral part
of the consolidated financial statements.
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BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. PRINCIPLES OF REPORTING
The consolidated financial statements of Brooke Group Ltd. (the
"Company") include the consolidated statements of its wholly-owned
subsidiary, BGLS Inc. ("BGLS"). The consolidated statements of BGLS
include the accounts of Liggett Group Inc. ("Liggett"), Brooke
(Overseas) Ltd. ("BOL"), New Valley Holdings, Inc. ("NV Holdings"),
Liggett-Ducat Ltd. ("Liggett-Ducat") and other less significant
subsidiaries. Liggett is engaged primarily in the manufacture and sale
of cigarettes, principally in the United States. Liggett-Ducat is
engaged in the manufacture and sale of cigarettes in Russia. All
significant intercompany balances and transactions have been
eliminated.
The interim consolidated financial statements of the Company and BGLS
are unaudited and, in the opinion of management, reflect all
adjustments necessary (which are normal and recurring) to present
fairly the Company's and BGLS' 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
and BGLS' Annual Report on Form 10-K, as amended, for the year ended
December 31, 1998, 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.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities and
the reported amounts of revenues and expenses. Actual results could
differ from those estimates.
Certain amounts in the 1998 consolidated financial statements have
been reclassified to conform to the 1999 presentation.
LIQUIDITY:
The Company's anticipated sources of liquidity for 1999 include, among
other things, proceeds from the exercise of an option in an entity to
which a subsidiary of Liggett will contribute certain trademarks (the
"Marks") and the distribution of loan proceeds from the entity (refer
to Note 2), additional debt and/or equity financing, management fees
and tax sharing and other payments from Liggett and certain funds
available from New Valley Corporation ("New Valley") subject to
limitations imposed by BGLS' indenture agreements. Liggett's and New
Valley's ability to make such payments is subject to risks and
uncertainties attendant to their businesses. (Refer to Notes 3 and 8.)
New Valley may also 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.
Liggett has a $40,000 revolving credit facility expiring March 8, 2000
(the "Facility"), under which $6,793 was outstanding and $12,990 was
available at March 31, 1999.
Liggett-Ducat is in the process of constructing a new tobacco factory
in Moscow, Russia, currently scheduled to be operational in June 1999.
The remaining construction costs and equipment required
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BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
for the new factory will be financed primarily by equipment lease
financing currently in place and loans from banks. (Refer to Note 4.)
EARNINGS PER SHARE:
For the three months ended March 31, 1999, 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.
For the three months ended March 31, 1998, stock options, warrants and
contingent shares (both vested and non-vested) were excluded from the
calculation of diluted per share results because their effect was
accretive.
COMPREHENSIVE INCOME:
Comprehensive income is a component of stockholders' equity and
includes the Company's net income and other comprehensive income such
as the proportionate interest in New Valley's capital transactions,
unrealized gains and losses on investment securities and minimum
pension liability adjustments. For the three months ended March 31,
1999, total comprehensive income was $14,723. For the three months
ended March 31, 1998, the total comprehensive loss was $13,179.
2. PHILIP MORRIS BRAND TRANSACTION
On November 20, 1998, the Company and Liggett entered into a
definitive agreement with Philip Morris Incorporated ("PM") which
provided for PM to purchase options in an entity which will hold three
cigarette brands, L&M, Chesterfield and Lark (the "Marks"), held by
Liggett's subsidiary, Eve Holdings Inc. ("Eve"). As contemplated by
the agreement, Liggett and PM entered into additional agreements
(collectively, the "PM Agreements") on January 12, 1999 to effectuate
the transactions.
Under the terms of the PM Agreements, Eve will contribute the Marks to
Brands LLC ("LLC"), a newly-formed limited liability company, in
exchange for 100% of two classes of LLC interests, the Class A Voting
Interest (the "Class A Interest") and the Class B Redeemable Nonvoting
Interest (the "Class B Interest"). PM acquired two options to purchase
such interests (the "Class A Option" and the "Class B Option"). On
December 2, 1998, PM paid Eve a total of $150,000 for such options,
$5,000 for the Class A Option and $145,000 for the Class B Option. The
payments were used to fund the redemption of the Liggett Notes on
December 28, 1998.
The Class A Option entitles PM to purchase the Class A Interest for
$10,100. The statutory waiting period under the Hart-Scott-Rodino Act
regarding the exercise by PM of the Class A Option expired on February
12, 1999. On March 19, 1999, PM exercised the Class A Option with the
closing scheduled for no later than June 10, 1999 (currently scheduled
to close May 24, 1999), subject to customary closing conditions.
The Class B Option will entitle PM to purchase the Class B Interest
for $139,900. The Class B Option will be exercisable during the 90-day
period beginning on December 2, 2008, with PM being entitled to extend
the 90-day period for up to an additional six months under certain
circumstances. The Class B Interest will also be redeemable by the LLC
for $139,900 during the same period the Class B Option may be
exercised.
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BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
The LLC will seek to borrow $134,900 (the "Loan") from a lending
institution. The Loan will be guaranteed by Eve and collateralized by
a pledge by the LLC of the Marks and of the LLC's interest in the
trademark license agreement (discussed below) and by a pledge by Eve
of its Class B Interest. In connection with the closing of the Class A
Option, the LLC will distribute the Loan proceeds to Eve with respect
to its Class B Interest. The cash exercise price of the Class B Option
and the LLC's redemption price will be reduced by the amount
distributed to Eve. Upon PM's exercise of the Class B Option or the
LLC's exercise of its redemption right, PM or the LLC, as relevant,
will be required to procure Eve's release from its guaranty. The Class
B Interest will be entitled to a guaranteed payment of $500 each year,
with the Class A Interest allocated all remaining LLC income or loss.
The LLC will grant PM an exclusive license of the Marks for an 11-year
term at an annual royalty based on sales of cigarettes under the
Marks, subject to a minimum annual royalty payment equal to the annual
debt service obligation on the Loan plus $1,000.
If PM fails to exercise the Class B Option, Eve will have an option to
put its Class B Interest to PM, or PM's designees (the "Eve Put
Option"), at a put price that is $5,000 less than the exercise price
of the Class B Option (and includes PM's procuring Eve's release from
its Loan guarantee). The Eve Put Option is exercisable at any time
during the 90-day period beginning March 2, 2010.
If the Class B Option, the LLC's redemption right and the Eve Put
Option expire unexercised, the holder of the Class B Interest will be
entitled to convert the Class B Interest, at its election, into a
Class A Interest with the same rights to share in future profits and
losses, the same voting power and the same claim to capital as the
entire existing outstanding Class A Interest, i.e., a 50% LLC
interest.
The $150,000 in proceeds received from the sale of the Class A and B
Options is presented as a liability on the consolidated balance sheet
until the closing of the exercise of the Class A Option and the
distribution of the Loan proceeds which is scheduled to occur during
the second quarter of 1999. Upon such closing, PM will obtain control
of the LLC, and the Company anticipates, based on the expected
structure of the transactions, to recognize a gain in its consolidated
financial statements to the extent of the total cash proceeds received
from the payment of the option fees, the exercise of the Class A
Option and the distribution of the Loan proceeds.
3. INVESTMENT IN NEW VALLEY CORPORATION
At March 31, 1999 and December 31, 1998, the Company's investment in
New Valley consisted of an approximate 42% voting interest. At March
31, 1999 and December 31, 1998, the Company owned 57.7% of the
outstanding $15.00 Class A Increasing Rate Cumulative Senior Preferred
Shares ($100 Liquidation Value), $.01 par value (the "Class A
Preferred Shares"), 9.0% of the outstanding $3.00 Class B Cumulative
Convertible Preferred Shares ($25 Liquidation Value), $.10 par value
(the "Class B Preferred Shares"), and 41.7% of New Valley's common
shares, $.01 par value (the "Common Shares").
The Class A Preferred Shares and the Class B Preferred Shares are
accounted for as debt and equity securities, respectively, pursuant to
the requirements of SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities", and are classified as
available-for-sale. The
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BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Common Shares are accounted for pursuant to APB No. 18, "The Equity
Method of Accounting for Investments in Common Stock".
The Company determines the fair value of the Class A Preferred Shares
and Class B Preferred Shares based on the quoted market price. Through
September 1996, earnings on the Class A Preferred Shares were
comprised of dividends accrued during the period and the accretion of
the difference between the Company's basis and their mandatory
redemption price. During the quarter ended September 30, 1996, the
decline in the market value of the Class A Preferred Shares, the
dividend received on the Class A Preferred Shares and the Company's
equity in losses incurred by New Valley caused the carrying value of
the Company's investment in New Valley to be reduced to zero.
Beginning in the fourth quarter of 1996, the Company suspended the
recording of its earnings on the dividends accrued and the accretion
of the difference between the Company's basis in the Class A Preferred
Shares and their mandatory redemption price.
The Company's and BGLS' investment in New Valley at March 31, 1999 is
summarized below:
Number of Fair Carrying
Shares Value Amount
--------- ------- --------
Class A Preferred Shares....... 618,326 $51,939 $ 51,939
Class B Preferred Shares....... 250,885 847 847
Common Shares.................. 3,989,710 1,621 (52,786)
------- --------
$54,407 $ 0
======= ========
In November 1994, New Valley's First Amended Joint Chapter 11 Plan of
Reorganization, as amended ("Joint Plan"), was confirmed by order of
the United States Bankruptcy Court for the District of New Jersey and
on January 18, 1995, New Valley emerged from bankruptcy reorganization
proceedings and completed substantially all distributions to creditors
under the Joint Plan. Pursuant to the Joint Plan, among other things,
the Class A Preferred Shares, the Class B Preferred Shares, the Common
Shares and other equity interests were reinstated and retained all of
their legal, equitable and contractual rights.
The Class A Preferred Shares of New Valley are required to be redeemed
on January 1, 2003 for $100.00 per share plus dividends accrued to the
redemption date. The shares are redeemable, at any time, at the option
of New Valley, at $100.00 per share plus accrued dividends. The
holders of Class A Preferred Shares are entitled to receive a
quarterly dividend, as declared by the Board of Directors, payable at
the rate of $19.00 per annum. At March 31, 1999, the accrued and
unpaid dividends arrearage was $234,581 ($218.94 per share).
Holders of the Class B Preferred Shares are entitled to receive a
quarterly dividend, as declared by the Board, at a rate of $3.00 per
annum. At March 31, 1999, the accrued and unpaid dividends arrearage
was $172,905 ($61.96 per share).
-13-
15
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Summarized financial information for New Valley as of March 31, 1999
and December 31, 1998 and for the three ended March 31, 1998 and 1998
follows:
March 31, December 31,
1999 1998
--------- ------------
Current assets, primarily cash and marketable
securities .................................... $ 70,851 $ 91,451
Non-current assets ............................... 183,787 181,271
Current liabilities .............................. 66,975 83,581
Non-current liabilities .......................... 83,001 78,251
Redeemable preferred shares ...................... 332,198 316,202
Shareholders' deficit ............................ (227,536) (205,312)
Three Months Ended
-----------------------
March 31, March 31,
1999 1998
--------- ----------
Revenues ............................................. $ 22,770 $ 33,840
Costs and expenses ................................... 28,917 34,260
(Loss) income from continuing operations ............. (5,682) 157
Gain from discontinued operations .................... 4,100
Net loss applicable to common shares(A) .............. (23,801) (18,675)
(A) Considers all preferred accrued dividends, whether or not
declared.
In February 1998, New Valley and Apollo Real Estate Investment Fund
III, L.P. ("Apollo") organized Western Realty Development LLC
("Western Realty Ducat") to make real estate and other investments in
Russia. In connection with the formation of Western Realty Ducat, New
Valley agreed, among other things, to contribute the real estate
assets of BrookeMil Ltd. ("BML"), including Ducat Place II and the
site for Ducat Place III, to Western Realty Ducat and Apollo agreed to
contribute up to $58,750, including the investment in Western Realty
Repin discussed below. Through March 31, 1999, Apollo had funded
$36,529 of its investment in Western Realty Ducat.
The ownership and voting interests in Western Realty Ducat will be
held equally by Apollo and New Valley. Apollo will be entitled to a
preference on distributions of cash from Western Realty Ducat to the
extent of its investment ($40,000), together with a 15% annual rate of
return, and New Valley will then be entitled to a return of $20,000 of
BML-related expenses incurred and cash invested by New Valley since
March 1, 1997, together with a 15% annual rate of return; subsequent
distributions will be made 70% to New Valley and 30% to Apollo.
Western Realty Ducat will be managed by a Board of Managers consisting
of an equal number of representatives chosen by Apollo and New Valley.
All material corporate transactions by Western Realty Ducat generally
require the unanimous consent of the Board of Managers. Accordingly,
New Valley has accounted for its non-controlling interest in Western
Realty Ducat using the equity method of accounting.
New Valley recorded its basis in the investment in Western Realty
Ducat in the amount of $60,169 based on the carrying value of assets
less liabilities transferred. There was no difference between the
carrying value of the investment and New Valley's proportionate
interest in the underlying value of net assets of Western Realty
Ducat. New Valley recognizes losses incurred by Western Realty
-14-
16
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Ducat to the extent that cumulative earnings of Western Realty Ducat
are not sufficient to satisfy Apollo's preferred return.
Western Realty Ducat will seek to make additional real estate and
other investments in Russia. Western Realty Ducat has made a $30,000
participating loan to, and payable out of a 30% profits interest in, a
company organized by BOL which, among other things, acquired an
interest in a new factory being constructed on the outskirts of Moscow
by a subsidiary of BOL. (Refer to Note 4.)
In June 1998, New Valley and Apollo organized Western Realty Repin LLC
("Western Realty Repin") to make a $25,000 participating loan (the
"Repin Loan") to BML. The proceeds of the loan will be used by BML for
the acquisition and preliminary development of two adjoining sites
totaling 10.25 acres (the "Kremlin Sites") located in Moscow across
the Moscow River from the Kremlin. BML, which is planning the
development of a 1.1 million sq. ft. hotel, office, retail and
residential complex on the Kremlin Sites, owned 95.29% of one site and
52% of the other site at March 31, 1999. Apollo will be entitled to a
preference on distributions of cash from Western Realty Repin to the
extent of its investment ($18,750) together with a 20% annual rate of
return, and New Valley will then be entitled to a return of its
investment ($6,250), together with a 20% annual rate of return;
subsequent distributions will be made 50% to New Valley and 50% to
Apollo. Western Realty Repin will be managed by a Board of Managers
consisting of an equal number of representatives chosen by Apollo and
New Valley. All material corporate transactions by Western Realty
Repin will generally require the unanimous consent of the Board of
Managers.
Through March 31, 1999, Western Realty Repin has advanced $25,000 (of
which $18,773 was funded by Apollo) under the Repin Loan to BML. The
Repin Loan, which bears no fixed interest, is payable only out of 100%
of the distributions, if made, by the entities owning the Kremlin
Sites to BML. Such distributions shall be applied first to pay the
principal of the Repin Loan and then as contingent participating
interest on the Repin Loan. Any rights of payment on the Repin Loan
are subordinate to the rights of all other creditors of BML. BML used
a portion of the proceeds to repay New Valley for certain expenditures
on the Kremlin Sites previously incurred. The Repin Loan is due and
payable upon the dissolution of BML and is collateralized by a pledge
of New Valley's shares of BML.
As of March 31, 1999, BML had invested $19,621 in the Kremlin sites
and held $3,525, in cash, which was restricted for future investment.
In connection with the acquisition of its interest in one of the
Kremlin Sites, BML has agreed with the City of Moscow to invest an
additional $6,000 (which has been funded) in 1999 and $22,000 in 2000
in the development of the property.
The development of Ducat Place III and the Kremlin Sites will require
significant amounts of debt and other financing. New Valley is
actively pursuing various financing alternatives on behalf of Western
Realty Ducat and BML. However, in light of the recent economic turmoil
in Russia, no assurance can be given that such financing will be
available on acceptable terms. Failure to obtain sufficient capital
for the projects would force Western Realty Ducat and BML to curtail
or delay the planned development of Ducat Place III and the Kremlin
Sites.
Proposed Recapitalization Plan:
New Valley has submitted for approval of its shareholders at its 1999
annual meeting, which will be held on May 21, 1999, a proposed
recapitalization of its capital stock (the "Recapitalization Plan").
-15-
17
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Under the Recapitalization Plan, each of New Valley's outstanding
Class A Preferred Shares would be reclassified and changed into 20
Common Shares and one Warrant to purchase Common Shares (the
"Warrants"). Each of the Class B Preferred Shares would be
reclassified and changed into one-third of a Common Share and five
Warrants. The existing Common Shares would be reclassified and changed
into one-tenth of a Common Share and three-tenths of a Warrant. The
number of authorized Common Shares would be reduced from 850,000,000
to 100,000,000. The Warrants to be issued as part of the
Recapitalization Plan would have an exercise price of $12.50 per share
subject to adjustment in certain circumstances and be exercisable for
five years following the effective date of New Valley's Registration
Statement covering the underlying Common Shares. The Warrants would
not be callable by New Valley for a three-year period. Upon completion
of the Recapitalization Plan, New Valley will apply for listing of the
Common Shares and Warrants on NASDAQ. Completion of the
Recapitalization Plan is subject to, among other things, approval by
the required holders of the various classes of New Valley's shares.
The Company has agreed to vote all of its shares in New Valley in
favor of the Recapitalization Plan. As a result of the
Recapitalization Plan and assuming no warrant holder exercises its
warrants, the Company will increase its ownership of the outstanding
Common Shares of New Valley from 42.3% to 55.1% and its total voting
power from 42.3% to 55.1%. New Valley would become part of the
Company's consolidated group for financial statement purposes.
4. INVESTMENT IN BROOKE (OVERSEAS) LTD.
At March 31, 1999, BOL owned approximately 99.9% of the stock of
Liggett-Ducat through its subsidiary, Western Tobacco Investments LLC
("Western Tobacco"). (Refer to Note 7 for information concerning
pledges of interests in Western Tobacco.)
Liggett-Ducat is currently completing construction of a new cigarette
factory on the outskirts of Moscow. Production at Liggett-Ducat's
existing factory ceased in March 1999, with production scheduled to
start in the new factory in mid-1999. The remaining liability under
the factory construction contract, as amended, at March 31, 1999 is
approximately $2,500. Equipment purchase agreements in place at March
31, 1999 total $35,846, of which $29,438 is being financed by the
manufacturers.
Western Realty Ducat has made a $30,000 participating loan to Western
Tobacco which holds BOL's interest in Liggett-Ducat and the new
factory. The loan, which bears no fixed interest, is payable only out
of 30% of distributions, if any, made by Western Tobacco to BOL. After
the prior payment of debt service on loans to finance the construction
of the new factory, 30% of distributions from Western Tobacco to BOL
will be applied first to pay the principal of the loan and then as
contingent participating interest on the loan. Any rights of payment
on the loan are subordinate to the rights of all other creditors of
Western Tobacco. For the period ended March 31, 1999, a preference
requirement equal to 30% of Western Tobacco's net income, $1,002, has
been charged to interest expense. The loan is classified in other
long-term liabilities on the consolidated balance sheet at March 31,
1999. (Refer to Note 3.)
In connection with the sale by BOL of the common shares of BML to New
Valley in 1997, a portion of the gain was deferred in recognition of
the fact that the Company retains an interest in BML through its 42%
equity ownership of New Valley and that a portion of the property sold
(the site of the third
-16-
18
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
phase of the Ducat Place real estate project being developed by BML,
which was used by Liggett-Ducat for its cigarette factory operation)
was subject to a put option held by New Valley. The option expired
when Liggett-Ducat ceased factory operations at the site in March
1999. The Company recognized that portion of the deferred gain,
$7,050, in March 1999.
In 1998, the Russian Federation entered a period of economic
instability. The impact includes, but is not limited to, a steep
decline in prices of domestic debt and equity securities, a severe
devaluation of the currency, a moratorium on foreign debt repayments,
an increasing rate of inflation and increasing rates on government and
corporate borrowings. The return to economic stability is dependent to
a large extent on the effectiveness of the fiscal measures taken by
government and other actions beyond the control of companies operating
in the Russian Federation. The operations of Liggett-Ducat may be
significantly affected by these factors for the foreseeable future.
5. INVENTORIES
Inventories consist of:
March 31, December 31,
1999 1998
--------- ------------
Leaf tobacco ..................................... $ 10,884 $ 13,882
Other raw materials .............................. 5,445 4,629
Work-in-process .................................. 2,481 2,001
Finished goods ................................... 23,209 15,446
Replacement parts and supplies ................... 4,195 4,130
-------- --------
Inventories at current cost ...................... 46,214 40,088
LIFO adjustments ................................. (3,474) (3,772)
-------- --------
$ 42,740 $ 36,316
======== ========
At March 31, 1999, Liggett and Liggett-Ducat had leaf tobacco purchase
commitments of approximately $4,754 and $11,560, respectively.
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
March 31, December 31,
1999 1998
--------- ------------
Land and improvements ............................ $ 412 $ 412
Buildings ........................................ 5,823 5,823
Machinery and equipment .......................... 60,732 54,144
Construction-in-progress ......................... 77,379 66,981
--------- --------
144,346 127,360
Less accumulated depreciation .................... (35,427) (33,856)
--------- --------
$ 108,919 $ 93,504
========= ========
Equipment purchase commitments for $3,011 were outstanding at BOL at
March 31, 1999.
-17-
19
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
7. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
March 31, December 31,
1999 1998
--------- ------------
15.75% Series B Senior Secured Notes due 2001,
net of unamortized discount of $15,449 and $17,374 ...... $ 217,415 $215,490
Deferred interest on 15.75% Series B Senior Secured
Notes due 2001 .......................................... 34,602 24,985
Liggett:
Revolving credit facility ................................... 6,793 2,538
Note payable ................................................ 4,475
BOL:
Foreign credit facilities ................................... 19,737 11,600
Notes payable ............................................... 25,475 28,057
Other ....................................................... 990 1,171
--------- --------
Total notes payable, long-term debt and other obligations ... 309,487 283,841
Less:
Current maturities ...................................... 29,077 21,176
--------- --------
Amount due after one year ................................... $ 280,410 $262,665
========= ========
15.75% Series B Senior Secured Notes Due 2001 - BGLS:
On March 2, 1998, the Company entered into an agreement with AIF II,
L.P. and an affiliated investment manager on behalf of a managed
account (together the "Apollo Holders"), who held approximately 41.8%
of the $232,864 principal amount of the 15.75% Series B Senior Secured
Notes (the "Notes") then outstanding. The Apollo Holders (and any
transferees) agreed to defer the payment of interest on the Notes held
by them, commencing with the interest payment that was due July 31,
1997, which they had previously agreed to defer, through the interest
payment due July 31, 2000. The deferred interest payments will be
payable at final maturity of the Notes on January 31, 2001 or upon an
event of default under the Indenture for the Notes. In connection with
the agreement, the Company pledged 50.1% of Western Tobacco to
collateralize the Notes held by the Apollo Holders (and any
transferees).
In connection with the March 2, 1998 agreement with the Apollo
Holders, the Company issued to the Apollo Holders a five-year warrant
to purchase 2,000,000 shares of the Company's common stock at a price
of $5.00 per share. The Apollo Holders were also issued a second
warrant expiring October 31, 2004 to purchase an additional 2,150,000
shares of the Company's common stock at a price of $0.10 per share.
The second warrant will become exercisable on October 31, 1999, and
the Company will have the right under certain conditions prior to that
date to substitute for that warrant a new warrant for 9.9% of the
common stock of Liggett.
-18-
20
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Based on the fair value of the equity instruments given to the holders
of the debt, and the difference between the fair value of the modified
debt and the carrying value of the debt held by the Apollo Holders
prior to the transaction, no gain or loss was recorded on the
transaction. The fair value of the equity instruments was estimated
based on the Black-Scholes option pricing model and the following
assumptions: volatility of 77%, risk-free interest rate of 6%,
expected life of five to seven years and a dividend rate of 0%.
Imputed interest of approximately $23,000 is being accreted over the
term of the modified debt based on its recorded fair value.
On February 17, 1999, BGLS entered into an agreement with a third
party to purchase, during the second quarter of 1999, approximately
$31,139 principal amount of the Notes, originally held by the Apollo
Holders and subject to the standstill agreement. The purchase price is
95% of the principal amount of the notes and the accrued interest
thereon. Such purchase is contingent upon receipt by the Company of
approximately $145,000 (in addition to the $150,000 option fee paid in
December 1998) on terms substantially consistent with the transactions
contemplated by the PM Agreements. (Refer to Note 2.)
In April 1999, the Company agreed with a third party to purchase
during the second quarter 1999, approximately $3,697 of the BGLS
Notes. The purchase price is 98% of the principal amount of the notes
and the accrued interest thereon. BGLS will fund both purchases with
tax sharing payments from Liggett.
The Notes are collateralized by substantially all of BGLS' assets,
including a pledge of BGLS' equity interests in Liggett, BOL and NV
Holdings as well as a pledge of all of the New Valley securities held
by BGLS and NV Holdings. The Notes Indenture contains certain
covenants, which among other things, limit the ability of BGLS to make
distributions to the Company to $6,000 per year ($12,000 if less than
50% of the Notes remain outstanding), limit additional indebtedness of
BGLS to $10,000, limit guaranties of subsidiary indebtedness by BGLS
to $50,000, and restrict certain transactions with affiliates that
exceed $2,000 in any year subject to certain exceptions which include
payments to the Company not to exceed $6,500 per year for permitted
operating expenses, payment of the Chairman's salary and bonus and
certain other expenses, fees and payments. In addition, the Indenture
contains certain restrictions on the ability of the Chairman and
certain of his affiliates to enter into certain transactions with, and
receive payments above specified levels from, New Valley. The Notes
may be redeemed, in whole or in part, through December 31, 1999, at a
price of 101% of the principal amount and thereafter at 100%. Interest
is payable at the rate of 15.75% per annum on January 31 and July 31
of each year.
Revolving Credit Facility - Liggett:
Liggett entered into the Facility for $40,000 with a syndicate of
commercial lenders in 1994 which is collateralized by all inventories
and receivables of Liggett. At March 31, 1999, $12,990 was available
under the Facility based on eligible collateral. Borrowings under the
Facility, whose interest is calculated at a rate equal to 1.5% above
the Philadelphia National Bank's prime rate, bore a rate of 9.25% at
March 31, 1999. The Facility requires Liggett's compliance with
certain financial and other covenants including restrictions on the
payment of cash dividends and distributions by Liggett. In addition,
the Facility, as amended, imposes requirements with respect to
Liggett's permitted maximum adjusted net worth (not to fall
-19-
21
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
below a deficit of $195,000 as computed in accordance with the
agreement, this computation was $146,239 at March 31, 1999) and net
working capital (not to fall below a deficit of $17,000 as computed in
accordance with the agreement, this computation was $4,466 at March
31, 1999).
Equipment Loan - Liggett:
In January 1999, Liggett purchased equipment for $5,750 and borrowed
$4,500 to fund the purchase from a third party. The loan, which is
collateralized by the equipment and guaranteed by BGLS and the Company,
is payable in 60 monthly installments of $56 including annual interest
of 7.67% with a final payment of $2,550.
Foreign Loans:
At March 31, 1999, Liggett-Ducat had various credit facilities under
which approximately $19,700 was outstanding. One, for $10,000, expired
in May 1999 but was extended for one year at an interest rate of 25%.
The second, for $5,000, expires in December 1999. The interest rate is
20%. The remaining facilities, denominated in rubles (approximately
$7,200 at the March 31, 1999 exchange rate), have terms of six -
twelve months with interest rates of 52% - 55%. The facilities are
collateralized by factory equipment and tobacco inventory.
Notes Payable - BOL:
In 1997, Western Tobacco entered into two contracts for the purchase
of cigarette manufacturing equipment. A portion (85%) of both
contracts is being financed with promissory notes. One contract is
financed by ten half-year promissory notes payable at the rate of
6.71% per annum interest, with the first note due in May 1999. The
outstanding balance on the contract is $13,677 at March 31, 1999. The
second contract is financed by 60 monthly promissory notes payable at
the rate of 7.5% interest. The first note was paid in December 1998.
The outstanding balance at March 31, 1999 is $8,250. The Company also
has a promissory note for $1,514 at March 31, 1999 covering deposits
for equipment being purchased for the factory. The note is due March
31, 2000.
On July 29, 1998, the Company borrowed $3,000, subsequently reduced to
$2,034, from an unaffiliated third party with interest at 14% per
annum. The note, which is due on August 1, 1999, is collateralized by
factory equipment. Payments of $50 toward principal and interest are
made monthly, with the remaining principal balance due at maturity.
8. CONTINGENCIES
TOBACCO-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 from cancer and other
adverse health effects alleged to have been caused by cigarette
smoking or by exposure to secondary smoke (environmental tobacco
smoke, "ETS") from cigarettes. These cases are reported hereinafter as
though having been commenced against Liggett (without regard to
whether such cases were actually commenced against the Company 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 four categories: (i)
smoking and health cases alleging personal injury brought on behalf of
individual
-20-
22
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
smokers ("Individual Actions"); (ii) smoking and health cases alleging
personal 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 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 is not quantifiable at this
time. For the three months ended March 31, 1999, Liggett incurred
counsel fees and costs totaling approximately $1,568, compared to
$1,342 for the comparable prior year period.
Individual Actions. As of March 31, 1999, there were approximately 265
cases pending against Liggett, and in most cases the other tobacco
companies, where individual plaintiffs allege injury resulting from
cigarette smoking, addiction to cigarette smoking or exposure to ETS
and seek compensatory and, in some cases, punitive damages. Of these,
89 were pending in Florida, 91 in New York, 29 in Massachusetts and 19
in Texas. The balance of the individual cases were pending in 21
states. There are four individual cases pending where Liggett is the
only named defendant.
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for personal injuries allegedly caused by
cigarette smoking are based on various theories of recovery, including
negligence, gross negligence, special duty, voluntary undertaking,
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, indemnity, market share liability and violations of
deceptive trade practices laws, the Federal Racketeer Influenced and
Corrupt Organization Act ("RICO") and antitrust statutes. In many of
these cases, in addition to compensatory damages, plaintiffs also seek
other forms of relief including 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.
In February 1999, a state court jury in San Francisco awarded $51,500
in damages to a woman who claimed lung cancer from smoking Marlboro
cigarettes made by PM. The award includes $1,500 in compensatory
damages and $50,000 in punitive damages. The court subsequently
reduced the punitive damages award to $25,000.
In March 1999, a state court jury in Portland awarded $80,311 in
damages to the family of a deceased smoker who smoked Marlboro made by
PM. The award includes $79,500 in punitive damages.
Class Actions. As of March 31, 1999, there were approximately 50
actions pending, for which either a class has been certified or
plaintiffs are seeking class certification, where Liggett, among
others, was a named defendant. Two of these cases, Fletcher, et al. v.
Brooke Group Ltd., et al. and Walker, et al. v. Liggett Group Inc., et
al., have been settled by the Company, subject to court approval.
These two settlements are more fully discussed below under the
"Settlements" section.
In October 1991, an action entitled Broin, et al. v. Philip Morris
Incorporated, et al., Circuit Court of the Eleventh Judicial District
in and for Dade County, Florida, was filed against Liggett and others.
-21-
23
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
This case was brought by plaintiffs on behalf of all flight attendants
that worked or are presently working for airlines based in the United
States and who never regularly smoked cigarettes but allege that they have
been damaged by involuntary exposure to ETS. In October 1997, the other
major tobacco companies settled this matter, which settlement provides for
a release of the Company and Liggett. In February 1998, the Circuit Court
approved the settlement, which settlement was affirmed by the Third
District Court of Appeals in March 1999.
In March 1994, an action entitled Castano, et al. v. The American Tobacco
Company Inc., et al., United States District Court, Eastern District of
Louisiana, was filed against Liggett and others. The class action
complaint sought relief for a nationwide class of smokers based on their
alleged addiction to nicotine. In February 1995, the District Court
granted plaintiffs' motion for class certification (the "Class
Certification Order").
In May 1996, the Court of Appeals for the Fifth Circuit reversed the Class
Certification Order and instructed the District Court to dismiss the class
complaint. The Fifth Circuit ruled that the District Court erred in its
analysis of the class certification issues by failing to consider how
variations in state law affect predominance of common questions and the
superiority of the class action mechanism. The appeals panel also held
that the District Court's predominance inquiry did not include
consideration of how a trial on the merits in Castano would be conducted.
The Fifth Circuit further ruled that the "addiction-as-injury" tort is
immature and, accordingly, the District Court could not know whether
common issues would be a "significant" portion of the individual trials.
According to the Fifth Circuit's decision, any savings in judicial
resources that class certification may bring about were speculative and
would likely be overwhelmed by the procedural problems certification
brings. Finally, the Fifth Circuit held that in order to make the class
action manageable, the District Court would be forced to bifurcate issues
in violation of the Seventh Amendment.
The extent of the impact of the Castano decision on tobacco-related class
action litigation is still uncertain, although the decertification of the
Castano class by the Fifth Circuit may preclude other federal courts from
certifying a nationwide class action for trial purposes with respect to
tobacco-related claims. The Castano decision has had to date, however,
only limited effect with respect to courts' decisions regarding narrower
tobacco-related classes or class actions brought in state rather than
federal court. For example, since the Fifth Circuit's ruling, courts in
New York, Louisiana and Maryland have certified "addiction-as-injury"
class actions that covered only citizens in those states. Two class
actions pending in state court in Florida have also been certified, one of
which, the Broin case, was settled in 1997. The Castano decision has had
no measurable impact on litigation brought by or on behalf of single
individual claimants.
Class certification motions are pending in a number of putative class
actions. Class certification has been denied or reversed in 13 actions
while classes remain certified in two cases in Florida and Maryland. A
number of class certification decisions are on appeal.
Governmental Actions. As of March 31, 1999, there were approximately 20
Governmental Actions pending against Liggett. In these proceedings, the
governmental entities seek reimbursement for Medicaid and other health
care expenditures allegedly caused by use of tobacco products. 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
-22-
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BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
claims of negligence, strict liability, breach of express and implied
warranty, violation of a voluntary undertaking or 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.
On January 19, 1999, at the State of the Union Address, President
Clinton announced that the Department of Justice ("DOJ") was preparing
a litigation plan to take the tobacco industry to court to recover
monies that Medicare and other programs allegedly expended to treat
smoking-related illnesses. The effects of this lawsuit cannot be
predicted at this time; however, an adverse verdict could have a
material adverse effect on the Company and Liggett.
Third-Party Payor Actions. As of March 31, 1999, there were
approximately 70 Third-Party Payor Actions pending against Liggett.
The claims in these cases are similar to those in the Governmental
Actions but have been commenced by insurance companies, union health
and welfare trust funds, asbestos manufacturers and others. In April
1998, a group known as the "Coalition for Tobacco Responsibility",
which represents Blue Cross and Blue Shield Plans in more than 35
states, filed federal lawsuits against the industry seeking payment of
health-care costs allegedly incurred as a result of cigarette smoking
and ETS. The lawsuits were filed in Federal District Courts in New
York, Chicago, and Seattle and seek billions of dollars in damages.
The lawsuits allege conspiracy, fraud, misrepresentation and violation
of federal racketeering and antitrust laws as well as other claims. In
January 1999, a federal judge in Seattle dismissed a Third-Party Payor
Action brought by seven Blue Cross/Blue Shield Plans against the
tobacco industry. The court ruled that the insurance providers did not
have standing to bring the lawsuit. However, in February 1999, a
federal judge in the Eastern District of New York denied pleas by the
industry to dismiss the Third-Party Payor Action brought by 24 Blue
Cross/Blue Shield Plans.
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.
Settlements. In March 1996, the Company and Liggett entered into an
agreement, subject to court approval, to settle the Castano class
action tobacco litigation. Under the Castano settlement agreement,
upon final court approval of the settlement, the Castano class would
be entitled to receive up to five percent of Liggett's pretax income
(income before income taxes) each year (up to a maximum of $50,000 per
year) for the next 25 years, subject to certain reductions provided
for in the agreement and a $5,000 payment from Liggett if the Company
or Liggett fail to consummate a merger or similar transaction with
another non-settling tobacco company defendant within three years of
the date of settlement. The Company and Liggett have the right to
terminate the Castano settlement under certain circumstances. In March
1996, the Company, the Castano Plaintiffs Legal Committee and the
Castano plaintiffs entered into a letter agreement. According to the
terms of the letter agreement, for the period ending nine months from
the date of Final Approval (as defined in the letter), if granted, of
the Castano settlement or, if earlier, the completion by the Company
or Liggett of a combination with any defendant in Castano, except PM,
the Castano plaintiffs and their counsel agree not to enter into any
more favorable settlement agreement with any Castano defendant which
would reduce the terms of the Castano settlement agreement. If the
Castano plaintiffs or their
-23-
25
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
counsel enter into any such settlement during this period, they shall
pay the Company $250,000 within 30 days of the more favorable
agreement and offer the Company and Liggett the option to enter into a
settlement on terms at least as favorable as those included in such
other settlement. The letter agreement further provides that during
the same time period, and if the Castano settlement agreement has not
been earlier terminated by the Company in accordance with its terms,
the Company and its affiliates will not enter into any business
transaction with any third party which would cause the termination of
the Castano settlement agreement. If the Company or its affiliates
enter into any such transaction, then the Castano plaintiffs will be
entitled to receive $250,000 within 30 days from the transacting
party. In May 1996, the Castano Plaintiffs Legal Committee filed a
motion with the United States District Court for the Eastern District
of Louisiana seeking preliminary approval of the Castano settlement.
In September 1996, shortly after the class was decertified, the
Castano plaintiffs withdrew the motion for approval of the Castano
settlement.
In March 1996, March 1997 and March 1998, the Company and Liggett
entered into settlements of tobacco-related litigation with the
Attorneys General of a total of 45 states and territories. The
settlements released the Company and Liggett from all tobacco-related
claims including claims for health care cost reimbursement and claims
concerning sales of cigarettes to minors.
On November 23, 1998, PM, B&W, R.J. Reynolds Tobacco Company ("RJR")
and Lorillard Tobacco Company ("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. As
described below, the Company and Liggett had previous settlements with
a number of these Settling States and also had previously settled
similar claims brought by Florida, Mississippi, Texas and Minnesota.
The MSA is subject to final judicial approval in each of the Settling
States, which approval has been obtained, to date, in 42 states and
territories.
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 in dimension 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 twenty 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.
-24-
26
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Pursuant to the MSA, Liggett has no payment obligations unless its
market share exceeds 125% of its 1997 market share (the "Base Share").
In the year following any year in which Liggett's market share does
exceed the Base Share, Liggett will pay on each excess unit an amount
equal (on a per-unit basis) to that paid during such following year by
the OPMs pursuant to the annual and strategic contribution payment
provisions of the MSA, subject to applicable adjustments, offsets and
reductions. Pursuant to the annual and strategic contribution payment
provisions of the MSA, the OPMs (and Liggett to the extent its market
share exceeds the Base Share) will pay the following annual amounts
(subject to certain adjustments):
Year Amount
---- ------
2000 $4,500,000
2001 $5,000,000
2002 - 2003 $6,500,000
2004 - 2007 $8,000,000
2008 - 2017 $8,139,000
2018 and each $9,000,000
year thereafter
These annual payments will be allocated based on relative unit volume
of domestic cigarette shipments. The payment obligations under the MSA
are the several, and not joint, obligations of each Participating
Manufacturer and are not the responsibility of any parent or affiliate
of a Participating Manufacturer.
The MSA replaces Liggett's prior settlements with all states and
territories except for Florida, Mississippi, Texas and Minnesota. In
the event the MSA does not receive final judicial approval in any
state or territory, Liggett's prior settlement with that state or
territory, if any, will be revived.
The states of Florida, Mississippi, Texas and Minnesota, 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
nations" protection for both the Company and Liggett, the payments due
these states by Liggett (with certain possible exceptions) have been
eliminated. With respect to all non-economic obligations under the
previous settlements, both the Company and Liggett are entitled to the
most favorable provisions as between the MSA and each state's
respective settlement with the other major tobacco companies.
Therefore, Liggett's non-economic obligations to all states and
territories are now defined by the MSA.
In March 1997, Liggett, the Company and a nationwide class of
individuals that allege smoking-related claims filed a mandatory class
settlement agreement in an action entitled Fletcher, et al. v. Brooke
Group Ltd., et al., Circuit Court of Mobile County, Alabama, where the
court granted preliminary approval and preliminary certification of
the class, and in May 1997, a similar mandatory class settlement
agreement was filed in an action entitled Walker, et al. v. Liggett
Group Inc., et al., United States District Court, Southern District of
West Virginia. In July 1998, Liggett, the Company and plaintiffs filed
an amended class action settlement agreement in Fletcher which
agreement was preliminarily approved by the court in December 1998. A
hearing on final approval of the settlement is scheduled for June 3,
1999; however, hearing dates are subject to change. Effectiveness of
the
-25-
27
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
mandatory settlement is conditioned on final court approval of the
settlement. There can be no assurance as to whether, or when, such
court approval will be obtained. Pursuant to the amended agreement,
Liggett is required to pay to the class 7.5% of Liggett's pre-tax
income each year for 25 years, with a minimum annual payment guarantee
of $1,000 over the term of the agreement. The amended agreement does
not set forth a formula with respect to the distribution of settlement
proceeds to the class. If the court issues a final order and judgment
approving the settlement, such an order, the Company anticipates,
would preclude further prosecution by class members of tobacco-related
claims against both Liggett and the Company. Under the Full Faith and
Credit Act, a final judgment entered in a nationwide class action
pending in a state court has a preclusive effect against any class
member with respect to the claims settled and released. As the class
definition in Fletcher encompasses all persons in the United States
who could claim injury as a result of cigarette smoking or ETS and any
third-party payor claimants, it is anticipated that, upon final order
and judgment, all such persons and third-party payor claimants would
be barred from further prosecution of tobacco-related claims against
Liggett and the Company.
The Walker court also granted preliminary approval and preliminary
certification of the nationwide class; however, in August 1997, the
court vacated its preliminary certification of the settlement class,
which decision is currently on appeal. The Walker court relied on the
Supreme Court's decision in Amchem Products Inc. v. Windsor in
reaching its decision to vacate preliminary certification of the
class. In Amchem, the Supreme Court affirmed a decision of the Third
Circuit vacating the certification of a settlement class that involved
asbestos-exposure claims. The Supreme Court held that the proposed
settlement class did not meet the requirements of Rule 23 of the
Federal Rules of Civil Procedure for predominance of common issues and
adequacy of representation. The Third Circuit had held that, although
classes could be certified for settlement purposes, Rule 23's
requirements had to be satisfied as if the case were going to be
litigated. The Supreme Court agreed that the fairness and adequacy of
the settlement are not pertinent to the predominance inquiry under
Rule 23(b)(3), and thus, the proposed class must have sufficient unity
so that absent class members can fairly be bound by decisions of class
representatives.
After the Amchem opinion was issued by the Supreme Court in June 1997,
objectors to Liggett's settlement in Walker moved for decertification.
Although Liggett's settlement in the Walker action is a "limited fund"
class action settlement proceeding under Rule 23(b)(1) and Amchem was
a Rule 23 (b)(3) case, the court in the Walker action, nonetheless,
decertified the Walker class. Applying Amchem to the Walker case, the
District Court, in a decision issued in August 1997, determined that
while plaintiffs in Walker have a common interest in "maximizing the
limited fund available from the defendants," there remained
"substantial conflicts among class members relating to distribution of
the fund and other key concerns" that made class certification
inappropriate.
The Amchem decision's ultimate affect on the viability of both the
Walker and Fletcher settlements remains uncertain given the Fifth
Circuit's recent ruling reaffirming a limited fund class action
settlement in In re Asbestos Litigation ("Ahearn"). In June 1997, the
Supreme Court remanded Ahearn to the Fifth Circuit for consideration
in light of Amchem. On remand, the Fifth Circuit made two decisive
distinctions between Amchem and Ahearn. First, the Ahearn class action
proceeded under Rule 23(b)(1) while Amchem was a Rule 23(b)(3) case,
and second, in Ahearn, there was no allocation or difference in award,
according to nature or severity of injury, as there was in Amchem. The
Fifth Circuit concluded that all members of the class and all class
representatives share common interests and none of the uncommon
questions abounding in Amchem exist. In June 1998, the Supreme Court
granted certiorari to review the Fifth Circuit decision.
-26-
28
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
The Company previously accrued approximately $4,000 for the present
value of the fixed payments under the March 1996 Attorneys General
settlements and $16,902 for the present value of the fixed payments
under the March 1998 Attorneys General settlements. As a result of the
Company's treatment under the MSA, $14,928 of net charges accrued for
the prior settlements were reversed in 1998.
Copies of the various settlement agreements are filed as exhibits to
the Company's Form 10-K and the discussion herein is qualified in its
entirety by reference thereto.
Trials. In July 1998, trial commenced in the Engle, et al. v. Philip
Morris Incorporated, et al., case, a class action pending in Miami
Dade County, Florida, brought on behalf of all Florida residents
allegedly injured by smoking. Plaintiffs seek compensatory and
punitive damages ranging into the billions of dollars, as well as
equitable relief including, but not limited to, a medical fund for
future health care costs, attorneys' fees and court costs. The class
consists of all Florida residents and citizens, and their survivors,
who claim to have suffered, presently suffer or have died from
diseases and medical conditions caused by their addiction to
cigarettes that contain nicotine.
The current trial plan calls for the case to be tried in three
"Phases". Phase One, which is currently underway, involves evidence
concerning certain "common" class issues relating to the plaintiff
class' causes of action. Entitlement to punitive damages will be
decided at the end of Phase One, but no amount will be set at that
time.
If plaintiffs prevail in Phase One, the first two stages of Phase Two
will involve individual determinations of specific causation and other
individual issues regarding entitlement to compensatory damages for
the class representatives. Stage three of Phase Two will involve an
assessment of the amount of punitive damages, if any, that individual
class representatives will be awarded. Stage four of Phase Two will
involve the setting of a percentage or ratio of punitive damages for
absent class members, assuming entitlement was found at the end of
Phase One.
Phase Three of the trial will be held before separate juries to
address absent class members' claims, including issues of specific
causation and other individual issues regarding entitlement to
compensatory damages.
Additional cases are currently scheduled for trial during 1999,
including two Third-Party Payor Actions brought by unions in
Washington (September) and New York (September), and three Class
Actions in Alabama (August), Wisconsin (September) and New York
(November). Also, six Individual Actions are currently scheduled for
trial during 1999. Trial dates, however, are subject to change.
Other Related Matters. A grand jury investigation is being conducted
by the office of the United States Attorney for the Eastern District
of New York (the "Eastern District Investigation") regarding possible
violations of criminal law relating to the activities of The Council
for Tobacco Research - USA, Inc. (the "CTR"). Liggett was a sponsor of
the CTR at one time. In May 1996, Liggett received a subpoena from a
Federal grand jury sitting in the Eastern District of New York, to
which Liggett has responded.
In March 1996, and in each of March, July, October and December 1997,
the Company and/or Liggett received subpoenas from a Federal grand
jury in connection with an investigation by the
-27-
29
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
United States Department of Justice (the "DOJ Investigation")
involving the industry's knowledge of: the health consequences of
smoking cigarettes; the targeting of children by the industry; and the
addictive nature of nicotine and the manipulation of nicotine by the
industry. Liggett has responded to the March 1996, March 1997 and July
1997 subpoenas and is in the process of responding to the October and
December 1997 subpoenas. The Company understands that the Eastern
District Investigation and the DOJ Investigation essentially have been
consolidated into one investigation conducted by the DOJ. The Company
and Liggett are unable, at this time, to predict the outcome of this
investigation.
In April 1998, the Company announced that Liggett had reached an
agreement with the DOJ to cooperate in both the Eastern District
Investigation and the DOJ Investigation. The agreement does not
constitute an admission of any wrongful behavior by Liggett. The DOJ
has not provided immunity to Liggett and has full discretion to act or
refrain from acting with respect to Liggett in the investigation.
In September 1998, Liggett received a subpoena from a federal grand
jury in the Eastern District of Philadelphia investigating possible
antitrust violations in connection with the purchase of tobacco by and
for tobacco companies. Liggett has responded to this subpoena. Liggett
and the Company are unable, at this time, to predict the outcome of
this investigation.
Litigation is subject to many uncertainties, and it is possible that
some of the aforementioned actions could be decided unfavorably
against the Company or Liggett. An unfavorable outcome of a pending
smoking and health case could encourage the commencement of additional
similar litigation. The Company is unable to make a meaningful
estimate with respect to the amount of loss that could result from an
unfavorable outcome of many of the cases pending against the Company,
because 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 flow could be materially adversely
affected by an unfavorable outcome in any such tobacco-related
litigation.
Liggett has been involved in certain environmental proceedings, none
of which, either individually or in the aggregate, rises to the level
of materiality. Liggett's management believes that current operations
are conducted in material compliance with all environmental laws and
regulations. Management is unaware of any material environmental
conditions affecting its existing facilities. Compliance with federal,
state and local provisions regulating the discharge of materials into
the environment, or otherwise relating to the protection of the
environment, has not had a material effect on the capital
expenditures, earnings or competitive position of Liggett.
There are several other proceedings, lawsuits and claims pending
against the Company 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.
-28-
30
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
LEGISLATION AND REGULATION:
In 1993, the United States Environmental Protection Agency ("EPA")
released a report on the respiratory effect of ETS which concludes
that ETS is a known human lung carcinogen in adults and in children,
causes increased respiratory tract disease and middle ear disorders
and increases the severity and frequency of asthma. In June 1993, the
two largest of the major domestic cigarette manufacturers, together
with other segments of the tobacco and distribution industries,
commenced a lawsuit against the EPA seeking a determination that the
EPA did not have the statutory authority to regulate ETS, and that
given the current body of scientific evidence and the EPA's failure to
follow its own guidelines in making the determination, the EPA's
classification of ETS was arbitrary and capricious. Whatever the
outcome of this litigation, issuance of the report may encourage
efforts to limit smoking in public areas. In July 1998, the court
ruled that the EPA made procedural and scientific mistakes when it
declared in its 1993 report that secondhand smoke caused as many as
3,000 cancer deaths a year among nonsmokers.
In February 1996, the United States Trade representative issued an
"advance notice of rule making" concerning how tobaccos imported under
a previously established tobacco rate quota ("TRQ") should be
allocated. Currently, tobacco imported under the TRQ is allocated on a
"first-come, first-served" basis, meaning that entry is allowed on an
open basis to those first requesting entry in the quota year. Others
in the cigarette industry have suggested an "end-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 FDA filed in the Federal Register a Final Rule
(the "FDA Rule") classifying tobacco as a drug, asserting jurisdiction
by the FDA over the manufacture and marketing of tobacco products and
imposing restrictions on the sale, advertising and promotion of
tobacco products. Litigation was commenced in the United States
District Court for the Middle District of North Carolina challenging
the legal authority of the FDA to assert such jurisdiction, as well as
challenging the constitutionality of the rules. The court, after
argument, granted plaintiffs' motion for summary judgment prohibiting
the FDA from regulating or restricting the promotion and advertising
of tobacco products and denied plaintiffs' motion for summary judgment
on the issue of whether the FDA has the authority to regulate access
to, and labeling of, tobacco products. The Fourth Circuit reversed the
district court on appeal and in August 1998 held that the FDA cannot
regulate tobacco products because Congress had not given them the
authority to do so. The Company and Liggett support the FDA Rule and
have begun to phase in compliance with certain of the proposed interim
FDA regulations. See discussions of the Castano and Governmental
Actions settlements above. See also "Subsequent Events" below.
In August 1996, Massachusetts enacted legislation requiring tobacco
companies to publish information regarding the ingredients in
cigarettes and other tobacco products sold in that state. In December
1997, the United States District Court for the District of
Massachusetts enjoined this legislation from going into effect;
however, in December 1997, Liggett began complying with this
legislation by providing ingredient information to the Massachusetts
Department of Public Health. Several other states have enacted, or are
considering, legislation similar to that enacted in Massachusetts.
-29-
31
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
As part of the 1997 budget agreement approved by Congress, federal
excise taxes on a pack of cigarettes, which are currently 24 cents,
would rise 10 cents in the year 2000 and 5 cents more in the year
2002. Additionally, in November 1998, the citizens of California voted
in favor of a 50 cents per pack tax on cigarettes sold in that state.
In addition to the foregoing, there have been a number of other
restrictive regulatory actions, adverse political decisions and other
unfavorable developments concerning cigarette smoking and the tobacco
industry, the effects of which, at this time, the Company is not able
to evaluate.
Subsequent Events: In April 1999, the Supreme Court granted certiorari
to review the Fourth Circuit's decision that the FDA does not have the
authority to regulate access to, and labeling of, tobacco products.
OTHER MATTERS:
In March 1997, a shareholder derivative suit was filed against New
Valley, as a nominal defendant, its directors and the Company in the
Delaware Chancery Court, by a shareholder of New Valley. The suit
alleges that New Valley's purchase in January 1997 of the BML shares
from BOL constituted a self-dealing transaction which involved the
payment of excessive consideration by New Valley. The plaintiff seeks
(i) a declaration that New Valley's directors breached their fiduciary
duties, the Company aided and abetted such breaches and such parties
are therefore liable to New Valley, and (ii) unspecified damages to be
awarded to New Valley. The Company's time to respond to the complaint
has not yet expired. The Company believes that the allegations are
without merit. Although there can be no assurances, management is of
the opinion, after consultation with counsel, that the ultimate
resolution of this matter will not have a material adverse effect on
the Company's consolidated financial position, results of operations
or cash flows.
In September 1998, a lawsuit was commenced against the Company, New
Valley, certain officers, directors and shareholders and others in the
United States District Court, Southern District of Texas, Houston
Division. The defendants have moved to dismiss the case. The court, in
the interim, has stayed all discovery.
-30-
32
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
9. SEGMENT INFORMATION
The Company's business segment is tobacco with reportable segments
being geographic, i.e., the United States and Russia. Information for
the three months ended March 31, 1999 and 1998 follows:
United
States Russia Corporate
Tobacco Tobacco and Other Total
-------- -------- --------- ---------
1999
Net sales ....................... $ 86,047 $ 22,350 $ 12 $ 108,409
Operating income ................ 20,069 1,302 774 22,145
Identifiable assets ............. 77,000 121,812 49,533 248,345
Depreciation and amortization ... 855 798 3 1,656
Capital expenditures ............ 6,369 13,248 19,617
1998
Net sales ....................... $ 65,626 $ 19,154 $ 23 $ 84,803
Operating income (loss) ......... 6,251 1,397 (105) 7,543
Identifiable assets ............. 69,241 50,048 15,144 134,433
Depreciation and amortization ... 1,585 235 82 1,902
Capital expenditures ............ 353 42 395
-31-
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Amounts)
INTRODUCTION
The following discussion provides an assessment of the consolidated
results of operations, capital resources and liquidity of Brooke Group Ltd.
(the "Company") and its subsidiaries and should be read in conjunction with the
Consolidated Financial Statements and notes thereto of the Company and BGLS
Inc. ("BGLS") included elsewhere in this document. BGLS is a wholly owned
subsidiary of the Company. The consolidated financial statements include the
accounts of BGLS, Liggett Group Inc. ("Liggett"), Brooke (Overseas) Ltd.
("BOL"), New Valley Holdings, Inc. ("NV Holdings"), Liggett-Ducat Ltd.
("Liggett-Ducat") and other less significant subsidiaries. The Company holds an
equity interest in New Valley Corporation ("New Valley") through NV Holdings.
(See "Recent Developments - New Valley", below.)
The Company is a holding company for a number of businesses which it
holds through its wholly-owned subsidiary BGLS. Accordingly, a separate
Management's Discussion and Analysis of Financial Condition and Results of
Operations for BGLS is not presented herein as it would not differ materially
from the discussion of the Company's consolidated results of operations,
capital resources and liquidity.
For purposes of this discussion and other consolidated financial
reporting, the Company's significant business segment is tobacco sold in the
United States and Russia for the three months ended March 31, 1999 and March
31, 1998.
RECENT DEVELOPMENTS
THE COMPANY AND LIGGETT
Philip Morris Brand Transaction. On November 20, 1998, the Company and
Liggett entered into a definitive agreement with PM which provided for PM to
purchase options in an entity which will hold three cigarette brands, L&M,
Chesterfield and Lark, held by Liggett's subsidiary, Eve. As contemplated by
the agreement, Liggett and PM entered into the PM Agreements on January 12,
1999 to effectuate the transactions. (See Note 2 to the Company's Consolidated
Financial Statements.)
Under the terms of the PM Agreements, Eve will contribute the Marks to
Brands LLC, a newly-formed limited liability company, in exchange for 100% of
two classes of LLC interests, the Class A Interest and the Class B Interest. PM
acquired two options to purchase such interests, the Class A Option and the
Class B Option. On December 2, 1998, PM paid Eve a total of $150,000 for such
options, $5,000 for the Class A Option and $145,000 for the Class B Option. The
payments were used to fund the redemption of Liggett's 11.50% Series B Senior
Secured Notes and Series C Variable Rate Notes (the "Liggett Notes"), together
with accrued interest, on December 28, 1998.
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BOL
Liggett-Ducat. Liggett-Ducat is currently completing construction of a
new cigarette factory on the outskirts of Moscow. Production at Liggett-Ducat's
existing factory ceased in March 1999, with production scheduled to start at
the new factory in mid-1999.
NEW VALLEY
Western Realty Ducat. In February 1998, New Valley and Apollo
organized Western Realty Ducat to make real estate and other investments in
Russia. In connection with the formation of Western Realty Ducat, New Valley
agreed, among other things, to contribute the real estate assets of BML to
Western Realty Ducat and Apollo agreed to contribute up to $58,750, including
the investment in Western Realty Repin. Western Realty Ducat has made a $30,000
participating loan to, and payable out of a 30% profits interest in Western
Tobacco which was organized by BOL to hold BOL's interests in Liggett-Ducat.
Proposed Recapitalization Plan. New Valley intends to submit a
proposed recapitalization plan to its stockholders at its 1999 annual meeting
of stockholders. The recapitalization plan, if implemented, will have a
significant effect on New Valley's and the Company's financial position and
results of operations. (See Note 3 to the Company's Consolidated Financial
Statements.)
YEAR 2000 COSTS
The "Year 2000 issue" is the result of computer programs that were
written using two digits rather than four digits to define the applicable year.
If the Company's or its subsidiaries' computer programs with date-sensitive
functions are not Year 2000 compliant, they may recognize a date using "00" as
the Year 1900 rather than the Year 2000. This could result in system failure or
miscalculations causing disruption to operations, including, among other
things, an inability to process transactions or engage in similar normal
business activities.
The Company, New Valley and BOL. The Company, New Valley and BOL use
personal computers for all transactions. All such computers and related systems
and software are less than three years old and are Year 2000 compliant. As a
result, the Company, New Valley and BOL believe they are Year 2000 compliant.
Liggett. Liggett utilizes management information systems and software
technology that may be affected by Year 2000 issues throughout its operations.
Liggett has evaluated the costs to implement century date change compliant
systems conversions and is in the process of executing a planned conversion of
its systems prior to the Year 2000. To date, the focus of Year 2000 compliance
and verification efforts has been directed at the implementation of new
customer service, inventory control and financial reporting systems at each of
the three regional Strategic Business Units formed as part of Liggett's
reorganization which began in January 1997. Liggett estimates that
approximately $138 of the expenditures for this reengineering effort related to
Year 2000 compliance, validation and testing. In January of 1998, Liggett
initiated a major conversion of factory accounting, materials management and
information systems at its Durham production facility with upgrades that have
been successfully tested for Year 2000 compliance. This conversion was
completed in November 1998. Program upgrades to Liggett's human resources and
payroll systems are scheduled for completion in July 1999. Enhancements to
Liggett's finished goods inventory system are expected to be completed in
September 1999. It is anticipated that all factory, corporate, field sales and
physical distribution systems will be completed in sufficient time to support
Year 2000 compliance and verification.
Although such costs may be a factor in describing changes in operating
profit in any given reporting period, Liggett currently does not believe that
the anticipated costs of Year 2000
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systems conversions will have a material impact on its future consolidated
results of operations. Based on the progress Liggett has made in addressing
Year 2000 issues and its strategy and timetable to complete its compliance
program, Liggett does not foresee significant risks associated with its Year
2000 initiatives at this time.
External Service Providers. While modifications for Year 2000
compliance by the Company, its subsidiaries and New Valley are proceeding
according to plan and are expected to be completed by 1999, the failure of the
Company's service providers or vendors to resolve their own processing issues
in a timely manner could result in a material financial risk. The most
significant outside service provider is the clearing agent for Ladenburg, a
broker-dealer subsidiary of New Valley. Ladenburg has been informed by its
clearing agent that it has initiated an extensive effort to ensure that it is
Year 2000 compliant and that the clearing agent will conduct system-wide
testing of its Year 2000 software throughout 1999.
It is unclear whether the Russian government and other organizations
who provide significant infrastructure services in Russia have addressed the
Year 2000 problem sufficiently to mitigate potential substantial disruption to
these infrastructure services. The substantial disruption to these services
would have an adverse affect on the operations of Liggett-Ducat. Furthermore,
the current financial crises in Russia could affect the ability of the
government and other organizations to fund Year 2000 compliance programs.
Although the Company and its subsidiaries are in the process of
confirming that their service providers are adequately addressing Year 2000
issues, there can be no complete assurance of success, or that interaction with
other service providers will not impair the Company's or its subsidiaries'
services.
RECENT DEVELOPMENTS IN THE CIGARETTE INDUSTRY
Pricing Activity. List price increases initiated by the industry
during 1998 amounted to $6.35 per carton. In 1998, Liggett announced list price
increases of $.25 per carton in January, $.50 per carton in April, $.50 per
carton in May, $.60 per carton in August and $4.50 per carton in December.
Legislation, Regulation and Litigation. The cigarette industry
continues to be challenged on numerous fronts. New cases continue to be
commenced against Liggett and other cigarette manufacturers. As of March 31,
1999, there were approximately 270 individual suits, 50 purported class actions
and 85 governmental and other third-party payor health care reimbursement
actions pending in the United States in which Liggett was a named defendant. As
new cases are commenced, the costs associated with defending such cases and the
risks attendant to the inherent unpredictability of litigation continue to
increase. Recently, there have been a number of restrictive regulatory actions
from various Federal administrative bodies, including the United States
Environmental Protection Agency ("EPA") and the Food and Drug Administration
("FDA"), 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. The Company is not able to evaluate the effect of these
developing matters on pending litigation or the possible commencement of
additional litigation, but 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 of such tobacco-related
litigation. (See Part II, Item 1, "Legal Proceedings" and Note 8 to the
Company's Consolidated Financial Statements for a description of legislation,
regulation and litigation.)
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The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for personal injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence, gross
negligence, special duty, voluntary undertaking, 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, indemnity, market share liability, and
violations of deceptive trade practices laws, RICO and antitrust statutes. In
many of these cases, in addition to compensatory damages, plaintiffs also seek
other forms of relief including 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, statutes of limitations or repose, equitable defenses such as
"unclean hands" and lack of benefit, failure to state a claim and federal
preemption.
The claims asserted in the third-party payor 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, violation of a voluntary undertaking or 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 the RICO.
In March 1996, March 1997 and March 1998, the Company and Liggett
entered into settlements of tobacco-related litigation with the Attorneys
General of 45 states and territories. The settlements released the Company and
Liggett from all tobacco claims including claims for health care cost
reimbursement and claims concerning sales of cigarettes to minors.
On November 23, 1998, PM, B&W, RJR 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. As
described below, the Company and Liggett had previous settlements with a number
of these Settling States and also had previously settled similar claims brought
by Florida, Mississippi, Texas and Minnesota.
The MSA is subject to final judicial approval in each of the Settling
States, which approval has been obtained, to date, in 42 states and
territories.
Pursuant to the MSA, Liggett has no payment obligations unless its
market share exceeds 125% of its 1997 market share (the "Base Share"). In the
year following any year in which Liggett's market share does exceed the Base
Share, Liggett will pay on each excess unit an amount equal (on a per-unit
basis) to that paid during such following year by the OPMs pursuant to the
annual and strategic contribution payment provisions of the MSA, subject to
applicable adjustments, offsets and reductions. Pursuant to the annual and
strategic contribution payment provisions of the MSA, the OPMs (and Liggett to
the extent its market share exceeds the Base Share) will pay the following
annual amounts (subject to certain adjustments):
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Year Amount
---- ------
2000 $4,500,000
2001 $5,000,000
2002 - 2003 $6,500,000
2004 - 2007 $8,000,000
2008 - 2017 $8,139,000
2018 and each $9,000,000
year thereafter
These annual payments will be allocated based on relative unit volume
of domestic cigarette shipments. The payment obligations under the MSA are the
several, and not joint, obligations of each Participating Manufacturer and are
not the responsibility of any parent or affiliate of a Participating
Manufacturer.
The MSA replaces Liggett's prior agreements with all states and
territories except for Florida, Mississippi, Texas and Minnesota. In the event
the MSA does not receive final judicial approval in any state or territory,
Liggett's prior settlement with that state or territory, if any, will be
revived.
The states of Florida, Mississippi, Texas and Minnesota, 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 nations" protection for both the
Company and Liggett, the payments due these states by Liggett (with certain
possible exceptions) have been eliminated.
In March 1997, Liggett, the Company and a nationwide class of
individuals that allege smoking-related claims filed a mandatory class
settlement agreement in an action entitled Fletcher, et al. v. Brooke Group
Ltd., et al., Circuit Court of Mobile County, Alabama, where the court granted
preliminary approval and preliminary certification of the class. On July 2,
1998, Liggett, the Company and plaintiffs filed an amended class action
settlement agreement which was preliminarily approved by the court on December
8, 1998. A hearing on final approval of the settlement is scheduled for June 3,
1999; however, hearing dates are subject to change. Effectiveness of the
mandatory settlement is conditioned on final court approval of the settlement.
There can be no assurance as to whether, or when, such court approval will be
obtained. Pursuant to the amended agreement, Liggett is required to pay to the
class 7.5% of Liggett's pre-tax income each year for 25 years, with a minimum
annual payment guarantee of $1,000 over the term of the agreement. The amended
agreement does not set forth a formula with respect to the distribution of
settlement proceeds to the class. If the court issues a final order and
judgment approving the settlement, such an order, the Company anticipates,
would preclude further prosecution by class members of tobacco-related claims
against both Liggett and the Company. Under the Full Faith and Credit Act, a
final judgment entered in a nationwide class action pending in a state court
has a preclusive effect against any class member with respect to the claims
settled and released. As the class definition in Fletcher encompasses all
persons in the United States who could claim injury as a result of cigarette
smoking or ETS and any third-party payor claimants, it is anticipated that,
upon final order and judgment, all such persons and third-party payor claimants
would be barred from further prosecution tobacco-related claims against Liggett
and the Company.
The Company accrued approximately $4,000 for the present value of the
fixed payments under the March 1996 Attorneys General settlements and $16,902
for the present value of the fixed payments under the March 1998 Attorneys
General settlements. As a result of the Company's treatment under the MSA,
$14,928 of net charges accrued for the prior settlements were reversed
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in 1998. (See the discussions of the tobacco litigation settlements appearing
in Note 8 to the Company's Consolidated Financial Statements.)
RESULTS OF OPERATIONS
Revenues Operating Income
----------------------- ----------------------
Three Months Ended Three Months Ended
March 31, March 31,
----------------------- ----------------------
1999 1998 1999 1998
--------- -------- -------- -------
Liggett $ 86,047 $ 65,626 $ 20,069 $ 6,251
Liggett-Ducat 22,350 19,154 1,302 1,710
Other 12 23 774 (418)
--------- -------- -------- -------
Total $ 108,409 $ 84,803 $ 22,145 $ 7,543
========= ======== ======== =======
Three months ended March 31, 1999 compared to three months ended March 31,
1998.
Revenues. Total revenues were $108,409 for the three months ended
March 31, 1999 compared to $84,803 for the three months ended March 31, 1998.
This 27.8% increase in revenues was primarily due to an increase in tobacco
revenues at Liggett of $20,421 and at Liggett-Ducat of $3,196. Revenues at
Liggett increased in both the premium and discount segments by 31.1% ($20,421)
due to price increases of $30,497 (see "Recent Developments in the Cigarette
Industry - Pricing Activity"), partially offset by an 14.2% decline in unit
sales volume (approximately 178 million units), accounting for $9,337 in volume
variance and an unfavorable product mix of $739. The decline in Liggett's sales
volume was due to an overall decline in industry volume, certain competitors'
continuing leveraged rebate programs tied to their products and increased
promotional activity by certain other manufacturers.
Premium sales at Liggett for the first quarter of 1999 amounted to
$25,366 and represented 29.5% of total revenues, compared to $22,958 and 35.0%
of total sales in the prior year period. In the premium segment, revenues grew
by 10.5% ($2,408) for the three months ended March 31, 1999, compared to the
prior year period, due to price increases of $8,202, which were partially
offset by a 25.2% decline in unit sales volume (approximately 91 million
units), accounting for $5,794 in volume variance.
Discount sales at Liggett (comprising the brand categories of branded
discount, private label, control label, generic, international and contract
manufacturing) for the first three months of 1999 amounted to $60,681 and
represented 70.5% of total revenues, compared to $42,668 and 65.0% of total
sales for the year-ago first quarter. In the discount segment, revenues grew by
42.2% ($18,013) for the three months ended March 31, 1999 compared to the prior
year period, due to price increases of $22,295, which were partially offset by
a 9.8% decline in unit sales volume (approximately 87 million units),
accounting for $4,169 in volume variance and an unfavorable product mix among
the discount brand categories of $113.
For the three months ended March 31, 1999, fixed manufacturing costs
on a basis comparable to 1998 was $1,149 lower, although costs per thousand
units increased by $0.09 per thousand.
Net sales at Liggett-Ducat for the three months ended March 31, 1999
increased 14.9% ($3,196) to $22,350 over the same period in 1998 due primarily
to an increase in unit sales
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volume of 38.8% (1,400 million units) accounting for a $7,425 volume variance
and favorable product mix of $745 offset by unfavorable price effect of $4,974.
Gross Profit. Consolidated gross profit was $66,982 for the three
months ended March 31, 1999 compared to $43,147 for the three months ended
March 31, 1998, an increase of $23,835 or 55.2% when compared to the same
period last year, reflecting an increase in gross profit at Liggett of $23,477
and an increase at Liggett-Ducat of $348 for the three months ended March 31,
1999 compared to the same period in the prior year.
Gross profit at Liggett of $62,882 for the three months ended March
31, 1999 increased $23,477 from gross profit of $39,405 for the first quarter
of 1998, due primarily to the price increases discussed above. (See "Recent
Developments in the Cigarette Industry - Pricing Activity".) In 1999, Liggett's
premium and discount brands contributed 28.62% and 65.26%, respectively, to the
Company's overall gross profit. Over the same period in 1998, Liggett's premium
and discount brands contributed 36.1% and 63.9%, respectively, to total gross
profit. As a percent of revenues (excluding federal excise taxes), gross profit
at Liggett increased to 85.6% for the three months ended March 31, 1999
compared to 77.5% for the same period in 1998, with gross profit for the
premium segment at 86.6% and 79.2%, respectively, in the first quarter of 1999
and 1998, respectively, and gross profit for the discount segment at 85.1% and
76.6% in 1999 and 1998, respectively. This increase is the result of the 1998
list price increases, a total of 63.5 cents per pack, and improved production
variances. These increases were partially offset by increased tobacco costs at
Liggett due to a reduction in the average discount available to the Company
from leaf tobacco dealers on tobacco purchased under prior years' purchase
commitments.
As a percent of revenues (excluding Russian excise taxes), gross
profit at Liggett-Ducat decreased to 20.5% for the three months ended March 31,
1999 compared to 22.0% in the same period in 1998, primarily due to the
devaluation of the ruble.
Expenses. Selling, general and administrative expenses were $44,837
for the three months ended March 31, 1999 compared to $35,604 for the same
period last year due to an increase in expenses at Liggett of $9,659 and an
increase of $507 at Liggett-Ducat offset by lower corporate expense primarily
due to lower pension expense. Operating, selling, general and administrative
expenses at Liggett increased to $42,813 for the three months ended March 31,
1999 compared to $33,154 for the same period for the prior year. This increase
in operating expenses was due primarily to higher spending for promotional and
marketing programs of approximately $11,011, partially offset by a reduction in
amortization of approximately $867 and the absence of system development costs
in the current year quarter of $485. The increase at Liggett-Ducat of $507 was
primarily due to increased marketing and depreciation expense.
Other Income (Expense). Interest expense was $14,988 for the three
months ended March 31, 1999 compared to $20,786 for the same period last year,
a decrease of $5,798 primarily due to the redemption by Liggett of the Liggett
Senior Secured Notes on December 28, 1998 and lower interest expense of
approximately $800 at corporate. Net interest expense at Liggett decreased by
$6,376 for the three months ended March 31, 1999 compared to the three months
ended March 31, 1998. This was offset by higher interest expense at BOL of
$1,390 primarily due to increased interest rates on credit facilities in
Russia.
Equity in earnings of affiliate was a loss of $7,629 for the three
months ended March 31, 1999 compared to a loss of $4,187 for the three months
ended March 31, 1998 and relates in both periods to New Valley's net loss
applicable to common shares of $23,801 and $18,675, respectively.
For the three months ended March 31, 1999, interest expense and loss
in equity of affiliate were offset by foreign currency gain of $2,270 and the
recognition of deferred gain of
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$7,050 relating to the expiration of the put obligation on Ducat III (the site
of the old cigarette factory in Russia) in connection with the sale of the
BrookeMil Ltd. common shares in 1997. The factory ceased operations in March
1999.
Provision for Income Taxes. Income tax for the first quarter of 1999
was $1,729 compared to $931 for the first quarter of 1998. The effective tax
rate does not bear a customary relationship with pre-tax accounting income
principally as a consequence of the change in the valuation allowance relating
to deferred tax assets and foreign taxes.
CAPITAL RESOURCES AND LIQUIDITY
Net cash and cash equivalents decreased $1,877 and $172 for the three
months ended March 31, 1999 and March 31, 1998, respectively. Net cash provided
by operations for the three months ended March 31, 1999 was $2,571 compared to
net cash used in operations of $25,984 for the comparable period of 1998. The
increase of $28,555 in net cash provided by operating activities in 1999 over
the prior year was primarily due to an increase in operating income at Liggett
and a reduction in debt service, resulting from Liggett's bond redemption on
December 28, 1998. In the 1998 period, cash was used in operations at BGLS and
Liggett to make interest payments of approximately $29,600. In addition, there
were also reductions in promotional expenses, taxes payable and other accrued
liabilities, in total amount of $6,366, and an increase in inventories of
$8,385. These items were partially offset by an increase in accounts payable of
$4,842.
Cash used in investing activities of $19,581 compares to cash provided
of $822 for the periods ended March 31, 1999 and 1998, respectively. In 1999,
capital expenditures for machinery and equipment at Liggett amounted to $6,369
while equipment and construction costs for the new factory amounted to $13,248
at Liggett-Ducat. In 1998, proceeds from sales of equipment and an investment
of $1,295 were partially offset by capital expenditures of $395 at Liggett and
BOL.
Cash provided by financing activities was $15,452 and $24,911 for the
three months ended March 31, 1999 and 1998, respectively. Proceeds in the 1999
period included net borrowings under revolving credit facilities at both Liggett
and Liggett-Ducat of $12,667 and proceeds from equipment financing of $4,500.
These proceeds were offset primarily by distributions on common stock of
$1,358. Proceeds in the 1998 period included cash received from the sale of
common stock and exercise of stock options, in total $9,796, proceeds from the
participating loan made by Western Realty Ducat, and net borrowings under
Liggett's revolving credit facility (the "Facility") of $5,162 partially offset
by distributions on common stock of $900.
Liggett. On December 28, 1998, Liggett redeemed the $144,891 principal
amount of the Liggett Notes at 100% of the principal amount together with
accrued interest. Proceeds of $150,000 from the purchase by PM of two options
to purchase the Class A Interest and the Class B Interest in the LLC were used
to fund the redemption.
The closing of the exercise by PM of the Class A Option is scheduled
for no later than June 10, 1999 (currently scheduled for May 24, 1999). Upon
closing, Liggett will receive approximately $145,000 from the purchase of the
Class A Interest and the distribution of the Loan proceeds by the LLC.
Liggett has a $40,000 Facility expiring March 8, 2000, under which
$6,793 was outstanding at March 31, 1999. Availability under the Facility was
approximately $12,990 based on eligible collateral at March 31, 1999. The
Facility is collateralized by all inventories and receivables of Liggett.
Borrowings under the Facility, whose interest is calculated at a rate equal to
1.5% above Philadelphia National Bank's (the indirect parent of Congress
Financial Corporation, the lead lender) prime rate, bear a rate of 9.25% at
March 31, 1999. The Facility required Liggett's compliance with certain
financial and other covenants including restrictions on the payment of cash
dividends and distributions by Liggett. In addition, the Facility, as amended,
imposes requirements with respect to Liggett's adjusted net worth (not to fall
below a deficit of $195,000 as computed in accordance with the agreement) and
working capital (not to fall below a deficit of $17,000 as
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computed in accordance with the agreement). At March 31, 1999, Liggett was in
compliance with all covenants under the Facility; Liggett's adjusted net worth
deficiency and net working capital, as computed in accordance with the
agreement, were $146,239 and $4,466, respectively.
In January 1999, Liggett purchased equipment for $5,750 and borrowed
$4,500 to fund the purchase from a third party. The loan, which is
collateralized by the equipment, is payable in 60 monthly installments of $56
including annual interest of 7.6% with a final payment of $2,550.
Liggett (and, in certain cases, the Company) 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 (environmental tobacco smoke) from cigarettes.
The Company believes, and has been so advised by counsel handling the
respective cases, that the Company and Liggett have a number of valid defenses
to the claim or claims asserted against them. Litigation is subject to many
uncertainties, and it is possible that some of these actions could be decided
unfavorably. An unfavorable outcome of a pending smoking and health case could
encourage the commencement of additional similar litigation. Recently, 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 the Company nor Liggett
is able to evaluate the effect of these developing matters on pending
litigation or the possible commencement of additional litigation or regulation.
(See "Recent Developments in the Cigarette Industry - Legislation, Regulation
and Litigation" above and Note 8 to the Company's Consolidated Financial
Statements.)
The Company 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 the Company and Liggett. 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
tobacco-related litigation.
BGLS. At March 31, 1999, BGLS had outstanding $232,864 principal
amount of the BGLS Notes which mature on January 31, 2001. On March 5, 1998,
BGLS entered into the Standstill Agreement whereby the Apollo Holders (and any
transferees) agreed to the deferral of interest payments, commencing with the
interest payment due July 31, 1997 through the interest payment due July 31,
2000. BGLS has deferred a total of $34,602 of interest as of March 31, 1999.
On February 17, 1999, BGLS entered into an agreement with a third
party to purchase, during the second quarter of 1999, approximately $31,139
principal amount of the BGLS Notes, originally held by the Apollo Holders and
subject to the Standstill Agreement. The purchase price is 95% of the principal
amount of the notes and the accrued interest thereon. The purchase is
contingent upon receipt by the Company of approximately an additional $145,000
(in addition to the $150,000 option fee paid in December 1998) on terms
substantially consistent with the transactions contemplated by the PM
Agreements.
In April 1999, the Company agreed with a third party to purchase during
the second quarter 1999, approximately $3,697 of the BGLS Notes. The purchase
price is 98% of the principal amount of the notes and the accrued interest
thereon. BGLS will fund both purchases with tax sharing payments from Liggett.
BOL. Liggett-Ducat is currently completing construction of a new
cigarette factory on the outskirts of Moscow which is currently scheduled to be
operational in June 1999. The new factory, which will utilize Western cigarette
making technology and have a capacity of in excess of 30 billion units per
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year, will produce American and international blend cigarettes, as well as
traditional Russian cigarettes. Western Realty Ducat has made a $30,000
participating loan to, and payable out of a 30% profits interest in, a company
organized by BOL which, among other things, holds BOL's interest in
Liggett-Ducat and the new factory. In addition, BOL has entered into promissory
notes for equipment purchases which have a liability of approximately $23,500
at March 31, 1999. The Company is a guarantor on purchases for which the
remaining obligation is approximately $8,500. The remaining costs for
construction and equipment for the new factory are being financed by loans from
Russian banks and approximately $12,000 of loans from BOL made during the first
half of 1999.
The Company. The Company has substantial near-term consolidated debt
service requirements, with aggregate required principal payments of
approximately $297,000 due in the years 1999 through 2001. The Company believes
that it will continue to meet its liquidity requirements through 1999, although
the BGLS Notes Indenture limits the amount of restricted payments BGLS is
permitted to make to the Company during the calendar year. At March 31, 1999,
the remaining amount available through December 31, 1999 in the Restricted
Payment Basket related to BGLS' payment of dividends to the Company (as defined
by the BGLS Notes Indenture) is $15,472. Company expenditures (exclusive of
Liggett and Liggett-Ducat) in 1999 for current operations include cash interest
expense of approximately $21,350 (excluding accrued interest due on the BGLS
Notes discussed above that BGLS has contingently agreed to repurchase),
dividends on the Company's shares (currently at an annual rate of approximately
$6,300) and corporate expenses. The Company anticipates funding its 1999
expenditures for current operations with 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.
MARKET RISK
The Company is principally exposed to market risks from fluctuations
in interest rates, foreign currency exchange rates and equity prices. The
Company seeks to minimize these risks through its regular operating and
financing activities and its long-term investment strategy.
Equity Price Risk. The Company holds investment securities available
for sale with a fair market value of $54,407 at March 31, 1999. These
securities represent an investment in New Valley Class A Preferred Shares,
Class B Preferred Shares and Common Shares which the Company carries on its
balance sheet at zero.
Foreign Market Risk
Europe. The Company has foreign currency exchange risk relating to its
outstanding obligations under foreign currency denominated construction and
equipment contracts with various European companies where costs are affected by
fluctuations in the United States dollar as compared to certain European
currencies. Management believes that currencies in which it presently has such
exposure are relatively stable.
Russia. Liggett-Ducat's and Western Tobacco's operations are conducted
in Russia. During 1998 and continuing into 1999, the economy of the Russian
Federation entered a period of economic instability. The impact includes, but
is not limited to, a steep decline in prices of domestic debt and equity
securities, a severe devaluation of the currency, a moratorium on foreign debt
repayments, an increasing rate of inflation and increasing rates on government
and corporate borrowings. The Company seeks to minimize such risks by reducing
its cash exposure when appropriate. The return to economic stability is
dependent to a large extent on the effectiveness of
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the fiscal measures taken by government and other actions beyond the control of
companies operating in the Russian Federation. The operations of Liggett-Ducat
and Western Tobacco may be significantly affected by these factors for the
foreseeable future.
Russian taxation is subject to varying interpretations and constant
changes. Furthermore, the interpretation of tax legislation by tax authorities
as applied to the transactions and activity of Liggett-Ducat and Western
Tobacco may not coincide with that of management. As a result, transactions may
be challenged by tax authorities and Liggett-Ducat and Western Tobacco may be
assessed additional taxes, penalties and interest, which can be significant.
Management regularly reviews the Company's taxation compliance with applicable
legislation, laws and decrees and current interpretations and from time to time
potential exposures are identified. At any point in time, a number of open
matters may exist; however, management believes that adequate provision has
been made for all material liabilities. Tax years remain open to review by the
authorities for six years.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Company and its representatives may from time to time make oral or
written "forward-looking statements" within the meaning of the Private
Securities Reform Act of 1995 (the "Reform Act"), 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 its reports
to shareholders, which reflect management's current views 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 Reform Act, the Company is hereby identifying
important factors that could cause actual results to differ materially from
those contained in any forward-looking statement made by or on behalf of the
Company. Liggett continues to be subject to risk factors endemic to the
domestic tobacco industry including, without limitation, health concerns
relating to the use of tobacco products and exposure to ETS, legislation,
including tax increases, governmental regulation, privately imposed smoking
restrictions, governmental and grand jury investigations and litigation. Each
of the Company's operating subsidiaries, namely Liggett and Liggett-Ducat, are
subject to intense competition, changes in consumer preferences, the effects of
changing prices for its raw materials and local economic conditions.
Furthermore, the performance of Liggett-Ducat's operations in Russia are
affected by uncertainties in Russia which include, among others, political or
diplomatic developments, regional tensions, currency repatriation restrictions,
foreign exchange fluctuations, inflation, and an undeveloped system of
commercial laws and legislative reform relating to foreign ownership in Russia.
In addition, the Company has a high degree of leverage and substantial
near-term debt service requirements, as well as a net worth deficiency. The
Indenture for BGLS' Series B Notes provides for, among other things, the
restriction of certain affiliated transactions between the Company and its
affiliates, as well as for certain restrictions on the use of future
distributions received from New Valley. The failure of the Company or its
significant suppliers and customers to adequately address the "Year 2000" issue
could result in misstatement of reported financial information or could
adversely affect its business. 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. The Company does
not undertake to update any forward-looking statement that may be made from
time to time by or on behalf of the Company.
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.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
Reference is made to Note 8, incorporated herein by reference, to
the Consolidated Financial Statements of Brooke Group Ltd. and
BGLS Inc. (collectively, the "Companies") included elsewhere in
this report on Form 10-Q which contains a general description of
certain legal proceedings to which the Company and/or BGLS or
their subsidiaries are a party and certain related matters.
Reference is also made to Exhibit 99.1 for additional information
regarding the pending material legal proceedings to which the
Company, BGLS and/or Liggett are party. A copy of Exhibit 99.1
will be furnished to security holders of the Company and its
subsidiaries without charge upon written request to the Company
at its principal executive offices, 100 S.E. Second St., Miami,
Florida 33131, Attn. Investor Relations.
Item 2. Changes in Securities and Use of Proceeds
No securities of the Company which were not registered under the
Securities Act of 1933, as amended (the "Securities Act"), have
been issued or sold by the Company during the three months ended
March 31, 1999.
Item 3. Defaults Upon Senior Securities
As of March 31, 1999, New Valley Corporation, the Companies'
affiliate, had the following respective accrued and unpaid
dividend arrearages on its 1,071,462 outstanding shares of $15.00
Class A Increasing Rate Cumulative Senior Preferred Shares ($100
Liquidation Value), $.01 par value per share (the "Class A
Shares") and 2,790,776 outstanding shares of $3.00 Class B
Cumulative Convertible Preferred Shares ($25 Liquidation Value),
$.10 par value per share (the "Class B Shares): (1) $234.6
million or $218.94 per Class A Share; and (2) $172.9 million or
$61.96 per Class B Share.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
--------
27.1 Brooke Group Ltd.'s Financial Data Schedule (for SEC use only).
27.2 BGLS Inc.'s Financial Data Schedule (for SEC use only).
99.1 Material Legal Proceedings.
99.2 Liggett Group Inc.'s Interim Consolidated Financial
Statements for the quarterly periods ended March 31,
1999 and 1998.
99.3 New Valley Corporation's Interim Consolidated
Financial Statements for the quarterly periods ended
March 31, 1999 and 1998.
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99.4 Brooke (Overseas) Ltd.'s Interim Consolidated
Financial Statements for the quarterly periods ended
March 31, 1999 and 1998.
99.5 New Valley Holdings, Inc.'s Interim Consolidated
Financial Statements for the quarterly periods ended
March 31, 1999 and 1998.
(b) Reports on Form 8-K
None.
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SIGNATURES
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.
BROOKE GROUP LTD.
(REGISTRANT)
By: /s/ Joselynn D. Van Siclen
------------------------------
Joselynn D. Van Siclen
Vice President and Chief
Financial Officer
Date: May 14, 1999
BGLS INC.
(REGISTRANT)
By: /s/ Joselynn D. Van Siclen
------------------------------
Joselynn D. Van Siclen
Vice President and Chief
Financial Officer
Date: May 14, 1999
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