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Securities And Exchange Commission
Washington, D.C. 20549
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FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
VECTOR GROUP LTD.
(Exact name of registrant as specified in its charter)
DELAWARE 1-5759 65-0949535
(State or other jurisdiction of Commission File Number (I.R.S. Employer Identification No.)
incorporation or organization)
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 May 7, 2004, Vector Group Ltd. had 39,177,653 shares of common stock
outstanding.
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VECTOR GROUP LTD.
FORM 10-Q
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. VECTOR GROUP LTD. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED):
Vector Group Ltd. Consolidated Balance Sheets as of March 31, 2004 and
December 31, 2003..................................................................... 2
Vector Group Ltd. Consolidated Statements of Operations for the three months
ended March 31, 2004 and March 31, 2003............................................... 3
Vector Group Ltd. Consolidated Statement of Stockholders' Equity for the three
months ended March 31, 2004........................................................... 4
Vector Group Ltd. Consolidated Statements of Cash Flows for the three months ended
March 31, 2004 and March 31, 2003..................................................... 5
Notes to Consolidated Financial Statements.................................................. 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...................................... 32
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................. 49
Item 4. CONTROLS AND PROCEDURES................................................................ 49
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS...................................................................... 50
Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES....... 50
Item 6. EXHIBITS AND REPORTS ON FORM 8-K....................................................... 50
SIGNATURE 52
CERTIFICATIONS................................................................................. 53
- 1 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
March 31, December 31,
2004 2003
-------- ------------
ASSETS:
Current assets:
Cash and cash equivalents.................................................... $ 74,323 $ 74,808
Investment securities available for sale..................................... 52,157 67,521
Accounts receivable - trade.................................................. 14,849 10,425
Other receivables............................................................ 3,201 2,605
Inventories.................................................................. 119,419 127,351
Restricted assets............................................................ 1,025 771
Deferred income taxes........................................................ 16,336 19,328
Other current assets......................................................... 14,100 12,568
-------- --------
Total current assets....................................................... 295,410 315,377
Property, plant and equipment, net............................................. 139,652 143,596
Assets held for sale........................................................... 9,438 9,438
Long-term investments, net..................................................... 2,512 2,431
Investments in non-consolidated real estate businesses......................... 20,705 18,718
Restricted assets.............................................................. 5,571 5,571
Deferred income taxes.......................................................... 13,679 13,200
Intangible asset............................................................... 107,511 107,511
Other assets................................................................... 12,231 12,370
-------- --------
Total assets............................................................... $606,709 $628,212
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Current portion of notes payable and long-term debt.......................... $ 7,679 $ 10,762
Accounts payable............................................................. 9,578 8,635
Accrued promotional expenses................................................. 19,800 22,203
Accrued taxes payable, net................................................... 40,061 48,577
Settlement accruals.......................................................... 58,335 52,650
Deferred income taxes........................................................ 4,002 4,000
Accrued interest............................................................. 3,183 7,004
Other accrued liabilities.................................................... 15,133 19,255
-------- --------
Total current liabilities.................................................. 157,771 173,086
Notes payable, long-term debt and other obligations, less current portion...... 298,606 299,977
Noncurrent employee benefits................................................... 14,409 13,438
Deferred income taxes.......................................................... 141,753 139,927
Other liabilities.............................................................. 4,470 4,781
Minority interests............................................................. 44,816 43,478
Commitments and contingencies..................................................
Stockholders' equity (deficit):
Preferred stock, par value $1.00 per share, authorized 10,000,000 shares.....
Common stock, par value $0.10 per share, authorized 100,000,000
shares, issued 42,147,240 and 42,103,276 shares and outstanding
39,087,653 and 39,021,189 shares........................................... 3,909 3,902
Additional paid-in capital................................................... 236,398 251,239
Deficit...................................................................... (275,971) (280,598)
Accumulated other comprehensive loss......................................... (7,854) (9,335)
Less: 3,059,587 and 3,082,087 shares of common stock in treasury, at cost... (11,598) (11,683)
-------- --------
Total stockholders' equity (deficit)..................................... (55,116) (46,475)
-------- --------
Total liabilities and stockholders' equity (deficit)..................... $606,709 $628,212
======= =======
The accompanying notes are an integral part
of the consolidated financial statements.
- 2 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
Three Months Ended
---------------------------
March 31, March 31,
2004 2003
---------- ----------
Revenues:
Tobacco*...................................................... $ 126,573 $ 131,343
Real estate leasing........................................... 1,781 1,799
---------- ----------
Total revenues.............................................. 128,354 133,142
Expenses:
Cost of goods sold*........................................... 74,100 83,791
Operating, selling, administrative and general expenses....... 39,837 49,551
Restructuring charges......................................... 653 --
---------- ----------
Operating income (loss)..................................... 13,764 (200)
Other income (expenses):
Interest and dividend income.................................. 695 1,445
Interest expense.............................................. (6,422) (7,149)
Gain (loss) on investments, net............................... 251 (62)
Equity income (loss) from non-consolidated real
estate businesses........................................... 646 (717)
Other, net.................................................... (5) (7)
---------- ----------
Income (loss) from operations before provision (benefit) for
income taxes and minority interests......................... 8,929 (6,690)
Provision (benefit) for income taxes.......................... 4,688 (593)
Minority interests............................................ 386 1,248
---------- ----------
Net income (loss)................................................. $ 4,627 $ (4,849)
---------- ----------
Per basic common share:
Net income (loss) applicable to common shares................. $ 0.12 $ (0.13)
========== ==========
Basic weighted average common shares outstanding.................. 39,062,999 38,432,593
========== ==========
Per diluted common share:
Net income (loss) applicable to common shares................. $ 0.11 $ (0.13)
========== ==========
Diluted weighted average common shares outstanding................ 41,259,968 38,432,593
========== ==========
Dividends declared per share...................................... $ 0.40 $ 0.38
========== ==========
- -------------
* Revenues and Cost of goods sold include excise taxes of $46,170 and $49,818
for the three months ended March 31, 2004 and 2003, respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
- 3 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
Accumulated
Common Stock Additional Other
---------------------- Paid-In Treasury Comprehensive
Shares Amount Capital Deficit Stock Income (Loss) Total
---------- ---------- ----------- ---------- ---------- -------------- ----------
Balance, December 31, 2003 ............. 39,021,189 $ 3,902 $ 251,239 $ (280,598) $ (11,683) $ (9,335) $ (46,475)
Net income ............................. -- -- -- 4,627 -- -- 4,627
Unrealized gain on investment
securities ......................... -- -- -- -- -- 1,481 1,481
----------
Total other comprehensive
income ...................... -- -- -- -- -- -- 1,481
----------
Total comprehensive income ............. -- -- -- -- -- -- 6,108
----------
Distributions on common stock .......... -- -- (15,635) -- -- -- (15,635)
Exercise of warrants and options ....... 66,464 7 575 -- 85 -- 667
Tax benefit of options exercised ....... -- -- 141 -- -- -- 141
Amortization of deferred
compensation, net .................... -- -- 78 -- -- -- 78
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, March 31, 2004 ........... 39,087,653 $ 3,909 $ 236,398 $ (275,971) $ (11,598) $ (7,854) $ (55,116)
========== ========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part
of the consolidated financial statements.
- 4 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
Three Months Ended
-----------------------------
March 31, March 31,
2004 2003
--------- ---------
Net cash provided by (used in) operating activities: .. $ 2,109 $ (12,048)
--------- ---------
Cash flows from investing activities:
Capital expenditures ................................ (581) (1,804)
Sale or maturity of investment securities ........... 29,950 45,578
Purchase of investment securities ................... (10,317) (27,541)
Sale or maturity of long-term investments ........... 149 --
Purchase of long-term investments ................... (230) --
Investment in non-consolidated real estate businesses (1,500) (9,500)
Increase in restricted assets ....................... -- (4)
Payment of prepetition claims ....................... -- (17)
--------- ---------
Net cash provided by investing activities ............. 17,471 6,712
--------- ---------
Cash flows from financing activities:
Repayments of debt .................................. (5,109) (4,894)
Borrowings under revolver ........................... 129,243 154,916
Repayments on revolver .............................. (129,231) (143,117)
Distributions on common stock ....................... (15,635) (14,794)
Proceeds from exercise of warrants and options ...... 667 507
New Valley repurchase of common stock ............... -- (1,346)
--------- ---------
Net cash used in financing activities ................. (20,065) (8,728)
--------- ---------
Net decrease in cash and cash equivalents ............. (485) (14,064)
Cash and cash equivalents, beginning of period ........ 74,808 100,027
--------- ---------
Cash and cash equivalents, end of period .............. $ 74,323 $ 85,963
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
- 5 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BASIS OF PRESENTATION:
The consolidated financial statements of Vector Group Ltd. (the
"Company" or "Vector") include the accounts of VGR Holding Inc. ("VGR
Holding"), Liggett Group Inc. ("Liggett"), Vector Tobacco Inc.
("Vector Tobacco"), Liggett Vector Brands Inc. ("Liggett Vector
Brands") and other less significant subsidiaries. The Company owned
58.1% of the common shares of New Valley Corporation ("New Valley")
at March 31, 2004. All significant intercompany balances and
transactions have been eliminated.
Liggett is engaged in the manufacture and sale of cigarettes in the
United States. Vector Tobacco is engaged in the development and
marketing of low nicotine and nicotine-free cigarette products and
the development of reduced risk cigarette products. New Valley is
currently engaged in the real estate business and is seeking to
acquire additional operating companies.
The interim consolidated financial statements of the Company are
unaudited and, in the opinion of management, reflect all adjustments
necessary (which are normal and recurring) to present fairly the
Company's consolidated financial position, results of operations and
cash flows. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2003, as filed with the Securities and
Exchange Commission. The consolidated results of operations for
interim periods should not be regarded as necessarily indicative of
the results that may be expected for the entire year.
(b) ESTIMATES AND ASSUMPTIONS:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities and the reported amounts of revenues and
expenses. Significant estimates subject to material changes in the
near term include restructuring and impairment charges, inventory
valuation, deferred tax assets, allowance for doubtful accounts,
promotional accruals, sales returns and allowances, actuarial
assumptions of pension plans, settlement accruals and litigation and
defense costs. Actual results could differ from those estimates.
(c) RECLASSIFICATIONS:
Certain amounts in the 2003 consolidated financial statements have
been reclassified to conform to the 2004 presentation.
(d) EARNINGS PER SHARE:
Information concerning the Company's common stock has been adjusted
to give effect to the 5% stock dividend paid to Company stockholders
on September 29, 2003. In connection with the 5% dividend, the
Company increased the number of outstanding stock options by 5% and
reduced the exercise prices accordingly. All share amounts have been
presented as if the stock dividends had occurred on January 1, 2003.
- 6 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
Basic net income per share is computed by dividing net income by the
weighted-average number of shares outstanding. Diluted net income per
share includes the dilutive effect of stock options, vested
restricted stock grants and warrants. Basic and diluted EPS were
calculated using the following shares for the years ended March 31,
2004 and 2003.
Three Months Ended
---------------------------
March 31, March 31,
2004 2003
---------- ----------
Weighted-average shares for basic EPS ..... 39,062,999 38,432,593
Plus incremental shares related to stock
options, vested restricted stock grants
and warrants .......................... 2,196,969 --
---------- ----------
Weighted-average shares for diluted EPS ... 41,259,968 38,432,593
========== ==========
The Company had a net loss for the three months ended March 31, 2003.
Therefore, the effect of the common stock equivalents and convertible
securities is excluded from the computation of diluted net loss per
share since the effect is antidilutive. Potentially dilutive shares
that were not included in the diluted loss per share calculation were
1,330,794 at March 31, 2003 which shares are issuable upon the
exercise of stock options, vested restricted stock grants and
warrants, assuming the treasury stock method.
(e) COMPREHENSIVE INCOME (LOSS):
Other comprehensive income (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 income was $6,108 for the three
months ended March 31, 2004 and total comprehensive loss was $4,922
for the three months ended March 31, 2003.
(f) NEW ACCOUNTING PRONOUNCEMENTS:
In December 2003, Financial Accounting Standards Board Interpretation
("FIN") No. 46(R), "Consolidation of Variable Interest Entities
(revised December 2003)", was issued. The interpretation revises FIN
No. 46, "Consolidation of Variable Interest Entities", to exempt
certain entities from the requirements of FIN No. 46. The
interpretation requires a company to consolidate a variable interest
entity ("VIE"), as defined, when the company will absorb a majority
of the variable interest entity's expected losses, receive a majority
of the variable interest entity's expected residual returns, or both.
FIN No. 46(R) also requires consolidation of existing, non-controlled
affiliates if the VIE is unable to finance its operations without
investor support, or where the other investors do not have exposure
to the significant risks and rewards of ownership. The interpretation
applies immediately to a VIE created or acquired after January 31,
2003. For a VIE acquired before February 1, 2003, FIN No. 46(R)
applies in the first interim period ending after March 15, 2004. The
adoption of this interpretation did not impact the Company's
consolidated financial statements.
In December 2003, the FASB issued SFAS No. 132(R), which replaces
SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits." SFAS No. 132(R) does not change the
measurement and recognition provisions of SFAS No. 87, SFAS No. 88,
"Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits," and SFAS No.
106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions," however, it includes additional disclosure provisions for
annual reporting,
- 7 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
including detailed plan asset information by category, expanded
benefit obligation disclosure and key assumptions. In addition,
interim disclosures related to the individual elements of plan costs
and employer's current year contributions are required. (See Note 6.)
2. RESTRUCTURING
On October 8, 2003, the Company announced that it would close Vector
Tobacco's Timberlake, North Carolina cigarette manufacturing facility in
order to reduce excess tobacco production capacity and improve operating
efficiencies company-wide. Production of the QUEST line of low nicotine
and nicotine-free cigarettes, as well as production of Vector Tobacco's
other cigarette brands, has been moved to Liggett's state-of-the-art
manufacturing facility in Mebane, North Carolina.
The Mebane facility currently produces in excess of 9 billion units per
year, but maintains the capacity to produce 16 billion units per year.
Vector Tobacco has contracted with Liggett Group to produce its cigarettes
and has transitioned production from Timberlake to Mebane. All production
ceased at Timberlake by December 31, 2003. As part of the transition,
Vector eliminated approximately 150 positions.
As a result of these actions, the Company recognized pre-tax restructuring
and impairment charges of $21,521, of which $21,300 was taken in 2003 and
the remaining $221 was taken in the first quarter of 2004. Machinery and
equipment to be disposed of was reduced to estimated fair value less costs
to sell during 2003 and is being carried on the accompanying consolidated
balance sheets as assets held for sale. The asset impairment charges are
based on management's current estimates of the values the Company will be
able to realize on sales of the excess machinery and equipment, and may be
adjusted in future periods based on the actual amounts realized.
As part of the continuing effort to adjust the cost structure of the
Company's tobacco business and improve operating efficiency, Liggett
Vector Brands eliminated approximately 85 positions during April 2004. As
a result of these actions, we currently expect to recognize additional
pre-tax restructuring charges of approximately $2,027 during 2004,
including approximately $804 relating to employee severance and benefit
costs and approximately $1,223 for contract termination and other
associated costs. Approximately $470 of these charges represent non-cash
items. The Company recognized $432 of these pre-tax restructuring charges
in the first quarter of 2004, with the balance to be recognized primarily
in the second quarter.
Annual cost savings related to the restructuring and impairment charges
are currently expected to be at least $23,000 beginning in 2004.
Management is currently reviewing opportunities for additional cost
savings as a result of these restucturing activities at Vector Tobacco
and Liggett Vector Brands.
- 8 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
The components of the pre-tax restructuring and impairment charges for
2003 and the quarter ended March 31, 2004 are as follows:
Employee Non-Cash Contract
Severance Asset Termination/
and Benefits Impairment Exit Costs Total
------------ ---------- ------------ --------
Balance, December 31, 2002 $ -- $ -- $ -- $ --
Original charges ......... 2,045 18,752 503 21,300
Utilized in 2003 ......... (182) (18,752) (54) (18,988)
-------- -------- -------- --------
Balance, December 31, 2003 1,863 -- 449 2,312
Original charges ......... 432 -- 221 653
Utilized in 2004 ......... (1,434) -- (236) (1,670)
-------- -------- -------- --------
Balance, March 31, 2004 .. $ 861 $ -- $ 434 $ 1,295
======== ======== ======== ========
3. INVENTORIES
Inventories consist of:
March 31, December 31,
2004 2003
--------- ------------
Leaf tobacco ................. $ 79,902 $ 80,239
Other raw materials .......... 3,401 3,060
Work-in-process .............. 1,771 1,609
Finished goods ............... 36,598 42,825
Replacement parts and supplies 507 636
--------- ---------
Inventories at current cost .. 122,179 128,369
LIFO adjustments ............. (2,760) (1,018)
--------- ---------
$ 119,419 $ 127,351
========= =========
The Company has a leaf inventory management program whereby, among other
things, it is committed to purchase certain quantities of leaf tobacco.
The purchase commitments are for quantities not in excess of anticipated
requirements and are at prices, including carrying costs, established at
the date of the commitment. At March 31, 2004, Liggett had leaf tobacco
purchase commitments of approximately $3,439 and Vector Tobacco had leaf
tobacco purchase commitments of approximately $1,624.
LIFO inventories represent approximately 58.4% and 53.8% of total
inventories at March 31, 2004 and December 31, 2003, respectively.
Included in the above table is approximately $41,919 at March 31, 2004 and
$44,220 at December 31, 2003 of inventory associated with Vector Tobacco's
new product initiatives. The recoverability of costs of such inventory is
dependent upon future demand for these products and market conditions. If
actual demand or market conditions in the near term are less favorable
than those estimated, material inventory write-downs may be required.
- 9 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
March 31, December 31,
2004 2003
--------- ------------
Land and improvements ....... $ 10,019 $ 10,019
Buildings ................... 74,326 74,326
Machinery and equipment ..... 104,509 105,032
Leasehold improvements ...... 1,023 1,023
Construction-in-progress .... 1,987 1,554
--------- ---------
191,864 191,954
Less accumulated depreciation (52,212) (48,358)
--------- ---------
$ 139,652 $ 143,596
========= =========
The table above includes real estate assets and accumulated depreciation
owned and operated by New Valley in the amounts of $54,258 and $1,544 as
of March 31, 2004 and $54,258 and $1,246 as of December 31, 2003. (Refer
to Note 9.)
Depreciation and amortization expense for the three months ended March 31,
2004 was $3,525. Future machinery and equipment purchase commitments at
Liggett are $2,673 as of March 31, 2004.
In July 2003, Liggett granted an unaffiliated third party an option to
purchase Liggett's former manufacturing facility and other excess real
estate in Durham, North Carolina with a net book value at March 31, 2004
of approximately $1,342. The option agreement permits the purchaser to
acquire the property, during a period of up to two years, at a purchase
price of $14,000 if the closing occurs by August 23, 2004 and $15,000 if
the closing occurs thereafter during the term of the option. Liggett has
received option fees of $1,000, of which $250 is refundable if the
purchaser terminates the agreement prior to August 23, 2004. Liggett will
be entitled to receive additional option fees of up to $500 during the
remaining option period. The option fees will generally be creditable
against the purchase price. The purchaser is currently conducting due
diligence, and there can be no assurance the sale of the property will
occur.
The Company recorded an $18,752 non-cash asset impairment charge during
the third quarter of 2003 in conjunction with the closing of Vector
Tobacco's Timberlake, North Carolina facility of which $17,968 relates to
machinery and equipment. (See Note 2.) Vector Tobacco has entered into
negotiations to sell the Timberlake facility, including all equipment not
relocated to Mebane.
During 2003, Liggett entered into sale-leaseback transactions in which
equipment with a book value of $4,483 was sold and leased back from a
third party as operating leases. Liggett received cash of $2,386, and no
gain or loss was recognized on these transactions.
- 10 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
5. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
March 31, December 31,
2004 2003
--------- ------------
Vector:
6.25% Convertible Subordinated Notes due 2008 ............ $ 132,500 $ 132,500
VGR Holding:
10% Senior Secured Notes due 2006, net of
unamortized discount of $6,032 and $6,675 ............. 63,968 63,325
Liggett:
Revolving credit facility ................................ 12 --
Term loan under credit facility .......................... 5,113 5,190
Other notes payable ...................................... 8,882 9,758
Vector Tobacco:
Notes payable ............................................ 5,576 5,999
Notes payable - Medallion acquisition .................... 35,000 38,125
V.T. Aviation:
Notes payable ............................................ 10,208 10,496
VGR Aviation:
Notes payable ............................................ 5,276 5,346
New Valley:
Notes payable - operating real estate .................... 39,750 39,910
Other .................................................... -- 90
--------- ---------
Total notes payable, long-term debt and other obligations 306,285 310,739
Less:
Current maturities ................................. (7,679) (10,762)
--------- ---------
Amount due after one year ................................ $ 298,606 $ 299,977
========= =========
6.25% CONVERTIBLE SUBORDINATED NOTES DUE JULY 15, 2008 - VECTOR:
In July 2001, Vector completed the sale of $172,500 (net proceeds of
approximately $166,400) of its 6.25% convertible subordinated notes due
July 15, 2008 through a private offering to qualified institutional
investors in accordance with Rule 144A under the Securities Act of 1933.
The notes pay interest at 6.25% per annum and are convertible into
Vector's common stock, at the option of the holder. The conversion price,
which was $27.11 per share at March 31, 2004, is subject to adjustment for
various events, and any cash distribution on Vector's common stock will
result in a corresponding decrease in the conversion price. In December
2001, $40,000 of the notes were converted into Vector's common stock, and
$132,500 of the notes were outstanding at March 31, 2004.
The notes may be redeemed by Vector, in whole or in part, prior to July
15, 2004, if the closing price of Vector's common stock exceeds 150% of
the conversion price then in effect for a period of at least 20 trading
days in any consecutive 30 day trading period, at a price equal to 100% of
the principal amount, plus accrued interest and a "make whole" payment.
Vector may redeem the notes, in whole or in part, at a price of 103.125%
in the year beginning July 15, 2004, 102.083% in the year beginning July
15, 2005, 101.042% in the year beginning July 15, 2006 and 100% in the
year beginning July 15, 2007, together with accrued interest. If a change
of control occurs, Vector will be required to offer to repurchase the
notes at 101% of their principal amount, plus accrued interest and, under
certain circumstances, a "make whole" payment.
- 11 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
10% SENIOR SECURED NOTES DUE MARCH 31, 2006 - VGR HOLDING:
In May 2001, VGR Holding issued at a discount $60,000 principal amount of
10% senior secured notes due March 31, 2006 in a private placement. VGR
Holding received net proceeds from the offering of approximately $46,500.
In April 2002, VGR Holding issued at a discount an additional $30,000
principal amount of 10% senior secured notes due March 31, 2006 in a
private placement and received net proceeds of approximately $24,500. The
notes were priced to provide the purchasers with a 15.75% yield to
maturity. The new notes are on the same terms as the $60,000 principal
amount of senior secured notes previously issued. All of the notes have
been guaranteed by the Company and by Liggett.
The notes are collateralized by substantially all of VGR Holding's assets,
including a pledge of VGR Holding's equity interests in its direct
subsidiaries, including Brooke Group Holding, Liggett Vector Brands,
Vector Tobacco and New Valley Holdings, Inc. ("NV Holdings"), as well as a
pledge of the shares of Liggett and all of the New Valley securities held
by VGR Holding and NV Holdings. The purchase agreement for the notes
contains covenants, which the Company is in compliance with at March 31,
2004. Among other things, the covenants limit the ability of VGR Holding
to make distributions to the Company to 50% of VGR Holding's net income,
unless VGR Holding holds an amount in cash equal to the then principal
amount of the notes outstanding ($70,000 at March 31, 2004) after giving
effect to the payment of the distribution, and limit additional
indebtedness of VGR Holding, Liggett, Vector Tobacco and Liggett Vector
Brands to 250% of EBITDA (as defined in the purchase agreements) for the
trailing 12 months. The covenants also restrict transactions with
affiliates subject to exceptions which include payments to Vector not to
exceed $9,500 per year for permitted operating expenses, and limit the
ability of VGR Holding to merge, consolidate or sell certain assets.
VGR Holding has the right (which it has not exercised) under the purchase
agreement for the notes to elect to treat Vector Tobacco as a "designated
subsidiary" and exclude the losses of Vector Tobacco in determining the
amount of additional indebtedness permitted to be incurred. If VGR Holding
were to make this election, future cash needs of Vector Tobacco would be
required to be funded directly by Vector or by third-party financing as to
which neither VGR Holding nor Liggett could provide any guarantee or
credit support.
VGR Holding may redeem the notes, in whole or in part, at a redemption
price of 100% of the principal amount. During the term of the notes, VGR
Holding is required to offer to repurchase all the notes at a purchase
price of 101% of the principal amount, in the event of a change of
control, and to offer to repurchase notes, at 100% of the principal
amount, with the proceeds of material asset sales.
REVOLVING CREDIT FACILITY - LIGGETT:
On April 14, 2004, Liggett entered into an Amended and Restated Loan and
Security Agreement with Congress Financial Corporation, as lender. The
$50,000 credit facility replaces Liggett's previous $40,000 facility with
Congress, under which $12 was outstanding at March 31, 2004. Availability
as determined under the facility was approximately $28,527 based on
eligible collateral at March 31, 2004. Had the new facility been in place
at March 31, 2004, availability would have been approximately $41,433. The
facility is collateralized by all inventories and receivables of Liggett.
Borrowings under the facility bear interest at a rate equal to 1.0% above
the prime rate of Wachovia Bank, N.A. (the indirect parent of Congress).
The facility requires Liggett's compliance with certain financial and
other covenants including a restriction on Liggett's ability to pay cash
dividends unless Liggett's borrowing availability under the facility for
the 30-day period prior to the payment of the dividend, and after giving
effect to the dividend, is at least $5,000. In addition, the facility
imposes requirements with respect to Liggett's adjusted net worth (not to
fall below $8,000 as computed in accordance with the agreement) and
working capital (not to fall below a deficit of $17,000 as computed in
accordance
- 12 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
with the agreement). At March 31, 2004, Liggett was in compliance with all
covenants under the credit facility; Liggett's adjusted net worth was
$52,396 and net working capital was $21,397, as computed in accordance
with the agreement.
100 Maple LLC, a company formed by Liggett in 1999 to purchase its Mebane,
North Carolina manufacturing plant, has a term loan of $5,113 outstanding
under Liggett's credit facility at March 31, 2004. The remaining balance
of the term loan is payable in monthly installments of $77 with a final
payment on June 1, 2006 of $3,101. Interest is charged at the same rate as
applicable to Liggett's credit facility, and the outstanding balance of
the term loan reduces the maximum availability under the credit facility.
Liggett has guaranteed the term loan, and a first mortgage on the Mebane
property and manufacturing equipment collateralizes the term loan and
Liggett's credit facility.
EQUIPMENT LOANS - LIGGETT:
In March 2000, Liggett purchased equipment for $1,000 through the issuance
of a note, payable in 60 monthly installments of $21 with an effective
annual interest rate of 10.14%. In April 2000, Liggett purchased equipment
for $1,071 through the issuance of notes, payable in 60 monthly
installments of $22 with an effective interest rate of 10.20%.
In October and December 2001, Liggett purchased equipment for $3,204 and
$3,200, respectively, through the issuance of notes guaranteed by the
Company, each payable in 60 monthly installments of $53 with interest
calculated at the prime rate.
In March 2002, Liggett purchased equipment for $3,023 through the issuance
of a note, payable in 30 monthly installments of $62 and then 30 monthly
installments of $51 with an effective annual interest rate of 4.68%.
In May 2002, Liggett purchased equipment for $2,871 through the issuance
of a note, payable in 30 monthly installments of $59 and then 30 monthly
installments of $48 with an effective annual interest rate of 4.64%.
In September 2002, Liggett purchased equipment for $1,573 through the
issuance of a note guaranteed by the Company, payable in 60 monthly
installments of $26 plus interest calculated at LIBOR plus 4.31%.
NOTES PAYABLE - VECTOR TOBACCO:
In June 2001, Vector Tobacco purchased for $8,400 an industrial facility
in Timberlake, North Carolina. Vector Tobacco financed the purchase with
an $8,200 loan, payable in 60 monthly installments of $85, plus annual
interest at 4.85% above LIBOR with a final payment of approximately
$3,160. The loan, which 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%.
- 13 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
NOTES FOR MEDALLION ACQUISITION - VECTOR TOBACCO:
The purchase price for the acquisition of Medallion included $60,000 in
notes of Vector Tobacco, guaranteed by the Company and Liggett. Of the
notes, $25,000 have been repaid with the final quarterly principal payment
of $3,125 made on March 31, 2004. The remaining $35,000 of notes bear
interest at 6.5% per year, payable semiannually, and mature on April 1,
2007.
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 119 monthly installments
of $125, including annual interest of 2.31% above the 30-day commercial
paper rate, with a final payment of $1,420, based on current interest
rates.
NOTES PAYABLE - VGR AVIATION:
In February 2002, V.T. Aviation purchased an airplane for $6,575 and
borrowed $5,800 to fund the purchase. The loan is guaranteed by the
Company. The loan is payable in 119 monthly installments of $40, including
annual interest of 2.75% above the 30-day average commercial paper rate,
with a final payment of $2,793, based on current interest rates. During
the fourth quarter of 2003, this airplane was transferred to the Company's
direct subsidiary, VGR Aviation LLC, which has assumed the debt.
NOTE PAYABLE - NEW VALLEY:
In December 2002, New Valley financed a portion of its purchase of two
office buildings in Princeton, New Jersey with a mortgage loan of $40,500
from HSBC Realty Credit Corporation (USA). The loan has a term of four
years, bears interest at a floating rate of 2% above LIBOR, and is
collateralized by a first mortgage on the office buildings, as well as by
an assignment of leases and rents. Principal is amortized to the extent of
$54 per month during the term of the loan. The loan may be prepaid without
penalty and is non-recourse against New Valley, except for various
specified environmental and related matters, misapplications of tenant
security deposits and insurance and condemnation proceeds, and fraud or
misrepresentation by New Valley in connection with the indebtedness.
- 14 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
6. EMPLOYEE BENEFITS
Net periodic benefit cost for the Company's pension and other
postretirement benefit plans for the three months ended March 31, 2004 and
2003 consists of the following (in thousands):
Other
Pension Benefits Postretirement Benefits
---------------------- -----------------------
2004 2003 2004 2003
------- ------ ------- -------
Service cost - benefits earned
during the period ............. $ 1,248 $ 981 $ 8 $ 20
Interest cost on projected benefit
obligation .................... 2,240 2,390 157 169
Expected return on plan assets ... (3,027) (2,930) -- --
Amortization of net (gain) loss .. 506 414 5 (32)
------- ------- ------- -------
Net expense ............. $ 967 $ 855 $ 170 $ 157
======= ======= ======= =======
The Company did not make contributions to its pension benefits plans for
the three months ended March 31, 2004 and does not anticipate making any
contributions to such plans in 2004. The Company anticipates paying $550
in other postretirement benefits in 2004.
7. CONTINGENCIES
SMOKING-RELATED LITIGATION:
OVERVIEW. Since 1954, Liggett and other United States cigarette
manufacturers have been named as defendants in numerous direct and
third-party actions predicated on the theory that cigarette manufacturers
should be liable for damages alleged to have been caused by cigarette
smoking or by exposure to secondary smoke from cigarettes. These cases are
reported here as though having been commenced against Liggett (without
regard to whether such cases were actually commenced against Brooke Group
Holding Inc., the Company's predecessor and a wholly-owned subsidiary of
VGR Holding, or Liggett). There has been a noteworthy increase in the
number of cases 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 three months ended March
31, 2004, Liggett incurred legal fees and other litigation costs totaling
approximately $1,738 compared to $1,113 for the three months ended March
31, 2003.
INDIVIDUAL ACTIONS. As of March 31, 2004, there were approximately 382
cases pending against Liggett, and in most cases the other tobacco
companies, where one or more individual plaintiffs allege injury resulting
from cigarette smoking, addiction to cigarette smoking or exposure to
- 15 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
secondary smoke and seek compensatory and, in some cases, punitive
damages. Of these, 103 were pending in Maryland, 95 in Florida, 51 in New
York, 34 in Mississippi and 21 in California. The balance of the
individual cases were pending in 22 states. In addition to these cases, an
action against cigarette manufacturers involving approximately 1,050 named
individual plaintiffs has been consolidated before a single West Virginia
state court. Liggett is a defendant in most of the cases pending in West
Virginia. In January 2002, the court severed Liggett from the trial of the
consolidated action, which is currently scheduled for March 2005.
There are eight individual cases pending where Liggett is the only named
defendant. In April 2004, in one of these cases, BEVERLY DAVIS V. LIGGETT
GROUP INC., a jury in a Florida state court action awarded compensatory
damages of $540 against Liggett. Liggett believes there are a number of
grounds to challenge the verdict and intends to pursue all post-trial and
appellate relief.
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence,
gross negligence, breach of special duty, strict liability, fraud,
misrepresentation, design defect, failure to warn, breach of express and
implied warranties, conspiracy, aiding and abetting, concert of action,
unjust enrichment, common law public nuisance, property damage, invasion
of privacy, mental anguish, emotional distress, disability, shock,
indemnity and violations of deceptive trade practice laws, the Federal
Racketeer Influenced and Corrupt Organization Act ("RICO"), state RICO
statutes and antitrust statutes. In many of these cases, in addition to
compensatory damages, plaintiffs also seek other forms of relief including
treble/multiple damages, medical monitoring, disgorgement of profits and
punitive damages. Defenses raised by defendants in these cases include
lack of proximate cause, assumption of the risk, comparative fault and/or
contributory negligence, lack of design defect, statute of limitations,
equitable defenses such as "unclean hands" and lack of benefit, failure to
state a claim and federal preemption.
Jury awards in various states have been entered against other cigarette
manufacturers. The awards in these individual actions are for both
compensatory and punitive damages and represent a material amount of
damages. 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, and the
Oregon Supreme Court refused to hear Philip Morris' appeal of the
appellate court ruling in December 2002. Philip Morris appealed to the
United States Supreme Court, which, in October 2003, vacated the judgment
and remanded the case to the Oregon appellate court for further
consideration in light of the recent STATE FARM decision by the United
States Supreme Court limiting punitive damages. 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 October 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. Philip
Morris appealed to the California Supreme Court, which vacated the
decision. In September 2003, the California appellate court, citing the
STATE FARM decision, reduced the punitive damages award to $9,000. The
case is on appeal to the California Supreme Court. During 2001, as a
result of a Florida Supreme Court decision
- 16 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
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
paid the damages and interest following completion of the appeals process.
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. In
May 2004, a Florida appellate court affirmed, without explanation, the
jury award. The defendants will seek further appellate review. 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 defendant intends to appeal
the verdict. In November 2003, in an individual action involving other
cigarette manufacturers, a Missouri state court jury awarded $2,100 in
compensatory damages. The defendants have appealed the verdict. In January
2004, a jury in a New York state court action awarded compensatory damages
of $175 and punitive damages of $8,000 in an individual action against
another cigarette manufacturer. The defendant intends to appeal the
verdict.
One of the states in which cases are pending against Liggett is
Mississippi. During 2003, the Mississippi Supreme Court ruled that the
Mississippi Product Liability Act "precludes all tobacco cases that are
based on product liability." Based on this ruling, Liggett is seeking, or
intends to seek, dismissal of each of the approximately 34 cases pending
against it in Mississippi.
CLASS ACTIONS. As of March 31, 2004, there were approximately 33 actions
pending, for which either a class has been certified or plaintiffs are
seeking class certification, where Liggett, among others, was a named
defendant. Many of these actions purport to constitute statewide class
actions and were filed after May 1996 when the Fifth Circuit Court of
Appeals, in the CASTANO case, reversed a Federal district court's
certification of a purported nationwide class action on behalf of persons
who were allegedly "addicted" to tobacco products.
The extent of the impact of the CASTANO decision on smoking-related class
action litigation is still uncertain. The CASTANO decision has had a
limited effect with respect to courts' decisions regarding narrower
smoking-related classes or class actions brought in state rather than
federal court. For example, since the Fifth Circuit's ruling, a court in
Louisiana (Liggett is not a defendant in this proceeding) has certified
"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.
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
- 17 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
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 October 2003, the Third District Court of Appeals denied class
counsel's motions seeking, among other things, a rehearing by the court.
Class counsel has filed a motion with the Florida Supreme Court to invoke
discretionary review on the basis that the Third District Court of Appeals
decision construes the due process provisions of the state and federal
constitutions and conflicts with other appellate and supreme court
decisions. If the appellate court's ruling is not upheld on further
appeal, it will have a material adverse effect on the Company.
In May 2000, legislation was enacted in Florida that limits the size of
any bond required, pending appeal, to stay execution of a punitive damages
verdict to the lesser of the punitive award plus twice the statutory rate
of interest, $100,000 or 10% of the net worth of the defendant, but the
limitation on the bond does not affect the amount of the underlying
verdict. In November 2000, Liggett filed the $3,450 bond required by the
Florida law in order to stay execution of the ENGLE judgment, pending
appeal. Legislation limiting the amount of bonds required to file an
appeal of an adverse judgment has also been enacted in Arkansas,
California, Colorado, Georgia, Idaho, Indiana, Kansas, Kentucky,
Louisiana, Michigan, Mississippi, Missouri, Nevada, New Jersey, North
Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, South
Dakota, Tennessee, Texas, Virginia, West Virginia and Wisconsin.
In May 2001, Liggett, along with Philip Morris and Lorillard Tobacco Co.,
reached an agreement with the class in the ENGLE case, which provided
assurance of Liggett's ability to appeal the jury's July 2000 verdict. As
required by the agreement, Liggett paid $6,273 into an escrow account to
be held for the benefit of the ENGLE class, and released, along with
Liggett's existing $3,450 statutory bond, to 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
- 18 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
consolidated statement of operations for the first quarter of 2001. The
agreement, which was approved by the court, assured that the stay of
execution, in effect pursuant to the Florida bonding statute, would not be
lifted or limited at any point until completion of all appeals, including
an appeal to the United States Supreme Court. If Liggett's balance sheet
net worth fell below $33,781 (as determined in accordance with generally
accepted accounting principles in effect as of July 14, 2000), the
agreement provided that the stay granted in favor of Liggett in the
agreement would terminate and the ENGLE class would be free to challenge
the Florida bonding statute.
In June 2002, the jury in a Florida state court action entitled LUKACS V.
PHILIP MORRIS, ET AL. awarded $37,500 in compensatory damages in a case
involving Liggett and two other tobacco manufacturers. In March 2003, the
court reduced the amount of the compensatory damages to $25,100. The jury
found Liggett 50% responsible for the damages incurred by the plaintiff.
The LUKACS case was the first individual case to be tried as part of Phase
III of the ENGLE case; the claims of all other individuals who are members
of the class were stayed pending resolution of the appeal of the ENGLE
verdict. The LUKACS verdict, which was subject to the outcome of the Engle
appeal, has been overturned as a result of the appellate court's ruling.
As discussed above, class counsel in ENGLE is pursuing various appellate
remedies seeking reversal of the appellate court's decision.
Class certification motions are pending in a number of putative class
actions. Classes remain certified against Liggett in West Virginia
(BLANKENSHIP), in California (BROWN), in New York (SIMON), in Kansas
(SMITH) and in New Mexico (ROMERO). A number of class certification
denials are on appeal.
In August 2000, in BLANKENSHIP V. PHILIP MORRIS, INC., a West Virginia
state court conditionally certified (only to the extent of medical
monitoring) a class of present or former West Virginia smokers who desire
to participate in a medical monitoring plan. The trial of this case ended
in January 2001, when the judge declared a mistrial. In July 2001, the
court issued an order severing Liggett from the retrial of the case which
began in September 2001. In November 2001, the jury returned a verdict in
favor of the other defendants. In May 2004, the West Virginia Supreme
Court affirmed the defense jury verdict.
In April 2001, the California state court in the case of BROWN V. THE
AMERICAN TOBACCO COMPANY, INC., ET AL., granted in part plaintiff's motion
for class certification and certified a class comprised of adult residents
of California who smoked at least one of defendants' cigarettes "during
the applicable time period" and who were exposed to defendants' marketing
and advertising activities in California. Certification was granted as to
plaintiff's claims that defendants violated California's unfair business
practices statute. The court subsequently defined "the applicable class
period" for plaintiff's claims, pursuant to a stipulation submitted by the
parties, as June 10, 1993 through April 23, 2001. The California Court of
Appeals denied defendants' writ application, which sought review of the
trial court's class certification orders. Defendants filed a petition for
review with the California Supreme Court, which was subsequently denied.
The defendants' summary judgment motions are pending before the court.
Liggett is a defendant in the case.
In September 2002, in IN RE SIMON II LITIGATION, the federal district
court for the Eastern District of New York granted plaintiffs' motion for
certification of a nationwide non-opt-out punitive damages class action
against the tobacco companies, including Liggett. The class is not seeking
compensatory damages, but was created to determine whether smokers across
the country may be entitled to punitive damages. In 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, and oral argument was held
in November 2003.
- 19 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
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 were
filed against the cigarette manufacturers, including Liggett, for alleged
antitrust violations. The actions allege that the cigarette manufacturers
have engaged in a nationwide and international conspiracy to fix the price
of cigarettes in violation of state and federal antitrust laws. Plaintiffs
allege that defendants' price-fixing conspiracy raised the price of
cigarettes above a competitive level. Plaintiffs in the 31 state actions
purport to represent classes of indirect purchasers of cigarettes in 16
states; plaintiffs in the seven federal actions purport to represent a
nationwide class of wholesalers who purchased cigarettes directly from the
defendants. The federal class actions were consolidated and, in July 2000,
plaintiffs filed a single consolidated complaint that did not name Liggett
as a defendant, although Liggett complied with discovery requests. In July
2002, the court granted defendants' motion for summary judgment in the
consolidated federal cases, which decision was affirmed on appeal by the
United States Court of Appeals for the Eleventh Circuit. All state court
cases on behalf of indirect purchasers have been dismissed, except for two
cases pending in Kansas and New Mexico. A Kansas state court, in the case
of SMITH V. PHILIP MORRIS COMPANIES INC., ET AL., granted class
certification in November 2001. In April 2003, plaintiffs' motion for
class certification was granted in ROMERO V. PHILIP MORRIS COMPANIES INC.,
a case pending in New Mexico state court, which decision has been
appealed. Liggett is one of the defendants in the Kansas and New Mexico
cases.
GOVERNMENTAL ACTIONS. As of March 31, 2004, there were approximately 13
Governmental Actions pending against Liggett. In these proceedings, both
foreign and domestic governmental entities seek reimbursement for Medicaid
and other health care expenditures. The claims asserted in these health
care cost recovery actions vary. In most of these cases, plaintiffs assert
the equitable claim that the tobacco industry was "unjustly enriched" by
plaintiffs' payment of health care costs allegedly attributable to smoking
and seek reimbursement of those costs. Other claims made by some but not
all plaintiffs include the equitable claim of indemnity, common law claims
of negligence, strict liability, breach of express and implied warranty,
breach of special duty, fraud, negligent misrepresentation, conspiracy,
public nuisance, claims under state and federal statutes governing
consumer fraud, antitrust, deceptive trade practices and false
advertising, and claims under RICO.
In August 2003, following the refusal by the Florida Supreme Court to hear
the appeal of the Republic of Venezuela in connection with the dismissal
of its health care cost recovery action (which decision plaintiff has
appealed to the United States Supreme Court), the trial court hearing the
health care cost recovery actions brought in Florida by the Republic of
Tajikistan and the Brazilian State of Tocantins granted defendants'
motions to dismiss the cases. Subsequently, plaintiffs voluntarily
dismissed additional heath care cost recovery cases brought in Florida by
various foreign governmental entities.
THIRD-PARTY PAYOR ACTIONS. As of March 31, 2004, there were approximately
five 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
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
UnitedStates Supreme Court has denied petitions for certiorari in the
cases decided by five of the courts of appeal. However, a number of
Third-Party Payor Actions, including an action brought by 24 Blue
Cross/Blue Shield Plans, remain pending.
In June 2001, a jury in a third party payor action brought by Empire Blue
Cross and Blue Shield in the Eastern District of New York rendered a
verdict awarding the plaintiff $17,800 in damages against the major
tobacco companies. As against Liggett, the jury awarded the plaintiff
damages of $89. In February 2002, the court awarded plaintiff's counsel
$37,800 in attorneys' fees, without allocating the fee award among the
several defendants. Liggett has appealed both the jury verdict and the
attorneys' fee award. In September 2003, the United States Court of
Appeals for the Second Circuit certified two questions relating to
plaintiff's direct claims of deceptive business practices to the New York
Court of Appeals, which has agreed to review the certified questions. The
Second Circuit reversed the portion of the judgment relating to the
verdict returned against defendants under plaintiff's subrogation claim,
and deferred its ruling on defendants' appeal of the attorneys' fees award
until such time as the New York Court of Appeals rules on the certified
questions.
In other Third-Party Payor Actions claimants have set forth several
additional theories of relief sought: funding of corrective public
education campaigns relating to issues of smoking and health; funding for
clinical smoking cessation programs; disgorgement of profits from sales of
cigarettes; restitution; treble damages; and attorneys' fees.
Nevertheless, no specific amounts are provided. It is understood that
requested damages against the tobacco company defendants in these cases
might be in the billions of dollars.
FEDERAL GOVERNMENT ACTION. In September 1999, the United States government
commenced litigation against Liggett and the other major tobacco companies
in the United States District Court for the District of Columbia. The
action seeks to recover an unspecified amount of health care costs paid
for and furnished, and to be paid for and furnished, by the Federal
Government for lung cancer, heart disease, emphysema and other
smoking-related illnesses allegedly caused by the fraudulent and tortious
conduct of defendants, to restrain defendants and co-conspirators from
engaging in fraud and other unlawful conduct in the future, and to compel
defendants to disgorge the proceeds of their unlawful conduct. The
complaint alleges that such costs total more than $20,000,000 annually.
The action asserted claims under three federal statutes, the Medical Care
Recovery Act ("MCRA"), the Medicare Secondary Payer provisions of the
Social Security Act ("MSP") and RICO. In September 2000, the court
dismissed the government's claims based on MCRA and MSP, reaffirming its
decision in July 2001. In the September 2000 decision, the court also
determined not to dismiss the government's RICO claims, under which the
government continues to seek court relief to restrain the defendant
tobacco companies from allegedly engaging in fraud and other unlawful
conduct and to compel disgorgement. In May 2003, the court denied the
industry's motion which sought partial summary judgment as to the
government's advertising, marketing, promotion and warning claims on the
basis that these claims are within the exclusive jurisdiction of the
Federal Trade Commission. In January 2004, the court granted one of the
government's pending motions and dismissed certain equitable defenses of
defendants. In April 2004, the court denied Liggett's motion to be
dismissed from the case. The remaining motions for summary judgment filed
by the government and defendants are still 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,
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
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. Trial has
been scheduled for September 2004.
SETTLEMENTS. In March 1996, Brooke Group Holding and Liggett entered into
an agreement, subject to court approval, to settle the CASTANO class
action tobacco litigation. The CASTANO class was subsequently decertified
by the court.
In March 1996, March 1997 and March 1998, Brooke Group Holding and Liggett
entered into settlements of smoking-related litigation with the Attorneys
General of 45 states and territories. The settlements released both Brooke
Group Holding and Liggett from all smoking-related claims, including
claims for health care cost reimbursement and claims concerning sales of
cigarettes to minors.
In November 1998, Philip Morris, Brown & Williamson Tobacco Corporation,
R.J. Reynolds Tobacco Company and Lorillard Tobacco Company (collectively,
the "Original Participating Manufacturers" or "OPMs") and Liggett
(together with the OPMs and any other tobacco product manufacturer that
becomes a signatory, the "Participating Manufacturers") entered into the
Master Settlement Agreement (the "MSA") with 46 states, the District of
Columbia, Puerto Rico, Guam, the United States Virgin Islands, American
Samoa and the Northern Marianas (collectively, the "Settling States") to
settle the asserted and unasserted health care cost recovery and certain
other claims of those Settling States. The MSA received final judicial
approval in each settling jurisdiction.
The MSA restricts tobacco product advertising and marketing within the
Settling States and otherwise restricts the activities of Participating
Manufacturers. Among other things, the MSA prohibits the targeting of
youth in the advertising, promotion or marketing of tobacco products; bans
the use of cartoon characters in all tobacco advertising and promotion;
limits each Participating Manufacturer to one tobacco brand name
sponsorship during any 12-month period; bans all outdoor advertising, with
the exception of signs, 14 square feet or less, at retail establishments
that sell tobacco products; prohibits payments for tobacco product
placement in various media; bans gift offers based on the purchase of
tobacco products without sufficient proof that the intended recipient is
an adult; prohibits Participating Manufacturers from licensing third
parties to advertise tobacco brand names in any manner prohibited under
the MSA; prohibits Participating Manufacturers from using as a tobacco
product brand name any nationally recognized non-tobacco brand or trade
name or the names of sports teams, entertainment groups or individual
celebrities; and prohibits Participating Manufacturers from selling packs
containing fewer than 20 cigarettes.
The MSA also requires Participating Manufacturers to affirm corporate
principles to comply with the MSA and to reduce underage usage of tobacco
products and imposes requirements applicable to lobbying activities
conducted on behalf of Participating Manufacturers.
Liggett has no payment obligations under the MSA except to the extent its
market share exceeds a base share of 125% of its 1997 market share, or
approximately 1.65% of total cigarettes sold in the United States. As a
result of the Medallion acquisition in April 2002, Vector Tobacco has no
payment obligations under the MSA, except to the extent its market share
exceeds a base amount of approximately 0.28% of total cigarettes sold in
the United States. During 1999 and 2000, Liggett's market share did not
exceed the base amount. According to data from Management Source
Associates, Inc., domestic shipments by Liggett and Vector Tobacco
accounted for approximately 2.2% of the total cigarettes shipped in the
United States during 2001, 2.5% during 2002 and 2.7% during 2003. On April
15 of any year following a year in which Liggett's and/or Vector Tobacco's
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
market shares exceed their base shares, Liggett and/or Vector Tobacco will
pay on each excess unit an amount equal (on a per-unit basis) to that due
during the same following year by the OPMs under the annual and strategic
contribution payment provisions of the MSA, subject to applicable
adjustments, offsets and reductions. In March and April 2002, Liggett and
Vector Tobacco paid a total of $31,130 for their 2001 MSA obligations. In
March and April 2003, Liggett and Vector Tobacco paid a total of $37,541
for their 2002 MSA obligations. In June 2003, Liggett and Vector Tobacco
reached a settlement with the jurisdictions party to the MSA whereby they
agreed to pay $2,478 in April 2004. The settlement resolved Liggett's and
Vector Tobacco's claims that they were entitled to a reduction in their
MSA payments as a result of market share loss to non-participating
manufacturers for payments based on sales through December 31, 2002. In
April 2004, Liggett and Vector Tobacco also paid a total of $50,322 for
their 2003 MSA obligations. Liggett and Vector Tobacco have expensed
$4,728 for their estimated MSA obligations for the first three months of
2004 as part of cost of goods sold. Under the annual and strategic
contribution payment provisions of the MSA, the OPMs (and Liggett and
Vector Tobacco to the extent their market shares exceed their base shares)
are required to pay the following annual amounts (subject to certain
adjustments):
Year Amount
---- ------
2004 - 2007 $8,000,000
2008 - 2017 $8,139,000
2018 and each year thereafter $9,000,000
These annual payments will be allocated based on relative unit volume of
domestic cigarette shipments. The payment obligations under the MSA are
the several, and not joint, obligations of each Participating Manufacturer
and are not the responsibility of any parent or affiliate of a
Participating Manufacturer.
The MSA replaces Liggett's prior settlements with all states and
territories except for Florida, Mississippi, Texas and Minnesota. Each of
these four states, prior to the effective date of the MSA, negotiated and
executed settlement agreements with each of the other major tobacco
companies, separate from those settlements reached previously with
Liggett. Because these states' settlement agreements with Liggett provided
for "most favored nation" protection for both Brooke Group Holding and
Liggett, the payments due these states by Liggett (with certain possible
exceptions) have been eliminated, other than a $100 a year payment to
Minnesota starting in 2003, to be paid any year cigarettes manufactured by
Liggett are sold in the state. With respect to all non-economic
obligations under the previous settlements, both Brooke Group Holding and
Liggett are entitled to the most favorable provisions as between the MSA
and each state's respective settlement with the other major tobacco
companies. Therefore, Liggett's non-economic obligations to all states and
territories are now defined by the MSA.
Copies of the various settlement agreements are filed as exhibits to the
Company's Annual Report on Form 10-K and the discussion herein is
qualified in its entirety by reference thereto.
TRIALS. Cases currently scheduled for trial during the next six months
include two individual actions in Florida state court with one scheduled
for July 2004 and one for August 2004. Liggett is the sole defendant in
each of these cases. Trial in the United States government action is
scheduled for September 2004 in federal court in the District of Columbia.
One individual action in Iowa state court, involving the major companies
as defendants, is scheduled for trial in October 2004. Trial dates,
however, are subject to change.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
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
court's ruling. In April 2004, a jury in a Florida state court action
awarded compensatory damages of approximately $540 against Liggett in an
individual action. Liggett intends to appeal the verdict. It is possible
that additional cases could be decided unfavorably and that there could be
further adverse developments in the ENGLE case. Liggett may enter into
discussions in an attempt to settle particular cases if it believes it is
appropriate to do so. Management cannot predict the cash requirements
related to any future settlements and judgments, including cash required
to bond any appeals, and there is a risk that those requirements will not
be able to be met. An unfavorable outcome of a pending smoking and health
case could encourage the commencement of additional similar litigation.
Management is unable to make a meaningful estimate with respect to the
amount or range of loss that could result from an unfavorable outcome of
the cases pending against Brooke Group Holding or Liggett or the costs of
defending such cases. The complaints filed in these cases rarely detail
alleged damages. Typically, the claims set forth in an individual's
complaint against the tobacco industry pray for money damages in an amount
to be determined by a jury, plus punitive damages and costs. These damage
claims are typically stated as being for the minimum necessary to invoke
the jurisdiction of the court.
It is possible that the Company's consolidated financial position, results
of operations or cash flows could be materially adversely affected by an
unfavorable outcome in any such smoking-related litigation.
Liggett's and Vector Tobacco's management are unaware of any material
environmental conditions affecting their existing facilities. Liggett's
and Vector Tobacco's management believe that current operations are
conducted in material compliance with all environmental laws and
regulations and other laws and regulations governing cigarette
manufacturers. Compliance with federal, state and local provisions
regulating the discharge of materials into the environment, or otherwise
relating to the protection of the environment, has not had a material
effect on the capital expenditures, results of operations or competitive
position of Liggett or Vector Tobacco.
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.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
There are several other proceedings, lawsuits and claims pending against
the Company and certain of its consolidated subsidiaries unrelated to
smoking or tobacco product liability. Management is of the opinion that
the liabilities, if any, ultimately resulting from such other proceedings,
lawsuits and claims should not materially affect the Company's financial
position, results of operations or cash flows.
LEGISLATION AND REGULATION:
Many cities and states have recently enacted legislation banning smoking
in public places including offices, restaurants, public buildings and
bars. Efforts to limit smoking in public places could have a material
adverse effect on the Company and Liggett.
In January 1993, the Environmental Protection Agency ("EPA") released a
report on the respiratory effect of secondary smoke which concludes that
secondary smoke is a known human lung carcinogen in adults and in
children, causes increased respiratory tract disease and middle ear
disorders and increases the severity and frequency of asthma. In June
1993, the two largest of the major domestic cigarette manufacturers,
together with other segments of the tobacco and distribution industries,
commenced a lawsuit against the EPA seeking a determination that the EPA
did not have the statutory authority to regulate secondary smoke, and that
given the scientific evidence and the EPA's failure to follow its own
guidelines in making the determination, the EPA's classification of
secondary smoke was arbitrary and capricious. In July 1998, a federal
district court vacated those sections of the report relating to lung
cancer, finding that the EPA may have reached different conclusions had it
complied with relevant statutory requirements. The federal government
appealed the court's ruling. In December 2002, the United States Court of
Appeals for the Fourth Circuit rejected the industry challenge to the EPA
report ruling that it was not subject to court review. Issuance of the
report may encourage efforts to limit smoking in public areas.
In February 1996, the United States Trade representative issued an
"advance notice of proposed rule making" concerning how tobacco is
imported under a previously established tobacco tariff rate quota ("TRQ")
should be allocated. Currently, tobacco imported under the TRQ is
allocated on a "first-come, first-served" basis, meaning that entry is
allowed on an open basis to those first requesting entry in the quota
year. Others in the cigarette industry have suggested an "end-user
licensing" system under which the right to import tobacco under the quota
would be initially assigned based on domestic market share. Such an
approach, if adopted, could have a material adverse effect on the Company
and Liggett.
In August 1996, the Food and Drug Administration (the "FDA") filed in the
Federal Register a Final Rule classifying tobacco as a "drug" or "medical
device", asserting jurisdiction over the manufacture and marketing of
tobacco products and imposing restrictions on the sale, advertising and
promotion of tobacco products. Litigation was commenced challenging the
legal authority of the FDA to assert such jurisdiction, as well as
challenging the constitutionality of the rules. In March 2000, the United
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
- 25 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
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. Proposed legislation
has also been introduced in Congress that would eliminate the federal
tobacco quota system and impose assessments on manufacturers of tobacco
products to compensate tobacco growers and quota holders for the
elimination of their quota rights. The ultimate outcome of these proposals
cannot be predicted.
In August 1996, Massachusetts enacted legislation requiring tobacco
companies to publish information regarding the ingredients in cigarettes
and other tobacco products sold in that state. In December 2002, the
United States Court of Appeals for the First Circuit ruled that the
ingredients disclosure provisions violated the constitutional prohibition
against unlawful seizure of property by forcing firms to reveal trade
secrets. The decision was not appealed by the state. Liggett began
voluntarily complying with this legislation in December 1997 by providing
ingredient information to the Massachusetts Department of Public Health
and, notwithstanding the appellate court's ruling, has continued to
provide ingredient disclosure. Liggett also provides ingredient
information annually, as required by law, to the states of Texas and
Minnesota. Several other states are considering ingredient disclosure
legislation.
Cigarettes are subject to substantial and increasing federal, state and
local excise taxes. The federal excise tax on cigarettes is currently
$0.39 per pack. State and local sales and excise taxes vary considerably
and, when combined with sales taxes, local taxes and the current federal
excise tax, may currently exceed $4.00 per pack. Proposed further tax
increases in various jurisdictions are currently under consideration or
pending. In 2003, 15 states and the District of Columbia enacted increases
in excise taxes. Congress has considered significant increases in the
federal excise tax or other payments from tobacco manufacturers, and
several states have pending legislation proposing further state excise tax
increases. In 2004, one state has increased the excise tax rate and
several other states are likely to impose additional taxes on cigarettes.
In the opinion of the Company, increases in excise and similar taxes have
had an adverse impact on sales of cigarettes.
Various state governments have adopted or are considering adopting
legislation establishing fire safety standards for cigarettes. Compliance
with this legislation could be burdensome and costly. In June 2000, the
New York State legislature passed legislation charging the state's Office
of Fire Prevention and Control, referred to as the "OFPC," with developing
standards for "fire-safe" or self-extinguishing cigarettes. New York State
must be manufactured to certain self-extinguishment standards set out in
the regulations. Certain design and manufacturing changes will be
necessary for cigarettes manufactured for sale in New York to comply with
the standards. Inventories of cigarettes existing in the wholesale and
retail trade as of June 28, 2004 that do not comply with the standards,
may continue to be sold provided New York tax stamps have been affixed and
such inventories have been purchased in comparable quantities to the same
period in the previous year. Liggett and Vector Tobacco have not
historically provided products that would be compliant under these new
OFPC regulations. Liggett and Vector Tobacco expect, however, to supply
compliant products by June 28, 2004. Similar legislation is being
considered by other state governments and at the federal level. Compliance
with such legislation could harm the business of Liggett and Vector
Tobacco, particularly if there are varying standards from state to state.
Federal or state regulators may object to Vector Tobacco's reduced
carcinogen and low nicotine and nicotine-free cigarette products as
unlawful or allege they bear deceptive or unsubstantiated product claims,
and seek the removal of the products from the marketplace, or significant
changes to advertising. Various concerns regarding Vector Tobacco's
advertising practices have been expressed to Vector Tobacco by certain
state attorneys general. Vector Tobacco has engaged in discussions in an
effort to resolve these concerns. Allegations by federal or state
regulators, public
- 26 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) -- (CONTINUED)
(UNAUDITED)
health organizations and other tobacco manufacturers that Vector Tobacco's
products are unlawful, or that its public statements or advertising
contain misleading or unsubstantiated health claims or product
comparisons, may result in litigation or governmental proceedings. Vector
Tobacco's business may become subject to extensive domestic and
international governmental regulation. Various proposals have been made
for federal, state and international legislation to regulate cigarette
manufacturers generally, and reduced constituent cigarettes specifically.
It is possible that laws and regulations may be adopted covering issues
like the manufacture, sale, distribution, advertising and labeling of
tobacco products as well as any express or implied health claims
associated with reduced carcinogen and low nicotine and nicotine-free
cigarette products and the use of genetically modified tobacco. A system
of regulation by agencies like the FDA, the Federal Trade Commission or
the United States Department of Agriculture may be established. In
addition, a group of public health organizations submitted a petition to
the FDA, alleging that the marketing of the OMNI product is subject to
regulation by the FDA under existing law. Vector Tobacco has filed a
response in opposition to the petition. The FTC has also expressed
interest in the regulation of tobacco products made by tobacco
manufacturers, including Vector Tobacco, which bear reduced carcinogen
claims. The ultimate outcome of any of the foregoing cannot be predicted,
but any of the foregoing could have a material adverse impact on the
Company.
In addition to the foregoing, there have been a number of other
restrictive regulatory actions, adverse legislative and political
decisions and other unfavorable developments concerning cigarette smoking
and the tobacco industry. These developments may negatively affect the
perception of potential triers of fact with respect to the tobacco
industry, possibly to the detriment of certain pending litigation, and may
prompt the commencement of additional similar litigation or legislation.
OTHER MATTERS:
In March 1997, a stockholder derivative suit was filed in Delaware
Chancery Court against New Valley, as a nominal defendant, its directors
and Brooke Group Holding by a stockholder of New Valley. The suit alleges
that New Valley's purchase of the BrookeMil Ltd. shares from Brooke
(Overseas) Ltd., which was then an indirect subsidiary of Brooke Group
Holding, in January 1997 constituted a self-dealing transaction which
involved the payment of excessive consideration by New Valley. The
plaintiff seeks a declaration that New Valley's directors breached their
fiduciary duties and Brooke Group Holding aided and abetted such breaches
and that damages be awarded to New Va