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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 SEPTEMBER 30, 2004
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VECTOR GROUP LTD.
(Exact name of registrant as specified in its charter)
DELAWARE 1-5759 65-0949535
(State or other jurisdiction of Commission File Number (I.R.S. Employer 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 November 8, 2004, Vector Group Ltd. had 41,746,026 shares of common
stock outstanding.
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VECTOR GROUP LTD.
FORM 10-Q
TABLE OF CONTENTS
Page
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PART I. FINANCIAL INFORMATION
Item 1. VECTOR GROUP LTD. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED):
Vector Group Ltd. Consolidated Balance Sheets as of September 30, 2004 and
December 31, 2003......................................................................... 2
Vector Group Ltd. Consolidated Statements of Operations for the three and nine
months ended September 30, 2004 and September 30, 2003.................................... 3
Vector Group Ltd. Consolidated Statement of Stockholders' Equity (Deficit) for the
nine months ended September 30, 2004...................................................... 4
Vector Group Ltd. Consolidated Statements of Cash Flows for the nine months
ended September 30, 2004 and September 30, 2003........................................... 5
Notes to Consolidated Financial Statements................................................... 6
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS..................................................................... 38
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................... 61
Item 4. CONTROLS AND PROCEDURES...................................................................... 61
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS............................................................................ 63
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.................................. 63
Item 6. EXHIBITS..................................................................................... 63
SIGNATURE................................................................................................. 64
- 1 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
September 30, December 31,
2004 2003
------------- ------------
ASSETS:
Current assets:
Cash and cash equivalents ................................................ $ 97,500 $ 74,808
Investment securities available for sale ................................. 17,187 67,521
Accounts receivable - trade .............................................. 4,794 10,425
Other receivables ........................................................ 1,646 2,605
Inventories .............................................................. 82,062 127,351
Restricted assets ........................................................ 577 771
Deferred income taxes .................................................... 20,885 19,328
Other current assets ..................................................... 12,838 12,568
--------- ---------
Total current assets ................................................... 237,489 315,377
Property, plant and equipment, net ......................................... 120,889 143,596
Assets held for sale ....................................................... -- 9,438
Long-term investments, net ................................................. 2,334 2,431
Investments in non-consolidated real estate businesses ..................... 27,602 18,718
Restricted assets .......................................................... 3,739 5,571
Deferred income taxes ...................................................... 16,045 13,200
Intangible asset ........................................................... 107,511 107,511
Other assets ............................................................... 12,438 12,370
--------- ---------
Total assets ........................................................... $ 528,047 $ 628,212
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Current portion of notes payable and long-term debt ...................... $ 21,699 $ 10,762
Accounts payable ......................................................... 8,810 8,635
Accrued promotional expenses ............................................. 14,743 22,203
Accrued taxes payable, net ............................................... 38,771 48,577
Settlement accruals ...................................................... 17,559 52,650
Deferred income taxes .................................................... 4,000 4,000
Accrued interest ......................................................... 3,038 7,004
Other accrued liabilities ................................................ 19,096 19,255
--------- ---------
Total current liabilities .............................................. 127,716 173,086
Notes payable, long-term debt and other obligations, less current portion .. 286,272 299,977
Noncurrent employee benefits ............................................... 15,952 13,438
Deferred income taxes ...................................................... 141,012 139,927
Other liabilities .......................................................... 5,183 4,781
Minority interests ......................................................... 45,633 43,478
Commitments and contingencies .............................................. -- --
Stockholders' equity (deficit):
Preferred stock, par value $1.00 per share, authorized 10,000,000 shares . -- --
Common stock, par value $0.10 per share, authorized 100,000,000
shares, issued 45,128,184 and 42,103,276 shares and outstanding
41,734,407 and 39,021,189 shares ....................................... 4,173 3,902
Additional paid-in capital ............................................... 243,543 251,239
Accumulated deficit ...................................................... (314,475) (280,598)
Accumulated other comprehensive loss ..................................... (10,791) (9,335)
Less: 3,393,777 and 3,082,087 shares of common stock in treasury, at cost (16,171) (11,683)
--------- ---------
Total stockholders' equity (deficit) ................................. (93,721) (46,475)
--------- ---------
Total liabilities and stockholders' equity (deficit) ................. $ 528,047 $ 628,212
========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
- 2 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Nine Months Ended
-------------------------------- ------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Revenues:
Tobacco*.................................................. $ 124,251 $ 141,053 $ 370,869 $ 401,796
Real estate leasing....................................... 1,809 1,797 5,401 5,373
---------- ---------- ---------- ----------
Total revenues.......................................... 126,060 142,850 376,270 407,169
Expenses:
Cost of goods sold, excluding inventory impairment*....... 71,117 92,711 215,347 262,512
Inventory impairment...................................... -- -- 37,000 --
Operating, selling, administrative and general expenses... 32,718 38,367 109,884 132,262
Restructuring and impairment charges...................... 4,532 20,079 7,544 20,079
---------- ---------- ---------- ----------
Operating income (loss)................................. 17,693 (8,307) 6,495 (7,684)
Other income (expenses):
Interest and dividend income.............................. 322 844 1,548 3,416
Interest expense.......................................... (6,832) (7,422) (19,745) (23,087)
Gain on sale of investments, net.......................... 302 806 5,888 1,076
Equity income from non-consolidated New Valley
real estate businesses.................................. 4,539 1,527 9,827 636
Other, net................................................ (1) 4 (10) 21
---------- ---------- ---------- ----------
Income (loss) from operations before provision (benefit)
for income taxes and minority interests................. 16,023 (12,548) 4,003 (25,622)
Provision (benefit) for income taxes...................... 6,995 (3,240) 4,502 (4,482)
Minority interests........................................ (962) (72) (3,710) 1,981
---------- ---------- ---------- ----------
Net income (loss)............................................. $ 8,066 $ (9,380) $ (4,209) $ (19,159)
========== ========== ========== ==========
Per basic common share:
Net income (loss) applicable to common shares $ 0.19 $ (0.23) $ (0.10) $ (0.47)
========== ========== ========== ==========
Basic weighted average common shares outstanding 41,669,127 40,787,431 41,287,777 40,633,009
========== ========== ========== ==========
Per diluted common share:
Net income (loss) applicable to common shares $ 0.19 $ (0.23) $ (0.10) $ (0.47)
========== ========== ========== ==========
Diluted weighted average common shares outstanding 43,307,392 40,787,431 41,287,777 40,633,009
========== ========== ========== ==========
- --------------
*Revenues and Cost of goods sold include excise taxes of $42,626, $51,132,
$132,729 and $149,468, respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
- 3 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
Accumulated
Common Stock Additional Other
---------------------- Paid-In Accumulated Treasury Comprehensive
Shares Amount Capital Deficit Stock Loss Total
---------- ---------- ---------- ------------ ----------- ------------- -----------
Balance, December 31, 2003 ................. 39,021,189 $ 3,902 $ 251,239 $ (280,598) $ (11,683) $ (9,335) $ (46,475)
Net loss ................................... -- -- -- (4,209) -- -- (4,209)
Unrealized loss on investment securities . -- -- -- -- -- (1,456) (1,456)
----------
Total other comprehensive loss .... -- -- -- -- -- -- (1,456)
----------
Total comprehensive loss ................... -- -- -- -- -- -- (5,665)
Distributions on common stock ($1.14
per share) ............................... -- -- (47,397) -- -- -- (47,397)
Exercise of options ........................ 686,028 69 7,136 -- (4,488) -- 2,717
Stock dividend ............................. 1,987,190 198 29,470 (29,668) -- -- --
Restricted stock grants .................... 40,000 4 (4) -- -- -- --
Tax benefit of options exercised ........... -- -- 2,891 -- -- -- 2,891
Amortization of deferred compensation, net . -- -- 208 -- -- -- 208
---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance, September 30, 2004 ................ 41,734,407 $ 4,173 $ 243,543 $ (314,475) $ (16,171) $ (10,791) $ (93,721)
========== ========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part
of the consolidated financial statements.
- 4 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Nine Months Ended
----------------------------------
September 30, September 30,
2004 2003
----------------- ----------------
Net cash used in operating activities.................................. $ (3,675) $ (9,660)
-------- ----------
Cash flows from investing activities:
Proceeds from sale of assets, net.................................... 25,821 3,852
Sale or maturity of investment securities............................ 65,454 109,341
Purchase of investment securities.................................... (10,747) (49,127)
Sale of long-term investments........................................ 243 679
Investments in non-consolidated real estate businesses............... (2,500) (9,500)
Distribution from non-consolidated real estate businesses............ -- 670
Decrease (increase) in restricted assets............................. 1,832 (13,691)
New Valley repurchase of common shares............................... (202) (1,346)
Capital expenditures................................................. (3,005) (7,691)
-------- ----------
Net cash provided by investing activities.............................. 76,896 33,187
-------- ----------
Cash flows from financing activities:
Repayments of debt................................................... (20,782) (26,764)
Borrowings under revolver............................................ 411,150 487,105
Repayments on revolver............................................... (395,660) (470,878)
Increase in cash overdraft........................................... -- 183
Distributions on common stock........................................ (47,397) (44,371)
Proceeds from exercise of options and warrants....................... 2,868 1,106
Issuance of note receivable.......................................... (500) --
Deferred financing costs............................................. (208) --
-------- ----------
Net cash used in financing activities.................................. (50,529) (53,619)
-------- ----------
Net increase in cash and cash equivalents.............................. 22,692 (30,092)
Cash and cash equivalents, beginning of period......................... 74,808 100,027
------- ----------
Cash and cash equivalents, end of period............................... $97,500 $ 69,935
======= ==========
The accompanying notes are an integral part
of the consolidated financial statements.
- 5 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BASIS OF PRESENTATION:
The consolidated financial statements of Vector Group Ltd. (the
"Company" or "Vector") include the accounts of VGR Holding Inc. ("VGR
Holding"), Liggett Group Inc. ("Liggett"), Vector Tobacco Inc.
("Vector Tobacco"), Liggett Vector Brands Inc. ("Liggett Vector
Brands"), New Valley Corporation ("New Valley") and other less
significant subsidiaries. The Company owned 58.2% of the common
shares of New Valley at September 30, 2004. All significant
intercompany balances and transactions have been eliminated.
Liggett is engaged in the manufacture and sale of cigarettes in the
United States. Vector Tobacco is engaged in the development and
marketing of low nicotine and nicotine-free cigarette products and
the development of reduced risk cigarette products. New Valley is
currently engaged in the real estate business and is seeking to
acquire additional operating companies and real estate properties.
The interim consolidated financial statements of the Company are
unaudited and, in the opinion of management, reflect all adjustments
necessary (which are normal and recurring) to present fairly the
Company's consolidated financial position, results of operations and
cash flows. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2003, as filed with the Securities and
Exchange Commission. The consolidated results of operations for
interim periods should not be regarded as necessarily indicative of
the results that may be expected for the entire year.
(b) ESTIMATES AND ASSUMPTIONS:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities and the reported amounts of revenues and
expenses. Significant estimates subject to material changes in the
near term include restructuring and impairment charges, inventory
valuation, deferred tax assets, allowance for doubtful accounts,
promotional accruals, sales returns and allowances, actuarial
assumptions of pension plans, settlement accruals and litigation and
defense costs. Actual results could differ from those estimates.
(c) RECLASSIFICATIONS:
Certain amounts in the 2003 consolidated financial statements have
been reclassified to conform to the 2004 presentation.
(d) EARNINGS PER SHARE:
Information concerning the Company's common stock has been adjusted
to give effect to the 5% stock dividends paid to Company stockholders
on September 29, 2003 and September 29, 2004. In connection with the
5% dividend, the Company increased the number of outstanding stock
options by 5% and reduced the exercise prices accordingly. All share
amounts have been presented as if the stock dividends had occurred on
January 1, 2003.
- 6 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Basic net income per share is computed by dividing net income by the
weighted-average number of shares outstanding. Diluted net income per
share includes the dilutive effect of stock options, vested
restricted stock grants and warrants.
The Company had net income for the three months ended September 30,
2004 and a net loss for the nine months ended September 30, 2004 and
for the three and nine months ended September 30, 2003. The effect of
the common stock equivalents and convertible securities is excluded
from the computation of diluted net loss per share since the effect
is antidilutive. Potentially dilutive shares that were not included
in the diluted loss per share calculations were 1,841,180 for the
nine months ended September 30, 2004 and 1,926,493 and 1,608,809 for
the three and nine months ended September 30, 2003, which shares were
issuable upon the exercise of stock options, vested restricted stock
grants and warrants, assuming the treasury stock method.
(e) COMPREHENSIVE LOSS:
Other comprehensive loss is a component of stockholders' equity
(deficit) and includes such items as the unrealized gains and losses
on investment securities available for sale and minimum pension
liability adjustments. Total comprehensive loss was $5,665 for the
nine months ended September 30, 2004 and $16,758 for the nine months
ended September 30, 2003.
(f) NEW ACCOUNTING PRONOUNCEMENTS:
In March 2004, the Financial Accounting Standards Board (the "FASB")
reached a consensus on Emerging Issues Task Force Issue 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" ("EITF 03-1"). EITF 03-1 provides guidance for
determining when an investment is impaired and whether the impairment
is other than temporary. EITF 03-1 also incorporates into its
consensus the required disclosures about unrealized losses on
investments announced by the EITF in late 2003 and adds new
disclosure requirements relating to cost-method investments. The
impairment accounting guidance is effective for reporting periods
beginning after June 15, 2004 and the new disclosure requirements for
annual reporting periods ending after June 15, 2004. The adoption of
the impairment guidance contained in EITF 03-1 did not have a
material impact on the Company's financial position or results of
operations.
In December 2003, the FASB issued Statement on Financial Accounting
Standards ("SFAS") No. 132(R), which replaces SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement
Benefits." SFAS No. 132(R) does not change the measurement and
recognition provisions of SFAS No. 87, SFAS No. 88, "Employers
Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits," and SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other Than
Pensions," however, it includes additional disclosure provisions for
annual reporting, including detailed plan asset information by
category, expanded benefit obligation disclosure and key assumptions.
In addition, interim disclosures related to the individual elements
of plan costs and employer's current year contributions are required.
(See Note 6.)
- 7 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
2. RESTRUCTURING
LIGGETT VECTOR BRANDS RESTRUCTURINGS. Liggett Vector Brands, as part of
the continuing effort to adjust the cost structure of the Company's
tobacco business and improve operating efficiency, eliminated 83 positions
during April 2004, sublet its New York office space and relocated several
employees. As a result of these actions, the Company recognized pre-tax
restructuring charges of $2,791 in the first half of 2004, including $824
relating to employee severance and benefit costs and $1,967 for contract
termination and other associated costs. Approximately $518 of these
charges represent non-cash items.
On October 6, 2004, the Company announced an additional plan to further
restructure the operations of Liggett Vector Brands, its sales, marketing
and distribution agent for its Liggett and Vector Tobacco subsidiaries.
Liggett Vector Brands is realigning its sales force and adjusting its
business model to more efficiently serve its chain and independent
accounts nationwide. In connection with the restructuring, the Company is
eliminating approximately 330 full-time positions and 135 part-time
positions, effective December 15, 2004.
As a result of the actions announced in October 2004, the Company
currently expects to realize annual cost savings of approximately $30,000
beginning in 2005. The Company will recognize pre-tax restructuring
charges currently estimated to total $12,058, of which $4,428 has been
recognized in the third quarter of 2004 and approximately $7,630 will be
taken in the fourth quarter of 2004. Approximately $5,883 of the charges
relate to employee severance and benefit costs and approximately $6,175 to
contract termination and other associated costs. Approximately $2,455 of
these charges represent non-cash items. Additionally, in the fourth
quarter of 2004, the Company will incur other charges for various
compensation and related payments to employees which are related to the
restructuring. These charges will approximate $1,784 and will be included
in selling, general and administrative expenses.
The components of the combined pre-tax restructuring charges relating to
the Liggett Vector Brands restructurings for the nine months ended
September 30, 2004 are as follows:
Employee Non-Cash Contract
Severance Asset Termination/
and Benefits Impairment Exit Costs Total
------------ ---------- ----------- -------
Balance, December 31, 2003 $ -- $ -- $ -- $ --
Original charges .......... 824 518 1,449 2,791
Utilized/reclassifications,
net...................... (752) (483) (1,060) (2,295)
------- ------- ------- -------
Balance, June 30, 2004 .... 72 35 389 496
Change in estimate ........ (26) (15) 41 --
Restructuring charges ..... 4,428 -- (71) 4,357
Utilized/reclassifications,
net...................... (46) (20) (122) (188)
------- ------- ------- -------
Balance, September 30, 2004 $ 4,428 $ -- $ 237 $ 4,665
======= ======= ======= =======
- 8 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
The Company has recorded the sublease of the New York office space in
accordance with SFAS No. 146, "Accounting for Costs Associated with Exit
or Disposal Activities," reducing future minimum lease payments by
estimated sublease rentals. The charge of $967 recorded during the second
quarter was reduced by $71 during the third quarter 2004 due to a
modification of the sub-lease terms. The future minimum lease payments
liability was $804 at September 30, 2004; $734 of which is recorded in
other long-term liabilities and the balance is recorded in other accrued
liabilities. These amounts are not recorded in the $4,665 balance at
September 30, 2004. The $4,665 balance has also been recorded in other
accrued liabilities.
TIMBERLAKE RESTRUCTURING. In October 2003, the Company announced that it
would close Vector Tobacco's Timberlake, North Carolina cigarette
manufacturing facility in order to reduce excess tobacco production
capacity and improve operating efficiencies company-wide. Production of
the QUEST line of low nicotine and nicotine-free cigarettes, as well as
production of Vector Tobacco's other cigarette brands, has been moved to
Liggett's state-of-the-art manufacturing facility in Mebane, North
Carolina.
The Mebane facility currently produces in excess of 9 billion units per
year, but maintains the capacity to produce 16 billion units per year.
Vector Tobacco has contracted with Liggett to produce its cigarettes, and
all production was transitioned from Timberlake to Mebane by December 31,
2003. As part of the transition, Vector eliminated approximately 150
positions.
As a result of these actions, the Company recognized pre-tax restructuring
and impairment charges of $21,521, of which $21,300 was taken in 2003 and
the remaining $221 was recognized in the first quarter of 2004. Machinery
and equipment to be disposed of was reduced to estimated fair value less
costs to sell during 2003 and was carried on the accompanying December 31,
2003 consolidated balance sheets as assets held for sale. The asset
impairment charges were based on management's estimates of the values the
Company would be able to realize on sales of the excess machinery and
equipment, and were adjusted in future periods based on the actual amounts
realized.
In June 2004, a wholly-owned subsidiary of Vector Tobacco entered into an
agreement to sell the Timberlake facility, along with all equipment, which
sale closed in July 2004. (Refer to Note 4.) The Company decreased the
asset impairment accrual as of June 30, 2004 to reflect the actual amounts
to be realized from the Timberlake sale and to reduce the values of other
excess Vector Tobacco machinery and equipment in accordance with SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The
Company further adjusted the previously recorded restructuring accrual as
of June 30, 2004 to reflect additional employee severance and benefits,
contract termination and associated costs resulting from the Timberlake
sale. No charge to operations resulted from these adjustments as there was
no change to the total impairment and restructuring accruals previously
recognized. During the third quarter of 2004, the Company recognized a
restructuring charge of $175 in connection with additional employee
severance and benefit costs relating to the Timberlake sale.
The components of the pre-tax restructuring charge relating to the closing
of Vector Tobacco's Timberlake, North Carolina cigarette manufacturing
facility for the year ended 2003 and the nine months ended September 30,
2004 are as follows:
- 9 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Employee Non-Cash Contract
Severance Asset Termination/
and Benefits Impairment Exit Costs Total
------------ ---------- ----------- --------
Balance, December 31, 2002 .......... $ -- $ -- $ -- $ --
Original charges .................... 2,045 18,752 503 21,300
Utilized in 2003 .................... (182) (18,752) (54) (18,988)
-------- -------- -------- --------
Balance, December 31, 2003 .......... 1,863 -- 449 2,312
Restructuring and impairment charges 175 -- 221 396
Adjustments/reclassifications in 2004 507 (871) 364 --
Utilized/recoveries in 2004, net .... (1,888) 871 (900) (1,917)
-------- -------- -------- --------
Balance, September 30, 2004 ......... $ 657 $ -- $ 134 $ 791
======== ======== ======== ========
Annual cost savings related to the Timberlake restructuring and impairment
charges and the actions taken at Liggett Vector Brands in the first half
of 2004 are currently expected to be at least $23,000 beginning in 2004.
Management continues to review opportunities for additional cost savings
in the Company's tobacco business.
3. INVENTORIES
Inventories consist of:
September 30, December 31,
2004 2003
------------- ------------
Leaf tobacco................................. $37,787 $ 80,239
Other raw materials.......................... 3,170 3,060
Work-in-process.............................. 1,275 1,609
Finished goods............................... 43,276 42,825
Replacement parts and supplies............... -- 636
------- --------
Inventories at current cost.................. 85,508 128,369
LIFO adjustments............................. (3,446) (1,018)
------- --------
$82,062 $127,351
======= ========
The Company has a leaf inventory management program whereby, among other
things, it is committed to purchase certain quantities of leaf tobacco.
The purchase commitments are for quantities not in excess of anticipated
requirements and are at prices, including carrying costs, established at
the date of the commitment. At September 30, 2004, Liggett had leaf
tobacco purchase commitments of approximately $523 and Vector Tobacco had
leaf tobacco purchase commitments of approximately $1,595.
Included in the above table is approximately $2,752 at September 30, 2004
and $44,220 at December 31, 2003 of inventory associated with Vector
Tobacco's QUEST product. During the second quarter of 2004, based on an
analysis of the market data obtained since the introduction of the QUEST
product, the Company determined to postpone indefinitely the national
launch of QUEST
- 10 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
and, accordingly, the Company recognized a non-cash charge of $37,000 to
adjust the carrying value of excess leaf tobacco inventory for the QUEST
product, based on estimated future demand and market conditions. If actual
demand for the product or market conditions are less favorable than those
estimated, additional inventory write-downs may be required.
LIFO inventories represent approximately 93.4% and 53.8% of total
inventories at September 30, 2004 and December 31, 2003, respectively.
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
September 30, December 31,
2004 2003
------------- ------------
Land and improvements ....... $ 9,263 $ 10,019
Buildings ................... 63,359 74,326
Machinery and equipment ..... 100,037 105,032
Leasehold improvements ...... 2,828 1,023
Construction-in-progress .... 2,500 1,554
--------- ---------
177,987 191,954
Less accumulated depreciation (57,098) (48,358)
--------- ---------
$ 120,889 $ 143,596
========= =========
The table above includes real estate assets and accumulated depreciation
owned and operated by New Valley in the amounts of $54,258 and $2,142 as
of September 30, 2004 and $54,258 and $1,246 as of December 31, 2003.
(Refer to Note 9.)
Depreciation and amortization expense for the three and nine months ended
September 30, 2004 was $3,200 and $10,256, respectively, and for the three
and nine months ended September 2003 was $4,174 and $12,630, respectively.
Future machinery and equipment purchase commitments at Liggett were $4,202
as of September 30, 2004.
In July 2003, Liggett granted an unaffiliated third party an option to
purchase Liggett's former manufacturing facility and other excess real
estate in Durham, North Carolina with a net book value at September 30,
2004 of approximately $2,285. The option agreement permits the purchaser
to acquire the property during a period of up to two years, at a purchase
price of $15,000. Liggett has received option fees of $1,250, of which
$250 is refundable if the purchaser terminates the agreement prior to
February 14, 2005. Liggett will be entitled to receive additional option
fees of up to $250 during the remaining option period. The option fees
will generally be creditable against the purchase price. The purchaser is
currently seeking financing for the transaction, and there can be no
assurance the sale of the property will occur.
The Company recorded an $18,752 non-cash asset impairment charge during
the third quarter of 2003 in conjunction with the closing of Vector
Tobacco's Timberlake, North Carolina facility of which $17,968 relates to
machinery and equipment. (See Note 2.)
- 11 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
In July 2004, a wholly-owned subsidiary of Vector Tobacco completed the
sale of its Timberlake, North Carolina manufacturing facility along with
all equipment to an affiliate of the Flue-Cured Tobacco Cooperative
Stabilization Corporation for $25,800. In connection with the sale, the
subsidiary of Vector Tobacco entered into a consulting agreement to
provide certain services to the buyer for $400. Vector Tobacco recognized
$200 as income in the third quarter of 2004. (See Notes 2 and 5.)
During 2003, Liggett entered into sale-leaseback transactions in which
equipment with a book value of $4,483 was sold and leased back from a
third party as operating leases. Liggett received cash of $2,386, and no
gain or loss was recognized on these transactions.
5. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
September 30, December 31,
2004 2003
------------- ------------
Vector:
6.25% Convertible Subordinated Notes due 2008 ............ $ 132,500 $ 132,500
VGR Holding:
10% Senior Secured Notes due 2006, net of
unamortized discount of $4,151 and $6,675 ............. 58,849 63,325
Liggett:
Revolving credit facility ................................ 15,490 --
Term loan under credit facility .......................... 4,649 5,190
Equipment loans .......................................... 7,173 9,758
Vector Tobacco:
Notes payable ............................................ -- 5,999
Notes payable - Medallion acquisition .................... 35,000 38,125
V.T. Aviation:
Note payable ............................................. 9,720 10,496
VGR Aviation:
Note payable ............................................. 5,157 5,346
New Valley:
Note payable - operating real estate ..................... 39,374 39,910
Other .................................................... 59 90
--------- ---------
Total notes payable, long-term debt and other obligations 307,971 310,739
Less:
Current maturities ................................. (21,699) (10,762)
--------- ---------
Amount due after one year ................................ $ 286,272 $ 299,977
========= =========
6.25% CONVERTIBLE SUBORDINATED NOTES DUE JULY 15, 2008 - VECTOR:
In July 2001, Vector completed the sale of $172,500 (net proceeds of
approximately $166,400) of its 6.25% convertible subordinated notes due
July 15, 2008 through a private offering to qualified institutional
investors in accordance with Rule 144A under the Securities Act of 1933.
The notes pay interest at 6.25% per annum and are convertible into
Vector's common stock, at the option of the holder. The conversion price,
which was $25.06 per share at September 30, 2004, is subject to adjustment
for various events, and any cash distribution on Vector's common stock
will result in a
- 12 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
corresponding decrease in the conversion price. In December 2001, $40,000
of the notes were converted into Vector's common stock, and $132,500 of
the notes were outstanding at September 30, 2004. In October 2004, an
additional $8 of the notes were converted into Vector's common stock.
Vector may redeem the notes, in whole or in part, at a price of 103.125%
in the year beginning July 15, 2004, 102.083% in the year beginning July
15, 2005, 101.042% in the year beginning July 15, 2006 and 100% in the
year beginning July 15, 2007, together with accrued interest. If a change
of control occurs, Vector will be required to offer to repurchase the
notes at 101% of their principal amount, plus accrued interest and, under
certain circumstances, a "make whole" payment.
10% SENIOR SECURED NOTES DUE MARCH 31, 2006 - VGR HOLDING:
In May 2001, VGR Holding issued at a discount $60,000 principal amount of
10% senior secured notes due March 31, 2006 in a private placement. VGR
Holding received net proceeds from the offering of approximately $46,500.
In April 2002, VGR Holding issued at a discount an additional $30,000
principal amount of 10% senior secured notes due March 31, 2006 in a
private placement and received net proceeds of approximately $24,500. The
notes were priced to provide the purchasers with a 15.75% yield to
maturity. The new notes are on the same terms as the $60,000 principal
amount of senior secured notes previously issued. All of the notes have
been guaranteed by the Company and by Liggett.
The notes are collateralized by substantially all of VGR Holding's assets,
including a pledge of VGR Holding's equity interests in its direct
subsidiaries, including Brooke Group Holding, Liggett Vector Brands,
Vector Tobacco and New Valley Holdings, Inc. ("NV Holdings"), as well as a
pledge of the shares of Liggett held by Brooke Group Holding and all of
the New Valley securities held by VGR Holding and NV Holdings. The
purchase agreement for the notes contains covenants, which the Company is
in compliance with at September 30, 2004. Among other things, the
covenants limit the ability of VGR Holding to make distributions to the
Company to 50% of VGR Holding's net income, unless VGR Holding holds an
amount in cash equal to the then principal amount of the notes outstanding
($63,000 at September 30, 2004) after giving effect to the payment of the
distribution, and limit additional indebtedness of VGR Holding, Liggett,
Vector Tobacco and Liggett Vector Brands to 250% of EBITDA (as defined in
the purchase agreements) for the trailing 12 months. The covenants also
restrict transactions with affiliates subject to exceptions which include
payments to Vector not to exceed $9,500 per year for permitted operating
expenses, and limit the ability of VGR Holding to merge, consolidate or
sell certain assets. In August 2004, in connection with an amendment to
the note purchase agreement, VGR Holding repurchased $7,000 of the notes
at a price of 100% of the principal amount plus accrued interest. The
Company recognized as additional interest expense a loss of $639 in the
third quarter of 2004 on the early extinguishment of debt.
VGR Holding has the right (which it has not exercised) under the purchase
agreement for the notes to elect to treat Vector Tobacco as a "designated
subsidiary" and exclude the losses of Vector Tobacco in determining the
amount of additional indebtedness permitted to be incurred. If VGR Holding
were to make this election, future cash needs of Vector Tobacco would be
required to be funded directly by Vector or by third-party financing as to
which neither VGR Holding nor Liggett could provide any guarantee or
credit support.
- 13 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
VGR Holding may redeem the notes, in whole or in part, at a redemption
price of 100% of the principal amount. During the term of the notes, VGR
Holding is required to offer to repurchase all the notes at a purchase
price of 101% of the principal amount, in the event of a change of
control, and to offer to repurchase notes, at 100% of the principal
amount, with the proceeds of material asset sales.
REVOLVING CREDIT FACILITY - LIGGETT:
On April 14, 2004, Liggett entered into an Amended and Restated Loan and
Security Agreement with Congress Financial Corporation, as lender. The
$50,000 credit facility replaced Liggett's previous $40,000 facility with
Congress, under which $15,490 was outstanding at September 30, 2004.
Availability as determined under the facility was approximately $15,670
based on eligible collateral at September 30, 2004. The facility is
collateralized by all inventories and receivables of Liggett and a
mortgage on its manufacturing facility. Borrowings under the facility bear
interest at a rate equal to 1.0% above the prime rate of Wachovia Bank,
N.A. (the indirect parent of Congress). The facility requires Liggett's
compliance with certain financial and other covenants including a
restriction on Liggett's ability to pay cash dividends unless Liggett's
borrowing availability under the facility for the 30-day period prior to
the payment of the dividend, and after giving effect to the dividend, is
at least $5,000 and no event of default has occurred under the agreement,
including Liggett's compliance with the covenants in the credit facility,
including an adjusted net worth and working capital requirement. In
addition, the facility imposes requirements with respect to Liggett's
adjusted net worth (not to fall below $8,000 as computed in accordance
with the agreement) and working capital (not to fall below a deficit of
$17,000 as computed in accordance with the agreement). At September 30,
2004, Liggett was in compliance with all covenants under the credit
facility; Liggett's adjusted net worth was $52,055 and net working capital
was $41,669, as computed in accordance with the agreement.
100 Maple LLC, a company formed by Liggett in 1999 to purchase its Mebane,
North Carolina manufacturing plant, has a term loan of $4,649 outstanding
under Liggett's credit facility at September 30, 2004. The remaining
balance of the term loan is payable in monthly installments of $77 with a
final payment on June 1, 2006 of $3,023. Interest is charged at the same
rate as applicable to Liggett's credit facility, and the outstanding
balance of the term loan reduces the maximum availability under the credit
facility. Liggett has guaranteed the term loan, and a first mortgage on
the Mebane property and manufacturing equipment collateralizes the term
loan and Liggett's credit facility.
EQUIPMENT LOANS - LIGGETT:
In March 2000, Liggett purchased equipment for $1,000 through the issuance
of a note, payable in 60 monthly installments of $21 with an effective
annual interest rate of 10.14%. In April 2000, Liggett purchased equipment
for $1,071 through the issuance of notes, payable in 60 monthly
installments of $22 with an effective interest rate of 10.20%.
In October and December 2001, Liggett purchased equipment for $3,204 and
$3,200, respectively, through the issuance of notes guaranteed by the
Company, each payable in 60 monthly installments of $53 with interest
calculated at the prime rate.
- 14 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
In March 2002, Liggett purchased equipment for $3,023 through the issuance
of a note, payable in 30 monthly installments of $62 and then 30 monthly
installments of $51 with an effective annual interest rate of 4.68%.
In May 2002, Liggett purchased equipment for $2,871 through the issuance
of a note, payable in 30 monthly installments of $59 and then 30 monthly
installments of $48 with an effective annual interest rate of 4.64%.
In September 2002, Liggett purchased equipment for $1,573 through the
issuance of a note guaranteed by the Company, payable in 60 monthly
installments of $26 plus interest calculated at LIBOR plus 4.31%.
NOTES PAYABLE - VECTOR TOBACCO:
In June 2001, Vector Tobacco purchased for $8,400 an industrial facility
in Timberlake, North Carolina. Vector Tobacco financed the purchase with
an $8,200 loan, payable in 60 monthly installments of $85, plus annual
interest at 4.85% above LIBOR with a final payment of approximately
$3,160. The loan, which was collateralized by a mortgage and a letter of
credit of $1,750, was guaranteed by VGR Holding and Vector. During
December 2001, Vector Tobacco borrowed an additional $1,159 from the same
lender to finance building improvements. This loan was payable in 30
monthly installments of $39 plus accrued interest, with an annual interest
rate of LIBOR plus 5.12%. These loans were repaid on July 13, 2004 with a
portion of proceeds from the sale of the Timberlake property.
(See Note 4.)
NOTES FOR MEDALLION ACQUISITION - VECTOR TOBACCO:
The purchase price for the acquisition of Medallion included $60,000 in
notes of Vector Tobacco, guaranteed by the Company and Liggett. Of the
notes, $25,000 have been repaid with the final quarterly principal payment
of $3,125 made on March 31, 2004. The remaining $35,000 of notes bear
interest at 6.5% per year, payable semiannually, and mature on April 1,
2007.
NOTE PAYABLE - V.T. AVIATION:
In February 2001, V.T. Aviation LLC, a subsidiary of Vector Research Ltd.,
purchased an airplane for $15,500 and borrowed $13,175 to fund the
purchase. The loan, which is collateralized by the airplane and a letter
of credit from the Company for $775, is guaranteed by Vector Research, VGR
Holding and the Company. The loan is payable in 119 monthly installments
of $125, including annual interest of 2.31% above the 30-day commercial
paper rate, with a final payment of $1,603, based on current interest
rates.
NOTE PAYABLE - VGR AVIATION:
In February 2002, V.T. Aviation purchased an airplane for $6,575 and
borrowed $5,800 to fund the purchase. The loan is guaranteed by the
Company. The loan is payable in 119 monthly installments of $40, including
annual interest of 2.75% above the 30-day average commercial paper rate,
with a final payment of $2,948, based on current interest rates. During
the fourth quarter of 2003, this airplane was transferred to the Company's
direct subsidiary, VGR Aviation LLC, which has assumed the debt.
- 15 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
NOTE PAYABLE - NEW VALLEY:
In December 2002, New Valley financed a portion of its purchase of two
office buildings in Princeton, New Jersey with a mortgage loan of $40,500
from HSBC Realty Credit Corporation (USA). The loan has a term of four
years, bears interest at a floating rate of 2% above LIBOR, and is
collateralized by a first mortgage on the office buildings, as well as by
an assignment of leases and rents. Principal is amortized to the extent of
$54 per month during the term of the loan. The loan may be prepaid without
penalty and is non-recourse against New Valley, except for various
specified environmental and related matters, misapplications of tenant
security deposits and insurance and condemnation proceeds, and fraud or
misrepresentation by New Valley in connection with the indebtedness.
6. EMPLOYEE BENEFITS
Net periodic benefit cost for the Company's pension and other
postretirement benefit plans for the three and nine months ended September
30, 2004 and 2003 consists of the following:
Pension Benefits Pension Benefits
----------------------- -----------------------
Three Months Ended Nine Months Ended
----------------------- -----------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2004 2003 2004 2003
--------- --------- --------- ---------
Service cost - benefits earned
during the period.......................... $ 1,248 $ 981 $ 3,744 $ 2,943
Interest cost on projected benefit
obligation................................. 2,240 2,390 6,720 7,170
Expected return on plan assets................ (3,027) (2,950) (9,081) (8,850)
Amortization of net loss...................... 506 414 1,518 1,242
------- ------- ------- -------
Net expense.......................... $ 967 $ 835 $ 2,901 $ 2,505
======= ======= ======= =======
Other Other
Postretirement Benefits Postretirement Benefits
----------------------- -----------------------
Three Months Ended Nine Months Ended
----------------------- -----------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2004 2003 2004 2003
--------- --------- --------- ---------
Service cost - benefits earned
during the period.......................... $ 8 $ 20 $ 24 $ 60
Interest cost on projected benefit
obligation................................. 157 169 471 507
Expected return on plan assets................ - - - -
Amortization of net loss (gain)............... 5 (32) 15 (96)
---- ---- ---- ----
Net expense.......................... $170 $157 $510 $471
==== ==== ==== ====
The Company did not make contributions to its pension benefits plans for
the nine months ended September 30, 2004 and does not anticipate making
any contributions to such plans in 2004. The Company anticipates paying
approximately $550 in other postretirement benefits in 2004.
- 16 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
7. CONTINGENCIES
SMOKING-RELATED LITIGATION:
OVERVIEW. Since 1954, Liggett and other United States cigarette
manufacturers have been named as defendants in numerous direct and
third-party actions predicated on the theory that cigarette manufacturers
should be liable for damages alleged to have been caused by cigarette
smoking or by exposure to secondary smoke from cigarettes. These cases are
reported here as though having been commenced against Liggett (without
regard to whether such cases were actually commenced against Brooke Group
Holding Inc., the Company's predecessor and a wholly-owned subsidiary of
VGR Holding, or Liggett). There has been a noteworthy increase in the
number of cases commenced against Liggett and the other cigarette
manufacturers in recent years. The cases generally fall into the following
categories: (i) smoking and health cases alleging injury brought on behalf
of individual plaintiffs ("Individual Actions"); (ii) smoking and health
cases alleging injury and purporting to be brought on behalf of a class of
individual plaintiffs ("Class Actions"); (iii) health care cost recovery
actions brought by various foreign and domestic governmental entities
("Governmental Actions"); and (iv) health care cost recovery actions
brought by third-party payors including insurance companies, union health
and welfare trust funds, asbestos manufacturers and others ("Third-Party
Payor Actions"). As new cases are commenced, defense costs and the risks
attendant to the inherent unpredictability of litigation continue to
increase. The future financial impact of the risks and expenses of
litigation and the effects of the tobacco litigation settlements discussed
below are not quantifiable at this time. For the nine months ended
September 30, 2004, Liggett incurred legal fees and other litigation costs
totaling approximately $3,677 compared to $3,373 for the nine months ended
September 30, 2003.
INDIVIDUAL ACTIONS. As of September 30, 2004, there were approximately 384
cases pending against Liggett, and in most cases the other tobacco
companies, where one or more individual plaintiffs allege injury resulting
from cigarette smoking, addiction to cigarette smoking or exposure to
secondary smoke and seek compensatory and, in some cases, punitive
damages. Of these, 111 were pending in Maryland, 92 in Florida, 52 in New
York, 45 in Mississippi and 20 in California. The balance of the
individual cases were pending in 16 states. In one of these cases, an
action against cigarette manufacturers involving approximately 1,000 named
individual plaintiffs has been consolidated before a single West Virginia
state court. Liggett is a defendant in most of the cases pending in West
Virginia. In January 2002, the court severed Liggett from the trial of the
consolidated action, which is currently scheduled for March 2005.
- 17 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
There are six individual cases pending where Liggett is the only named
defendant. In April 2004, in one of these cases, BEVERLY DAVIS V. LIGGETT
GROUP INC., a jury in a Florida state court action awarded compensatory
damages of $540 against Liggett. In addition, plaintiff's counsel is
seeking legal fees of $760. Liggett has appealed the verdict.
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence,
gross negligence, breach of special duty, strict liability, fraud,
misrepresentation, design defect, failure to warn, breach of express and
implied warranties, conspiracy, aiding and abetting, concert of action,
unjust enrichment, common law public nuisance, property damage, invasion
of privacy, mental anguish, emotional distress, disability, shock,
indemnity and violations of deceptive trade practice laws, the Federal
Racketeer Influenced and Corrupt Organization Act ("RICO"), state RICO
statutes and antitrust statutes. In many of these cases, in addition to
compensatory damages, plaintiffs also seek other forms of relief including
treble/multiple damages, medical monitoring, disgorgement of profits and
punitive damages. Defenses raised by defendants in these cases include
lack of proximate cause, assumption of the risk, comparative fault and/or
contributory negligence, lack of design defect, statute of limitations,
equitable defenses such as "unclean hands" and lack of benefit, failure to
state a claim and federal preemption.
Jury awards in various states have been entered against other cigarette
manufacturers. The awards in these individual actions are for both
compensatory and punitive damages and represent a material amount of
damages. Liggett is not a party to these actions. The following is a brief
description of various of these matters:
o In February, 1999, in HENLEY V. PHILIP MORRIS, a California state
court jury awarded $1,500 in compensatory damages and $50,000 in
punitive damages. The trial court reduced the punitive damages award
to $25,000. In September 2003, the California Court of Appeals
reduced the punitive damages award to $9,000 based on the United
States Supreme Court's 2003 opinion in STATE FARM, limiting punitive
damages. In September 2004, the California Supreme Court upheld the
$9,000 punitive damages award. The defendant has appealed.
o In March 1999, an Oregon state court jury found in favor of the
plaintiff in WILLIAMS-BRANCH V. PHILIP Morris. The jury awarded $800
in compensatory damages and $79,500 in punitive damages. The trial
court reduced the punitive damages award to $32,000. In June 2002,
the Oregon Court of Appeals reinstated the $79,500 punitive damages
award. In October 2003, the United States Supreme Court set aside
the Oregon appellate court's ruling and directed the Oregon court to
reconsider the case in light of the STATE FARM decision. In June
2004, the Oregon appellate court reinstated the original jury
verdict. The defendant has appealed.
o In March 2000, a California state court jury found in favor of the
plaintiff in WHITELEY V. RAYBESTOS-MANHATTAN, INC., ET AL. The jury
awarded the plaintiff $1,720 in compensatory damages and $20,000 in
punitive damages. In April 2004, the California Court of Appeals
reversed the judgment and remanded the case for a new trial.
- 18 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
o In 2001, as a result of a Florida Supreme Court decision upholding
the award, in CARTER V. BROWN AND WILLIAMSON TOBACCO CORP., the
defendant paid $1,100 in compensatory damages and interest to a
former smoker and his spouse for injuries they allegedly incurred as
a result of smoking.
o In June 2001, a California state court jury found in favor of the
plaintiff in BOEKEN V. PHILIP MORRIS and awarded $5,500 in
compensatory damages and $3,000,000 in punitive damages. In August
2001, the trial court reduced the punitive damages award to
$100,000. In September 2004, the California Court of Appeals
affirmed the compensatory damages award, but reduced the punitive
damages award to $50,000. In October 2004, the California Court of
Appeals granted the parties' petitions for rehearing and vacated its
decision.
o In December 2001, in KENYON V. R.J. REYNOLDS TOBACCO CO., a Florida
state court jury awarded the plaintiff $165 in compensatory damages,
but no punitive damages. In May 2003, the Florida Court of Appeals
affirmed per curiam (that is, without an opinion) the trial court's
final judgment in favor of the plaintiffs. The defendant paid the
amount of the judgment plus accrued interest ($196) after exhausting
all appeals.
o In February 2002, in BURTON V. R.J. REYNOLDS TOBACCO CO., ET AL, a
federal district court jury in Kansas awarded the plaintiff $198 in
compensatory damages, and determined that the plaintiff was entitled
to punitive damages. In June 2002, the trial court awarded the
plaintiff $15,000 in punitive damages. The defendant has appealed.
o In March 2002, an Oregon state court jury found in favor of the
plaintiff in SCHWARZ V. PHILIP MORRIS and awarded $169 in
compensatory damages and $150,000 in punitive damages. In May 2002,
the trial court reduced the punitive damages award to $100,000. The
parties have appealed.
o In October 2002, a California state court jury found in favor of the
plaintiff in BULLOCK V. PHILIP MORRIS and awarded $850 in
compensatory damages and $28,000,000 in punitive damages. In
December 2002, the trial court reduced the punitive damages award to
$28,000. The parties have appealed.
o In April 2003, in EASTMAN V. BROWN & WILLIAMSON TOBACCO CORP., ET
AL, a Florida state court jury awarded $6,500 in compensatory
damages. In May 2004, the Florida Court of Appeals affirmed the
verdict in a per curiam opinion. The defendants' motion for
rehearing was denied, and the judgment was paid in October 2004.
o In May 2003, in BOERNER V. BROWN & WILLIAMSON TOBACCO CORP., a
federal district court jury in Arkansas awarded $4,000 in
compensatory damages and $15,000 in punitive damages. The defendant
has appealed.
o In November 2003, in THOMPSON V. BROWN & WILLIAMSON TOBACCO CORP.,
ET AL., a Missouri state court jury awarded $2,100 in compensatory
damages. The defendants have appealed.
o In December 2003, in FRANKSON V. BROWN & WILLIAMSON TOBACCO CORP.,
ET AL., a New York state court jury awarded $350 in compensatory
damages. In January 2004, the jury awarded $20,000 in punitive
damages. The deceased smoker was found to be 50% at fault.
- 19 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
In June 2004, the court increased the compensatory damages to $500
and decreased the punitive damages to $5,000. Post-trial motions are
pending.
o In October 2004, in ARNITZ V. PHILIP MORRIS, a Florida state court
jury awarded $600 in damages but found that the plaintiff was 60% at
fault, thereby reducing the verdict against Philip Morris to $240.
Philip Morris intends to appeal.
One of the states where several individual cases are pending against
Liggett is Mississippi. In 2003, the Mississippi Supreme Court ruled that
the Mississippi Product Liability Act "precludes all tobacco cases that
are based on product liability." Based on this ruling, Liggett is seeking,
or intends to seek, dismissal of each of the approximately 45 cases
pending against it in Mississippi.
CLASS ACTIONS. As September 30, 2004, there were approximately 28 actions
pending, for which either a class has been certified or plaintiffs are
seeking class certification, where Liggett, among others, was a named
defendant. Many of these actions purport to constitute statewide class
actions and were filed after May 1996 when the Fifth Circuit Court of
Appeals, in the CASTANO case, reversed a Federal district court's
certification of a purported nationwide class action on behalf of persons
who were allegedly "addicted" to tobacco products.
The extent of the impact of the CASTANO decision on smoking-related class
action litigation is still uncertain. The CASTANO decision has had a
limited effect with respect to courts' decisions regarding narrower
smoking-related classes or class actions brought in state rather than
federal court. For example, since the Fifth Circuit's ruling, a court in
Louisiana (Liggett is not a defendant in this proceeding) has certified an
"addiction-as-injury" class action that covered only citizens in the
state. In May 2004, the jury returned a verdict in the amount of $591,000,
plus prejudgment interest, on the class' claim for a smoking cessation
program. The case is on appeal. Two other class actions, BROIN, ET AL., V.
PHILIP MORRIS COMPANIES INC., ET AL., and ENGLE, ET AL., V. R.J. REYNOLDS
TOBACCO COMPANY, ET AL., were certified in state court in Florida prior to
the Fifth Circuit's decision. In April 2001, BROWN, ET AL., V. THE
AMERICAN TOBACCO COMPANY, INC., ET AL., was certified as a class action in
California.
In May 1994, the ENGLE case was filed against Liggett and others in the
Circuit Court, Eleventh Judicial Circuit, Miami-Dade County, Florida. The
class consists of all Florida residents and citizens, and their survivors,
who have suffered, presently suffer or have died from diseases and medical
conditions caused by their addiction to cigarettes that contain nicotine.
Phase I of the trial commenced in July 1998 and in July 1999, the jury
returned the Phase I verdict. The Phase I verdict concerned certain issues
determined by the trial court to be "common" to the causes of action of
the plaintiff class. Among other things, the jury found that: smoking
cigarettes causes 20 diseases or medical conditions, cigarettes are
addictive or dependence producing, defective and unreasonably dangerous,
defendants made materially false statements with the intention of
misleading smokers, defendants concealed or omitted material information
concerning the health effects and/or the addictive nature of smoking
cigarettes and agreed to misrepresent and conceal the health effects
and/or the addictive nature of smoking cigarettes, and defendants were
negligent and engaged in extreme and outrageous conduct or acted with
reckless disregard with the intent to inflict emotional distress. The jury
also found that defendants' conduct "rose to a level that would permit a
potential award or entitlement to punitive damages." The court decided
that Phase II of the trial, which commenced November 1999, would be a
causation and damages trial for three of the class representatives and a
punitive damages trial on a class-wide basis, before the same jury that
returned the verdict in Phase I. Phase III of the trial was to be
conducted before separate juries to
- 20 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
address absent class members' claims, including issues of specific
causation and other individual issues regarding entitlement to
compensatory damages. In April 2000, the jury awarded compensatory damages
of $12,704 to the three plaintiffs, to be reduced in proportion to the
respective plaintiff's fault. The jury also decided that the claim of one
of the plaintiffs, who was awarded compensatory damages of $5,831, was not
timely filed. In July 2000, the jury awarded approximately $145,000,000 in
the punitive damages portion of Phase II against all defendants including
$790,000 against Liggett. The court entered a final order of judgment
against the defendants in November 2000. The court's final judgment, which
provided for interest at the rate of 10% per year on the jury's awards,
also denied various post-trial motions, including a motion for new trial
and a motion seeking reduction of the punitive damages award. Liggett
appealed the court's order.
In May 2003, Florida's Third District Court of Appeals decertified the
ENGLE class and set aside the jury's decision in the case against Liggett
and the other cigarette makers, including the $145,000,000 punitive
damages award. The intermediate appellate court ruled that there were
multiple legal bases why the class action trial, including the punitive
damages award, could not be sustained. The court found that the class
failed to meet the legal requirements for class certification and that
class members needed to pursue their claims on an individualized basis.
The court also ruled that the trial plan violated Florida law and the
appellate court's 1996 certification decision, and was unconstitutional.
The court further found that the proceedings were irretrievably tainted by
class counsel's misconduct and that the punitive damages award was
bankrupting under Florida law.
In October 2003, the Third District Court of Appeals denied class
counsel's motions seeking, among other things, a rehearing by the court.
Class counsel filed a motion with the Florida Supreme Court to invoke
discretionary review on the basis that the Third District Court of Appeals
decision construes the due process provisions of the state and federal
constitutions and conflicts with other appellate and supreme court
decisions. In May 2004, the Florida Supreme Court agreed to review the
case. Oral argument was held on November 3, 2004. If the Third District
Court of Appeal's ruling is not upheld on further appeal, it will have a
material adverse effect on the Company.
In May 2000, legislation was enacted in Florida that limits the size of
any bond required, pending appeal, to stay execution of a punitive damages
verdict to the lesser of the punitive award plus twice the statutory rate
of interest, $100,000 or 10% of the net worth of the defendant, but the
limitation on the bond does not affect the amount of the underlying
verdict. In November 2000, Liggett filed the $3,450 bond required by the
Florida law in order to stay execution of the ENGLE judgment, pending
appeal. Legislation limiting the amount of the bond required to file an
appeal of an adverse judgment has been enacted in over 30 states.
In May 2001, Liggett, Philip Morris and Lorillard Tobacco Company reached
an agreement with the class in the ENGLE case, which provided assurance of
Liggett's ability to appeal the jury's July 2000 verdict. As required by
the agreement, Liggett paid $6,273 into an escrow account to be held for
the benefit of the ENGLE class, and released, along with Liggett's
existing $3,450 statutory bond, to the court for the benefit of the class
upon completion of the appeals process, regardless of the outcome of the
appeal. As a result, the Company recorded a $9,723 pre-tax charge to the
consolidated statement of operations for the first quarter of 2001. The
agreement, which was approved by the court, assured that the stay of
execution, in effect pursuant to the Florida bonding statute, would not be
lifted or limited at any point until completion of all appeals, including
an appeal to the United States Supreme Court. If Liggett's balance sheet
net worth fell below $33,781 (as determined in accordance with generally
accepted accounting principles in effect as of July 14, 2000), the
agreement provided
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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(UNAUDITED)
that the stay granted in favor of Liggett in the agreement would terminate
and the ENGLE class would be free to challenge the Florida bonding
statute.
In June 2002, the jury in a Florida state court action entitled LUKACS V.
PHILIP MORRIS, ET AL. awarded $37,500 in compensatory damages in a case
involving Liggett and two other tobacco manufacturers. In March 2003, the
court reduced the amount of the compensatory damages to $25,100. The jury
found Liggett 50% responsible for the damages incurred by the plaintiff.
The LUKACS case was the first individual case to be tried as part of Phase
III of the ENGLE case; the claims of all other individuals who are members
of the class were stayed pending resolution of the appeal of the ENGLE
verdict. The LUKACS verdict, which was subject to the outcome of the Engle
appeal, has been overturned as a result of the appellate court's ruling.
As discussed above, class counsel in ENGLE is pursuing various appellate
remedies seeking reversal of the appellate court's decision.
Class certification motions are pending in a number of putative class
actions. Classes remain certified against Liggett in West Virginia
(BLANKENSHIP), California (BROWN), New York (SIMON), Kansas (SMITH) and
New Mexico (ROMERO). A number of class certification denials are on
appeal.
In August 2000, in BLANKENSHIP V. PHILIP MORRIS, a West Virginia state
court conditionally certified (only to the extent of medical monitoring) a
class of present or former West Virginia smokers who desire to participate
in a medical monitoring plan. The trial of this case ended in January
2001, when the judge declared a mistrial. In July 2001, the court issued
an order severing Liggett from the retrial of the case which began in
September 2001. In November 2001, the jury returned a verdict in favor of
the other defendants. In May 2004, the West Virginia Supreme Court
affirmed the defense jury verdict. In June 2004, plaintiff's motion for
rehearing was denied.
In April 2001, the California state court in BROWN granted in part
plaintiff's motion for class certification and certified a class comprised
of adult residents of California who smoked at least one of defendants'
cigarettes "during the applicable time period" and who were exposed to
defendants' marketing and advertising activities in California.
Certification was granted as to plaintiff's claims that defendants
violated California's unfair business practices statute. The court
subsequently defined "the applicable class period" for plaintiff's claims,
pursuant to a stipulation submitted by the parties, as June 10, 1993
through April 23, 2001. The California Court of Appeals denied defendants'
writ application, which sought review of the trial court's class
certification orders. Defendants filed a petition for review with the
California Supreme Court, which was subsequently denied. In September
2004, the court granted in part and denied in part defendants' motion for
summary judgment. Trial is currently scheduled for March 2005. Liggett is
a defendant in the case.
In September 2002, in IN RE SIMON II LITIGATION, the federal district
court for the Eastern District of New York granted plaintiffs' motion for
certification of a nationwide non-opt-out punitive damages class action
against the tobacco companies, including Liggett. The class is not seeking
compensatory damages, but was created to determine whether smokers across
the country may be entitled to punitive damages. In February 2003, the
Second Circuit agreed to review the district court's class certification
decision, and oral argument was held in November 2003.
Class action suits have been filed in a number of states against
individual cigarette manufacturers, alleging that the use of the terms
"lights" and "ultralights" constitutes unfair and deceptive trade
practices. One such suit (MCLAUGHLIN V. PHILIP MORRIS , ET AL.), pending
in federal court in New York
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
against the cigarette manufacturers, seeks to create a nationwide class of
"light" cigarette smokers and includes Liggett as a defendant.
In March 2003, in a class action brought against Philip Morris on behalf
of smokers of light cigarettes, a state court judge in Illinois in the
PRICE, ET AL., V. PHILIP Morris case awarded $7,100,500 in actual damages
to the class members, $3,000,000 in punitive damages to the State of
Illinois (which was not a plaintiff in this matter), and approximately
$1,800,000 in attorney's fees and costs. Entry of judgment has been
stayed. Philip Morris has appealed the verdict.
Approximately 38 purported state and federal class action complaints were
filed against the cigarette manufacturers, including Liggett, for alleged
antitrust violations. The actions allege that the cigarette manufacturers
have engaged in a nationwide and international conspiracy to fix the price
of cigarettes in violation of state and federal antitrust laws. Plaintiffs
allege that defendants' price-fixing conspiracy raised the price of
cigarettes above a competitive level. Plaintiffs in the 31 state actions
purport to represent classes of indirect purchasers of cigarettes in 16
states; plaintiffs in the seven federal actions purport to represent a
nationwide class of wholesalers who purchased cigarettes directly from the
defendants. The federal class actions were consolidated and, in July 2000,
plaintiffs filed a single consolidated complaint that did not name Liggett
as a defendant, although Liggett complied with discovery requests. In July
2002, the court granted defendants' motion for summary judgment in the
consolidated federal cases, which decision was affirmed on appeal by the
United States Court of Appeals for the Eleventh Circuit. All state court
cases on behalf of indirect purchasers have been dismissed, except for two
cases pending in Kansas and New Mexico. A Kansas state court, in the case
of SMITH V. PHILIP MORRIS, ET AL., granted class certification in November
2001. In April 2003, plaintiffs' motion for class certification was
granted in ROMERO V. PHILIP MORRIS, a case pending in New Mexico state
court, which decision has been appealed. Liggett is one of the defendants
in the Kansas and New Mexico cases.
GOVERNMENTAL ACTIONS. As of September 30, 2004, there were approximately
12 Governmental Actions pending against Liggett. In these proceedings,
both foreign and domestic governmental entities seek reimbursement for
Medicaid and other health care expenditures. The claims asserted in these
health care cost recovery actions vary. In most of these cases, plaintiffs
assert the equitable claim that the tobacco industry was "unjustly
enriched" by plaintiffs' payment of health care costs allegedly
attributable to smoking and seek reimbursement of those costs. Other
claims made by some but not all plaintiffs include the equitable claim of
indemnity, common law claims of negligence, strict liability, breach of
express and implied warranty, breach of special duty, fraud, negligent
misrepresentation, conspiracy, public nuisance, claims under state and
federal statutes governing consumer fraud, antitrust, deceptive trade
practices and false advertising, and claims under RICO. Trial in the
health care recovery case brought by the City of St. Louis, Missouri,
against the major cigarette manufacturers is scheduled for June 2005.
In August 2003, following the refusal by the Florida Supreme Court to hear
the appeal of the Republic of Venezuela in connection with the dismissal
of its health care cost recovery action (which decision plaintiff has
appealed to the United States Supreme Court), the trial court hearing the
health care cost recovery actions brought in Florida by the Republic of
Tajikistan and the Brazilian State of Tocantins granted defendants'
motions to dismiss the cases. Subsequently, plaintiffs voluntarily
dismissed additional heath care cost recovery cases brought in Florida by
various foreign governmental entities.
THIRD-PARTY PAYOR ACTIONS. As of September 30, 2004, there were
approximately six Third-Party Payor Actions pending against Liggett. The
claims in these cases are similar to those in the Governmental Actions but
have been commenced by insurance companies, union health and welfare
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
trust funds, asbestos manufacturers and others. Nine United States Circuit
Courts of Appeal have ruled that Third-Party Payors did not have standing
to bring lawsuits against cigarette manufacturers. The United States
Supreme Court has denied petitions for certiorari in the cases decided by
five of the courts of appeal. However, a number of Third-Party Payor
Actions, including an action brought by 24 Blue Cross/Blue Shield Plans,
remain pending.
In June 2001, a jury in a third party payor action brought by Empire Blue
Cross and Blue Shield in the Eastern District of New York rendered a
verdict awarding the plaintiff $17,800 in damages against the major
cigarette manufacturers. As against Liggett, the jury awarded the
plaintiff damages of $89. In February 2002, the court awarded plaintiff's
counsel $37,800 in attorneys' fees, without allocating the fee award among
the several defendants. Liggett has appealed both the jury verdict and the
attorneys' fee award. In September 2003, the United States Court of
Appeals for the Second Circuit certified two questions relating to
plaintiff's direct claims of deceptive business practices to the New York
Court of Appeals, which ruled in October 2004 that the plaintiff cannot
use the state consumer protection law to pursue direct claims for the
recovery of medical expenses from cigarette manufacturers. The Second
Circuit had previously reversed the portion of the judgment relating to
the verdict returned against defendants under the plaintiff's subrogation
claim, and deferred its ruling on defendants' appeal of the attorneys'
fees award until such time as the New York Court of Appeals rules on the
certified questions.
In other Third-Party Payor Actions claimants have set forth several
additional theories of relief sought: funding of corrective public
education campaigns relating to issues of smoking and health; funding for
clinical smoking cessation programs; disgorgement of profits from sales of
cigarettes; restitution; treble damages; and attorneys' fees.
Nevertheless, no specific amounts are provided. It is understood that
requested damages against the tobacco company defendants in these cases
might be in the billions of dollars.
FEDERAL GOVERNMENT ACTION. In September 1999, the United States government
commenced litigation against Liggett and the other major tobacco companies
in the United States District Court for the District of Columbia. The
action seeks to recover an unspecified amount of health care costs paid
for and furnished, and to be paid for and furnished, by the Federal
Government for lung cancer, heart disease, emphysema and other
smoking-related illnesses allegedly caused by the fraudulent and tortious
conduct of defendants, to restrain defendants and co-conspirators from
engaging in fraud and other unlawful conduct in the future, and to compel
defendants to disgorge the proceeds of their unlawful conduct. The
complaint alleges that such costs total more than $20,000,000 annually.
The action asserted claims under three federal statutes, the Medical Care
Recovery Act ("MCRA"), the Medicare Secondary Payer provisions of the
Social Security Act ("MSP") and RICO. In September 2000, the court
dismissed the government's claims based on MCRA and MSP, reaffirming its
decision in July 2001. In the September 2000 decision, the court also
determined not to dismiss the government's RICO claims, under which the
government continues to seek court relief to restrain the defendant
tobacco companies from allegedly engaging in fraud and other unlawful
conduct and to compel disgorgement. In May 2003, the court denied the
industry's motion which sought partial summary judgment as to the
government's advertising, marketing, promotion and warning claims on the
basis that these claims are within the exclusive jurisdiction of the
Federal Trade Commission. In January 2004, the court granted one of the
government's pending motions and dismissed certain equitable defenses of
defendants. In April 2004, the court denied Liggett's motion to be
dismissed from the case. In May 2004, the court denied the defendants'
motion for summary judgment to dismiss the government's disgorgement claim
and, in June 2004, certified that
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
decision for interlocutory appeal to the United States Court of Appeals
for the District of Columbia, which has agreed to hear the appeal. Oral
argument is scheduled for November 17, 2004.
In June 2001, the United States Attorney General assembled a team of three
Department of Justice ("DOJ") lawyers to work on a possible settlement of
the federal lawsuit. The DOJ lawyers met with representatives of the
tobacco industry, including Liggett, in July 2001. No settlement was
reached. In a January 2003 filing with the court, the government alleged
that disgorgement by defendants of approximately $289,000,000 is an
appropriate remedy in the case. Trial of the case began on September 21,
2004.
SETTLEMENTS. In March 1996, Brooke Group Holding and Liggett entered into
an agreement, subject to court approval, to settle the CASTANO class
action tobacco litigation. The CASTANO class was subsequently decertified
by the court.
In March 1996, March 1997 and March 1998, Brooke Group Holding and Liggett
entered into settlements of smoking-related litigation with the Attorneys
General of 45 states and territories. The settlements released both Brooke
Group Holding and Liggett from all smoking-related claims, including
claims for health care cost reimbursement and claims concerning sales of
cigarettes to minors.
In November 1998, Philip Morris, Brown & Williamson, R.J. Reynolds and
Lorillard (collectively, the "Original Participating Manufacturers" or
"OPMs") and Liggett (together with the OPMs and any other tobacco product
manufacturer that becomes a signatory, the "Participating Manufacturers")
entered into the Master Settlement Agreement (the "MSA") with 46 states,
the District of Columbia, Puerto Rico, Guam, the United States Virgin
Islands, American Samoa and the Northern Marianas (collectively, the
"Settling States") to settle the asserted and unasserted health care cost
recovery and certain other claims of those Settling States. The MSA
received final judicial approval in each settling jurisdiction.
The MSA restricts tobacco product advertising and marketing within the
Settling States and otherwise restricts the activities of Participating
Manufacturers. Among other things, the MSA prohibits the targeting of
youth in the advertising, promotion or marketing of tobacco products; bans
the use of cartoon characters in all tobacco advertising and promotion;
limits each Participating Manufacturer to one tobacco brand name
sponsorship during any 12-month period; bans all outdoor advertising, with
the exception of signs, 14 square feet or less, at retail establishments
that sell tobacco products; prohibits payments for tobacco product
placement in various media; bans gift offers based on the purchase of
tobacco products without sufficient proof that the intended recipient is
an adult; prohibits Participating Manufacturers from licensing third
parties to advertise tobacco brand names in any manner prohibited under
the MSA; prohibits Participating Manufacturers from using as a tobacco
product brand name any nationally recognized non-tobacco brand or trade
name or the names of sports teams, entertainment groups or individual
celebrities; and prohibits Participating Manufacturers from selling packs
containing fewer than 20 cigarettes.
The MSA also requires Participating Manufacturers to affirm corporate
principles to comply with the MSA and to reduce underage usage of tobacco
products and imposes requirements applicable to lobbying activities
conducted on behalf of Participating Manufacturers.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Liggett has no payment obligations under the MSA except to the extent its
market share exceeds a base share of 125% of its 1997 market share, or
approximately 1.65% of total cigarettes sold in the United States. As a
result of the Medallion acquisition in April 2002, Vector Tobacco has no
payment obligations under the MSA, except to the extent its market share
exceeds a base amount of approximately 0.28% of total cigarettes sold in
the United States. During 1999 and 2000, Liggett's market share did not
exceed the base amount. According to data from Management Science
Associates, Inc., domestic shipments by Liggett and Vector Tobacco
accounted for approximately 2.1% of the total cigarettes shipped in the
United States during 2001, 2.4% during 2002 and 2.4% during 2003. On April
15 of any year following a year in which Liggett's and/or Vector Tobacco's
market shares exceed their base shares, Liggett and/or Vector Tobacco will
pay on each excess unit an amount equal (on a per-unit basis) to that due
during the same following year by the OPMs under the annual and strategic
contribution payment provisions of the MSA, subject to applicable
adjustments, offsets and reductions. In March and April 2002, Liggett and
Vector Tobacco paid a total of $31,130 for their 2001 MSA obligations. In
March and April 2003, Liggett and Vector Tobacco paid a total of $37,541
for their 2002 MSA obligations. At that time, funds were held back based
on Liggett's and Vector Tobacco's belief that their MSA payments for 2002
should be reduced as a result of market share loss to non-participating
manufacturers. In June 2003, Liggett and Vector Tobacco reached a
settlement with the jurisdictions party to the MSA whereby Liggett and
Vector Tobacco agreed to pay $2,478 in April 2004 to resolve these claims.
In April 2004, Liggett and Vector Tobacco paid a total of $50,322 for
their 2003 MSA obligations. Liggett and Vector Tobacco have expensed
$14,813 for their estimated MSA obligations for the first nine months of
2004 as part of cost of goods sold. Under the annual and strategic
contribution payment provisions of the MSA, the OPMs (and Liggett and
Vector Tobacco to the extent their market shares exceed their base shares)
are required to pay the following annual amounts (subject to certain
adjustments):
Year Amount
---- ----------
2004 - 2007............................ $8,000,000
2008 - 2017............................ $8,139,000
2018 and each year thereafter.......... $9,000,000
These annual payments will be allocated based on relative unit volume of
domestic cigarette shipments. The payment obligations under the MSA are
the several, and not joint, obligations of each Participating Manufacturer
and are not the responsibility of any parent or affiliate of a
Participating Manufacturer.
The MSA replaces Liggett's prior settlements with all states and
territories except for Florida, Mississippi, Texas and Minnesota. Each of
these four states, prior to the effective date of the MSA, negotiated and
executed settlement agreements with each of the other major tobacco
companies, separate from those settlements reached previously with
Liggett. Because these states' settlement agreements with Liggett provided
for "most favored nation" protection for both Brooke Group Holding and
Liggett, the payments due these states by Liggett (with certain possible
exceptions) have been eliminated, other than a $100 a year payment to
Minnesota starting in 2003, to be paid any year cigarettes manufactured by
Liggett are sold in the state. With respect to all non-economic
obligations under the previous settlements, both Brooke Group Holding and
Liggett are entitled to the most favorable provisions as between the MSA
and each state's respective settlement with the other major tobacco
companies. Therefore, Liggett's non-economic obligations to all states and
territories are now defined by the MSA.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
On August 30, 2004, the Company announced that Liggett and Vector Tobacco
had notified the Attorneys General of 46 states that they intend to
initiate proceedings against the Attorneys General for violating the terms
of the MSA. The Company's subsidiaries allege that the Attorneys General
violated their rights and the MSA by extending unauthorized favorable
financial terms to Miami based Vibo Corporation d/b/a/ General Tobacco
when, on August 19, 2004, the Attorneys General entered into an agreement
with General Tobacco allowing it to become a Subsequent Participating
Manufacturer under the MSA. General Tobacco imports discount cigarettes
manufactured in Colombia, South America.
In the notice sent to the Attorneys General, the Company's subsidiaries
indicate that they will seek to enforce the terms of the MSA, void the
General Tobacco agreement and enjoin the Settling States and National
Association of Attorneys General from listing General Tobacco as a
Participating Manufacturer on their websites.
Copies of the various settlement agreements are filed as exhibits to the
Company's Annual Report on Form 10-K and the discussion herein is
qualified in its entirety by reference thereto.
TRIALS. Trial in the United States government action began on September
21, 2004 in federal court in the District of Columbia. Cases currently
scheduled for trial during the next six months include two individual
actions in Florida state court, with one of these cases scheduled for
trial in January 2005 and one in early 2005. Liggett is the sole defendant
in each of these cases. In addition, the BROWN class action is scheduled
for trial in California state court in March 2005, two individual actions
involving the major companies as defendants are scheduled for trial in
federal court in Puerto Rico in March 2005 and April 2005, another
individual action is scheduled for trial in Louisiana state court in April
2005 and the CITY OF ST. LOUIS governmental action is scheduled for trial
in June 2005. Trial dates, however, are subject to change.
Management is not able to predict the outcome of the litigation pending
against Brooke Group Holding or Liggett. Litigation is subject to many
uncertainties. In May 2003, a Florida intermediate appellate court
overturned a $790,000 punitive damages award against Liggett and
decertified the ENGLE smoking and health class action. In May 2004, the
Florida Supreme Court agreed to review the case. Oral argument was held on
November 3, 2004. If the intermediate appellate court's ruling is not
upheld on further appeal, it will have a material adverse effect on the
Company. In November 2000, Liggett filed the $3,450 bond required under
the bonding statute enacted in 2000 by the Florida legislature which
limits the size of any bond required, pending appeal, to stay execution of
a punitive damages verdict. In May 2001, Liggett reached an agreement with
the class in the ENGLE case, which provided assurance to Liggett that the
stay of execution, in effect pursuant to the Florida bonding statute,
would not be lifted or limited at any point until completion of all
appeals, including to the United States Supreme Court. As required by the
agreement, Liggett paid $6,273 into an escrow account to be held for the
benefit of the ENGLE class, and released, along with Liggett's existing
$3,450 statutory bond, to the court for the benefit of the class upon
completion of the appeals process, regardless of the outcome of the
appeal. As a result, the Company recorded a $9,723 pre-tax charge to the
consolidated statement of operations for the first quarter of 2001. In
June 2002, the jury in an individual case brought under the third phase of
the ENGLE case awarded $37,500 (subsequently reduced by the court to
$25,100) of compensatory damages against Liggett and two other defendants
and found Liggett 50% responsible for the damages. The verdict, which was
subject to the outcome of the ENGLE appeal, has been overturned as a
result of the appellate court's ruling. In April 2004, a jury in a Florida
state court action awarded compensatory damages of approximately $540
against Liggett in an individual