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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
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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
incorporation or organization) Identification No.)
100 S.E. SECOND STREET, MIAMI, FLORIDA 33131
(Address of principal executive offices) (Zip Code)
(305) 579-8000
(Registrant's telephone number, including area code)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange on
Title of each class which registered
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Common Stock, par value $.10 per share New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
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 if disclosure of delinquent filers pursuant to
Item 405 Regulation S-K is not contained herein, and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statement incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filed
(as defined in Exchange Act Rule 12b-2). [ X ] Yes [ ] No
The aggregate market value of the common stock held by non-affiliates
of Vector Group Ltd. as of June 30, 2003 was approximately $430 million.
At March 12, 2004, Vector Group Ltd. had 39,087,653 shares of common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III (Items 10, 11, 12 and 13) from the definitive Proxy Statement
for the 2004 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission no later than 120 days after the end of the Registrant's
fiscal year covered by this report.
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VECTOR GROUP LTD.
FORM 10-K
TABLE OF CONTENTS
Page
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PART I
Item 1. Business....................................................................... 1
Item 2. Properties..................................................................... 35
Item 3. Legal Proceedings.............................................................. 36
Item 4. Submission of Matters to a Vote of Security Holders;
Executive Officers of the Registrant........................................... 36
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.......... 39
Item 6. Selected Financial Data........................................................ 40
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................... 41
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................... 63
Item 8. Financial Statements and Supplementary Data.................................... 63
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure....................................................... 63
Item 9A. Controls and Procedures........................................................ 63
PART III
Item 10. Directors and Executive Officers of the Registrant............................. 64
Item 11. Executive Compensation......................................................... 64
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters................................................ 64
Item 13. Certain Relationships and Related Transactions................................. 64
Item 14. Principal Accounting Services and Fees......................................... 64
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K................ 65
SIGNATURES................................................................................... 74
PART I
ITEM 1. BUSINESS
OVERVIEW
Vector Group Ltd., a Delaware corporation, is a holding company for a
number of businesses. We hold these businesses through our wholly-owned
subsidiary VGR Holding Inc. We are engaged principally in:
- the manufacture and sale of cigarettes in the United States
through our subsidiary Liggett Group Inc., and
- the development and marketing of the low nicotine and
nicotine-free QUEST cigarette products and the development of
reduced risk cigarette products through our subsidiary Vector
Tobacco Inc.
During 2002, the sales and marketing functions, along with certain
support functions, of our Liggett and Vector Tobacco subsidiaries were combined
into a new entity, Liggett Vector Brands Inc. This company coordinates and
executes the sales and marketing efforts for all of our tobacco operations. With
the combined resources of Liggett and Vector Tobacco, Liggett Vector Brands has
enhanced distribution and marketing capabilities.
In October 2003, we announced that we would close Vector Tobacco's
Timberlake, North Carolina cigarette manufacturing facility in order to reduce
excess cigarette production capacity and improve operating efficiencies
company-wide. Production of QUEST and Vector Tobacco's other cigarette brands
has been moved to Liggett's state-of-the-art manufacturing facility in Mebane,
North Carolina.
The Mebane facility currently produces in excess of 9 billion units per
year, but maintains the capacity to produce approximately 16 billion units per
year. Vector Tobacco has contracted with Liggett to produce its cigarettes and
has transitioned production from Timberlake to Mebane. All production ceased at
Timberlake by December 31, 2003. As part of the transition, we eliminated
approximately 150 positions.
Our majority-owned subsidiary, New Valley Corporation, is currently
engaged in the real estate business and is seeking to acquire additional
operating companies. In December 2002, New Valley acquired two office buildings
in Princeton, New Jersey and increased its ownership to 50% in Douglas Elliman
Realty, LLC, which operates the largest residential brokerage company in the New
York metropolitan area.
We are controlled by Bennett S. LeBow, our Chairman and the Chairman of
New Valley, who beneficially owns approximately 35.9% of our common stock.
Financial information relating to our business segments can be found in
Note 22 to our consolidated financial statements. For the purposes of this
discussion and segment reporting in this report, references to the Liggett
segment encompass the manufacture and sale of conventional cigarettes and
includes the former operations of The Medallion Company, Inc. acquired on April
1, 2002 (which operations are held for legal purposes as part of Vector
Tobacco). References to the Vector Tobacco segment include the development and
marketing of the low nicotine and nicotine-free cigarette products as well as
the development of reduced risk cigarette products and, for these purposes,
exclude the operations of Medallion.
1
LIGGETT GROUP INC.
General. Liggett, which is the operating successor to the Liggett &
Myers Tobacco Company, is currently the sixth largest manufacturer of cigarettes
in the United States in terms of unit sales. Substantially all of Liggett's
manufacturing facilities are located in Mebane, North Carolina.
Liggett is a wholly-owned subsidiary of Brooke Group Holding Inc., our
predecessor and a wholly-owned subsidiary of VGR Holding.
Liggett manufactures and sells cigarettes in the United States.
According to data from Management Science Associates, Inc., Liggett's domestic
shipments of approximately 9.8 billion cigarettes during 2003 accounted for 2.6%
of the total cigarettes shipped in the United States during such year. This
market share percentage represents an increase of 0.1% from 2002 and an increase
of 0.4% from 2001. Historically, Liggett has produced premium cigarettes as well
as discount cigarettes (which include among others, control label, private
label, branded discount and generic cigarettes). Premium cigarettes are
generally marketed under well-recognized brand names at higher retail prices to
adult smokers with a strong preference for branded products, whereas discount
cigarettes are marketed at lower retail prices to adult smokers who are more
cost conscious. In recent years, the discounting of premium cigarettes has
become far more significant in the marketplace. This has led to brands that were
traditionally considered premium brands to become more appropriately categorized
as branded discount, despite their premium list price. Liggett's EVE brand would
fall into that category. Approximately 94.6% of Liggett's unit volume in 2003
was in the discount segment, which Liggett's management believes has been the
primary growth segment in the industry for over a decade.
Liggett's cigarettes are produced in approximately 240 combinations of
length, style and packaging. Liggett's current brand portfolio includes:
- LIGGETT SELECT - the second largest brand in the deep discount
category;
- EVE - a leading brand of 120 millimeter cigarettes in the
branded discount category;
- JADE - the industry's newest free-standing branded discount
menthol brand;
- PYRAMID - the industry's first branded discount brand; and
- USA and various control and private label brands.
In 1980, Liggett was the first major domestic cigarette manufacturer to
successfully introduce discount cigarettes as an alternative to premium
cigarettes. In 1989, Liggett established a new price point within the discount
market segment by introducing Pyramid, a branded discount product which, at that
time, sold for less than most other discount cigarettes. In 1999, Liggett
introduced LIGGETT SELECT, one of the fastest growing brands in the deep
discount category. LIGGETT SELECT is now the largest seller in Liggett's family
of brands, comprising 50.9% of Liggett's unit volume in 2003, 42.1% in 2002 and
31.6% in 2001. According to Management Science Associates data, Liggett held a
share of approximately 9.4% of the overall discount market segment for 2003
compared to 8.3% for 2002 and 7.6% for 2001.
Liggett's premium cigarettes represented approximately 6.2% in 2003,
9.0% in 2002 and 15.5% in 2001 of Liggett's revenues. According to Management
Science Associates data, Liggett's unit share of the premium market segment was
approximately 0.2% in 2003, 0.3% in 2002 and 0.3% for 2001. Until May 1999,
Liggett produced four premium cigarette brands: L&M, Chesterfield, Lark and Eve.
As part of the Philip Morris brand transaction (which is further described
below) which closed in May 1999, Liggett transferred the L&M, Chesterfield and
Lark brands.
2
Liggett introduced nationally a new premium cigarette, JADE, in
September 2001. JADE is a menthol cigarette with unique holographic packaging.
JADE's sales represented 14.2% of Liggett's total premium unit sales during
2003, 27.8% during 2002 and 17.7% during 2001.
Effective February 1, 2004, Liggett reduced the JADE and EVE list
prices to the branded discount level from the premium price level. During 2003,
the net list prices for JADE and EVE were at the branded discount level after
giving effect to promotional spending.
The source of industry data in this report is Management Science
Associates, an independent third-party database management organization that
collects wholesale shipment data from various cigarette manufacturers and
provides analysis of market share, unit sales volume and premium versus discount
mix for individual companies and the industry as a whole. Management Science
Associates' information relating to unit sales volume and market share of
certain of the smaller, primarily deep discount, cigarette manufacturers is
based on estimates derived by it. Liggett management believes that the volume
and market share information published by Management Science Associates for
these manufacturers is understated and, correspondingly, share information for
the larger manufacturers, including Liggett, is overstated by Management Science
Associates.
We believe that Liggett has gained a sustainable cost advantage over
its competitors through its various settlement agreements. Under the Master
Settlement Agreement reached in November 1998 with 46 state attorneys general
and various territories, Liggett's four major competitors must make settlement
payments to the states and territories based on how many cigarettes they sell
annually. Liggett, however, is not required to make any payments unless its
market share exceeds approximately 1.65% of the U.S. cigarette market.
Additionally, as a result of the Medallion acquisition, Vector Tobacco likewise
has no payment obligation unless its market share exceeds approximately 0.28% of
the U.S. market.
In November 1999, Liggett acquired an industrial facility in Mebane,
North Carolina. Liggett completed the relocation of its tobacco manufacturing
operations from its old plant in Durham, North Carolina to the Mebane facility
in October 2000. Effective January 1, 2004, Liggett produces all of Vector
Tobacco's cigarette brands at the Mebane facility pursuant to a contract
manufacturing agreement.
At the present time, Liggett has no foreign operations. Liggett does
not own the international rights to Eve, which is marketed by Philip Morris in
foreign markets. Prior to 2003, Liggett exported other cigarette brands
primarily to Eastern Europe and the Middle East. Revenues from export sales were
$0.2 million for 2002 and $0.9 million for 2001. Operating income attributable
to export sales amounted to approximately $36,000 in 2002 and $0.3 million in
2001. In 2000, Liggett effectively terminated its export business, other than to
complete existing contracts, as domestic margins, on even the lowest priced
brands, exceeded those of its export sales.
Business Strategy. Liggett's business strategy is to capitalize upon
its cost advantage in the United States cigarette market due to the favorable
treatment Liggett has received under the settlement agreements with the state
attorneys general and the Master Settlement Agreement. Liggett's long-term
business strategy is to continue to focus its marketing efforts on the discount
segment of the market and to pursue niche opportunities in the premium segment.
Liggett will seek to increase its profitability by continuing to upgrade the
efficiency of its manufacturing operation at the Mebane facility and by better
targeting of marketing and selling costs using market research and analysis.
Liggett intends to continue to reinvest a portion of cost savings and a portion
of any future price increases in marketing to grow its volume and income from
LIGGETT SELECT and its other brands in the discount segment. Liggett's strategy
for EVE and JADE is to improve the profitability of these brands through
expanded distribution and targeted promotional strategies focused on the
consumer. In addition, Liggett may bring other niche-driven brands to the market
in the future. Liggett may also pursue strategic acquisitions of smaller tobacco
manufacturers.
3
Sales, Marketing and Distribution. Liggett's products are distributed
from a central distribution center in Mebane to 20 public warehouses located
throughout the United States. These warehouses serve as local distribution
centers for Liggett's customers. Liggett's products are transported from the
central distribution centers to the warehouses via third-party trucking
companies to meet pre-existing contractual obligations to its customers.
Liggett's customers are primarily candy and tobacco distributors, the
military, warehouse club chains, and large grocery, drug and convenience store
chains. Liggett offers its customers discount payment terms, traditional rebates
and promotional incentives. Customers typically pay for purchased goods within
two weeks following delivery from Liggett, and approximately 90% of customers
pay more rapidly through electronic funds transfer arrangements. Liggett's
largest single customer, Speedway SuperAmerica LLC, accounted for approximately
16.6% of its revenues in 2003, 16.5% of its revenues in 2002 and 23.5% of its
revenues in 2001. Sales to this customer were primarily in the private label
discount segment and constituted approximately 17.7% in 2003, 18.1% in 2002 and
27.9% in 2001 of Liggett's revenues from discount cigarettes.
During 2002, the sales and marketing functions, along with certain
support functions, of our Liggett and Vector Tobacco subsidiaries were combined
into a new entity, Liggett Vector Brands. This company coordinates and executes
the sales and marketing efforts for all of our tobacco operations. With the
combined resources of Liggett and Vector Tobacco, Liggett Vector Brands has
enhanced distribution and marketing capabilities. In connection with the
formation of the Liggett Vector Brands entity, we took a restructuring charge of
$3.46 million in the first quarter of 2002, related to the reorganization of our
business. As of March 31, 2003, these restructuring activities had been
substantially completed.
Trademarks. All of the major trademarks used by Liggett are federally
registered or are in the process of being registered in the United States and
other markets. Trademark registrations typically have a duration of ten years
and can be renewed at Liggett's option prior to their expiration date. In view
of the significance of cigarette brand awareness among consumers, management
believes that the protection afforded by these trademarks is material to the
conduct of its business. All of Liggett's trademarks are owned by its
wholly-owned subsidiary, Eve Holdings Inc., except for the JADE trademark, which
is licensed on a long-term exclusive basis from a third-party for use in
connection with cigarettes.
Manufacturing. Liggett purchases and maintains leaf tobacco inventory
to support its cigarette manufacturing requirements. Liggett believes that there
is a sufficient supply of tobacco within the worldwide tobacco market to satisfy
its current production requirements. Liggett stores its leaf tobacco inventory
in warehouses in North Carolina and Virginia. There are several different types
of tobacco, including flue-cured leaf, burley leaf, Maryland leaf, oriental
leaf, cut stems and reconstituted sheet. Leaf components of American-style
cigarettes are generally the flue-cured and burley tobaccos. While premium and
discount brands use many of the same tobacco products, input ratios of tobacco
products may vary between premium and discount products. Domestically grown
tobacco is an agricultural commodity subject to United States government
production controls and price supports which can substantially affect its market
price. Foreign flue-cured and burley tobaccos, some of which are used in the
manufacture of Liggett's cigarettes, are generally 30% to 35% less expensive
than comparable domestic tobaccos. Liggett normally purchases all of its tobacco
requirements from domestic and foreign leaf tobacco dealers, much of it under
long-term purchase commitments. As of December 31, 2003, virtually all of
Liggett's commitments were for the purchase of foreign tobacco.
Liggett's cigarette manufacturing facilities in Mebane, North Carolina
were designed for the execution of short production runs in a cost-effective
manner, which enable Liggett to manufacture and market a wide variety of
cigarette brand styles. Liggett's cigarettes are produced in approximately 240
different brand styles under Eve's trademarks and brand names as well as private
labels for other companies, typically retail or wholesale distributors who
supply supermarkets and convenience stores.
4
Beginning in October 2001, Liggett upgraded the efficiency of its
manufacturing operation with the addition of four new state-of-the-art cigarette
makers and packers as well as related equipment. The installation of the new
lines continued through May 2002. The total cost of these upgrades was
approximately $20 million. During 2002, Liggett also installed a new tobacco
dryer that has improved both production capacity and the quality of blends. The
cost of the new dryer was approximately $2.9 million.
During 2003, Liggett leased two 100 millimeter box packers, which will
allow Liggett to meet the growing demand for this cigarette style, and a new
filter maker to improve product quality and capacity. These operating lease
agreements provide for payments totaling approximately $4.5 million.
The Mebane facility currently produces in excess of 9 billion units per
year, but maintains the capacity to produce approximately 16 billion units per
year. Vector Tobacco has contracted with Liggett to produce its cigarettes and
has transitioned production from its Timberlake facility, which has been closed,
to Mebane. All production ceased at Timberlake by December 31, 2003. As part of
the transition, we have eliminated approximately 150 positions.
While Liggett pursues product development, its total expenditures for
research and development on new products have not been financially material over
the past three years.
Competition. Liggett's competition is now divided into two segments.
The first segment is made up of the four largest manufacturers of cigarettes in
the United States: Philip Morris USA Inc., R.J. Reynolds Tobacco Company, Brown
& Williamson Tobacco Corporation and Lorillard Tobacco Company. The four largest
manufacturers, while primarily premium cigarette based companies, also produce
and sell discount cigarettes. The second segment of competition is comprised of
a group of smaller manufacturers and importers, most of which sell lower
quality, deep discount cigarettes.
Historically, there have been substantial barriers to entry into the
cigarette business, including extensive distribution organizations, large
capital outlays for sophisticated production equipment, substantial inventory
investment, costly promotional spending, regulated advertising and, for premium
brands, strong brand loyalty. However, in recent years, a number of these
smaller companies have been able to overcome these competitive barriers due to
excess production capacity in the industry and the cost advantage for certain
manufacturers and importers created by the Master Settlement Agreement.
Recently, during the phase-in payment period under the Master
Settlement Agreement, these smaller manufacturers and importers have generally
not yet been impacted to a significant degree by the agreement and, because of
their significant cost advantages, have primarily focused on the deepest
discount segment of the market. Liggett's management believes, while these
companies have significantly increased market share through competitive
discounting in this segment, they will lose their cost advantage over time as
their payment obligations under the Master Settlement Agreement increase and the
agreement's provisions are more effectively enforced by the states.
In the cigarette business, Liggett competes on a dual front. The four
major manufacturers compete among themselves and with Liggett for premium brand
market share on the basis of brand loyalty, advertising and promotional
activities, and trade rebates and incentives. These four competitors all have
substantially greater financial resources and most of their brands have greater
sales and consumer recognition than Liggett's premium brands. Liggett's discount
brands must also compete in the marketplace with the four major manufacturers'
discount brands as well as the smaller manufacturers' and importers' deep
discount brands.
5
According to Management Science Associates data, Philip Morris' and
RJR's unit sales together accounted for approximately 72% of the domestic
cigarette market in 2003. Liggett's domestic shipments of approximately 9.8
billion cigarettes during 2003 accounted for 2.6% of the approximately 371.5
billion cigarettes shipped in the United States during that year, compared to
9.8 billion cigarettes in 2002 (2.5%) and 9.1 billion cigarettes (2.2%) during
2001. RJR and Brown & Williamson announced in October 2003 plans to combine
their United States tobacco businesses. This transaction, if completed, will
further consolidate the dominance of the domestic cigarette market by Philip
Morris and the newly created Reynolds American.
Industry-wide shipments of cigarettes in the United States have been
generally declining for a number of years, with Management Science Associates
data indicating that domestic industry-wide shipments decreased by approximately
5.1% (20 billion units) in 2003. Liggett's management believes this decline may
be overstated due to volume for various smaller manufacturers being understated
by Management Science Associates. However, Liggett's management does believe
that industry-wide shipments of cigarettes in the United States will generally
continue to decline as a result of numerous factors, including health
considerations, diminishing social acceptance of smoking, legislative
limitations on smoking in public places, federal and state excise tax increases
and settlement-related expenses, which have contributed to high cigarette price
levels in recent years.
Historically, because of their dominant market share, Philip Morris and
RJR have been able to determine cigarette prices for the various pricing tiers
within the industry and the other cigarette manufacturers have brought their
prices in line with the levels established by the two industry leaders. Off-list
price discounting and similar promotional activity by manufacturers, however,
has substantially affected the average price differential at retail, which can
be significantly less than the manufacturers' list price gap. Recent discounting
by manufacturers has been far greater than historical levels, and the actual
price gap between premium and deep-discount cigarettes has changed accordingly.
This has led to shifts in price segment performance depending upon the actual
retail price gaps of products at retail.
Acquisition of Medallion. In April 2002, a subsidiary of ours acquired
the stock of The Medallion Company, Inc., and related assets from Gary L. Hall,
Medallion's principal stockholder. The total purchase price consisted of $50
million in cash and $60 million in notes, with the notes guaranteed by us and
Liggett. Medallion is a discount cigarette manufacturer selling product in the
deep discount category, primarily under the USA brand name. Medallion is a
participating manufacturer under the Master Settlement Agreement. Medallion has
no payment obligations under the Master Settlement Agreement unless its market
share exceeds approximately 0.28% of total cigarettes sold in the United States
(approximately 1.1 billion units in 2003).
Following the purchase of the Medallion stock, Vector Tobacco merged
into Medallion and Medallion changed its name to Vector Tobacco Inc. For
purposes of this discussion and segment reporting in this report, references to
the Liggett segment encompass the manufacture and sale of conventional
cigarettes and include the former operations of Medallion (which operations are
held for legal purposes as part of Vector Tobacco).
Philip Morris Brand Transaction. In November 1998, we and Liggett
granted Philip Morris options to purchase interests in Trademarks LLC which
holds three domestic cigarette brands, L&M, CHESTERFIELD and LARK, formerly held
by Liggett's subsidiary, Eve.
Under the terms of the Philip Morris agreements, Eve contributed the
three brands to Trademarks, a newly-formed limited liability company, in
exchange for 100% of two classes of Trademarks' interests, the Class A Voting
Interest and the Class B Redeemable Nonvoting Interest. Philip Morris acquired
two options to purchase the interests from Eve. In December 1998, Philip Morris
paid Eve a total of $150 million for the options, $5 million for the option for
the Class A interest and $145 million for the option for the Class B interest.
6
The Class A option entitled Philip Morris to purchase the Class A
interest for $10.1 million. On March 19, 1999, Philip Morris exercised the Class
A option, and the closing occurred on May 24, 1999.
The Class B option entitles Philip Morris to purchase the Class B
interest for $139.9 million. The Class B option will be exercisable during the
90-day period beginning on December 2, 2008, with Philip Morris being entitled
to extend the 90-day period for up to an additional six months under certain
circumstances. The Class B interest will also be redeemable by Trademarks for
$139.9 million during the same period the Class B option may be exercised.
On May 24, 1999, Trademarks borrowed $134.9 million from a lending
institution. The loan is guaranteed by Eve and is collateralized by a pledge by
Trademarks of the three brands and Trademarks' interest in the trademark license
agreement (discussed below) and by a pledge by Eve of its Class B interest. In
connection with the closing of the Class A option, Trademarks distributed the
loan proceeds to Eve as the holder of the Class B interest. The cash exercise
price of the Class B option and Trademarks' redemption price were reduced by the
amount distributed to Eve. Upon Philip Morris' exercise of the Class B option or
Trademarks' exercise of its redemption right, Philip Morris or Trademarks, as
relevant, will be required to obtain Eve's release from its guaranty. The Class
B interest will be entitled to a guaranteed payment of $500,000 each year with
the Class A interest allocated all remaining income or loss of Trademarks.
Trademarks has granted Philip Morris an exclusive license of the three
brands for an 11-year term expiring May 24, 2010 at an annual royalty based on
sales of cigarettes under the brands, subject to a minimum annual royalty
payment of not less than the annual debt service obligation on the loan plus $1
million.
If Philip Morris fails to exercise the Class B option, Eve will have an
option to put its Class B interest to Philip Morris, or Philip Morris'
designees, at a put price that is $5 million less than the exercise price of the
Class B option (and includes Philip Morris' obtaining Eve's release from its
loan guaranty). The Eve put option is exercisable at any time during the 90-day
period beginning March 2, 2010.
If the Class B option, Trademarks' redemption right and the Eve put
option expire unexercised, the holder of the Class B interest will be entitled
to convert the Class B interest, at its election, into a Class A interest with
the same rights to share in future profits and losses, the same voting power and
the same claim to capital as the entire existing outstanding Class A interest,
i.e., a 50% interest in Trademarks.
Upon the closing of the exercise of the Class A option and the
distribution of the loan proceeds on May 24, 1999, Philip Morris obtained
control of Trademarks, and we recognized a pre-tax gain of $294.1 million in our
consolidated financial statements and established a deferred tax liability of
$103.1 million relating to the gain. As discussed in Note 12 to our consolidated
financial statements, the Internal Revenue Service has issued to us a notice of
proposed adjustment asserting, for tax purposes, that the entire gain should
have been recognized by the Company in 1998 and 1999.
VECTOR TOBACCO INC.
Vector Tobacco, a wholly-owned subsidiary of VGR Holding, is engaged in
the development and marketing of the low nicotine and nicotine-free QUEST
cigarette products and the development of reduced risk cigarette products.
QUEST. In January 2003, Vector Tobacco introduced QUEST, its brand of
low nicotine and nicotine-free cigarette products. QUEST is designed for adult
smokers who are interested in reducing their levels of nicotine intake and is
available in six different menthol and nonmenthol varieties, each with
decreasing amounts of nicotine - QUEST 1, 2 and 3. QUEST 1, the low
7
nicotine variety, contains 0.6 milligrams of nicotine. QUEST 2, the extra-low
nicotine variety, contains 0.3 milligrams of nicotine. QUEST 3, the
nicotine-free variety, contains only trace levels of nicotine - no more than
0.05 milligrams of nicotine per cigarette. QUEST cigarettes utilize proprietary,
patented and patent pending processes and materials that enable the production
of cigarettes with nicotine-free tobacco that smokes, tastes and burns like
tobacco in conventional cigarettes. All six QUEST varieties are being sold in
hard packs and are priced comparable to other premium brands.
QUEST was initially available in New York, New Jersey, Pennsylvania,
Ohio, Indiana, Illinois and Michigan. These seven states account for
approximately 30% of all cigarette sales in the United States. A multi-million
dollar advertising and marketing campaign, with advertisements running in
magazines and regional newspapers, supported the product launch. The brand
continues to be supported by significant point-of-purchase campaigns, as well as
store-related and periodic newspaper advertisements. Vector Tobacco has
established a website, www.questcigs.com, and a toll free hotline,
1-866-QUEST123, to provide consumers with additional information about QUEST.
The premium segment of the tobacco industry is currently experiencing
intense competitive activity, with increased discounting of premium brands at
all levels of retail. Given these marketplace conditions, and the results that
we have seen to date with QUEST, we intend to take a measured approach to
expanding the market presence of the brand. In November 2003, Vector Tobacco
introduced three menthol varieties of QUEST in the seven state market. In
addition, we are utilizing the information that we have obtained since the
introduction of the QUEST non-menthol product to more specifically target our
focus in the seven state market in the coming months. Based upon those results,
the success of the menthol product and market conditions in the premium segment,
we will make a determination on the timing of a national launch of QUEST at a
later date.
Vector Tobacco also introduced QUEST and QUEST Menthol into an
expansion market in Arizona in January 2004. Arizona accounts for approximately
1% of the industry volume nationwide.
QUEST brand cigarettes are currently marketed to permit adult smokers,
who wish to continue smoking, to gradually reduce their intake of nicotine. The
products are not labeled or advertised for smoking cessation. To emphasize this
important point for consumers, Vector Tobacco has included the following
additional prominent warning on its QUEST advertising: "WARNING: This product is
NOT intended for use in quitting smoking. QUEST is for smokers seeking to reduce
nicotine exposure only." Vector Tobacco makes no claims that QUEST is safer than
other cigarette products.
In October 2003, we announced that Jed E. Rose, Ph.D., Director of Duke
University Medical Center's Nicotine Research Program and co-inventor of the
nicotine patch, had conducted a study at Duke University Medical Center to
provide preliminary evaluation of the use of the QUEST technology as a smoking
cessation aid. In the preliminary study on QUEST, 33% of QUEST 3 smokers were
able to achieve four-week continuous abstinence, a standard threshold for
smoking cessation. Management believes these results show real promise for the
QUEST technology as a smoking cessation aid and has asked the Food and Drug
Administration to supply us with guidance as to the additional research and
regulatory filings necessary to market QUEST as a smoking cessation product.
The nicotine-free tobacco in QUEST cigarettes is produced by
genetically modifying nicotine-producing tobacco plants, using a combination of
patented and patent pending processes and materials to produce tobacco plants
which are essentially nicotine-free. Management believes that, based on testing
at Vector Tobacco's research facility, the QUEST 3 product will contain trace
levels of nicotine that have no discernible physiological impact on the smoker,
and that, consistent with other products bearing "free" claims, QUEST 3 may be
labeled as "nicotine-free" with an appropriate disclosure of the trace levels.
The QUEST 3 product is
8
similarly referred to in this report as "nicotine-free". As the process
genetically blocks formation of nicotine in the root of the plant, the tobacco
leaf taste is not affected. Cigarettes produced with this technology have been
tested in focus groups, with such tests indicating that these cigarettes smoke,
taste and burn like conventional cigarettes.
OMNI. In November 2001, Vector Tobacco launched OMNI nationwide, the
first reduced carcinogen cigarette that smokes, tastes and burns like other
premium cigarettes. In comparison to comparable styles of the leading U.S.
cigarette brand, OMNI cigarettes produce significantly lower levels of many of
the recognized carcinogens and toxins that the medical community has identified
as major contributors to lung cancer and other diseases in smokers. While OMNI
has not been proven to reduce health risks, management believes that the
significant reduction of carcinogens is a step in the right direction. The data
show lower levels in OMNI of the main carcinogens and toxins in both mainstream
and sidestream tobacco smoke, including polycyclic aromatic hydrocarbons (PAHs),
tobacco specific nitrosamines (TSNAs), catechols and organics, with somewhat
increased levels of nitric oxide and formaldehyde. Mainstream smoke is what the
smoker directly inhales and sidestream smoke, which is the major component of
environmental tobacco smoke, is released from the burning end of a cigarette.
During 2002, acceptance of OMNI in the marketplace was limited, with
revenues of approximately $5.1 million on sales of 70.7 million units. During
2003, OMNI sales activity was minimal as Vector Tobacco has not been actively
marketing the OMNI product. Vector Tobacco was unable to achieve the anticipated
breadth of distribution and sales of the OMNI product due, in part, to the lack
of success of its advertising and marketing efforts in differentiating OMNI with
consumers through the "reduced carcinogen" message. Over the next several years,
our in-house research program, together with third-party collaborators, plans to
conduct appropriate studies as to the human effects of OMNI's reduction of
carcinogens and, based on these studies, management will review the marketing
and positioning of the OMNI brand in order to formulate a strategy for its
long-term success.
OMNI cigarettes are produced using a patent pending process developed
by Vector Tobacco. Traditional tobacco is treated with a complex catalytic
system that significantly reduces the levels of certain carcinogens and other
toxins. Additionally, OMNI employs the use of an innovative carbon filter, which
reduces a wide range of harmful compounds in smoke, yet has no impact on OMNI's
premium taste. Vector Tobacco is committed to continuing its research to find
new, innovative ways to further reduce carcinogens as well as other identified
substances that may play a role in smoking-related diseases.
The relationship between smoking and disease occurrence is exceedingly
complex. Vector Tobacco has begun the process of devising and funding studies of
the health impact of the OMNI product. Vector Tobacco does not presently have
any objective evidence that OMNI cigarettes will reduce the known health risks
of cigarette smoking to the smoker or nonsmoking bystander, and no health claims
are being made by Vector Tobacco.
Manufacturing and Marketing. The QUEST brands are priced as premium
cigarettes and marketed by the sales representatives of Liggett Vector Brands,
which coordinates and executes the sales and marketing efforts for all our
tobacco operations. In the fourth quarter of 2002, Vector Tobacco began
production of QUEST at a facility it had purchased in Timberlake, North
Carolina, and converted into a modern cigarette manufacturing plant. In October
2003, we announced that we would close Vector Tobacco's Timberlake facility in
order to reduce excess cigarette production capacity and improve operating
efficiencies company-wide. Production of QUEST and Vector Tobacco's other
cigarette brands has been moved to Liggett's state-of-the-art manufacturing
facility in Mebane, North Carolina.
The Mebane facility currently produces in excess of 9 billion units per
year, but maintains the capacity to produce approximately 16 billion units per
year. Vector Tobacco has contracted
9
with Liggett to produce its cigarettes and has transitioned production from
Timberlake to Mebane. All production ceased at Timberlake by December 31, 2003.
As part of the transition, we eliminated approximately 150 positions.
As a result of these actions, we currently expect to realize annual
cost savings of approximately $23 million beginning in 2004. We recognized
pre-tax restructuring and impairment charges of $21.3 million in 2003, and
additional charges of approximately $0.2 million will be taken in the first
quarter 2004. Approximately $2 million relates to employee severance and benefit
costs, $0.7 million to contract termination and exit and moving costs, and $18.8
million to non-cash asset impairment charges. Machinery and equipment to be
disposed of was reduced to fair value less costs to sell. The asset impairment
charges are based on management's current estimates of the values we will be
able to realize on sales of excess machinery and equipment, and may be adjusted
in future periods based on the actual amounts realized.
Vector Tobacco has entered into negotiations to sell the Timberlake
facility, including all equipment not relocated to Mebane.
The OMNI product uses traditional tobaccos, and the QUEST 3 product
uses genetically modified tobacco grown specifically for Vector Tobacco. The
Quest 1 and 2 products use a mixture of the genetically modified tobacco as well
as traditional tobaccos.
The introduction of the QUEST and OMNI brands required the expenditure
of substantial sums for advertising and sales promotion. The advertising media
used included magazines, newspapers, direct mail and point-of-sale display
materials. Sales promotion activities are conducted by distribution of store
coupons, point-of-sale display and advertising, advertising in print media, and
personal contact with distributors, retailers and consumers.
Expenditures by Vector Tobacco for research and development activities
were $9.8 million in 2003, $9.7 million in 2002 and $12.6 million in 2001.
Competition. The cigarette industry is highly competitive. Vector
Tobacco's competitors generally have substantially greater resources than it,
including financial, marketing and personnel resources. Other major tobacco
companies have stated that they are working on reduced risk cigarette products
and have made publicly available at this time only limited additional
information concerning their activities. Philip Morris has announced that it is
developing products that potentially reduce smokers' exposure to harmful
compounds in cigarette smoke and may introduce such a product during 2004. R. J.
Reynolds Tobacco Company has stated that in 2003 it began a phased expansion
into a select number of retail chain outlets of a cigarette product that
primarily heats rather than burns tobacco, which it claims reduces the toxicity
of its smoke. In 2002, Brown & Williamson Tobacco Corporation announced it was
test marketing a new cigarette with reduced levels of many toxins which it may
introduce on a national basis. There is a substantial likelihood that other
major tobacco companies will continue to introduce new products that are
designed to compete directly with Vector Tobacco's reduced nicotine,
nicotine-free and reduced carcinogen products.
Intellectual Property. Vector Tobacco is the exclusive sublicensee of
the technology for reducing or eliminating nicotine in tobacco through certain
genetic engineering techniques. Patent applications for this invention have been
filed in the United States and more than 70 countries. Patents have been issued
in 15 countries, including the United States. Patent applications in various
countries around the world remain pending.
Vector Tobacco has filed United States patent applications relating to
the use of palladium and other compounds to reduce the presence of carcinogens
and other toxins. Vector Tobacco has filed these patent applications
internationally and may file additional patent applications relating to this
invention as warranted by its ongoing research. Additional patent applications
related to OMNI are currently being considered.
10
The process to reduce carcinogens and toxins from cigarette smoke was
developed by Dr. Robert Bereman, Vice President of Chemical Research at Vector
Research Ltd. Dr. Bereman was formerly a Professor in the Department of
Chemistry at North Carolina State University. The process to genetically modify
tobacco seeds to reduce or eliminate nicotine was developed by Dr. Mark A.
Conkling, Vice President of Genetic Research at Vector Research. Dr. Conkling
was formerly Associate Professor in the Department of Genetics and Director of
the Biotechnology Program at North Carolina State University.
Additionally, extensive research related to the biological basis of
tobacco-related disease is being conducted at Vector Tobacco and together with
third-party collaborators. This research is being directed by Dr. Anthony P.
Albino, our Vice President of Public Health. Vector Tobacco believes that as
this research progresses, it will generate additional intellectual property.
Risks. Vector Tobacco's new product initiatives are subject to
substantial risks, uncertainties and contingencies which include, without
limitation, the challenges inherent in new product development initiatives, the
ability to raise capital and manage the growth of its business, potential
disputes concerning Vector Tobacco's intellectual property, intellectual
property of third parties, potential extensive government regulation or
prohibition, third party allegations that Vector Tobacco products are unlawful
or bear deceptive or unsubstantiated product claims, potential delays in
obtaining tobacco, other raw materials and any technology needed to produce
Vector Tobacco's products, market acceptance of Vector Tobacco's products,
competition from companies with greater resources and the dependence on key
employees. See the section entitled "Risk Factors".
LEGISLATION, REGULATION AND LITIGATION
Reports with respect to the alleged harmful physical effects of
cigarette smoking have been publicized for many years and, in the opinion of
Liggett's management, have had and may continue to have an adverse effect on
cigarette sales. Since 1964, the Surgeon General of the United States and the
Secretary of Health and Human Services have released a number of reports which
state that cigarette smoking is a causative factor with respect to a variety of
health hazards, including cancer, heart disease and lung disease, and have
recommended various government actions to reduce the incidence of smoking. In
1997, Liggett publicly acknowledged that, as the Surgeon General and respected
medical researchers have found, smoking causes health problems, including lung
cancer, heart and vascular disease, and emphysema.
Since 1966, federal law has required that cigarettes manufactured,
packaged or imported for sale or distribution in the United States include
specific health warnings on their packaging. Since 1972, Liggett and the other
cigarette manufacturers have included the federally required warning statements
in print advertising and on certain categories of point-of-sale display
materials relating to cigarettes. The Federal Cigarette Labeling and Advertising
Act requires that packages of cigarettes distributed in the United States and
cigarette advertisements in the United States bear one of the following four
warning statements: "SURGEON GENERAL'S WARNING: Smoking Causes Lung Cancer,
Heart Disease, Emphysema, and May Complicate Pregnancy"; "SURGEON GENERAL'S
WARNING: Quitting Smoking Now Greatly Reduces Serious Risks to Your Health";
"SURGEON GENERAL'S WARNING: Smoking by Pregnant Women May Result in Fetal
Injury, Premature Birth, and Low Birth Weight"; and "SURGEON GENERAL'S WARNING:
Cigarette Smoke Contains Carbon Monoxide". The law also requires that each
person who manufactures, packages or imports cigarettes annually provide to the
Secretary of Health and Human Services a list of ingredients added to tobacco in
the manufacture of cigarettes. Annual reports to the United States Congress are
also required from the Secretary of Health and Human Services as to current
information on the health consequences of smoking and from the Federal Trade
Commission on the effectiveness of cigarette labeling and current practices and
methods of cigarette advertising and promotion. Both federal agencies are also
required annually to make such recommendations as they deem appropriate with
regard to further legislation. In addition, since 1997, Liggett has included the
warning "Smoking is Addictive" on its cigarette packages.
11
In August 1996, the Food and Drug Administration filed in the Federal
Register a final rule classifying tobacco as a "drug" or "medical device",
asserting jurisdiction over the manufacture and marketing of tobacco products
and imposing restrictions on the sale, advertising and promotion of tobacco
products. Litigation was commenced challenging the FDA's authority to assert
such jurisdiction, as well as challenging the constitutionality of the rules. In
March 2000, the United States Supreme Court ruled that the FDA does not have the
power to regulate tobacco. Liggett supported the FDA rule and began to phase in
compliance with certain of the proposed FDA regulations.
Since the Supreme Court decision, various proposals and recommendations
have been made for additional federal and state legislation to regulate
cigarette manufacturers. Congressional advocates of FDA regulation have
introduced legislation that would give the FDA authority to regulate the
manufacture, sale, distribution and labeling of tobacco products to protect
public health, thereby allowing the FDA to reinstate its prior regulations or
adopt new or additional regulations. Proposed legislation has also been
introduced in Congress that would eliminate the federal tobacco quota system and
impose assessments on manufacturers of tobacco products to compensate tobacco
growers and quota holders for the elimination of their quota rights. The
ultimate outcome of these proposals cannot be predicted, although they could
have a material adverse effect on Liggett and us.
In August 1996, Massachusetts enacted legislation requiring tobacco
companies to publish information regarding the ingredients in cigarettes and
other tobacco products sold in that state. In December 2002, the United States
Court of Appeals for the First Circuit ruled that the ingredients disclosure
provisions violated the constitutional prohibition against unlawful seizure of
property by forcing firms to reveal trade secrets. Liggett began complying with
this legislation in December 1997 by providing ingredient information to the
Massachusetts Department of Public Health and, notwithstanding the appellate
court's ruling, has continued to provide ingredient disclosure. Liggett also
provides ingredient information annually, as required by law, to the states of
Texas and Minnesota. Several other states are considering ingredient disclosure
legislation.
In 1993, Congress amended the Agricultural Adjustment Act of 1938 to
require each United States cigarette manufacturer to use at least 75% domestic
tobacco in the aggregate of the cigarettes manufactured by it in the United
States, effective January 1994, on an annualized basis. Manufacturers failing to
satisfy these standards are obligated to pay a domestic marketing assessment
based upon price differentials between foreign and domestic tobacco and, under
certain circumstances, make purchases of domestic tobacco from the tobacco
stabilization cooperatives organized by the United States government.
In February 1996, the United States Trade representative issued an
"advance notice of proposed rule making" concerning how tobaccos imported under
a previously established tobacco tariff rate quota should be allocated.
Currently, tobacco imported under the quota is allocated on a "first-come,
first-served" basis, meaning that entry is allowed on an open basis to those
first requesting entry in the quota year. Others in the cigarette industry have
suggested an "end-user licensing" system under which the right to import tobacco
under the quota would be initially assigned on the basis of domestic market
share. Such an approach, if adopted, could have a material adverse effect on
Liggett and us.
In January 1993, the Environmental Protection Agency released a report
on the respiratory effect of secondary smoke which concluded that secondary
smoke is a known human lung carcinogen in adults and, in children, causes
increased respiratory tract disease and middle ear disorders and increases the
severity and frequency of asthma. In June 1993, the two largest domestic
cigarette manufacturers, together with other segments of the tobacco and
distribution industries, commenced a lawsuit against the agency seeking a
determination that the agency did not have the statutory authority to regulate
secondary smoke and that given the scientific evidence and the agency's failure
to follow its own guidelines in making the determination, its classification of
secondary smoke was arbitrary and capricious. In July 1998, a federal district
12
court vacated those sections of the report relating to lung cancer, finding that
the agency may have reached different conclusions had it complied with relevant
statutory requirements. The federal government appealed the court's ruling. In
December 2002, the United States Court of Appeals for the Fourth Circuit
rejected the industry challenge to the EPA report ruling that it was not subject
to court review. Issuance of the report may encourage efforts to limit smoking
in public areas.
A wide variety of federal, state and local laws limit the advertising,
sale and use of cigarettes, and these laws have proliferated in recent years.
For example, many local laws prohibit smoking in restaurants and other public
places, and many employers have initiated programs restricting or eliminating
smoking in the workplace. There are various other legislative efforts pending on
the federal and state level which seek, among other things, to further restrict
displays and advertising of cigarettes, require additional warnings, including
graphic warnings, on cigarette packaging and advertising, ban vending machine
sales and curtail affirmative defenses of tobacco companies in product liability
litigation. This trend has had, and is likely to continue to have, an adverse
impact on Liggett and us.
Cigarettes are subject to substantial and increasing federal, state and
local excise taxes. The federal excise tax on cigarettes is currently $0.39 per
pack. State and local sales and excise taxes vary considerably and, when
combined with sales taxes, local taxes and the current federal excise tax, may
currently exceed $4.00 per pack. Proposed further tax increases in various
jurisdictions are currently under consideration or pending. In 2003, 15 states
and the District of Columbia enacted increases in excise taxes. Congress has
considered significant increases in the federal excise tax or other payments
from tobacco manufacturers, and several states have pending legislation
proposing further state excise tax increases. In 2004, several states are likely
to impose additional taxes on cigarettes. Management believes that increases in
excise and similar taxes have had an adverse impact on sales of cigarettes.
Various state governments have adopted or are considering adopting
legislation establishing fire safety standards for cigarettes. Compliance with
this legislation could be burdensome and costly. In June 2000, the New York
State legislature passed legislation charging the state's Office of Fire
Prevention and Control, referred to as the "OFPC," with developing standards for
"fire-safe" or self-extinguishing cigarettes. The OFPC has issued regulations
requiring that by June 28, 2004 all cigarettes offered for sale in New York
state must be manufactured to certain self-extinguishment standards set out in
the regulations. Certain design and manufacturing changes will be necessary for
cigarettes manufactured for sale in New York to comply with the standards.
Inventories of cigarettes existing in the wholesale and retail trade as of June
28, 2004 that do not comply with the standards, may continue to be sold provided
New York state excise tax stamps have been affixed and such inventories have
been purchased in comparable quantities to the same period in the previous year.
Liggett and Vector Tobacco have not historically provided products that would be
compliant under these new OFPC regulations. Liggett and Vector Tobacco expect,
however, to supply compliant products by June 28, 2004. Similar legislation is
being considered by other state governments and at the federal level. Compliance
with such legislation could harm the business of Liggett and Vector Tobacco,
particularly if there are varying standards from state to state.
Federal or state regulators may object to Vector Tobacco's low nicotine
and nicotine-free cigarette products as unlawful or allege they bear deceptive
or unsubstantiated product claims, and seek the removal of the products from the
marketplace, or significant changes to advertising. Various concerns regarding
Vector Tobacco's advertising practices have been expressed to Vector Tobacco by
certain state attorneys general. Vector Tobacco has engaged in discussions in an
effort to resolve these concerns. Allegations by federal or state regulators,
public health organizations and other tobacco manufacturers that Vector
Tobacco's products are unlawful, or that its public statements or advertising
contain misleading or unsubstantiated health claims or product comparisons, may
result in litigation or governmental proceedings. Vector Tobacco's business may
become subject to extensive domestic and international government regulation.
Various proposals have been made for federal, state and international
legislation to regulate
13
cigarette manufacturers generally, and reduced constituent cigarettes
specifically. It is possible that laws and regulations may be adopted covering
issues like the manufacture, sale, distribution and labeling of tobacco products
as well as any express or implied health claims associated with reduced
carcinogen and low nicotine and nicotine-free cigarette products and the use of
genetically modified tobacco. A system of regulation by agencies like the Food
and Drug Administration, the Federal Trade Commission or the United States
Department of Agriculture may be established. In addition, a group of public
health organizations submitted a petition to the FDA, alleging that the
marketing of the OMNI product is subject to regulation by the FDA under existing
law. Vector Tobacco has filed a response in opposition to the petition. The FTC
has also expressed interest in the regulation of tobacco products made by
tobacco manufacturers, including Vector Tobacco, which bear reduced carcinogen
claims. The ultimate outcome of any of the foregoing cannot be predicted, but
any of the foregoing could have a material adverse impact on Vector Tobacco's
business, operating results and prospects.
The cigarette industry continues to be challenged on numerous fronts.
The industry is facing increased pressure from anti-smoking groups and an
increase in smoking and health litigation, including private class action
litigation and health care cost recovery actions brought by governmental
entities and other third parties, the effects of which, at this time, we are
unable to evaluate. As of December 31, 2003, there were approximately 377
individual suits, approximately 32 purported class actions or actions where
class certification has been sought and approximately 18 governmental and other
third-party payor health care recovery actions pending in the United States in
which Liggett was a named defendant. In addition to these cases, in 2000, an
action against cigarette manufacturers involving approximately 1,050 named
individual plaintiffs was consolidated before a single West Virginia state
court. Liggett is a defendant in most of the cases pending in West Virginia. In
January 2002, the court severed Liggett from the trial of the consolidated
action. There are eight individual actions where Liggett is the only defendant,
with three of these cases currently scheduled for trial between April 2004 and
August 2004. These cases are referred to herein as though commenced against
Liggett (without regard to whether such cases were actually commenced against
Liggett or against Brooke Group Holding, our predecessor, and a wholly-owned
subsidiary of VGR Holding). 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 racketeering 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,
statutes of limitations, equitable defenses such as "unclean hands" and lack of
benefit, failure to state a claim and federal preemption.
The claims asserted in the health care cost recovery actions vary. In
most of these cases, plaintiffs assert the equitable claim that the tobacco
industry was "unjustly enriched" by plaintiffs' payment of health care costs
allegedly attributable to smoking and seek reimbursement of those costs. Other
claims made by some but not all plaintiffs include the equitable claim of
indemnity, common law claims of negligence, strict liability, breach of express
and implied warranty, breach of special duty, fraud, negligent
misrepresentation, conspiracy, public nuisance, claims under state and federal
statutes governing consumer fraud, antitrust, deceptive trade practices and
false advertising, and claims under RICO.
In 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
14
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
billion annually. The action asserts claims under three Federal statutes: the
Medical Care Recovery Act, the Medicare Secondary Payer provisions of the Social
Security Act and RICO. In September 2000, the court dismissed the government's
claims based on the Medical Care Recovery Act and the Medicare Secondary Payor
provisions, reaffirming its decision in July 2001. In the September 2000 ruling,
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. The remaining motions for summary
judgment filed by the government and defendants are still pending before the
court.
In June 2001, the United States Attorney General assembled a team of
three Department of Justice lawyers to work on a possible settlement of the
federal lawsuit. The government lawyers met with representatives of the tobacco
industry, including Liggett, in July 2001. No settlement was reached, and no
further meetings are planned. In a January 2003 filing with the court, the
government alleged that disgorgement by defendants of approximately $289 billion
is an appropriate remedy in the case. Trial has been scheduled for September
2004.
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. State
court cases have been dismissed in 10 states and the District of Columbia. A
Kansas state court, in the case of Smith v. Philip Morris Companies Inc., et
al., granted class certification in November 2001. In April 2003, plaintiffs'
motion for class certification was granted in Romero v. Philip Morris Companies
Inc., a case pending in New Mexico state court, which decision has been
appealed. Liggett is one of the defendants in the Kansas and New Mexico cases.
In 1996, 1997 and 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 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, RJR, Brown & Williamson, Lorillard and
Liggett entered into the Master Settlement Agreement with 46 states, the
District of Columbia, Puerto Rico, Guam, the United States Virgin Islands,
American Samoa and the Northern Marianas to settle the asserted and unasserted
health care cost recovery and certain other claims of those settling
jurisdictions. As described above, Brooke Group Holding and Liggett had previous
settlements with a number of these settling states. The Master Settlement
Agreement received final judicial approval in each of the 52 settling
jurisdictions.
15
Liggett has no payment obligations under the Master Settlement
Agreement unless 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 Master Settlement Agreement 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 Management Science Associates
data, domestic shipments by Liggett and Vector Tobacco accounted for 2.2% of the
total cigarettes shipped in the United States during 2001, 2.5% during 2002 and
2.7% during 2003. On April 15 of any year following a year in which Liggett's
and/or Vector Tobacco's 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 paid during such following year by the original participating
manufacturers under the annual and strategic contribution payment provisions of
the Master Settlement Agreement, subject to applicable adjustments, offsets and
reductions. In March and April 2002, Liggett and Vector Tobacco paid a total of
$31.1 million for their 2001 Master Settlement Agreement obligations. In March
and April 2003, Liggett and Vector Tobacco paid a total of $37.5 million for
their 2002 Master Settlement Agreement obligations. Liggett and Vector Tobacco
have expensed $35.9 million for their estimated Master Settlement Agreement
obligations for 2003 as part of cost of goods sold. In June 2003, Liggett and
Vector Tobacco reached a settlement with the jurisdictions party to the Master
Settlement Agreement whereby they agreed to pay $2.5 million in April 2004. The
settlement resolved Liggett's and Vector Tobacco's claims that they were
entitled to a reduction in its Master Settlement Agreement payments as a result
of market share loss to non-participating manufacturers for payments based on
sales through December 31, 2002. Under the annual and strategic contribution
payment provisions of the Master Settlement Agreement, the original
participating manufacturers (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............................................. $8.0 billion
2008 - 2017............................................. $8.1 billion
2018 and each year thereafter.......................... $9.0 billion
These annual payments will be allocated based on relative unit volume
of domestic cigarette shipments. The payment obligations under the Master
Settlement Agreement 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 Master Settlement Agreement 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 Master
Settlement Agreement, 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, any payments due these states by Liggett (with certain
possible exceptions) have been eliminated, other than a $0.1 million a year
payment to Minnesota starting in 2003, to be paid any year cigarettes
manufactured by Liggett are sold in the state.
Cigarette manufacturers that have not signed the Master Settlement
Agreement ("non-participating manufacturers") are required by law to make escrow
deposits in each settling state where they sell cigarettes. The amount of escrow
deposit is based on the number of cigarettes the non-participating manufacturer
sells in the settling state. The escrow deposits are intended as a source of
funds to pay potential future judgments against the non-participating
manufacturers for smoking-related healthcare costs. Forty-two states have
passed, and various states are considering, legislation intended to prevent
non-participating manufacturers from
16
evading their escrow deposit obligations. Under this legislation, distributors
are prohibited from selling or applying excise tax stamps to any cigarette brand
that is not on a state-approved list. In order for a brand to be on the
state-approved list, the manufacturer must be a compliant party to the Master
Settlement Agreement, or must be a non-participating manufacturer that has made
all required escrow deposits. Failure to make escrow deposits in a settling
state could result in the loss of a non-participating manufacturer's ability to
sell tobacco products in that state. Additionally, 23 states have enacted, and
several other states have pending, legislation, known as an "allocable share"
amendment, that is designed to correct a loophole in the settling states' escrow
statutes. The loophole allows many non-participating manufacturers to obtain a
refund of monies deposited into escrow, and thereby reduce, in many cases
substantially, the amounts they deposit into escrow.
In May 1994, an action entitled Engle, et al. v. R.J. Reynolds Tobacco
Company, et al., Circuit Court, Eleventh Judicial Circuit, Dade County, Florida,
was filed against Liggett and others. The class consists of all Florida
residents and citizens, and their survivors, who have suffered, presently suffer
or have died from diseases and medical conditions caused by their addiction to
cigarettes that contain nicotine. Phase I of the trial commenced in July 1998
and in July 1999, the jury returned the Phase I verdict. The Phase I verdict
concerned certain issues determined by the trial court to be "common" to the
causes of action of the plaintiff class. Among other things, the jury found
that: smoking cigarettes causes 20 diseases or medical conditions, cigarettes
are addictive or dependence producing, defective and unreasonably dangerous,
defendants made materially false statements with the intention of misleading
smokers, defendants concealed or omitted material information concerning the
health effects and/or the addictive nature of smoking cigarettes and agreed to
misrepresent and conceal the health effects and/or the addictive nature of
smoking cigarettes, and defendants were negligent and engaged in extreme and
outrageous conduct or acted with reckless disregard with the intent to inflict
emotional distress. The jury also found that defendants' conduct "rose to a
level that would permit a potential award or entitlement to punitive damages."
The court decided that Phase II of the trial, which commenced November 1999,
would be a causation and damages trial for three of the class representatives
and a punitive damages trial on a class-wide basis, before the same jury that
returned the verdict in Phase I. Phase III of the trial was to be conducted
before separate juries to address absent class members' claims, including issues
of specific causation and other individual issues regarding entitlement to
compensatory damages. In April 2000, the jury awarded compensatory damages of
$12.7 million 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 $5.8 million, was not timely
filed. In July 2000, the jury awarded approximately $145 billion in the punitive
damages portion of Phase II against all defendants including $790 million
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 award, 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 billion 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.
17
In October 2003, the Third District Court of Appeals denied class
counsel's motions seeking, among other things, a rehearing by the court. Class
counsel has filed a motion with the Florida Supreme Court to invoke
discretionary review on the basis that the Third District Court of Appeals
decision construes the due process provisions of the state and federal
constitutions and conflicts with other appellate and supreme court decisions. If
the appellate court's ruling is not upheld on further appeal, it will have a
material adverse effect on us.
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 million punitive damages award against Liggett and decertified the Engle
smoking and health class action. Class counsel in Engle is pursuing various
appellate remedies seeking reversal of the appellate court's decision. If the
appellate court's ruling is not upheld on further appeal, it will have a
material adverse effect on us. In November 2000, Liggett filed the $3.45 million
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 $6.27 million into an escrow account to be held for the benefit of
the Engle class, and released, along with Liggett's existing $3.45 million
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, we
recorded a $9.7 million 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 $37.5
million (subsequently reduced by the court to $25.1 million) of compensatory
damages against Liggett and two other defendants and found Liggett 50%
responsible for the damages. The verdict, which was subject to the outcome of
the Engle appeal, has been overturned as a result of the appellate court's
ruling discussed above. It is possible that additional cases could be decided
unfavorably and that there could be further adverse developments in the Engle
case. Management cannot predict the cash requirements related to any future
settlements and judgments, including cash required to bond any appeals, and
there is a risk that those requirements will not be able to be met. An
unfavorable outcome of a pending smoking and health case could encourage the
commencement of additional similar litigation. Management is unable to make a
meaningful estimate with respect to the amount or range of loss that could
result from an unfavorable outcome of the cases pending against Brooke Group
Holding or Liggett or the costs of defending such cases. The complaints filed in
these cases rarely detail alleged damages. Typically, the claims set forth in an
individual's complaint against the tobacco industry pray for money damages in an
amount to be determined by a jury, plus punitive damages and costs. These damage
claims are typically stated as being for the minimum necessary to invoke the
jurisdiction of the court.
It is possible that our consolidated financial position, results of
operations or cash flows could be materially adversely affected by an
unfavorable outcome in any such smoking-related litigation.
Liggett's and Vector Tobacco's management is unaware of any material
environmental conditions affecting its existing facilities. Liggett's and Vector
Tobacco's management believes that current operations are conducted in
accordance with all environmental laws and regulations. Compliance with federal,
state and local provisions regulating the discharge of materials into the
environment, or otherwise relating to the protection of the environment, have
not had a material effect on the capital expenditures, earnings or competitive
position of Liggett or Vector Tobacco.
Liggett's management believes that it is in compliance in all material
respects with the laws regulating cigarette manufacturers.
18
See Note 16 to our consolidated financial statements, which contains a
description of legislation, regulation and litigation and of the Master
Settlement Agreement and Brooke Group Holding's and Liggett's other settlements.
LIGGETT-DUCAT LTD.
In August 2000, Brooke (Overseas) Ltd., a wholly-owned subsidiary of
VGR Holding, completed the sale of all of the membership interests of Western
Tobacco Investments LLC to Gallaher Overseas (Holdings) Ltd. Brooke (Overseas)
held its 99.9% equity interest in Liggett-Ducat Ltd., a Russian joint stock
company, through its subsidiary Western Tobacco Investments LLC. Liggett-Ducat,
one of Russia's leading cigarette producers since 1892, produced or had rights
to produce 26 different brands of cigarettes, including Russian brands such as
Pegas, Prima, Novosti and Belomorkanal, and American blend cigarettes under the
names Dukat and LD.
The purchase price for the sale consisted of $334.1 million in cash and
$64.4 million in assumed debt and capital commitments. The proceeds generated
from the sale were divided among Brooke (Overseas) and Western Realty
Development LLC, a joint venture of New Valley and Apollo Real Estate Investment
Fund III, L.P., in accordance with the terms of the participating loan. Of the
net cash proceeds from the transaction, Brooke (Overseas) received $197.1
million, New Valley received $57.2 million and Apollo received $68.3 million. We
recorded a gain of $161 million (including our share of New Valley's gain), net
of income taxes and minority interests, in connection with the sale in 2000.
NEW VALLEY CORPORATION
General. New Valley, a Delaware corporation, is engaged in the real
estate business and is seeking to acquire additional operating companies. New
Valley owns, through its New Valley Realty Division, two commercial office
buildings in Princeton, New Jersey and a 50% interest in the former Kona Surf
Hotel in Kailua-Kona, Hawaii. New Valley also holds a 50% interest in Douglas
Elliman Realty, LLC, which operates the largest residential brokerage company in
the New York metropolitan area. In December 2001, New Valley completed the
distribution to its stockholders of its shares in Ladenburg Thalmann Financial
Services Inc., its former majority-owned subsidiary engaged in the investment
banking and brokerage business. New Valley (NASDAQ: NVAL) is registered under
the Securities Exchange Act of 1934 and files periodic reports and other
information with the SEC.
As of March 12, 2004, VGR Holding holds, either directly or indirectly
through VGR Holding's wholly-owned subsidiary, New Valley Holdings, Inc.,
approximately 58.1% of the common shares of New Valley.
New Valley was originally organized under the laws of New York in 1851
and operated for many years under the name "Western Union Corporation". In 1991,
bankruptcy proceedings were commenced against New Valley. In January 1995, New
Valley emerged from bankruptcy. As part of the plan of reorganization, New
Valley sold the Western Union money transfer and messaging services businesses
and all allowed claims in the bankruptcy were paid in full.
In October 1999, New Valley's board of directors authorized the
repurchase of up to 2,000,000 common shares from time to time in the open market
or in privately negotiated transactions. As of December 31, 2003, New Valley had
repurchased 1,185,615 shares for approximately $4.7 million.
19
Plan of Recapitalization. New Valley consummated a plan of
recapitalization on June 4, 1999, following approval by New Valley's
stockholders. Pursuant to the plan of recapitalization:
- each $15.00 Class A senior preferred share ($100 liquidation)
was reclassified into 20 Common Shares and one Warrant
exercisable for five years,
- each $3.00 Class B preferred share was reclassified into 1/3
of a common share and five warrants, and
- each outstanding common share was reclassified into 1/10 of a
common share and 3/10 of a warrant.
The recapitalization had a significant effect on New Valley's financial
position and results of operations. As a result of the exchange of the
outstanding preferred shares for common shares and warrants in the
recapitalization, New Valley's stockholders' equity increased by $343.4 million
from the elimination of the carrying value and dividend arrearages on the
redeemable preferred stock. Furthermore, the recapitalization resulted in the
elimination of the on-going dividend accruals on the existing redeemable
preferred shares of New Valley, as well as the redemption obligation for the
Class A preferred shares in January 2003. Also as a result of the
recapitalization, the number of outstanding common shares more than doubled, and
additional common shares were reserved for issuance upon exercise of the
warrants, which have a current effective exercise price of $11.30 per common
share and expire on June 14, 2004. In addition, we increased our ownership of
the common shares from 42.3% to 55.1%, and its total voting power from 42% to
55.1%. We currently own approximately 58.1% of New Valley's common shares. If
all outstanding warrants were exercised, the percentage of the common shares
that we own would decline to approximately 40%.
Business Strategy. Following the distribution of the Ladenburg Thalmann
Financial Services shares in 2001 and asset dispositions in Russia in December
2001 and April 2002 (discussed below), New Valley is engaged in the real estate
business and holds a significant amount of cash and other investments. The
business strategy of New Valley is to continue to operate its real estate
business and to acquire operating companies through merger, purchase of assets,
stock acquisition or other means, or to acquire control of operating companies
through one of such means. In the interim, New Valley's cash and investments
(aggregating approximately $84.5 million at December 31, 2003) are available for
general corporate purposes, including for acquisition purposes.
As a result of the distribution of the Ladenburg Thalmann Financial
Services shares, New Valley's broker-dealer operations, which were the primary
source of New Valley's revenues between May 1995 and December 2001, have been
treated as discontinued operations in our consolidated financial statements. See
"Discontinued Operations - Broker-Dealer".
New Valley Realty Division
Acquisition of Office Buildings. On December 13, 2002, New Valley
completed the acquisition of two commercial office buildings in Princeton, New
Jersey for an aggregate purchase price of $54 million. New Valley purchased the
two adjacent office buildings, located at 100 and 150 College Road West, from
100 College Road, LLC, an entity affiliated with Patrinely Group LLC and Apollo
Real Estate Investment Fund III, L.P. The two buildings were constructed in July
2000 and June 2001 and have a total of approximately 225,000 square feet of
rentable space.
New Valley acquired a fee simple interest in each office building
(subject to certain rights of existing tenants) and in the underlying land for
each property. Space in the office buildings is leased to commercial tenants
and, as of December 31, 2003, the office buildings were approximately 98%
occupied.
20
To finance a portion of the purchase price for the office buildings, on
the closing date, New Valley borrowed $40.5 million 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 $53,635 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.
Concurrently with the acquisition of the office buildings, New Valley
engaged a property-management affiliate of Patrinely Group LLC that had
previously managed the office buildings to act as the property manager for the
office buildings. The agreement has a one-year term, but may be terminated by
New Valley on 30 days' notice without cause or economic penalty (other than the
payment of one month's management fee).
Hawaiian Hotel. In July 2001, Koa Investors, LLC, an entity owned by
New Valley, developer Brickman Associates and other investors, acquired the
leasehold interests in the former Kona Surf Hotel in Kailua-Kona, Hawaii in a
foreclosure proceeding. New Valley, which holds a 50% interest in Koa Investors,
had invested $7.4 million in the project and had committed to make additional
investments of up to an aggregate of $5.1 million as of December 31, 2003. New
Valley funded $1.5 million of this amount in February 2004. New Valley accounts
for its investment in Koa Investors under the equity method and recorded losses
of $0.3 million and $1.3 million in 2003 and 2002, respectively, associated with
the Kona Surf Hotel. Koa Investors' losses primarily represent management fees
and the loss of a deposit on an adjoining golf course, which it determined not
to purchase. Koa Investors capitalizes all costs related to the acquisition and
development of the property.
The hotel, which is currently closed, is located on a 20-acre tract,
which is leased under two ground leases with Kamehameha Schools, the largest
private land owner in Hawaii. In December 2002, Koa Investors and Kamehameha
amended the leases to provide for significant rent abatements over the next ten
years and extended the remaining term of the leases from 33 years to 65 years.
In addition, Kamehameha granted Koa Investors various right of first offer
opportunities to develop adjoining resort sites.
Koa Investors has entered into an agreement with Starwood Hotels and
Resorts Worldwide, Inc. for Starwood to manage the hotel when it reopens as the
Sheraton Keauhou Bay Resort & Spa, a four star family resort with approximately
525 rooms. The planned major renovation of the property includes comprehensive
room enhancements, construction of a fresh water 13,000 square foot fantasy
pool, lobby and entrance improvements, a new gym and spa, retail stores and new
restaurants. A 10,000 square foot convention center, wedding chapel and other
revenue producing amenities would also be restored.
Koa Investors estimates that the cost of the hotel's renovation will be
approximately $55 million. Preliminary development is underway and, subject to
completing the necessary financing arrangements, the reopening of the hotel is
currently scheduled for late 2004. A predevelopment credit line of $6.5 million
has been obtained from a Taiwanese lender. Koa Investors is currently in
negotiations with a lender to provide construction financing for the planned
renovation. However, no assurance can be given that the necessary financing will
be available on terms acceptable to Koa Investors. Koa Investors has capitalized
all costs related to the acquisition and development of the property.
Sales of Shopping Centers. In February 2001, New Valley sold its Royal
Palm Beach, Florida shopping center for $9.5 million before closing adjustments
and expenses and recorded a gain of approximately $0.9 million on the sale. In
May 2002, New Valley disposed of its
21
remaining shopping center in Kanawha, West Virginia and recorded a gain of
approximately $0.6 million for the year ended December 31, 2002, which
represented the shopping center's negative book value, in connection with the
disposal. No proceeds were received in the disposal.
Douglas Elliman Realty, LLC. During 2000 and 2001, New Valley acquired
for approximately $1.7 million a 37.2% ownership interest in B&H Associates of
NY, which conducts business as Prudential Douglas Elliman Real Estate, formerly
known as Prudential Long Island Realty, the largest independently owned and
operated real estate brokerage company on Long Island, and a minority interest
in an affiliated mortgage company, Preferred Empire Mortgage Company. In
December 2002, New Valley and the other owners of Prudential Douglas Elliman
Real Estate contributed their interests in Prudential Douglas Elliman Real
Estate to Douglas Elliman Realty, LLC, formerly known as Montauk Battery Realty,
LLC, a newly formed entity. New Valley acquired a 50% interest in Douglas
Elliman Realty as a result of an additional investment of approximately $1.4
million by New Valley and the redemption by Prudential Douglas Elliman Real
Estate of various ownership interests. As part of the transaction, Prudential
Douglas Elliman Real Estate renewed its franchise agreement with The Prudential
Real Estate Affiliates, Inc. for an additional ten-year term. The owners of
Douglas Elliman Realty also agreed, upon receipt of the required regulatory
approvals, to contribute to Douglas Elliman Realty their interests in the
related mortgage company.
In March 2003, Douglas Elliman Realty purchased the New York City -
based residential brokerage firm, Douglas Elliman, LLC, formerly known as
Insignia Douglas Elliman, and an affiliated property management company, for
$71.25 million. With that acquisition, the combination of Prudential Douglas
Elliman Real Estate with Douglas Elliman has created the largest residential
brokerage company in the New York metropolitan area. Upon closing of the
acquisition, Douglas Elliman entered into a ten-year franchise agreement with
The Prudential Real Estate Affiliates, Inc. New Valley invested an additional
$9.5 million in subordinated debt and equity of Douglas Elliman Realty to help
fund the acquisition. The subordinated debt, which has a principal amount of
$9.5 million, bears interest at 12% per annum and is due in March 2013. As part
of the Douglas Elliman acquisition, Douglas Elliman Realty acquired Douglas
Elliman's affiliate, Residential Management Group LLC, which conducts business
as Douglas Elliman Property Management and is the New York metropolitan area's
largest manager of rental, co-op and condominium housing.
New Valley accounts for its interest in Douglas Elliman Realty on the
equity method. New Valley recorded income of $1.2 million in 2003 and $0.6
million in 2002 associated with Douglas Elliman Realty. New Valley's equity
income from Douglas Elliman Realty includes interest earned by New Valley on the
subordinated debt and 46% of the mortgage company's results from operations.
Douglas Elliman Realty is engaged in the real estate brokerage business
through its subsidiaries Douglas Elliman and Prudential Douglas Elliman Real
Estate. The two brokerage companies have 47 offices with more than 2,250 real
estate brokers in the metropolitan New York area. The companies achieved
combined sales of approximately $6.8 billion of real estate for the year ended
December 31, 2003.
Douglas Elliman was founded in 1911 and has grown to be one of
Manhattan's leading residential brokers by specializing in the highest end of
the sales and rental marketplaces. It has nine New York City offices, more than
900 real estate brokers and sales volume of approximately $4 billion of real
estate for the year ended December 31, 2003.
Prudential Douglas Elliman Real Estate is headquartered in Huntington,
New York and is the largest residential brokerage company on Long Island with
approximately 37 offices. During 2003, Prudential Douglas Elliman Real Estate
closed approximately 6,955 transactions, representing sales volume of
approximately $2.8 billion of real estate. Prudential Douglas Elliman Real
Estate's 37 offices serve approximately 250 communities from Manhattan to
22
Montauk. In 2003, Prudential Douglas Elliman Real Estate was ranked as one of
the top 50 residential brokerage companies in the United States based on closed
sales volume by the Real Trends broker survey.
Russian Real Estate
BrookeMil Ltd. In January 1997, New Valley purchased BrookeMil Ltd.
from Brooke (Overseas) Ltd., an indirect wholly-owned subsidiary of ours.
BrookeMil, which was engaged in the real estate development business in Moscow,
Russia, was the developer of a three-phase complex on 2.2 acres of land in
downtown Moscow, for which it had a 49-year lease. In 1993, the first phase of
the project, Ducat Place I, a 46,500 sq. ft. Class-A office building, was
successfully built and leased. In April 1997, BrookeMil sold Ducat Place I to
one of its tenants, Citibank. In 1997, BrookeMil completed construction of Ducat
Place II, a premier 150,000 sq. ft. office building. Ducat Place II was leased
to a number of leading international companies and was one of the leading modern
office buildings in Moscow due to its design and full range of amenities. The
third phase, Ducat Place III, had been planned as an office tower. BrookeMil was
also engaged in the acquisition and preliminary development of the Kremlin sites
in Moscow.
Western Realty Development. In February 1998, New Valley and Apollo
Real Estate Investment Fund III, L.P. organized Western Realty Development LLC
to make real estate investments in Russia. New Valley contributed the real
estate assets of BrookeMil, including the Ducat Place II office building and the
adjoining site for the proposed development of Ducat Place III, to Western
Realty Development, and Apollo contributed $73.3 million, including the
investment in Western Realty Repin LLC discussed below.
Western Realty Development made a $30 million participating loan to
Western Tobacco Investments LLC which held Brooke (Overseas)'s interest in
Liggett-Ducat Ltd., which was engaged in the tobacco business in Russia. In
August 2000, Western Tobacco Investments was sold to Gallaher Group Plc and the
proceeds were divided between us and Western Realty Development in accordance
with the terms of the participating loan, which was terminated at the closing.
Through their investments in Western Realty Development, New Valley received
$57.2 million in cash proceeds from the sale and Apollo received $68.3 million.
New Valley recorded a gain of $52.5 million in connection with the transaction
in 2000.
In December 2001, Western Realty Development sold to Andante Limited, a
Bermuda company, all of the membership interests in its subsidiary Western
Realty Investments LLC, the entity through which Western Realty Development
owned Ducat Place II and the adjoining Ducat Place III site. The purchase price
for the sale was approximately $42 million including the assumption of mortgage
debt and payables. Of the net cash proceeds from the sale, New Valley received
approximately $22 million, and Apollo received approximately $9.5 million. New
Valley recorded a loss of approximately $21.8 million in connection with the
sale in 2001.
Western Realty Repin. In June 1998, New Valley and Apollo organized
Western Realty Repin to make a loan to BrookeMil. The proceeds of the loan were
used by BrookeMil for the acquisition and preliminary development of the Kremlin
sites, two adjoining sites totaling 10.25 acres located on the Sofiskaya
Embankment of the Moscow River. The sites are directly across the river from the
Kremlin and have views of the Kremlin walls, towers and nearby church domes. The
Kremlin sites were planned for development as a residential and hotel complex.
In April 2002, New Valley sold the shares of BrookeMil for
approximately $22 million before closing expenses. BrookeMil owned the two
Kremlin sites in Moscow, which were New Valley's remaining real estate holdings
in Russia. Under the terms of the Western Realty Repin participating loan to
BrookeMil, New Valley received approximately $7.5 million of the net proceeds
from the sale and Apollo received approximately $12.5 million of the proceeds.
New Valley recorded a gain on the sale of real estate of approximately $8.5
million for the year ended December 31, 2002 in connection with the sale.
23
Discontinued Operations - Broker-Dealer. In May 1995, a subsidiary of
New Valley acquired all of the outstanding shares of common stock and other
equity interests of Ladenburg Thalmann & Co. Inc. for $25.8 million, net of cash
acquired. Ladenburg Thalmann & Co. is a full service broker-dealer, which has
been a member of the New York Stock Exchange since 1876.
In December 1999, New Valley completed the sale of a 19.9% interest in
Ladenburg Thalmann & Co. to Berliner Effektengesellschaft AG, a German public
financial holding company. New Valley received $10.2 million in cash and
Berliner shares valued in accordance with the purchase agreement.
In May 2001, GBI Capital Management Corp. acquired all of the
outstanding common stock of Ladenburg Thalmann & Co., and the name of GBI was
changed to Ladenburg Thalmann Financial Services Inc. New Valley received
18,598,098 shares, $8.01 million in cash and $8.01 million principal amount of
senior convertible notes due December 31, 2005. The notes issued to New Valley
bear interest at 7.5% per annum and are convertible into 3,844,216 shares of
Ladenburg Thalmann Financial Services common stock. Upon closing, New Valley
also acquired an additional 3,945,060 shares of Ladenburg Thalmann Financial
Services common stock from the former Chairman of Ladenburg Thalmann Financial
Services for $1.00 per share. Following completion of the transactions, New
Valley owned 53.6% and 49.5% of the common stock of Ladenburg Thalmann Financial
Services, on a basic and fully diluted basis, respectively. Ladenburg Thalmann
Financial Services (AMEX: LTS) is registered under the Securities Act of 1934
and files periodic reports and other information with the SEC.
To provide the funds for the acquisition of the common stock of
Ladenburg Thalmann & Co., Ladenburg Thalmann Financial Services borrowed $10
million from Frost-Nevada, Limited Partnership and issued to Frost-Nevada $10
million principal amount of 8.5% senior convertible notes due December 31, 2005.
The notes issued to the Ladenburg Thalmann & Co. stockholders and to
Frost-Nevada are secured by a pledge of the Ladenburg Thalmann & Co. stock. In
June 2002, New Valley, Berliner and Frost-Nevada agreed with Ladenburg Thalmann
Financial Services to forbear until May 15, 2003 payment of the interest due to
them under the convertible notes on the interest payment dates commencing June
30, 2002 through March 31, 2003. In March 2003, the holders of the convertible
notes agreed to extend the interest forbearance period to January 15, 2005 with
respect to interest payments due through December 31, 2004. Interest on the
deferred amounts accrues at 8% on the New Valley and Berliner notes and 9% on
the Frost-Nevada note.
On November 30, 2001, New Valley announced that it would distribute its
22,543,158 shares of Ladenburg Thalmann Financial Services common stock to
holders of New Valley common shares through a special dividend. On the same
date, we announced that we would, in turn, distribute the 12,694,929 shares of
Ladenburg Thalmann Financial Services common stock that we would receive from
New Valley to the holders of our common stock as a special dividend. The special
dividends were accomplished through pro rata distributions of the Ladenburg
Thalmann Financial Services shares, paid on December 20, 2001 to holders of
record as of December 10, 2001. New Valley stockholders received 0.988 of a
Ladenburg Thalmann Financial Services share for each share of New Valley, and
our stockholders received 0.348 of a Ladenburg Thalmann Financial Services share
for each share of ours.
Following the distribution, New Valley continues to hold the $8.01
million principal amount of Ladenburg Thalmann Financial Services' senior
convertible notes and a warrant to purchase 100,000 shares of its common stock
at $1.00 per share.
In March 2002, Ladenburg Thalmann Financial Services borrowed $2.5
million from New Valley. The loan, which bears interest at 1% above the prime
rate, was due on the earlier of December 31, 2003 or the completion of one or
more equity financings where Ladenburg Thalmann Financial Services receives at
least $5.0 million in total proceeds. In July 2002, Ladenburg Thalmann Financial
Services borrowed an additional $2.5 million from New Valley on the same terms.
In November 2002, New Valley agreed, in connection with a $3.5 million loan to
24
Ladenburg Thalmann Financial Services by an affiliate of its clearing broker, to
extend the maturity of the notes to December 31, 2006 and to subordinate the
notes to the repayment of the loan.
During 2002, Ladenburg Thalmann Financial Services incurred significant
operating losses as its revenues and liquidity were adversely affected by the
overall declines in the U.S. equity markets and the continued weak operating
environment for the broker-dealer industry. Accordingly, New Valley evaluated
its ability to collect its notes receivable and related interest from Ladenburg
Thalmann Financial Services at September 30, 2002. These notes receivable
included the $5 million of notes issued in March 2002 and July 2002 and the
$8.01 million convertible note issued to New Valley in May 2001. Management
determined, based on current trends in the broker-dealer industry and Ladenburg
Thalmann Financial Services' operating results and liquidity needs, that a
reserve for uncollectibility should be established against these notes and
interest receivable. As a result, New Valley recorded a charge of $13.2 million
in the third quarter of 2002.
On October 8, 2002, Ladenburg Thalmann Financial Services borrowed an
additional $2 million from New Valley. The loan, which bore interest at 1% above
the prime rate, was repaid in December 2002 with the proceeds from the loan to
Ladenburg Thalmann Financial Services from an affiliate of its clearing broker.
Howard M. Lorber and Richard J. Lampen, executive officers and
directors of New Valley, Victor M. Rivas, a director of New Valley, and Henry C.
Beinstein, a director of New Valley and us, also serve as directors of Ladenburg
Thalmann Financial Services. Bennett S. LeBow, the Chairman and Chief Executive
Officer of New Valley, served as director of Ladenburg Thalmann Financial
Services until September 2003. Mr. Rivas also serves as President and CEO of
Ladenburg Thalmann Financial Services. Mr. Rivas will retire March 31, 2004 as
an officer and director of Ladenburg Thalmann Financial Services. J. Bryant
Kirkland III, New Valley's Vice President, Treasurer and Chief Financial
Officer, served as Chief Financial Officer of Ladenburg Thalmann Financial
Services from June 2001 to October 2002. Messrs. LeBow and Lorber serve as
executive officers and directors, and Mr. Lampen serves as an executive officer,
of us, and Robert J. Eide, a director of Ladenburg Thalmann Financial Services,
serves as a director of ours.
Following December 20, 2001, holders of New Valley's outstanding
warrants are entitled, upon exercise of a warrant and payment of the $12.50
exercise price per warrant, to receive a common share of New Valley and a cash
payment of $1.20, an amount equal to 0.988 of the current market price of a
share of Ladenburg Thalmann Financial Services common stock on December 20,
2001. The current market price was determined based on the average daily closing
prices for a share of Ladenburg Thalmann Financial Services common stock for the
15 consecutive trading days commencing 20 trading days before December 20, 2001.
New Valley's warrants expire on June 14, 2004.
As of December 31, 2003, New Valley's long-term investments consisted
primarily of investments in limited partnerships and limited liability companies
of $2.4 million. New Valley has committed to make an additional investment in
one of these limited partnerships of up to approximately $1 million at December
31, 2003.
EMPLOYEES
At January 1, 2004, we had approximately 1,143 employees, of whom
approximately 300 were employed by Liggett, approximately 200 were employed by
Vector Tobacco and Vector Research and approximately 625 were employed by
Liggett Vector Brands. Approximately 20% of our employees are hourly employees
who are represented by unions. We have not experienced any significant work
stoppages since 1977, and we believe that relations with our employees and their
unions are satisfactory.
25
AVAILABLE INFORMATION
Our website address is www.vectorgroupltd.com. We make available free
of charge on the Investor Relations section of our website
(http://vectorgroupltd.com/invest.asp) our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those
reports as soon as reasonably practicable after such material is electronically
filed with the Securities and Exchange Commission. We also make available
through our website other reports filed with the SEC under the Exchange Act,
including our proxy statements and reports filed by officers and directors under
Section 16(a) of that Act. Copies of our Code of Business Conduct and Ethics,
Corporate Governance Guidelines, Audit Committee charter, Compensation Committee
charter and Corporate Governance and Nominating Committee charter have been
posted on the Investor Relations section of our website and are also available
in print to any shareholder who requests it. We do not intend for information
contained in our website to be part of this Annual Report on Form 10-K.
RISK FACTORS
WE AND OUR SUBSIDIARIES HAVE A SUBSTANTIAL AMOUNT OF INDEBTEDNESS
We and our subsidiaries have significant indebtedness and debt service
obligations. At December 31, 2003, we and our subsidiaries had total outstanding
indebtedness of $310.7 million. In addition, subject to the terms of any future
agreements, we and our subsidiaries will be able to incur additional
indebtedness in the future. There is a risk that we will not be able to generate
sufficient funds to repay our debt. If we cannot service our fixed charges, it
would significantly harm us and the value of our common stock.
WE ARE A HOLDING COMPANY AND DEPEND ON CASH PAYMENTS FROM SUBSIDIARIES, WHICH
ARE SUBJECT TO CONTRACTUAL AND OTHER RESTRICTIONS, IN ORDER TO SERVICE OUR DEBT
AND TO PAY DIVIDENDS ON OUR COMMON STOCK
We are a holding company and have no operations of our own. We hold our
interests in our various businesses through our wholly-owned subsidiary, VGR
Holding. In addition to our own cash resources, our ability to pay interest on
our convertible notes and to pay dividends on our common stock depends on the
ability of VGR Holding to make cash available to us. The purchase agreement for
the VGR Holding 10% senior secured notes due 2006 contains covenants which limit
the ability of VGR Holding to make distributions to us to 50% of VGR Holding's
net income, unless VGR Holding holds an amount in cash equal to the then
principal amount of the notes outstanding ($70 million at December 31, 2003)
after giving effect to the payment of the distribution. Under the terms of these
covenants, at December 31, 2003, VGR Holding was generally not permitted to pay
distributions to us except for tax sharing payments and specified amounts of
operating expenses. In addition, VGR Holding's ability to pay dividends to us
depends primarily on the ability of Liggett, our wholly owned subsidiary, and
New Valley, in which we indirectly hold an approximately 58% interest, to
generate cash and make it available to VGR Holding. Liggett's revolving credit
agreement prohibits Liggett from paying cash dividends to VGR Holding unless
Liggett's borrowing availability exceeds $5 million for the thirty days prior to
payment of the dividend, and immediately after giving effect to the dividend,
and it is in compliance with the covenants in the credit facility, including an
adjusted net worth and working capital requirement.
As the controlling New Valley stockholder, we must deal fairly with New
Valley, which may limit our ability to enter into transactions with New Valley
that result in the receipt of cash from New Valley and to influence New Valley's
dividend policy. In addition, since we indirectly own only approximately 58% of
the common shares of New Valley, a significant portion of any cash and other
assets distributed by New Valley will be received by persons other than us and
our subsidiaries.
Our receipt of cash payments, as dividends or otherwise, from our
subsidiaries is an important source of our liquidity and capital resources. If
we do not have sufficient cash resources
26
of our own and do not receive payments from our subsidiaries in an amount
sufficient to repay our debts and to pay dividends on our common stock, we must
obtain additional funds from other sources. There is a risk that we will not be
able to obtain additional funds at all or on terms acceptable to us. Our
inability to service these obligations and to continue to pay dividends on our
common stock would significantly harm us and the value of our common stock.
OUR LIQUIDITY COULD BE ADVERSELY AFFECTED IF TAXING AUTHORITIES PREVAIL IN THEIR
ASSERTION THAT WE INCURRED A TAX OBLIGATION IN 1998 AND 1999 IN CONNECTION WITH
THE PHILIP MORRIS BRAND TRANSACTION
In connection with the 1998 and 1999 transaction with Philip Morris
Incorporated where a subsidiary of Liggett contributed three of its premium
cigarette brands to Trademarks LLC, a newly-formed limited liability company, we
recognized in 1999 a pre-tax gain of $294.1 million in our consolidated
financial statements and established a deferred tax liability of $103.1 million
relating to the gain. In such transaction, Philip Morris acquired an option to
purchase the remaining interest in Trademarks for a 90-day period commencing in
December 2008, and we have an option to require Philip Morris to purchase the
remaining interest for a 90-day period commencing in March 2010. Upon exercise
of the options during the 90-day periods commencing in December 2008 or in March
2010, we will be required to pay tax in the amount of the deferred tax
liability, which will be offset by the benefit of any deferred tax assets,
including any net operating losses, available to us at that time. In connection
with an examination of our 1998 and 1999 federal income tax returns, the
Internal Revenue Service issued to us in September 2003 a notice of proposed
adjustment. The notice asserts that, for tax reporting purposes, the entire gain
should have been recognized in 1998 and in 1999 in the additional amounts of
$150 million and $129.9 million, respectively, rather than upon the exercise of
the options during the 90-day periods commencing in December 2008 or in March
2010. If the Internal Revenue Service were to ultimately prevail with the
proposed adjustment, it would result in the potential acceleration of tax
payments of approximately $117 million, including interest, net of tax benefits,
through December 31, 2003. These amounts have been previously recognized in our
consolidated financial statements as tax liabilities.
We believe the positions reflected on our income tax returns are
correct and intend to vigorously oppose any proposed adjustments to our returns.
We have filed a protest with the Appeals Division of the Internal Revenue
Service. Although no payment is due with respect to these matters during the
appeal process, interest is accruing on the disputed amounts. There is a risk,
however, the taxing authorities will ultimately prevail in their assertion that
we incurred a tax obligation prior to the exercise dates of these options and we
will be required to make such tax payments prior to 2009 or 2010. If that were
to occur and any necessary financing were not available to us, our liquidity
could be adversely affected.
LIGGETT FACES INTENSE COMPETITION IN THE DOMESTIC TOBACCO INDUSTRY
Liggett is considerably smaller and has fewer resources than all its
major competitors and as a result has a more limited ability to respond to
market developments. Management Science Associates data indicate that the three
largest manufacturers control approximately 82.4% of the United States cigarette
market. Philip Morris is the largest and most profitable manufacturer in the
market, and its profits are derived principally from its sale of premium
cigarettes. Philip Morris had approximately 62.6% of the premium segment and
50.4% of the total domestic market during 2003. During 2003, Liggett's share of
the premium cigarette segment was 0.2%, and its share of the total domestic
cigarette market was 2.6%. Philip Morris and RJR, the two largest cigarette
manufacturers, have historically, because of their dominant market share, been
able to determine cigarette prices for the various pricing tiers within the
industry. The other cigarette manufacturers historically have brought their
prices into line with the levels established by the two major manufacturers. RJR
and Brown & Williamson announced in October 2003 plans to combine their United
States tobacco businesses. This transaction, if completed, will further
consolidate the dominance of the domestic cigarette market by Philip Morris and
the newly created Reynolds American.
27
LIGGETT'S BUSINESS IS HIGHLY DEPENDENT ON THE DISCOUNT CIGARETTE SEGMENT
Liggett depends more on sales in the discount cigarette segment of the
market, relative to the full-price premium segment, than its major competitors.
Approximately 94.6% of Liggett's unit sales in 2003 were generated in the
discount segment. The discount segment is highly competitive with consumers
having less brand loyalty and placing greater emphasis on price. While the four
major manufacturers all compete with Liggett in the discount segment of the
market, the strongest competition for market share has recently come from a
group of small manufacturers and importers, most of which sell low quality, deep
discount cigarettes. While Liggett's share of the discount market increased to
9.4% in 2003 from 8.3% in 2002 and 7.6% in 2001, Management Science Associates
data indicate that these other smaller manufacturers' and importers' discount
market share increased to 19.9% in 2003 from 17.6% in 2002 and 15.1% in 2001 due
to their increased competitive discounting. If the discount market pricing
continues to be impacted by these smaller manufacturers and importers, margins
in Liggett's largest market segment could be negatively affected, which in turn
could negatively affect the value of our common stock.
LIGGETT'S MARKET SHARE IS SUSCEPTIBLE TO DECLINE
In years prior to 2000, Liggett suffered a substantial decline in unit
sales and associated market share. Liggett's unit sales and market share
increased during 2000, 2001 and 2002, and its market share increased in 2003
while its unit sales declined. This earlier market share erosion resulted in
part from Liggett's highly leveraged capital structure that existed until
December 1998 and its limited ability to match other competitors' wholesale and
retail trade programs, obtain retail shelf space for its products and advertise
its brands. The decline in recent years also resulted from adverse developments
in the tobacco industry, intense competition and changes in consumer
preferences. According to Management Science Associates data, Liggett's overall
domestic market share during 2003 was 2.6%, compared with 2.5% for 2002 and 2.2%
for 2001. Liggett's share of the premium segment during 2003 was 0.2% as
compared to 0.3% in both 2002 and 2001, and its share of the discount segment
during 2003 was 9.4%, up from 8.3% in 2002 and 7.6% for 2001. If Liggett's
market share declines, Liggett's sales volume, operating income and cash flows
could be negatively affected, which in turn could negatively affect the value of
our common stock.
THE DOMESTIC CIGARETTE INDUSTRY HAS EXPERIENCED DECLINING UNIT SALES IN RECENT
PERIODS
Industry-wide shipments of cigarettes in the United States have been
generally declining for a number of years, with published industry sources
estimating that domestic industry-wide shipments decreased by approximately 5.1%
during 2003. According to Management Science Associates data, domestic
industry-wide shipments decreased by 3.7% in 2002 compared to 2001 and by 3.2%
in 2001 compared to 2000. Liggett's management believes that industry-wide
shipments of cigarettes in the United States will generally continue to decline
as a result of numerous factors. These factors include health considerations,
diminishing social acceptance of smoking, and a wide variety of federal, state
and local laws limiting smoking in restaurants and other public places, as well
as federal and state excise tax increases and settlement-related expenses which
have contributed to high cigarette price levels in recent years. If this decline
in industry shipments continues and Liggett is unable to capture market share
from its competitors, or if the industry is unable to offset the decline in unit
sales with price increases, Liggett's sales volume, operating income and cash
flows could be negatively affected, which in turn could negatively affect the
value of our common stock.
LITIGATION AND REGULATION WILL CONTINUE TO HARM THE TOBACCO INDUSTRY
The cigarette industry continues to be challenged on numerous fronts.
New cases continue to be commenced against Liggett and other cigarette
manufacturers. As of December 31, 2003, there were approximately 377 individual
suits, 32 purported class actions and 18 governmental and other third-party
payor health care reimbursement actions pending in the United States in which
Liggett was a named defendant. A civil lawsuit has been filed by the
28
United States federal government seeking disgorgement of approximately $289
billion from various cigarette manufacturers, including Liggett. In addition to
these cases, in 2000, an action against cigarette manufacturers involving
approximately 1,050 named individual plaintiffs was consolidated before a single
West Virginia state court. Liggett is a defendant in most of the cases pending
in West Virginia. In January 2002, the court severed Liggett from the trial of
the consolidated action. There are eight individual actions where Liggett is the
only defendant, with three of these cases currently scheduled for trial between
March 2004 and August 2004. Approximately 38 purported class action complaints
have been filed against the cigarette manufacturers for alleged antitrust
violations. As new cases are commenced, the costs associated with defending
these cases and the risks relating to the inherent unpredictability of
litigation continue to increase.
In May 2003, a Florida intermediate appellate court overturned a $790
million punitive damages award against Liggett and decertified the Engle smoking
and health class action. Class counsel is pursuing various appellate remedies
seeking to reverse the appellate court's decision. If the appellate court's
ruling is not upheld on further appeal, it will have a material adverse effect
on us. In November 2000, Liggett filed the $3.45 million bond required under the
bonding statute enacted in 2000 by the Florida legislature which limits the size
of any bond required, pending appeal, to stay execution of a punitive damages
verdict. In May 2001, Liggett reached an agreement with the class in the Engle
case, which provided assurance to Liggett that the stay of execution, in effect
under the Florida bonding statute, would not be lifted or limited at any point
until completion of all appeals, including to the United States Supreme Court.
As required by the agreement, Liggett paid $6.27 million into an escrow account
to be held for the benefit of the Engle class, and released, along with
Liggett's existing $3.45 million statutory bond, to the court for the benefit of
the class upon completion of the appeals process, regardless of the outcome of
the appeal. In June 2002, the jury in an individual case brought under the third
phase of the Engle case awarded $37.5 million (subsequently reduced by the court
to $25.1 million) of compensatory damages against Liggett and two other
defendants and found Liggett 50% responsible for the damages. The verdict, which
is subject to the outcome of the Engle appeal, has been overturned as a result
of the appellate court's ruling. It is possible that additional cases could be
decided unfavorably and that there could be further adverse developments in the
Engle case. Management cannot predict the cash requirements related to any
future settlements and judgments, including cash required to bond any appeals,
and there is a risk that those requirements will not be able to be met.
In recent years, there have been a number of restrictive regulatory
actions from various Federal administrative bodies, including the United States
Environmental Protection Agency and the Food and Drug Administration. There have
also been adverse political decisions and other unfavorable developments
concerning cigarette smoking and the tobacco industry, including the
commencement and certification of class actions and the commencement of
third-party payor actions. These developments generally receive widespread media
attention. We are not able to evaluate the effect of these developing matters on
pending litigation or the possible commencement of additional litigation, but
our consolidated financial position, results of operations or cash flows could
be materially adversely affected by an unfavorable outcome in any
smoking-related litigation.
LIGGETT HAS SIGNIFICANT SALES TO A SINGLE CUSTOMER
During 2003, 16.6% of Liggett's revenues, 17.7% of Liggett's revenues
in the discount segment and 15.6% of our consolidated revenues were to Liggett's
largest customer. If this customer discontinues its relationship with Liggett or
experiences financial difficulties, Liggett's results of operations could be
materially adversely affected.
EXCISE TAX INCREASES ADVERSELY AFFECT CIGARETTE SALES
Cigarettes are subject to substantial and increasing federal, state and
local excise taxes. The federal excise tax on cigarettes is currently $0.39 per
pack. State and local sales and excise
29
taxes vary considerably and, when combined with sales taxes, local taxes and the
current federal excise tax, may currently exceed $4.00 per pack. In 2003, 15
states and the District of Columbia enacted increases in excise taxes. Congress
has considered significant increases in the federal excise tax or other payments
from tobacco manufacturers, and several states have pending legislation
proposing further state excise tax increases. In 2004, several states are likely
to impose additional taxes on cigarettes. Management believes that increases in
excise and similar taxes have had an adverse impact on sales of cigarettes.
Further substantial federal or state excise tax increases could accelerate the
trend away from smoking and could have an unfavorable effect on Liggett's sales
and profitability, which in turn could negatively affect the value of our common
stock.
VECTOR TOBACCO IS SUBJECT TO RISKS INHERENT IN NEW PRODUCT DEVELOPMENT
INITIATIVES
We have made and plan to continue to make significant investments in
Vector Tobacco's development projects in the tobacco industry. Vector Tobacco is
in the business of the development and marketing of the low nicotine and
nicotine-free QUEST cigarette products and the development of reduced risk
cigarette products. These initiatives are subject to high levels of risk,
uncertainties and contingencies, including the challenges inherent in new
product development. There is a risk that continued investments in Vector
Tobacco will harm results of operations, liquidity or cash flow.
The substantial risks facing Vector Tobacco include:
Risks of market acceptance of the new products. In November 2001,
Vector Tobacco launched nationwide its reduced carcinogen OMNI cigarettes.
During 2002, acceptance of OMNI in the marketplace was limited, with revenues of
only approximately $5.1 million on sales of 70.7 million units. During 2003,
OMNI sales activity was minimal as Vector Tobacco has not been actively
marketing the OMNI product. Vector Tobacco was unable to achieve the anticipated
breadth of distribution and sales of the OMNI product due, in part, to the lack
of success of its advertising and marketing efforts in differentiating OMNI with
consumers through the "reduced carcinogen" message. Over the next several years,
our in-house research program, together with third-party collaborators, plans to
conduct appropriate studies as to the human effects of OMNI's reduction of
carcinogens and, based on these studies, management will review the marketing
and positioning of the OMNI brand in order to formulate a strategy for its
long-term success. OMNI has not been a commercially successful product to date,
and there is a risk management will be unable to significantly increase the
level of OMNI sales in the future.
Vector Tobacco introduced its low nicotine and nicotine-free QUEST
cigarettes in an initial seven-state market in January 2003 and in Arizona in
January 2004. A national launch of the QUEST brands would require the
expenditure of substantial additional sums for advertising and sales promotion,
with no assurance of consumer acceptance. Low nicotine and nicotine-free
cigarettes may not be accepted ultimately by adult smokers and may also not
prove to be commercially successful products. Adult smokers may decide not to
purchase cigarettes made with low nicotine and nicotine-free tobaccos due to
taste or other preferences, or due to the use of genetically modified tobacco or
other product modifications.
Third party allegations that Vector Tobacco products are unlawful or
bear deceptive or unsubstantiated product claims. Vector Tobacco is engaged in
the development and marketing of low nicotine and nicotine-free cigarettes and
the development of reduced risk cigarette products. With respect to OMNI,
reductions in carcinogens have not yet been proven to result in a safer
cigarette. Like other cigarettes, the OMNI and QUEST products also produce tar,
carbon monoxide, other harmful by-products, and, in the case of OMNI, increased
levels of nitric oxide and formaldehyde. There are currently no specific
governmental standards or parameters for these products and product claims.
There is a risk that federal or state regulators may object to Vector Tobacco's
reduced carcinogen and low nicotine and nicotine-free cigarette products as
unlawful or allege they bear deceptive or unsubstantiated product claims, and
seek the removal of the products from the marketplace, or significant changes to
advertising. Various concerns regarding Vector Tobacco's advertising practices
have been expressed to Vector Tobacco by certain state attorneys general. Vector
Tobacco has been engaged in discussions in an effort to
30
resolve these concerns. Allegations by federal or state regulators, public
health organizations and other tobacco manufacturers that Vector Tobacco's
products are unlawful, or that its public statements or advertising contain
misleading or unsubstantiated health claims or product comparisons, may result
in litigation or governmental proceedings. Vector Tobacco's defense against such
claims could require it to incur substantial expense and to divert significant
efforts of its scientific and marketing personnel. An adverse determination in a
judicial proceeding or by a regulatory agency could have a material and adverse
impact on Vector Tobacco's business, operating results and prospects.
Potential extensive government regulation. Vector Tobacco's business
may become subject to extensive domestic and international government
regulation. Various proposals have been made for federal, state and
international legislation to regulate cigarette manufacturers generally, and
reduced constituent cigarettes specifically. It is possible that laws and
regulations may be adopted covering issues like the manufacture, sale,
distribution and labeling of tobacco products as well as any health claims
associated with reduced carcinogen and low nicotine and nicotine-free cigarette
products and the use of genetically modified tobacco. A system of regulation by
agencies like the Food and Drug Administration, the Federal Trade Commission or
the United States Department of Agriculture may be established. In addition, a
group of public health organizations submitted a petition to the Food and Drug
Administration, alleging that the marketing of the OMNI product is subject to
regulation by the FDA under existing law. Vector Tobacco has filed a response in
opposition to the petition. The FTC has also expressed interest in the
regulation of tobacco products made by tobacco manufacturers, including Vector
Tobacco, which bear reduced carcinogen claims. The ultimate outcome of any of
the foregoing cannot be predicted, but any of the foregoing could have a
material adverse impact on Vector Tobacco's business, operating results and
prospects.
Competition from other cigarette manufacturers with greater resources.
The cigarette industry is highly competitive. Vector Tobacco's competitors
generally have substantially greater resources than Vector Tobacco has,
including financial, marketing and personnel resources. Other major tobacco
companies have stated that they are working on reduced risk cigarette products
and have made publicly available at this time only limited additional
information concerning their activities. Philip Morris has announced it is
developing products that potentially reduce smokers' exposure to harmful
compounds in cigarette smoke and may introduce such a product during 2004. RJR
has stated that in 2003 it began a phased expansion into a select number of
retail chain outlets of a cigarette product that primarily heats rather than
burns tobacco, which it claims reduces the toxicity of its smoke. In 2002, Brown
& Williamson Tobacco Corporation announced it was test marketing a new cigarette
with reduced levels of many toxins which it may introduce on a national basis.
There is a substantial likelihood that other major tobacco companies will
continue to introduce new products that are designed to compete directly with
Vector Tobacco's reduced carcinogen and low nicotine and nicotine-free products.
Recoverability of costs of inventory. At December 31, 2003,
approximately $44.2 million of our inventory was associated with Vector
Tobacco's new product initiatives. We estimate an inventory reserve for excess
quantities and obsolete items, taking into account future demand and market
conditions. If actual demand or market conditions in the future are less
favorable then those estimated, additional inventory write-downs may be
required.
Potential disputes concerning intellectual property. Vector Tobacco's
ability to commercially exploit its proprietary technology for its reduced
carcinogen and low nicotine and nicotine-free products depends in large part on
its ability to obtain and defend issued patents, to obtain further patent
protection for the technology in the United States and other jurisdictions, and
to operate without infringing on the patents and proprietary rights of others
both in the United States and abroad. Additionally, it must be able to obtain
appropriate licenses to patents or proprietary rights held by third parties if
infringement would otherwise occur, both in the United States and in foreign
countries.
31
Intellectual property rights, including Vector Tobacco's patents (owned
or licensed), involve complex legal and factual issues. Any conflicts resulting
from third party patent applications and granted patents could significantly
limit Vector Tobacco's ability to obtain meaningful patent protection or to
commercialize its technology. If necessary patents currently exist or are issued
to other companies that contain competitive or conflicting claims, Vector
Tobacco may be required to obtain licenses to these patents or to develop or
obtain alternative technology. Licensing agreements, if required, may not be
available on acceptable terms or at all. If licenses are not obtained, Vector
Tobacco could be delayed in or prevented from pursuing the further development
or marketing of its new cigarette products. Any alternative technology, if
feasible, could take several years to develop.
Litigation which could result in substantial cost may also be necessary
to enforce any patents to which Vector Tobacco has rights, or to determine the
scope, validity and unenforceability of other parties' proprietary rights which
may affect its rights. Vector Tobacco may also have to participate in
interference proceedings declared by the U.S. Patent and Trademark Office to
determine the priority of an invention or opposition proceedings in foreign
counties or jurisdictions, which could result in substantial costs. There is a
risk that its licensed patents would be held invalid by a court or
administrative body or that an alleged infringer would not be found to be
infringing. The mere uncertainty resulting from the institution and continuation
of any technology-related litigation, interference proceedings or oppositions
could have a material and adverse effect on Vector Tobacco's business, operating
results and prospects.
Vector Tobacco may also rely on unpatented trade secrets and know-how
to maintain its competitive position, which it seeks to protect, in part, by
confidentiality agreements with employees, consultants, suppliers and others.
There is a risk that these agreements will be breached or terminated, that
Vector Tobacco will not have adequate remedies for any breach, or that its trade
secrets will otherwise become known or be independently discovered by
competitors.
Dependence on key scientific personnel. Vector Tobacco's business
depends for its continued development and growth on the continued services of
key scientific personnel. The loss of Dr. Anthony Albino, Vice President of
Public Health, Dr. Robert Bereman, Vice President of Chemical Research, or Dr.
Mark A. Conkling, Vice President of Genetic Research, could have a serious
negative impact upon Vector Tobacco's business, operating results and prospects.
Ability to raise capital and manage growth of business. If Vector
Tobacco succeeds in introducing to market and increasing consumer acceptance for
its new cigarette products, Vector Tobacco will be required to obtain
significant amounts of additional capital and manage substantial volume from its
customers. There is a risk that adequate amounts of additional capital will not
be available to Vector Tobacco to fund the growth of its business. To
accommodate growth and compete effectively, Vector Tobacco will also be required
to attract, integrate, motivate and retain additional highly skilled sales,
technical and other employees. Vector Tobacco will face competition for these
people. Its ability to manage volume also will depend on its ability to scale up
its tobacco processing, production and distribution operations. There is a risk
that it will not succeed in scaling its processing, production and distribution
operations and that its personnel, systems, procedures and controls will not be
adequate to support its future operations.
Potential delays in obtaining tobacco, other raw materials and any
technology needed to produce products. Vector Tobacco is dependent on third
parties to produce tobacco and other raw materials that Vector Tobacco requires
to manufacture its products. In addition, the growing of new tobacco and new
seeds is subject to adverse weather conditions. Vector Tobacco may also need to
obtain licenses to technology subject to patents or proprietary rights of third
parties to produce its products. The failure by such third parties to supply
Vector Tobacco with tobacco, other raw materials and technology on commercially
reasonable terms, or at all, in the absence of readily available alternative
sources, would have a serious negative impact on Vector Tobacco's business,
operating results and prospects. There is also a risk that interruptions in the
supply of
32
these materials and technology may occur in the future. Any interruption in
their supply could have a serious negative impact on Vector Tobacco.
THE ACTUAL COSTS AND SAVINGS ASSOCIATED WITH THE CLOSING OF VECTOR TOBACCO'S
TIMBERLAKE MANUFACTURING FACILITY MAY DIFFER MATERIALLY FROM THE AMOUNTS WE HAVE
CURRENTLY ESTIMATED
In October 2003, we announced we would close Vector Tobacco's
Timberlake, North Carolina cigarette manufacturing facility in order to reduce
excess cigarette production capacity and improve operating efficiencies
company-wide. As of January 1, 2004, all production of Vector Tobacco's brands
has been moved to Liggett's Mebane facility. We currently expect to realize
significant annual cost savings beginning in 2004 and have taken in 2003 and
will take in 2004 pre-tax restructuring and impairment charges currently
estimated to total approximately $21.5 million, which include asset impairment
charges of $18.8 million. There is a risk that the actual cost savings realized
may differ materially from the amounts currently estimated by us. In addition,
the asset impairment charges are based on management's current estimates of the
values we will be able to realize on sales of excess machinery and equipment.
There is a risk that these values will not be obtained or that the costs of sale
will be greater than expected, and the asset impairment charges may be
materially adjusted in future periods based on the actual amounts realized.
NEW VALLEY IS SUBJECT TO RISKS RELATING TO THE INDUSTRIES IN WHICH IT OPERATES
Risks of real estate ventures. New Valley has two significant
investments, Douglas Elliman Realty, LLC and the former Kona Surf Hotel in
Hawaii, where it holds only a 50% interest. New Valley must seek approval from
other parties for important actions regarding these joint ventures. Since these
other parties' interests may differ from those of New Valley, a deadlock could
arise that might impair the ability of the ventures to function. Such a deadlock
could significantly harm the ventures.
New Valley plans to pursue a variety of real estate development
projects. Development projects are subject to special risks including potential
increase in costs, inability to meet deadlines which may delay the timely
completion of projects, reliance on contractors who may be unable to perform and
the need to obtain various governmental and third party consents.
Risks relating to the residential brokerage business. Through its
investment in Douglas Elliman Realty, New Valley is subject to the risks and
uncertainties endemic to the residential brokerage business. Both Douglas
Elliman and Prudential Elliman Real Estate operate as franchisees of The
Prudential Real Estate Affiliates, Inc. Prudential Douglas Elliman operates each
of its offices under its franchiser's brand name, but generally does not own any
of the brand names under which it operates. The franchiser has significant
rights over the use of the franchised service marks and the conduct of the two
brokerage companies' business. Prudential Douglas Elliman's franchiser also has
the right to terminate Douglas Elliman's and Prudential Douglas Elliman's
franchises, upon the occurrence of certain events, including a bankruptcy or
insolvency event, a change in control, a transfer of rights under the franchise
agreements and a failure to promptly pay amounts due under the franchise
agreements. A termination of Douglas Elliman's or Prudential Douglas Elliman's
franchise agreement could adversely affect New Valley's investment in Douglas
Elliman Realty.
Interest rates in the United States are currently at 40-year lows. The
low interest rate environment in recent years has significantly contributed to
high levels of existing home sales and residential prices and has positively
impacted Douglas Elliman Realty's operating results. However, the residential
real estate market tends to be cyclical and typically is affected by changes in
the general economic conditions that are beyond Douglas Elliman Realty's
control. Any of the following could have a material adverse effect on Douglas
Elliman Realty's residential business by causing a general decline in the number
of home sales and/or prices, which in turn, could adversely affect its revenues
and profitability:
33
- periods of economic slowdown or recession,
- a change in the current low interest rate environment
resulting in rising interest rates,
- decreasing home ownership rates, or
- declining demand for real estate.
All of Douglas Elliman Realty's current operations are located in the
New York metropolitan area. Local and regional economic conditions in this
market could differ materially from prevailing conditions in other parts of the
country. A downturn in the residential real estate market or economic conditions
in that region could have a material adverse effect on Douglas Elliman Realty
and New Valley's investment in that company.
NEW VALLEY'S POTENTIAL INVESTMENTS ARE UNIDENTIFIED AND MAY NOT SUCCEED
New Valley currently holds a significant amount of marketable
securities and cash not committed to any specific investments. This subjects a
security holder to increased risk and uncertainty because a security holder will
not be able to evaluate how this cash will be invested and the economic merits
of particular investments. There may be substantial delay in locating suitable
investment opportunities. In addition, New Valley may lack relevant management
experience in the areas in which New Valley may invest. There is a risk that New
Valley will fail in targeting, consummating or effectively managing any of these
investments.
WE DEPEND ON OUR KEY PERSONNEL
We depend on the efforts of our executive officers and other key
personnel. While we believe that we could find replacements for these key
personnel, the loss of their services could have a significant adverse effect on
our operations.
WE AND NEW VALLEY HAVE MANY POTENTIALLY DILUTIVE SECURITIES OUTSTANDING
At December 31, 2003, we had outstanding options granted to employees
to purchase 9,639,229 shares of our common stock, at prices ranging from $3.92
to $39.48 per share, of which options for 8,694,607 shares were exercisable at
December 31, 2003. The issuance of these shares will cause dilution which may
adversely affect the market price of our common stock. The availability for sale
of significant quantities of our common stock could adversely affect the
prevailing market price of the stock.
As part of New Valley's recapitalization, a total of 17,867,438
warrants expiring June 14, 2004 to purchase common shares were issued to New
Valley's stockholders. The potential issuance of common shares on exercise of
the warrants would increase the number of New Valley's common shares outstanding
by more than 80% and decrease our holdings.
OUR STOCK PRICE HAS BEEN VOLATILE
The trading price of our common stock has fluctuated widely, ranging
between $10.44 and $18.25 per share over the past 52 weeks. The overall market
and the price of our common stock may continue to fluctuate greatly. The trading
price of our common stock may be significantly affected by various factors,
including:
34
- the depth and liquidity of the trading market for our common
stock,
- quarterly variations in its actual or anticipated operating
results,
- changes in investors' and analysts' perceptions of the
business and legal risks facing us and the tobacco industry,
- changes in estimates of our earnings by investors and
analysts, and
- announcements or activities by our competitors.
ITEM 2. PROPERTIES
Our and New Valley's principal executive offices are located in Miami,
Florida. We lease 12,356 square feet of office space from an unaffiliated
company in an office building in Miami, which we share with New Valley and
various of our and their subsidiaries. New Valley has entered into an
expense-sharing arrangement for its use of such office space. We are currently
in discussion to extend the term of the lease which expires in November 2004.
We lease approximately 18,000 square feet of office space in New York,
New York under leases that expire in 2013. New Valley's operating properties are
discussed above under the description of New Valley's business.
Substantially all of Liggett's tobacco manufacturing facilities,
consisting principally of factories, distribution and storage facilities, are
located in or near Mebane and Durham, North Carolina. Such facilities are both
owned and leased. As of December 31, 2003, the principal properties owned or
leased by Liggett are as follows:
OWNED APPROXIMATE
OR TOTAL SQUARE
TYPE LOCATION LEASED FOOTAGE
---- -------- ------ -------
Office and
Manufacturing Complex Durham, NC Owned 836,000
Warehouse Durham, NC Leased 203,000
Storage Facilities Danville, VA Owned 578,000
Office and
Manufacturing Complex Mebane, NC Owned 240,000
Warehouse Mebane, NC Owned 60,000
Warehouse Mebane, NC Leased 30,000
Liggett's Durham, North Carolina complex consists of seven major
structures over approximately nine acres. Included are Liggett's former
manufacturing plant, a research facility and offices. Liggett leases portions of
these facilities to Vector Tobacco and Vector Research Ltd.
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. The option agreement permits the purchaser to acquire
the property, during a period of up to two years, at a purchase price of $14
million if the closing occurs by August 23, 2004 and $15 million if the closing
occurs thereafter during the term of the option. Liggett has received option
fees of $1 million, of which $0.25 million is refundable if the purchaser
terminates the agreement prior to August 23, 2004. Liggett will be entitled to
receive additional option fees of up to $0.5 million during the remaining option
period. The option fees will generally be creditable against the purchase price.
The purchaser is currently conducting due diligence, and there can be no
assurance the sale of the property will occur.
35
In November 1999, 100 Maple LLC, a newly formed entity owned by
Liggett, purchased an approximately 240,000 square foot manufacturing facility
located on 42 acres in Mebane, North Carolina. In October 2000, Liggett
completed a 60,000 square foot warehouse addition at the Mebane facility, and
finished the relocation of its tobacco manufacturing operations to Mebane.
Liggett also leases a 30,000 square foot warehouse in Mebane.
In June 2001, a subsidiary of Vector Tobacco purchased an approximately
350,000 square foot manufacturing facility located on approximately 56 acres in
Timberlake, North Carolina. In the first quarter of 2002, Vector Tobacco began
production at the facility. As of January 1, 2004, the Timberlake facility has
been closed, and production of Vector Tobacco's brands has been moved to
Liggett's Mebane facility. Vector Tobacco has entered into negotiations to sell
the Timberlake facility, including all equipment not relocated to Mebane.
Liggett Vector Brands leases approximately 24,000 square feet of space
in Research Triangle Park, North Carolina. The lease expires in October 2007.
Liggett's management believes that its property, plant and equipment
are well maintained and in good condition and that its existing facilities are
sufficient to accommodate a substantial increase in production.
ITEM 3. LEGAL PROCEEDINGS
Liggett (and, in certain cases, Brooke Group Holding) and other United
States cigarette manufacturers have been named as defendants in numerous direct,
third-party and class actions predicated on the theory that they should be
liable for damages from adverse health effects alleged to have been caused by
cigarette smoking or by exposure to secondary smoke from cigarettes. See Item 1.
"Business -- Liggett Group Inc. -- Legislation, Regulation and Litigation."
Reference is made to Note 16 to our consolidated financial statements, which
contains a general description of certain legal proceedings to which Brooke
Group Holding, Liggett, New Valley or their subsidiaries are a party and certain
related matters. Reference is also made to Exhibit 99.1, Material Legal
Proceedings, incorporated herein, for additional information regarding the
pending smoking-related material legal proceedings to which Brooke Group Holding
and/or Liggett are party. A copy of Exhibit 99.1 will be furnished without
charge upon written request to us at our principal executive offices, 100 S.E.
Second Street, Miami, Florida 33131, Attn: Investor Relations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the last quarter of 2003, no matter was submitted to
stockholders for their vote or approval, through the solicitation of proxies or
otherwise.
EXECUTIVE OFFICERS OF THE REGISTRANT
The table below, together with the accompanying text, presents certain
information regarding all our current executive officers as of March 12, 2004.
Each of the executive officers serves until the election and qualification of
such individual's successor or until such individual's death, resignation or
removal by the Board of Directors of the respective company.
36
YEAR INDIVIDUAL
BECAME AN
NAME AGE POSITION EXECUTIVE OFFICER
---- --- -------- -----------------
Bennett S. LeBow 66 Chairman of the Board 1990
and Chief Executive
Officer
Howard M. Lorber 55 President and Chief 2001
Operating Officer
Richard J. Lampen 50 Executive Vice President 1996
Joselynn D. Van Siclen 63 Vice President, Chief 1996
Financial Officer and
Treasurer
Marc N. Bell 43 Vice President, General 1998
Counsel and Secretary
Ronald J. Bernstein 50 President and Chief 2000
Executive Officer of
Liggett
BENNETT S. LEBOW has been our Chairman of the Board and Chief Executive
Officer since June 1990 and has been a director of ours since October 1986.
Since November 1990, he has been Chairman of the Board and Chief Executive
Officer of VGR Holding. Mr. LeBow has served as President and Chief Executive
Officer of Vector Tobacco since January 2001 and as a director since October
1999. Mr. LeBow has been Chairman of the Board of New Valley since January 1988
and Chief Executive Officer since November 1994.
HOWARD M. LORBER has been our President and Chief Operating Officer and
a director of ours since January 2001. Since January 2001, Mr. Lorber has served
as President and Chief Operating Officer of VGR Holding. Since November 1994,
Mr. Lorber has served as President and Chief Operating Officer of New Valley,
where he also serves as a director. Mr. Lorber has been Chairman of the Board of
Hallman & Lorber Assoc., Inc., consultants and actuaries of qualified pension
and profit sharing plans, and various of its affiliates since 1975; a
stockholder and a registered representative of Aegis Capital Corp., a
broker-dealer and a member firm of the National Association of Securities
Dealers, since 1984; Chairman of the Board of Directors since 1987 and Chief
Executive Officer since November 1993 of Nathan's Famous, Inc., a chain of fast
food restaurants; a consultant to us and Liggett from January 1994 to January
2001; a director of United Capital Corp., a real estate investment and
diversified manufacturing company, since May 1991; a director of Prime
Hospitality Corp., a company doing business in the lodging industry, since May
1994; and Chairman of the Board of Ladenburg Thalmann Financial Services since
May 2001. He is also a trustee of Long Island University.
RICHARD J. LAMPEN has served as the Executive Vice President of us and
of VGR Holding since July 1996. Since October 1995, Mr. Lampen has served as the
Executive Vice President of New Valley and since November 1998 as President and
Chief Executive Officer of CDSI Holdings Inc., an affiliate of New Valley with
an interest in a direct mail and telemarketing services company. From May 1992
to September 1995, Mr. Lampen was a partner at Steel Hector & Davis, a law firm
located in Miami, Florida. From January 1991 to April 1992, Mr. Lampen was a
Managing Director at Salomon Brothers Inc, an investment bank, and was an
employee at Salomon Brothers Inc from 1986 to April 1992. Mr. Lampen is a
director of New Valley, CDSI Holdings and Ladenburg Thalmann Financial Services.
Mr. Lampen has served as a director of a number of other companies, including
U.S. Can Corporation, The International Bank of Miami, N.A. and Spec's Music
Inc., as well as a court-appointed independent director of Trump Plaza Funding,
Inc.
37
JOSELYNN D. VAN SICLEN has been Vice President, Chief Financial Officer
and Treasurer of us and of VGR Holding since May 1996, and currently holds
various positions with certain of VGR Holding's subsidiaries, including Vice
President and Treasurer of Eve since April 1994 and May 1996, respectively.
Prior to May 1996, Ms. Van Siclen served as our Director of Finance and was
employed in various accounting capacities with our subsidiaries since 1992.
Since before 1990 to November 1992, Ms. Van Siclen was an audit manager for the
accounting firm of Coopers & Lybrand L.L.P.
MARC N. BELL has been the Vice President of us and of VGR Holding since
January 1998, the General Counsel and Secretary of us and of VGR Holding since
May 1994 and the Senior Vice President and General Counsel of Vector Tobacco
since April 2002. Since November 1994, Mr. Bell has served as Associate General
Counsel and Secretary of New Valley and since February 1998, as Vice President
of New Valley. Prior to May 1994, Mr. Bell was with the law firm of Zuckerman
Spaeder LLP in Miami, Florida and from June 1991 to May 1993, with the law firm
of Fischbein o Badillo o Wagner o Harding in New York, New York.
RONALD J. BERNSTEIN has served as President and Chief Executive Officer
of Liggett since September 1, 2000 and of Liggett Vector Brands since March 2002
and has been a director of ours since March 2004. From July 1996 to December
1999, Mr. Bernstein served as General Director and, from December 1999 to
September 2000, as Chairman of Liggett-Ducat. Prior to that time, Mr. Bernstein
served in various positions with Liggett commencing in 1991, including Executive
Vice President and Chief Financial Officer.
38
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is listed and traded on the New York Stock Exchange
under the symbol "VGR". The following table sets forth, for the periods
indicated, high and low sale prices for a share of its common stock on the NYSE,
as reported by the NYSE, and quarterly cash dividends declared on shares of
common stock:
CASH
YEAR HIGH LOW DIVIDENDS
---- ---- --- ---------
2003:
Fourth Quarter $ 17.25 $ 14.31 $.40
Third Quarter 17.38 13.32 .38
Second Quarter 17.19 10.44 .38
First Quarter 13.81 10.47 .38
2002:
Fourth Quarter $ 13.18 $ 8.92 $.38
Third Quarter 16.19 11.69 .36
Second Quarter 25.94 13.83 .36
First Quarter 29.88 21.10 .36
At March 12, 2004, there were approximately 410 holders of record of
our common stock.
The declaration of future cash dividends is within the discretion of
our Board of Directors and is subject to a variety of contingencies such as
market conditions, earnings and our financial condition as well as the
availability of cash.
The payment of dividends and other distributions to us by VGR Holding
are subject to the note purchase agreement for VGR Holding's senior secured
notes. The agreement limits the ability of VGR Holding to make distributions to
us to 50% of VGR Holding's net income, unless VGR Holding holds $70 million in
cash after giving effect to the payment of the distribution.
Liggett's revolving credit agreement currently prohibits Liggett from
paying dividends to VGR Holding unless Liggett's borrowing availability exceeds
$5 million for the thirty days prior to payment of the dividend, and immediately
after giving effect to the dividend, and it is in compliance with the covenants
in the credit facility, including an adjusted net worth and working capital
requirement.
We paid 5% stock dividends on September 28, 2001, September 27, 2002
and September 29, 2003 to the holders of our common stock. All information
presented in this report is adjusted for the stock dividends.
RECENT SALES OF UNREGISTERED SECURITIES
No securities of ours which were not registered under the Securities
Act of 1933 have been issued or sold by us during the fourth quarter of 2003.
39
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31,
--------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(dollars in thousands, except per share amounts)
STATEMENT OF OPERATIONS DATA:
Revenues(1), (4) ................................. $ 536,683 $ 503,418 $ 447,382 $ 415,055 $ 344,193
(Loss) income from continuing operations ......... (15,610) (31,794) 21,200 167,754 235,763
(Loss) income from discontinued operations ....... - - (537) 8,285 1,570
Loss from extraordinary items(2) ................. - - - (1,821) (1,660)
Net (loss) income ................................ (15,610) (31,794) 20,663 174,218 235,673
Per basic common share(3):
(Loss) income from continuing
operations ............................... $ (0.40) $ (0.87) $ 0.65 $ 6.16 $ 8.82
(Loss) income from discontinued operations .... - - $ (0.02) $ 0.30 $ 0.06
Loss from extraordinary items ................. - - - $ (0.06) $ (0.06)
Net (loss) income applicable to
common shares ............................ $ (0.40) $ (0.87) $ 0.63 $ 6.40 $ 8.82
Per diluted common share(3):
(Loss) income from continuing
operations ............................... $ (0.40) $ (0.87) $ 0.54 $ 5.23 $ 7.23
(Loss) income from discontinued operations .... - - $ (0.01) $ 0.26 $ 0.05
Loss from extraordinary items ................. - - - $ (0.06) $ (0.05)
Net (loss) income applicable to
common shares ............................ $ (0.40) $ (0.87) $ 0.53 $ 5.43 $ 7.23
Cash distributions declared per common
share(3) ...................................... $ 1.54 $ 1.47 $ 1.40 $ 1.08 $ 0.52
BALANCE SHEET DATA:
Current assets ................................... $ 315,377 $ 376,815 $ 515,727 $ 269,942 $ 188,732
Total assets ..................................... 628,212 707,270 688,903 425,848 504,448
Current liabilities .............................. 173,086 184,384 141,629 138,775 226,654
Notes payable, long-term debt and
other obligations, less current portion ....... 299,977 307,028 225,415 39,890 148,349
Noncurrent employee benefits, deferred
income taxes, minority interests and
other long-term liabilities ................... 201,624 193,561 208,501 234,734 262,543
Stockholders' equity (deficit) ................... (46,475) 22,297 113,358 12,449 (133,098)
- -----------------------
(1) Revenues include excise taxes of $195,342, $192,664, $151,174, $116,116 and
$66,698, respectively.
(2) Represents loss resulting from the early extinguishment of debt.
(3) Per share computations include the impact of 5% stock dividends on
September 29, 2003, September 27, 2002, September 28, 2001, September 28,
2000 and September 30, 1999.
(4) Revenues in 2002 include $35,199 related to the Medallion acquisition.
40
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(Dollars in Thousands, Except Per Share Amounts)
OVERVIEW
We are a holding company for a number of businesses. We are engaged
principally in:
- the manufacture and sale of cigarettes in the United States
through our subsidiary Liggett Group Inc., and
- the development and marketing of the low nicotine and
nicotine-free QUEST cigarette products and the development of
reduced risk cigarette products through our subsidiary Vector
Tobacco Inc.
During 2002, the sales and marketing functions, along with certain
support functions, of our Liggett and Vector Tobacco subsidiaries were combined
into a new entity, Liggett Vector Brands Inc. This company coordinates and
executes the sales and marketing efforts for all of our tobacco operations. With
the combined resources of Liggett and Vector Tobacco, Liggett Vector Brands has
enhanced distribution and marketing capabilities.
In October 2003, we announced that we would close Vector Tobacco's
Timberlake, North Carolina cigarette manufacturing facility in order to reduce
excess cigarette production capacity and improve operating efficiencies
company-wide. Production of QUEST and Vector Tobacco's other cigarette brands
has been moved to Liggett's state-of-the-art manufacturing facility in Mebane,
North Carolina.
We continue to explore various other opportunities to streamline the
cost structure of our tobacco business and improve long-term earnings. Such
activities may result in additional restructuring and impairment charges.
Our majority-owned subsidiary, New Valley Corporation, is currently
engaged in the real estate business and is seeking to acquire additional
operating companies. In December 2002, New Valley acquired two office buildings
in Princeton, New Jersey and increased its ownership to 50% in Douglas Elliman
Realty, LLC, which operates the largest residential brokerage company in the New
York metropolitan area.
Our conventional cigarette business, Liggett, shipped approximately 9.8
billion cigarettes during 2003 which accounted for 2.6% of the total cigarettes
shipped in the United States during that year. Approximately 94.6% of Liggett's
unit sales in 2003 were generated in the discount segment.
We believe that Liggett has gained a sustainable cost advantage over
its competitors through its various settlement agreements. Under the Master
Settlement Agreement reached in November 1998 with 46 state attorneys general
and various territories, Liggett's four major competitors must make settlement
payments to the states and territories based on how many cigarettes they sell
annually. Liggett, however, is not required to make any payments unless its
market share exceeds approximately 1.65% of the U.S. cigarette market.
Additionally, as a result of the Medallion acquisition, Vector Tobacco likewise
has no payment obligation unless its market share exceeds approximately 0.28% of
the U.S. market.
41
In recent years, the domestic tobacco business has experienced the
following trends:
- Declining unit volumes due to health considerations,
diminishing social acceptance of smoking, legislative
limitations on smoking in public places, federal and state
excise tax increases and settlement-related expenses which
have augmented cigarette prices,
- Narrower price spreads between the premium and traditional
discount segments resulting from aggressive premium price
promotions by larger competitors including Philip Morris and
RJR, while price spreads between the premium and deep discount
markets widen due to the influx of smaller companies producing
low quality, deep discount cigarettes, and
- Loss of discount market share for branded discount cigarettes
such as those sold by Liggett due to a significant increase in
market share by the smaller cigarette companies producing low
quality, deep discount cigarettes.
In January 2003, Vector Tobacco introduced QUEST, its brand of low
nicotine and nicotine-free cigarette products. QUEST is designed for adult
smokers who are interested in reducing their levels of nicotine intake and is
available in six different menthol and nonmenthol varieties, each with
decreasing amounts of nicotine - QUEST 1, 2 and 3. QUEST 1, the low nicotine
variety, contains 0.6 milligrams of nicotine. QUEST 2, the extra-low nicotine
variety, contains 0.3 milligrams of nicotine. QUEST 3, the nicotine-free
variety, contains only trace levels of nicotine - no more than 0.05 milligrams
of nicotine per cigarette. QUEST cigarettes utilize a proprietary process that
enables the production of nicotine-free tobacco that tastes and smokes like
tobacco in conventional cigarettes. All six QUEST varieties are being sold in
hard packs and are priced comparable to other premium brands.
QUEST is initially available in New York, New Jersey, Pennsylvania,
Ohio, Indiana, Illinois and Michigan. These seven states account for
approximately 30% of all cigarette sales in the United States. A multi-million
dollar advertising and marketing campaign, with advertisements running in
magazines and regional newspapers, supported the product launch. The brand
continues to be supported by significant point-of-purchase awareness campaigns,
as well as store related and periodic newspaper advertisements.
The premium segment of the industry is currently experiencing intense
competitive activity, with increased discounting of premium brands at all levels
of retail. Given these marketplace conditions, and the results that we have seen
to date with QUEST, we intend to take a measured approach to expanding the
market presence of the brand. In November 2003, Vector Tobacco introduced three
menthol varieties of QUEST in the seven state market. In addition, we are
utilizing the information that we have obtained since the introduction of the
QUEST non-menthol product to more specifically target our focus in the seven
state market in the coming months. Based upon those results, the success of the
menthol product and market conditions in the premium segment, we will make a
determination on the timing of a national launch of QUEST at a later date.
Vector Tobacco also introduced QUEST and QUEST Menthol into an
expansion market in Arizona in January 2004. Arizona accounts for approximately
1% of the industry volume nationwide.
QUEST brand cigarettes are currently marketed solely to permit adult
smokers, who wish to continue smoking, to gradually reduce their intake of
nicotine. The products are not labeled or advertised for smoking cessation or as
a safer form of smoking.
42
In October 2003, we announced that Jed E. Rose, Ph.D., Director of Duke
University Medical Center's Nicotine Research Program and co-inventor of the
nicotine patch, had conducted a study at Duke University Medical Center to
provide preliminary evaluation of the use of the QUEST technology as a smoking
cessation aid. In the preliminary study on QUEST, 33% of QUEST 3 smokers were
able to achieve four-week continuous abstinence, a standard threshold for
smoking cessation. Management believes these results show real promise for the
QUEST technology as a smoking cessation aid and has asked the Food and Drug
Administration to supply us with guidance as to the additional research and
regulatory filings necessary to market QUEST as a smoking cessation product.
In November 2001, Vector Tobacco launched nationwide OMNI, the first
reduced carcinogen cigarette that tastes, smokes and burns like other premium
cigarettes. The OMNI cigarettes are produced using a patent pending process
developed by Vector Tobacco. In comparison to comparable styles of the leading
U.S. cigarette brand, OMNI cigarettes produce significantly lower levels of many
of the recognized carcinogens and toxins that the medical community has
identified as major contributors to lung cancer and other diseases in smokers.
During 2002, acceptance of OMNI in the marketplace was limited, with revenues of
approximately $5,100 on sales of 70.7 million units. During 2003, OMNI sales
activity was minimal as Vector Tobacco has not been actively marketing the OMNI
product. Vector Tobacco was unable to achieve the anticipated breadth of
distribution and sales of the OMNI product, due in part, to the lack of success
of its advertising and marketing efforts in differentiating OMNI with consumers
through the "reduced carcinogen" message. Over the next several years,
our in-house research program, together with third-party collaborators, plans to
conduct appropriate studies as to the human effects of OMNI's reduction of
carcinogens and, based on these studies, management will review the marketing
and positioning of the OMNI brand in order to formulate a strategy for its
long-term success.
RECENT DEVELOPMENTS
Vector Tobacco Restructuring. On October 8, 2003, we announced that we
would close Vector Tobacco's Timberlake, North Carolina cigarette manufacturing
facility in order to reduce excess cigarette production capacity and improve
operating efficiencies company-wide. Production of the QUEST line of low
nicotine and nicotine-free cigarettes, as well as production of Vector Tobacco's
other cigarette brands, has been moved to Liggett's state-of-the-art
manufacturing facility in Mebane, North Carolina.
The Mebane facility currently produces in excess of 9 billion units per
year, but maintains the capacity to produce approximately 16 billion units per
year. Vector Tobacco has contracted with Liggett to produce its cigarettes and
has transitioned production from Timberlake to Mebane. All production ceased at
Timberlake by December 31, 2003. As part of the transition, we eliminated
approximately 150 positions.
As a result of these actions, we currently expect to realize annual
cost savings of approximately $23,000 beginning in 2004. We recognized pre-tax
restructuring and impairment charges of $21,300 in 2003, and additional charges
of approximately $222 will be taken in the first quarter 2004. Approximately
$2,045 relate to employee severance and benefit costs, $725 to contract
termination and exit and moving costs, and $18,752 to non-cash asset impairment
charges. Machinery and equipment to be disposed of was reduced to fair value
less costs to sell. The asset impairment charges are based on management's
current estimates of the values we will be able to realize on sales of excess
machinery and equipment, and may be adjusted in future periods based on the
actual amounts realized.
Vector Tobacco has entered into negotiations to sell the Timberlake
facility, including all equipment not relocated to Mebane.
Liggett Vector Brands. During 2002, the sales and marketing functions,
along with certain support functions, of our Liggett and Vector Tobacco
subsidiaries were combined into a new entity, Liggett Vector Brands Inc. This
company coordinates and executes the sales and
43
marketing efforts for all of our tobacco operations. With the combined resources
of Liggett and Vector Tobacco, Liggett Vector Brands has enhanced distribution
and marketing capabilities. In connection with the formation of the new Liggett
Vector Brands entity, we took a charge of approximately $3,460 in the first
quarter of 2002, related to the reorganization of our business. As of March 31,
2003, these restructuring activities had been substantially completed.
Acquisition of Medallion. On April 1, 2002, a subsidiary of ours
acquired the stock of The Medallion Company, Inc., and related assets from
Medallion's principal stockholder. The total purchase price consisted of $50,000
in cash and $60,000 in notes, with the notes guaranteed by us and Liggett.
Medallion, a discount cigarette manufacturer, is a participant in the Master
Settlement Agreement between the state Attorneys General and the tobacco
industry. Medallion has no payment obligations under the Master Settlement
Agreement unless its market share exceeds approximately 0.28% of total
cigarettes sold in the United States.
VGR Holding Notes. In connection with an amendment to the note purchase
agreement for VGR Holding's 10% senior secured notes due March 31, 2006, VGR
Holding repurchased a total of $8,000 of the notes in the second quarter of 2003
and $4,000 of the notes on September 30, 2003, at a price of 100% of the
principal amount plus accrued interest. We recognized losses of $1,721 in 2003
on the early extinguishment of debt.
Tax Matters. In connection with the 1998 and 1999 transaction with
Philip Morris Incorporated where a subsidiary of Liggett contributed three of
its premium cigarette brands to Trademarks LLC, a newly-formed limited liability
company, we recognized in 1999 a pre-tax gain of $294,078 in our consolidated
financial statements and established a deferred tax liability of $103,100
relating to the gain. In such transaction, Philip Morris acquired an option to
purchase the remaining interest in Trademarks for a 90-day period commencing in
December 2008, and we have an option to require Philip Morris to purchase the
remaining interest for a 90-day period commencing in March 2010. Upon exercise
of the options during the 90-day periods commencing in December 2008 or in March
2010, we will be required to pay tax in the amount of the deferred tax
liability, which will be offset by the benefit of any deferred tax assets,
including any net operating losses, available to us at that time. In connection
with an examination of our 1998 and 1999 federal income tax returns, the
Internal Revenue Service issued to us in September 2003 a notice of proposed
adjustment. The notice asserts that, for tax reporting purposes, the entire gain
should have been recognized in 1998 and in 1999 in the additional amounts of
$150,000 and $129,900, respectively, rather than upon the exercise of the
options during the 90-day periods commencing in December 2008 or in March 2010.
If the Internal Revenue Service were to ultimately prevail with the proposed
adjustment, it would result in the potential acceleration of tax payments of
approximately $117,000, including interest, net of tax benefits, through
December 31, 2003. These amounts have been previously recognized in our
consolidated financial statements as tax liabilities. As of December 31, 2003,
we believe amounts potentially due have been fully provided for in our
consolidated statements of operations.
We believe the positions reflected on our income tax returns are
correct and intend to vigorously oppose any proposed adjustments to our returns.
We have filed a protest with the Appeals Division of the Internal Revenue
Service. No payment is due with respect to these matters during the appeals
process. Interest currently is accruing on the disputed amounts at a rate of 6%,
with the rate adjusted quarterly based on rates published by the U.S. Treasury
Department. If taxing authorities were to ultimately prevail in their assertion
that we incurred a tax obligation prior to the exercise dates of these options
and we were required to make such tax payments prior to 2009 or 2010, and if any
necessary financing were not available to us, our liquidity could be adversely
affected.
Real Estate Acquisitions. In December 2002, New Valley purchased two
office buildings in Princeton, New Jersey for a total purchase price of $54,000.
New Valley financed a portion of the purchase price through a borrowing of
$40,500 from HSBC Realty Credit Corporation (USA).
44
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.
Also in December 2002, New Valley and the other owners of Prudential
Douglas Elliman Real Estate, formerly known as Prudential Long Island Realty,
contributed their interests in Prudential Douglas Elliman Real Estate to Douglas
Elliman Realty, formerly known as Montauk Battery Realty LLC, a newly formed
entity. New Valley acquired a 50% ownership interest in Douglas Elliman Realty,
an increase from its previous 37.2% interest in Prudential Douglas Elliman Real
Estate as a result of an additional investment of $1,413 by New Valley and the
redemption by Prudential Douglas Elliman Real Estate of various ownership
interests.
In March 2003, Douglas Elliman Realty purchased the leading New York
City-based residential brokerage firm, Douglas Elliman, LLC, formerly known as
Insignia Douglas Elliman, and an affiliated property management company for
$71,250. With that acquisition, the combination of Prudential Douglas Elliman
Real Estate with Douglas Elliman has created the largest residential brokerage
company in the New York metropolitan area. New Valley invested an additional
$9,500 in subordinated debt and equity of Douglas Elliman Realty to help fund
the acquisition. The subordinated debt, which has a principal amount of $9,500,
bears interest at 12% per annum and is due in March 2013.
RECENT DEVELOPMENTS IN LEGISLATION, REGULATION AND LITIGATION
The cigarette industry continues to be challenged on numerous fronts.
New cases continue to be commenced against Liggett and other cigarette
manufacturers. As of December 31, 2003, there were approximately 377 individual
suits, 32 purported class actions and 18 governmental and other third-party
payor health care reimbursement actions pending in the United States in which
Liggett was a named defendant. A civil lawsuit has been filed by the United
States federal government seeking disgorgement of approximately $289,000,000
from various cigarette manufacturers, including Liggett. In addition to these
cases, in 2000, an action against cigarette manufacturers involving
approximately 1,050 named individual plaintiffs was consolidated before a single
West Virginia state court. Liggett is a defendant in most of the cases pending
in West Virginia. In January 2002, the court severed Liggett from the trial of
the consolidated action. There are eight individual actions where Liggett is the
only defendant, with three of these cases currently scheduled for trial between
April 2004 and August 2004. Approximately 38 purported class action complaints
have been filed against the cigarette manufacturers for alleged antitrust
violations. As new cases are commenced, the costs associated with defending
these cases and the risks relating to the inherent unpredictability of
litigation continue to increase.
In May 2003, a Florida intermediate appellate court overturned a
$790,000 punitive damages award against Liggett and decertified the Engle
smoking and health class action. Class counsel is pursuing various appellate
remedies seeking to reverse the appellate court's decision. If the appellate
court's ruling is not upheld on further appeal, it will have a material adverse
effect on us. In November 2000, Liggett filed the $3,450 bond required under the
bonding statute enacted in 2000 by the Florida legislature which limits the size
of any bond required, pending appeal, to stay execution of a punitive damages
verdict. In May 2001, Liggett reached an agreement with the class in the Engle
case, which provided assurance to Liggett that the stay of execution, in effect
under the Florida bonding statute, would not be lifted or limited at any point
until completion of all appeals, including to the United States Supreme Court.
As required by the
45
agreement, Liggett paid $6,273 into an escrow account to be held for the benefit
of the Engle class, and released, along with Liggett's existing $3,450 statutory
bond, to the court for the benefit of the class upon completion of the appeals
process, regardless of the outcome of the appeal. In June 2002, the jury in an
individual case brought under the third phase of the Engle case awarded $37,500
(subsequently reduced by the court to $25,100) of compensatory damages against
Liggett and two other defendants and found Liggett 50% responsible for the
damages. The verdict, which is subject to the outcome of the Engle appeal, has
been overturned as a result of the appellate court's ruling discussed above. It
is possible that additional cases could be decided unfavorably and that there
could be further adverse developments in the Engle case. Management cannot
predict the cash requirements related to any future settlements and judgments,
including cash required to bond any appeals, and there is a risk that those
requirements will not be able to be met.
In recent years, there have been a number of restrictive regulatory
actions from various Federal administrative bodies, including the United States
Environmental Protection Agency and the Food and Drug Administration. There have
also been adverse political decisions and other unfavorable developments
concerning cigarette smoking and the tobacco industry, including the
commencement and certification of class actions and the commencement of
third-party payor actions. These developments generally receive widespread media
attention. We are not able to evaluate the effect of these developing matters on
pending litigation or the possible commencement of additional litigation, but
our consolidated financial position, results of operations or cash flows could
be materially adversely affected by an unfavorable outcome in any
smoking-related litigation. See Note 16 to our consolidated financial statements
for a description of legislation, regulation and litigation.
CRITICAL ACCOUNTING POLICIES
General. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities and the reported amounts of revenues and expenses. Significant
estimates subject to material changes in the near term include restructuring and
impairment charges, inventory valuation, deferred tax assets, allowance for
doubtful accounts, promotional accruals, sales returns and allowances, actuarial
assumptions of pension plans, settlement accruals and litigation and defense
costs. Actual results could differ from those estimates.
Revenue Recognition. Revenues from sales of cigarettes are recognized
upon the shipment of finished goods to the customer, there is persuasive
evidence of an arrangement, the sale price is determinable and collectibility is
reasonably assured. We provide an allowance for expected sales returns, net of
related inventory cost recoveries. Since our primary line of business is
tobacco, our financial position and our results of operations and cash flows
have been and could continue to be materially adversely effected by significant
unit sales volume declines, litigation and defense costs, increased tobacco
costs or reductions in the selling price of cigarettes in the near term.
Effective January 1, 2002, we adopted new required accounting standards
mandating that certain sales incentives previously reported as operating,
selling, general and administrative expenses be shown as a reduction of
operating revenues. The adoption of the new accounting standards did not have an
impact on our net earnings or basic or diluted earnings per share.
Marketing Costs. We record marketing costs as an expense in the period
to which such costs relate. We do not defer the recognition of any amounts on
our consolidated balance sheets with respect to marketing costs. We expense
advertising costs as incurred, which is the period in which the related
advertisement initially appears. We record consumer incentive and trade
promotion costs as an expense in the period in which these programs are offered,
based on estimates of utilization and redemption rates that are developed from
historical information. As discussed above under "Revenue Recognition",
beginning January 1, 2002, we have adopted the
46
previously mentioned revenue recognition accounting standards that mandate that
certain costs previously reported as marketing expense be shown as a reduction
of operating revenues. The adoption of the new accounting standards did not have
an impact on our net earnings or basic or diluted earnings per share.
Impairment of Long-Lived Assets. We evaluate our long-lived assets for
possible impairment whenever events or changes in circumstances indicate that
the carrying value of the asset, or related group of assets, may not be fully
recoverable. Examples of such events or changes in circumstances include a
significant adverse charge in the manner in which a long-lived asset, or group
of assets, is being used or a current expectation that, more likely than not, a
long-lived asset, or group of assets, will be disposed of before the end of its
estimated useful life.
In October 2003, we announced that we would close Vector Tobacco's
Timberlake, North Carolina cigarette manufacturing and produce its cigarette
products at Liggett's Mebane, North Carolina facility. We have evaluated the net
realizable value of the long-lived assets located at the Timberlake facility
which will no longer be used in operations. Based on management's current
estimates of the values we will be able to realize on sales of the excess
machinery and equipment, we have recognized non-cash asset impairment charges of
$18,752 in the third quarter of 2003. The estimate of fair value of these
long-lived assets is based on the best information available, including prices
for similar assets and the results of using other valuation techniques. Such
asset impairment charges may be adjusted in future periods based on the actual
amounts realized. Since judgment is involved in determining the fair value of
long-lived assets, there is a risk that the carrying value of our long-lived
assets may be overstated or understated.
Contingencies. We record Liggett's product liability legal expenses and
other litigation costs as operating, selling, general and administrative
expenses as those costs are incurred. As discussed in Note 16 of our
consolidated financial statements and above under the heading "Recent
Developments in Legislation, Regulation and Litigation", legal proceedings
covering a wide range of matters are pending or threatened in various
jurisdictions against Liggett. Management is unable to make a meaningful
estimate with respect to the amount or range of loss that could result from an
unfavorable outcome of pending smoking-related litigation or the costs of
defending such cases, and we have not provided any amounts in our consolidated
financial statements for unfavorable outcomes, if any. Litigation is subject to
many uncertainties, and it is possible that our consolidated financial position,
results of operations or cash flows could be materially adversely affected by an
unfavorable outcome in any such smoking-related litigation.
Settlement Agreements. As discussed in Note 16 to our consolidated
financial statements, Liggett and Vector Tobacco are participants in the Master
Settlement Agreement, the 1998 agreement to settle governmental healthcare cost
recovery actions brought by various states. Liggett and Vector Tobacco have no
payment obligations under the Master Settlement Agreement except to the extent
their market shares exceed approximately 1.65% and 0.28%, respectively, of total
cigarettes sold in the United States. Their obligations, and the related expense
charges under the Master Settlement Agreement, are subject to adjustments based
upon, among other things, the volume of cigarettes sold by Liggett and Vector
Tobacco, their relative market shares and inflation. Since relative market
shares are based on cigarette shipments, the best estimate of the allocation of
charges under the Master Settlement Agreement is recorded in cost of goods sold
as the products are shipped. Settlement expenses under the Master Settlement
Agreement recorded in the accompanying consolidated statements of operations
were $35,854 for 2003, $35,412 for 2002 and $25,354 for 2001. Adjustments to
these estimates are recorded in the period that the change becomes probable and
the amount can be reasonably estimated.
Inventories. Tobacco inventories are stated at lower of cost or market
and are determined primarily by the last-in, first-out (LIFO) method at Liggett
and the first-in, first-out (FIFO) method at Vector Tobacco. At December 31,
2003, approximately $44,220 of our
47
inventory was associated with Vector Tobacco's new product initiatives. Although
portions of leaf tobacco inventories may not be used or sold within one year
because of time required for aging, they are included in current assets, which
is common practice in the industry. We estimate an inventory reserve for excess
quantities and obsolete items based on specific identification and historical
write-offs, taking into account future demand and market conditions. If actual
demand or market conditions in the future are less favorable than those
estimated, additional inventory write-downs may be required.
Employee Benefit Plans. Since 1997, income from our defined benefit
pension plans, partially offset by the costs of postretirement medical and life
insurance benefits, have contributed to our reported operating income up to and
including 2002. The determination of our net pension and other postretirement
benefit income or expense is dependent on our selection of certain assumptions
used by actuaries in calculating such amounts. Those assumptions include, among
others, the discount rate, expected long-term rate of return on plan assets and
rates of increase in compensation and healthcare costs. In accordance with
accounting principles generally accepted in the United States of America, actual
results that differ from our assumptions are accumulated and amortized over
future periods and therefore, generally affect our recognized income or expense
in such future periods. While we believe that our assumptions are appropriate,
significant differences in our actual experience or significant changes in our
assumptions may materially affect our future net pension and other
postretirement benefit income or expense.
Based on the declines in the securities markets, we recorded a non-cash
charge of $11,090 net of tax to stockholders' equity in the fourth quarter of
2002 relating primarily to one of Liggett's defined benefit plans. The charge
was based on the extent to which our accumulated benefit obligations under the
pension plan on September 30, 2002 exceeded the fair value of the pension plan's
assets on that date. Net pension expense for defined benefit pension plans and
other postretirement benefit expense aggregated approximately $4,100 for 2003,
and we currently anticipate such expense will be approximately $3,700 for 2004.
In contrast, our funding obligations under the pension plans are governed by
ERISA. To comply with ERISA's minimum funding requirements, we do not currently
anticipate that we will be required to make any funding to the pension plans for
the pension plan year beginning on January 1, 2004 and ending on December 31,
2004. Any additional funding obligation that we may have for subsequent years is
contingent on several factors and is not reasonably estimable at this time.
RESULTS OF OPERATIONS
The following discussion provides an assessment of our results of
operations, capital resources and liquidity and should be read in conjunction
with our consolidated financial statements and related notes included elsewhere
in this report. The consolidated financial statements include the accounts of
VGR Holding, Liggett, Vector Tobacco, Liggett Vector Brands, New Valley and
other less significant subsidiaries. Our interest in New Valley's common shares
was 58.1% at December 31, 2003.
For purposes of this discussion and other consolidated financial
reporting, our significant business segments for each of the three years ended
December 31, 2003 were Liggett, Vector Tobacco and real estate. The Liggett
segment consists of the manufacture and sale of conventional cigarettes and, for
segment reporting purposes, includes the operations of Medallion acquired on
April 1, 2002 (which operations are held for legal purposes as part of Vector
Tobacco). The Vector Tobacco segment includes the development and marketing of
the low nicotine and nicotine-free cigarette products as well as the development
of reduced risk cigarette products and, for segment reporting purposes, excludes
the operations of Medallion.
48
2003 compared to 2002 and 2002 compared to 2001
For the Year Ended December 31,
2003 2002 2001
------------ ------------ ------------
(Dollars in Thousands)
Revenues:
Liggett ............................. $ 503,231 $ 494,975 $ 432,918
Vector Tobacco ...................... 26,154 7,442 4,498
------------ ------------ ------------
Total tobacco ..................... 529,385 502,417 437,416
Real estate .......................... 7,298 1,001 9,966
------------ ------------ ------------
Total revenues ................. $ 536,683 $ 503,418 $ 447,382
============ ============ ============
Operating income (loss):
Liggett ............................. $ 119,749 $ 102,718(2) $ 107,052
Vector Tobacco ...................... (92,825)(1) (88,159) (48,643)
------------ ------------ ------------
Total tobacco .................. 26,924 14,559 58,409
Real estate .......................... 4,245 (578) 413
Corporate and other .................. (26,912) (32,688) (27,479)
------------ ------------ ------------
Total operating income (loss) .. $ 4,257(1) $ (18,707)(2) $ 31,343
============ ============ ============
- -----------------
(1) Includes restructuring and impairment charges of $21,300 in 2003.
(2) Includes restructuring charges of $3,460 in 2002.
2003 Compared to 2002
Revenues. Total revenues were $536,683 for the year ended December 31,
2003 compared to $503,418 for the year ended December 31, 2002. This 6.6%
($33,265) increase in revenues was due to a $8,256 or 1.7% increase in revenues
at Liggett, an $18,712 increase in revenues at Vector Tobacco, and a $6,297
increase in real estate revenues at New Valley.
Tobacco Revenues. In April 2002, the major manufacturers announced list
price increases of $1.20 per carton. Liggett matched the increase on its premium
brands only. In July 2002, Liggett announced a list price increase of $.60 per
carton on LIGGETT SELECT. In December 2002, Liggett announced a list price
increase of $.80 per carton on LIGGETT SELECT. In February 2003, Liggett
increased its net sales price for other selected discount brands by $.80 per
carton. In May 2003, Liggett increased its list price on USA by $.50 per carton.
In June 2003, Liggett increased its list price for LIGGETT SELECT by $1.10 per
carton. In September 2003, Liggett increased its net sales price for PYRAMID by
$.95 per carton.
Effective February 1, 2004, Liggett reduced the JADE and EVE list
prices to the branded discount level from the premium price level. During 2003,
the net list prices for JADE and EVE were at the branded discount level after
giving effect to promotional spending.
For the year ended December 31, 2003, net sales at Liggett totaled
$503,231, compared to $494,975 for the year ended December 31, 2002. Revenues
increased by 1.7% ($8,256) due to list price increases net of promotional
spending of $13,423 and a favorable sales mix of $1,749 offset by a 1.4%
decrease in unit sales volume (approximately 137.3 million units) accounting for
$6,916 in unfavorable volume variance. Revenues at Vector Tobacco in 2003 were
$26,154 and related primarily to sales of QUEST compared to revenues of $7,442,
which related primarily to sales of OMNI, in 2002.
49
Premium sales at Liggett in 2003 amounted to $31,184 and represented
6.2% of total Liggett sales, compared to $44,621 and 9.0% of total sales for
2002. In the premium segment, revenues decreased by 30.1% ($13,437) for the year
ended December 31, 2003 compared to 2002, due to an unfavorable price variance
of $10,179, primarily associated with promotional activities, and an unfavorable
volume variance of $3,258, reflecting a 7.3% decrease in unit sales volume
(approximately 41.1 million units).
The decline in Liggett's premium sales revenue during the 2002 and 2003
periods reflects both the decrease in sales volume of premium-priced cigarettes
and increased promotional spending on premium brands driven primarily by weak
economic conditions, substantial excise tax increases in many states, and
significant promotional and pricing activity from the major U.S. cigarette
manufacturers. Also impacting the decline in net revenues was the shift from
significant free goods activity in 2002 (recorded in cost of goods sold) to
other promotional activity recorded as a reduction of revenue in 2003.
Discount sales at Liggett (comprising the brand categories of branded
discount, private label, control label, generic, international and contract
manufacturing) in 2003 amounted to $472,047 and represented 93.8% of total
Liggett sales, compared to $450,354 and 91.0% of total Liggett sales for 2002.
In the discount segment, revenues grew by 4.8% ($21,693) for the year ended
December 31, 2003 compared to 2002, due to net price increases of $23,602 and to
a favorable product mix among the discount brand categories of $2,767 partially
offset by a 1.0% decrease in unit sales volume (approximately 96.1 million
units) accounting for $4,676 in unfavorable volume variances. Net sales of the
LIGGETT SELECT brand increased $54,401 in 2003 over net sales for 2002, and its
unit volume increased 19.2% in 2003 compared to 2002.
Tobacco Gross Profit. Tobacco gross profit was $189,350 for the year
ended December 31, 2003 compared to $157,795 for the year ended December 31,
2002, an increase of $31,555 or 20.0% when compared to last year, due primarily
to the price increases discussed above at Liggett and increased sales and
reduced costs associated with the operations of Vector Tobacco. Liggett's brands
contributed 104.7% to our gross profit, and Vector Tobacco cost 4.7% for the
year ended December 31, 2003. In 2002, Liggett brands contributed 112.3% to our
gross profit and Vector Tobacco cost 12.3%.
Liggett's gross profit of $198,229 for the year ended December 31, 2003
increased $20,998 from gross profit of $177,231 in 2002. As a percent of
revenues (excluding federal excise taxes), gross profit at Liggett increased to
63.1% for the year ended December 31, 2003 compared to 58.3% for 2002, with
gross profit for the premium segment increasing to 56.6% for the year ended
December 31, 2003 compared to 45.0% for 2002 and gross profit for the discount
segment increasing to 63.5% in 2003 from 59.9% in 2002. This increase in
Liggett's gross profit in 2003 is due to an increase in revenues, lower excise
taxes due to reduced unit sales and reduced cost of goods sold due to decreased
use of free promotional product.
Vector Tobacco had negative gross profit of $8,879 for 2003 and
$19,436 for 2002. The negative gross profit reflected significant initial
promotional costs associated with the QUEST launch in 2003 and the OMNI launch
in 2002. The negative gross profit in both years also reflected costs
associated with excess manufacturing capacity at Vector Tobacco's Timberlake
facility and various inventory charges.
Real Estate Revenues. New Valley's real estate revenues were $7,298 for
the year ended December 31, 2003. This compares to revenues of $1,001 from real
estate activities for the year ended December 31, 2002, with the increase
primarily attributable to the acquisition of the two office buildings in
December 2002, offset by the absence of rental revenues from New Valley's
remaining shopping center, which was disposed of in May 2002.
Expenses. Operating, selling, general and administrative expenses were
$171,509 for the year ended December 31, 2003 compared to $174,043 for the prior
year. These expenses are net of restructuring and impairment charges of $21,300
at Vector Tobacco taken in 2003 and restructuring charges of $3,460 at Liggett
taken in 2002. Expenses at Liggett were $78,480 for the year ended December 31,
2003 compared to $74,513 for the prior year, an increase of $3,967, due
primarily to a larger sales force with the formation of Liggett Vector Brands as
well as increased
50
depreciation expenses related to equipment upgrades at Liggett's Mebane, North
Carolina facility and increased legal, marketing and pension expenses. Operating
expenses at Liggett include Liggett's product liability legal expenses and other
litigation costs of $6,122 in 2003 compared with $4,931 in 2002. Expenses at
Vector Tobacco for the year ended December 31, 2003 were $83,946 including the
restructuring and impairment charges of $21,300, compared to expenses of $68,723
for the prior year.
New Valley's expenses for real estate operations increased $2,412 in
2003 due primarily to higher expenses resulting from the acquisition of the
office buildings offset by expenses associated with the shopping center and the
closing of BrookeMil's Russian operations.
For the year ended December 31, 2003, Liggett's operating income
increased to $119,749 compared to $102,718 in 2002 due primarily to the higher
gross profit discussed above and the $3,460 restructuring charge in 2002. Vector
Tobacco's operating loss was $92,825, including the restructuring and impairment
charges of $21,300 in 2003, compared to $88,159 in 2002.
Other Income (Expenses). For the year ended December 31, 2003, other
income (expenses) was a loss of $21,685 compared to a loss of $28,954 for the
year ended December 31, 2002. In 2003, interest expense of $29,734 was offset by
interest and dividend income of $4,696, a gain on sale of investments of $1,955,
equity income from non-consolidated New Valley real estate businesses of $901
and a gain on sale of assets of $478. In 2002, interest expense of $27,825, a
provision for uncollectibility of notes receivable at New Valley of $13,198 and
a loss on investments of $6,240 were offset by interest and dividend income of
$10,071 and a gain on sale of assets of $9,097, which included $8,484 related to
the gain on the sale of BrookeMil in April 2002 by New Valley.
Loss from Continuing Operations. The loss from continuing operations
before income taxes and minority interests for the year ended December 31, 2003
was $17,428 compared to a loss of $47,661 for the year ended December 31, 2002.
Income taxes were $574 and minority interests in losses of subsidiaries were
$2,392 for the year ended December 31, 2003. This compared to income tax benefit
of $6,353 and minority interests in losses of subsidiaries of $9,514 for the
year ended December 31, 2002. The effective tax rates for the years ended
December 31, 2003 and December 31, 2002 do not bear a customary relationship to
pre-tax accounting income principally as a consequence of non-deductible
expenses and state income taxes.
2002 Compared to 2001
Revenues. Total revenues were $503,418 for the year ended December 31,
2002 compared to $447,382 for the year ended December 31, 2001. This 12.5%
($56,036) increase in revenues was due to a $62,057 or 14.3% increase in
revenues at Liggett, and a $2,944 increase in revenues at Vector Tobacco, offset
by a decrease of $8,965 in real estate revenues at New Valley.
Tobacco Revenues. In 2001, the major cigarette manufacturers, including
Liggett, announced list price increases of $1.90 per carton. On April 2, 2002,
the major manufacturers announced list price increases of $1.20 per carton.
Liggett matched the increase on its premium brands only. On July 1, 2002,
Liggett announced a list price increase of $.60 per carton on LIGGETT SELECT. On
December 2, 2002, Liggett announced a list price increase of $.80 per carton on
LIGGETT SELECT.
For the year ended December 31, 2002, revenues at Liggett totaled
$494,975, compared to $432,918 for the year ended December 31, 2001. Revenues
increased by 14.3% ($62,057) due to price increases of $34,965 and a 10.5%
increase in unit sales volume (approximately 929.9 million units) accounting for
$45,271 in positive volume variance, partially offset by $18,179
51
in unfavorable sales mix. Revenues for 2002 include $35,199 related to sales of
cigarette brands acquired in the April 2002 Medallion acquisition. Tobacco
revenues at Vector Tobacco were $7,442 and relate primarily to sales of OMNI.
Premium revenues at Liggett in 2002 amounted to $44,621 and represented
9.0% of total Liggett revenues, compared to $67,051 and 15.5% of total sales for
2001. In the premium segment, revenues decreased by 33.5% ($22,430) for the year
ended December 31, 2002, compared to 2001, due to unfavorable volume variances
of $17,884, reflecting a 26.7% decrease in unit sales volume (approximately
204.9 million units), and unfavorable price variances of $4,546.
The decline in Liggett's premium sales revenue during the 2002 period
reflects both the decrease in sales volume of premium-priced cigarettes and
increased promotional spending on premium brands driven primarily by weak
economic conditions, substantial excise tax increases in many states, and
significant promotional and pricing activity from the major U.S. cigarette
manufacturers.
Discount revenues at Liggett in 2002 amounted to $450,354 and
represented 91.0% of total Liggett revenues, compared to $365,866 and 84.5% of
total Liggett sales for 2001. In the discount segment, revenues grew by 23.1%
($84,488) for the year ended December 31, 2002 compared to 2001, due to price
increases of $39,512, a 14.0% increase in unit sales volume (approximately
1,134.8 million units) accounting for $51,103 in positive volume variances,
partially offset by an unfavorable product mix among the discount brand
categories of $6,127. The growth in discount volume in 2002 related primarily to
the increased sales volume of LIGGETT SELECT and the Medallion brands acquired
in April 2002 offset by reduced volume among other discount brands. LIGGETT
SELECT brand revenues increased $77,197 in 2002 over revenues for 2001, and its
unit volume increased 48.3% in 2002 compared to 2001.
Tobacco Gross Profit. Tobacco gross profit was $157,795 for the year
ended December 31, 2002 compared to $177,109 for the year ended December 31,
2001, a decrease of $19,314 or 10.9% when compared to last year, due primarily
to the volume and price increases discussed above at Liggett offset by costs
associated with the operations of Vector Tobacco. Liggett's brands contributed
112.3% to our gross profit, and Vector Tobacco cost 12.3% for the year ended
December 31, 2002. In 2001, essentially all of the tobacco gross profit related
to Liggett's brands.
Liggett's gross profit of $177,231 for the year ended December 31, 2002
increased $951 from gross profit of $176,280 in 2001 due primarily to price and
unit volume increases partially offset by the increase in fixed manufacturing
costs. As a percent of revenues (excluding federal excise taxes), gross profit
at Liggett decreased to 58.3% for the year ended December 31, 2002 compared to
62.4% for 2001, with gross profit for the premium segment decreasing to 45.0%
for the year ended December 31, of 2002 compared to 72.1% for the year ended
December 31, 2001 and gross profit for the discount segment decreasing to 59.9%
in 2002 from 60.1% in 2001. This overall decrease in Liggett's gross profit is
due primarily to the inclusion of the higher estimated payment obligations under
the Attorneys General Master Settlement Agreement within cost of goods sold, the
increase in promotional spending on premium brands discussed above and the
disproportionate rise in deep discount sales, leading to lower gross profit.
Real Estate Revenues. New Valley's real estate revenues were $1,001 for
the year ended December 31, 2002. This compares to revenues of $9,966 from real
estate activities for the year ended December 31, 2001, a decrease of $8,965,
with the decline primarily due to the absence of rental revenues of $8,024 from
Western Realty Investments, which was sold in December 2001, and New Valley's
remaining shopping center, which was disposed of in May 2002.
52
Expenses. Operating, selling, general and administrative expenses net
of restructuring charges of $3,460 were $174,043 for the year ended December 31,
2002 compared to $156,332 for the prior year. The increase of $17,711 was due
primarily to a $19,251 increase in expenses at Vector Tobacco related to
expenses of product development and marketing for Vector Tobacco's OMNI and
QUEST brands and increased expenses at corporate offset by lower expenses at New
Valley primarily due to a decrease in professional fees. Expenses at Liggett
were $74,513 for the year ended December 31, 2002 compared to $69,228 for the
prior year, an increase of $5,285. The increase in operating expenses at Liggett
was due primarily to a larger sales force and increased marketing efforts.
Operating expenses at Liggett include Liggett's product liability legal expenses
and other litigation costs of $4,931 in 2002 and $6,832 in 2001. Expenses at
Vector Tobacco for the year ended December 31, 2002 were $68,723, compared to
expenses of $49,472 for the prior year. In addition, a $3,460 restructuring
charge was taken in March 2002 in connection with the formation of Liggett
Vector Brands and used for reorganization of its business.
For the year ended December 31, 2001, Liggett operating income of
$107,052 included $9,723 of expense relating to the Engle class action. As
discussed in Note 16 to our consolidated financial statements, on May 7, 2001,
Liggett reached an agreement with the class in the Engle case, which will
provide assurance to Liggett that the stay of execution, currently in effect
pursuant to the Florida bonding statute, will 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, we recorded a $9,723 pre-tax charge to the consolidated
statement of operations for the first quarter of 2001. Vector Tobacco's
operating loss was $88,159 for the year ended December 31, 2002 compared to
$48,643 in the 2001 period.
Other Income (Expenses). Other expenses were $48,122 offset by other
income of $19,168 for the year ended December 31, 2002 compared to expenses of
$31,952 offset by other income of $29,419 for the year ended December 31, 2001.
In 2002, a provision for loss on notes receivable of $13,198 established by New
Valley, a loss on investments of $6,240 and increased interest expense of
$27,825 were offset by interest and dividend income of $10,071 and a gain on
sale of assets of $9,097. The gain on sale of assets includes a gain of $8,484
related to the sale of BrookeMil in April 2002 and a gain of $564 on the
disposal of New Valley's remaining shopping center in May 2002. For 2001,
interest and dividend income of $11,799 and a gain on a legal settlement of
$17,620 arising from the resolution of an insurance claim relating to New
Valley's former Western Union satellite business were offset primarily by
interest expense and a loss on the sale of real estate assets.
Interest expense was $27,825 for the year ended December 31, 2002
compared to $21,387 for the prior year, due to the issuance of additional
long-term debt at the corporate level, early extinguishment of debt also at the
corporate level and increased equipment financing when compared to the prior
period as well as issuance of the notes relating to the Medallion acquisition.
In 2001, interest expense included a charge of $6,445 for the loss on conversion
of a portion of our convertible subordinated notes due 2008 to common stock.
(Loss) Income from Continuing Operations. The loss from continuing
operations before income taxes and minority interests for the year ended
December 31, 2002 was $47,661 compared to income of $28,810 for the year ended
December 31, 2001. Income tax benefit was $6,353 and minority interests in
losses of subsidiaries were $9,514 for the year ended December 31, 2002. This
compared to tax expense of $15,017 and minority interests in losses of
subsidiaries of $7,407 for the year ended December 31, 2001. The effective tax
rates for the year ended December 31, 2002 and December 31, 2001 do not bear a
customary relationship to pre-tax accounting income principally as a consequence
of non-deductible expenses and state income taxes.
53
DISCONTINUED OPERATIONS
On November 30, 2001, New Valley announced that it would distribute its
22,543,158 shares of Ladenburg Thalmann Financial Services common stock, a 53.6%
interest, to holders of New Valley common shares through a special dividend. On
the same date, we announced that we would, in turn, distribute the 12,694,929
shares of Ladenburg Thalmann Financial Services common stock that we would
receive from New Valley to the holders of our common stock. The special
dividends were accomplished through pro rata distributions of the Ladenburg
Thalmann Financial Services shares, paid on December 20, 2001 to holders of
record as of December 10, 2001. New Valley stockholders received 0.988 of a
Ladenburg Thalmann Financial Services share for each share of New Valley, and
our stockholders received 0.348 of a Ladenburg Thalmann Financial Services share
for each of our shares.
Our consolidated financial statements reflect New Valley's
broker-dealer operations as discontinued operations for the year ended December
31, 2001. Accordingly, revenues, costs and expenses, and cash flows of the
discontinued operations have been excluded from the respective captions in the
consolidated statements of operations and consolidated statements of cash flows.
The net operating results of these entities have been reported, net of minority
interests and applicable income taxes, as "Loss from discontinued operations,"
and the net cash flows of these entities have been reported as "Impact of
discontinued operations."
Summarized operating results of the discontinued broker-dealer
operations for the period January 1, 2001 to December 20, 2001 are as follows:
2001
--------
Revenues................................................... $ 88,473
Loss from operations before income taxes................... (12,030)
Benefit for income taxes................................... (1,356)
Minority interests......................................... 8,557
--------
Net loss................................................... $ (2,117)
========
In 2001, we recognized a gain on disposal of discontinued operations of
$1,580 relating to New Valley's adjustments of accruals established during its
bankruptcy proceedings in 1993 and 1994. The reversal of these accruals was made
due to the completion of settlements related to these matters.
LIQUIDITY AND CAPITAL RESOURCES
Net cash and cash equivalents decreased $25,219 in 2003 and $117,734 in
2002 and increased $60,248 in 2001.
Net cash provided by operations in 2003 was $16,200 compared to net
cash used in 2002 of $11,603 and net cash provided by operations of $19,720 in
2001. Net cash provided in 2003 resulted from non-cash charges for depreciation
and amortization, restructuring, stock-based expense and interest expense, a
decrease in receivables and an increase in accounts payable and accrued
liabilities and other assets and liabilities. These were offset primarily by an
increase in inventories as well as income from minority interests and deferred
income taxes. Net cash used in operations for 2002 resulted primarily from a net
loss of $31,794 due to increased operating losses at Vector Tobacco and
marketing promotions at Liggett. In addition, there was an increase in
inventories offset by a decrease in accounts receivable and an increase in
current liabilities. Further, in 2002, there was the non-cash impact of
depreciation and amortization, stock-based expense, restructuring charges,
provision for loss on investments and provision for uncollectibility of notes
receivable offset by minority interests, gain on sale of investments and a
change in current taxes. Cash provided by operations in 2001 resulted primarily
from increased net income of Liggett offset by expenses of product development
at Vector Tobacco and a loss at New Valley. In addition, in 2001, there was the
non-cash impact of
54
depreciation and amortization, non-cash stock-based expense, losses on the sale
of real estate and the conversion of debt offset by the impact of discontinued
operations, income taxes and minority interests.
Cash provided by investing activities of $49,829 in 2003 is compared to
cash used of $93,791 in 2002 and cash used of $176,034 in 2001. In 2003, cash
was provided principally through the sale or maturity of investment securities
for $135,737 offset primarily by the purchase of investment securities of
$68,978, the investment by New Valley of $9,500 in Douglas Elliman Realty and
$1,500 in KOA Investors LLC and capital expenditures principally at Liggett of
$8,894. In 2002, cash was used principally for a portion ($50,000) of the
purchase price of Medallion and for the purchase of two office buildings by New
Valley for $54,258 and machinery and equipment Liggett and Vector Tobacco. In
addition, there was the issuance of a note receivable at New Valley for $4,000.
These expenditures were offset primarily by net proceeds of $20,461 received
from the sale by New Valley of BrookeMil and the net sale or maturity of
investment securities of $36,700. In 2001, cash was used primarily for
investment in debt securities at the corporate level of $152,793, investment in
equity securities at New Valley of $10,166 and for capital expenditures,
primarily at Vector Tobacco and Liggett. In addition, there were purchases of
long-term investments at New Valley of $5,711. These expenditures were offset
primarily by the sale or maturity of investment securities of $16,418, sales of
assets of $7,912 and proceeds from sales of real estate of $42,160 in Russia and
the United States.
Cash used in financing activities was $91,248 in 2003 compared to cash
used of $12,340 for 2002 and cash provided by financing activities of $212,556
in 2001. In 2003, cash was used principally for distributions on common stock of
$59,997 and repayments of debt of $31,654 including $12,000 of the VGR Holding
10% Senior Secured Notes, $12,500 of the Medallion notes and $7,154 in various
other notes. In 2002, cash was used primarily for dividends of $54,477 and
repayments of debt of $23,338 offset by proceeds from debt of $78,135 and
proceeds from the exercise of options of $2,957. In 2001, proceeds from debt
were $264,441 offset by repayments on debt of $32,777 and net repayments on the
revolving credit facilities of $19,374. In addition, cash was provided by the
issuance of common stock of $50,000 as well as the exercise of warrants and
options for $17,185. These transactions were offset by distributions on common
stock of $46,751, deferred financing charges of $9,642 and decreases of $4,675
in margin loans payable.
Liggett. Liggett has a $40,000 credit facility under which $0 was
outstanding at December 31, 2003. Availability under the facility was
approximately $29,688 based on eligible collateral at December 31, 2003. The
facility is collateralized by all inventories and receivables of Liggett.
Borrowings under the facility, whose interest is calculated at a rate equal to
1.0% above Wachovia's (the indirect parent of Congress Financial Corporation,
the lead lender) prime rate, bore a rate of 5.0% at December 31, 2003. The
facility requires Liggett's compliance with certain financial and other
covenants including a restriction on the payment of cash dividends unless
Liggett's borrowing availability under the facility for the 30-day period prior
to the payment of the dividend, and after giving effect to the dividend, is at
least $5,000. In addition, the facility, as amended, imposes requirements with
respect to Liggett's adjusted net worth (not to fall below $8,000 as computed in
accordance with the agreement) and working capital (not to fall below a deficit
of $17,000 as computed in accordance with the agreement). At December 31, 2003,
Liggett was in compliance with all covenants under the credit facility;
Liggett's adjusted net worth was $47,068 and net working capital was $16,874 as
computed in accordance with the agreement. The facility expires on March 8, 2004
subject to automatic renewal for an additional year unless a notice of
termination is given by the lender at least 60 days prior to such date or the
anniversary of such date.
In November 1999, 100 Maple LLC, a new company formed by Liggett to
purchase an industrial facility in Mebane, North Carolina, borrowed $5,040 from
the lender under Liggett's credit facility. In July 2001, Maple borrowed an
additional $2,340 under the loan, and a total of $5,190 was outstanding at
December 31, 2003. In September 2002, the lender agreed that no further
regularly scheduled principal payments would be due under the Maple loan until
March 1, 2004. Thereafter, the loan is payable in 27 monthly installments of $77
with a final payment of $3,111. Interest is charged at the same rate as
applicable to Liggett's credit facility, and borrowings under the Maple loan
reduce the maximum availability under the credit facility. Liggett has
guaranteed the loan, and a first mortgage on the Mebane property and equipment
collateralizes the Maple loan and Liggett's credit facility.
55
In April 2003, the credit facility was amended to increase the maximum
credit available under the facility to $45,000 for the period through October
15, 2003. We guaranteed $10,000 of borrowings under the facility and
collateralized the guarantee with $10,000 in cash. Our guarantee was terminated,
and the pledge of the cash collateral released, on October 16, 2003.
In March 2000, Liggett purchased equipment for $1,000 through the
issuance of a note, payable in 60 monthly installments of $21 with an effective
annual interest rate of 10.14%. In April 2000, Liggett purchased equipment for
$1,071 through the issuance of notes, payable in 60 monthly installments of $22
with an effective interest rate of 10.20%.
Beginning in October 2001, Liggett upgraded the efficiency of its
manufacturing operation at Mebane with the addition of four new state-of-the-art
cigarette makers and packers, as well as related equipment. The total cost of
these upgrades was approximately $20,000. Liggett took delivery of the first two
of the new lines in the fourth quarter of 2001 and financed the purchase price
of $6,404 through the issuance of notes, guaranteed by us and payable in 60
monthly installments of $106 with interest calculated at the prime rate. In
March 2002, the third line was delivered, and the purchase price of $3,023 was
financed through the issuance of a note, payable in 30 monthly installments of
$62 and then 30 monthly installments of $51 with an effective annual interest
rate of 4.68%. In May 2002, the fourth line was delivered, and Liggett financed
the purchase price of $2,871 through the issuance of a note, payable in 30
monthly installments of $59 and then 30 monthly installments of $48 with an
effective annual interest rate of 4.64%. In September 2002, Liggett purchased
additional equipment for $1,573 through the issuance of a note guaranteed by us,
payable in 60 monthly installments of $26 plus interest rate calculated at LIBOR
plus 4.31%.
During 2003, Liggett leased two 100 millimeter box packers, which will
allow Liggett to meet the growing demand for this cigarette style, and a new
filter maker to improve product quality and capacity. These operating lease
agreements provide for payments totaling approximately $4,500.
In July 2003, Liggett granted an unaffiliated third party an option to
purchase Liggett's former manufacturing facility and other excess real estate in
Durham, North Carolina with a net book value at December 31, 2003 of
approximately $1,347. The option agreement permits the purchaser to acquire the
property, during a period of up to two years, at a purchase price of $14,000 if
the closing occurs by August 23, 2004 and $15,000 if the closing occurs
thereafter during the term of the option. Liggett has received option fees of
$1,000, of which $250 is refundable if the purchaser terminates the agreement
prior to August 23, 2004. Liggett will be entitled to receive additional option
fees of up to $500 during the remaining option period. The option fees will
generally be creditable against the purchase price. The purchaser is currently
conducting due diligence, and there can be no assurance the sale of the property
will occur.
Liggett (and, in certain cases, Brooke Group Holding, our predecessor
and a wholly-owned subsidiary of VGR Holding) and other United States cigarette
manufacturers have been named as defendants in a number of direct and
third-party actions (and purported class actions) predicated on the theory that
they should be liable for damages from cancer and other adverse health effects
alleged to have been caused by cigarette smoking or by exposure to so-called
secondary smoke from cigarettes. We believe, and have been so advised by counsel
handling the respective cases, that Brooke Group Holding and Liggett have a
number of valid defenses to claims asserted against them. Litigation is subject
to many uncertainties. In May 2003, a Florida intermediate appellate court
overturned a $790,000 punitive damages award against Liggett and decertified the
Engle smoking and health class action. Class counsel is pursuing various
appellate remedies seeking to reverse the appellate court's decision. If the
appellate court's ruling is not upheld on further appeal, it will have a
material adverse effect on us. In November 2000, Liggett filed the $3,450 bond
required under the bonding statute enacted in 2000 by the Florida legislature
which limits
56
the size of any bond required, pending appeal, to stay execution of a punitive
damages verdict. In May 2001, Liggett reached an agreement with the class in the
Engle case, which provided assurance to Liggett that the stay of execution, in
effect pursuant to the Florida bonding statute, would not be lifted or limited
at any point until completion of all appeals, including to the United States
Supreme Court. As required by the agreement, Liggett paid $6,273 into an escrow
account to be held for the benefit of the Engle class, and released, along with
Liggett's existing $3,450 statutory bond, to the court for the benefit of the
class upon completion of the appeals process, regardless of the outcome of the
appeal. In June 2002, the jury in an individual case brought under the third
phase of the Engle case awarded $37,500 (subsequently reduced by the court to
$25,100) of compensatory damages against Liggett and two other defendants and
found Liggett 50% responsible for the damages. The verdict, which was subject to
the outcome of the Engle appeal, has been overturned as a result of the
appellate court's ruling discussed above. It is possible that additional cases
could be decided unfavorably and that there could be further adverse
developments in the Engle case. Management cannot predict the cash requirements
related to any future settlements and judgments, including cash required to bond
any appeals, and there is a risk that those requirements will not be able to be
met. An unfavorable outcome of a pending smoking and health case could encourage
the commencement of additional similar litigation. In recent years, there have
been a number of adverse regulatory, political and other developments concerning
cigarette smoking and the tobacco industry. These developments generally receive
widespread media attention. Neither we nor Liggett are able to evaluate the
effect of these developing matters on pending litigation or the possible
commencement of additional litigation or regulation. See Note 16 to our
consolidated financial statements.
Management is unable to make a meaningful estimate of the amount or
range of loss that could result from an unfavorable outcome of the cases pending
against Brooke Group Holding or Liggett or the costs of defending such cases. It
is possible that our consolidated financial position, results of operations or
cash flows could be materially adversely affected by an unfavorable outcome in
any such tobacco-related litigation.
V.T. Aviation. In February 2001, V.T. Aviation LLC, a subsidiary of
Vector Research Ltd., purchased an airplane for $15,500 and borrowed $13,175 to
fund the purchase. The loan, which is collateralized by the airplane and a
letter of credit from us for $775, is guaranteed by Vector Research, VGR Holding
and us. The loan is payable in 119 monthly installments of $125 including annual
interest of 2.31% above the 30-day commercial paper rate, with a final payment
of $1,420, based on current interest rates.
VGR Aviation. In February 2002, V.T. Aviation purchased an airplane for
$6,575 and borrowed $5,800 to fund the purchase. The loan is guaranteed by us.
The loan is payable in 119 monthly installments of $40, including annual
interest at 2.75% above the 30-day commercial paper rate, with a final payment
of $2,793, based on current interest rates. During the fourth quarter of 2003,
this airplane was transferred to our direct subsidiary, VGR Aviation LLC, which
has assumed the debt.
Vector Tobacco. In June 2001, Vector Tobacco purchased for $8,400 an
industrial facility in Timberlake, North Carolina. Vector Tobacco financed the
purchase with an $8,200 loan. The loan is payable in 60 monthly installments of
$85, plus interest at 4.85% above the LIBOR rate, with a final payment of
approximately $3,160. The loan, which is collateralized by a mortgage and a
letter of credit of $1,750, is guaranteed by us and by VGR Holding.
During December 2001, Vector Tobacco borrowed an additional $1,159 from
the same lender to finance building improvements. This loan is payable in 30
monthly installments of $39 plus accrued interest, with an annual interest rate
of LIBOR plus 5.12%.
On April 1, 2002, a subsidiary of ours acquired the stock of The
Medallion Company, Inc., a discount cigarette manufacturer, and related assets
from Medallion's principal stockholder.
57
Following the purchase of the Medallion stock, Vector Tobacco merged into
Medallion and Medallion changed its name to Vector Tobacco Inc. The total
purchase price for the Medallion shares and the related assets consisted of
$50,000 in cash and $60,000 in notes, with the notes guaranteed by us and by
Liggett. Of the notes, $25,000 bear interest at a 9.0% annual rate and mature
$3,125 per quarter commencing June 30, 2002 and continuing through March 31,
2004. At December 31, 2003, $3,125 of these notes were outstanding. The
remaining $35,000 of notes bear interest at 6.5% per year, payable semiannually,
and mature on April 1, 2007.
VGR Holding. In May 2001, VGR Holding issued at a discount $60,000
principal amount of 10% senior secured notes due March 31, 2006 in a private
placement. VGR Holding received net proceeds from the offering of approximately
$46,500. In April 2002, VGR Holding issued at a discount an additional $30,000
principal amount of 10% senior secured notes due March 31, 2006 in a private
placement and received net proceeds of approximately $24,500. The notes were
priced to provide purchasers with a 15.75% yield to maturity. The notes are on
the same terms as the $60,000 principal amount of senior secured notes
previously issued. All of the notes have been guaranteed by us and by Liggett.
The notes are collateralized by substantially all of VGR Holding's
assets, including a pledge of VGR Holding's equity interests in its direct
subsidiaries, including Brooke Group Holding, Liggett Vector Brands, Vector
Tobacco and New Valley Holdings, Inc., as well as a pledge of the shares of
Liggett and all of the New Valley securities held by VGR Holding and New Valley
Holdings. The purchase agreement for the notes contains covenants, which among
other things, limit the ability of VGR Holding to make distributions to us to
50% of VGR Holding's net income, unless VGR Holding holds an amount in cash
equal to the then principal amount of the notes outstanding ($70,000 at December
31, 2003) 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 plus, for periods through December 31, 2003, additional
amounts including up to $50,000 during the period commencing on September 30,
2003 and ending on December 31, 2003. The covenants also restrict transactions
with affiliates subject to exceptions which include payments to us not to exceed
$9,500 per year for permitted operating expenses, and limit the ability of VGR
Holding to merge, consolidate or sell certain assets. In November 2002, in
connection with an amendment to the note purchase agreement, VGR Holding
repurchased $8,000 of the notes at a price of 100% of the principal amount plus
accrued interest. We recognized a loss of $1,320 in 2002 on the early
extinguishment of debt.
In connection with an additional amendment to the note purchase
agreement, VGR Holding repurchased a total of $8,000 of the notes in the second
quarter of 2003 and $4,000 of the notes on September 30, 2003, at a price of
100% of the principal amount plus accrued interest. We recognized a loss of
$1,721 in 2003 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 us or by third-party financing as to which
neither VGR Holding nor Liggett could provide any guarantee or credit support.
VGR Holding may redeem the notes, in whole or in part, at a redemption
price of 100% of the principal amount. During the term of the notes, VGR Holding
is required to offer to repurchase all the notes at a purchase price of 101% of
the principal amount, in the event of a change of control, and to offer to
repurchase notes, at 100% of the principal amount, with the proceeds of material
asset sales.
New Valley. In December 2002, New Valley financed a portion of its
purchase of two office buildings in Princeton, New Jersey with a $40,500
mortgage loan from HSBC Realty Credit
58
Corporation (USA). The loan has a term of four years, bears interest at a
floating rate of 2% above LIBOR, and is secured by a first mortgage on the
office buildings, as well as by an assignment of leases and rents. Principal is
amortized to the extent of $54 per month during the term of the loan. The loan
may be prepaid without penalty and is non-recourse against New Valley, except
for various specified environmental and related matters, misapplication of
tenant security deposits and insurance and condemnation proceeds, and fraud or
misrepresentation by New Valley in connection with the indebtedness.
Vector. We believe that we will continue to meet our liquidity
requirements through 2004, although the covenants in the purchase agreement for
VGR Holding's notes limit the ability of VGR Holding to make distributions to us
unless certain tests are met. Under the terms of these covenants, at December
31, 2003, VGR Holding was generally not permitted to pay distributions to us
except for tax sharing payments and specified amounts of operating expenses.
Corporate expenditures (exclusive of Liggett, Vector Research, Vector Tobacco
and New Valley) over the next twelve months for current operations include cash
interest expense of approximately $15,300, dividends on our outstanding shares
(currently at an annual rate of approximately $63,500) and corporate expenses.
We anticipate funding our expenditures for current operations with available
cash resources, proceeds from public and/or private debt and equity financing,
management fees from subsidiaries and tax sharing and other payments from
Liggett or New Valley. New Valley may acquire or seek to acquire additional
operating businesses through merger, purchase of assets, stock acquisition or
other means, or to make other investments, which may limit its ability to make
such distributions.
In July 2001, we completed the sale of $172,500 (net proceeds of
approximately $166,400) of our 6.25% convertible subordinated notes due July 15,
2008 through a private offering to qualified institutional investors in
accordance with Rule 144A under the Securities Act of 1933. The notes pay
interest at 6.25% per annum and are convertible into our common stock, at the
option of the holder. The conversion price, which was $27.51 at December 31,
2003, is subject to adjustment for various events, and any cash distribution on
our common stock results in a corresponding decrease in the conversion price. In
December 2001, $40,000 of the notes were converted into our common stock, and
$132,500 principal amount of the notes were outstanding at December 31, 2003.
Our consolidated balance sheets include deferred income tax assets and
liabilities, which represent temporary differences in the application of
accounting rules established by generally accepted accounting principles and
income tax laws. As of December 31, 2003, our deferred income tax liabilities
exceeded our deferred income tax assets by $111,399. The largest component of
our deferred tax liabilities exists because of differences that resulted from a
1998 and 1999 transaction with Philip Morris Incorporated where a subsidiary of
Liggett contributed three of its premium brands to Trademarks LLC, a
newly-formed limited liability company. In such transaction, Philip Morris
acquired an option to purchase the remaining interest in Trademarks for a 90-day
period commencing in December 2008, and we have an option to require Philip
Morris to purchase the remaining interest commencing in March 2010. For
additional information concerning the Philip Morris brand transaction, see Note
19 to our consolidated financial statements.
In connection with the transaction, we recognized in 1999 a pre-tax
gain of $294,078 in our consolidated financial statements and established a
deferred tax liability of $103,100 relating to the gain. Upon exercise of the
options during the 90-day periods commencing in December 2008 or in March 2010,
we will be required to pay tax in the amount of the deferred tax liability,
which will be offset by the benefit of any deferred tax assets, including any
net operating losses, available to us at that time. In connection with an
examination of our 1998 and 1999 federal income tax returns, the Internal
Revenue Service issued to us in September 2003 a notice of proposed adjustment.
The notice asserts that, for tax reporting purposes, the entire gain should have
been recognized in 1998 and in 1999 in the additional amounts of $150,000 and
$129,900, respectively, rather than upon the exercise of the options during the
90-day periods commencing
59
in December 2008 or in March 2010. If the Internal Revenue Service were to
ultimately prevail with the proposed adjustment, it would result in the
potential acceleration of tax payments of approximately $117,000, including
interest, net of tax benefits, through December 31, 2003. These amounts have
been previously recognized in our consolidated financial statements as tax
liabilities. As of December 31, 2003, we believe amounts potentially due have
been fully provided for in our consolidated statements of operations.
We believe the positions reflected on our income tax returns are
correct and intend to vigorously oppose any proposed adjustments to our returns.
We have filed a protest with the Appeals Division of the Internal Revenue
Service. No payment is due with respect to these matters during the appeal
process. Interest currently is accruing on the disputed amounts at a rate of 6%,
with the rate adjust quarterly based on rates published by the U.S. Treasury
Department. If taxing authorities were to ultimately prevail in their assertion
that we incurred a tax obligation prior to the exercise dates of these options
and we were required to make such tax payments prior to 2009 or 2010, and if any
necessary financing were not available to us, our liquidity could be adversely
affected.
LONG-TERM FINANCIAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
Our significant long-term contractual obligations as of December 31,
2003 were as follows:
Fiscal Year
--------------------------------------------------------------
Contractual Obligations 2004 2005 2006 2007 2008 Thereafter Total
- ------------------------------ ---------- ---------- ---------- ---------- ---------- ---------- ----------
Long-term debt(1) ............ $ 10,762 $ 6,692 $ 111,326 $ 39,746 $ 134,167 $ 8,046 $ 310,739
Operating leases(2) .......... 7,863 5,870 4,374 2,898 2,271 9,165 32,441
Inventory purchase
Commitments(3) ............. 9,365 - - - - 9,365
Capital expenditure
purchase commitments(4) .... 970 - - - - - 970
New Valley obligations
under limited partnership
agreements ................. 6,080 - - - - - 6,080
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total ........................ $ 35,040 $ 12,562 $ 115,700 $ 42,644 $ 136,438 $ 17,211 $ 359,595
========== ========== ========== ========== ========== ========== ==========
- ----------------
(1) For more information concerning our long-term debt, see "Liquidity and
Capital Resources" above and Note 9 to our consolidated financial
statements.
(2) Operating lease obligations represent estimated lease payments for
facilities and equipment. See Note 10 to our consolidated financial
statements.
(3) Inventory purchase commitments represent purchase commitments under
our leaf inventory management program. See Note 6 to our consolidated
financial statements.
(4) Capital expenditure purchase commitments represent purchase
commitments for machinery and equipment at Liggett and Vector Tobacco.
Payments under the Master Settlement Agreement discussed in Note 16 to
our consolidated financial statements are excluded from the table above, as the
payments are subject to adjustment for several factors, including inflation,
overall industry volume, our market share and the market share of
non-participating manufacturers.
60
OFF-BALANCE SHEET ARRANGEMENTS
We have various agreements in which we may be obligated to indemnify
the other party with respect to certain matters. Generally, these
indemnification clauses are included in contracts arising in the normal course
of business under which we customarily agree to hold the other party harmless
against losses arising from a breach of representations related to such matters
as title to assets sold and licensed or certain intellectual property rights.
Payment by us under such indemnification clauses is generally conditioned on the
other party making a claim that is subject to challenge by us and dispute
resolution procedures specified in the particular contract. Further, our
obligations under these arrangements may be limited in terms of time and/or
amount, and in some instances, we may have recourse against third parties for
certain payments made by us. It is not possible to predict the maximum potential
amount of future payments under these indemnification agreements due to the
conditional nature of our obligations and the unique facts of each particular
agreement. Historically, payments made by us under these agreements have not
been material. As of December 31, 2003, we were not aware of any indemnification
agreements that would or are reasonably expected to have a current or future
material adverse impact on our financial position, results of operations or cash
flows.
In May 1999, in connection with the Philip Morris brand transaction,
Eve Holdings Inc., a subsidiary of Liggett, guaranteed a $134,900 bank loan to
Trademarks LLC. The loan is secured by Trademarks' three premium cigarette
brands and Trademarks' interest in the exclusive license of the three brands by
Philip Morris. The license provides for a minimum annual royalty payment equal
to the annual debt service on the loan plus $1,000. We believe that the fair
value of Eve's guarantee was negligible at December 31, 2003.
At December 31, 2003, we had outstanding approximately $5,500 of
letters of credit, collateralized by certificates of deposit. The letters of
credit have been issued as security deposits for leases of office space, to
secure the performance of our subsidiaries under various insurance programs and
to provide collateral for various subsidiary borrowing and capital lease
arrangements.
MARKET RISK
We are exposed to market risks principally from fluctuations in
interest rates, foreign currency exchange rates and equity prices. We seek to
minimize these risks through our regular operating and financing activities and
our long-term investment strategy. The market risk management procedures of us
and New Valley cover all market risk sensitive financial instruments.
As of December 31, 2003, approximately $71,834 of our outstanding debt
had variable interest rates, which increases the risk of fluctuating interest
rates. Our exposure to market risk includes interest rate fluctuations in
connection with our variable rate borrowings, which could adversely affect our
cash flows. As of December 31, 2003, we had no interest rate caps or swaps.
Based on a hypothetical 100 basis point increase or decrease in interest rates
(1%), our annual interest expense could increase or decrease by approximately
$869.
We held investment securities available for sale totaling $67,521 at
December 31, 2003. Adverse market conditions could have a significant effect on
the value of these investments.
New Valley also holds long-term investments in limited partnerships and
limited liability companies. These investments are illiquid, and their ultimate
realization is subject to the performance of the investee entities.
61
NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, Financial Accounting Standards Board Interpretation
("FIN") No. 46(R), "Consolidation of Variable Interest Entities (revised
December 2003)", was issued. The interpretation revises FIN No. 46,
"Consolidation of Variable Interest Entities", to exempt certain entities from
the requirements of FIN No. 46. The interpretation requires a company to
consolidate a variable interest entity ("VIE"), as defined, when the company
will absorb a majority of the variable interest entity's expected losses,
receive a majority of the variable interest entity's expected residual returns,
or both. FIN No. 46(R) also requires consolidation of existing, non-controlled
affiliates if the VIE is unable to finance its operations without investor
support, or where the other investors do not have exposure to the significant
risks and rewards of ownership. The interpretation applies immediately to a VIE
created or acquired after January 31, 2003. For a VIE acquired before February
1, 2003, FIN No. 46(R) applies in the first interim period ending after March
15, 2004. We have not completed our assessment of the impact of this
interpretation, but we do not anticipate a material impact on our consolidated
financial statements.
In April 2003, SFAS No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities" was issued. SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003 and for hedging relationships designated after June 30, 2003. The
adoption of this statement did not impact our consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for how companies classify and measure certain
financial instruments with characteristics of both liabilities and equity. It
requires companies to classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS No. 150 is effective
immediately for financial instruments entered into or modified after May 15,
2003 and in the first interim period after June 15, 2003 for all other financial
instruments. The adoption of this statement did not impact our consolidated
financial statements.
In December 2003, the FASB issued SFAS No. 132(R), which replaces SFAS
No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits." SFAS No. 132(R) does not change the measurement and recognition
provisions of SFAS No. 87, SFAS No. 88, "Employers' Accounting for Settlements
and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,"
and SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions," however, it includes additional disclosure provisions for annual
reporting, 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 11 to our consolidated
financial statements.)
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We and our representatives may from time to time make oral or written
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995, including any statements that may be contained in
the foregoing discussion in "Management's Discussion and Analysis of Financial
Condition and Results of Operations", in this report and in other filings with
the Securities and Exchange Commission and in our reports to stockholders, which
reflect our expectations or beliefs with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties and, in connection with the "safe-
62
harbor" provisions of the Private Securities Litigation Reform Act, we have
identified under "Risk Factors" in Item 1 above important factors that could
cause actual results to differ materially from those contained in any
forward-looking statement made by or on behalf of us.
Results actually achieved may differ materially from expected results
included in these forward-looking statements as a result of these or other
factors. Due to such uncertainties and risks, readers are cautioned not to place
undue reliance on such forward-looking statements, which speak only as of the
date on which such statements are made. We do not undertake to update any
forward-looking statement that may be made from time to time by or on behalf of
us.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Market Risk" is incorporated
herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Consolidated Financial Statements and Notes thereto, together with
the report thereon of PricewaterhouseCoopers LLP dated March 12, 2004, are set
forth beginning on page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
have evaluated the effectiveness of our disclosure controls and procedures as of
the end of the period covered by this report, and, based on their evaluation,
our principal executive officer and principal financial officer have concluded
that these controls and procedures are effective. There were no significant
changes in our internal control over financial reporting during the period
covered by this report that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
Disclosure controls and procedures are our controls and other
procedures that are designed to ensure that information required to be disclosed
by us in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commission's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by us in the reports that we
file under the Exchange Act is accumulated and communicated to our management,
including our principal executive officer and principal financial officer, as
appropriate to allow timely decisions regarding disclosure.
63
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This information is contained in our definitive Proxy Statement for our
2004 Annual Meeting of Stockholders, to be filed with the SEC not later than 120
days after the end of our fiscal year covered by this report pursuant to
Regulation 14A under the Securities Exchange Act of 1934, and incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
This information is contained in the Proxy Statement and incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
This information is contained in the Proxy Statement and incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is contained in the Proxy Statement and incorporated
herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING SERVICES AND FEES
This information is contained in the Proxy Statement and incorporated
herein by reference.
64
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) INDEX TO 2003 CONSOLIDATED FINANCIAL STATEMENTS:
Our Consolidated Financial Statements and the Notes thereto, together
with the report thereon of PricewaterhouseCoopers LLP dated March 12, 2004,
appear beginning on page F-1 of this report. Financial statement schedules not
included in this report have been omitted because they are not applicable or the
required information is shown in the Consolidated Financial Statements or the
Notes thereto.
(a)(2) FINANCIAL STATEMENT SCHEDULES:
Schedule II - Valuation and Qualifying Accounts ..................... Page F-53
65
(a)(3) EXHIBITS
(a) The following is a list of exhibits filed herewith as part of this Annual
Report on Form 10-K:
INDEX OF EXHIBITS
EXHIBIT
NO. DESCRIPTION
- ------- -----------------------------------------------------------
* 3.1 Amended and Restated Certificate of Incorporation of Vector
Group Ltd. (formerly known as Brooke Group Ltd.) ("Vector")
(incorporated by reference to Exhibit 3.1 in Vector's Form
10-Q for the quarter ended September 30, 1999).
* 3.2 Certificate of Amendment to the Amended and Restated
Certificate of Incorporation of Vector (incorporated by
reference to Exhibit 3.1 in Vector's Form 8-K dated May 24,
2000).
3.3 By-Laws of Vector.
* 4.1 Loan and Security Agreement, dated as of March 8, 1994,
between Liggett Group Inc. ("Liggett") and Congress Financial
Corporation (incorporated by reference to Exhibit 10(xx) in
Vector's Form 10-K for the year ended December 31, 1993).
* 4.2 Note Purchase Agreement, dated as of May 14, 2001, between VGR
Holding Inc (formerly known as BGLS Inc.) ("Vector Holding")
and TCW Leveraged Income Trust, L.P., TCW Leveraged Income
Trust II, L.P., TCW LINC II CBO Ltd., POWRs 1997-2, Captiva II
Finance Ltd. and AIMCO CDO, Series 2000-A (the "Purchasers"),
relating to the 10% Senior Secured Notes due March 31, 2006
(the "Notes"), including the form of Note (the "Note Purchase
Agreement") (incorporated by reference to Exhibit 10.1 in
Vector's Form 8-K dated May 14, 2001).
* 4.3 First Amendment to Note Purchase Agreement, dated as of
November 6, 2001, by and between VGR Holding and the
Purchasers (incorporated by reference to Exhibit 10.4 in
Vector's Form 10-Q for the quarter ended September 30, 2001).
* 4.4 Second Amendment to Note Purchase Agreement and New Note
Purchase Agreement, dated as of April 30, 2002, between VGR
Holding and the Purchasers, including the amended form of Note
(incorporated by reference to Exhibit 10.1 in Vector's Form
10-Q for the quarter ended March 31, 2002).
* 4.5 Third Amendment to Note Purchase Agreement, dated as of
September 30, 2002, between VGR Holding and the Purchasers
(incorporated by reference to Exhibit 10.1 in Vector's Form
10-Q for the quarter ended September 30, 2002).
* 4.6 Fourth Amendment to Note Purchase Agreement dated as of March
31, 2003, between VGR Holding and the Purchasers (incorporated
by reference to Exhibit 10.1 in Vector's Form 10-Q for the
quarter ended March 31, 2003).
66
EXHIBIT
NO. DESCRIPTION
- ------- -------------------------------------------------------------
4.7 Fifth Amendment to Note Purchase Agreement, dated as of
October 1, 2003, between VGR Holding and the Purchasers.
* 4.8 Collateral Agency Agreement, dated as of May 14, 2001, by and
among VGR Holding, Brooke Group Holding Inc., Vector, New
Valley Holdings, Inc., United States Trust Company of New
York, as collateral agent for the benefit of the holders of
the Notes pursuant to the Note Purchase Agreement (the
"Collateral Agent"), and the Purchasers (incorporated by
reference to Exhibit 10.2 in Vector's Form 8-K dated May 14,
2001).
* 4.9 First Amendment to Collateral Agency Agreement, dated as of
September 4, 2001, by and among VGR Holding, Brooke Group
Holding Inc., Vector, New Valley Holdings, Inc. and the
Collateral Agent (incorporated by reference to Exhibit 10.3 in
Vector's Form 10-Q for the quarter ended September 30, 2001).
* 4.10 Second Amendment to Collateral Agency Agreement, dated as of
April 30, 2002, by and among VGR Holding, Brooke Group Holding
Inc., Vector, New Valley Holdings, Inc., Liggett and the
Collateral Agent (incorporated by reference to Exhibit 10.2 in
Vector's Form 10-Q for the quarter ended March 31, 2002).
* 4.11 Pledge and Security Agreement, dated as of May 14, 2001
between VGR Holding and the Collateral Agent (incorporated by
reference to Exhibit 10.3 in Vector's Form 8-K dated May 14,
2001).
* 4.12 Amendment to Pledge and Security Agreement, dated as of April
30, 2002, between VGR Holding and the Collateral Agent
(incorporated by reference to Exhibit 10.3 in Vector's Form
10-Q for the quarter ended March 31, 2002).
* 4.13 Pledge and Security Agreement, dated as of May 24, 2001,
between New Valley Holdings, Inc. and the Collateral Agent
(incorporated by reference to Exhibit 10.4 in Vector's Form
8-K dated May 14, 2001).
* 4.14 Amendment to Pledge and Security Agreement, dated as of April
30, 2002, between New Valley Holdings, Inc. and the Collateral
Agent (incorporated by reference to Exhibit 10.4 in Vector's
Form 10-Q for the quarter ended March 31, 2002).
* 4.15 Pledge and Security Agreement, dated as of May 14, 2001,
between Brooke Group Holding Inc. and the Collateral Agent
(incorporated by reference to Exhibit 10.4 in Vector's Form
8-K dated May 14, 2001).
* 4.16 Amendment to Pledge and Security Agreement, dated as of April
30, 2002, between Brooke Group Holding Inc. and the Collateral
Agent (incorporated by reference to Exhibit 10.5 in Vector's
Form 10-Q for the quarter ended March 31, 2002).
* 4.17 Acknowledgment and Pledge Agreement, dated as of May 14, 2001,
between Vector and the Collateral Agent (incorporated by
reference to Exhibit 10.6 in Vector's Form 8-K dated May 14,
2001).
67
EXHIBIT
NO. DESCRIPTION
- ------- --------------------------------------------------------------
* 4.18 Amended and Restated Guarantee, Acknowledgement and Pledge
Agreement, dated as of April 30, 2002, between Vector and the
Collateral Agent (incorporated by reference to Exhibit 10.6 in
Vector's Form 10-Q for the quarter ended March 31, 2002).
* 4.19 Guarantee, dated as of April 30, 2002, by Liggett in favor of
the Collateral Agent (incorporated by reference to Exhibit
10.7 in Vector's Form 10-Q for the quarter ended March 31,
2002).
* 4.20 Account Control Agreement, dated as of May 14, 2001, between
Vector Holding, Bank of America, N.A. and the Collateral Agent
(incorporated by reference to Exhibit 10.7 in Vector's Form
8-K dated May 14, 2001).
* 4.21 Indenture, dated as of July 5, 2001, between Vector and U.S.
Bank Trust National Association, as Trustee, relating to the
6.25% Convertible Subordinated Notes due 2008 (the "Notes"),
including the form of Note (incorporated by reference to
Exhibit 10.1 in Vector's Form 8-K dated July 16, 2001).
* 4.22 Form of 9% Promissory Note of VGR Acquisition Inc. due 2004
(incorporated by reference to Exhibit 10.2 in Vector's Form
8-K dated February 15, 2002).
* 4.23 Form of 6 1/2% Promissory Note of VGR Acquisition Inc. due
2007 (incorporated by reference to Exhibit 10.3 in Vector's
Form 8-K dated February 15, 2002).
* 10.1 Corporate Services Agreement, dated as of June 29, 1990,
between Vector and Liggett (incorporated by reference to
Exhibit 10.10 in Liggett's Registration Statement on Form S-1,
No. 33-47482).
* 10.2 Services Agreement, dated as of February 26, 1991, between
Brooke Management Inc. ("BMI") and Liggett (the "Liggett
Services Agreement") (incorporated by reference to Exhibit
10.5 in VGR Holding's Registration Statement on Form S-1, No.
33-93576).
* 10.3 First Amendment to Liggett Services Agreement, dated as of
November 30, 1993, between Liggett and BMI (incorporated by
reference to Exhibit 10.6 in VGR Holding's Registration
Statement on Form S-1, No. 33-93576).
* 10.4 Second Amendment to Liggett Services Agreement, dated as of
October 1, 1995, between BMI, Vector and Liggett (incorporated
by reference to Exhibit 10(c) in Vector's Form 10-Q for the
quarter ended September 30, 1995).
10.5 Third Amendment to Liggett Services Agreement, dated as of
March 31, 2001, by and between Vector and Liggett.
* 10.6 Corporate Services Agreement, dated January 1, 1992, between
VGR Holding and Liggett (incorporated by reference to Exhibit
10.13 in Liggett's Registration Statement on Form S-1, No.
33-47482).
68
EXHIBIT
NO. DESCRIPTION
- ------- --------------------------------------------------------------
* 10.7 Employment Agreement, dated February 21, 1992, between Vector
and Bennett S. LeBow (incorporated by reference to Exhibit
10(xx) in Vector's Form 10-K for the year ended December 31,
1991).
* 10.8 Amendment to Employment Agreement, dated as of July 20, 1998,
between Vector and Bennett S. LeBow (incorporated by reference
to Exhibit 10.8 in Vector's Form 10-K for the year ended
December 31, 1998).
* 10.9 Tax-Sharing Agreement, dated June 29, 1990, among Brooke Group
Holding Inc. ("Brooke Group Holding"), Liggett and certain
other entities (incorporated by reference to Exhibit 10.12 in
Liggett's Registration Statement on Form S-1, No. 33-47482).
* 10.10 Tax Indemnity Agreement, dated as of October 6, 1993, among
Brooke Group Holding, Liggett and certain other entities
(incorporated by reference to Exhibit 10.2 in SkyBox
International Inc.'s Form 10-Q for the quarter ended September
30, 1993).
* 10.11 Expense Sharing Agreement, dated as of January 18, 1995,
between Vector and New Valley Corporation ("New Valley")
(incorporated by reference to Exhibit 10(d) in Vector's Form
10-Q for the quarter ended September 30, 1995).
* 10.12 Settlement Agreement, dated March 15, 1996, by and among the
State of West Virginia, State of Florida, State of
Mississippi, Commonwealth of Massachusetts, and State of
Louisiana, Brooke Group Holding and Liggett (incorporated by
reference to Exhibit 15 in the Schedule 13D filed by Vector
on March 11, 1996, as amended, with respect to the common
stock of RJR Nabisco Holdings Corp.).
* 10.13 Addendum to Initial States Settlement Agreement (incorporated
by reference to Exhibit 10.43 in Vector's Form 10-Q for the
quarter ended March 31, 1997).
* 10.14 Settlement Agreement, dated March 12, 1998, by and among the
States listed in Appendix A thereto, Brooke Group Holding and
Liggett (incorporated by reference to Exhibit 10.35 in
Vector's Form 10-K for the year ended December 31, 1997).
* 10.15 Master Settlement Agreement made by the Settling States and
Participating Manufacturers signatories thereto (incorporated
by reference to Exhibit 10.1 in Philip Morris Companies Inc.'s
Form 8-K dated November 25, 1998, Commission File No. 1-8940).
* 10.16 General Liggett Replacement Agreement, dated as of November
23, 1998, entered into by each of the Settling States under
the Master Settlement Agreement, and Brooke Group Holding and
Liggett (incorporated by reference to Exhibit 10.34 in
Vector's Form 10-K for the year ended December 31, 1998).
69
EXHIBIT
NO. DESCRIPTION
- ------- --------------------------------------------------------------
* 10.17 Stipulation and Agreed Order regarding Stay of Execution
Pending Review and Related Matters, dated May 7, 2001, entered
into by Philip Morris Incorporated, Lorillard Tobacco Co.,
Liggett Group Inc. and Brooke Group Holding Inc. and the class
counsel in Engel, et. al., v. R.J. Reynolds Tobacco Co., et.
al. (incorporated by reference to Exhibit 99.2 in Philip
Morris Companies Inc.'s Form 8-K dated May 7, 2001).
* 10.18 Stock Option Agreement, dated January 1, 1997, between Vector
and Richard J. Lampen (incorporated by reference to Exhibit
10.35 in Vector's Form 10-K for the year ended December 31,
1996).
* 10.19 Stock Option Agreement, dated January 1, 1997, between Vector
and Marc N. Bell (incorporated by reference to Exhibit 4.3 in
the Vector's Registration Statement on Form S-8, No.
333-24217).
* 10.20 Stock Option Agreement, dated January 1, 1998, between Vector
and Joselynn D. Van Siclen (incorporated by reference to
Exhibit 10.43 in Vector's Form 10-K for the year ended
December 31, 1997).
* 10.21 Vector Group Ltd. 1998 Long-Term Incentive Plan (incorporated
by reference to the Appendix to Vector's Proxy Statement dated
September 15, 1998).
* 10.22 Stock Option Agreement, dated July 20, 1998, between Vector
and Bennett S. LeBow (incorporated by reference to Exhibit 6
in the Amendment No. 5 to the Schedule 13D filed by Bennett S.
LeBow on October 16, 1998 with respect to the common stock of
Vector).
* 10.23 Stock Option Agreement, dated July 20, 1998, between Vector
and Howard M. Lorber (incorporated by reference to Exhibit
10.3 in Vector's Form 10-Q for the quarter ended September 30,
1998).
* 10.24 Letter Agreement, dated November 20, 1998, by and among Philip
Morris Incorporated ("PM"), Brooke Group Holding, Liggett &
Myers Inc. ("L&M") and Liggett (incorporated by reference to
Exhibit 10.1 in Vector's Report on Form 8-K dated November 25,
1998).
* 10.25 Amended and Restated Formation and Limited Liability Company
Agreement of Trademarks LLC, dated as of May 24, 1999, among
Brooke Group Holding, L&M, Eve Holdings Inc. ("Eve"), Liggett
and PM, including the form of Trademark License Agreement
(incorporated by reference to Exhibit 10.4 in Vector's Form
10-Q for the quarter ended June 30, 1999).
* 10.26 Class A Option Agreement, dated as of January 12, 1999, among
Brooke Group Holding, L&M, Eve, Liggett and PM (incorporated
by reference to Exhibit 10.61 in Vector's Form 10-K for the
year ended December 31, 1998).
70
EXHIBIT
NO. DESCRIPTION
- ------- --------------------------------------------------------------
* 10.27 Class B Option Agreement, dated as of January 12, 1999, among
Brooke Group Holding, L&M, Eve, Liggett and PM (incorporated
by reference to Exhibit 10.62 in Vector's Form 10-K for the
year ended December 31, 1998).
* 10.28 Pledge Agreement dated as of May 24, 1999 from Eve, as
grantor, in favor of Citibank, N.A., as agent (incorporated by
reference to Exhibit 10.5 in Vector's Form 10-Q for the
quarter ended June 30, 1999).
* 10.29 Guaranty dated as of June 10, 1999 from Eve, as guarantor, in
favor of Citibank, N.A., as agent (incorporated by reference
to Exhibit 10.6 in Vector's Form 10-Q for the quarter ended
June 30, 1999).
* 10.30 Employment Agreement dated as of June 1, 1995, as amended,
effective as of January 1, 1996, between New Valley and
Bennett S. LeBow (incorporated by reference to Exhibit
10(b)(i) in New Valley's Form 10-K for the year ended December
31, 1995).
* 10.31 Employment Agreement ("Lorber Employment Agreement") dated as
June 1, 1995, as amended, effective as of January 1, 1996,
between New Valley and Howard M. Lorber (incorporated by
reference to Exhibit 10(b)(ii) in New Valley's Form 10-K for
the year ended December 31, 1995).
* 10.32 Amendment dated January 1, 1998 to Lorber Employment Agreement
(incorporated by reference to Exhibit 10(b)(iii) in New
Valley's Form 10-K for the year ended December 31, 1997).
* 10.33 Employment Agreement dated September 22, 1995, between New
Valley and Richard J. Lampen (incorporated by reference to
Exhibit 10(a) in New Valley's Form 10-Q for the quarter ended
September 30, 1995).
* 10.34 Employment Agreement dated April 15, 1994, between Vector and
Marc N. Bell (incorporated by reference to Exhibit 10.67 in
Vector's Form 10-K for the year ended December 31, 1998).
* 10.35 Employment Agreement dated as of August 1, 1999, between
Vector and Joselynn D. Van Siclen (incorporated by reference
to Exhibit 10.8 in Vector's Form 10-Q for the quarter ended
June 30, 1999).
* 10.36 Vector Group Ltd. 1999 Long-Term Incentive Plan (incorporated
by reference to Exhibit 10.58 in Vector's Form 10-K for the
year ended December 31, 1999).
* 10.37 Stock Option Agreement, dated November 4, 1999, between Vector
and Bennett S. LeBow (incorporated by reference to Exhibit
10.59 in Vector's Form 10-K for the year ended December 31,
1999).
* 10.38 Stock Option Agreement, dated November 4, 1999, between Vector
and Richard J. Lampen (incorporated by reference to Exhibit
10.60 in Vector's Form 10-K for the year ended December 31,
1999).
71
EXHIBIT
NO. DESCRIPTION
- ------- --------------------------------------------------------------
* 10.39 Stock Option Agreement, dated November 4, 1999, between Vector
and Marc N. Bell (incorporated by reference to Exhibit 10.61
in Vector's Form 10-K for the year ended December 31, 1999).
* 10.40 Stock Option Agreement, dated November 4, 1999, between Vector
and Joselynn D. Van Siclen (incorporated by reference to
Exhibit 10.62 in Vector's Form 10-K for the year ended
December 31, 1999).
* 10.41 Stock Option Agreement, dated November 4, 1999, between Vector
and Howard M. Lorber (incorporated by reference to Exhibit
10.63 in Vector's Form 10-K for the year ended December 31,
1999).
* 10.42 Letter Agreement, dated September 1, 2000, between Ronald J.
Bernstein and Liggett (incorporated by reference to Exhibit
10.62 in Vector's Form 10-K for the year ended December 31,
2000).
* 10.43 Stock Option Agreement, dated October 26, 2000, between Vector
and Ronald J. Bernstein (incorporated by reference to Exhibit
10.63 in Vector's Form 10-K for the year ended December 31,
2000).
* 10.44 Stock Option Agreement, dated January 22, 2001, between Vector
and Bennett S. LeBow (incorporated by reference to Exhibit
10.1 in Vector's Form 10-Q for the quarter ended March 31,
2001).
* 10.45 Stock Option Agreement, dated January 22, 2001, between Vector
and Howard M. Lorber (incorporated by reference to Exhibit
10.2 in Vector's Form 10-Q for the quarter ended March 31,
2001).
* 10.46 Employment Agreement, dated as of January 17, 2001, between
Vector and Howard M. Lorber (incorporated by reference to
Exhibit 10.3 in Vector's Form 10-Q for the quarter ended March
31, 2001).
10.47 Vector Supplemental Executive Retirement Plan (as amended and
restated March 3, 2004).
* 10.48 Purchase and Sale Agreement, dated as of February 15, 2002,
between VGR Acquisition Inc., The Medallion Company, Inc. and
Gary L. Hall (incorporated by reference to Exhibit 10.1 in
Vector's Form 8-K dated February 15, 2002).
* 10.49 Form of Asset Purchase Agreement between VGR Acquisition Inc.
and Gary L. Hall (incorporated by reference to Exhibit 10.4 in
Vector's Form 8-K dated February 15, 2002).
21 Subsidiaries of Vector.
23 Consent of PricewaterhouseCoopers LLP relating to Vector's
Registration Statements on Form S-8 (No. 333-24217, No.
333-50189, No. 333-59615, No. 333-59210 and No. 333-71596) and
Registration Statements on Form S-3 (No. 333-46055, No.
33-38869, No. 33-63119, No. 333-45377, No. 333-56873, No.
333-62156, No. 333-69294 and No. 333-82212).
72
EXHIBIT
NO. DESCRIPTION
- ------- --------------------------------------------------------------
31.1 Certification of Chief Executive Officer, Pursuant to Exchange
Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer, Pursuant to Exchange
Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer, Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer, Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99 Material Legal Proceedings.
- ---------------------------------
*Incorporated by reference
Each management contract or compensatory plan or arrangement required
to be filed as an exhibit to this report pursuant to Item 14(c) is listed in
exhibit nos. 10.7, 10.8, 10.18 through 10.23 and 10.30 through 10.47.
(B) REPORTS ON FORM 8-K:
We filed the following reports on Form 8-K during the fourth
quarter of 2003:
Date Items Financial Statements
---- ----- --------------------
October 8, 2003 7, 12 None
November 13, 2003 5, 7 None
73
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.
VECTOR GROUP LTD.
(REGISTRANT)
By: /s/ Joselynn D. Van Siclen
---------------------------------
Joselynn D. Van Siclen
Vice President, Chief Financial Officer and
Treasurer
Date: March 15, 2004
74
POWER OF ATTORNEY
The undersigned directors and officers of Vector Group Ltd. hereby
constitute and appoint Richard J. Lampen, Joselynn D. Van Siclen and Marc N.
Bell, and each of them, with full power to act without the other and with full
power of substitution and resubstitutions, our true and lawful attorneys-in-fact
with full power to execute in our name and behalf in the capacities indicated
below, this Annual Report on Form 10-K and any and all amendments thereto and to
file the same, with all exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, and hereby ratify and
confirm all that such attorneys-in-fact, or any of them, or their substitutes
shall lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 15, 2004.
SIGNATURE TITLE
/s/ Bennett S. LeBow
- ----------------------------
Bennett S. LeBow Chairman of the Board
(Principal Executive Officer)
/s/ Joselynn D. Van Siclen
- ----------------------------
Joselynn D. Van Siclen Vice President and Chief
Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
/s/ Henry C. Beinstein
- ----------------------------
Henry C. Beinstein Director
/s/ Ronald J. Bernstein
- ----------------------------
Ronald J. Bernstein Director
/s/ Robert J. Eide
- ----------------------------
Robert J. Eide Director
/s/ Howard M. Lorber
- ----------------------------
Howard M. Lorber Director
/s/ Jeffrey S. Podell
- ----------------------------
Jeffrey S. Podell Director
/s/ Jean E. Sharpe
- ----------------------------
Jean E. Sharpe Director
75
VECTOR GROUP LTD.
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2003
ITEMS 8, 14(a)(1) AND (2), AND 14(d)
INDEX TO FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Financial Statements and Schedule of the Registrant and its
subsidiaries required to be included in Items 8, 14(a) (1) and (2), and 14(d)
are listed below:
Page
----
FINANCIAL STATEMENTS:
Vector Group Ltd. Consolidated Financial Statements
Report of Independent Certified Public Accountants................................................. F-2
Vector Group Ltd. Consolidated Balance Sheets as of December 31, 2003 and 2002..................... F-3
Vector Group Ltd. Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001............................................................. F-4
Vector Group Ltd. Consolidated Statements of Stockholders' Equity (Deficit) for
the years ended December 31, 2003, 2002 and 2001............................................. F-5
Vector Group Ltd. Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001............................................................. F-6
Notes to Consolidated Financial Statements......................................................... F-8
FINANCIAL STATEMENT SCHEDULE:
Schedule II -- Valuation and Qualifying Accounts................................................... F-53
Financial Statement Schedules not listed above have been omitted because they are not applicable or
the required information is contained in our consolidated financial statements or accompanying notes.
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Vector Group Ltd.
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of Vector
Group Ltd. and its subsidiaries at December 31, 2003 and 2002, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule listed in the accompanying index presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and financial statement schedule are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Miami, Florida
March 12, 2004
F-2
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 31, December 31,
2003 2002
------------ ------------
Current assets:
Cash and cash equivalents ........................................................ $ 74,808 $ 100,027
Investment securities available for sale ......................................... 67,521 128,430
Accounts receivable - trade ...................................................... 10,425 13,395
Other receivables ................................................................ 2,605 3,853
Inventories ...................................................................... 127,351 100,373
Restricted assets ................................................................ 771 -
Deferred income taxes ............................................................ 19,328 12,825
Other current assets ............................................................. 12,568 17,912
------------ ------------
Total current assets ........................................................... 315,377 376,815
Property, plant and equipment, net .................................................. 143,596 181,972
Assets held for sale ................................................................ 9,438 -
Long-term investments, net .......................................................... 2,431 3,150
Investments in non-consolidated real estate businesses .............................. 18,718 7,811
Restricted assets ................................................................... 5,571 4,857
Deferred income taxes ............................................................... 13,200 12,501
Intangible asset .................................................................... 107,511 107,511
Other assets ........................................................................ 12,370 12,653
------------ ------------
Total assets ................................................................... $ 628,212 $ 707,270
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Current portion of notes payable and long-term debt .............................. $ 10,762 $ 31,277
Accounts payable ................................................................. 8,635 17,046
Accrued promotional expenses ..................................................... 22,203 24,998
Accrued taxes payable, net ....................................................... 48,577 39,370
Settlement accruals .............................................................. 52,650 40,528
Deferred income taxes ............................................................ 4,000 5,277
Accrued interest ................................................................. 7,004 7,556
Other accrued liabilities ........................................................ 19,255 18,332
------------ ------------
Total current liabilities ...................................................... 173,086 184,384
Notes payable, long-term debt and other obligations, less current portion ........... 299,977 307,028
Noncurrent employee benefits ........................................................ 13,438 9,896
Deferred income taxes ............................................................... 139,927 134,762
Other liabilities ................................................................... 4,781 4,866
Minority interests .................................................................. 43,478 44,037
Commitments and contingencies
Stockholders' equity:
Preferred stock, par value $1.00 per share, authorized 10,000,000 shares
Common stock, par value $0.10 per share, authorized 100,000,000
shares, issued 42,103,276 shares and outstanding 39,021,189 shares ............. 3,902 3,643
Additional paid-in capital ....................................................... 251,239 279,305
Deficit .......................................................................... (280,598) (236,718)
Accumulated other comprehensive loss ............................................. (9,335) (11,630)
Less: 3,082,087 shares of common stock in treasury, at cost ..................... (11,683) (12,303)
------------ ------------
Total stockholders' equity (deficit) ........................................ (46,475) 22,297
------------ ------------
Total liabilities and stockholders' equity (deficit) ........................ $ 628,212 $ 707,270
============ ============
The accompanying notes are an integral part
of the consolidated financial statements.
F-3
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31,
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
Revenues:
Tobacco* .................................................................. $ 529,385 $ 502,417 $ 437,416
Real estate leasing ....................................................... 7,298 1,001 9,966
------------ ------------ ------------
Total revenues ......................................................... 536,683 503,418 447,382
Expenses:
Cost of goods sold* ....................................................... 339,617 344,622 259,707
Operating, selling, administrative and general expenses ................... 171,509 174,043 156,332
Restructuring and impairment charges ...................................... 21,300 3,460 -
------------ ------------ ------------
Operating income (loss) ................................................ 4,257 (18,707) 31,343
Other income (expenses):
Interest and dividend income .............................................. 4,696 10,071 11,799
Interest expense .......................................................... (29,734) (27,825) (21,387)
Gain on legal settlement .................................................. - - 17,620
Gain (loss) on investments, net ........................................... 1,955 (6,240) (1,799)
Gain (loss) on sale of assets ............................................. 478 9,097 (8,708)
Equity income (loss) from non-consolidated real estate businesses ......... 901 (749) -
Provision for uncollectibility of notes receivable ........................ - (13,198) -
Other, net ................................................................ 19 (110) (58)
------------ ------------ ------------
(Loss) income from continuing operations before provision (benefit)
for income taxes and minority interests ................................ (17,428) (47,661) 28,810
Provision (benefit) for income taxes ...................................... 574 (6,353) 15,017
Minority interests ........................................................ 2,392 9,514 7,407
------------ ------------ ------------
(Loss) income from continuing operations ....................................... (15,610) (31,794) 21,200
------------ ------------ ------------
Discontinued operations:
Loss from discontinued operations .............................................. - - (2,117)
Gain on disposal of discontinued operations, net of minority interests ......... - - 1,580
------------ ------------ ------------
Loss from discontinued operations .............................................. - - (537)
------------ ------------ ------------
Net (loss) income .............................................................. $ (15,610) $ (31,794) $ 20,663
============ ============ ============
Per basic common share:
(Loss) income from continuing operations .................................. $ (0.40) $ (0.87) $ 0.65
============ ============ ============
Loss from discontinued operations ......................................... - - $ (0.02)
============
Net (loss) income applicable to common shares ............................. $ (0.40) $ (0.87) $ 0.63
============ ============ ============
Basic weighted average common shares outstanding ............................... 38,744,013 36,723,204 32,541,467
============ ============ ============
Per diluted common share:
(Loss) income from continuing operations .................................. $ (0.40) $ (0.87) $ 0.54
============ ============ ============
Loss from discontinued operations ......................................... - - $ (0.01)
============
Net (loss) income applicable to common shares ............................. $ (0.40) $ (0.87) $ 0.53
============ ============ ============
Diluted weighted average common shares outstanding ............................. 38,744,013 36,723,204 39,177,244
============ ============ ============
------------
*Revenues and Cost of goods sold include excise taxes of $195,342,
$192,664 and $151,174 for the years ended December 31, 2003, 2002 and
2001, respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
F-4
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Accumulated
Additional Other
Common Stock Paid-In Treasury Comprehensive
Shares Amount Capital Deficit Stock Income (Loss) Total
---------- ------ -------- --------- -------- ------------- ---------
Balance, December 31, 2000........................ 25,667,018 $2,567 $184,807 $(148,789) $(27,473) $ 1,337 $ 12,449
Net income........................................ - - - 20,663 - - 20,663
Unrealized loss on investment securities....... - - - - - (60) (60)
Effect of New Valley capital transactions...... - - - - - (107) (107)
---------
Total other comprehensive loss............ - - - - - - (167)
---------
Total comprehensive income........................ - - - - - - 20,496
---------
Distributions on common stock..................... - - (46,751) - - - (46,751)
Effect of New Valley acquisition of LTS........... - - 8,556 - - - 8,556
Issuance of stock................................. 1,669,344 167 41,974 - 7,859 - 50,000
Exercise of options and warrants.................. 2,975,025 297 15,607 - 1,281 - 17,185
Effect of stock dividend.......................... 1,502,107 150 54,369 (54,519) - - -
Conversion of debt................................ 1,358,353 136 45,018 - - - 45,154
Tax benefit of options exercised.................. - - 11,133 - - - 11,133
Effect of New Valley share repurchase............. - - 176 - - - 176
Amortization of deferred compensation, net........ - - 5,907 - - - 5,907
LTS distribution.................................. - - (10,947) - - - (10,947)
---------- ------ -------- --------- -------- --------- ---------
Balance, December 31, 2001........................ 33,171,847 3,317 309,849 (182,645) (18,333) 1,170 113,358
Net loss.......................................... - - - (31,794) - - (31,794)
Pension related minimum liability adjustments.. - - - - - (11,090) (11,090)
Unrealized loss on investment securities....... - - - - - (203) (203)
---------
Total other comprehensive loss............ - - - - - - (11,293)
---------
Total comprehensive loss.......................... - - - - - - (43,087)
---------
Distributions on common stock..................... - - (54,477) - - - (54,477)
Effect of stock dividend.......................... 1,662,619 166 22,113 (22,279) - - -
Exercise of options............................... 1,604,819 160 (3,233) - 6,030 - 2,957
Tax benefit of options exercised.................. - - 526 - - - 526
Amortization of deferred compensation, net........ - - 2,234 - - - 2,234
Effect of New Valley share repurchase............. - - 786 - - - 786
Other, net........................................ - - 1,507 - - (1,507) -
---------- ------ -------- --------- -------- ====----- ---------
Balance, December 31, 2002........................ 36,439,285 3,643 279,305 (236,718) (12,303) (11,630) 22,297
========== ====== ======== ========= ======== ========= =========
Net loss.......................................... - - - (15,610) - - (15,610)
Pension related minimum liability adjustments.. - - - - - 17 17
Unrealized gain on investment securities....... - - - - - 2,278 2,278
---------
Total other comprehensive income.......... 2,295
---------
Total comprehensive loss.......................... - - - - - - (13,315)
Distributions on common stock..................... - - (59,997) - - - (59,997)
Effect of stock dividend.......................... 1,850,126 185 28,085 (28,270) - - -
Exercise of warrants and options.................. 731,778 74 1,055 - 620 - 1,749
Tax benefit of options exercised.................. - - 2,037 - - - 2,037
Amortization of deferred compensation, net........ - - 586 - - - 586
Effect of New Valley share repurchase............. - - 75 - - - 75
Other, net........................................ - - 93 - - - 93
---------- ------ -------- --------- -------- --------- ---------
Balance, December 31, 2003........................ 39,021,189 $3,902 $251,239 $(280,598) $(11,683) $ (9,335) $ (46,475)
========== ====== ======== ========= ======== ========= =========
The accompanying notes are an integral part
of the consolidated financial statements.
F-5
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------ ------------ ------------
Cash flows from operating activities:
Net (loss) income ........................................................... $ (15,610) $ (31,794) $ 20,663
---------- ------------ ------------
Adjustments to reconcile net (loss) income to net cash (used in)
provided by operating activities:
Depreciation and amortization .......................................... 16,011 13,863 9,973
Non-cash stock-based expense ........................................... 906 3,534 5,878
Restructuring and impairment charges ................................... 21,300 3,460 -
Impact of discontinued operations ...................................... - - 537
Minority interests ..................................................... (2,392) (9,514) (7,407)
(Gain) loss on sale of investments ..................................... (301) (9,249) 820
Provision for loss on investments ...................................... - 7,628 -
Gain on sale of assets ................................................. (2,202) (57) (1,334)
Loss (gain) on sale of real estate ..................................... - - 9,866
Write-down of equipment ................................................ - 804 -
Loss on debt conversion ................................................ - - 6,445
Deferred income taxes .................................................. (3,314) 1,186 (16,731)
Equity (income) in non-consolidated real estate businesses.............. (901) 749 -
Non-cash interest expense .............................................. 5,885 5,062 2,956
Provision for uncollectibility of notes receivable ..................... - 13,198 -
Other .................................................................. - - (430)
Changes in assets and liabilities (net of effect of acquisitions and
dispositions):
Receivables ............................................................ 4,218 21,861 (23,613)
Inventories ............................................................ (26,978) (48,590) (23,730)
Accounts payable and accrued liabilities ............................... 10,494 9,354 54,075
Other assets and liabilities, net ...................................... 9,084 6,902 (18,248)
---------- ------------ ------------
Net cash provided by (used in) operating activities ............................ 16,200 (11,603) 19,720
---------- ------------ ------------
Cash flows from investing activities:
Proceeds from sale of businesses and assets, net ............................ 2,723 3,644 7,912
Sale or maturity of investment securities ................................... 135,737 111,795 16,418
Purchase of investment securities ........................................... (68,978) (75,095) (162,959)
Sale or liquidation of long-term investments ................................ 1,004 - 1,133
Purchase of long-term investments ........................................... (195) - (5,711)
Purchase of Medallion ....................................................... - (50,103) -
(Increase) decrease in restricted assets .................................... (1,485) (168) 1,231
Proceeds from sale of real estate, net ...................................... - 18,798 42,160
Purchase of non-consolidated real estate businesses.......................... (11,000) - -
Distributions from non-consolidated real estate businesses................... 991 - -
Repayment (issuance) of note receivable, net ................................ - (4,000) -
Payment of prepetition claims ............................................... (74) (2,026) (3,183)
Cash received in LTS acquisition, net ....................................... - - 4,065
Capital expenditures ........................................................ (8,894) (96,636) (77,100)
---------- ------------ ------------
Net cash provided by (used in) investing activities ............................ 49,829 (93,791) (176,034)
---------- ------------ ------------
The accompanying notes are an integral part
of the consolidated financial statements.
F-6
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from debt........................................................... - 78,135 264,441
Repayments of debt........................................................... (31,654) (23,338) (32,777)
Deferred financing charges................................................... - (1,281) (9,642)
Borrowings under revolver.................................................... 629,699 612,121 508,121
Repayments on revolver....................................................... (629,699) (612,121) (527,495)
(Decrease) increase in margin loan payable................................... - - (4,675)
(Decrease) increase in cash overdraft........................................ - - (501)
Distributions on common stock................................................ (59,997) (54,477) (46,751)
(Repayments) proceeds from participating loan............................... - (12,445) 2,981
Issuance of common stock..................................................... - - 50,000
Proceeds from exercise of options and warrants............................... 1,749 2,957 17,185
Cash impact of LTS distribution.............................................. - - (8,136)
New Valley purchase of common shares......................................... (1,346) (1,891) (274)
Other, net................................................................... - - 79
------------ ------------ ------------
Net cash (used in) provided by financing activities............................. (91,248) (12,340) 212,556
------------ ------------ ------------
Net cash provided by discontinued operations.................................... - - 4,006
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents............................ (25,219) (117,734) 60,248
Cash and cash equivalents, beginning of year.................................... 100,027 217,761 157,513
------------ ------------ ------------
Cash and cash equivalents, end of year.......................................... $ 74,808 $ 100,027 $ 217,761
============ ============ ============
The accompanying notes are an integral part
of the consolidated financial statements.
F-7
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation:
The consolidated financial statements of Vector Group Ltd.
(the "Company" or "Vector") include the accounts of VGR
Holding Inc. ("VGR Holding"), Liggett Group Inc. ("Liggett"),
Vector Tobacco Inc. ("Vector Tobacco"), Liggett Vector Brands
Inc. ("Liggett Vector Brands") and other less significant
subsidiaries. The Company owned 58.1% of the common shares of
New Valley Corporation ("New Valley") at December 31, 2003.
All significant intercompany balances and transactions have
been eliminated. Certain amounts in prior years' consolidated
financial statements have been reclassified to conform to the
current year's presentation.
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.
As discussed in Note 4, a subsidiary of the Company acquired
The Medallion Company, Inc. on April 1, 2002.
As discussed in Note 20, New Valley's former broker-dealer
operations are presented as discontinued operations for the
year ended December 31, 2001.
(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) Cash and Cash Equivalents:
For purposes of the statements of cash flows, cash includes
cash on hand, cash on deposit in banks and cash equivalents,
comprised of short-term investments which have an original
maturity of 90 days or less. Interest on short-term
investments is recognized when earned.
(d) Financial Instruments:
The carrying value of cash and cash equivalents, restricted
assets and short-term loans are reasonable estimates of their
fair value.
F-8
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
The carrying amounts of short-term debt reported in the
consolidated balance sheets are a reasonable estimate of fair
value. The fair value of long-term debt for the years ended
December 31, 2003 and December 31, 2002 was estimated based on
current market quotations, where available.
The methods and assumptions used by the Company's management
in estimating fair values for financial instruments presented
herein are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of
different market assumptions and/or estimation methodologies
may have a material effect on the estimated fair values.
(e) Investment Securities:
The Company classifies investments in debt and marketable
equity securities as available for sale. Investments
classified as available for sale are carried at fair value,
with net unrealized gains and losses included as a separate
component of stockholders' equity. The cost of securities sold
is determined based on average cost.
Gains are recognized when realized in the Company's
consolidated statements of operations. Losses are recognized
as realized or upon the determination of the occurrence of an
other-than-temporary decline in fair value. The Company's
policy is to review its securities on a regular basis to
evaluate whether any security has experienced an
other-than-temporary decline in fair value. If it is
determined that an other-than-temporary decline exists in one
of the Company's marketable securities, it is the Company's
policy to record an impairment charge with respect to such
investment in the Company's consolidated statements of
operations.
(f) Significant Concentrations of Credit Risk:
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and
cash equivalents and trade receivables. The Company places its
temporary cash in money market securities (investment grade or
better) with what management believes are high credit quality
financial institutions.
Liggett's customers are primarily candy and tobacco
distributors, the military and large grocery, drug and
convenience store chains. One customer accounted for
approximately 16.6% of Liggett's revenues in 2003, 16.5% of
Liggett's revenues in 2002 and 23.5% of Liggett's revenues in
2001. Sales to this customer were primarily in the private
label discount segment. Concentrations of credit risk with
respect to trade receivables are generally limited due to the
large number of customers, located primarily throughout the
United States, comprising Liggett's customer base. Ongoing
credit evaluations of customers' financial condition are
performed and, generally, no collateral is required. Liggett
maintains reserves for potential credit losses and such
losses, in the aggregate, have generally not exceeded
management's expectations.
(g) Accounts Receivable:
Accounts receivable-trade are recorded at their net realizable
value.
The allowance for doubtful accounts and cash discounts was
$746 and $2,248 at December 31, 2003 and 2002, respectively.
(h) Inventories:
Tobacco inventories are stated at the lower of cost or market
and are determined primarily by the last-in, first-out (LIFO)
method at Liggett and the first-in, first out (FIFO) method at
Vector Tobacco. Although portions of leaf tobacco inventories
may not be used or sold within one year because of the time
required for aging, they are included in current assets, which
is common practice in the industry. It is not practicable to
determine the amount that will not be used or sold within one
year.
F-9
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(i) Restricted Assets:
Current restricted assets of $771 at December 31, 2003
consist of amounts held in escrow related to New Valley's
real estate operations. Long-term restricted assets of $5,571
and $4,857 at December 31, 2003 and December 31, 2002,
respectively, consist primarily of certificates of deposit
which collateralize letters of credit.
(j) Property, Plant and Equipment:
Property, plant and equipment are stated at cost. Property,
plant and equipment are depreciated using the straight-line
method over the estimated useful lives of the respective
assets, which are 20 to 30 years for buildings and 3 to 10
years for machinery and equipment. Office buildings held by
New Valley are depreciated over periods approximating 39
years.
Interest costs are capitalized in connection with the
construction of major facilities. Capitalized interest is
recorded as part of the asset to which it relates and is
amortized over the asset's estimated useful life. In 2003,
2002 and 2001, interest costs of $0, $305 and $779,
respectively, were capitalized.
Repairs and maintenance costs are charged to expense as
incurred. The costs of major renewals and betterments are
capitalized. The cost and related accumulated depreciation of
property, plant and equipment are removed from the accounts
upon retirement or other disposition and any resulting gain or
loss is reflected in operations.
(k) Intangible Assets:
The Company is required to conduct an annual review of
intangible assets for potential impairment including the
intangible asset of $107,511, which is not subject to
amortization due to its indefinite useful life, and relates to
Medallion's exemption under the Master Settlement Agreement.
(Refer to Note 4.)
Other intangible assets, included in other assets, consisting
of trademarks and patent rights, are amortized using the
straight-line method over 10-12 years. The book value of
other intangible assets are $21,998 and $21,998 and the
related accumulated amortization is $20,936 and $20,789 at
December 31, 2003 and 2002, respectively. Amortization expense
for the years ended December 31, 2003, 2002 and 2001 was $147,
$145 and $19, respectively. Based on the current amount of
intangible assets subject to amortization, the estimated
expense for each of the succeeding five years is $148 in
2004, $148 in 2005, $124 in 2006, $122 in 2007 and $122 in
2008.
(l) Impairment of Long-Lived Assets:
The Company reviews long-lived assets for impairment annually
or whenever events or changes in business circumstances
indicate that the carrying amount of the assets may not be
fully recoverable. The Company performs undiscounted operating
cash flow analyses to determine if an impairment exists. If an
impairment is determined to exist, any related impairment loss
is calculated based on fair value of the asset on the basis of
discounted cash flow. Impairment losses on assets to be
disposed of, if any, are based on the estimated proceeds to be
received, less costs of disposal.
Effective January 1, 2002, the Company adopted SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived
Assets". SFAS No. 144 supersedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed of", and requires (i) the recognition and
measurement of the impairment of long-lived assets to be held
and used and (ii) the measurement of long-lived assets to be
disposed of by sale.
F-10
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
As discussed in Note 2, the Company recorded an $18,752 asset
impairment charge in 2003 in connection with the closing of
Vector Tobacco's Timberlake, North Carolina cigarette
manufacturing facility.
(m) Employee Benefits:
In 2002 and 2001, Liggett sponsored self-insured health and
dental insurance plans for all eligible employees. The expense
recorded for such benefits contained an estimate of unpaid
claims as of December 31, 2002 and 2001 which were subject to
significant fluctuations in the near term. In January 2003,
Liggett converted to fully-insured health and dental plans.
(n) Postretirement Benefits other than Pensions:
The cost of providing retiree health care and life insurance
benefits is actuarially determined and accrued over the
service period of the active employee group.
(o) Stock Options:
The Company accounts for employee stock compensation plans
under APB Opinion No. 25, "Accounting for Stock Issued to
Employees" with the intrinsic value-based method permitted by
SFAS No. 123, "Accounting for Stock-Based Compensation" as
amended by SFAS No. 148. Accordingly, no compensation expense
is recognized when the exercise price is equal to the market
price of the underlying common stock on the date of grant.
Awards under the Company's stock compensation plans generally
vest over periods ranging from four to five years. The expense
related to stock option compensation included in the
determination of net income for 2003, 2002 and 2001 is less
than that which would have been recognized if the fair value
method had been applied to all awards since the original
effective date of SFAS No. 123. The following table
illustrates the effect on net (loss) income and (loss) income
per share if the Company had applied the fair value provisions
of SFAS No. 123:
2003 2002 2001
------------ ------------ ------------
Net (loss) income as adjusted ......................... $ (15,610) $ (31,794) $ 20,663
Add: stock option employee compensation
expense included in reported net (loss)
income, net of related tax effects ............... 4,738 5,375 5,305
Deduct: total stock option employee
compensation expense determined
under the fair value method for all awards,
net of related tax effects ....................... (7,759) (10,272) (10,275)
------------ ------------ ------------
Pro forma net (loss) income ........................... $ (18,631) $ (36,691) $ 15,693
============ ============ ============
(Loss) income per share:
Basic - as reported .............................. $ (0.40) $ (0.87) $ 0.63
Basic - pro forma ................................ $ (0.48) $ (1.00) $ 0.48
Diluted - as reported ............................ $ (0.40) $ (0.87) $ 0.53
Diluted - pro forma .............................. $ (0.48) $ (1.00) $ 0.40
F-11
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
For purposes of this pro forma presentation, the fair value of
each option grant was estimated at the date of the grant using
the Black-Scholes option pricing model. The Black-Scholes
option valuation model was developed for use in estimating the
fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective
assumptions including expected stock price characteristics
which are significantly different from those of traded
options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, the
existing models do not necessarily provide a reliable single
measure of the fair value of stock-based compensation awards.
(p) Income Taxes:
Deferred taxes reflect the impact of temporary differences
between the amounts of assets and liabilities recognized for
financial reporting purposes and the amounts recognized for
tax purposes as well as tax credit carryforwards and loss
carryforwards. These deferred taxes are measured by applying
currently enacted tax rates. A valuation allowance reduces
deferred tax assets when it is deemed more likely than not
that some portion or all of the deferred tax assets will not
be realized.
(q) Revenue Recognition:
Sales: Revenues from sales are recognized upon the shipment of
finished goods when title and risk of loss have passed to the
customer, there is persuasive evidence of an arrangement, the
sale price is determinable and collectibility is reasonably
assured. The Company provides an allowance for expected sales
returns, net of related inventory cost recoveries. Since the
Company's primary line of business is tobacco, the Company's
financial position and its results of operations and cash
flows have been and could continue to be materially adversely
affected by significant unit sales volume declines, litigation
and defense costs, increased tobacco costs or reductions in
the selling price of cigarettes in the near term.
Effective January 1, 2002, the Company adopted Emerging Issues
Task Force "EITF") Issue No. 00-14, "Accounting for Certain
Sales Incentives," and EITF Issue No. 00-25, "Vendor Income
Statement Characterization of Consideration Paid to a Reseller
of the Vendor's Products." Prior period consolidated
statements of earnings have been reclassified to reflect the
adoption. EITF No. 01-9, "Accounting for Consideration Given
by a Vendor to a Customer (Including a Reseller of the
Vendor's Products)," became effective in November 2001,
codifying and reconciling certain issues in EITF No. 00-25.
With respect to estimated amounts of consideration that will
be claimed by customers, costs are recognized at the later of
the date at which the related revenue is recognized or the
date at which the sales incentive is offered. The adoption of
these EITF Issues resulted in a reduction of revenues of
$296,836 in 2001. In addition, the adoption reduced marketing,
administration and research costs in 2001 by $305,756, and
cost of goods sold increased by $8,920. The adoption of these
EITF Issues had no impact on operating income, net earnings or
basic and diluted earnings per share ("EPS").
Real Estate Leasing Revenues: The Company's real estate
properties are being leased to tenants under operating leases.
Base rental revenue is generally recognized on a straight-line
basis over the term of the lease. The lease agreements for
certain properties contain provisions which provide for
reimbursement of real estate taxes and operating expenses over
base year amounts, and in certain cases as fixed increases in
rent. In addition, the lease agreements for certain tenants
provide additional rentals based upon revenues in excess of
base amounts, and such amounts are accrued as earned. The
future minimum rents scheduled to be received on
non-cancelable operating leases at December 31, 2003 are
$6,578 in 2004, $6,662 in 2005, $6,519 in 2006, $5,612 in
2007, $5,620 in 2008 and $10,284 thereafter.
F-12
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(r) Advertising and Research and Development:
Advertising costs, which are expensed as incurred, were
$19,473, $15,544 and $11,439 for the years ended December 31,
2003, 2002 and 2001, respectively.
Research and development costs, primarily at Vector Tobacco,
are expensed as incurred, and were $10,546, $10,103 and
$13,174 for the years ended December 31, 2003, 2002 and 2001,
respectively.
(s) Legal Costs:
The Company's policy is to accrue legal and other costs
related to contingencies as services are performed.
(t) 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, September 27, 2002
and September 28, 2001. The dividends were charged to retained
earnings in the net amount of $28,270 in 2003, $22,279 in 2002
and $54,519 in 2001 and were based on the fair value of the
Company's common stock. In connection with each 5% dividend,
the Company increased the number of outstanding warrants and
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, 2001.
Basic net income per share is computed by dividing net income
by the weighted-average number of shares outstanding. Diluted
net income per share includes the dilutive effect of stock
options, vested restricted stock grants and warrants. Basic
and diluted EPS were calculated using the following shares for
the years ended December 31, 2003, 2002 and 2001:
2003 2002 2001
---------- ---------- ----------
Weighted-average shares for basic EPS ...... 38,744,013 36,723,204 32,541,467
Plus incremental shares related to
stock options and warrants ............. - - 6,635,777
---------- ---------- ----------
Weighted-average shares for diluted EPS 38,744,013 36,723,204 39,177,244
========== ========== ==========
The Company had a net loss for the years ended December 31,
2003 and December 31, 2002. Therefore, the effect of the
common stock equivalents and convertible securities is
excluded from the computation of diluted net loss per share
since the effect is antidilutive for these years. Potentially
dilutive shares that were not included in the diluted loss
per share calculation were 1,735,722 in 2003 and 1,203,500
in 2002 which shares are issuable upon the exercise of stock
options and warrants assuming the treasury stock method.
(u) Comprehensive Income (Loss):
Other comprehensive income (loss) is a component of
stockholders' equity and includes such items as the Company's
proportionate interest in New Valley's capital transactions,
unrealized gains and losses on investment securities and
minimum pension liability adjustments. Total comprehensive
loss was $13,315 for the year ended December 31, 2003 and
$11,293 for the year ended December 31, 2002, and total
comprehensive income was $20,496 for the year ended December
31, 2001.
F-13
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(v) New Accounting Pronouncements:
In December 2003, Financial Accounting Standards Board
Interpretation ("FIN") No. 46(R), "Consolidation of Variable
Interest Entities (revised December 2003)", was issued. The
interpretation revises FIN No. 46, "Consolidation of Variable
Interest Entities", to exempt certain entities from the
requirements of FIN No. 46. The interpretation requires a
company to consolidate a variable interest entity ("VIE"), as
defined, when the company will absorb a majority of the
variable interest entity's expected losses, receive a majority
of the variable interest entity's expected residual returns,
or both. FIN No. 46(R) also requires consolidation of
existing, non-controlled affiliates if the VIE is unable to
finance its operations without investor support, or where the
other investors do not have exposure to the significant risks
and rewards of ownership. The interpretation applies
immediately to a VIE created or acquired after January 31,
2003. For a VIE acquired before February 1, 2003, FIN No.
46(R) applies in the first interim period ending after March
15, 2004. The Company has not completed its assessment of the
impact of this interpretation, but it does not anticipate a
material impact on its consolidated financial statements.
In April 2003, SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" was issued.
SFAS No. 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded
in other contracts, and for hedging activities under SFAS No.
133. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The adoption of this statement
did not impact the Company's consolidated financial
statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity." SFAS No. 150 establishes standards
for how companies classify and measure certain financial
instruments with characteristics of both liabilities and
equity. It requires companies to classify a financial
instrument that is within its scope as a liability (or an
asset in some circumstances). SFAS No. 150 is effective
immediately for financial instruments entered into or modified
after May 15, 2003 and in the first interim period after June
15, 2003 for all other financial instruments. The adoption of
this statement did not impact the Company's consolidated
financial statements.
In December 2003, the FASB issued SFAS No. 132(R), which
replaces SFAS No. 132, "Employers' Disclosures about Pensions
and Other Postretirement Benefits." SFAS No. 132(R) does not
change the measurement and recognition provisions of SFAS No.
87, SFAS No. 88, ""Employers' Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for
Termination Benefits," and SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions,"
however, it includes additional disclosure provisions for
annual reporting, 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 11.)
2. VECTOR TOBACCO RESTRUCTURING
On October 8, 2003, the Company announced that it would close Vector
Tobacco's Timberlake, North Carolina cigarette manufacturing facility
in order to reduce excess tobacco production capacity and improve
operating efficiencies company-wide. Production of the QUEST line of
low nicotine and nicotine-free cigarettes, as well as production of
Vector Tobacco's other cigarette brands, has been moved to Liggett's
state-of-the-art manufacturing facility in Mebane, North Carolina.
F-14
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
The Mebane facility currently produces in excess of 9 billion units per
year, but maintains the capacity to produce 16 billion units per year.
Vector Tobacco has contracted with Liggett Group to produce its
cigarettes and has transitioned production from Timberlake to Mebane.
All production ceased at Timberlake by December 31, 2003. As part of
the transition, Vector eliminated approximately 150 positions.
As a result of these actions, the Company recognized pre-tax
restructuring and impairment charges currently estimated to total
approximately $21,522, of which $21,300 has been taken in 2003 and
approximately $222 will be taken in the first quarter of 2004.
Machinery and equipment to be disposed of was reduced to estimated fair
value less costs to sell and is being carried on the accompanying
consolidated balance sheets as assets held for sale. The asset
impairment charges are based on management's current estimates of the
values the Company will be able to realize on sales of the excess
machinery and equipment, and may be adjusted in future periods based on
the actual amounts realized.
The components of the pre-tax restructuring and impairment charge for
the year ended December 31, 2003 are as follows:
Employee Non-Cash Contract
Severance Asset Termination/
and Benefits Impairment Exit Costs Total
------------ ------------ ------------ ------------
Balance, December 31, 2002 $ - $ - $ - $ -
Original charges ......... 2,045 18,752 503 21,300
Utilized in 2003 ......... (182) (18,752) (54) (18,988)
------------ ------------ ------------ ------------
Balance, December 31, 2003 $ 1,863 $ 0 $ 449 $ 2,312
============ ============ ============ ============
3. LIGGETT VECTOR BRANDS
In 2002, the Company approved a plan to combine the sales and marketing
functions of its Liggett and Vector Tobacco subsidiaries into a new
entity, Liggett Vector Brands Inc., in order to enhance the
effectiveness of the Company's sales and marketing operations. This
company coordinates and executes the sales and marketing efforts for all
of the Company's tobacco operations. As a result of this plan, during
the first quarter of 2002, the Company recognized a pre-tax
restructuring charge of approximately $3,460, consisting of
approximately $2,000 in involuntary severance and other exit costs and
an impairment charge of approximately $1,500 related to certain
long-lived assets. The Company had substantially completed all of these
restructuring activities as of March 31, 2003.
4. MEDALLION ACQUISITION
On April 1, 2002, a subsidiary of the Company acquired 100% of the stock
of The Medallion Company, Inc. ("Medallion"), and related assets from
Medallion's principal stockholder. Following the purchase of the
Medallion stock, Vector Tobacco merged into Medallion and Medallion
changed its name to Vector Tobacco Inc. The total purchase price
consisted of $50,000 in cash and $60,000 in notes, with the notes
guaranteed by the Company and by Liggett. (See Note 9.) Medallion, a
discount cigarette manufacturer, is a participant in the Master
Settlement Agreement between the
F-15
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
state Attorneys General and the tobacco industry. Medallion has no
payment obligations under the Master Settlement Agreement except to the
extent its market share exceeds approximately 0.28% of total cigarettes
sold in the United States. The results of operations of Medallion are
included in the Company's financial statements beginning April 1, 2002.
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition.
At April 1, 2002
----------------
Receivable from seller...................................... $ 3,189
Inventory................................................... 1,019
Property, plant and equipment............................... 2,181
Intangible asset............................................ 107,511
----------
Total assets acquired.................................. 113,900
----------
Accrued merger costs........................................ 300
Allowance for sales returns................................. 500
Accrued Master Settlement Agreement liability............... 3,100
----------
Total liabilities assumed.............................. 3,900
----------
Net assets acquired.................................... $110,000
==========
The $107,511 intangible asset, which is not subject to amortization,
relates to Medallion's exemption under the Master Settlement Agreement
and has been included with the Liggett segment for segment reporting
purposes.
The following table presents unaudited pro forma results of operations
as if the Medallion acquisition had occurred immediately prior to
January 1, 2001. These pro forma results have been prepared for
comparative purposes only and do not purport to be indicative of what
would have occurred had these transactions been consummated as of such
date.
Year Ended December 31,
2002 2001
------------ ------------
Revenues ............................... $ 518,279 $ 491,652
============ ============
Net (loss) income ...................... $ (33,042) $ 21,131
============ ============
Net (loss) income per common share:
Basic ............................. $ (0.90) $ 0.65
============ ============
Diluted ........................... $ (0.90) $ 0.54
============ ============
5. INVESTMENT SECURITIES AVAILABLE FOR SALE
Investment securities classified as available for sale are carried at
fair value, with net unrealized gains or losses included as a component
of stockholders' equity, net of taxes and minority interests. For the
year ended December 31, 2003, net realized gains were $1,955 and for
the years ended
F-16
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
December 31, 2002 and 2001, net realized losses were $6,240 and $1,799,
respectively. During 2002, the Company recorded a loss of $6,776 related
to other-than-temporary declines in the fair value of marketable equity
securities held by New Valley and $852 related to an
other-than-temporary decline in the fair value of marketable debt
securities.
The components of investment securities available for sale at December
31, 2003 and 2002 are as follows:
Gross Gross
Unrealized Unrealized Fair
Cost Gain Loss Value
---------- ---------- ---------- ----------
2003
Marketable equity securities ...... $ 11,535 $ 6,411 $ - $ 17,946
Marketable debt securities ........ 50,051 447 (923) 49,575
---------- ---------- ---------- ----------
$ 61,586 $ 6,858 $ (923) $ 67,521
========== ========== ========== ==========
2002
Marketable equity securities ...... $ 14,430 $ - $ (1,037) $ 13,393
Marketable debt securities ........ 115,220 1,157 (1,340) 115,037
---------- ---------- ---------- ----------
$ 129,650 $ 1,157 $ (2,377) $ 128,430
========== ========== ========== ==========
6. INVENTORIES
Inventories consist of:
December 31,
2003 2002
------------ ------------
Leaf tobacco ...................... $ 80,239 $ 63,196
Other raw materials ............... 3,060 5,438
Work-in-process ................... 1,609 2,888
Finished goods .................... 42,825 30,014
Replacement parts and supplies .... 636 602
------------ ------------
Inventories at current cost ....... 128,369 102,138
LIFO adjustments .................. (1,018) (1,765)
------------ ------------
$ 127,351 $ 100,373
============ ============
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 December 31, 2003,
Liggett had leaf tobacco purchase commitments of approximately $7,741
and Vector Tobacco had leaf tobacco purchase commitments of
approximately $1,624.
LIFO inventories represent approximately 58.0% and 61.4% of total
inventories at December 31, 2003 and 2002, respectively.
F-17
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Included in the above table is approximately $44,220 at December 31,
2003 and $38,000 at December 31, 2002 of inventory associated with
Vector Tobacco's new product initiatives. The recoverability of costs
of such inventory is dependent upon market conditions and consumer
demands for the product.
7. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
December 31,
2003 2002
------------ ------------
Land and improvements ........ $ 10,019 $ 10,019
Buildings .................... 74,326 74,828
Machinery and equipment ...... 105,032 136,738
Leasehold improvements ....... 1,023 130
Construction-in-progress ..... 1,554 3,566
------------ ------------
191,954 225,281
Less accumulated depreciation (48,358) (43,309)
------------ ------------
$ 143,596 $ 181,972
============ ============
The table above includes real estate assets and accumulated
depreciation owned and operated by New Valley in the amounts of $54,258
and $1,246 and $54,528 and $50 as of December 31, 2003 and 2002,
respectively. (Refer to Note 21.)
Depreciation and amortization expense for the years ended December 31,
2003, 2002 and 2001 was $16,011, $13,863 and $9,973, respectively.
Future machinery and equipment purchase commitments at Liggett are
$970.
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 December 31,
2003 of approximately $1,347. The option agreement permits the
purchaser to acquire the property, during a period of up to two years,
at a purchase price of $14,000 if the closing occurs by August 23, 2004
and $15,000 if the closing occurs thereafter during the term of the
option. Liggett has received option fees of $1,000, of which $250 is
refundable if the purchaser terminates the agreement prior to August
23, 2004. Liggett will be entitled to receive additional option fees of
up to $500 during the remaining option period. The option fees will
generally be creditable against the purchase price. The purchaser is
currently conducting due diligence, and there can be no assurance the
sale of the property will occur.
The Company recorded an $18,752 non-cash asset impairment charge during
the third quarter of 2003 in conjunction with the closing of Vector
Tobacco's Timberlake, North Carolina facility of which $17,968 relates
to machinery and equipment. (See Note 2.) Vector Tobacco has entered
into negotiations to sell the Timberlake facility, including all
equipment not relocated to Mebane.
During 2003, Liggett entered into sale-leaseback transactions in which
equipment with a book value of $4,483 was sold and leased back from a
third party as operating leases. Liggett received cash of $2,386, and
no gain or loss was recognized on these transactions. Deposits of
$2,097 made by Liggett under the leases have been recorded as other
assets in the December 31, 2003 balance sheet.
F-18
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
8. LONG-TERM INVESTMENTS
Long-term investments consist of investments in the following:
December 31, 2003 December 31, 2002
-------------------------- --------------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- ------- -------- -------
Limited partnerships................... $ 2,431 $11,741 $ 3,150 $10,694
The principal business of the limited partnerships is investing in real
estate and investment securities. The estimated fair value of the
limited partnerships was provided by the partnerships based on the
indicated market values of the underlying assets or investment
portfolio. New Valley is an investor in real estate partnerships where
it has committed to make additional investments of up to an aggregate
of $979 at December 31, 2003. New Valley's investments in limited
partnerships are illiquid and the ultimate realization of these
investments is subject to the performance of the underlying partnership
and its management by the general partners.
The Company's estimate of the fair value of its long-term investments
are subject to judgment and are not necessarily indicative of the
amounts that could be realized in the current market.
9. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
December 31, December 31,
2003 2002
------------ ------------
Vector:
6.25% Convertible Subordinated Notes due 2008 ........... $ 132,500 $ 132,500
VGR Holding:
10% Senior Secured Notes due 2006, net of
unamortized discount of $6,675 and $10,751 ........... 63,325 71,249
Liggett:
Term loan under credit facility ......................... 5,190 5,190
Other notes payable ..................................... 9,758 13,195
Vector Tobacco:
Notes payable ........................................... 5,999 7,357
Notes payable - Medallion acquisition ................... 38,125 50,625
V.T. Aviation:
Notes payable ........................................... 10,496 17,237
VGR Aviation:
Notes payable ........................................... 5,346 -
New Valley:
Notes payable - operating real estate ................... 39,910 40,500
Other ................................................... 90 452
------------ ------------
Total notes payable, long-term debt and other obligations 310,739 338,305
Less:
Current maturities .............................. (10,762) (31,277)
------------ ------------
Amount due after one year ............................... $ 299,977 $ 307,028
============ ============
F-19
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
6.25% Convertible Subordinated Notes Due July 15, 2008 - Vector:
In July 2001, Vector completed the sale of $172,500 (net proceeds of
approximately $166,400) of its 6.25% convertible subordinated notes due
July 15, 2008 through a private offering to qualified institutional
investors in accordance with Rule 144A under the Securities Act of
1933. The notes pay interest at 6.25% per annum and are convertible
into Vector's common stock, at the option of the holder. The conversion
price, which was $27.51 per share at December 31, 2003, is subject to
adjustment for various events, and any cash distribution on Vector's
common stock will result in a corresponding decrease in the conversion
price. In December 2001, $40,000 of the notes were converted into
Vector's common stock, and $132,500 of the notes were outstanding at
December 31, 2003.
The notes may be redeemed by Vector, in whole or in part, prior to July
15, 2004, if the closing price of Vector's common stock exceeds 150% of
the conversion price then in effect for a period of at least 20 trading
days in any consecutive 30 day trading period, at a price equal to 100%
of the principal amount, plus accrued interest and a "make whole"
payment. Vector may redeem the notes, in whole or in part, at a price
of 103.125% in the year beginning July 15, 2004, 102.083% in the year
beginning July 15, 2005, 101.042% in the year beginning July 15, 2006
and 100% in the year beginning July 15, 2007, together with accrued
interest. If a change of control occurs, Vector will be required to
offer to repurchase the notes at 101% of their principal amount, plus
accrued interest and, under certain circumstances, a "make whole"
payment.
10% Senior Secured Notes Due March 31, 2006 - VGR Holding:
In May 2001, VGR Holding issued at a discount $60,000 principal amount
of 10% senior secured notes due March 31, 2006 in a private placement.
VGR Holding received net proceeds from the offering of approximately
$46,500. In April 2002, VGR Holding issued at a discount an additional
$30,000 principal amount of 10% senior secured notes due March 31, 2006
in a private placement and received net proceeds of approximately
$24,500. The notes were priced to provide the purchasers with a 15.75%
yield to maturity. The new notes are on the same terms as the $60,000
principal amount of senior secured notes previously issued. All of the
notes have been guaranteed by the Company and by Liggett.
The notes are collateralized by substantially all of VGR Holding's
assets, including a pledge of VGR Holding's equity interests in its
direct subsidiaries, including Brooke Group Holding, Liggett Vector
Brands, Vector Tobacco and New Valley Holdings, Inc. ("NV Holdings"),
as well as a pledge of the shares of Liggett and all of the New Valley
securities held by VGR Holding and NV Holdings. The purchase agreement
for the notes contains covenants, which among other things, limit the
ability of VGR Holding to make distributions to the Company to 50% of
VGR Holding's net income, unless VGR Holding holds an amount in cash
equal to the then principal amount of the notes outstanding ($70,000 at
December 31, 2003) 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 plus,
for periods through December 31, 2003, additional amounts including up
to $50,000 during the period commencing on September 30, 2003 and
ending on December 31, 2003. The covenants also restrict transactions
with affiliates subject to exceptions which include payments to Vector
not to exceed $9,500 per year for permitted operating expenses, and
limit the ability of VGR Holding to merge, consolidate or sell certain
assets. In November 2002, in connection with an amendment to the note
purchase agreement, VGR Holding repurchased $8,000 of the notes at a
price of 100% of the principal amount plus accrued interest. The
Company recognized a loss of $1,320 in 2002 on the early extinguishment
of debt.
F-20
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
In connection with an additional amendment to the note purchase
agreement, VGR Holding repurchased a total of $8,000 of the notes in
the second quarter of 2003 and $4,000 of the notes on September 30,
2003, at a price of 100% of the principal amount plus accrued interest.
The Company recognized a loss of $1,721 in 2003 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.
VGR Holding may redeem the notes, in whole or in part, at a redemption
price of 100% of the principal amount. During the term of the notes,
VGR Holding is required to offer to repurchase all the notes at a
purchase price of 101% of the principal amount, in the event of a
change of control, and to offer to repurchase notes, at 100% of the
principal amount, with the proceeds of material asset sales.
Revolving Credit Facility - Liggett:
Liggett has a $40,000 credit facility, under which $0 was outstanding
at December 31, 2003 and 2002. Availability under the credit facility
was approximately $29,688 based on eligible collateral at December 31,
2003. The facility is collateralized by all inventories and receivables
of Liggett. Borrowings under the facility, whose interest is calculated
at a rate equal to 1.0% above Wachovia's (the indirect parent of
Congress Financial Corporation, the lead lender) prime rate, bore a
rate of 5.0% at December 31, 2003. The facility requires Liggett's
compliance with certain financial and other covenants including a
restriction on the payment of cash dividends unless Liggett's borrowing
availability under the facility for the 30-day period prior to the
payment of the dividend, and after giving effect to the dividend, is at
least $5,000. In addition, the facility, as amended, imposes
requirements with respect to Liggett's adjusted net worth (not to fall
below $8,000 as computed in accordance with the agreement) and working
capital (not to fall below a deficit of $17,000 as computed in
accordance with the agreement). At December 31, 2003, Liggett was in
compliance with all covenants under the credit facility; Liggett's
adjusted net worth was $47,068 and net working capital was $16,874, as
computed in accordance with the agreement. The facility expires on
March 8, 2004 subject to automatic renewal for an additional year
unless a notice of termination is given by the lender at least 60 days
prior to such date or the anniversary of such date.
In November 1999, 100 Maple LLC, a new company formed by Liggett to
purchase an industrial facility in Mebane, North Carolina, borrowed
$5,040 from the lender under Liggett's credit facility. In July 2001,
Maple borrowed an additional $2,340 under the loan, and a total of
$5,190 was outstanding at December 31, 2003. In September 2002, the
lender agreed that no further regularly scheduled principal payments
would be due under the Maple loan until March 1, 2004. Thereafter, the
loan is payable in 27 monthly installments of $77 with a final payment
of $3,111. Interest is charged at the same rate as applicable to
Liggett's credit facility, and borrowings under the Maple loan reduce
the maximum availability under the credit facility. Liggett has
guaranteed the loan, and a first mortgage on the Mebane property and
equipment collateralizes the Maple loan and Liggett's credit facility.
In April 2003, the credit facility was amended to increase the maximum
credit available under the facility to $45,000 for the period through
October 15, 2003. Vector guaranteed $10,000 of borrowings under the
facility and collateralized the guarantee with $10,000 in cash.
Vector's guarantee was terminated, and the pledge of the cash
collateral released, on October 16, 2003.
F-21
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Equipment Loans - Liggett:
In March 2000, Liggett purchased equipment for $1,000 through the
issuance of a note, payable in 60 monthly installments of $21 with an
effective annual interest rate of 10.14%. In April 2000, Liggett
purchased equipment for $1,071 through the issuance of notes, payable
in 60 monthly installments of $22 with an effective interest rate of
10.20%.
In October and December 2001, Liggett purchased equipment for $3,204
and $3,200, respectively, through the issuance of notes guaranteed by
the Company, each payable in 60 monthly installments of $53 with
interest calculated at the prime rate.
In March 2002, Liggett purchased equipment for $3,023 through the
issuance of a note, payable in 30 monthly installments of $62 and then
30 monthly installments of $51 with an effective annual interest rate
of 4.68%.
In May 2002, Liggett purchased equipment for $2,871 through the
issuance of a note, payable in 30 monthly installments of $59 and then
30 monthly installments of $48 with an effective annual interest rate
of 4.64%.
In September 2002, Liggett purchased equipment for $1,573 through the
issuance of a note guaranteed by the Company, payable in 60 monthly
installments of $26 plus interest calculated at LIBOR plus 4.31%.
Notes Payable - Vector Tobacco:
In June 2001, Vector Tobacco purchased for $8,400 an industrial
facility in Timberlake, North Carolina. Vector Tobacco financed the
purchase with an $8,200 loan, payable in 60 monthly installments of
$85, plus annual interest at 4.85% above LIBOR with a final payment of
approximately $3,160. The loan, which is collateralized by a mortgage
and a letter of credit of $1,750, is guaranteed by VGR Holding and
Vector.
During December 2001, Vector Tobacco borrowed an additional $1,159 from
the same lender to finance building improvements. This loan is payable
in 30 monthly installments of $39 plus accrued interest, with an annual
interest rate of LIBOR plus 5.12%.
Notes for Medallion Acquisition - Vector Tobacco:
The purchase price for the acquisition of Medallion included $60,000 in
notes of Vector Tobacco, guaranteed by the Company and Liggett. Of the
notes, $25,000 bear interest at a 9.0% annual rate and mature $3,125
per quarter commencing June 30, 2002 and continuing through March 31,
2004. At December 31, 2003, $3,125 of these notes were outstanding. The
remaining $35,000 of notes bear interest at 6.5% per year, payable
semiannually, and mature on April 1, 2007.
Notes Payable - V.T. Aviation:
In February 2001, V.T. Aviation LLC, a subsidiary of Vector Research
Ltd., purchased an airplane for $15,500 and borrowed $13,175 to fund
the purchase. The loan, which is collateralized by the airplane and a
letter of credit from the Company for $775, is guaranteed by Vector
Research, VGR Holding and the Company. The loan is payable in 119
monthly installments of $125, including annual interest of 2.31% above
the 30-day commercial paper rate, with a final payment of $1,420,
based on current interest rates.
F-22
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Notes Payable - VGR Aviation:
In February 2002, V.T. Aviation purchased an airplane for $6,575 and
borrowed $5,800 to fund the purchase. The loan is guaranteed by the
Company. The loan is payable in 119 monthly installments of $40,
including annual interest of 2.75% above the 30-day average commercial
paper rate, with a final payment of $2,793, based on current interest
rates. During the fourth quarter of 2003, this airplane was transferred
to the Company's direct subsidiary, VGR Aviation LLC, which has assumed
the debt.
Note Payable - New Valley:
In December 2002, New Valley financed a portion of its purchase of two
office buildings in Princeton, New Jersey with a mortgage loan of
$40,500 from HSBC Realty Credit Corporation (USA). The loan has a term
of four years, bears interest at a floating rate of 2% above LIBOR, and
is secured by a first mortgage on the office buildings, as well as by
an assignment of leases and rents. Principal is amortized to the extent
of $54 per month during the term of the loan. The loan may be prepaid
without penalty and is non-recourse against New Valley, except for
various specified environmental and related matters, misapplications of
tenant security deposits and insurance and condemnation proceeds, and
fraud or misrepresentation by New Valley in connection with the
indebtedness.
Scheduled Maturities:
Scheduled maturities of long-term debt are as follows:
Year ending December 31:
2004........................................ $ 10,762
2005........................................ 6,692
2006........................................ 111,326
2007........................................ 39,746
2008........................................ 134,167
Thereafter.................................. 8,046
---------
Total........................... $ 310,739
=========
10. COMMITMENTS
Certain of the Company's subsidiaries lease facilities and equipment
used in operations under both month-to-month and fixed-term agreements.
The aggregate minimum rentals under operating leases with noncancelable
terms of one year or more are as follows:
Year ending December 31:
2004 ....................................... $ 7,863
2005 ....................................... 5,870
2006 ....................................... 4,374
2007 ....................................... 2,898
2008 ....................................... 2,271
Thereafter.................................. 9,165
--------
Total .......................... $ 32,441
========
The Company's rental expense for the years ended December 31, 2003,
2002 and 2001 was $9,704, $7,500 and $3,792, respectively.
F-23
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
11. EMPLOYEE BENEFIT PLANS
Defined Benefit and Postretirement Plans:
The Company sponsors several defined benefit pension plans covering
virtually all of its employees, who were employed by Liggett on a
full-time basis prior to 1994. The benefit plans provide pension
benefits for eligible employees based primarily on their compensation
and length of service. Contributions are made to the pension plans in
amounts necessary to meet the minimum funding requirements of the
Employee Retirement Income Security Act of 1974. The plans' assets and
benefit obligations are measured at September 30 of each year.
All defined benefit plans were frozen between 1993 and 1995.
In addition, the Company provides certain postretirement medical and
life insurance benefits to certain employees. Substantially all of
Liggett's employees as of December 31, 2003 are eligible for
postretirement medical benefits if they reach retirement age while
working for Liggett or certain affiliates. Retirees are required to
fund 100% of participant medical premiums and, pursuant to union
contracts, Liggett reimburses approximately 700 hourly retirees, who
retired prior to 1991, for Medicare Part B premiums. In addition, the
Company provides life insurance benefits to approximately 300 active
employees and 525 retirees who reach retirement age and are eligible to
receive benefits under one of the Company's defined benefit pension
plans.
The following provides a reconciliation of benefit obligations, plan
assets and the funded status of the pension plans and other
postretirement benefits:
F-24
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Other
Pension Benefits Postretirement Benefits
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Change in benefit obligation:
Benefit obligation at January 1 ............. $ (151,127) $ (147,700) $ (10,372) $ (8,915)
Service cost ................................ (3,573) (3,224) (79) (50)
Interest cost ............................... (9,559) (10,062) (676) (621)
Benefits paid ............................... 14,462 14,887 599 658
Actuarial loss .............................. (9,723) (5,028) (261) (1,444)
------------ ------------ ------------ ------------
Benefit obligation at December 31 ........... $ (159,520) $ (151,127) $ (10,789) $ (10,372)
------------ ------------ ------------ ------------
Change in plan assets:
Fair value of plan assets at January 1 ...... $ 146,512 $ 165,641 $ - $ -
Actual return on plan assets ................ 18,260 (4,607) - -
Contributions ............................... 353 365 599 658
Benefits paid ............................... (14,462) (14,887) (599) (658)
------------ ------------ ------------ ------------
Fair value of plan assets at December 31 .... $ 150,663 $ 146,512 $ - $ -
============ ============ ============ ============
Assets (less than) in excess of projected
benefit obligations at December 31 ......... $ (8,857) $ (4,615) $ (10,789) $ (10,372)
Unrecognized actuarial losses (gains) ....... 24,702 23,527 (777) (1,167)
Contributions of SERP benefits .............. 92 92 - -
------------ ------------ ------------ ------------
Net pension asset before additional minimum
liability and purchase accounting
valuation adjustments ...................... 15,937 19,004 (11,566) (11,539)
Additional minimum liability ..................... (19,139) (19,118) - -
------------ ------------
Purchase accounting valuation adjustments
relating to income taxes ................... 991 1,339 339 418
------------ ------------ ------------ ------------
(Liability) asset included in the December 31
balance sheet .............................. $ (2,211) $ 1,225 $ (11,227) $ (11,121)
============ ============ ============ ============
Actuarial assumptions:
Discount rates ................................ 4.75%-6.75% 5.50%-7.25% 6.00% 6.75%
Accrued rates of return on invested assets .... 8.50% 9.25% - -
Salary increase assumptions ................... N/A N/A 3.00% 3.00%
Pension Benefits Other Postretirement Benefits
-------------------------------- --------------------------------
2003 2002 2001 2003 2002 2001
-------- -------- -------- -------- -------- --------
Service cost - benefits earned
during the period .............. $ 3,923 $ 3,574 $ 350 $ 79 $ 50 $ 43
Interest cost on projected benefit
Obligation ..................... 9,559 10,062 10,687 676 621 640
Expected return on assets .............. (11,721) (14,549) (19,792) - - -
Amortization of net (gain) loss ........ 1,659 84 (4,411) (129) (281) (306)
-------- -------- -------- -------- -------- --------
Net (income) expense ................... $ 3,420 $ (829) $(13,166) $ 626 $ 390 $ 377
======== ======== ======== ======== ======== ========
F-25
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Plan assets are invested employing multiple investment management
firms. Managers within each asset class cover a range of investment
styles and focus primarily on issue selection as a means to add value.
Risk is controlled through a diversification among asset classes,
managers, styles and securities. Risk is further controlled both at the
manager and asset class level by assigning excess return and tracking
error targets. Investment managers are monitored to evaluate
performance against these benchmark indices and targets.
Allowable investment types include equity, investment grade fixed
income, high yield fixed income, hedge funds and short term
investments. The equity fund is comprised of common stocks and mutual
funds of large, medium and small companies, which are predominantly
U.S. based. The investment grade fixed income fund includes managed
funds investing in fixed income securities issued or guaranteed by the
U.S. government, or by its respective agencies, mortgage backed
securities, including collateralized mortgage obligations, and
corporate debt obligations. The high yield fixed income fund includes a
fund which invests in non-investment grade corporate debt securities.
The hedge funds invest in both equity, including common and preferred
stock, and debt obligations, including convertible debentures, of
private and public companies. The Company generally utilizes its short
term investments, including interest-bearing cash, to pay benefits and
to deploy in special situations.
The current target asset allocation percentage is 48% equity
investments, 22% investment grade fixed income, 5% high yield fixed
income, 20% hedge funds and 5% short-term investments, with a
rebalancing range of approximately plus or minus 5% around the target
asset allocations.
Vector's defined benefit retirement plan allocations at December 31,
2003 and 2002, by asset category, were as follows:
Plan assets at December 31
2003 2002
---- ----
Asset category:
Equity securities................................................... 43% 36%
Investment grade fixed income securities............................ 20% 22%
High yield fixed income securities.................................. 4% 5%
Hedge funds......................................................... 24% 22%
Short-term investments.............................................. 9% 15%
--- ---
Total....................................................... 100% 100%
As of December 31, 2003, three of the Company's four defined benefit
plans experienced accumulated benefit obligations in excess of plan
assets, for which the projected benefit obligation, accumulated benefit
obligation and fair value of plan assets were $91,083, $91,083 and
$78,173, respectively. As of December 31, 2002, three of the Company's
four defined benefit plans experienced accumulated benefit obligations
in excess of plan assets, for which the projected benefit obligation,
accumulated benefit obligation and fair value of plan assets were
$83,787, $83,787 and $75,822, respectively.
SFAS No. 87, "Employers' Accounting for Pensions," permits the delayed
recognition of pension fund gains and losses in ratable periods over
the average remaining service period of active employees expected to
receive benefits under the plan. Gains and losses are only amortized to
the extent that they exceed 10% of the greater of Projected Benefit
Obligation and the fair value of assets. For the year ended December
31, 2003, Liggett used a 10 year period for its Hourly Plan and a six
year period for its Salaried Plan to amortize pension fund gains and
losses on a straight line basis. Such amounts are reflected in the
pension expense calculation beginning the year after the gains or
losses occur. Declines in the securities markets in 2001 and 2002
resulted in deferred losses, and an additional minimum
F-26
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
pension liability primarily related to one of Liggett's defined benefit
plans of $17,590, $11,090 after tax, was included in other
comprehensive loss in 2002. The amortization of deferred losses will
negatively impact pension expense in the future.
Effective January 1, 2002, the Company adopted a Supplemental Executive
Retirement Plan ("SERP"). The plan is a defined benefit plan pursuant
to which the Company will pay supplemental pension benefits to certain
key employees upon retirement. Under the SERP, the projected annual
benefit payable to a participant at his normal retirement date is a
predetermined amount set by the Company's board of directors. Normal
retirement date is defined as the January 1 following the attainment by
the participant of the later of age 60 or completion of eight years of
participation following January 1, 2002 for the Company or a
subsidiary. Benefits under the SERP are generally payable in the form
of a joint and survivor annuity (in the case of a married participant)
or a single life annuity (in the case of an unmarried participant),
with either such form of distribution representing the actuarial
equivalent of the benefits due the participant. A participant may also
request that his benefits be paid in a lump sum, but the Company may
approve or disapprove such request in its discretion. The total cost of
the plan for the years ended December 31, 2003 and 2002 was $3,573 and
$3,224, respectively.
For 2002 measurement purposes for retiree life insurance liability, a
3.0% annual increase in compensation levels was assumed. For 2003
measurement purposes, annual increases in Medicare Part B trends were
assumed to equal rates between 4.1% and 6.04% between 2004 and 2013 and
5.0% after 2013.
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A 1% change in assumed in
health care cost trend rates would have the following effects:
1% Increase 1% Decrease
----------- -----------
Effect on total of service and
interest cost components....................... $ 20 $ (18)
Effect on benefit obligation...................... $ 330 $ (299)
Profit Sharing and Other Plans:
The Company maintains 401(k) plans for substantially all U.S. employees
which allow eligible employees to invest a percentage of their pre-tax
compensation. The Company contributed to the 401(k) plans and expensed
$1,437, $1,458 and $593 for the years ended December 31, 2003, 2002 and
2001, respectively.
12. INCOME TAXES
The Company files a consolidated U.S. income tax return that includes
its more than 80%-owned U.S. subsidiaries. The consolidated U.S. income
tax return does not include the activities of New Valley and the
Company's foreign subsidiaries. New Valley files a consolidated U.S.
income tax return that includes its more than 80%-owned U.S.
subsidiaries. The amounts provided for income taxes are as follows:
F-27
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Year Ended December 31,
2003 2002 2001
---------- ---------- ----------
Current:
U.S. Federal ......... $ - $ (7,774) $ 15,634
Foreign .............. - - 227
State ................ 3,888 2,296 4,017
---------- ---------- ----------
$ 3,888 $ (5,478) $ 19,878
---------- ---------- ----------
Deferred:
U.S. Federal ......... $ (2,910) $ (2,634) $ (5,658)
Foreign .............. - - -
State ................ (404) 1,759 797
---------- ---------- ----------
(3,314) (875) (4,861)
---------- ---------- ----------
Total provision (benefit) .... $ 574 $ (6,353) $ 15,017
========== ========== ==========
The tax effect of temporary differences which give rise to a
significant portion of deferred tax assets and liabilities are as
follows:
December 31, 2003 December 31, 2002
-------------------------- --------------------------
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Assets Liabilities Assets Liabilities
------------ ----------- ------------ -----------
Excess of tax basis over book basis-
non-consolidated subsidiaries ....................... $ 9,406 $ 16,754 $ 6,522 $ 16,311
Deferral on Philip Morris brand transaction ........... - 103,100 - 103,100
Employee benefit accruals ............................. 12,549 1,743 11,737 1,644
Book/tax differences on fixed and
intangible assets ................................... - 18,329 - 13,706
Other ................................................. 16,193 4,001 22,306 5,278
U.S. tax loss and contribution carryforwards - Vector.. 6,170 - 3,621 -
U.S. tax credit carryforwards - Vector ................ 3,178 - 1,859 -
U.S. tax loss carryforwards-New Valley ................ - - 63,074 -
U.S. tax and capital loss carryforwards - New Valley... 66,894 - - -
U.S. tax credit carryforwards - New Valley ............ 13,512 - 13,512 -
Valuation allowance ................................... (95,374) - (97,305) -
------------ ----------- ------------ -----------
$ 32,528 $ 143,927 $ 25,326 $ 140,039
============ =========== ============ ===========
The Company provides a valuation allowance against deferred tax assets
if, based on the weight of available evidence, it is more likely than
not that some or all of the deferred tax assets will not be realized.
The Company has established a valuation allowance against deferred tax
assets of $95,374 at December 31, 2003, which relates to the deferred
tax assets of New Valley.
The valuation allowance of $95,374 at December 31, 2003 consisted
primarily of New Valley's net operating loss carryforwards of $161,500.
In addition, a valuation allowance was established against New Valley's
additional deferred tax assets of $28,500 primarily related to minimum
tax credit carryforwards of approximately $13,500 and differences for
book and tax accounting purposes related to bases in investments and
subsidiaries.
As of December 31, 2003, the Company and its more than 80%-owned
subsidiaries had U.S. net operating loss carryforwards of approximately
$14,500 and charitable contribution carryforwards of approximately
$3,100 which expire at various dates from 2007 through 2024. The
Company and its more than 80%-owned subsidiaries also had approximately
$2,100 of alternative minimum tax credit carryforwards, which may be
carried forward indefinitely under current U.S. tax law, and $1,000 of
general business credit carryforwards, which expire at various dates
from 2021 through 2023.
F-28
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
As of December 31, 2003, New Valley and its consolidated group had U.S.
net operating loss carryforwards of approximately $161,500 and capital
loss carryforwards of approximately $5,000 for tax purposes, which
expire at various dates from 2006 through 2024. New Valley also has
approximately $13,500 of alternative minimum tax credit carryforwards,
which may be carried forward indefinitely under current U.S. tax law.
Differences between the amounts provided for income taxes and amounts
computed at the federal statutory tax rate are summarized as follows:
Year Ended December 31,
2003 2002 2001
---------- ---------- ----------
(Loss) income from continuing operations before
income taxes ..................................... $ (15,036) $ (38,147) $ 36,217
---------- ---------- ----------
Federal income tax (benefit) provision at
statutory rate .............................. (5,263) (13,351) 12,676
Increases (decreases) resulting from:
State income taxes, net of federal income tax
Benefits ...................................... 2,265 2,628 3,129
Foreign taxes .................................... - - 227
Difference in basis related to disposal of
foreign subsidiary ............................ - - (4,228)
Impact of LTS distribution, net .................. - - 4,072
Non-taxable items ................................ 3,572 4,397 3,855
Other, equity adjustments and tax audit
adjustments ................................... 1,931 6,085 (718)
Changes in valuation allowance, net of equity
and tax audit adjustments ..................... (1,931) (6,112) (3,996)
---------- ---------- ----------
Provision (benefit) for income tax ............... $ 574 $ (6,353) $ 15,017
========== ========== ==========
The consolidated balance sheets of the Company include deferred income
tax assets and liabilities, which represent temporary differences in
the application of accounting rules established by generally accepted
accounting principles and income tax laws. As of December 31, 2003, the
Company's deferred income tax liabilities exceeded its deferred income
tax assets by $111,399. The largest component of the Company's deferred
tax liabilities exists because of differences that resulted from a 1998
and 1999 transaction with Philip Morris Incorporated where a subsidiary
of Liggett contributed three of its premium cigarette brands to
Trademarks LLC, a newly-formed limited liability company. In such
transaction, Philip Morris acquired an option to purchase the remaining
interest in Trademarks for a 90-day period commencing in December 2008,
and the Company has an option to require Philip Morris to purchase the
remaining interest for a 90-day period commencing in March 2010. (See
Note 19.)
In connection with the transaction, the Company recognized in 1999 a
pre-tax gain of $294,078 in its consolidated financial statements and
established a deferred tax liability of $103,100 relating to the gain.
Upon exercise of the options during the 90-day periods commencing in
December 2008 or in March 2010, the Company will be required to pay tax
in the amount of the deferred tax liability, which will be offset by
the benefit of any deferred tax assets, including any net operating
losses, available to the Company at that time. In connection with an
examination of the Company's 1998 and 1999 federal income tax returns,
the Internal Revenue Service issued to the Company in September 2003 a
notice of proposed adjustment. The notice asserts that, for tax
reporting purposes, the entire gain should have been recognized in 1998
and in 1999 in the additional amounts of $150,000 and $129,900,
respectively, rather than upon the exercise of the options during the
90-day periods commencing in December 2008 or in March 2010. If the
Internal Revenue Service were to ultimately
F-29
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
prevail with the proposed adjustment, it would result in the potential
acceleration of tax payments of approximately $117,000, including
interest, net of tax benefits, through December 31, 2003. These amounts
have been previously recognized in the Company's consolidated financial
statements as tax liabilities. As of December 31, 2003, the Company
believes amounts potentially due have been fully provided for in its
consolidated statements of operations.
The Company believes the positions reflected on its income tax returns
are correct and intends to vigorously oppose any proposed adjustments
to its returns. The Company has filed a protest with the Appeals
Division of the Internal Revenue Service. No payment is due with
respect to these matters during the appeal process. Interest currently
is accruing on the disputed amounts at a rate of 6%, with the rate
adjusted quarterly based on rates published by the U.S. Treasury
Department. If taxing authorities were to ultimately prevail in their
assertion that the Company incurred a tax obligation prior to the
exercise dates of these options and it was required to make such tax
payments prior to 2009 or 2010, and if any necessary financing were not
available to the Company, its liquidity could be adversely affected.
13. EQUITY
During 2003, the remaining 133,697 warrants to purchase Vector's common
stock at $3.79 per share issued in 1998 were exercised.
During 2003, the remaining 415,229 options to purchase Vector's common
stock at $4.69 per share granted in 1998 to a law firm which represents
the Company and Liggett were exercised. The exercise price was paid by
the surrender of 236,657 options.
During 2003, employees of the Company exercised 211,232 options to
purchase Vector's common stock at prices ranging from $3.92 to $12.70
per share.
In June 2001, the Company granted 11,025 shares of its common stock to
each of its three outside directors which will vest over a period of
three years. The Company will recognize compensation expense of $1,017
over the vesting period.
14. STOCK PLANS
In November 1999, the Company adopted its 1999 Long-Term Incentive Plan
(the "1999 Plan") which authorizes the granting of up to 6,077,531
shares of common stock through awards of stock options (which may
include incentive stock options and/or nonqualified stock options),
stock appreciation rights and shares of restricted Company common
stock. All officers, employees and consultants of the Company and its
subsidiaries are eligible to receive awards under the 1999 Plan.
In October 1998, stockholders of the Company approved the adoption of
the 1998 Long-Term Incentive Plan (the "1998 Plan") which authorizes
the granting of up to 6,381,407 shares of common stock through awards
of stock options (which may include incentive stock options and/or
nonqualified stock options), stock appreciation rights and shares of
restricted Company common stock. All officers, employees and
consultants of the Company and its subsidiaries are eligible to receive
awards under the 1998 Plan.
In January 2001, the Company granted non-qualified stock options to the
Chairman and to the President of the Company pursuant to the Company's
1999 Long-Term Incentive Plan. Under the options, the option holders
have the right to purchase an aggregate of 868,218 shares of common
F-30
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
stock at an exercise price of $16.51 per share (the fair market value
of a share of common stock on the date of grant). The options have a
ten-year term and became exercisable on November 4, 2003. Common stock
dividend equivalents are paid currently with respect to each share
underlying the unexercised portion of the options. In 2003, 2002 and
2001, the Company recorded charges to income of $5,520, $6,839 and
$6,794, respectively, for the dividend equivalent rights on these
options and the November 1999, December 1996 and January 1995 option
grants discussed below.
During the year ended December 31, 2001, other employees of the Company
or its subsidiaries were awarded a total of 1,061,073 non-qualified
options to purchase shares of common stock at prices ranging from
$15.44 to $39.49, generally at the fair market value on the dates of
grant under the Company's 1998 and 1999 Long-Term Incentive Plan. The
Company recognized compensation expense of $1,031 over the vesting
period. Non-qualified options for additional 15,750 and 57,881 shares
of common stock were issued under the 1998 Plan during 2003 and 2002,
respectively. The exercise prices of the options granted in 2003 were
$12.62 and the exercise prices ranged from $11.46 to $26.14 in 2002,
the fair market value on the dates of grant.
In November 1999, the Company granted non-qualified stock options to
six executive officers of the Company or its subsidiaries, including
the Chairman and a consultant to the Company who now serves as
President and a director of the Company (the "Consultant"), pursuant to
the 1999 Plan. Under the options, the option holders have the right to
purchase an aggregate of 2,686,268 shares of common stock at an
exercise price of $12.70 per share (the fair market value of a share of
common stock on the date of grant). The options have a ten-year term
and became exercisable on November 4, 2003. Common stock dividend
equivalents are paid currently with respect to each share underlying
the unexercised portion of the options.
In July 1998, the Company granted a non-qualified stock option to each
of the Chairman and the Consultant, pursuant to the 1998 Plan. Under
the options, the Chairman and the Consultant have the right to purchase
3,190,703 shares and 638,139 shares, respectively, of common stock at
an exercise price of $7.65 per share (the fair market value of a share
of common stock on the date of grant). The options have a ten-year term
and became exercisable as to one-fourth of the shares on each of the
first four anniversaries of the date of grant.
In November 1999, the Company granted non-qualified stock options to
purchase 1,118,265 shares of common stock to key employees of Liggett
under the 1998 Plan. Under the options, the Liggett option holders had
the right to purchase shares at prices ranging from $12.70 to $14.80
per share. The options became fully exercisable on December 31, 2003,
assuming the continued employment of the option holder. The Company
recognized compensation expense of $1,717 over the vesting period.
As of January 1, 1998 and 1997, the Company granted to employees of the
Company non-qualified stock options to purchase 54,878 and 538,589,
respectively, shares of the Company's common stock at an exercise price
of $4.11 per share. The options have a ten-year term and vested in six
equal annual installments. The Company recognized compensation expense
of $154 over the vesting period.
F-31
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
A summary of employee stock option transactions follows:
Weighted-
Number of Average
Shares Exercise Price
----------- --------------
Balance at January 1, 2001 ........ 8,093,109 $ 6.95
Granted ..................... 4,183,620 $ 23.15
Exercised ................... (427,339) $ 12.25
Cancelled ................... (99,193) $ 21.28
-----------
Outstanding on December 31, 2001 .. 11,750,197 $ 6.11
Granted ..................... 57,881 $ 16.60
Exercised ................... (1,689,547) $ 1.60
Cancelled ................... (130,303) $ 13.47
-----------
Outstanding on December 31, 2002 .. 9,988,228 $ 12.29
Granted ..................... 15,750 $ 12.62
Exercised ................... (211,232) $ 5.88
Cancelled ................... (153,517) $ 17.60
-----------
Outstanding on December 31, 2003 .. 9,639,229 $ 12.34
===========
Options exercisable at:
December 31, 2001........................... 4,242,228
December 31, 2002........................... 4,428,974
December 31, 2003........................... 8,694,607
Additional information relating to options outstanding at December 31,
2003 follows:
OPTIONS OUTSTANDING
------------------- OPTIONS EXERCISABLE
Weighted-Average -------------------
Outstanding Remaining Exercisable
Range of as of Contractual Life Weighted-Average as of Weighted-Average
Exercise Prices 12/31/2003 (Years) Exercise Price 12/31/2003 Exercise Price
--------------- ----------- ---------------- ---------------- ----------- ----------------
$ 0.0000 - $ 3.9480 185,733 3.0 $ 3.9200 185,733 $ 3.9200
$ 3.9481 - $ 7.8960 3,828,842 4.6 $ 7.6400 3,828,842 $ 7.6400
$ 7.8961 - $11.8440 336,951 7.0 $ 11.6945 189,922 $ 11.7200
$11.8441 - $15.7920 3,326,855 5.9 $ 12.7524 3,199,796 $ 12.7235
$15.7921 - $19.7400 1,336,979 7.0 $ 16.8241 1,132,673 $ 16.5604
$19.7401 - $23.6880 4,408 8.3 $ 22.9100 - -
$23.6881 - $27.6360 140,766 7.3 $ 25.8680 34,726 $ 26.1162
$27.6361 - $31.5840 46,004 6.8 $ 28.9837 14,750 $ 29.3143
$31.5841 - $35.5320 358,034 7.7 $ 34.4857 89,507 $ 34.4857
$35.5321 - $39.4800 74,657 7.7 $ 36.4660 18,658 $ 36.4653
---------- --- --------- ----------- ---------
9,639,229 5.6 $ 12.3438 8,694,607 $ 11.1313
The fair value of option grants to employees is estimated on the date
of grant using the Black-Scholes option pricing model with the
following assumptions for options granted:
2003 2002 2001
---- ---- ----
Risk-free interest rate..................... 4.0% 3.9% - 4.7% 4.4% - 5.2%
Expected volatility......................... 53.4% 45.8% - 53.5% 51.5% - 53.6%
Dividend yield.............................. 12.7% 5.7% - 13.3% 0.0% - 9.0%
Expected holding period..................... 10 years 10 years 10 years
Weighted average fair value................. $ 1.54 $ 1.36 - $8.63 $ 3.54 - $20.98
F-32
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
In December 1996, the Company granted the Consultant non-qualified
stock options to purchase 1,276,281 shares of the Company's common
stock at an exercise price of $0.78 per share, which options were
exercised in December 2002. The Company recognized compensation expense
of $2,242 in 2002 and $3,186 in 2001 over the vesting period. Under the
agreement, common stock dividend equivalents were paid on each vested
and unexercised option.
In January 1995, the Company granted the Consultant non-qualified stock
options, of which the remaining options to purchase 319,069 shares at
$1.57 per share were exercised in December 2002. The grant provided for
dividend equivalent rights on all the shares underlying the unexercised
options.
15. SUPPLEMENTAL CASH FLOW INFORMATION
Year Ended December 31,
2003 2002 2001
-------- -------- --------
I. Cash paid during the period for:
Interest ......................................... $ 23,970 $ 24,206 $ 8,253
Income taxes ..................................... 2,016 3,148 8,517
II. Non-cash investing and financing activities:
Issuance of stock dividend ....................... 28,270 22,279 54,519
Conversion of debt ............................... - - 45,018
LTS acquisition:
Assets acquired, net of cash ................... - - 54,014
Liabilities assumed, including minority
interest .................................. - - 49,523
Effect of acquisition in equity ................ - - 8,556
LTS distribution:
Assets distributed, net of cash ................ - - 90,645
Liabilities distributed ........................ - - 87,834
Effect of distribution in equity ............... - - 10,947
(Refer to Note 4 for non-cash activities related to the Medallion
acquisition.)
16. 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
F-33
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
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 year ended December 31, 2003, Liggett incurred legal fees
and other litigation costs totaling approximately $6,122 compared to
$4,931 and $6,832 for 2002 and 2001, respectively.
Individual Actions. As of December 31, 2003, there were approximately
377 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, 96 were pending in Maryland, 96 in Florida,
52 in New York, 34 in Mississippi and 21 in California. The balance of
the individual cases were pending in 22 states. There are eight
individual cases pending where Liggett is the only named defendant. In
addition to these cases, an action against cigarette manufacturers
involving approximately 1,050 named individual plaintiffs has been
consolidated before a single West Virginia state court. Liggett is a
defendant in most of the cases pending in West Virginia. In January
2002, the court severed Liggett from the trial of the consolidated
action.
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including
negligence, gross negligence, breach of special duty, strict liability,
fraud, misrepresentation, design defect, failure to warn, breach of
express and implied warranties, conspiracy, aiding and abetting,
concert of action, unjust enrichment, common law public nuisance,
property damage, invasion of privacy, mental anguish, emotional
distress, disability, shock, indemnity and violations of deceptive
trade practice laws, the Federal Racketeer Influenced and Corrupt
Organization Act ("RICO"), state RICO statutes and antitrust statutes.
In many of these cases, in addition to compensatory damages, plaintiffs
also seek other forms of relief including treble/multiple damages,
medical monitoring, disgorgement of profits and punitive damages.
Defenses raised by defendants in these cases include lack of proximate
cause, assumption of the risk, comparative fault and/or contributory
negligence, lack of design defect, statute of limitations, equitable
defenses such as "unclean hands" and lack of benefit, failure to state
a claim and federal preemption.
Jury awards in various states have been entered against other cigarette
manufacturers. The awards in these individual actions are for both
compensatory and punitive damages and represent a material amount of
damages. In 1999, a jury awarded $800 in compensatory damages and
$79,500 in punitive damages in an Oregon state court case involving
Philip Morris. The trial court later determined that the punitive
damage award was excessive and reduced it to $32,000. In June 2002, an
Oregon intermediate appellate court reinstated the jury's punitive
damages award, and the Oregon Supreme Court refused to hear Philip
Morris' appeal of the appellate court ruling in December 2002. Philip
Morris appealed to the United States Supreme Court, which, in October
2003, vacated the judgment and remanded the case to the Oregon
appellate court for further consideration in light of the recent State
Farm decision by the United States Supreme Court limiting punitive
damages. In June 2001, a jury awarded $5,500 in compensatory damages
and $3,000,000 in punitive damages in a California state court case
involving Philip Morris. In March 2002, a jury awarded $169 in
compensatory damages and $150,000 in punitive damages in an Oregon
state court case also involving Philip Morris. The punitive damages
awards in both the California and Oregon actions were subsequently
reduced to $100,000 by the trial courts. In October 2002, a jury
awarded $850 in compensatory damages and $28,000,000 in punitive
damages in a California state court case involving Philip Morris. In
December 2002, the trial court reduced the punitive damages award to
$28,000. Both the verdict and damage awards in these cases are being
appealed. In November 2001, in another case, a $25,000 punitive damages
judgment against Philip Morris was
F-34
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
affirmed by a California intermediate appellate court. Philip Morris
appealed to the California Supreme Court, which vacated the decision.
In September 2003, the California appellate court, citing the State
Farm decision, reduced the punitive damages award to $9,000. The case
is on appeal to the California Supreme Court. During 2001, as a result
of a Florida Supreme Court decision upholding the award, another
cigarette manufacturer paid $1,100 in compensatory damages and interest
to a former smoker and his spouse for injuries they allegedly incurred
as a result of smoking. In December 2001, in an individual action
involving another cigarette manufacturer, a Florida jury awarded a
smoker $165 in compensatory damages. The defendant paid the damages and
interest following completion of the appeals process. In February 2002,
a federal district court jury in Kansas awarded a smoker $198 in
compensatory damages from two other cigarette manufacturers and, in
June 2002, the trial court assessed punitive damages of $15,000 against
one of the defendants. The defendant has appealed the verdict. In April
2003, in an individual Florida state court action involving two other
cigarette manufacturers, a jury awarded compensatory damages of $6,500
(reduced by the court to $3,250). The defendants have appealed the
verdict. In May 2003, a federal district court jury in Arkansas awarded
compensatory damages of $4,025 and punitive damages of $15,000 in an
individual action involving another cigarette manufacturer. The
defendant intends to appeal the verdict. In November 2003, in an
individual action involving other cigarette manufacturers, a Missouri
state court jury awarded $2,100 in compensatory damages. The defendants
have appealed the verdict. In January 2004, a jury in a New York
state court action awarded compensatory damages of $175 and punitive
damages of $8,000 in an individual action against another cigarette
manufacturer. The defendant intends to appeal the verdict.
One of the states in which cases are pending against Liggett is
Mississippi. During 2003, the Mississippi Supreme Court ruled that the
Mississippi Product Liability Act "precludes all tobacco cases that are
based on product liability." Based on this ruling, Liggett is seeking,
or intends to seek, dismissal of each of the approximately 34 cases
pending against it in Mississippi.
Class Actions. As of December 31, 2003, there were approximately 32
actions pending, for which either a class has been certified or
plaintiffs are seeking class certification, where Liggett, among
others, was a named defendant. Many of these actions purport to
constitute statewide class actions and were filed after May 1996 when
the Fifth Circuit Court of Appeals, in the Castano case, reversed a
Federal district court's certification of a purported nationwide class
action on behalf of persons who were allegedly "addicted" to tobacco
products.
The extent of the impact of the Castano decision on smoking-related
class action litigation is still uncertain. The Castano decision has
had a limited effect with respect to courts' decisions regarding
narrower smoking-related classes or class actions brought in state
rather than federal court. For example, since the Fifth Circuit's
ruling, a court in Louisiana (Liggett is not a defendant in this
proceeding) has certified "addiction-as-injury" class actions that
covered only citizens in those states. Two other class actions, Broin
and Engle, were certified in state court in Florida prior to the Fifth
Circuit's decision. In April 2001, the Brown case was certified as a
class action in California.
In May 1994, an action entitled Engle, et al. v. R.J. Reynolds Tobacco
Company, et al., Circuit Court, Eleventh Judicial Circuit, Miami-Dade
County, Florida, was filed against Liggett and others. The class
consists of all Florida residents and citizens, and their survivors,
who have suffered, presently suffer or have died from diseases and
medical conditions caused by their addiction to cigarettes that contain
nicotine. Phase I of the trial commenced in July 1998 and in July 1999,
the jury returned the Phase I verdict. The Phase I verdict concerned
certain issues determined by the trial court to be "common" to the
causes of action of the plaintiff class. Among other things, the jury
found that: smoking cigarettes causes 20 diseases or medical
conditions, cigarettes are addictive or dependence producing, defective
and unreasonably dangerous, defendants made materially false statements
with the intention of misleading smokers, defendants concealed or
omitted material
F-35
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
information concerning the health effects and/or the addictive nature
of smoking cigarettes and agreed to misrepresent and conceal the health
effects and/or the addictive nature of smoking cigarettes, and
defendants were negligent and engaged in extreme and outrageous conduct
or acted with reckless disregard with the intent to inflict emotional
distress. The jury also found that defendants' conduct "rose to a level
that would permit a potential award or entitlement to punitive
damages." The court decided that Phase II of the trial, which commenced
November 1999, would be a causation and damages trial for three of the
class representatives and a punitive damages trial on a class-wide
basis, before the same jury that returned the verdict in Phase I. Phase
III of the trial was to be conducted before separate juries to address
absent class members' claims, including issues of specific causation
and other individual issues regarding entitlement to compensatory
damages. In April 2000, the jury awarded compensatory damages of
$12,704 to the three plaintiffs, to be reduced in proportion to the
respective plaintiff's fault. The jury also decided that the claim of
one of the plaintiffs, who was awarded compensatory damages of $5,831,
was not timely filed. In July 2000, the jury awarded approximately
$145,000,000 in the punitive damages portion of Phase II against all
defendants including $790,000 against Liggett. The court entered a
final order of judgment against the defendants in November 2000. The
court's final judgment, which provided for interest at the rate of 10%
per year on the jury's awards, also denied various post-trial motions,
including a motion for new trial and a motion seeking reduction of the
punitive damages award. Liggett appealed the court's order.
In May 2003, Florida's Third District Court of Appeals decertified the
Engle class and set aside the jury's decision in the case against
Liggett and the other cigarette makers, including the $145,000,000
punitive damages award. The intermediate appellate court ruled that
there were multiple legal bases why the class action trial, including
the punitive damages award, could not be sustained. The court found
that the class failed to meet the legal requirements for class
certification and that class members needed to pursue their claims on
an individualized basis. The court also ruled that the trial plan
violated Florida law and the appellate court's 1996 certification
decision, and was unconstitutional. The court further found that the
proceedings were irretrievably tainted by class counsel's misconduct
and that the punitive damages award was bankrupting under Florida law.
In October 2003, the Third District Court of Appeals denied class
counsel's motions seeking, among other things, a rehearing by the
court. Class counsel has filed a motion with the Florida Supreme Court
to invoke discretionary review on the basis that the Third District
Court of Appeals decision construes the due process provisions of the
state and federal constitutions and conflicts with other appellate and
supreme court decisions. If the appellate court's ruling is not upheld
on further appeal, it will have a material adverse effect on the
Company.
In May 2000, legislation was enacted in Florida that limits the size of
any bond required, pending appeal, to stay execution of a punitive
damages verdict to the lesser of the punitive award plus twice the
statutory rate of interest, $100,000 or 10% of the net worth of the
defendant, but the limitation on the bond does not affect the amount of
the underlying verdict. In November 2000, Liggett filed the $3,450 bond
required by the Florida law in order to stay execution of the Engle
judgment, pending appeal. Legislation limiting the amount of bonds
required to file an appeal of an adverse judgment has also been enacted
in Arkansas, California, Colorado, Georgia, Idaho, Indiana, Kansas,
Kentucky, Louisiana, Michigan, Mississippi, Missouri, Nevada, New
Jersey, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South
Carolina, South Dakota, Tennessee, Texas, Virginia, West Virginia and
Wisconsin.
In May 2001, Liggett, along with Philip Morris and Lorillard Tobacco
Co., reached an agreement with the class in the Engle case, which
provided assurance of Liggett's ability to appeal the jury's July 2000
verdict. As required by the agreement, Liggett paid $6,273 into an
escrow account to be held for the benefit of the Engle class, and
released, along with Liggett's existing $3,450 statutory bond, to the
court for the benefit of the class upon completion of the appeals
process, regardless of the outcome of the appeal. As a result, the
Company recorded a $9,723 pre-tax charge to the
F-36
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
consolidated statement of operations for the first quarter of 2001. The
agreement, which was approved by the court, assured that the stay of
execution, in effect pursuant to the Florida bonding statute, would not
be lifted or limited at any point until completion of all appeals,
including an appeal to the United States Supreme Court. If Liggett's
balance sheet net worth fell below $33,781 (as determined in accordance
with generally accepted accounting principles in effect as of July 14,
2000), the agreement provided that the stay granted in favor of Liggett
in the agreement would terminate and the Engle class would be free to
challenge the Florida bonding statute.
In June 2002, the jury in a Florida state court action entitled Lukacs
v. Philip Morris, et al. awarded $37,500 in compensatory damages in a
case involving Liggett and two other tobacco manufacturers. In March
2003, the court reduced the amount of the compensatory damages to
$25,100. The jury found Liggett 50% responsible for the damages
incurred by the plaintiff. The Lukacs case was the first individual
case to be tried as part of Phase III of the Engle case; the claims of
all other individuals who are members of the class were stayed pending
resolution of the appeal of the Engle verdict. The Lukacs verdict,
which was subject to the outcome of the Engle appeal, has been
overturned as a result of the appellate court's ruling. As discussed
above, class counsel in Engle is pursuing various appellate remedies
seeking reversal of the appellate court's decision.
Class certification motions are pending in a number of putative class
actions. Classes remain certified against Liggett in West Virginia
(Blankenship), in California (Brown), in New York (Simon), in Kansas
(Smith) and in New Mexico (Romero). A number of class certification
denials are on appeal.
In August 2000, in Blankenship v. Philip Morris, Inc., a West Virginia
state court conditionally certified (only to the extent of medical
monitoring) a class of present or former West Virginia smokers who
desire to participate in a medical monitoring plan. The trial of this
case ended in January 2001, when the judge declared a mistrial. In July
2001, the court issued an order severing Liggett from the retrial of
the case which began in September 2001. In November 2001, the jury
returned a verdict in favor of the defendants. In January 2002, the
trial court denied plaintiffs' motion for a new trial, and plaintiffs
appealed to the West Virginia Supreme Court.
In April 2001, the California state court in the case of Brown v. The
American Tobacco Company, Inc., et al., granted in part plaintiff's
motion for class certification and certified a class comprised of adult
residents of California who smoked at least one of defendants'
cigarettes "during the applicable time period" and who were exposed to
defendants' marketing and advertising activities in California.
Certification was granted as to plaintiff's claims that defendants
violated California's unfair business practices statute. The court
subsequently defined "the applicable class period" for plaintiff's
claims, pursuant to a stipulation submitted by the parties, as June 10,
1993 through April 23, 2001. The California Court of Appeals denied
defendants' writ application, which sought review of the trial court's
class certification orders. Defendants filed a petition for review with
the California Supreme Court, which was subsequently denied. The
defendants' summary judgment motions are pending before the court.
Liggett is a defendant in the case.
In September 2002, in In Re Simon II Litigation, the federal district
court for the Eastern District of New York granted plaintiffs' motion
for certification of a nationwide non-opt-out punitive damages class
action against the tobacco companies, including Liggett. The class is
not seeking compensatory damages, but was created to determine whether
smokers across the country may be entitled to punitive damages. In its
order, the court set a trial date of January 2003, but has since stayed
the order pending the tobacco companies' appeal to the U.S. Court of
Appeals for the Second Circuit. In February 2003, the Second Circuit
agreed to review the district court's class certification decision, and
oral argument was held in November 2003.
F-37
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
In March 2003, in a class action brought against Philip Morris on
behalf of smokers of light cigarettes, a state court judge in Illinois
awarded $7,100,000 in actual damages to the class members, $3,000,000
in punitive damages to the State of Illinois (which was not a plaintiff
in this matter), and approximately $1,800,000 in attorney's fees and
costs. Entry of judgment has been stayed. Philip Morris has appealed
the verdict.
Approximately 38 purported state and federal class action complaints
were filed against the cigarette manufacturers, including Liggett, for
alleged antitrust violations. The actions allege that the cigarette
manufacturers have engaged in a nationwide and international conspiracy
to fix the price of cigarettes in violation of state and federal
antitrust laws. Plaintiffs allege that defendants' price-fixing
conspiracy raised the price of cigarettes above a competitive level.
Plaintiffs in the 31 state actions purport to represent classes of
indirect purchasers of cigarettes in 16 states; plaintiffs in the seven
federal actions purport to represent a nationwide class of wholesalers
who purchased cigarettes directly from the defendants. The federal
class actions were consolidated and, in July 2000, plaintiffs filed a
single consolidated complaint that did not name Liggett as a defendant,
although Liggett complied with discovery requests. In July 2002, the
court granted defendants' motion for summary judgment in the
consolidated federal cases, which decision was affirmed on appeal by
the United States Court of Appeals for the Eleventh Circuit. State
court cases have been dismissed in Arizona, District of Columbia,
Florida, Maine, Michigan, Minnesota, New York, South Dakota, Tennessee,
West Virginia and Wisconsin. A Kansas state court, in the case of Smith
v. Philip Morris Companies Inc., et al., granted class certification in
November 2001. In April 2003, plaintiffs' motion for class
certification was granted in Romero v. Philip Morris Companies Inc., a
case pending in New Mexico state court, which decision has been
appealed. Liggett is one of the defendants in the Kansas and New Mexico
cases.
Governmental Actions. As of December 31, 2003, there were approximately
13 Governmental Actions pending against Liggett. In these proceedings,
both foreign and domestic governmental entities seek reimbursement for
Medicaid and other health care expenditures. The claims asserted in
these health care cost recovery actions vary. In most of these cases,
plaintiffs assert the equitable claim that the tobacco industry was
"unjustly enriched" by plaintiffs' payment of health care costs
allegedly attributable to smoking and seek reimbursement of those
costs. Other claims made by some but not all plaintiffs include the
equitable claim of indemnity, common law claims of negligence, strict
liability, breach of express and implied warranty, breach of special
duty, fraud, negligent misrepresentation, conspiracy, public nuisance,
claims under state and federal statutes governing consumer fraud,
antitrust, deceptive trade practices and false advertising, and claims
under RICO.
In August 2003, following the refusal by the Florida Supreme Court to
hear the appeal of the Republic of Venezuela in connection with the
dismissal of its health care cost recovery action (which decision
plaintiff has appealed to the United States Supreme Court), the trial
court hearing the health care cost recovery actions brought in Florida
by the Republic of Tajikistan and the Brazilian State of Tocantins
granted defendants' motions to dismiss the cases. Subsequently,
plaintiffs voluntarily dismissed additional heath care cost recovery
cases brought in Florida by various foreign governmental entities.
Third-Party Payor Actions. As of December 31, 2003, there were
approximately five Third-Party Payor Actions pending against Liggett.
The claims in these cases are similar to those in the Governmental
Actions but have been commenced by insurance companies, union health
and welfare trust funds, asbestos manufacturers and others. Nine United
States Circuit Courts of Appeal have ruled that Third-Party Payors did
not have standing to bring lawsuits against the cigarette
manufacturers. The 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.
F-38
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
In June 2001, a jury in a third party payor action brought by Empire
Blue Cross and Blue Shield in the Eastern District of New York rendered
a verdict awarding the plaintiff $17,800 in damages against the major
tobacco companies. As against Liggett, the jury awarded the plaintiff
damages of $89. In February 2002, the court awarded plaintiff's counsel
$37,800 in attorneys' fees, without allocating the fee award among the
several defendants. Liggett has appealed both the jury verdict and the
attorneys' fee award. In September 2003, the United States Court of
Appeals for the Second Circuit certified two questions relating to
plaintiff's direct claims of deceptive business practices to the New
York Court of Appeals, which has agreed to review the certified
questions. The Second Circuit reversed the portion of the judgment
relating to the verdict returned against defendants under plaintiff's
subrogation claim, and deferred its ruling on defendants' appeal of the
attorneys' fees award until such time as the New York Court of Appeals
rules on the certified questions.
In other Third-Party Payor Actions claimants have set forth several
additional theories of relief sought: funding of corrective public
education campaigns relating to issues of smoking and health; funding
for clinical smoking cessation programs; disgorgement of profits from
sales of cigarettes; restitution; treble damages; and attorneys' fees.
Nevertheless, no specific amounts are provided. It is understood that
requested damages against the tobacco company defendants in these cases
might be in the billions of dollars.
Federal Government Action. In September 1999, the United States
government commenced litigation against Liggett and the other major
tobacco companies in the United States District Court for the District
of Columbia. The action seeks to recover an unspecified amount of
health care costs paid for and furnished, and to be paid for and
furnished, by the Federal Government for lung cancer, heart disease,
emphysema and other smoking-related illnesses allegedly caused by the
fraudulent and tortious conduct of defendants, to restrain defendants
and co-conspirators from engaging in fraud and other unlawful conduct
in the future, and to compel defendants to disgorge the proceeds of
their unlawful conduct. The complaint alleges that such costs total
more than $20,000,000 annually. The action asserted claims under three
federal statutes, the Medical Care Recovery Act ("MCRA"), the Medicare
Secondary Payer provisions of the Social Security Act ("MSP") and RICO.
In September 2000, the court dismissed the government's claims based on
MCRA and MSP, reaffirming its decision in July 2001. In the September
2000 decision, the court also determined not to dismiss the
government's RICO claims, under which the government continues to seek
court relief to restrain the defendant tobacco companies from allegedly
engaging in fraud and other unlawful conduct and to compel
disgorgement. In May 2003, the court denied the industry's motion which
sought partial summary judgment as to the government's advertising,
marketing, promotion and warning claims on the basis that these claims
are within the exclusive jurisdiction of the Federal Trade Commission.
In January 2004, the court granted one of the government's pending
motions and dismissed certain equitable defenses of defendants. The
remaining motions for summary judgment filed by the government and
defendants are still pending before the court.
In June 2001, the United States Attorney General assembled a team of
three Department of Justice ("DOJ") lawyers to work on a possible
settlement of the federal lawsuit. The DOJ lawyers met with
representatives of the tobacco industry, including Liggett, in July
2001. No settlement was reached, and no further meetings are planned.
In a January 2003 filing with the court, the government alleged that
disgorgement by defendants of approximately $289,000,000 is an
appropriate remedy in the case. Trial has been scheduled for September
2004.
Settlements. In March 1996, Brooke Group Holding and Liggett entered
into an agreement, subject to court approval, to settle the Castano
class action tobacco litigation. The Castano class was subsequently
decertified by the court.
F-39
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
In March 1996, March 1997 and March 1998, Brooke Group Holding and
Liggett entered into settlements of smoking-related litigation with the
Attorneys General of 45 states and territories. The settlements
released both Brooke Group Holding and Liggett from all smoking-related
claims, including claims for health care cost reimbursement and claims
concerning sales of cigarettes to minors.
In November 1998, Philip Morris, Brown & Williamson Tobacco
Corporation, R.J. Reynolds Tobacco Company and Lorillard Tobacco
Company (collectively, the "Original Participating Manufacturers" or
"OPMs") and Liggett (together with the OPMs and any other tobacco
product manufacturer that becomes a signatory, the "Participating
Manufacturers") entered into the Master Settlement Agreement (the
"MSA") with 46 states, the District of Columbia, Puerto Rico, Guam, the
United States Virgin Islands, American Samoa and the Northern Marianas
(collectively, the "Settling States") to settle the asserted and
unasserted health care cost recovery and certain other claims of those
Settling States. The MSA received final judicial approval in each
settling jurisdiction.
The MSA restricts tobacco product advertising and marketing within the
Settling States and otherwise restricts the activities of Participating
Manufacturers. Among other things, the MSA prohibits the targeting of
youth in the advertising, promotion or marketing of tobacco products;
bans the use of cartoon characters in all tobacco advertising and
promotion; limits each Participating Manufacturer to one tobacco brand
name sponsorship during any 12-month period; bans all outdoor
advertising, with the exception of signs, 14 square feet or less, at
retail establishments that sell tobacco products; prohibits payments
for tobacco product placement in various media; bans gift offers based
on the purchase of tobacco products without sufficient proof that the
intended recipient is an adult; prohibits Participating Manufacturers
from licensing third parties to advertise tobacco brand names in any
manner prohibited under the MSA; prohibits Participating Manufacturers
from using as a tobacco product brand name any nationally recognized
non-tobacco brand or trade name or the names of sports teams,
entertainment groups or individual celebrities; and prohibits
Participating Manufacturers from selling packs containing fewer than 20
cigarettes.
The MSA also requires Participating Manufacturers to affirm corporate
principles to comply with the MSA and to reduce underage usage of
tobacco products and imposes requirements applicable to lobbying
activities conducted on behalf of Participating Manufacturers.
Liggett has no payment obligations under the MSA except to the extent
its market share exceeds a base share of 125% of its 1997 market share,
or approximately 1.65% of total cigarettes sold in the United States.
As a result of the Medallion acquisition in April 2002, Vector Tobacco
has no payment obligations under the MSA, except to the extent its
market share exceeds a base amount of approximately 0.28% of total
cigarettes sold in the United States. During 1999 and 2000, Liggett's
market share did not exceed the base amount. According to data from
Management Source Associates, Inc., domestic shipments by Liggett and
Vector Tobacco accounted for approximately 2.2% of the total cigarettes
shipped in the United States during 2001, 2.5% during 2002 and 2.7%
during 2003. On April 15 of any year following a year in which
Liggett's and/or Vector Tobacco's 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. Liggett and Vector Tobacco have
expensed $35,854 for their estimated MSA obligations for 2003 as part
of cost of goods sold. In June 2003, Liggett reached a settlement with
the jurisdictions party to the MSA whereby it agreed to pay $2,500 in
April 2004. The settlement resolved Liggett's claims that it was
entitled to a reduction in its MSA payments as a result of market share
loss to non-participating manufacturers for payments based on sales
through December 31, 2002. Under the annual and strategic contribution
payment provisions
F-40
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
of the MSA, the OPMs (and Liggett and Vector Tobacco to the extent
their market shares exceed their base shares) are required to pay the
following annual amounts (subject to certain adjustments):
Year Amount
- ----------------------------------------------------- ----------
2004 - 2007.......................................... $8,000,000
2008 - 2017.......................................... $8,139,000
2018 and each year thereafter....................... $9,000,000
These annual payments will be allocated based on relative unit volume
of domestic cigarette shipments. The payment obligations under the MSA
are the several, and not joint, obligations of each Participating
Manufacturer and are not the responsibility of any parent or affiliate
of a Participating Manufacturer.
The MSA replaces Liggett's prior settlements with all states and
territories except for Florida, Mississippi, Texas and Minnesota. Each
of these four states, prior to the effective date of the MSA,
negotiated and executed settlement agreements with each of the other
major tobacco companies, separate from those settlements reached
previously with Liggett. Because these states' settlement agreements
with Liggett provided for "most favored nation" protection for both
Brooke Group Holding and Liggett, the payments due these states by
Liggett (with certain possible exceptions) have been eliminated, other
than a $100 a year payment to Minnesota starting in 2003, to be paid
any year cigarettes manufactured by Liggett are sold in the state. With
respect to all non-economic obligations under the previous settlements,
both Brooke Group Holding and Liggett are entitled to the most
favorable provisions as between the MSA and each state's respective
settlement with the other major tobacco companies. Therefore, Liggett's
non-economic obligations to all states and territories are now defined
by the MSA.
Copies of the various settlement agreements are filed as exhibits to
the Company's Annual Report on Form 10-K and the discussion herein is
qualified in its entirety by reference thereto.
Trials. Cases currently scheduled for trial during the next six months
include three individual actions in Florida state court with two
scheduled for April 2004 and one for August 2004. Liggett is the sole
defendant in each of these cases. Trial in the United States government
action is scheduled for September 2004 in federal court in the District
of Columbia. Trial dates, however, are subject to change.
Management is not able to predict the outcome of the litigation pending
against Brooke Group Holding or Liggett. Litigation is subject to many
uncertainties. In May 2003, a Florida intermediate appellate court
overturned a $790,000 punitive damages award against Liggett and
decertified the Engle smoking and health class action. Class counsel in
Engle is pursuing various appellate remedies seeking reversal of the
appellate court's decision. If the appellate court's ruling is not
upheld on further appeal, it will have a material adverse effect on the
Company. In November 2000, Liggett filed the $3,450 bond required under
the bonding statute enacted in 2000 by the Florida legislature which
limits the size of any bond required, pending appeal, to stay execution
of a punitive damages verdict. In May 2001, Liggett reached an
agreement with the class in the Engle case, which provided assurance to
Liggett that the stay of execution, in effect pursuant to the Florida
bonding statute, would not be lifted or limited at any point until
completion of all appeals, including to the United States Supreme
Court. As required by the agreement, Liggett paid $6,273 into an escrow
account to be held for the benefit of the Engle class, and released,
along with Liggett's existing $3,450 statutory bond, to the court for
the benefit of the class upon completion of the appeals process,
regardless of the outcome of the appeal. As a result, the Company
recorded a $9,723 pre-tax charge to the consolidated statement of
operations for the first quarter of 2001. In June 2002, the jury in an
individual case brought under the third phase of the Engle case awarded
$37,500
F-41
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(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. It is possible that additional cases could be
decided unfavorably and that there could be further adverse
developments in the Engle case. Management cannot predict the cash
requirements related to any future settlements and judgments, including
cash required to bond any appeals, and there is a risk that those
requirements will not be able to be met. An unfavorable outcome of a
pending smoking and health case could encourage the commencement of
additional similar litigation. Management is unable to make a
meaningful estimate with respect to the amount or range of loss that
could result from an unfavorable outcome of the cases pending against
Brooke Group Holding or Liggett or the costs of defending such cases.
The complaints filed in these cases rarely detail alleged damages.
Typically, the claims set forth in an individual's complaint against
the tobacco industry pray for money damages in an amount to be
determined by a jury, plus punitive damages and costs. These damage
claims are typically stated as being for the minimum necessary to
invoke the jurisdiction of the court.
It is possible that the Company's consolidated financial position,
results of operations or cash flows could be materially adversely
affected by an unfavorable outcome in any such smoking-related
litigation.
Liggett's and Vector Tobacco's management are unaware of any material
environmental conditions affecting their existing facilities. Liggett's
and Vector Tobacco's management believe that current operations are
conducted in material compliance with all environmental laws and
regulations and other laws and regulations governing cigarette
manufacturers. Compliance with federal, state and local provisions
regulating the discharge of materials into the environment, or
otherwise relating to the protection of the environment, has not had a
material effect on the capital expenditures, results of operations or
competitive position of Liggett or Vector Tobacco.
Liggett has been served in three reparations actions brought by
descendants of slaves. Plaintiffs in these actions claim that
defendants, including Liggett, profited from the use of slave labor.
Seven additional cases have been filed in California, Illinois and New
York. Liggett is a named defendant in only one of these additional
cases, but has not been served.
There are several other proceedings, lawsuits and claims pending
against the Company and certain of its consolidated subsidiaries
unrelated to smoking or tobacco product liability. Management is of the
opinion that the liabilities, if any, ultimately resulting from such
other proceedings, lawsuits and claims should not materially affect the
Company's financial position, results of operations or cash flows.
LEGISLATION AND REGULATION:
Many cities and states have recently enacted legislation banning
smoking in public places including offices, restaurants, public
buildings and bars. Efforts to limit smoking in public places could
have a material adverse effect on the Company and Liggett.
In January 1993, the Environmental Protection Agency ("EPA") released a
report on the respiratory effect of secondary smoke which concludes
that secondary smoke is a known human lung carcinogen in adults and in
children, causes increased respiratory tract disease and middle ear
disorders and increases the severity and frequency of asthma. In June
1993, the two largest of the major domestic cigarette manufacturers,
together with other segments of the tobacco and distribution
industries, commenced a lawsuit against the EPA seeking a determination
that the EPA did not have
F-42
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
the statutory authority to regulate secondary smoke, and that given the
scientific evidence and the EPA's failure to follow its own guidelines
in making the determination, the EPA's classification of secondary
smoke was arbitrary and capricious. In July 1998, a federal district
court vacated those sections of the report relating to lung cancer,
finding that the EPA may have reached different conclusions had it
complied with relevant statutory requirements. The federal government
appealed the court's ruling. In December 2002, the United States Court
of Appeals for the Fourth Circuit rejected the industry challenge to
the EPA report ruling that it was not subject to court review. Issuance
of the report may encourage efforts to limit smoking in public areas.
In February 1996, the United States Trade representative issued an
"advance notice of proposed rule making" concerning how tobacco is
imported under a previously established tobacco tariff rate quota
("TRQ") should be allocated. Currently, tobacco imported under the TRQ
is allocated on a "first-come, first-served" basis, meaning that entry
is allowed on an open basis to those first requesting entry in the
quota year. Others in the cigarette industry have suggested an
"end-user licensing" system under which the right to import tobacco
under the quota would be initially assigned based on domestic market
share. Such an approach, if adopted, could have a material adverse
effect on the Company and Liggett.
In August 1996, the Food and Drug Administration (the "FDA") filed in
the Federal Register a Final Rule classifying tobacco as a "drug" or
"medical device", asserting jurisdiction over the manufacture and
marketing of tobacco products and imposing restrictions on the sale,
advertising and promotion of tobacco products. Litigation was commenced
challenging the legal authority of the FDA to assert such jurisdiction,
as well as challenging the constitutionality of the rules. In March
2000, the United States Supreme Court ruled that the FDA does not have
the power to regulate tobacco. Liggett supported the FDA Rule and began
to phase in compliance with certain of the proposed FDA regulations.
Since the Supreme Court decision, various proposals and recommendations
have been made for additional federal and state legislation to regulate
cigarette manufacturers. Congressional advocates of FDA regulations
have introduced legislation that would give the FDA authority to
regulate the manufacture, sale, distribution and labeling of tobacco
products to protect public health, thereby allowing the FDA to
reinstate its prior regulations or adopt new or additional regulations.
Proposed legislation has also been introduced in Congress that would
eliminate the federal tobacco quota system and impose assessments on
manufacturers of tobacco products to compensate tobacco growers and
quota holders for the elimination of their quota rights. The ultimate
outcome of these proposals cannot be predicted.
In August 1996, Massachusetts enacted legislation requiring tobacco
companies to publish information regarding the ingredients in
cigarettes and other tobacco products sold in that state. In December
2002, the United States Court of Appeals for the First Circuit ruled
that the ingredients disclosure provisions violated the constitutional
prohibition against unlawful seizure of property by forcing firms to
reveal trade secrets. The decision was not appealed by the state.
Liggett began voluntarily complying with this legislation in December
1997 by providing ingredient information to the Massachusetts
Department of Public Health and, notwithstanding the appellate court's
ruling, has continued to provide ingredient disclosure. Liggett also
provides ingredient information annually, as required by law, to the
states of Texas and Minnesota. Several other states are considering
ingredient disclosure legislation.
Cigarettes are subject to substantial and increasing federal, state and
local excise taxes. The federal excise tax on cigarettes is currently
$0.39 per pack. State and local sales and excise taxes vary
considerably and, when combined with sales taxes, local taxes and the
current federal excise tax, may currently exceed $4.00 per pack.
Proposed further tax increases in various jurisdictions are
F-43
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
currently under consideration or pending. In 2003, 15 states and the
District of Columbia enacted increases in excise taxes. Congress has
considered significant increases in the federal excise tax or other
payments from tobacco manufacturers, and several states have pending
legislation proposing further state excise tax increases. In 2004,
several states are likely to impose additional taxes on cigarettes. In
the opinion of the Company, increases in excise and similar taxes have
had an adverse impact on sales of cigarettes.
Various state governments have adopted or are considering adopting
legislation establishing fire safety standards for cigarettes.
Compliance with this legislation could be burdensome and costly. In
June 2000, the New York State legislature passed legislation charging
the state's Office of Fire Prevention and Control, referred to as the
"OFPC," with developing standards for "fire-safe" or self-extinguishing
cigarettes. The OFPC has issued regulations requiring that by June 28,
2004 all cigarettes offered for sale in New York state must be
manufactured to certain self-extinguishment standards set out in the
regulations. Certain design and manufacturing changes will be necessary
for cigarettes manufactured for sale in New York to comply with the
standards. Inventories of cigarettes existing in the wholesale and
retail trade as of June 28, 2004 that do not comply with the standards,
may continue to be sold provided New York tax stamps have been affixed
and such inventories have been purchased in comparable quantities to
the same period in the previous year. Liggett and Vector Tobacco have
not historically provided products that would be compliant under these
new OFPC regulations. Liggett and Vector Tobacco expect, however, to
supply compliant products by June 28, 2004. Similar legislation is
being considered by other state governments and at the federal level.
Compliance with such legislation could harm the business of Liggett and
Vector Tobacco, particularly if there are varying standards from state
to state.
Federal or state regulators may object to Vector Tobacco's reduced
carcinogen and low nicotine and nicotine-free cigarette products as
unlawful or allege they bear deceptive or unsubstantiated product
claims, and seek the removal of the products from the marketplace, or
significant changes to advertising. Various concerns regarding Vector
Tobacco's advertising practices have been expressed to Vector Tobacco
by certain state attorneys general. Vector Tobacco has engaged in
discussions in an effort to resolve these concerns. Allegations by
federal or state regulators, public health organizations and other
tobacco manufacturers that Vector Tobacco's products are unlawful, or
that its public statements or advertising contain misleading or
unsubstantiated health claims or product comparisons, may result in
litigation or governmental proceedings. Vector Tobacco's business may
become subject to extensive domestic and international governmental
regulation. Various proposals have been made for federal, state and
international legislation to regulate cigarette manufacturers
generally, and reduced constituent cigarettes specifically. It is
possible that laws and regulations may be adopted covering issues like
the manufacture, sale, distribution, advertising and labeling of
tobacco products as well as any express or implied health claims
associated with reduced carcinogen and low nicotine and nicotine-free
cigarette products and the use of genetically modified tobacco. A
system of regulation by agencies like the FDA, the Federal Trade
Commission or the United States Department of Agriculture may be
established. In addition, a group of public health organizations
submitted a petition to the FDA, alleging that the marketing of the
OMNI product is subject to regulation by the FDA under existing law.
Vector Tobacco has filed a response in opposition to the petition. The
FTC has also expressed interest in the regulation of tobacco products
made by tobacco manufacturers, including Vector Tobacco, which bear
reduced carcinogen claims. The ultimate outcome of any of the foregoing
cannot be predicted, but any of the foregoing could have a material
adverse impact on the Company.
In addition to the foregoing, there have been a number of other
restrictive regulatory actions, adverse legislative and political
decisions and other unfavorable developments concerning cigarette
smoking and the tobacco industry. These developments may negatively
affect the perception of potential triers of fact with respect to the
tobacco industry, possibly to the detriment of certain pending
litigation, and may prompt the commencement of additional similar
litigation or legislation.
F-44
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
OTHER MATTERS:
In March 1997, a stockholder derivative suit was filed in Delaware
Chancery Court against New Valley, as a nominal defendant, its
directors and Brooke Group Holding by a stockholder of New Valley. The
suit alleges that New Valley's purchase of the BrookeMil Ltd. shares
from Brooke (Overseas) Ltd., which was then an indirect subsidiary of
Brooke Group Holding, in January 1997 constituted a self-dealing
transaction which involved the payment of excessive consideration by
New Valley. The plaintiff seeks a declaration that New Valley's
directors breached their fiduciary duties and Brooke Group Holding
aided and abetted such breaches and that damages be awarded to New
Valley. In December 1999, another stockholder of New Valley commenced
an action in Delaware Chancery Court substantially similar to the March
1997 action. This stockholder alleges, among other things, that the
consideration paid by New Valley for the BrookeMil shares was
excessive, unfair and wasteful, that the special committee of New
Valley's board lacked independence, and that the appraisal and fairness
opinion were flawed. By order of the court, both actions were
consolidated. In January 2001, the court denied a motion to dismiss the
consolidated action. Brooke Group Holding and New Valley believe that
the allegations in the case are without merit. Discovery in the case is
ongoing.
In July 1999, a purported class action was commenced on behalf of New
Valley's former Class B preferred shareholders against New Valley,
Brooke Group Holding and certain directors and officers of New Valley
in Delaware Chancery Court. The complaint alleges that the
recapitalization, approved by a majority of each class of New Valley's
stockholders in May 1999, was fundamentally unfair to the Class B
preferred shareholders, the proxy statement relating to the
recapitalization was materially deficient and the defendants breached
their fiduciary duties to the Class B preferred shareholders in
approving the transaction. The plaintiffs seek class certification of
the action and an award of compensatory damages as well as all costs
and fees. The Court has dismissed six of plaintiff's nine claims
alleging inadequate disclosure in the proxy statement. Brooke Group
Holding and New Valley believe that the remaining allegations are
without merit and recently filed a motion for summary judgment on the
remaining three claims.
Although there can be no assurances, Brooke Group Holding and New
Valley believe, after consultation with counsel, that the ultimate
resolution of these matters will not have a material adverse effect on
the Company's or New Valley's consolidated financial position, results
of operations or cash flows.
As of December 31, 2003, New Valley had $655 of remaining prepetition
bankruptcy-related claims and restructuring accruals including claims
for lease rejection damages. The remaining claims may be subject to
future adjustments based on potential settlements or decisions of the
court.
17. RELATED PARTY TRANSACTIONS
In connection with the Company's convertible note offering in July
2001, the placement agent for the offering required that the principal
stockholder and Chairman of the Company grant the placement agent the
right, in its sole discretion, to borrow up to 3,472,875 shares of
Common Stock from the principal stockholder or any entity affiliated
with him during the three-year period ending June 29, 2004 and that he
agree not to dispose of such shares during the three-year period,
subject to limited exceptions. In consideration for the principal
stockholder agreeing to lend his shares in order to facilitate the
Company's offering and accepting the resulting liquidity risk, the
Company agreed to pay him or an affiliate designated by him an annual
fee, payable on a quarterly basis at his election in cash or shares of
Common Stock, equal to 1% of the aggregate market value of 3,472,875
shares of
F-45
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Common Stock. For the years ended December 31, 2003 and 2002 and for
the six months ended December 31, 2001, the Company paid an entity
affiliated with the principal stockholder an aggregate of $498, $616
and $594, respectively, under this agreement.
An outside director of the Company is a stockholder of and serves as
the chairman and treasurer of, and the Company's President is a
stockholder and registered representative in, a registered
broker-dealer that has performed stock brokerage and related services
for New Valley. The broker-dealer received brokerage commissions and
other income of approximately $48, $87 and $12 from New Valley during
2003, 2002 and 2001, respectively.
During 2001, New Valley paid a fee of $750 to a director of New Valley
who served as President of its Ladenburg Thalmann & Co. Inc.
broker-dealer subsidiary. The fee was paid for his services in
connection with the closing of the acquisition of the subsidiary.
(Refer to Note 21.) One-half of the fee was reimbursed to New Valley by
the subsidiary.
Various executive officers and directors of the Company and New Valley
serve as members of the Board of Directors of Ladenburg Thalmann
Financial Services, Inc., which is indebted to New Valley. (Refer to
Note 20.)
The Company's President, a firm of which he serves as Chairman of the
Board and the firm's affiliates received ordinary and customary
insurance commissions aggregating approximately $541, $606 and $285 in
2003, 2002 and 2001, respectively, on various insurance policies issued
for the Company and its subsidiaries and investees.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of the Company's financial instruments have
been determined by the Company using available market information and
appropriate valuation methodologies described in Note 1. However,
considerable judgment is required to develop the estimates of fair
value and, accordingly, the estimates presented herein are not
necessarily indicative of the amounts that could be realized in a
current market exchange.
December 31, 2003 December 31, 2002
--------------------- -------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- --------- -------- --------
Financial assets:
Cash and cash equivalents.............................. $ 74,808 $ 74,808 $100,027 $100,027
Investment securities available
for sale............................................. 67,521 67,521 128,430 128,430
Restricted assets...................................... 6,342 6,342 4,857 4,857
Long-term investments, net............................. 2,431 11,741 3,150 10,694
Financial liabilities:
Notes payable and long-term debt....................... 310,739 292,998 338,305 297,762
19. PHILIP MORRIS BRAND TRANSACTION
In November 1998, the Company and Liggett granted Philip Morris
Incorporated options to purchase interests in Trademarks LLC which
holds three domestic cigarette brands, L&M, Chesterfield and Lark,
formerly held by Liggett's subsidiary, Eve Holdings Inc.
F-46
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Under the terms of the Philip Morris agreements, Eve contributed the
three brands to Trademarks, a newly-formed limited liability company,
in exchange for 100% of two classes of Trademarks' interests, the Class
A Voting Interest and the Class B Redeemable Nonvoting Interest. Philip
Morris acquired two options to purchase the interests from Eve. In
December 1998, Philip Morris paid Eve a total of $150,000 for the
options, $5,000 for the option for the Class A interest and $145,000
for the option for the Class B interest.
The Class A option entitled Philip Morris to purchase the Class A
interest for $10,100. On March 19, 1999, Philip Morris exercised the
Class A option, and the closing occurred on May 24, 1999.
The Class B option entitles Philip Morris to purchase the Class B
interest for $139,900. The Class B option will be exercisable during
the 90-day period beginning on December 2, 2008, with Philip Morris
being entitled to extend the 90-day period for up to an additional six
months under certain circumstances. The Class B interest will also be
redeemable by Trademarks for $139,900 during the same period the Class
B option may be exercised.
On May 24, 1999, Trademarks borrowed $134,900 from a lending
institution. The loan is guaranteed by Eve and collateralized by a
pledge by Trademarks of the three brands and Trademarks' interest in
the trademark license agreement (discussed below) and by a pledge by
Eve of its Class B interest. In connection with the closing of the
Class A option, Trademarks distributed the loan proceeds to Eve as the
holder of the Class B interest. The cash exercise price of the Class B
option and Trademarks' redemption price were reduced by the amount
distributed to Eve. Upon Philip Morris' exercise of the Class B option
or Trademarks' exercise of its redemption right, Philip Morris or
Trademarks, as relevant, will be required to obtain Eve's release from
its guaranty. The Class B interest will be entitled to a guaranteed
payment of $500 each year with the Class A interest allocated all
remaining income or loss of Trademarks. The Company believes the fair
value of Eve's guarantee is negligible at December 31, 2003.
Trademarks has granted Philip Morris an exclusive license of the three
brands for an 11-year term expiring May 24, 2010 at an annual royalty
based on sales of cigarettes under the brands, subject to a minimum
annual royalty payment equal to the annual debt service obligation on
the loan plus $1,000.
If Philip Morris fails to exercise the Class B option, Eve will have an
option to put its Class B interest to Philip Morris, or Philip Morris'
designees, at a put price that is $5,000 less than the exercise price
of the Class B option (and includes Philip Morris' obtaining Eve's
release from its loan guarantee). The Eve put option is exercisable at
any time during the 90-day period beginning March 2, 2010.
If the Class B option, Trademarks' redemption right and the Eve put
option expire unexercised, the holder of the Class B interest will be
entitled to convert the Class B interest, at its election, into a Class
A interest with the same rights to share in future profits and losses,
the same voting power and the same claim to capital as the entire
existing outstanding Class A interest, i.e., a 50% interest in
Trademarks.
Upon the closing of the exercise of the Class A option and the
distribution of the loan proceeds on May 24, 1999, Philip Morris
obtained control of Trademarks, and the Company recognized a pre-tax
gain of $294,078 in its consolidated financial statements and
established a deferred tax liability of $103,100 relating to the gain.
As discussed in Note 12, the Internal Revenue Service has issued to the
Company a notice of proposed adjustment asserting, for tax purposes,
that the entire gain should have been recognized by the Company in 1998
and 1999.
F-47
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
20. DISCONTINUED OPERATIONS
The consolidated financial statements of the Company reflect New
Valley's broker-dealer operations, which were New Valley's primary
source of revenues from May 1995 to December 2001, as discontinued
operations for all periods presented. Accordingly, revenues, costs and
expenses, and cash flows of the discontinued operations have been
excluded from the respective captions in the consolidated statements of
operations and consolidated statements of cash flows. The net operating
results of these entities have been reported, net of minority interests
and applicable income taxes, as "Loss from discontinued operations,"
and the net cash flows of these entities have been reported as "Impact
of discontinued operations."
In May 2001, GBI Capital Management Corp. acquired all of the
outstanding common stock of Ladenburg Thalmann & Co. Inc. ("Ladenburg
Thalmann"), New Valley's 80.1% owned broker-dealer subsidiary. The
purchase price was 23,218,599 shares, $10,000 in cash and $10,000
principal amount of senior convertible notes due December 31, 2005.
Following the transaction, the name of GBI, a public company listed on
the American Stock Exchange, was changed to Ladenburg Thalmann
Financial Services Inc. ("LTS"). The notes bear interest at 7.5% per
annum and are convertible into 4,799,271 shares of LTS common stock.
Upon closing, New Valley also acquired an additional 3,945,060 shares
of LTS common stock from the former Chairman of LTS for $1.00 per
share. Following completion of the transaction, New Valley owned 53.6%
of the outstanding common stock of LTS.
On November 30, 2001, New Valley announced that it would distribute its
22,543,158 shares of LTS common stock to holders of New Valley common
shares through a special dividend. On the same date, Vector announced
that it would, in turn, distribute the 12,694,929 shares of LTS common
stock that it would receive from New Valley to the holders of Vector's
common stock as a special dividend. The special dividends were
accomplished through pro rata distributions of the LTS shares, paid on
December 20, 2001 to holders of record as of December 10, 2001. New
Valley stockholders received 0.988 of a LTS share for each share of New
Valley, and Vector stockholders received 0.348 of a LTS share for each
share of Vector.
Following completion of the special dividend of the LTS's shares, New
Valley continues to hold $8,010,000 principal amount of LTS's senior
convertible promissory notes, convertible into 3,844,216 shares of LTS
common stock, and a warrant to purchase 100,000 shares of LTS common
stock at $1.00 per share. (Refer to Note 21.)
Summarized operating results of the discontinued broker-dealer
operations for the period January 1, 2001 to December 20, 2001:
2001
--------
Revenues............................................................ $ 88,473
======
Loss from operations before income taxes............................ (12,030)
Benefit for income taxes............................................ (1,356)
Minority interests.................................................. 8,557
--------
Net loss............................................................ $ (2,117)
========
Gains on Disposal of Discontinued Operations. In 2001, Vector
recognized a gain on disposal of discontinued operations of $1,580
relating to New Valley's adjustments of accruals established during its
bankruptcy proceedings in 1993 and 1994. The reversal of these accruals
was made due to the completion of the settlements related to these
matters.
F-48
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
21. NEW VALLEY CORPORATION
Acquisition of Real Estate. In December 2002, New Valley purchased two
office buildings in Princeton, New Jersey. for a total purchase price
of $54,000. New Valley financed a portion of the purchase price through
a borrowing of $40,500 from HSBC Realty Credit Corporation (USA).
(Refer to Note 9.)
Also in December 2002, New Valley and the other owners of Prudential
Douglas Elliman Real Estate, formerly known as Prudential Long Island
Realty, contributed their interests in Prudential Douglas Elliman Real
Estate to Douglas Elliman Realty, LLC, formerly known as Montauk
Battery Realty LLC, a newly formed entity. New Valley acquired a 50%
ownership interest in Douglas Elliman Realty, LLC, an increase from its
previous 37.2% interest in Prudential Douglas Elliman Real Estate as a
result of an additional investment of $1,413 by New Valley and the
redemption by Prudential Douglas Elliman Real Estate of various
ownership interests.
In March 2003, Douglas Elliman Realty, LLC purchased the leading New
York City-based residential brokerage firm, Douglas Elliman, LLC,
formerly known as Insignia Douglas Elliman, and an affiliated property
management company for $71,250. New Valley invested an additional
$9,500 in subordinated debt and equity of Douglas Elliman Realty, LLC
to help fund the acquisition. The subordinated debt, which has a
principal amount of $9,500, bears interest at 12% per annum and is due
in March 2013.
Russian Real Estate. In April 2002, New Valley sold the shares of
BrookeMil Ltd., a wholly-owned subsidiary, for approximately $22,000
before closing expenses. BrookeMil owned the two Kremlin sites in
Moscow, which were New Valley's remaining real estate holdings in
Russia. Under the terms of the Western Realty Repin LLC joint venture
of New Valley and Apollo Real Estate Investment Fund III, L.P.
("Apollo"), New Valley received approximately $7,500 of the net
proceeds from the sale and Apollo received approximately $12,500 of the
proceeds. New Valley recorded a gain on sale of real estate of $8,484
for the year ended December 31, 2002 in connection with the sale.
In December 2001, Western Realty Development LLC sold to Andante
Limited, a Bermuda company, all of the membership interests in its
subsidiary Western Realty Investments LLC, the entity through which
Western Realty Development owned the Ducat Place II office building in
Moscow, Russia, and the adjoining site for the proposed development of
Ducat Place III. The purchase price for the sale was approximately
$42,000 including the assumption of mortgage debt and payables. Of the
net cash proceeds from the sale, New Valley received approximately
$22,000, and Apollo received approximately $9,500. New Valley recorded
a loss of $21,842 in connection with the sale in 2001.
LTS. In March 2002, LTS borrowed $2,500 from New Valley. The loan,
which bears interest at 1% above the prime rate, was due on the earlier
of December 31, 2003 or the completion of one or more equity financings
where LTS receives at least $5,000 in total proceeds. In July 2002, LTS
borrowed an additional $2,500 from New Valley on the same terms. In
November 2002, New Valley agreed, in connection with a $3,500 loan to
LTS by an affiliate of its clearing broker, to extend the maturity of
the notes to December 31, 2006 and to subordinate the notes to the
repayment of the loan.
New Valley evaluated its ability to collect the $13,198 of notes and
interest receivable from LTS at September 30, 2002. These notes
receivable include the $5,000 of notes discussed above and the $8,010
convertible note issued to New Valley in May 2002 in connection with
the LTS acquisition. New Valley determined, based on then current
trends in the broker-dealer industry and LTS's operating results and
liquidity needs, that a reserve for uncollectibility should be
established against these notes and interest receivable. As a result,
New Valley recorded a charge of $13,198 in the third quarter of 2002.
F-49
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
On October 8, 2002, LTS borrowed an additional $2,000 from New Valley.
The loan, which bore interest at 1% above the prime rate, was repaid in
December 2002 with the proceeds from the loan to LTS from an affiliate
of its clearing broker.
Other. In October 1999, New Valley's Board of Directors authorized the
repurchase of up to 2,000,000 common shares from time to time on the
open market or in privately negotiated transactions depending on market
conditions. As of December 31, 2003, New Valley had repurchased
1,185,615 shares for approximately $4,695. At December 31, 2003, the
Company owned 58.1% of New Valley's common shares.
In the fourth quarter of 2001, New Valley settled a lawsuit against
certain of its former insurers, which resulted in income of $17,620.
The litigation arose out of the insurers' participation in a program of
insurance covering the amount of fuel in the Westar IV and V
communication satellites owned by New Valley's former Western Union
satellite business, which was sold in 1989. The two satellites, each of
which were launched in 1982 with an expected ten-year life, had
shortened lives due to insufficient fuel. In the settlement, New Valley
received payment from the insurers for the shortened lives of the two
satellites. The settlement calls for dismissal of the lawsuit against
the settling insurers as well as dismissal of the counterclaims brought
against New Valley by these insurers.
22. SEGMENT INFORMATION
The Company's significant business segments for each of the three years
ended December 31, 2003 were Liggett, Vector Tobacco and real estate.
The Liggett segment consists of the manufacture and sale of
conventional cigarettes and, for segment reporting purposes, includes
the operations of Medallion acquired on April 1, 2002 (which operations
are held for legal purposes as part of Vector Tobacco). The Vector
Tobacco segment includes the development and marketing of the low
nicotine and nicotine-free cigarette products as well as the
development of reduced risk cigarette products and, for segment
reporting purposes, excludes the operations of Medallion.
Financial information for the Company's continuing operations before
taxes and minority interests for the years ended December 31, 2003,
2002 and 2001 follows:
F-50
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
Vector Real Corporate
Liggett Tobacco Estate and Other Total
------------ ------------ ------------ ------------ ------------
2003
Revenues .......................... $ 503,231 $ 26,154 $ 7,298 $ - $ 536,683
Operating income .................. 119,749 (92,825)(1) 4,245 (26,912) 4,257(1)
Identifiable assets ............... 304,155 76,718 74,594 172,745 628,212
Depreciation and amortization ..... 7,106 4,927 1,283 2,695 16,011
Capital expenditures .............. 5,644 2,296 - 954 8,894
2002
Revenues .......................... $ 494,975 $ 7,442 $ 1,001 $ - $ 503,418
Operating income .................. 102,718(2) (88,159) (578) (32,688) (18,707)(2)
Identifiable assets ............... 274,667 92,529 62,755 277,319 707,270
Depreciation and amortization ..... 5,634 5,166 245 2,818 13,863
Capital expenditures .............. 19,078 16,863 54,945 5,750 96,636
2001
Revenues .......................... $ 432,918 $ 4,498 $ 9,966 $ - $ 447,382
Operating income .................. 107,052 (48,643) 413 (27,479) 31,343
Identifiable assets ............... 174,342 93,533 10,581 410,447 688,903
Depreciation and amortization ..... 4,586 1,686 2,353 1,348 9,973
Capital expenditures .............. 18,746 41,224 1,762 15,368 77,100
- ------------
(1) Includes restructuring and impairment charges of $21,300 in 2003.
(2) Includes restructuring charges of $3,460 in 2002.
23. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
Quarterly data for the year ended December 31, 2003 and 2002 are as
follows:
December 31, September 30, June 30, March 31,
2003 2003 2003 2003
------------ ------------- ------------ ------------
Revenues .................................... $ 129,514 $ 142,850 $ 131,177 $ 133,142
Operating income (loss) ..................... 11,941 (8,307) 852 (229)
Net income (loss) applicable to
common shares ............................ $ 3,549 $ (9,380) $ (4,930) $ (4,849)
============ ============= ============ ============
*Per basic common share: $ 0.09 $ (0.24) $ (0.13) $ (0.13)
============ ============= ============ ============
*Per diluted common share: $ 0.09 $ (0.24) $ (0.13) $ (0.13)
============ ============= ============ ============
F-51
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
December 31, September 30, June 30, March 31,
2002 2002 2002 2002
------------ ------------- ------------ ------------
Revenues .................................... $ 124,472 $ 141,714 $ 140,050 $ 97,182
Operating income (loss) ..................... 875 314 (4,844) (15,052)
Net loss applicable to common shares ........ $ (8,423) $ (8,166) $ (3,342) $ (11,863)
============ ============= ============ ============
*Per basic common share: $ (0.23) $ (0.22) $ (0.09) $ (0.32)
============ ============= ============ ============
*Per diluted common share: $ (0.23) $ (0.22) $ (0.09) $ (0.32)
============ ============= ============ ============
*Per share computations include the impact of 5% stock dividends paid
on September 29, 2003 and September 27, 2002. Quarterly basic and
diluted net income (loss) per common share were computed independently
for each quarter and do not necessarily total to the year to date basic
and diluted net income (loss) per common share.
F-52
VECTOR GROUP LTD.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN THOUSANDS)
Additions
-------------
Balance at Charged to Balance
Beginning Costs and at End
Description of Period Expenses Deductions of Period
----------- ------------ ------------- ------------ ------------
YEAR ENDED DECEMBER 31, 2003
Allowances for:
Doubtful accounts ................... $ 1,499 $ - $ 1,149 $ 350
Cash discounts ...................... 749 29,373 29,726 396
Sales returns ....................... 8,947 - 475 8,472
------------ ------------- ------------ ------------
Total ........................... $ 11,195 $ 29,373 $ 31,350 $ 9,218
============ ============= ============ ============
YEAR ENDED DECEMBER 31, 2002
Allowances for:
Doubtful accounts ................... $ 238 $ 1,627 $ 366 $ 1,499
Cash discounts ...................... 1,863 29,740 30,854 749
Sales returns ....................... 3,894 5,053 - 8,947
------------ ------------- ------------ ------------
Total ........................... $ 5,995 $ 36,420 $ 31,220 $ 11,195
============ ============= ============ ============
YEAR ENDED DECEMBER 31, 2001
Allowances for:
Doubtful accounts ................... $ 565 $ 79 $ 406 $ 238
Cash discounts ...................... 508 26,166 24,811 1,863
Sales returns ....................... 3,690 204 - 3,894
------------ ------------- ------------ ------------
Total ........................... $ 4,763 $ 26,449 $ 25,217 $ 5,995
============ ============= ============ ============
F-53