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Securities And Exchange Commission
Washington, D.C. 20549
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FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
VECTOR GROUP LTD.
(Exact name of registrant as specified in its charter)
DELAWARE 1-5759 65-0949535
(State or other jurisdiction of Commission File Number (I.R.S. Employer Identification No.)
incorporation
100 S.E. SECOND STREET
MIAMI, FLORIDA 33131
305/579-8000
(Address, including zip code and telephone number, including area code,
of the principal executive offices)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
[X] Yes [ ] No
Indicate by check mark whether the Registrant is an accelerated filer as
defined in Rule 12b-2 of the Exchange Act. [X] Yes [ ] No
At August 13, 2003, Vector Group Ltd. had 37,006,930 shares of common stock
outstanding.
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VECTOR GROUP LTD.
FORM 10-Q
TABLE OF CONTENTS
PAGE
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PART I. FINANCIAL INFORMATION
Item 1. VECTOR GROUP LTD. CONSOLIDATED FINANCIAL STATEMENTS:
Vector Group Ltd. Consolidated Balance Sheets as of June 30, 2003 and
December 31, 2002............................................................................. 2
Vector Group Ltd. Consolidated Statements of Operations for the three and six months
ended June 30, 2003 and June 30, 2002......................................................... 3
Vector Group Ltd. Consolidated Statement of Stockholders' Equity (Deficit) for the six
months ended June 30, 2003.................................................................... 4
Vector Group Ltd. Consolidated Statements of Cash Flows for the six months ended
June 30, 2003 and June 30, 2002............................................................... 5
Notes to Consolidated Financial Statements.......................................................... 6
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................... 34
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................................... 51
Item 4. CONTROLS AND PROCEDURES........................................................................ 51
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.............................................................................. 52
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS...................................................... 52
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................ 52
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................................................... 53
SIGNATURE 54
- 1 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, Except Per Share Amounts)
(Unaudited)
June 30, December 31,
2003 2002
--------- ---------
ASSETS:
Current assets:
Cash and cash equivalents $ 77,473 $ 100,027
Investment securities available for sale 91,656 128,430
Accounts receivable - trade 15,942 13,395
Other receivables 2,273 3,853
Inventories 128,253 104,649
Restricted assets 11,202 --
Deferred income taxes 19,420 12,825
Other current assets 7,404 17,912
--------- ---------
Total current assets 353,623 381,091
Property, plant and equipment, net 180,261 181,972
Long-term investments, net 2,410 3,150
Investments in non-consolidated real estate businesses 15,912 7,811
Restricted assets 5,733 4,857
Deferred income taxes 12,019 12,501
Intangible asset 107,511 107,511
Pension assets -- 1,225
Other assets 7,270 8,377
--------- ---------
Total assets $ 684,739 $ 708,495
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Current portion of notes payable and long-term debt $ 52,908 $ 31,277
Accounts payable 19,653 17,046
Accrued promotional expenses 31,415 24,998
Accrued taxes payable, net 40,308 39,370
Settlement accruals 23,565 40,528
Deferred income taxes 5,277 5,277
Accrued interest 7,188 7,556
Other accrued liabilities 16,438 18,332
--------- ---------
Total current liabilities 196,752 184,384
Notes payable, long-term debt and other obligations, less current portion 302,424 307,028
Noncurrent employee benefits 11,308 11,121
Deferred income taxes 138,638 134,762
Other liabilities 4,585 4,866
Minority interests 43,434 44,037
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock, par value $1.00 per share, authorized 10,000,000 shares
Common stock, par value $0.10 per share, authorized 100,000,000
shares, issued 40,062,394 and 39,530,924 and outstanding 36,970,755
and 36,439,285 3,697 3,643
Additional paid-in capital 251,987 279,305
Deficit (246,497) (236,718)
Accumulated other comprehensive loss (9,286) (11,630)
Less: 3,091,639 shares of common stock in treasury, at cost (12,303) (12,303)
--------- ---------
Total stockholders' equity (deficit) (12,402) 22,297
--------- ---------
Total liabilities and stockholders' equity (deficit) $ 684,739 $ 708,495
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
- 2 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Amounts)
(Unaudited)
Three Months Ended Six Months Ended
---------------------------- ----------------------------
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues:
Tobacco* $ 129,400 $ 139,813 $ 260,743 $ 236,571
Real estate leasing 1,777 237 3,576 661
------------ ------------ ------------ ------------
Total revenues 131,177 140,050 264,319 237,232
Expenses:
Cost of goods sold* 86,010 100,873 169,801 161,875
Operating, selling, administrative and general expenses 44,344 44,021 93,895 96,060
Settlement charges -- -- -- (807)
------------ ------------ ------------ ------------
Operating income (loss) 823 (4,844) 623 (19,896)
Other income (expenses):
Interest and dividend income 1,127 2,581 2,572 5,401
Interest expense (8,516) (6,920) (15,665) (12,305)
Gain on investments, net 332 68 270 1,389
Gain on sale of assets -- 9,028 -- 8,684
Equity loss from non-consolidated New Valley real
estate businesses (174) -- (891) --
Other, net 24 (6) 17 (163)
------------ ------------ ------------ ------------
Loss from operations before (benefit) provision for income taxes
and minority interests (6,384) (93) (13,074) (16,890)
(Benefit) provision for income taxes (649) 591 (1,242) (3,671)
Minority interests 805 (2,658) 2,053 (1,986)
------------ ------------ ------------ ------------
Net loss $ (4,930) $ (3,342) $ (9,779) $ (15,205)
============ ============ ============ ============
Per basic common share:
Net loss applicable to common shares $ (0.13) $ (0.10) $ (0.27) $ (0.44)
============ ============ ============ ============
Basic weighted average common shares outstanding 36,963,695 34,920,148 36,784,081 34,912,553
============ ============ ============ ============
Per diluted common share:
Net loss applicable to common shares $ (0.13) $ (0.10) $ (0.27) $ (0.44)
============ ============ ============ ============
Diluted weighted average common shares outstanding 36,963,695 34,920,148 36,784,081 34,912,553
============ ============ ============ ============
- ---------------
* Revenues and Cost of goods sold include excise taxes of $48,519, $54,926,
$98,336 and $93,190, respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
- 3 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(Dollars in Thousands, Except Per Share Amounts)
(Unaudited)
Accumulated
Other
Common Stock Additional Compre-
-------------------- Paid-In Treasury hensive
Shares Amount Capital Deficit Stock Loss Total
---------- -------- --------- --------- -------- -------- --------
Balance, December 31, 2002 36,439,285 $3,643 $ 279,305 $(236,718) $(12,303) $(11,630) $ 22,297
Net loss -- -- -- (9,779) -- -- (9,779)
Unrealized gain on investment securities -- -- -- -- -- 2,344 2,344
--------
Total other comprehensive gain -- -- -- -- -- -- 2,344
--------
Total comprehensive loss -- -- -- -- -- -- (7,435)
--------
Distributions on common stock -- -- (29,565) -- -- -- (29,565)
Exercise of warrants and options 531,470 54 569 -- -- -- 623
Tax benefit of options exercised -- -- 1,311 -- -- -- 1,311
Amortization of deferred compensation, net -- -- 292 -- -- -- 292
Effect of New Valley share repurchase -- -- 75 -- -- -- 75
---------- ------ --------- --------- -------- -------- --------
Balance, June 30, 2003 36,970,755 $3,697 $ 251,987 $(246,497) $(12,303) $ (9,286) $(12,402)
========== ====== ========= ========= ======== ======== ========
The accompanying notes are an integral part
of the consolidated financial statements.
- 4 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands, Except Per Share Amounts)
(Unaudited)
Six Months Ended
-------------------------
June 30, June 30,
2003 2002
--------- ---------
Net cash used in operating activities: $ (24,091) $ (43,738)
--------- ---------
Cash flows from investing activities:
Proceeds from sale of assets, net 910 20,951
Sale or maturity of investment securities 79,391 57,429
Purchase of investment securities (37,061) (39,940)
Sale (purchase) of long-term investments 830 (50,853)
Investment in non-consolidated real estate businesses (9,500) (688)
Increase in restricted assets (11,010) (7)
Issuance of note receivable, net -- (2,500)
Repayment of note receivable -- 1,000
Payment of prepetition claims (18) (29)
New Valley repurchase of common shares (1,346) --
Capital expenditures (6,503) (32,763)
--------- ---------
Net cash provided by (used in) investing activities 15,693 (47,400)
--------- ---------
Cash flows from financing activities:
Proceeds from debt -- 37,117
Repayments of debt (17,836) (18,382)
Borrowings under revolver 332,181 297,417
Repayments on revolver (299,559) (297,417)
Deferred financing charges -- (930)
Increase in cash overdraft -- 1,349
Distributions on common stock (29,565) (26,604)
Proceeds from exercise of options and warrants 623 1,196
--------- ---------
Net cash used in financing activities (14,156) (6,254)
--------- ---------
Net decrease in cash and cash equivalents (22,554) (97,392)
Cash and cash equivalents, beginning of period 100,027 217,761
--------- ---------
Cash and cash equivalents, end of period $ 77,473 $ 120,369
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
- 5 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts)
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BASIS OF PRESENTATION:
The consolidated financial statements of Vector Group Ltd. (the
"Company" or "Vector") include the accounts of VGR Holding Inc. ("VGR
Holding"), Vector Tobacco Inc. ("Vector Tobacco"), Liggett Group Inc.
("Liggett"), New Valley Corporation ("New Valley") and other less
significant subsidiaries. The Company owned 58.1% of New Valley's
common shares at June 30, 2003. All significant intercompany balances
and transactions have been eliminated.
Vector Tobacco is engaged in the development and marketing of low
nicotine, nicotine-free and reduced carcinogen cigarette products.
Liggett is engaged primarily in the manufacture and sale of
cigarettes, principally in the United States. New Valley is currently
engaged in the real estate business and is seeking to acquire
additional operating companies.
As discussed in Note 3, a subsidiary of the Company acquired The
Medallion Company, Inc. on April 1, 2002.
The interim consolidated financial statements of the Company are
unaudited and, in the opinion of management, reflect all adjustments
necessary (which are normal and recurring) to present fairly the
Company's consolidated financial position, results of operations and
cash flows. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2002, as filed with the Securities and
Exchange Commission. The consolidated results of operations for
interim periods should not be regarded as necessarily indicative of
the results that may be expected for the entire year.
(b) ESTIMATES AND ASSUMPTIONS:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities and the reported amounts of revenues and
expenses. Significant estimates subject to material changes in the
near term include inventory valuation, deferred tax assets, allowance
for doubtful accounts, promotional accruals, sales returns and
allowances, actuarial assumptions of pension plans, settlement
accruals and litigation and defense costs. Actual results could
differ from those estimates.
- 6 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
(c) RECLASSIFICATIONS:
Certain amounts in the 2002 consolidated financial statements have
been reclassified to conform to the 2003 presentation.
(d) EARNINGS PER SHARE:
Information concerning the Company's common stock has been adjusted
to give effect to the 5% stock dividend paid to Company stockholders
on September 27, 2002. In connection with the stock dividend, the
Company increased the number of warrants and stock options by 5% and
reduced the exercise prices accordingly. All share amounts have been
presented as if the stock dividend had occurred on January 1, 2002.
The Company had a net loss for the three and six months ending June
30, 2003 and June 30, 2002. Therefore, the effect of the common stock
equivalents and convertible securities is excluded from the
computation of diluted net loss per share since the effect is
anti-dilutive for the three and six months ended June 30, 2003 and
June 30, 2002.
(e) COMPREHENSIVE LOSS:
Comprehensive loss is a component of stockholders' equity (deficit)
and includes such items as the unrealized gains and losses on
investment securities and minimum pension liability adjustments.
Total comprehensive loss was $7,435 for the six months ended June 30,
2003 and $15,518 for the six months ended June 30, 2002.
(f) NEW ACCOUNTING PRONOUNCEMENTS:
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of
SFAS No. 123." SFAS No. 148 amends SFAS No. 123 to provide
alternative methods of transition for a voluntary change to that
statement's fair value method of accounting for stock-based employee
compensation. SFAS No. 148 also amends the disclosure provisions of
SFAS No. 123 and APB No. 28, "Interim Financial Reporting," to
require disclosure in the summary of significant accounting policies
of the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings
per share in annual and interim financial statements. The transition
and disclosure provisions of this statement are effective for
financial statements for fiscal years ending after December 15, 2002
and for interim financial statements commencing after that date. The
Company has not elected the fair value-based method of accounting for
stock-based compensation under SFAS No. 123, as amended by SFAS No.
148. (See Note 7.)
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies EITF 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS
- 7 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
146 requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred as
opposed to EITF 94-3, which allowed a cost to be recognized when a
commitment to an exit plan was made. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after
December 31, 2002. The adoption of this statement did not have an
impact on the Company's consolidated financial statements.
In April 2003, SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" was issued. SFAS No.
149 amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other contracts,
and for hedging activities under SFAS No. 133. SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003
and for hedging relationships designated after June 30, 2003. The
Company does not believe that there will be any material impact on
its consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS No. 150 establishes standards for how companies
classify and measure certain financial instruments with
characteristics of both liabilities and equity. It requires companies
to classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). SFAS No. 150 is
effective immediately for financial instruments entered into or
modified after May 15, 2003 and in the first interim period after
June 15, 2003 for all other financial instruments. The Company is
currently analyzing the provisions of SFAS No. 150 to determine its
impact, but does not believe that there will be any material impact
on its consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 requires
that upon issuance of a guarantee, the guarantor must recognize a
liability for the fair value of the obligation it assumes under the
guarantee and expanded disclosure of certain guarantees existing at
December 31, 2002. The adoption of this statement did not have an
impact on the Company's consolidated financial statements.
In January 2003, FIN No. 46, "Consolidation of Variable Interest
Entities" was issued. This interpretation clarifies the application
of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," to certain entities in which equity investors do not
have the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from
other parties. FIN No. 46 is effective February 1, 2003 for variable
interest entities created after January 31, 2003, and July 1, 2003
for variable interest entities created prior to February 1, 2003. The
Company does not believe this interpretation will have a material
impact on its consolidated financial statements.
2. LIGGETT VECTOR BRANDS
In 2002, the Company approved a plan to combine the sales and marketing
functions of its Liggett and Vector Tobacco subsidiaries into a new
entity, Liggett Vector Brands Inc., in order to enhance the effectiveness
of the Company's sales and marketing operations. This company coordinates
- 8 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
and executes the sales and marketing efforts for all of the Company's
tobacco operations. As a result of this plan, during the first quarter of
2002, the Company recognized a pre-tax restructuring charge of
approximately $3,460, consisting of approximately $2,000 in involuntary
severance and other exit costs and an impairment charge of approximately
$1,500 related to certain long-lived assets. The Company had substantially
completed all of these restructuring activities as of March 31, 2003. The
Company's restructuring accrual has been reduced by payments of $1,935 and
impairments of $1,450 as of June 30, 2003. At June 30, 2003, the remaining
restructuring accrual of $75 was reflected in other current liabilities in
the accompanying consolidated balance sheet.
3. MEDALLION ACQUISITION
On April 1, 2002, a subsidiary of the Company acquired 100% of the stock
of The Medallion Company, Inc. ("Medallion"), and related assets from
Medallion's principal stockholder. Following the purchase of the Medallion
stock, Vector Tobacco merged into Medallion and Medallion changed its name
to Vector Tobacco Inc. The total purchase price consisted of $50,000 in
cash and $60,000 in notes, with the notes guaranteed by the Company and
Liggett. (See Note 6.) Medallion, a discount cigarette manufacturer, is a
participant in the Master Settlement Agreement between the state Attorneys
General and the tobacco industry. Medallion has no payment obligations
under the Master Settlement Agreement except to the extent its market
share exceeds approximately 0.28% of total cigarettes sold in the United
States. The results of operations of Medallion are included in the
Company's financial statements beginning April 1, 2002.
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition.
At April 1, 2002
Receivable from seller...................... $ 3,189
Inventory................................... 1,019
Property, plant and equipment............... 2,181
Intangible asset............................ 107,511
----------
Total assets acquired................... 113,900
----------
Accrued merger costs........................ 300
Allowance for sales returns................. 500
Accrued MSA liability....................... 3,100
----------
Total liabilities assumed............... 3,900
----------
Net assets acquired..................... $ 110,000
==========
The $107,511 intangible asset, which is not subject to amortization,
relates to Medallion's exemption under the Master Settlement Agreement and
has been included with the Liggett segment for segment reporting purposes.
The following table presents unaudited pro forma results of operations as
if the Medallion acquisition had occurred immediately prior to January 1,
2002. These pro forma results have been prepared for comparative purposes
only and do not purport to be indicative of what would have occurred had
these transactions been consummated as of such date.
- 9 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
Three Months Six Months
Ended Ended
June 30, 2002 June 30, 2002
---------------- -------------
Revenues $ 140,050 $ 252,093
=========== ===========
Net loss $ (3,342) $ (16,369)
=========== ===========
Net loss per common share:
Basic $ (0.10) $ (0.47)
=========== ===========
Diluted $ (0.10) $ (0.47)
=========== ===========
4. INVENTORIES
Inventories consist of:
June 30, December 31,
2003 2002
--------- ---------
Leaf tobacco $ 79,753 $ 63,196
Other raw materials 4,347 5,438
Work-in-process 2,310 2,888
Finished goods 39,566 30,014
Replacement parts and supplies 5,173 4,878
--------- ---------
Inventories at current cost 131,149 106,414
LIFO adjustments (2,896) (1,765)
--------- ---------
$ 128,253 $ 104,649
========= =========
The Company has a leaf inventory management program whereby, among other
things, it is committed to purchase certain quantities of leaf tobacco.
The purchase commitments are for quantities not in excess of anticipated
requirements and are at prices, including carrying costs, established at
the date of the commitment. At June 30, 2003, Liggett had leaf tobacco
purchase commitments of approximately $16,584 and Vector Tobacco had leaf
tobacco purchase commitments of approximately $1,684.
LIFO inventories represent approximately 63.6% and 61.4% of total
inventories at June 30, 2003 and December 31, 2002, respectively.
Included in the above table is approximately $43,500 and $38,000 at June
30, 2003 and December 31, 2002, respectively, of inventory associated with
Vector Tobacco's new product initiatives.
- 10 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
June 30, December 31,
2003 2002
--------- -----------
Land and improvements $ 10,019 $ 10,019
Buildings 73,654 72,811
Machinery and equipment 141,039 136,738
Leasehold improvements 1,400 2,147
Construction-in-progress 4,477 3,566
--------- ---------
230,589 225,281
Less accumulated depreciation (50,328) (43,309)
--------- ---------
$ 180,261 $ 181,972
========= =========
On July 16, 2003, Liggett granted an unaffiliated third party an option to
purchase Liggett's former manufacturing facility and other excess real
estate in Durham, North Carolina with a net book value at June 30, 2003 of
approximately $2,250. The option agreement permits the purchaser to
acquire the property, during a period of up to two years, at a purchase
price of $14,000 if the closing occurs by August 23, 2004 and $15,000 if
the closing occurs thereafter during the term of the option. Liggett has
received an option fee of $100, refundable if the purchaser terminates the
agreement prior to September 2, 2003. Liggett will be entitled to receive
additional option fees of up to $1,400 during the option period. The
option fees will generally be creditable against the purchase price and
are refundable in part upon termination of the agreement. The purchaser is
currently conducting due diligence, and there can be no assurance the sale
of the property will occur.
- 11 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
6. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
June 30, December 31,
2003 2002
--------- ---------
Vector:
6.25% Convertible Subordinated Notes due 2008 $ 132,500 $ 132,500
VGR Holding:
10% Senior Secured Notes due 2006, net of
unamortized discount of $8,515 and $10,751 65,485 71,249
Liggett:
Revolving credit facility 32,622 --
Term loan under credit facility 5,190 5,190
Other notes payable 11,480 13,195
Vector Tobacco:
Notes payable 6,809 7,357
Equipment loans 145 452
Notes payable - Medallion acquisition 44,374 50,625
V.T. Aviation:
Notes payable 16,548 17,237
New Valley:
Notes payable - operating real estate 40,179 40,500
--------- ---------
Total notes payable, long-term debt and other obligations 355,332 338,305
Less:
Current maturities (52,908) (31,277)
--------- ---------
Amount due after one year $ 302,424 $ 307,028
========= =========
6.25% CONVERTIBLE SUBORDINATED NOTES DUE JULY 15, 2008 - VECTOR:
In July 2001, Vector completed the sale of $172,500 (net proceeds of
approximately $166,400) of its 6.25% convertible subordinated notes due
July 15, 2008 through a private offering to qualified institutional
investors in accordance with Rule 144A under the Securities Act of 1933.
The notes pay interest at 6.25% per annum and are convertible into
Vector's common stock, at the option of the holder, at a conversion price
of $29.71 per share at June 30, 2003. The conversion price is subject to
adjustment for various events, and any cash distribution on Vector's
common stock will result in a corresponding decrease in the conversion
price. In December 2001, $40,000 of the notes were converted into Vector's
common stock, and $132,500 of the notes were outstanding at June 30, 2003.
The notes may be redeemed by Vector, in whole or in part, between July 15,
2003 and July 15, 2004, if the closing price of Vector's common stock
exceeds 150% of the conversion price then in effect for a period of at
least 20 trading days in any consecutive 30 day trading period, at a price
equal to 100% of the principal amount, plus accrued interest and a "make
whole" payment. Vector may redeem the notes, in whole or in part, at a
- 12 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
price of 103.125% in the year beginning July 15, 2004, 102.083% in the
year beginning July 15, 2005, 101.042% in the year beginning July 15, 2006
and 100% in the year beginning July 15, 2007, together with accrued
interest. If a change of control occurs, Vector will be required to offer
to repurchase the notes at 101% of their principal amount, plus accrued
interest and, under certain circumstances, a "make whole" payment.
10% SENIOR SECURED NOTES DUE MARCH 31, 2006 - VGR HOLDING:
On May 14, 2001, VGR Holding issued at a discount $60,000 principal amount
of 10% senior secured notes due March 31, 2006 in a private placement. VGR
Holding received net proceeds from the offering of approximately $46,500.
On April 30, 2002, VGR Holding issued at a discount an additional $30,000
principal amount of 10% senior secured notes due March 31, 2006 in a
private placement and received net proceeds of approximately $24,500. The
notes were priced to provide the purchasers with a 15.75% yield to
maturity. The new notes are on the same terms as the $60,000 principal
amount of senior secured notes previously issued. All of the notes have
been guaranteed by the Company and by Liggett.
The notes are collateralized by substantially all of VGR Holding's assets,
including a pledge of VGR Holding's equity interests in its direct
subsidiaries, including Brooke Group Holding, Brooke (Overseas), Vector
Tobacco and New Valley Holdings, Inc. ("NV Holdings"), as well as a pledge
of the shares of Liggett and all of the New Valley securities held by VGR
Holding and NV Holdings. The purchase agreement for the notes contains
covenants, which among other things, limit the ability of VGR Holding to
make distributions to the Company to 50% of VGR Holding's net income,
unless VGR Holding holds $75,000 in cash after giving effect to the
payment of the distribution, and limit additional indebtedness of VGR
Holding, Liggett and Vector Tobacco to 250% of EBITDA (as defined in the
purchase agreements) for the trailing 12 months plus, for periods through
December 31, 2003, additional amounts including up to $100,000 during the
period commencing on December 31, 2002 and ending on March 31, 2003,
$115,000 during the period commencing on April 1, 2003 and ending on June
29, 2003, $100,000 during the period commencing on June 30, 2003 and
ending on September 29, 2003 and $50,000 during the period commencing on
September 30, 2003 and ending on December 31, 2003. The covenants also
restrict transactions with affiliates subject to exceptions which include
payments to Vector not to exceed $9,500 per year for permitted operating
expenses, and limit the ability of VGR Holding to merge, consolidate or
sell certain assets. In November 2002, in connection with an amendment to
the note purchase agreement, VGR Holding repurchased $8,000 of the notes
at a price of 100% of the principal amount plus accrued interest. The
Company recognized a loss of $1,320 in the fourth quarter 2002 on the
early extinguishment of debt.
In the second quarter of 2003, in connection with an additional amendment
to the note purchase agreement, VGR Holding repurchased a total of $8,000
of the notes at a price of 100% of the principal amount plus accrued
interest. VGR Holding also agreed to repurchase, under certain conditions,
an additional $4,000 of the notes on September 30, 2003, at a price of
100% of the principal amount plus accrued interest. The Company recognized
a loss of $1,197 in the second quarter and expects to recognize a loss of
approximately $575 in the third quarter of 2003 on the early
extinguishment of debt if VGR Holding repurchases the additional $4,000 of
the notes.
VGR Holding has the right (which it has not exercised) under the purchase
agreement for the notes to elect to treat Vector Tobacco as a "designated
subsidiary" and exclude the losses of Vector Tobacco in determining the
amount of additional indebtedness permitted to be incurred.
- 13 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
If VGR Holding were to make this election, future cash needs of Vector
Tobacco would be required to be funded directly by Vector or by
third-party financing as to which neither VGR Holding nor Liggett could
provide any guarantee or credit support.
VGR Holding may redeem the notes, in whole or in part, at a redemption
price of 100% of the principal amount. During the term of the notes, VGR
Holding is required to offer to repurchase all the notes at a purchase
price of 101% of the principal amount, in the event of a change of
control, and to offer to repurchase notes, at 100% of the principal
amount, with the proceeds of material asset sales.
REVOLVING CREDIT FACILITY - LIGGETT:
Liggett has a $40,000 credit facility, under which $32,662 was outstanding
at June 30, 2003. Availability under the credit facility was approximately
$7,188 based on eligible collateral at June 30, 2003. The facility is
collateralized by all inventories and receivables of Liggett. Borrowings
under the facility, whose interest is calculated at a rate equal to 1.0%
above Wachovia's (the indirect parent of Congress Financial Corporation,
the lead lender) prime rate, bore a rate of 5.25% at June 30, 2003. The
facility requires Liggett's compliance with certain financial and other
covenants including a restriction on the payment of cash dividends unless
Liggett's borrowing availability under the facility for the 30-day period
prior to the payment of the dividend, and after giving effect to the
dividend, is at least $5,000. In addition, the facility, as amended,
imposes requirements with respect to Liggett's adjusted net worth (not to
fall below $8,000 as computed in accordance with the agreement) and
working capital (not to fall below a deficit of $17,000 as computed in
accordance with the agreement). At June 30, 2003, Liggett was in
compliance with all covenants under the credit facility; Liggett's
adjusted net worth was $32,947 and net working capital was $34,638, as
computed in accordance with the agreement. The facility expires on March
8, 2004 subject to automatic renewal for an additional year unless a
notice of termination is given by the lender at least 60 days prior to
such date or the anniversary of such date.
In November 1999, 100 Maple LLC, a new company formed by Liggett to
purchase an industrial facility in Mebane, North Carolina, borrowed $5,040
from the lender under Liggett's credit facility. In July 2001, Maple
borrowed an additional $2,340 under the loan, and a total of $5,190 was
outstanding at June 30, 2003. In September 2002, the lender agreed that no
further regularly scheduled principal payments would be due under the
Maple loan until March 1, 2004. Thereafter, the loan is payable in 27
monthly installments of $77 with a final payment of $3,111. Interest is
charged at the same rate as applicable to Liggett's credit facility, and
borrowings under the Maple loan reduce the maximum availability under the
credit facility. Liggett has guaranteed the loan, and a first mortgage on
the Mebane property and equipment collateralizes the Maple loan and
Liggett's credit facility.
In April 2003, the credit facility was amended to increase the maximum
credit available under the facility to $45,000 for the period through
October 15, 2003. Vector has guaranteed $10,000 of borrowings under the
facility and collateralized the guarantee with $10,000 in cash which is
reflected in current restricted assets. Vector's guarantee and the pledge
of the cash collateral will terminate October 16, 2003 subject to
satisfaction of various conditions.
- 14 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
EQUIPMENT LOANS - LIGGETT:
In March 2000, Liggett purchased equipment for $1,000 through the issuance
of a note, payable in 60 monthly installments of $21 with an effective
annual interest rate of 10.14%. In April 2000, Liggett purchased equipment
for $1,071 through the issuance of notes, payable in 60 monthly
installments of $22 with an effective interest rate of 10.20%.
In October and December 2001, Liggett purchased equipment for $3,204 and
$3,200, respectively, through the issuance of notes guaranteed by the
Company, each payable in 60 monthly installments of $53 with interest
calculated at the prime rate.
In March 2002, Liggett purchased equipment for $3,023 through the issuance
of a note, payable in 30 monthly installments of $62 and then 30 monthly
installments of $51 with an effective annual interest rate of 4.68%.
In May 2002, Liggett purchased equipment for $2,871 through the issuance
of a note, payable in 30 monthly installments of $59 and then 30 monthly
installments of $48 with an effective annual interest rate of 4.64%.
In September 2002, Liggett purchased equipment for $1,573 through the
issuance of a note guaranteed by the Company, payable in 60 monthly
installments of $26 plus interest calculated at LIBOR plus 4.31%.
NOTES PAYABLE - VECTOR TOBACCO:
In June 2001, Vector Tobacco purchased for $8,400 an industrial facility
in Timberlake, North Carolina. Vector Tobacco financed the purchase with
an $8,200 loan, payable in 60 monthly installments of $85, plus annual
interest at 4.85% above LIBOR with a final payment of approximately
$3,160. The loan, which is collateralized by a mortgage and a letter of
credit of $1,750, is guaranteed by VGR Holding and Vector.
During December 2001, Vector Tobacco borrowed an additional $1,159 from
the same lender to finance building improvements. This loan is payable in
30 monthly installments of $39 plus accrued interest, with an annual
interest rate of LIBOR plus 5.12%.
NOTES FOR MEDALLION ACQUISITION - VECTOR TOBACCO:
The purchase price for the acquisition of Medallion included $60,000 in
notes of Vector Tobacco, guaranteed by the Company and Liggett. Of the
notes, $25,000 bear interest at a 9.0% annual rate and mature $3,125 per
quarter commencing June 30, 2002 and continuing through March 31, 2004. At
June 30, 2003, $9,374 of these notes were outstanding. The remaining
$35,000 of notes bear interest at 6.5% per year, payable semiannually, and
mature on April 1, 2007.
- 15 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
NOTES PAYABLE - V.T. AVIATION:
In February 2001, V.T. Aviation LLC, a subsidiary of Vector Research Ltd.,
purchased an airplane for $15,500 and borrowed $13,175 to fund the
purchase. The loan, which is collateralized by the airplane and a letter
of credit from the Company for $775, is guaranteed by Vector Research, VGR
Holding and the Company. The loan is payable in 120 monthly installments
of $125, including annual interest of 2.31% above the 30-day commercial
paper rate with a final payment of $6,125.
In February 2002, V.T. Aviation purchased an airplane for $6,575 and
borrowed $6,150 to fund the purchase. The loan is guaranteed by Vector
Research and the Company. The loan is payable in 120 monthly installments
of $44, including annual interest of 2.75% above the 30-day average
commercial paper rate.
NOTE PAYABLE - NEW VALLEY:
In December 2002, New Valley financed a portion of its purchase of two
office buildings in Princeton, N.J. with a mortgage loan of $40,500 from
HSBC Realty Credit Corporation (USA). The loan has a term of four years,
bears interest at a floating rate of 2% above LIBOR, and is secured by a
first mortgage on the office buildings, as well as by an assignment of
leases and rents. Principal is amortized to the extent of $54 per month
during the term of the loan. The loan may be prepaid without penalty and
is non-recourse against New Valley, except for various specified
environmental and related matters, misapplications of tenant security
deposits and insurance and condemnation proceeds, and fraud or
misrepresentation by New Valley in connection with the indebtedness.
7. EQUITY
The Company accounts for employee stock compensation plans under APB
Opinion No. 25, "Accounting for Stock Issued to Employees", with the
intrinsic value-based method permitted by SFAS No. 123, "Accounting for
Stock-Based Compensation" as amended by SFAS No. 148. Accordingly, no
compensation expense is recognized when the exercise price is equal to the
market price of the underlying common stock on the date of grant.
Awards under the Company's stock compensation plans generally vest over
periods ranging from four to five years from the date of grant. The
expense related to stock option compensation included in the determination
of net income for the three and six months ended June 30, 2003 and June
30, 2002 is less than that which would have been recognized if the fair
value method had been applied to all awards since the original effective
date of SFAS No. 123. The following table illustrates the effect on net
loss and loss per share if the Company had applied the fair value
provisions of SFAS No. 123:
- 16 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
Three Months Ended Six Months Ended
-------------------------- --------------------------
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
------- ------- -------- --------
Net loss $(4,930) $(3,342) $ (9,779) $(15,205)
Add: stock option employee compensation
expense included in reported net loss,
net of related tax effects 1,365 1,328 2,719 2,656
Deduct: total stock option employee
compensation expense determined
under the fair value method for all
awards, net of related tax effects (2,254) (2,569) (4,487) (5,137)
------- ------- -------- --------
Pro forma net loss $(5,819) $(4,583) $(11,547) $(17,686)
======= ======= ======== ========
Loss per share:
Basic and diluted - as reported $ (0.13) $ (0.10) $ (0.27) $ (0.44)
Basic and diluted - pro forma $ (0.16) $ (0.13) $ (0.31) $ (0.51)
For purposes of this pro forma presentation, the fair value of each option
grant was estimated at the date of the grant using the Black-Scholes
option pricing model. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options which
have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions
including expected stock price characteristics which are significantly
different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value
estimate, the existing models do not necessarily provide a reliable single
measure of the fair value of stock-based compensation awards.
During the six months ended June 30, 2003, 127,331 warrants, exercisable
at $3.98 per share, and 404,139 options, exercisable at prices ranging
from $4.93 to $13.33 per share, were exercised for $623 of cash and the
surrender of 225,388 options.
8. CONTINGENCIES
SMOKING-RELATED LITIGATION:
OVERVIEW. Since 1954, Liggett and other United States cigarette
manufacturers have been named as defendants in numerous direct and
third-party actions predicated on the theory that cigarette manufacturers
should be liable for damages alleged to have been caused by cigarette
smoking or by exposure to secondary smoke from cigarettes. These cases are
reported here as though having been commenced against Liggett (without
regard to whether such cases were actually commenced against Brooke Group
- 17 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
Holding Inc., the Company's predecessor and a wholly-owned subsidiary of
VGR Holding, or Liggett). There has been a noteworthy increase in the
number of cases commenced against Liggett and the other cigarette
manufacturers in recent years. The cases generally fall into the following
categories: (i) smoking and health cases alleging injury brought on behalf
of individual plaintiffs ("Individual Actions"); (ii) smoking and health
cases alleging injury and purporting to be brought on behalf of a class of
individual plaintiffs ("Class Actions"); (iii) health care cost recovery
actions brought by various foreign and domestic governmental entities
("Governmental Actions"); and (iv) health care cost recovery actions
brought by third-party payors including insurance companies, union health
and welfare trust funds, asbestos manufacturers and others ("Third-Party
Payor Actions"). As new cases are commenced, defense costs and the risks
attendant to the inherent unpredictability of litigation continue to
increase. The future financial impact of the risks and expenses of
litigation and the effects of the tobacco litigation settlements discussed
below are not quantifiable at this time. For the six months ended June 30,
2003, Liggett incurred counsel fees and costs totaling approximately
$2,232 compared to $2,566 for the six months ended June 30, 2002.
INDIVIDUAL ACTIONS. As of June 30, 2003, there were approximately 352
cases pending against Liggett, and in most cases the other tobacco
companies, where one or more individual plaintiffs allege injury resulting
from cigarette smoking, addiction to cigarette smoking or exposure to
secondary smoke and seek compensatory and, in some cases, punitive
damages. Of these, 87 were pending in Florida, 81 in Maryland, 53 in New
York, 34 in Mississippi and 20 in California. The balance of the
individual cases were pending in 22 states. There are seven individual
cases pending where Liggett is the only named defendant. In addition to
these cases, an action against cigarette manufacturers involving
approximately 1,260 named individual plaintiffs has been consolidated
before a single West Virginia state court. Liggett is a defendant in most
of the cases pending in West Virginia. In January 2002, the court severed
Liggett from the trial of the consolidated action.
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence,
gross negligence, breach of special duty, strict liability, fraud,
misrepresentation, design defect, failure to warn, breach of express and
implied warranties, conspiracy, aiding and abetting, concert of action,
unjust enrichment, common law public nuisance, property damage, invasion
of privacy, mental anguish, emotional distress, disability, shock,
indemnity and violations of deceptive trade practice laws, the Federal
Racketeer Influenced and Corrupt Organization Act ("RICO"), state RICO
statutes and antitrust statutes. In many of these cases, in addition to
compensatory damages, plaintiffs also seek other forms of relief including
treble/multiple damages, medical monitoring, disgorgement of profits and
punitive damages. Defenses raised by defendants in these cases include
lack of proximate cause, assumption of the risk, comparative fault and/or
contributory negligence, lack of design defect, statute of limitations,
equitable defenses such as "unclean hands" and lack of benefit, failure to
state a claim and federal preemption.
Jury awards in various states have been entered against other cigarette
manufacturers. The awards in these individual actions are for both
compensatory and punitive damages and represent a material amount of
damages. In 1999, a jury awarded $800 in compensatory damages and $79,500
in punitive damages in an Oregon state court case involving Philip Morris.
The trial court later determined that the punitive damage award was
excessive and reduced it to $32,000. In June 2002, an Oregon intermediate
appellate court reinstated the jury's punitive damages award. The Oregon
Supreme Court refused to hear Philip Morris' appeal of the appellate court
- 18 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
ruling in December 2002, and Philip Morris has appealed to the United
States Supreme Court. In June 2001, a jury awarded $5,500 in compensatory
damages and $3,000,000 in punitive damages in a California state court
case involving Philip Morris. In March 2002, a jury awarded $169 in
compensatory damages and $150,000 in punitive damages in an Oregon state
court case also involving Philip Morris. The punitive damages awards in
both the California and Oregon actions were subsequently reduced to
$100,000 by the trial courts. In September 2002, a jury awarded $850 in
compensatory damages and $28,000,000 in punitive damages in a California
state court case involving Philip Morris. In December 2002, the trial
court reduced the punitive damages award to $28,000. Both the verdict and
damage awards in these cases are being appealed. In November 2001, in
another case, a $25,000 punitive damages judgment against Philip Morris
was affirmed by a California intermediate appellate court. In October
2002, the California Supreme Court vacated the decision and remanded the
case to the intermediate appellate court for reconsideration in light of
its August 2002 ruling that a state statute in effect from January 1988 to
December 1997 conferred immunity to cigarette manufacturers for conduct
during that ten-year period. In March 2003, the appellate court reaffirmed
its earlier decision approving the jury's verdict, and Philip Morris
appealed to the California Supreme Court. In June 2003, the California
Supreme Court remanded the case to the appellate court to reconsider its
ruling in light of a recent United States Supreme Court decision limiting
punitive damages. During 2001, as a result of a Florida Supreme Court
decision upholding the award, another cigarette manufacturer paid $1,100
in compensatory damages and interest to a former smoker and his spouse for
injuries they allegedly incurred as a result of smoking. In December 2001,
in an individual action involving another cigarette manufacturer, a
Florida jury awarded a smoker $165 in compensatory damages. The defendant
has appealed the verdict. In February 2002, a federal district court jury
in Kansas awarded a smoker $198 in compensatory damages from two other
cigarette manufacturers and, in June 2002, the trial court assessed
punitive damages of $15,000 against one of the defendants. The defendant
has appealed the verdict. In April 2003, in an individual Florida state
court action involving two other cigarette manufacturers, a jury awarded
compensatory damages of $6,500 (reduced by the court to $3,250). The
defendants have appealed the verdict. In May 2003, a federal district
court jury in Arkansas awarded compensatory damages of $4,025 and punitive
damages of $15,000 in an individual action involving another cigarette
manufacturer. The court subsequently struck the punitive damages award.
The defendant intends to appeal the verdict.
CLASS ACTIONS. As of June 30, 2003, there were approximately 41 actions
pending, for which either a class has been certified or plaintiffs are
seeking class certification, where Liggett, among others, was a named
defendant. Many of these actions purport to constitute statewide class
actions and were filed after May 1996 when the Fifth Circuit Court of
Appeals, in the Castano case, reversed a Federal district court's
certification of a purported nationwide class action on behalf of persons
who were allegedly "addicted" to tobacco products.
The extent of the impact of the Castano decision on smoking-related class
action litigation is still uncertain. The Castano decision has had a
limited effect with respect to courts' decisions regarding narrower
smoking-related classes or class actions brought in state rather than
federal court. For example, since the Fifth Circuit's ruling, a court in
Louisiana (Liggett is not a defendant in this proceeding) has certified
"addiction-as-injury" class actions that covered only citizens in those
states. Two other class actions, Broin and Engle, were certified in state
court in Florida prior to the Fifth Circuit's decision. In April 2001, the
Brown case was certified as a class action in California.
- 19 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
In May 1994, an action entitled ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO
COMPANY, ET AL., Circuit Court, Eleventh Judicial Circuit, Miami-Dade
County, Florida, was filed against Liggett and others. The class consists
of all Florida residents and citizens, and their survivors, who have
suffered, presently suffer or have died from diseases and medical
conditions caused by their addiction to cigarettes that contain nicotine.
Phase I of the trial commenced in July 1998 and in July 1999, the jury
returned the Phase I verdict. The Phase I verdict concerned certain issues
determined by the trial court to be "common" to the causes of action of
the plaintiff class. Among other things, the jury found that: smoking
cigarettes causes 20 diseases or medical conditions, cigarettes are
addictive or dependence producing, defective and unreasonably dangerous,
defendants made materially false statements with the intention of
misleading smokers, defendants concealed or omitted material information
concerning the health effects and/or the addictive nature of smoking
cigarettes and agreed to misrepresent and conceal the health effects
and/or the addictive nature of smoking cigarettes, and defendants were
negligent and engaged in extreme and outrageous conduct or acted with
reckless disregard with the intent to inflict emotional distress. The jury
also found that defendants' conduct "rose to a level that would permit a
potential award or entitlement to punitive damages." The court decided
that Phase II of the trial, which commenced November 1999, would be a
causation and damages trial for three of the class representatives and a
punitive damages trial on a class-wide basis, before the same jury that
returned the verdict in Phase I. Phase III of the trial was to be
conducted before separate juries to address absent class members' claims,
including issues of specific causation and other individual issues
regarding entitlement to compensatory damages. In April 2000, the jury
awarded compensatory damages of $12,704 to the three plaintiffs, to be
reduced in proportion to the respective plaintiff's fault. The jury also
decided that the claim of one of the plaintiffs, who was awarded
compensatory damages of $5,831, was not timely filed. In July 2000, the
jury awarded approximately $145,000,000 in the punitive damages portion of
Phase II against all defendants including $790,000 against Liggett. The
court entered a final order of judgment against the defendants in November
2000. The court's final judgment, which provided for interest at the rate
of 10% per year on the jury's awards, also denied various post-trial
motions, including a motion for new trial and a motion seeking reduction
of the punitive damages award. Liggett appealed the court's order.
In May 2003, Florida's Third District Court of Appeals decertified the
ENGLE class and set aside the jury's decision in the case against Liggett
and the other cigarette makers, including the $145,000,000 punitive
damages award. The intermediate appellate court ruled that there were
multiple legal bases why the class action trial, including the punitive
damages award, could not be sustained. The court found that the class
failed to meet the legal requirements for class certification and that
class members needed to pursue their claims on an individualized basis.
The court also ruled that the trial plan violated Florida law and the
appellate court's 1996 certification decision, and was unconstitutional.
The court further found that the proceedings were irretrievably tainted by
class counsel's misconduct and that the punitive damages award was
bankrupting under Florida law.
In July 2003, class counsel filed motions with the appellate court
seeking, among other things, a rehearing by the court, a rehearing en banc
by the full Third District Court of Appeals and certification by the court
of selective issues as a matter of "great public importance" which could
allow for review by the Florida Supreme Court. If the appellate court's
ruling is not upheld on further appeal, it will have a material adverse
effect on the Company.
- 20 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
In May 2000, legislation was enacted in Florida that limits the size of
any bond required, pending appeal, to stay execution of a punitive damages
verdict to the lesser of the punitive award plus twice the statutory rate
of interest, $100,000 or 10% of the net worth of the defendant, but the
limitation on the bond does not affect the amount of the underlying
verdict. In November 2000, Liggett filed the $3,450 bond required by the
Florida law in order to stay execution of the ENGLE judgment, pending
appeal. Similar legislation has been enacted in Arkansas, Colorado,
Georgia, Idaho, Indiana, Kansas, Kentucky, Louisiana, Michigan, Missouri,
Nevada, North Carolina, Ohio, Oklahoma, South Carolina, Tennessee,
Virginia and West Virginia. The Mississippi Supreme Court has also placed
limits on appeal bonds by court rule.
In May 2001, Liggett, along with Philip Morris and Lorillard Tobacco Co.,
reached an agreement with the class in the ENGLE case, which provided
assurance of Liggett's ability to appeal the jury's July 2000 verdict. As
required by the agreement, Liggett paid $6,273 into an escrow account to
be held for the benefit of the ENGLE class, and released, along with
Liggett's existing $3,450 statutory bond, to the court for the benefit of
the class upon completion of the appeals process, regardless of the
outcome of the appeal. As a result, the Company recorded a $9,723 pre-tax
charge to the consolidated statement of operations for the first quarter
of 2001. The agreement, which was approved by the court, assured that the
stay of execution, in effect pursuant to the Florida bonding statute,
would not be lifted or limited at any point until completion of all
appeals, including an appeal to the United States Supreme Court. If
Liggett's balance sheet net worth fell below $33,781 (as determined in
accordance with generally accepted accounting principles in effect as of
July 14, 2000), the agreement provided that the stay granted in favor of
Liggett in the agreement would terminate and the ENGLE class would be free
to challenge the Florida bonding statute.
In June 2002, the jury in a Florida state court action entitled LUKACS V.
PHILIP MORRIS, ET AL. awarded $37,500 in compensatory damages in a case
involving Liggett and two other tobacco manufacturers. In March 2003, the
court reduced the amount of the compensatory damages to $25,100. The jury
found Liggett 50% responsible for the damages incurred by the plaintiff.
The LUKACS case was the first individual case to be tried as part of Phase
III of the ENGLE case; the claims of all other individuals who are members
of the class were stayed pending resolution of the appeal of the ENGLE
verdict. The LUKACS verdict, which was subject to the outcome of the ENGLE
appeal, has been overturned as a result of the appellate court's ruling.
As discussed above, class counsel in ENGLE is pursuing various appellate
remedies seeking reversal of the appellate court's decision.
Class certification motions are pending in a number of putative class
actions. Classes remain certified against Liggett in West Virginia
(BLANKENSHIP), in California (BROWN), in New York (SIMON), in Kansas
(SMITH) and in New Mexico (ROMERO). A number of class certification
denials are on appeal.
In August 2000, in BLANKENSHIP V. PHILIP MORRIS, INC., a West Virginia
state court conditionally certified (only to the extent of medical
monitoring) a class of present or former West Virginia smokers who desire
to participate in a medical monitoring plan. The trial of this case ended
in January 2001, when the judge declared a mistrial. In an order issued in
March 2001, the court reaffirmed class certification of this medical
monitoring action. In July 2001, the court issued
- 21 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
an order severing Liggett from the retrial of the case which began in
September 2001. In November 2001, the jury returned a verdict in favor of
the defendants. In January 2002, the trial court denied plaintiffs' motion
for a new trial, and plaintiffs have appealed.
In April 2001, the California state court in the case of BROWN V. THE
AMERICAN TOBACCO COMPANY, INC., ET AL., granted in part plaintiff's motion
for class certification and certified a class comprised of adult residents
of California who smoked at least one of defendants' cigarettes "during
the applicable time period" and who were exposed to defendants' marketing
and advertising activities in California. Certification was granted as to
plaintiff's claims that defendants violated California's unfair business
practices statute. The court subsequently defined "the applicable class
period" for plaintiff's claims, pursuant to a stipulation submitted by the
parties, as June 10, 1993 through April 23, 2001. The California Court of
Appeals denied defendants' writ application, which sought review of the
trial court's class certification orders. Defendants filed a petition for
review with the California Supreme Court, which was subsequently denied.
Trial is currently scheduled to begin in September 2003. Liggett is a
defendant in the case.
In September 2002, in IN RE SIMON II LITIGATION, the federal district
court for the Eastern District of New York granted plaintiffs' motion for
certification of a nationwide non-opt-out punitive damages class action
against the tobacco companies, including Liggett. The class is not seeking
compensatory damages, but was created to determine whether smokers across
the country may be entitled to punitive damages. In its order, the court
set a trial date of January 2003, but has since stayed the order pending
the tobacco companies' appeal to the U.S. Court of Appeals for the Second
Circuit. In February 2003, the Second Circuit agreed to review the
district court's class certification decision.
In March 2003, in a class action brought against Philip Morris on behalf
of smokers of light cigarettes, a state court judge in Illinois awarded
$7,100,000 in actual damages to the class members, $3,000,000 in punitive
damages to the State of Illinois (which was not a plaintiff in this
matter), and approximately $1,800,000 in attorney's fees and costs. Entry
of judgment has been stayed. Philip Morris has appealed the verdict.
Approximately 38 purported state and federal class action complaints have
been filed against the cigarette manufacturers, including Liggett, for
alleged antitrust violations. The actions allege that the cigarette
manufacturers have engaged in a nationwide and international conspiracy to
fix the price of cigarettes in violation of state and federal antitrust
laws. Plaintiffs allege that defendants' price-fixing conspiracy raised
the price of cigarettes above a competitive level. Plaintiffs in the 31
state actions purport to represent classes of indirect purchasers of
cigarettes in 16 states; plaintiffs in the seven federal actions purport
to represent a nationwide class of wholesalers who purchased cigarettes
directly from the defendants. The federal class actions have been
consolidated and, in July 2000, plaintiffs in the federal consolidated
action filed a single consolidated complaint that did not name Liggett as
a defendant, although Liggett has complied with discovery requests. The
court granted defendants' motion for summary judgment in the consolidated
federal cases in July 2002, which decision has been appealed by plaintiffs
to the U.S. Court of Appeals for the Eleventh Circuit. Oral argument was
heard in May 2003. State court cases have been dismissed in Arizona, which
is currently on appeal, and in New York and Florida. Class certification
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
has been denied by courts in Minnesota and Michigan. A Kansas state court
in the case of SMITH V. PHILIP MORRIS COMPANIES INC., ET AL. granted class
certification in November 2001, and the trial in that case is currently
scheduled to commence in September 2003. In April 2003, plaintiffs' motion
for class certification was granted in ROMERO V. PHILIP MORRIS COMPANIES
INC., a case pending in New Mexico state court. The New Mexico Court of
Appeals has agreed to hear defendants' appeal of the class certification
decision. Liggett is one of the defendants in the Kansas and New Mexico
cases.
GOVERNMENTAL ACTIONS. As of June 30, 2003, there were approximately 40
Governmental Actions pending against Liggett. In these proceedings, both
foreign and domestic governmental entities seek reimbursement for Medicaid
and other health care expenditures. The claims asserted in these health
care cost recovery actions vary. In most of these cases, plaintiffs assert
the equitable claim that the tobacco industry was "unjustly enriched" by
plaintiffs' payment of health care costs allegedly attributable to smoking
and seek reimbursement of those costs. Other claims made by some but not
all plaintiffs include the equitable claim of indemnity, common law claims
of negligence, strict liability, breach of express and implied warranty,
breach of special duty, fraud, negligent misrepresentation, conspiracy,
public nuisance, claims under state and federal statutes governing
consumer fraud, antitrust, deceptive trade practices and false
advertising, and claims under RICO.
THIRD-PARTY PAYOR ACTIONS. As of June 30, 2003, there were approximately
six Third-Party Payor Actions pending against Liggett. The claims in these
cases are similar to those in the Governmental Actions but have been
commenced by insurance companies, union health and welfare trust funds,
asbestos manufacturers and others. Nine United States Circuit Courts of
Appeal have ruled that Third-Party Payors did not have standing to bring
lawsuits against the cigarette manufacturers. The United States Supreme
Court has denied petitions for certiorari in the cases decided by five of
the courts of appeal. However, a number of Third-Party Payor Actions,
including an action brought by 24 Blue Cross/Blue Shield Plans, remain
pending.
In June 2001, a jury in a third party payor action brought by Empire Blue
Cross and Blue Shield in the Eastern District of New York rendered a
verdict awarding the plaintiff $17,800 in damages against the major
tobacco companies. As against Liggett, the jury awarded the plaintiff
damages of $89. In February 2002, the court awarded plaintiff's counsel
$37,800 in attorneys' fees, without allocating the fee award among the
several defendants. Liggett has appealed both the jury verdict and the
attorneys' fee award. Oral argument before the United States Court of
Appeals for the Second Circuit was held in February 2003.
In other Third-Party Payor Actions claimants have set forth several
additional theories of relief sought: funding of corrective public
education campaigns relating to issues of smoking and health; funding for
clinical smoking cessation programs; disgorgement of profits from sales of
cigarettes; restitution; treble damages; and attorneys' fees.
Nevertheless, no specific amounts are provided. It is understood that
requested damages against the tobacco company defendants in these cases
might be in the billions of dollars.
FEDERAL GOVERNMENT ACTION. In September 1999, the United States government
commenced litigation against Liggett and the other tobacco companies in
the United States District Court for the District of Columbia. The action
seeks to recover an unspecified amount of health care costs paid for and
furnished, and to be paid for and furnished, by the Federal Government for
lung cancer, heart disease, emphysema and other smoking-related illnesses
allegedly caused by the fraudulent and tortious conduct of defendants, to
restrain defendants and co-conspirators from engaging in fraud and other
unlawful conduct in the future, and to compel defendants to disgorge the
proceeds of their unlawful conduct. The complaint alleges that such costs
total more than $20,000,000 annually. The action asserts claims under
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
three federal statutes, the Medical Care Recovery Act ("MCRA"), the
Medicare Secondary Payer provisions of the Social Security Act ("MSP") and
RICO. In December 1999, Liggett filed a motion to dismiss the lawsuit on
numerous grounds, including that the statutes invoked by the government do
not provide the basis for the relief sought. In September 2000, the court
dismissed the government's claims based on MCRA and MSP, and the court
reaffirmed its decision in July 2001. In the September 2000 decision, the
court also determined not to dismiss the government's claims based on
RICO, under which the government continues to seek court relief to
restrain the defendant tobacco companies from allegedly engaging in fraud
and other unlawful conduct and to compel disgorgement. In May 2003, the
court denied the industry's partial summary judgment motion which sought
summary judgment as to the government's advertising, marketing, promotion
and warning claims on the basis that these claims are within the exclusive
jurisdiction of the Federal Trade Commission. Additional motions for
summary judgment have been filed by the government and defendants, and
those motions are pending before the court.
In June 2001, the United States Attorney General assembled a team of three
Department of Justice ("DOJ") lawyers to work on a possible settlement of
the federal lawsuit. The DOJ lawyers met with representatives of the
tobacco industry, including Liggett, in July 2001. No settlement was
reached, and no further meetings are planned. In a January 2003 filing
with the court, the government alleged that disgorgement by defendants of
approximately $289,000,000 is an appropriate remedy in the case. Discovery
in the case has commenced, and trial has been scheduled for September
2004.
SETTLEMENTS. In March 1996, Brooke Group Holding and Liggett entered into
an agreement, subject to court approval, to settle the Castano class
action tobacco litigation. The CASTANO class was subsequently decertified
by the court.
In March 1996, March 1997 and March 1998, Brooke Group Holding and Liggett
entered into settlements of smoking-related litigation with the Attorneys
General of 45 states and territories. The settlements released both Brooke
Group Holding and Liggett from all smoking-related claims, including
claims for health care cost reimbursement and claims concerning sales of
cigarettes to minors.
In November 1998, Philip Morris, Brown & Williamson Tobacco Corporation,
R.J. Reynolds Tobacco Company and Lorillard Tobacco Company (collectively,
the "Original Participating Manufacturers" or "OPMs") and Liggett
(together with the OPMs and any other tobacco product manufacturer that
becomes a signatory, the "Participating Manufacturers") entered into the
Master Settlement Agreement (the "MSA") with 46 states, the District of
Columbia, Puerto Rico, Guam, the United States Virgin Islands, American
Samoa and the Northern Marianas (collectively, the "Settling States") to
settle the asserted and unasserted health care cost recovery and certain
other claims of those Settling States. The MSA has received final judicial
approval in each of the 52 settling jurisdictions.
The MSA restricts tobacco product advertising and marketing within the
Settling States and otherwise restricts the activities of Participating
Manufacturers. Among other things, the MSA prohibits the targeting of
youth in the advertising, promotion or marketing of tobacco products; bans
the use of cartoon characters in all tobacco advertising and promotion;
limits each Participating Manufacturer to one tobacco brand name
sponsorship during any 12-month period; bans all outdoor advertising, with
the exception of signs, 14 square feet or less, at retail establishments
that sell tobacco products; prohibits payments for tobacco product
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
placement in various media; bans gift offers based on the purchase of
tobacco products without sufficient proof that the intended recipient is
an adult; prohibits Participating Manufacturers from licensing third
parties to advertise tobacco brand names in any manner prohibited under
the MSA; prohibits Participating Manufacturers from using as a tobacco
product brand name any nationally recognized non-tobacco brand or trade
name or the names of sports teams, entertainment groups or individual
celebrities; and prohibits Participating Manufacturers from selling packs
containing fewer than 20 cigarettes.
The MSA also requires Participating Manufacturers to affirm corporate
principles to comply with the MSA and to reduce underage usage of tobacco
products and imposes requirements applicable to lobbying activities
conducted on behalf of Participating Manufacturers.
Liggett has no payment obligations under the MSA except to the extent its
market share exceeds a base share of 125% of its 1997 market share, or
approximately 1.65% of total cigarettes sold in the United States. As a
result of the Medallion acquisition on April 1, 2002, Vector Tobacco has
no payment obligations under the MSA except to the extent its market share
exceeds a base amount of approximately 0.28% of total cigarettes sold in
the United States. During 1999 and 2000, Liggett's market share did not
exceed the base amount. Based on published industry sources, domestic
shipments by Liggett and Vector Tobacco accounted for approximately 2.2%
of the total cigarettes shipped in the United States during 2001 and 2.5%
during 2002. On April 15 of any year following a year in which Liggett's
and Vector Tobacco's market shares exceed their base shares, Liggett and
Vector Tobacco will pay on each excess unit an amount equal (on a per-unit
basis) to that due during the same following year by the OPMs under the
annual and strategic contribution payment provisions of the MSA, subject
to applicable adjustments, offsets and reductions. In March and April
2002, Liggett and Vector Tobacco paid a total of $31,130 for their 2001
MSA obligations. In March and April 2003, Liggett and Vector Tobacco paid
a total of $37,541 for their 2002 MSA obligations. Liggett and Vector
Tobacco have expensed $14,332 for their estimated MSA obligations for the
first six months of 2003 as part of cost of goods sold. Under the annual
and strategic contribution payment provisions of the MSA, the OPMs (and
Liggett and Vector Tobacco to the extent their market shares exceed their
base shares) are required to pay the following annual amounts (subject to
certain adjustments):
Year Amount
---- ------
2003................................... $6,500,000
2004 - 2007............................ $8,000,000
2008 - 2017............................ $8,139,000
2018 and each year thereafter.......... $9,000,000
These annual payments will be allocated based on relative unit volume of
domestic cigarette shipments. The payment obligations under the MSA are
the several, and not joint, obligations of each Participating Manufacturer
and are not the responsibility of any parent or affiliate of a
Participating Manufacturer.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
The MSA replaces Liggett's prior settlements with all states and
territories except for Florida, Mississippi, Texas and Minnesota. Each of
these four states, prior to the effective date of the MSA, negotiated and
executed settlement agreements with each of the other major tobacco
companies, separate from those settlements reached previously with
Liggett. Because these states' settlement agreements with Liggett provided
for "most favored nation" protection for both Brooke Group Holding and
Liggett, the payments due these states by Liggett (with certain possible
exceptions) have been eliminated, other than a $100 a year payment to
Minnesota starting in 2003 during any year cigarettes manufactured by
Liggett are sold in the state. With respect to all non-economic
obligations under the previous settlements, both Brooke Group Holding and
Liggett are entitled to the most favorable provisions as between the MSA
and each state's respective settlement with the other major tobacco
companies. Therefore, Liggett's non-economic obligations to all states and
territories are now defined by the MSA.
Copies of the various settlement agreements are filed as exhibits to the
Company's Form 10-K and the discussion herein is qualified in its entirety
by reference thereto.
TRIALS. Cases currently scheduled for trial during the next six months
include two individual actions in Florida state court scheduled for August
2003 and January 2004, in both of which Liggett is the only defendant, an
individual action in New Hampshire state court scheduled for October 2003,
involving Liggett and Philip Morris as defendants, and an individual
action in New Jersey federal court scheduled for October 2003, involving
Liggett and Lorillard as defendants. In addition, in September 2003, the
Brown class action is scheduled for trial in California state court and
the Smith antitrust class action is scheduled for trial in Kansas state
court. Trial dates, however, are subject to change.
Management is not able to predict the outcome of the litigation pending
against Brooke Group Holding or Liggett. Litigation is subject to many
uncertainties. In May 2003, a Florida intermediate appellate court
overturned a $790,000 punitive damages award against Liggett and
decertified the ENGLE smoking and health class action. Class counsel in
ENGLE is pursuing various appellate remedies seeking reversal of the
appellate court's decision. If the appellate court's ruling is not upheld
on further appeal, it will have a material adverse effect on the Company.
In November 2000, Liggett filed the $3,450 bond required under the bonding
statute enacted in 2000 by the Florida legislature which limits the size
of any bond required, pending appeal, to stay execution of a punitive
damages verdict. In May 2001, Liggett reached an agreement with the class
in the ENGLE case, which provided assurance to Liggett that the stay of
execution, in effect pursuant to the Florida bonding statute, would not be
lifted or limited at any point until completion of all appeals, including
to the United States Supreme Court. As required by the agreement, Liggett
paid $6,273 into an escrow account to be held for the benefit of the ENGLE
class, and released, along with Liggett's existing $3,450 statutory bond,
to the court for the benefit of the class upon completion of the appeals
process, regardless of the outcome of the appeal. As a result, the Company
recorded a $9,723 pre-tax charge to the consolidated statement of
operations for the first quarter of 2001. In June 2002, the jury in an
individual case brought under the third phase of the ENGLE case awarded
$37,500 (subsequently reduced by the court to $25,100) of compensatory
damages against Liggett and two other defendants and found Liggett 50%
responsible for the damages. The verdict, which was subject to the outcome
of the ENGLE appeal, has been overturned as a result of the appellate
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
court's ruling. It is possible that additional cases could be decided
unfavorably and that there could be further adverse developments in the
ENGLE case. Management cannot predict the cash requirements related to any
future settlements and judgments, including cash required to bond any
appeals, and there is a risk that those requirements will not be able to
be met. An unfavorable outcome of a pending smoking and health case could
encourage the commencement of additional similar litigation. Management is
unable to make a meaningful estimate with respect to the amount or range
of loss that could result from an unfavorable outcome of the cases pending
against Brooke Group Holding or Liggett or the costs of defending such
cases. The complaints filed in these cases rarely detail alleged damages.
Typically, the claims set forth in an individual's complaint against the
tobacco industry pray for money damages in an amount to be determined by a
jury, plus punitive damages and costs. These damage claims are typically
stated as being for the minimum necessary to invoke the jurisdiction of
the court.
It is possible that the Company's consolidated financial position, results
of operations or cash flows could be materially adversely affected by an
unfavorable outcome in any such smoking-related litigation.
Liggett's and Vector Tobacco's management are unaware of any material
environmental conditions affecting their existing facilities. Liggett's
and Vector Tobacco's management believe that current operations are
conducted in material compliance with all environmental laws and
regulations and other laws and regulations governing cigarette
manufacturers. Compliance with federal, state and local provisions
regulating the discharge of materials into the environment, or otherwise
relating to the protection of the environment, has not had a material
effect on the capital expenditures, results of operations or competitive
position of Liggett or Vector Tobacco.
Liggett has been served in three reparations actions brought by
descendants of slaves. Plaintiffs in these actions claim that defendants,
including Liggett, profited from the use of slave labor. Seven additional
cases have been filed in California, Illinois and New York. Liggett is a
named defendant in only one of these additional cases, but has not been
served.
There are several other proceedings, lawsuits and claims pending against
the Company and certain of its consolidated subsidiaries unrelated to
smoking or tobacco product liability. Management is of the opinion that
the liabilities, if any, ultimately resulting from such other proceedings,
lawsuits and claims should not materially affect the Company's financial
position, results of operations or cash flows.
LEGISLATION AND REGULATION:
In January 1993, the Environmental Protection Agency ("EPA") released a
report on the respiratory effect of secondary smoke which concludes that
secondary smoke is a known human lung carcinogen in adults and in
children, causes increased respiratory tract disease and middle ear
disorders and increases the severity and frequency of asthma. In June
1993, the two largest of the major domestic cigarette manufacturers,
together with other segments of the tobacco and distribution industries,
commenced a lawsuit against the EPA seeking a determination that the EPA
did not have the statutory authority to regulate secondary smoke, and that
given the current body of scientific evidence and the EPA's failure to
follow its own guidelines in making the determination, the EPA's
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
classification of secondary smoke was arbitrary and capricious. In July
1998, a federal district court vacated those sections of the report
relating to lung cancer, finding that the EPA may have reached different
conclusions had it complied with relevant statutory requirements. The
federal government appealed the court's ruling. In December 2002, the
United States Court of Appeals for the Fourth Circuit rejected the
industry challenge to the EPA report ruling that it was not subject to
court review. Issuance of the report may encourage efforts to limit
smoking in public areas.
In February 1996, the United States Trade representative issued an
"advance notice of proposed rule making" concerning how tobacco is
imported under a previously established tobacco tariff rate quota ("TRQ")
should be allocated. Currently, tobacco imported under the TRQ is
allocated on a "first-come, first-served" basis, meaning that entry is
allowed on an open basis to those first requesting entry in the quota
year. Others in the cigarette industry have suggested an "end-user
licensing" system under which the right to import tobacco under the quota
would be initially assigned based on domestic market share. Such an
approach, if adopted, could have a material adverse effect on the Company
and Liggett.
In August 1996, the Food and Drug Administration (the "FDA") filed in the
Federal Register a Final Rule classifying tobacco as a "drug" or "medical
device", asserting jurisdiction over the manufacture and marketing of
tobacco products and imposing restrictions on the sale, advertising and
promotion of tobacco products. Litigation was commenced challenging the
legal authority of the FDA to assert such jurisdiction, as well as
challenging the constitutionality of the rules. In March 2000, the United
States Supreme Court ruled that the FDA does not have the power to
regulate tobacco. Liggett supported the FDA Rule and began to phase in
compliance with certain of the proposed FDA regulations.
Since the Supreme Court decision, various proposals and recommendations
have been made for additional federal and state legislation to regulate
cigarette manufacturers. Congressional advocates of FDA regulations have
introduced legislation that would give the FDA authority to regulate the
manufacture, sale, distribution and labeling of tobacco products to
protect public health, thereby allowing the FDA to reinstate its prior
regulations or adopt new or additional regulations. The ultimate outcome
of these proposals cannot be predicted.
In August 1996, Massachusetts enacted legislation requiring tobacco
companies to publish information regarding the ingredients in cigarettes
and other tobacco products sold in that state. In December 1997, the
United States District Court for the District of Massachusetts
preliminarily enjoined this legislation from going into effect on the
grounds that it is preempted by federal law. In November 1999, the United
States Court of Appeals for the First Circuit affirmed this ruling. In
September 2000, the federal district court permanently enjoined
enforcement of the law. In October 2001, the First Circuit reversed the
district court's decision, ruling that the ingredients disclosure
provisions are valid. The entire court, however, agreed to re-hear the
appeal, reinstating the district court's injunction in the meantime. In
December 2002, the First Circuit ruled that the ingredients disclosure
provisions violated the constitutional prohibition against unlawful
seizure of property by forcing firms to reveal trade secrets. The decision
was not appealed by the state. Notwithstanding the foregoing, in December
1997, Liggett began voluntarily complying with this legislation by
providing ingredient information to the Massachusetts Department of Public
Health. Several other states have enacted, or are considering, legislation
similar to that enacted in Massachusetts.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
(Unaudited)
Cigarettes are subject to substantial federal, state and local excise
taxes which, in general, have been increasing. The federal excise tax on
cigarettes is currently $0.39 per pack. State and local sales and excise
taxes vary considerably and, when combined with sales taxes, local taxes
and the current federal excise tax, may currently be as high as $4.10 per
pack. Proposed further tax increases in various jurisdictions are
currently under consideration or pending. In 2002, 21 states passed excise
tax increases, ranging from $0.07 per pack in Tennessee to as much as
$1.81 per pack in New York City and New York State combined. In addition,
since January 1, 2003, thirteen states and the District of Columbia
approved increases in excise taxes. Congress has considered significant
increases in the federal excise tax or other payments from tobacco
manufacturers, and significant increases in excise and other
cigarette-related taxes have been proposed or enacted at the state and
local levels. In the opinion of the Company, increases in excise and
similar taxes have had an adverse impact on sales of cigarettes.
In August 2000, the New York state legislature passed legislation charging
the state's Office of Fire Prevention and Control ("OFPC") with developing
standards for "fire safe" or self-extinguishing cigarettes. On December
31, 2002, the OFPC issued proposed standards for public comment. The
public comment period ended on April 15, 2003, and final standards have
not yet been issued. Six months from the issuance of the final standards,
all cigarettes offered for sale in New York state will be required to be
manufactured to those standards. It is not possible to predict the impact
of this law on the Company until the final standards are published.
Similar legislation is being considered by other state governments and at
the federal level.
Federal or state regulators may object to Vector Tobacco's reduced
carcinogen and low nicotine and nicotine-free cigarette products as
unlawful or allege they bear deceptive or unsubstantiated product claims,
and seek the removal of the products from the marketplace, or significant
changes to advertising. Various concerns regarding Vector Tobacco's
advertising practices have been expressed to Vector Tobacco by certain
state attorneys general. Vector Tobacco has been negotiating in an effort
to resolve these concerns. Allegations by federal or state regulators,
public health organizations and other tobacco manufacturers that Vector
Tobacco's products are unlawful, or that its public statements or
advertising contain misleading or unsubstantiated health claims or product
comparisons, may result in litigation or governmental proceedings. Vector
Tobacco's business may become subject to extensive domestic and
international governmental regulation. Various proposals have been made
for federal, state and international legislation to regulate cigarette
manufacturers generally, and reduced constituent cigarettes specifically.
It is possible that laws and regulations may be adopted covering issues
like the manufacture, sale, distribution, advertising and labeling of
tobacco products as well as any express or implied health