Vector Group Ltd.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 30, 2005
VECTOR GROUP LTD.
(Exact name of registrant as specified in its charter)
|
|
|
|
|
Delaware
(State or other jurisdiction of
incorporation or organization)
|
|
1-5759
Commission File Number
|
|
65-0949535
(I.R.S. Employer Identification No.) |
100 S.E. Second Street
Miami, Florida 33131
305/579-8000
(Address, including zip code and telephone number, including area code,
of the principal executive offices)
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.
þ Yes o No
Indicate by check mark whether the Registrant is an accelerated filer as defined in Rule 12b-2
of the Exchange Act. þ Yes o No
Indicate by check mark whether the Registrant is a shell company as defined in Rule 12b-2 of
the Exchange Act. þ Yes o No
At November 8, 2005, Vector Group Ltd. had 44,592,890 shares of common stock outstanding.
VECTOR GROUP LTD.
FORM 10-Q
TABLE OF CONTENTS
- 1 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, Except Per Share Amounts)
Unaudited
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2005 |
|
|
2004 |
|
ASSETS: |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
158,964 |
|
|
$ |
110,004 |
|
Investment securities available for sale |
|
|
19,672 |
|
|
|
14,927 |
|
Accounts receivable trade |
|
|
22,373 |
|
|
|
2,464 |
|
Other receivables |
|
|
502 |
|
|
|
653 |
|
Inventories |
|
|
76,602 |
|
|
|
78,941 |
|
Restricted assets |
|
|
|
|
|
|
606 |
|
Deferred income taxes |
|
|
3,486 |
|
|
|
22,695 |
|
Other current assets |
|
|
9,140 |
|
|
|
11,834 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
290,739 |
|
|
|
242,124 |
|
|
|
|
|
|
|
|
|
|
Property, plant and equipment, net |
|
|
62,615 |
|
|
|
65,357 |
|
Assets held for sale |
|
|
2,212 |
|
|
|
54,077 |
|
Long-term investments, net |
|
|
2,540 |
|
|
|
2,410 |
|
Investments in non-consolidated real estate businesses |
|
|
33,441 |
|
|
|
27,160 |
|
Restricted assets |
|
|
5,082 |
|
|
|
4,374 |
|
Deferred income taxes |
|
|
17,937 |
|
|
|
18,119 |
|
Intangible asset |
|
|
107,511 |
|
|
|
107,511 |
|
Other assets |
|
|
14,330 |
|
|
|
14,763 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
536,407 |
|
|
$ |
535,895 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Current portion of notes payable and long-term debt |
|
$ |
16,955 |
|
|
$ |
6,043 |
|
Accounts payable |
|
|
9,161 |
|
|
|
10,549 |
|
Accrued promotional expenses |
|
|
15,442 |
|
|
|
17,579 |
|
Accrued taxes payable, net |
|
|
31,084 |
|
|
|
28,859 |
|
Settlement accruals |
|
|
14,130 |
|
|
|
28,200 |
|
Tobacco quota buyout |
|
|
9,975 |
|
|
|
|
|
Deferred income taxes |
|
|
3,731 |
|
|
|
4,175 |
|
Accrued interest |
|
|
3,643 |
|
|
|
4,931 |
|
Other accrued liabilities |
|
|
18,555 |
|
|
|
19,499 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
122,676 |
|
|
|
119,835 |
|
|
|
|
|
|
|
|
|
|
Notes payable, long-term debt and other obligations, less current portion |
|
|
237,772 |
|
|
|
254,603 |
|
Fair value of derivatives embedded within convertible debt |
|
|
40,194 |
|
|
|
25,686 |
|
Noncurrent employee benefits |
|
|
17,760 |
|
|
|
15,727 |
|
Deferred income taxes |
|
|
150,332 |
|
|
|
146,284 |
|
Other liabilities |
|
|
5,328 |
|
|
|
5,134 |
|
Minority interests |
|
|
58,590 |
|
|
|
53,429 |
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity (deficit): |
|
|
|
|
|
|
|
|
Preferred stock, par value $1.00 per share, authorized 10,000,000 shares |
|
|
|
|
|
|
|
|
Common stock, par value $0.10 per share, authorized 100,000,000
shares, issued 48,160,679 and 45,163,386 shares and outstanding
44,592,890 and 41,773,591 shares |
|
|
4,459 |
|
|
|
4,177 |
|
Additional paid-in capital |
|
|
30,029 |
|
|
|
61,468 |
|
Unearned compensation |
|
|
(10,100 |
) |
|
|
(656 |
) |
Deficit |
|
|
(93,175 |
) |
|
|
(123,231 |
) |
Accumulated other comprehensive loss |
|
|
(11,138 |
) |
|
|
(10,409 |
) |
Less: 3,567,789 and 3,389,795 shares of common stock in treasury, at cost |
|
|
(16,320 |
) |
|
|
(16,152 |
) |
|
|
|
|
|
|
|
Total stockholders equity (deficit) |
|
|
(96,245 |
) |
|
|
(84,803 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity (deficit) |
|
$ |
536,407 |
|
|
$ |
535,895 |
|
|
|
|
|
|
|
|
The accompanying notes are an integral part
of the consolidated financial statements.
- 2 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Amounts)
Unaudited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Revenues* |
|
$ |
124,965 |
|
|
$ |
124,251 |
|
|
$ |
342,251 |
|
|
$ |
370,869 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of goods sold (including inventory impairment of $0, $0,
$0 and $37,000)* |
|
|
77,880 |
|
|
|
71,117 |
|
|
|
202,780 |
|
|
|
252,045 |
|
Operating, selling, administrative and general expenses |
|
|
27,109 |
|
|
|
31,887 |
|
|
|
76,485 |
|
|
|
107,623 |
|
Restructuring and impairment charges |
|
|
|
|
|
|
4,532 |
|
|
|
|
|
|
|
7,544 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
19,976 |
|
|
|
16,715 |
|
|
|
62,986 |
|
|
|
3,657 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expenses): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and dividend income |
|
|
1,380 |
|
|
|
322 |
|
|
|
3,260 |
|
|
|
1,548 |
|
Interest expense |
|
|
(8,266 |
) |
|
|
(6,378 |
) |
|
|
(24,155 |
) |
|
|
(18,650 |
) |
Gain on sale of investments, net |
|
|
8 |
|
|
|
302 |
|
|
|
1,433 |
|
|
|
5,888 |
|
Gain from conversion of LTS notes |
|
|
|
|
|
|
|
|
|
|
9,461 |
|
|
|
|
|
Equity loss on operations of LTS |
|
|
|
|
|
|
|
|
|
|
(299 |
) |
|
|
|
|
Equity income from non-consolidated New Valley real
estate businesses |
|
|
4,184 |
|
|
|
4,539 |
|
|
|
6,202 |
|
|
|
9,827 |
|
Other, net |
|
|
13 |
|
|
|
(1 |
) |
|
|
69 |
|
|
|
(10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations before income taxes
and minority interests |
|
|
17,295 |
|
|
|
15,499 |
|
|
|
58,957 |
|
|
|
2,260 |
|
Income tax expense |
|
|
7,541 |
|
|
|
6,708 |
|
|
|
29,322 |
|
|
|
3,562 |
|
Minority interests |
|
|
(779 |
) |
|
|
(837 |
) |
|
|
(2,403 |
) |
|
|
(3,286 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations |
|
|
8,975 |
|
|
|
7,954 |
|
|
|
27,232 |
|
|
|
(4,588 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discontinued operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from discontinued operations, net of minority
interests and taxes |
|
|
|
|
|
|
112 |
|
|
|
82 |
|
|
|
379 |
|
Gain on disposal of discontinued operations, net of
minority interests and taxes |
|
|
|
|
|
|
|
|
|
|
2,952 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain from discontinued operations |
|
|
|
|
|
|
112 |
|
|
|
3,034 |
|
|
|
379 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
8,975 |
|
|
$ |
8,066 |
|
|
$ |
30,266 |
|
|
$ |
(4,209 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per basic common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations |
|
$ |
0.20 |
|
|
$ |
0.18 |
|
|
$ |
0.62 |
|
|
$ |
(0.11 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from discontinued operations |
|
$ |
|
|
|
$ |
|
|
|
$ |
0.07 |
|
|
$ |
0.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) applicable to common shares |
|
$ |
0.20 |
|
|
$ |
0.18 |
|
|
$ |
0.69 |
|
|
$ |
(0.10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per diluted common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations |
|
$ |
0.19 |
|
|
$ |
0.17 |
|
|
$ |
0.59 |
|
|
$ |
(0.11 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from discontinued operations |
|
$ |
|
|
|
$ |
|
|
|
$ |
0.07 |
|
|
$ |
0.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) applicable to common shares |
|
$ |
0.19 |
|
|
$ |
0.17 |
|
|
$ |
0.66 |
|
|
$ |
(0.10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash distributions declared per share |
|
$ |
0.38 |
|
|
$ |
0.36 |
|
|
$ |
1.14 |
|
|
$ |
1.08 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Revenues and Cost of goods sold include excise taxes of $42,413, $42,626, $112,856 and
$132,729, respectively. |
The accompanying notes are an integral part
of the consolidated financial statements.
- 3 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
|
|
|
|
Common Stock |
|
|
Paid-In |
|
|
Unearned |
|
|
|
|
|
|
Treasury |
|
|
Comprehensive |
|
|
|
|
|
|
Shares |
|
|
Amount |
|
|
Capital |
|
|
Compensation |
|
|
Deficit |
|
|
Stock |
|
|
Loss |
|
|
Total |
|
Balance, December 31, 2004 |
|
|
41,773,591 |
|
|
$ |
4,177 |
|
|
$ |
61,468 |
|
|
$ |
(656 |
) |
|
$ |
(123,231 |
) |
|
$ |
(16,152 |
) |
|
$ |
(10,409 |
) |
|
$ |
(84,803 |
) |
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30,266 |
|
|
|
|
|
|
|
|
|
|
|
30,266 |
|
Foreign currency adjustments, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(543 |
) |
|
|
(543 |
) |
Unrealized loss on investment securities, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(186 |
) |
|
|
(186 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(729 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
29,537 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions on common stock |
|
|
|
|
|
|
|
|
|
|
(53,312 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(53,312 |
) |
Effect of stock dividend |
|
|
2,099,452 |
|
|
|
210 |
|
|
|
|
|
|
|
|
|
|
|
(210 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Impact of restricted stock grant |
|
|
500,000 |
|
|
|
50 |
|
|
|
9,634 |
|
|
|
(9,634 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
50 |
|
Exercise of options |
|
|
219,847 |
|
|
|
22 |
|
|
|
2,924 |
|
|
|
|
|
|
|
|
|
|
|
(168 |
) |
|
|
|
|
|
|
2,778 |
|
Effect of New Valley restricted stock transactions, net |
|
|
|
|
|
|
|
|
|
|
596 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
596 |
|
Amortization of deferred compensation, net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
190 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
190 |
|
Tax benefit of options exercised |
|
|
|
|
|
|
|
|
|
|
330 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
330 |
|
Beneficial conversion feature of notes payable |
|
|
|
|
|
|
|
|
|
|
8,450 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,450 |
|
Other |
|
|
|
|
|
|
|
|
|
|
(61 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(61 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2005 |
|
|
44,592,890 |
|
|
$ |
4,459 |
|
|
$ |
30,029 |
|
|
$ |
(10,100 |
) |
|
$ |
(93,175 |
) |
|
$ |
(16,320 |
) |
|
$ |
(11,138 |
) |
|
$ |
(96,245 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part
of the consolidated financial statements.
- 4 -
VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands, Except Per Share Amounts)
Unaudited
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
|
2005 |
|
|
2004 |
|
Net cash provided by (used in) operating activities: |
|
$ |
27,401 |
|
|
$ |
(6,194 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
Proceeds from sales of assets, net |
|
|
|
|
|
|
25,821 |
|
Sale or maturity of investment securities |
|
|
3,268 |
|
|
|
65,454 |
|
Purchase of investment securities |
|
|
(500 |
) |
|
|
(10,747 |
) |
Sale of long-term investments |
|
|
|
|
|
|
243 |
|
Purchase of long-term investments |
|
|
(128 |
) |
|
|
|
|
Investments in non-consolidated real estate businesses |
|
|
(6,250 |
) |
|
|
(2,500 |
) |
Distributions
from non-consolidated real estate businesses |
|
|
5,500 |
|
|
|
|
|
(Increase) decrease in restricted assets |
|
|
(842 |
) |
|
|
1,832 |
|
New Valley repurchase of common shares |
|
|
|
|
|
|
(202 |
) |
Issuance of
LTS common stock |
|
|
(1,500 |
) |
|
|
|
|
Issuance of
LTS notes |
|
|
(1,750 |
) |
|
|
|
|
Capital expenditures |
|
|
(5,164 |
) |
|
|
(3,005 |
) |
|
|
|
|
|
|
|
Net cash (used in) provided by investing activities |
|
|
(7,366 |
) |
|
|
76,896 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
Proceeds from debt |
|
|
44,959 |
|
|
|
|
|
Repayments of debt |
|
|
(3,542 |
) |
|
|
(20,246 |
) |
Borrowings under revolver |
|
|
328,086 |
|
|
|
411,150 |
|
Repayments on revolver |
|
|
(319,359 |
) |
|
|
(395,660 |
) |
Distributions on common stock |
|
|
(50,326 |
) |
|
|
(47,397 |
) |
Issuance of
restricted stock |
|
|
63 |
|
|
|
|
|
Proceeds from exercise of options |
|
|
2,778 |
|
|
|
2,868 |
|
Issuance of note receivable |
|
|
|
|
|
|
(500 |
) |
Deferred financing charges |
|
|
(2,168 |
) |
|
|
(208 |
) |
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
491 |
|
|
|
(49,993 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by discontinued operations |
|
|
28,434 |
|
|
|
1,983 |
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents |
|
|
48,960 |
|
|
|
22,692 |
|
Cash and cash equivalents, beginning of period |
|
|
110,004 |
|
|
|
74,808 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period |
|
$ |
158,964 |
|
|
$ |
97,500 |
|
|
|
|
|
|
|
|
The accompanying notes are an integral part
of the consolidated financial statements.
- 5 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts)
(Unaudited)
1. |
|
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
|
(a) |
|
Basis of Presentation: |
The consolidated financial statements of Vector Group Ltd. (the Company or Vector)
include the accounts of VGR Holding Inc. (VGR Holding), Liggett Group Inc. (Liggett),
Vector Tobacco Inc. (Vector Tobacco), Liggett Vector Brands Inc. (Liggett Vector
Brands), New Valley Corporation (New Valley) and other less significant subsidiaries.
The Company owned 57.7% of the common shares of New Valley at September 30, 2005. (See
Note 11.) All significant intercompany balances and transactions have been eliminated.
Liggett is engaged in the manufacture and sale of cigarettes in the United States. Vector
Tobacco is engaged in the development and marketing of low nicotine and nicotine-free
cigarette products and the development of reduced risk cigarette products. New Valley is
currently engaged in the real estate business and is seeking to acquire additional
operating companies and real estate properties.
The interim consolidated financial statements of the Company are unaudited and, in the
opinion of management, reflect all adjustments necessary (which are normal and recurring)
to state fairly the Companys consolidated financial position, results of operations and
cash flows. These consolidated financial statements should be read in conjunction with
the consolidated financial statements and the notes thereto included in the Companys
Annual Report on Form 10-K, as amended, for the year ended December 31, 2004, as filed with the Securities and Exchange Commission. The consolidated
results of operations for interim periods should not be regarded as necessarily indicative
of the results that may be expected for the entire year.
Certain
amounts in the 2004 consolidated financial statements have been
reclassified to conform to the current years presentation,
including reflecting stock dividends at par value when paid in a
deficit position in common stock rather than at fair value in
additional paid-in capital. Accordingly, the Company decreased its
December 31, 2004 additional paid-in capital by $180,307 to
$61,468 from $241,775 and decreased the deficit in like amount.
The Company decreased its December 31, 2003 additional paid-in
capital by $150,838 to $100,401 from $251,239 and decreased the
deficit in like amount. The Company decreased its December 2002
additional paid-in capital by $122,753 from $279,305 to $156,552 and
decreased the deficit in like amount. These
changes in classification do not affect assets, liabilities or
stockholders equity.
|
(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, embedded derivative liability, the tobacco quota buy-out, settlement
accruals and litigation and defense costs. Actual results could differ from those
estimates.
Information concerning the Companys common stock has been adjusted to give effect to the
5% stock dividends paid to Company stockholders on September 29, 2004 and September 29,
2005. In connection with the 5% stock dividends, the Company increased
- 6 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
the number of outstanding stock options by 5% and reduced the exercise prices accordingly.
All share amounts have been presented as if the stock dividends had occurred on January
1, 2004.
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 and restricted stock grants. Basic and diluted EPS were
calculated using the following shares for the three and nine months ended September 30,
2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Weighted-average shares for
basic EPS |
|
|
44,095,747 |
|
|
|
43,752,583 |
|
|
|
43,989,435 |
|
|
|
43,352,166 |
|
Plus incremental shares
related to stock options |
|
|
2,429,573 |
|
|
|
1,720,179 |
|
|
|
2,118,392 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares for
diluted EPS |
|
|
46,525,320 |
|
|
|
45,472,762 |
|
|
|
46,107,827 |
|
|
|
43,352,166 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company had a net loss for the nine months ended September 30, 2004. Therefore, the
effect of the common stock equivalents and convertible securities was excluded from the
computation of diluted net loss per share since the effect is antidilutive. Potentially
dilutive shares that were not included in the diluted loss per share calculations were
1,933,239 for the nine months ended September 30, 2004 which shares were issuable upon the
exercise of stock options or conversion of debt, assuming the treasury stock method.
|
(d) |
|
Comprehensive Income (Loss): |
Other comprehensive income (loss) is a component of stockholders equity (deficit) and
includes such items as the unrealized gains and losses on investment securities available
for sale, forward foreign contracts and minimum pension liability adjustments. Total
comprehensive income was $29,426 for the nine months ended September 30, 2005 and total
comprehensive loss was $5,665 for the nine months ended September 30, 2004.
|
(e) |
|
Financial Instruments: |
The Company uses forward foreign exchange contracts to mitigate its exposure to changes in
exchange rates relating to purchases of equipment from third parties. The primary
currency to which the Company is exposed is the euro. A substantial portion of the
Companys foreign exchange contracts is effective as hedges. The fair value of forward
foreign exchange contracts designated as hedges is reported in other current assets or
current liabilities and is recorded in other comprehensive income. The fair value of the
hedge at September 30, 2005 was a liability of approximately $775. The Company did not
have any open forward foreign exchange contracts at December 31, 2004.
- 7 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
|
(f) |
|
Change in Stock Ownership of Subsidiary: |
The Company recognizes changes in its ownership percentage in a subsidiary caused by
issuances of a subsidiarys stock as an adjustment to additional paid-in capital and
unearned compensation. During the nine month period ended September 30, 2005, the Company
recorded a net decrease to its stockholders equity of $596, net of taxes, in
connection with the decrease in the Companys ownership of New Valley from 58.2% to 57.7%.
|
(g) |
|
New Accounting Pronouncements: |
In 2004, the Financial Accounting Standards Board (the FASB) issued SFAS No. 123
(revised 2004), Share-Based Payment (SFAS No. 123R). SFAS No. 123R requires companies
to measure compensation cost for share-based payments at fair value. The Company will
adopt this new standard prospectively, on January 1, 2006, and has not yet determined
whether the adoption of SFAS No. 123R will have a material impact on its consolidated
financial position, results of operations or cash flows.
In 2004, the FASB issued SFAS No. 151, Inventory Costs. SFAS No. 151 requires that
abnormal idle facility expense and spoilage, freight and handling costs be recognized as
current-period charges. In addition, SFAS No. 151 requires that allocation of fixed
production overhead costs to inventories be based on the normal capacity of the production
facility. The Company is required to adopt the provisions of SFAS No. 151 prospectively
after January 1, 2006, but the effect of adoption is not expected to have a material
impact on its consolidated financial position, results of operations or cash flows.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections a
replacement of APB Opinion No. 20 and FASB Statement No. 3 (SFAS No. 154). SFAS No.
154 changes the requirements for the accounting for and reporting of a change in
accounting principle. The provisions of SFAS No. 154 require, unless impracticable,
retrospective application to prior periods financial statements of (1) all voluntary
changes in accounting principles and (2) changes required by a new accounting
pronouncement, if a specific transition is not provided. SFAS No. 154 also requires that
a change in depreciation, amortization, or depletion method for long-lived, non-financial
assets be accounted for as a change in accounting estimate, which requires prospective
application of the new method. SFAS No. 154 is effective for all accounting changes made
in fiscal years beginning after December 15, 2005. The application of SFAS No. 154 is not
expected to have a material impact on the Companys consolidated financial position,
results of operations or cash flows.
In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset
Retirement Obligations an Interpretation of SFAS Statement No. 143 (FIN 47). FIN 47
clarifies the timing of liability recognition for legal obligations associated with the
retirement of a tangible long-lived asset when the timing and/or method of settlement are
conditional on a future event. FIN 47 is effective for fiscal years
ending after December 15, 2005. The application of FIN 47 is not expected to have a material impact on
the Companys consolidated financial position, results of operations or cash flows.
- 8 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
In September 2005, the FASBs Emerging Issues Task Force (EITF) reached a consensus on
Issue No. 04-13, Inventory Exchanges. EITF No. 04-13 required two or more inventory
transactions with the same party to be considered a single nonmonetary transaction subject
to APB Opinion No. 29, Accounting for Nonmonetary Transactions, if the transactions were
entered into in contemplation of one another. EITF No. 04-13 is effective for the Company
for new arrangements entered into after April 2, 2006. The Company does not expect the
adoption of EITF No. 04-13 to have a material impact on its financial position, results of
operations or cash flows.
In September 2005, the EITF reached a consensus on Issue 05-8, Income Tax Effects of
Issuing Convertible Debt with a Beneficial Conversion Feature. The issuance of
convertible debt with a beneficial conversion feature creates a temporary difference on
which deferred taxes should be provided. The consensus is required to be applied in
fiscal periods beginning after December 15, 2005, by retroactive restatement of prior
financial statements back to the issuance of the convertible debt. The requirement to
restate applies even if the convertible debt has been repaid or converted and no longer
exists. The Company has not completed its assessment of the impact of this issue.
Liggett Vector Brands Restructurings. During April 2004, Liggett Vector Brands adopted a
restructuring plan in its continuing effort to adjust the cost structure of the Companys
tobacco business and improve operating efficiency. As part of the plan, Liggett Vector Brands
eliminated 83 positions and consolidated operations, subletting its New York office space and
relocating several employees. As a result of these actions, the Company recognized pre-tax
restructuring charges of $2,791 in the first half of 2004, including $824 relating to employee
severance and benefit costs and $1,967 for contract termination and other associated costs.
Approximately $518 of these charges represent non-cash items. A
reduction in contract termination and exit costs of $71
related to the above restructuring was recognized in the third quarter of 2004.
On October 6, 2004, the Company announced an additional plan to further restructure the
operations of Liggett Vector Brands, its sales, marketing and distribution agent for its
Liggett and Vector Tobacco subsidiaries. Liggett Vector Brands has realigned its sales force
and adjusted its business model to more efficiently serve its chain and independent accounts
nationwide. Liggett Vector Brands is seeking to expand the portfolio of private and control
label partner brands by utilizing a pricing strategy that offers long-term list price stability
for customers. In connection with the restructuring, the Company eliminated approximately 330
full-time positions and 135 part-time positions as of December 15, 2004.
The Company recognized pre-tax restructuring charges of $10,583 in 2004, with approximately
$5,659 of the charges related to employee severance and benefit costs and approximately $4,924
to contract termination and other associated costs. Approximately $2,503 of these charges
represented non-cash items. Approximately $4,428 was recognized in
the third quarter of 2004. Additionally, the Company incurred other charges in 2004 for
various compensation and related payments to employees which are related to the restructuring.
These charges of $1,670 were included in selling, general and administrative expenses.
- 9 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
The components of the combined pre-tax restructuring charges relating to the 2004 Liggett
Vector Brands restructurings for the nine months ended September 30, 2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee |
|
|
Non-Cash |
|
|
Contract |
|
|
|
|
|
|
Severance |
|
|
Asset |
|
|
Termination/ |
|
|
|
|
|
|
and Benefits |
|
|
Impairment |
|
|
Exit Costs |
|
|
Total |
|
Balance, December 31, 2004 |
|
$ |
3,614 |
|
|
$ |
186 |
|
|
$ |
3,285 |
|
|
$ |
7,085 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Utilized |
|
|
(2,561 |
) |
|
|
(113 |
) |
|
|
(1,682 |
) |
|
|
(4,356 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2005 |
|
$ |
1,053 |
|
|
$ |
73 |
|
|
$ |
1,603 |
|
|
$ |
2,729 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Timberlake Restructuring. In October 2003, the Company announced that it would close
Vector Tobaccos 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
Tobaccos other cigarette brands, was moved to Liggetts state-of-the-art manufacturing
facility in Mebane, North Carolina. As a result of these actions, the Company recognized
restructuring and impairment charges of $21,696, of which $21,300 was recognized in 2003.
Charges of $221 and $175 were taken in the first and third quarters of 2004, respectively.
The components of the pre-tax restructuring charge relating to the closing of Vector Tobaccos
Timberlake, North Carolina cigarette manufacturing facility for the nine months ended September
30, 2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee |
|
|
Contract |
|
|
|
|
|
|
Severance |
|
|
Termination/ |
|
|
|
|
|
|
and Benefits |
|
|
Exit Costs |
|
|
Total |
|
Balance, December 31, 2004 |
|
$ |
467 |
|
|
$ |
52 |
|
|
$ |
519 |
|
Change in estimate |
|
|
(22 |
) |
|
|
22 |
|
|
|
|
|
Utilized |
|
|
(227 |
) |
|
|
(74 |
) |
|
|
(301 |
) |
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2005 |
|
$ |
218 |
|
|
$ |
|
|
|
$ |
218 |
|
|
|
|
|
|
|
|
|
|
|
- 10 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
Inventories consist of:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2005 |
|
|
2004 |
|
Leaf tobacco |
|
$ |
34,685 |
|
|
$ |
35,416 |
|
Other raw materials |
|
|
2,989 |
|
|
|
3,400 |
|
Work-in-process |
|
|
1,976 |
|
|
|
1,610 |
|
Finished goods |
|
|
40,995 |
|
|
|
42,003 |
|
|
|
|
|
|
|
|
Inventories at current cost |
|
|
80,645 |
|
|
|
82,429 |
|
LIFO adjustments |
|
|
(4,043 |
) |
|
|
(3,488 |
) |
|
|
|
|
|
|
|
|
|
$ |
76,602 |
|
|
$ |
78,941 |
|
|
|
|
|
|
|
|
The Company has a leaf inventory management program whereby, among other things, it is
committed to purchase certain quantities of leaf tobacco. The purchase commitments are for
quantities not in excess of anticipated requirements and are at prices, including carrying
costs, established at the date of the commitment. At September 30, 2005, Liggett had leaf
tobacco purchase commitments of approximately $5,125. There were no leaf tobacco purchase
commitments at Vector Tobacco at that date.
Included in the above table was approximately $1,309 at September 30, 2005 and $1,595 at
December 31, 2004 of leaf inventory associated with Vector Tobaccos QUEST product. During the
second quarter of 2004, based on an analysis of the market data obtained since the introduction
of the QUEST product, the Company determined to postpone indefinitely the national launch of
QUEST and, accordingly, the Company recognized a non-cash charge of $37,000 to adjust the
carrying value of excess leaf tobacco inventory for the QUEST product, based on estimated
future demand and market conditions.
LIFO
inventories represent approximately 93% and 85% of total inventories at September 30, 2005 and December 31, 2004, respectively.
- 11 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2005 |
|
|
2004 |
|
Land and improvements |
|
$ |
1,418 |
|
|
$ |
1,418 |
|
Buildings |
|
|
13,792 |
|
|
|
13,431 |
|
Machinery and equipment |
|
|
97,343 |
|
|
|
93,700 |
|
Leasehold improvements |
|
|
2,432 |
|
|
|
3,045 |
|
Construction-in-progress |
|
|
2,607 |
|
|
|
3,240 |
|
|
|
|
|
|
|
|
|
|
|
117,592 |
|
|
|
114,834 |
|
Less accumulated depreciation |
|
|
(54,977 |
) |
|
|
(49,477 |
) |
|
|
|
|
|
|
|
|
|
$ |
62,615 |
|
|
$ |
65,357 |
|
|
|
|
|
|
|
|
Depreciation and amortization expense for the three and nine months ended September 30, 2005
was $2,737 and $8,281, respectively. Depreciation and amortization expense for the three and
nine months ended September 30, 2004 was $2,877 and $9,287, respectively. Future machinery and
equipment purchase commitments at Liggett were $9,463 at September 30, 2005.
In February 2005, New Valley completed the sale of its two office buildings in Princeton, New
Jersey for $71,500. (Refer to Notes 5 and 12). The buildings were classified as assets held
for sale on the balance sheet at December 31, 2004.
In July 2003, Liggett granted an unaffiliated third party an option to purchase Liggetts
former manufacturing facility and other excess real estate in Durham, North Carolina with a net
book value at September 30, 2005 of approximately $2,212. The option agreement, as amended in
October 2005, permits the purchaser to acquire the property during the period expiring December
15, 2005, at a purchase price of $15,450. At September 30, 2005, Liggett had received
non-refundable option fees of $1,625 (increased to $1,775 after the October 2005 amendment to
the agreement), creditable against the purchase price, which are recorded as deferred income in
other accrued liabilities. The purchaser has the right on or prior to December 9, 2005 to
further extend the closing date to January 31, 2006, in which event the purchase price will be
increased to $15,700 and the purchasers notice of extension must be accompanied by an
additional option payment of $250. The purchaser is currently seeking to complete the
financing for the transaction, and there can be no assurance the sale of the property will
occur.
During
the nine months ended September 30, 2005, the Company assumed
$266 of equipment in connection with capital lease obligations.
- 12 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
5. |
|
NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS |
Notes payable, long-term debt and other obligations consist of:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2005 |
|
|
2004 |
|
Vector: |
|
|
|
|
|
|
|
|
5% Variable Interest Senior Convertible Notes due 2011,
net of unamortized discount and premium of $55,375
and $38,259* |
|
$ |
56,489 |
|
|
$ |
28,646 |
|
6.25% Convertible Subordinated Notes due 2008 |
|
|
132,492 |
|
|
|
132,492 |
|
|
|
|
|
|
|
|
|
|
Liggett: |
|
|
|
|
|
|
|
|
Revolving credit facility |
|
|
9,092 |
|
|
|
17 |
|
Term loan under credit facility |
|
|
3,714 |
|
|
|
4,411 |
|
Equipment loans |
|
|
4,111 |
|
|
|
6,341 |
|
|
|
|
|
|
|
|
|
|
Vector Tobacco: |
|
|
|
|
|
|
|
|
Notes payable Medallion acquisition |
|
|
35,000 |
|
|
|
35,000 |
|
|
|
|
|
|
|
|
|
|
V.T. Aviation: |
|
|
|
|
|
|
|
|
Note payable |
|
|
8,637 |
|
|
|
9,436 |
|
|
|
|
|
|
|
|
|
|
VGR Aviation: |
|
|
|
|
|
|
|
|
Note payable |
|
|
4,926 |
|
|
|
5,090 |
|
|
|
|
|
|
|
|
|
|
New Valley: |
|
|
|
|
|
|
|
|
Note payable operating real estate |
|
|
|
|
|
|
39,213 |
|
|
|
|
|
|
|
|
|
|
Other |
|
|
266 |
|
|
|
|
|
|
|
|
|
|
|
|
Total notes payable, long-term debt and other obligations |
|
|
254,727 |
|
|
|
260,646 |
|
Less: |
|
|
|
|
|
|
|
|
Current maturities |
|
|
(16,955 |
) |
|
|
(6,043 |
) |
|
|
|
|
|
|
|
Amount due after one year |
|
$ |
237,772 |
|
|
$ |
254,603 |
|
|
|
|
|
|
|
|
|
|
|
* |
|
The fair value of the derivatives embedded within these notes ($40,194 at
September 30, 2005 and $25,686 at December 31, 2004) is separately
classified as a derivatives liability in the consolidated balance sheet and the
beneficial conversion feature ($22,075 at September 30, 2005 and $13,625 at
December 31, 2004) is recorded as additional paid-in capital. |
5% Variable Interest Senior Convertible Notes Due November 2011 Vector:
In November 2004, the Company sold $65,500 of its 5% variable interest senior convertible notes
due November 15, 2011 in a private offering to qualified institutional investors in accordance
with Rule 144A under the Securities Act of 1933. The buyers of the notes had the right, for a
120-day period ending March 18, 2005, to purchase up to an additional $16,375 of the notes. At
December 31, 2004, buyers had exercised their rights to purchase an additional $1,405 of the
notes, and the remaining $14,959 principal amount of notes were purchased during the first
quarter of 2005. In April 2005, Vector issued an additional $30,000 principal amount of 5%
variable interest senior convertible notes due November 15, 2011 in a separate private offering
to qualified institutional investors in accordance with Rule 144A. These notes, which were
issued under a new indenture at a net price of 103.5%, were on the same terms as
- 13 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
the $81,864 principal amount of notes previously issued in connection with the November 2004
placement.
The notes pay interest on a quarterly basis at a rate of 5% per year with an additional amount
of interest payable on the notes on each interest payment date. This additional amount is based
on the amount of cash dividends actually paid by the Company per share on its common stock
during the prior three-month period ending on the record date for such interest payment
multiplied by the number of shares of its common stock into which the notes are convertible on
such record date (together, the Total Interest). Notwithstanding the foregoing, however,
during the period prior to November 15, 2006, the interest payable on each interest payment
date will be the higher of (i) the Total Interest and (ii) 6 3/4% per year. The notes are
convertible into the Companys common stock, at the holders option. The conversion price,
which was $18.48 at September 30, 2005, is subject to adjustment for various events, including
the issuance of stock dividends.
The notes will mature on November 15, 2011. The Company must redeem 12.5% of the total
aggregate principal amount of the notes outstanding on November 15, 2009. In addition to such
redemption amount, the Company will also redeem on November 15, 2009 and on each interest
accrual period thereafter an additional amount, if any, of the notes necessary to prevent the
notes from being treated as an Applicable High Yield Discount Obligation under the Internal
Revenue Code. The holders of the notes will have the option on November 15, 2009 to require the
Company to repurchase some or all of their remaining notes. The redemption price for such
redemptions will equal 100% of the principal amount of the notes plus accrued interest. If a
fundamental change occurs, the Company will be required to offer to repurchase the notes at
100% of their principal amount, plus accrued interest and, under certain circumstances, a
make-whole premium.
In connection with the November 2004 placement, in order to facilitate hedging transactions by
the purchasers of the notes, the purchasers required the principal stockholder and Chairman of
the Company to enter into an agreement granting the placement agent for the offering the right,
in its sole discretion, to borrow up to 3,646,518 shares of common stock from the principal
stockholder or an entity affiliated with him during a 30-month period, subject to extension
under various conditions, and that he agree not to dispose of such shares during this period,
subject to limited exceptions. In consideration for the principal stockholder agreeing to lend
his shares in order to facilitate the Companys 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 in cash or, by mutual agreement of the Company and the principal stockholder,
shares of common stock, equal to 1% of the aggregate market value of 3,646,518 shares of common
stock. In addition, the Company agreed to hold the principal stockholder harmless on an
after-tax basis against any increase, if any, in the income tax rate applicable to dividends
paid on the shares as a result of the share loan agreement. The principal stockholder has the
right to assign to the President of the Company some or all of his obligation to lend the
shares under such agreement. In connection with the April 2005 placement, the Company entered
into a similar arrangement through May 2007 with one of the Companys principal stockholders,
who is the President of the Company, with respect to 315,000 shares of common stock.
Embedded Derivatives. The portion of the Total Interest on the notes which is computed by
reference to the cash dividends paid on the Companys common stock is considered an embedded
derivative. Pursuant to SFAS No. 133, Accounting for Derivative Instruments and
- 14 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments
and Certain Hedging Activities, the Company has bifurcated this dividend portion of the
interest on the notes and, based on a valuation by an independent third party, estimated the
fair value of the embedded derivative liability. At issuance of the November 2004 notes, the
estimated initial fair value was $24,738, which was recorded as a discount to the notes and
classified as a derivative liability on the consolidated balance sheet. At December 31, 2004,
with the issuance of $1,405 of additional notes, the derivative liability was estimated at
$25,686. At September 30, 2005, with the issuance of $14,959 of additional notes in connection
with the November 2004 placement and the issuance of $30,000 of additional notes in April 2005,
the derivative liability was estimated at $40,194. Changes to the fair value of this embedded
derivative are reflected quarterly as an adjustment to interest expense. The Company recognized
a gain of $1,131 in the third quarter of 2005 and a gain of $2,258 for the nine months ended
September 30, 2005, due to changes in the fair value of the embedded derivative, which was
reported as an adjustment to interest expense.
Beneficial Conversion Feature. After giving effect to the recording of the embedded derivative
liability as a discount to the notes, the Companys common stock had a fair value at the
issuance date of the notes in excess of the conversion price resulting in a beneficial
conversion feature. Emerging Issues Task Force (EITF) No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable Convertible Ratios,
requires that the intrinsic value of the beneficial conversion
feature ($22,075 at September
30, 2005) be recorded to additional paid-in capital and as a discount on the notes. The
discount is then amortized to interest expense over the term of the notes using the effective
interest rate method. The Company recognized non-cash interest expense of $731 in the third
quarter of 2005 and $2,089 for the nine months ended September 30, 2005 due to the amortization
of the debt discount attributable to the beneficial conversion feature.
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 Vectors common stock,
at the option of the holder. The conversion price, which was $22.12
per share at September 30, 2005, is subject to adjustment for various events, and any cash distribution on
Vectors common stock will result in a corresponding decrease in the conversion price. In
December 2001, $40,000 of the notes were converted into Vectors common stock and, in October
2004, an additional $8 of the notes were converted. A total $132,492 of the notes were
outstanding at September 30, 2005.
Vector may redeem the notes, in whole or in part, at a price of 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.
- 15 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
Revolving Credit Facility Liggett:
Liggett has a $50,000 credit facility with Wachovia Bank, N.A. (Wachovia). A total of $9,092
was outstanding under the facility at September 30, 2005. Availability as determined under the
facility was approximately $21,864 based on eligible collateral at September 30, 2005. The
facility is collateralized by all inventories and receivables of Liggett and a mortgage on its
manufacturing facility. Borrowings under the facility bear interest at a rate equal to 1.0%
above the prime rate of Wachovia. The facility requires Liggetts compliance with certain
financial and other covenants including a restriction on Liggetts ability to pay cash
dividends unless Liggetts borrowing availability under the facility for the 30-day period
prior to the payment of the dividend, and after giving effect to the dividend, is at least
$5,000 and no event of default has occurred under the agreement, including Liggetts compliance
with the covenants in the credit facility, including an adjusted net worth and working capital
requirement. In addition, the facility imposes requirements with respect to Liggetts adjusted
net worth (not to fall below $8,000 as computed in accordance with the agreement) and working
capital (not to fall below a deficit of $17,000 as computed in accordance with the agreement).
At September 30, 2005, Liggett was in compliance with all covenants under the credit facility;
Liggetts adjusted net worth was $64,554 and net working capital
was $43,771, as computed in
accordance with the agreement.
100 Maple LLC, a company formed by Liggett in 1999 to purchase its Mebane, North Carolina
manufacturing plant, has a term loan of $3,714 outstanding under Liggetts credit facility at
September 30, 2005. The remaining balance of the term loan is payable in monthly installments
of $77 with a final payment on June 1, 2006 of $3,099. Interest is charged at the same rate as
applicable to Liggetts credit facility, and the outstanding balance of the term loan reduces
the maximum availability under the credit facility. Liggett has guaranteed the term loan, and a
first mortgage on the Mebane property and manufacturing equipment collateralizes the term loan
and Liggetts credit facility.
Equipment Loans Liggett:
In March 2000, Liggett purchased equipment for $1,000 through the issuance of a note, payable
in 60 monthly installments of $21 with an effective annual interest rate of 10.14%. In April
2000, Liggett purchased equipment for $1,071 through the issuance of notes, payable in 60
monthly installments through April 2005 of $22 with an effective interest rate of 10.20%. The
notes were paid in full during the first half of 2005.
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. Interest is
calculated at LIBOR plus 2.8%.
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. Interest is calculated
at LIBOR plus 2.8%.
- 16 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
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%.
Each of these equipment loans is collateralized by the purchased equipment.
Notes for Medallion Acquisition Vector Tobacco:
The purchase price for the acquisition of Medallion included $60,000 in notes of Vector
Tobacco, guaranteed by the Company and Liggett. Of the notes, $25,000 have been repaid with
the final quarterly principal payment of $3,125 made on March 31, 2004. The remaining $35,000
of notes bear interest at 6.5% per year, payable semiannually, and mature on April 1, 2007.
Note Payable V.T. Aviation:
In February 2001, V.T. Aviation LLC, a subsidiary of Vector Research Ltd., purchased an
airplane for $15,500 and borrowed $13,175 to fund the purchase. The loan, which is
collateralized by the airplane and a letter of credit from the Company for $775, is guaranteed
by Vector Research, VGR Holding and the Company. The loan is payable in 119 monthly
installments of $125, including annual interest of 2.31% above the 30-day commercial paper
rate, with a final payment of $2,206 based on current interest rates.
Note Payable VGR Aviation:
In February 2002, V.T. Aviation purchased an airplane for $6,575 and borrowed $5,800 to fund
the purchase. The loan is guaranteed by the Company. The loan is payable in 119 monthly
installments of $40, including annual interest of 2.75% above the 30-day average commercial
paper rate, with a final payment of $3,479 based on current interest rates. During the fourth
quarter of 2003, this airplane was transferred to the Companys direct subsidiary, VGR Aviation
LLC, which 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 $40,500 mortgage loan. In February 2005, New Valley completed the
sale of the buildings, and the loan was retired at closing with the proceeds of the sale.
- 17 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
6. |
|
EMPLOYEE BENEFIT PLANS |
Net periodic benefit cost for the Companys pension and other postretirement benefit plans for
the three and nine months ended September 30, 2005 and 2004 consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits |
|
|
Pension Benefits |
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Service cost benefits earned
during the period |
|
$ |
1,321 |
|
|
$ |
1,248 |
|
|
$ |
3,963 |
|
|
$ |
3,744 |
|
Interest cost on projected benefit
obligation |
|
|
2,172 |
|
|
|
2,240 |
|
|
|
6,516 |
|
|
|
6,720 |
|
Expected return on plan assets |
|
|
(3,069 |
) |
|
|
(3,027 |
) |
|
|
(9,207 |
) |
|
|
(9,081 |
) |
Amortization of net loss |
|
|
468 |
|
|
|
506 |
|
|
|
1,404 |
|
|
|
1,518 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net expense |
|
$ |
892 |
|
|
$ |
967 |
|
|
$ |
2,676 |
|
|
$ |
2,901 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
Other |
|
|
|
Postretirement Benefits |
|
|
Postretirement Benefits |
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Service cost benefits earned
during the period |
|
$ |
7 |
|
|
$ |
8 |
|
|
$ |
21 |
|
|
$ |
24 |
|
Interest cost on projected benefit
obligation |
|
|
153 |
|
|
|
157 |
|
|
|
459 |
|
|
|
471 |
|
Expected return on plan assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of net loss |
|
|
11 |
|
|
|
5 |
|
|
|
33 |
|
|
|
15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net expense |
|
$ |
171 |
|
|
$ |
170 |
|
|
$ |
513 |
|
|
$ |
510 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company did not make contributions to its pension benefits plans for the three and nine
months ended September 30, 2005 and does not anticipate making any contributions to such plans
in the fourth quarter of 2005. The Company anticipates paying approximately $550 in other
postretirement benefits in 2005.
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. New cases continue to be commenced
against Liggett and the other cigarette manufacturers. 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
- 18 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
care cost recovery actions brought by various foreign and domestic governmental entities
(Governmental Actions); and (iv) health care cost recovery actions brought by third-party
payors including insurance companies, union health and welfare trust funds, asbestos
manufacturers and others (Third-Party Payor Actions). As new cases are commenced, the costs
associated with defending these cases and the risks relating to the inherent unpredictability
of litigation continue to increase. The future financial impact of the risks and expenses of
litigation and the effects of the tobacco litigation settlements discussed below are not
quantifiable at this time. For the nine months ended September 30, 2005, Liggett incurred
legal fees and other litigation costs totaling approximately $3,715 compared to $3,677 for the
nine months ended September 30, 2004.
Individual Actions. As of September 30, 2005, there were approximately 278 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, 106 were pending in Florida, 44 in Mississippi, 23 in Missouri, 27 in Maryland and 17
in New York. The balance of the individual cases were pending in 16 states. In one of these
cases, an action against cigarette manufacturers involving approximately 1,000 named
individual plaintiffs has been consolidated before a single West Virginia state court.
Liggett is a defendant in most of the cases pending in West Virginia. In January 2002, the
court severed Liggett from the trial of the consolidated action.
There are seven individual cases pending where Liggett is the only named defendant. In April
2004, in the Beverly Davis v. Liggett Group Inc. case, a Florida state court jury awarded
compensatory damages of $540 against Liggett. In addition, plaintiffs counsel was awarded
legal fees of $752. Liggett has appealed the verdict. In February 2005, in the Angel Martinez
v. Liggett Group Inc. case, a Florida state court jury returned a verdict in favor of Liggett.
In July 2005, the court denied the plaintiffs post-trial motion seeking a new trial. The
plaintiff may appeal. In March 2005, in the Ferlanti v. Liggett Group Inc. case, a Florida
state court granted Liggetts motion for summary judgment disposing of the case in its
entirety. The plaintiff has appealed.
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 Organizations 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.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
Jury awards in various states have been entered against other cigarette manufacturers. The
awards in these individual actions are for both compensatory and punitive damages and represent
a material amount of damages. Liggett is not a party to these actions. The following is a
brief description of various of these matters:
|
|
In February, 1999, in Henley v. Philip Morris, a California state court jury awarded
$1,500 in compensatory damages and $50,000 in punitive damages. The trial court reduced
the punitive damages award to $25,000. In September 2003, the California Court of Appeals
reduced the punitive damages award to $9,000 based on the United States Supreme Courts
2003 opinion in State Farm, limiting punitive damages. In September 2004, the California
Supreme Court upheld the $9,000 punitive damages award. In March 2005, the United States
Supreme Court denied review and the defendant has paid the amount of the judgment plus
accrued interest. |
|
|
|
In March 1999, an Oregon state court jury found in favor of the plaintiff in
Williams-Branch v. Philip Morris. The jury awarded $800 in compensatory damages and
$79,500 in punitive damages. The trial court reduced the punitive damages award to
$32,000. In June 2002, the Oregon Court of Appeals reinstated the $79,500 punitive
damages award. In October 2003, the United States Supreme Court set aside the Oregon
appellate courts ruling and directed the Oregon court to reconsider the case in light of
the State Farm decision. In June 2004, the Oregon appellate court reinstated the original
jury verdict. The Oregon Supreme Court agreed to review the case, and oral argument was
held in May 2005. |
|
|
|
In 2001, as a result of a Florida Supreme Court decision upholding the award, in Carter
v. Brown and Williamson Tobacco Corp., the defendant paid $1,100 in compensatory damages
and interest to a former smoker and his spouse for injuries they allegedly incurred as a
result of smoking. |
|
|
|
In June 2001, a California state court jury found in favor of the plaintiff in Boeken
v. Philip Morris and awarded $5,500 in compensatory damages and $3,000,000 in punitive
damages. In August 2001, the trial court reduced the punitive damages award to $100,000.
In September 2004, the California Court of Appeals affirmed the compensatory damages
award, but reduced the punitive damages award to $50,000. In April 2005, the California
Court of Appeals reaffirmed its decision. In August 2005, the California Supreme Court
declined further review of the case. The defendant is seeking review by the United States
Supreme Court. |
|
|
|
In December 2001, in Kenyon v. R.J. Reynolds Tobacco Co., a Florida state court jury
awarded the plaintiff $165 in compensatory damages, but no punitive damages. In May 2003,
the Florida Court of Appeals affirmed per curiam (that is, without an opinion) the trial
courts final judgment in favor of the plaintiffs. The defendant paid the amount of the
judgment plus accrued interest ($196) after exhausting all appeals. |
|
|
|
In February 2002, in Burton v. R.J. Reynolds Tobacco Co., et al, a federal district
court jury in Kansas awarded the plaintiff $198 in compensatory damages, and determined
that the plaintiff was entitled to punitive damages. In June 2002, the trial court
awarded the plaintiff $15,000 in punitive damages. In February 2005, the United States
Court of Appeals for the Tenth Circuit overturned the punitive damages award, |
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
while upholding the compensatory damages award. The defendant paid the compensatory
damages award in June 2005.
|
|
In March 2002, an Oregon state court jury found in favor of the plaintiff in Schwarz v.
Philip Morris and awarded $169 in compensatory damages and $150,000 in punitive damages.
In May 2002, the trial court reduced the punitive damages award to $100,000. The parties
have appealed to the Oregon Court of Appeals. |
|
|
|
In October 2002, a California state court jury found in favor of the plaintiff in
Bullock v. Philip Morris and awarded $850 in compensatory damages and $28,000,000 in
punitive damages. In December 2002, the trial court reduced the punitive damages award to
$28,000. The parties have appealed to the California Court of Appeals. |
|
|
|
In April 2003, in Eastman v. Brown & Williamson Tobacco Corp., et al, a Florida state
court jury awarded $6,540 in compensatory damages. In May 2004, the Florida Court of
Appeals affirmed the verdict in a per curiam opinion. The defendants motion for
rehearing was denied, and the judgment was paid in October 2004. |
|
|
|
In May 2003, in Boerner v. Brown & Williamson Tobacco Corp., a federal district court
jury in Arkansas awarded $4,000 in compensatory damages and $15,000 in punitive damages.
In January 2005, the United States Court of Appeals for the Eighth Circuit affirmed the
compensatory damages award, but reduced the punitive damages award to $5,000. The
judgment was paid in February 2005. |
|
|
|
In November 2003, in Thompson v. Brown & Williamson Tobacco Corp., et al., a Missouri
state court jury awarded $2,100 in compensatory damages. The defendants have appealed to
the Missouri Court of Appeals. |
|
|
|
In December 2003, in Frankson v. Brown & Williamson Tobacco Corp., et al., a New York
state court jury awarded $350 in compensatory damages. In January 2004, the jury awarded
$20,000 in punitive damages. The deceased smoker was found to be 50% at fault. In June
2004, the court increased the compensatory damages to $500 and decreased the punitive
damages to $5,000. The defendants have appealed to the New York Supreme Court, Appellate
Division. |
|
|
|
In October 2004, in Arnitz v. Philip Morris, a Florida state court jury awarded $600 in
damages but found that the plaintiff was 60% at fault, thereby reducing the verdict
against Philip Morris to $240. Philip Morris has appealed to the Florida Second District
Court of Appeals. |
|
|
|
In February 2005, in Smith v. Brown & Williamson Tobacco Corp., a Missouri state court
jury awarded $2,000 in compensatory damages and $20,000 in punitive damages. The
defendants have appealed to the Missouri Court of Appeals. |
|
|
|
In March 2005, in Rose v. Philip Morris, a New York state court jury awarded $3,400 in
compensatory damages and $17,100 in punitive damages. The defendants have appealed to the
New York Supreme Court, Appellate Division. |
- 21 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
In 2003, the Mississippi Supreme Court ruled that the Mississippi Product Liability Act
precludes all tobacco cases that are based on product liability. In a 2005 decision, the
Mississippi Supreme Court ruled that certain claims against cigarette manufacturers may remain
available to plaintiffs.
Class Actions. As of September 30, 2005, there were approximately 11 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 courts 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 Circuits ruling, a court in Louisiana
(Liggett is not a defendant in this proceeding) certified an addiction-as-injury class
action, in the Scott v. American Tobacco Co., Inc. case, that covered only citizens in the
state. In May 2004, the Scott jury returned a verdict in the amount of $591,000, plus
prejudgment interest, on the class claim for a smoking cessation program. The case is on
appeal. Two other class actions, Broin, et al., v. Philip Morris Companies Inc., et al., and
Engle, et al., v. R.J. Reynolds Tobacco Company, et al., were certified in state court in
Florida prior to the Fifth Circuits decision.
In May 1994, the Engle case was filed against Liggett and others in the Circuit Court, Eleventh
Judicial Circuit, Miami-Dade County, Florida. The class consists of all Florida residents and
citizens, and their survivors, who have suffered, presently suffer or have died from diseases
and medical conditions caused by their addiction to cigarettes that contain nicotine. Phase I
of the trial commenced in July 1998 and in July 1999, the jury returned the Phase I verdict.
The Phase I verdict concerned certain issues determined by the trial court to be common to
the causes of action of the plaintiff class. Among other things, the jury found that: smoking
cigarettes causes 20 diseases or medical conditions, cigarettes are addictive or dependence
producing, defective and unreasonably dangerous, defendants made materially false statements
with the intention of misleading smokers, defendants concealed or omitted material information
concerning the health effects and/or the addictive nature of smoking cigarettes and agreed to
misrepresent and conceal the health effects and/or the addictive nature of smoking cigarettes,
and defendants were negligent and engaged in extreme and outrageous conduct or acted with
reckless disregard with the intent to inflict emotional distress. The jury also found that
defendants conduct rose to a level that would permit a potential award or entitlement to
punitive damages. The court decided that Phase II of the trial, which commenced November
1999, would be a causation and damages trial for three of the class representatives and a
punitive damages trial on a class-wide basis, before the same jury that returned the verdict in
Phase I. Phase III of the trial was to be conducted before separate juries to 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
plaintiffs 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
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
defendants including $790,000 against Liggett. The court entered a final order of judgment
against the defendants in November 2000. The courts final judgment, which provided for
interest at the rate of 10% per year on the jurys 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 courts order.
In May 2003, Floridas Third District Court of Appeals decertified the Engle class and set
aside the jurys 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 courts 1996 certification decision, and was unconstitutional. The court further
found that the proceedings were irretrievably tainted by class counsels misconduct and that
the punitive damages award was bankrupting under Florida law.
In October 2003, the Third District Court of Appeals denied class counsels motions seeking,
among other things, a rehearing by the court. Class counsel filed a motion with the Florida
Supreme Court to invoke discretionary review on the basis that the Third District Court of
Appeals decision construes the due process provisions of the state and federal constitutions
and conflicts with other appellate and supreme court decisions. In May 2004, the Florida
Supreme Court agreed to review the case, and oral argument was held in November 2004. If the
Third District Court of Appeals ruling is not upheld on appeal, it will have a material
adverse effect on the Company.
In May 2000, legislation was enacted in Florida that limits the size of any bond required,
pending appeal, to stay execution of a punitive damages verdict to the lesser of the punitive
award plus twice the statutory rate of interest, $100,000 or 10% of the net worth of the
defendant, but the limitation on the bond does not affect the amount of the underlying verdict.
In November 2000, Liggett filed the $3,450 bond required by the Florida law in order to stay
execution of the Engle judgment, pending appeal. Legislation limiting the amount of the bond
required to file an appeal of an adverse judgment has been enacted in more than 30 states.
In May 2001, Liggett, Philip Morris and Lorillard Tobacco Company reached an agreement with the
class in the Engle case, which provided assurance of Liggetts ability to appeal the jurys
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 Liggetts existing $3,450
statutory bond, to the court for the benefit of the class upon completion of the appeals
process, regardless of the outcome of the appeal. As a result, the Company recorded a $9,723
pre-tax charge to the consolidated statement of operations for the first quarter of 2001. The
agreement, which was approved by the court, assured that the stay of execution, in effect
pursuant to the Florida bonding statute, would not be lifted or limited at any point until
completion of all appeals, including an appeal to the United States Supreme Court. If
Liggetts 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.
- 23 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
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 courts ruling.
As discussed above, class counsel in Engle is pursuing various appellate remedies seeking
reversal of the appellate courts decision.
Class certification motions are pending in a number of putative class actions. Classes remain
certified against Liggett in West Virginia (Blankenship), Kansas (Smith) and New Mexico
(Romero). A number of class certification denials are on appeal.
In August 2000, in Blankenship v. Philip Morris, a West Virginia state court conditionally
certified (only to the extent of medical monitoring) a class of present or former West Virginia
smokers who desire to participate in a medical monitoring plan. In January 2001, the judge
declared a mistrial. In July 2001, the court issued an order severing Liggett from the retrial
of the case which began in September 2001. In November 2001, the jury returned a verdict in
favor of the other defendants. In May 2004, the West Virginia Supreme Court affirmed the
defense jury verdict, and it denied plaintiffs petition for rehearing. Plaintiffs did not
seek further appellate review of this matter and the case has been concluded in favor of the
other defendants.
In April 2001, the California state court in Brown, et al., v. The American Tobacco Co., Inc.
et al. granted in part plaintiffs 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 plaintiffs claims that
defendants violated Californias unfair business practices statute. The court subsequently
defined the applicable class period for plaintiffs claims, pursuant to a stipulation
submitted by the parties, as June 10, 1993 through April 23, 2001. In March 2005, the court
issued a ruling granting defendants motion to decertify the class based on a recent change in
California law. In April 2005, the court denied plaintiffs motion for reconsideration of the
order which decertified the case. The plaintiffs have appealed. 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 major 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 May 2005, the United States Court of
Appeals for the Second Circuit vacated the trial courts class certification order and remanded
the case to the trial court for further proceedings. The Second Circuit Court of Appeals
denied plaintiffs motion for reconsideration of the decertification ruling.
Class action suits have been filed in a number of states against individual cigarette
manufacturers, alleging that the use of the terms lights and ultralights constitutes unfair
and
- 24 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
deceptive trade practices. One such suit (Schwab v. Philip Morris, et al.), pending in federal
court in New York against the cigarette manufacturers, seeks to create a nationwide class of
light cigarette smokers and includes Liggett as a defendant. Plaintiffs motion for class
certification and summary judgment motions by both sides were heard in September 2005.
In March 2003, in a class action brought against Philip Morris on behalf of smokers of light
cigarettes, a state court judge in Illinois in the Price, et al., v. Philip Morris case awarded
$7,100,500 in actual damages to the class members, $3,000,000 in punitive damages to the State
of Illinois (which was not a plaintiff in this matter), and approximately $1,800,000 in
attorneys fees and costs. Entry of judgment has been stayed. Philip Morris has appealed the
verdict.
Approximately 38 purported state and federal class action complaints were filed against the
cigarette manufacturers, including Liggett, for alleged antitrust violations. The actions
allege that the cigarette manufacturers have engaged in a nationwide and international
conspiracy to fix the price of cigarettes in violation of state and federal antitrust laws.
Plaintiffs allege that defendants price-fixing conspiracy raised the price of cigarettes above
a competitive level. Plaintiffs in the 31 state actions purport to represent classes of
indirect purchasers of cigarettes in 16 states; plaintiffs in the seven federal actions purport
to represent a nationwide class of wholesalers who purchased cigarettes directly from the
defendants. The federal class actions were consolidated and, in July 2000, plaintiffs filed a
single consolidated complaint that did not name Liggett as a defendant, although Liggett
complied with discovery requests. In July 2002, the court granted defendants motion for
summary judgment in the consolidated federal cases, which decision was affirmed on appeal by
the United States Court of Appeals for the Eleventh Circuit. All state court cases on behalf
of indirect purchasers have been dismissed, except for two cases pending in Kansas and New
Mexico. A Kansas state court, in the case of Smith v. Philip Morris, et al., granted class
certification in November 2001. In April 2003, plaintiffs motion for class certification was
granted in Romero v. Philip Morris, a case pending in New Mexico state court. In February
2005, the New Mexico Supreme Court affirmed the trial courts certification order. Liggett is
one of the defendants in both the Kansas and New Mexico cases.
Governmental Actions. As of September 30, 2005, there were approximately five Governmental
Actions pending against Liggett. In these proceedings, both foreign and domestic governmental
entities seek reimbursement for Medicaid and other health care expenditures. The claims
asserted in these health care cost recovery actions vary. In most of these cases, plaintiffs
assert the equitable claim that the tobacco industry was unjustly enriched by plaintiffs
payment of health care costs allegedly attributable to smoking and seek reimbursement of those
costs. Other claims made by some but not all plaintiffs include the equitable claim of
indemnity, common law claims of negligence, strict liability, breach of express and implied
warranty, breach of special duty, fraud, negligent misrepresentation, conspiracy, public
nuisance, claims under state and federal statutes governing consumer fraud, antitrust,
deceptive trade practices and false advertising, and claims under RICO. Trial in the health
care recovery case brought by the City of St. Louis, Missouri, and approximately 50 area
hospitals against the major cigarette manufacturers is scheduled for January 2006. As a result
of a June 2005 ruling, the court has limited plaintiffs claims by barring those that occurred
more than five years before the case was filed. The action is currently stayed pending a
petition for writ of mandamus and prohibition.
- 25 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
Third-Party Payor Actions. As of September 30, 2005, there were approximately three
Third-Party Payor Actions pending against Liggett. The claims in Third-Party Payor Actions 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 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 remain pending.
In June 2001, a jury in a third party payor action brought by Empire Blue Cross and Blue Shield
in the Eastern District of New York rendered a verdict awarding the plaintiff $17,800 in
damages against the major cigarette manufacturers. As against Liggett, the jury awarded the
plaintiff damages of $89. In February 2002, the court awarded plaintiffs 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 reversed the portion of the judgment relating to
subrogation, certified questions relating to plaintiffs direct claims of deceptive business
practices to the New York Court of Appeals and deferred its ruling on the appeal of the
attorneys fees award pending the ruling on the certified questions. In October 2004, the New
York Court of Appeals ruled in defendants favor on the certified questions and found that
plaintiffs direct claims are barred on grounds of remoteness. In December 2004, the Second
Circuit issued a revised decision, vacating the award of compensatory damages and attorneys
fees, and reversing the judgment. In February 2005, the parties stipulated to a dismissal with
prejudice.
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.
In June 2005, the Jerusalem District Court in Israel added Liggett as a defendant in a
Third-Party Payor Action brought by the largest private insurer in that country, Clalit Health
Services. The court ruled that, although Liggett had not sold product in Israel since 1978, it
may still have liability for damages resulting from smoking of its product when it did sell
cigarettes there.
In August 2005, the United Seniors Association, Inc. filed a lawsuit in federal court in
Massachusetts pursuant to the private cause of action provisions of the Medicare Secondary
Payer Act seeking to recover for the Medicare program all expenditures since August 1999 on
smoking-related diseases.
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
- 26 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
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 governments 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 governments 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 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.
In April 2004, the court denied Liggetts motion to be dismissed from the case. In February
2005, the United States Court of Appeals for the District of Columbia upheld the defendants
motion for summary judgment to dismiss the governments disgorgement claim, ruling that
disgorgement is not an available remedy in a civil RICO action. In April 2005, the appellate
court denied the governments request that the disgorgement ruling be reconsidered by the full
court. In October 2005, the United States Supreme Court declined to review this decision,
although the government could again seek review of this issue following a verdict.
Trial of the case concluded on June 15, 2005. On June 27, 2005, the government sought to
restructure its potential remedies and filed a proposed Final Judgment and Order. The relief
can be grouped into four categories: (1) $14,000,000 for a cessation and counter marketing
program; (2) so-called corrective statements; (3) disclosures; and (4) enjoined activities.
The parties are expected to complete their post-trial submissions during November 2005.
Settlements. In March 1996, Liggett entered into an agreement, subject to court approval, to
settle the Castano class action tobacco litigation. The Castano class was subsequently
decertified by the court.
In March 1996, March 1997 and March 1998, Liggett entered into settlements of smoking-related
litigation with the Attorneys General of 45 states and territories. The settlements released
Liggett from all smoking-related claims, including claims for health care cost reimbursement
and claims concerning sales of cigarettes to minors.
In November 1998, Philip Morris, Brown & Williamson, R.J. Reynolds and Lorillard (collectively,
the Original Participating Manufacturers or OPMs) and Liggett (together with the OPMs and
any other tobacco product manufacturer that becomes a signatory, the Participating
Manufacturers) entered into the Master Settlement Agreement (the MSA) with 46 states, the
District of Columbia, Puerto Rico, Guam, the United States Virgin Islands, American Samoa and
the Northern Mariana Islands (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;
- 27 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
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, Liggetts market share did not exceed the base amount. According to data from Management
Science Associates, Inc., domestic shipments by Liggett and Vector Tobacco accounted for
approximately 2.2% of the total cigarettes shipped in the United States during 2001, 2.4%
during 2002, 2.5% during 2003 and 2.3% during 2004. On April 15 of any year following a year
in which Liggetts and/or Vector Tobaccos market shares exceed their base shares, Liggett
and/or Vector Tobacco will pay on each excess unit an amount equal (on a per-unit basis) to
that due during the same following year by the OPMs under the annual and strategic contribution
payment provisions of the MSA, subject to applicable adjustments, offsets and reductions. In
March and April 2002, Liggett and Vector Tobacco paid a total of $31,130 for their 2001 MSA
obligations. In March and April 2003, Liggett and Vector Tobacco paid a total of $37,541 for
their 2002 MSA obligations. At that time, funds were held back based on Liggetts and Vector
Tobaccos belief that their MSA payments for 2002 should be reduced as a result of market share
loss to non-participating manufacturers. In June 2003, Liggett and Vector Tobacco entered into
a settlement agreement with the Settling States whereby Liggett and Vector Tobacco agreed to
pay $2,478 in April 2004 to resolve these claims. In April 2004, Liggett and Vector Tobacco
paid a total of $50,322 for their 2003 MSA obligations. Liggett and Vector Tobacco have
expensed $23,315 for their estimated MSA obligations for 2004 and $10,988 for the first nine
months of 2005 as part of cost of goods sold. Under the annual and strategic contribution
payment provisions of the MSA, the OPMs (and Liggett and Vector Tobacco to the extent their
market shares exceed their base shares) are required to pay the following annual amounts
(subject to certain adjustments):
|
|
|
|
|
Year |
|
Amount |
|
2005 - 2007 |
|
$ |
8,000,000 |
|
2008 - 2017 |
|
$ |
8,139,000 |
|
2018 and each year thereafter |
|
$ |
9,000,000 |
|
- 28 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
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.
On March 30, 2005, the Independent Auditor under the MSA calculated $28,668 in MSA payments for
Liggetts 2004 sales. On April 15, 2005, Liggett paid $11,678 of this amount and, in
accordance with its rights under the MSA, disputed the balance of $16,990. Of the disputed
amount, Liggett paid $9,304 into the disputed payments account under the MSA and withheld from
payment $7,686. The $9,304 paid into the disputed payment accounts represents the amount
claimed by Liggett as an adjustment to its 2003 payment obligation under the MSA for market
share loss to non-participating manufacturers. At September 30, 2005, included in Other
current assets on the Companys balance sheet was a receivable of $6,513 relating to such
amount. The $7,686 withheld from payment represents $5,318 claimed as an adjustment to
Liggetts 2004 MSA obligation for market share loss to non-participating manufacturers and
$2,368 relating to the retroactive change, discussed below, to the method for computing payment
obligations under the MSA which Liggett contends, among other things, is not in accordance with
the MSA. On May 31, 2005, New York State filed a motion on behalf of the Settling States in
New York state court seeking to compel Liggett and the other Subsequent Participating
Manufacturers that paid into the disputed payments account to release to the Settling States
the amounts paid into such account. The Settling States contend that Liggett had no right
under the MSA and related agreements to pay into the disputed payments account any amount
claimed as an adjustment for market share loss to non-participating manufacturers for 2003,
although they acknowledge that Liggett has the right to dispute such amounts. By stipulation
among the parties dated
July 25, 2005, New Yorks motion was dismissed and Liggett authorized the release to the
Settling States of the $9,304 it had paid into the account, although Liggett continues to
dispute that it owes this amount.
Liggett has recently been notified that all Participating Manufacturers payment obligations
under the MSA, dating from the agreements execution in late 1998, have been recalculated
utilizing net unit amounts, rather than gross unit amounts (which have been utilized since
1999). The change in the method of calculation could, among other things, require additional
payments by Liggett under the MSA of approximately $2,300 per year for the period 2001 through
2004, or a total of approximately $9,200, and require Liggett to pay an additional amount of
approximately $2,400 per year in 2005 and in future periods by lowering Liggetts market share
exemption under the MSA.
Liggett has objected to this retroactive change, and intends to challenge the change in
methodology. Liggett contends that the retroactive change from utilizing gross unit amounts to
net unit amounts is impermissible for several reasons, including:
|
|
|
utilization of net unit amounts is not required by the MSA (as reflected
by, among other things, the utilization of gross unit amounts for the past
six years), |
|
|
|
|
such a change is not authorized without the consent of affected parties to
the MSA, |
- 29 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
|
|
|
the MSA provides for four-year time limitation periods for revisiting
calculations and determinations, which precludes recalculating Liggetts 1997
Market Share (and thus, Liggetts market share exemption), and |
|
|
|
|
Liggett and others have relied upon the calculations based on gross unit
amounts for the past six years. |
The MSA replaces Liggetts 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. Liggetts agreements with these states remain in force and effect, and Liggett
made various payments to these states during 1996, 1997 and 1998 under the agreements.
These states settlement agreements with Liggett contained most-favored nations
provisions, which could reduce Liggetts payment obligations based on subsequent
settlements or resolutions by those states with certain other tobacco companies.
Beginning in 1999, Liggett determined that, based on each of these four states
settlements or resolutions with United States Tobacco Company, Liggetts payment
obligations to those states have been eliminated, except for a $100 a year payment to
Minnesota negotiated in 2003, to be paid any year cigarettes manufactured by Liggett are
sold in that state. With respect to all non-economic obligations under the previous
settlements, Liggett is entitled to the most favorable provisions as between the MSA and
each states respective settlement with the other major tobacco companies. Therefore,
Liggetts non-economic obligations to all states and territories are now defined by the
MSA.
In 2004, the Attorneys General for each of Florida, Mississippi and Texas advised Liggett that
they believed that Liggett had failed to make all required payments under the settlement
agreements with these three states for the period 1998 through 2003 and that additional
payments might be due for 2004 and subsequent years. Liggett believes these allegations are
without merit, based, among other things, on the language of the most-favored nation provisions
of the settlement agreements. In December 2004, the State of Florida offered to settle all
amounts allegedly owed by Liggett for the period through 2003 for the sum of $13,500. In
November 2004, the State of Mississippi offered to settle all amounts allegedly owed by Liggett
for the period through 2003 for the sum of $6,500. In March 2005, the State of Florida
reaffirmed its December 2004 offer to settle and provided Liggett with a 60 day notice to cure
the alleged defaults. In April 2005, the State of Mississippi reaffirmed its November 2004
offer to settle and provided Liggett with a 60 day notice to cure the alleged defaults.
Liggett has met with representatives of the three states to discuss the issues relating to the
alleged defaults. No resolution has been reached.
No amounts have been accrued in the accompanying financial statements for any additional
amounts that may be payable by Liggett under the MSA due to the recalculation of the
Participating Manufacturers payment obligations or under the settlement agreements with
Florida, Mississippi and Texas. There can be no assurance that Liggett will prevail in any of
these matters and that Liggett will not be required to make additional material payments, which
payments could adversely affect the Companys consolidated financial position, results of
operations or cash flows.
- 30 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
In August 2004, the Company announced that Liggett and Vector Tobacco had notified the
Attorneys General of 46 states that they intend to initiate proceedings against the Attorneys
General for violating the terms of the MSA. The Companys subsidiaries allege that the
Attorneys General violated their rights and the MSA by extending unauthorized favorable
financial terms to Miami-based Vibo Corporation d/b/a/ General
Tobacco when, on
August 19, 2004, the Attorneys General entered into an agreement with General Tobacco allowing
it to become a Subsequent Participating Manufacturer under the MSA. General Tobacco imports
discount cigarettes manufactured in Colombia, South America.
In the notice sent to the Attorneys General, the Companys subsidiaries indicated that they
will seek to enforce the terms of the MSA, void the General Tobacco agreement and enjoin the
Settling States and National Association of Attorneys General from listing General Tobacco as a
Participating Manufacturer on their websites.
There is a suit pending against New York state officials, in which importers of cigarettes
allege that the MSA and certain New York statutes enacted in connection with the MSA violate
federal antitrust law. In September 2004, the court denied plaintiffs motion to preliminarily
enjoin the MSA and certain related New York statutes, but the court issued a preliminary
injunction against the allocable share provision of the New York escrow statute. In
addition, similar lawsuits have been brought in Kentucky, Arkansas, Kansas, Louisiana,
Nebraska, Tennessee and Oklahoma. Liggett is not a defendant in these cases.
Copies of the various settlement agreements are filed as exhibits to the Companys Annual
Report on Form 10-K and the discussion herein is qualified in its entirety by reference
thereto.
Trials. Trial in the United States government action concluded on June 15, 2005 in federal
court in the District of Columbia. The parties are expected to complete their post-trial
submissions during November 2005. Cases currently scheduled for trial during the next six
months include an individual action in Missouri state court, where Liggett is the sole
defendant, scheduled for November 2005 and the health care recovery case in Missouri state
court brought by the City of St. Louis and area hospitals scheduled for January 2006. Trial
dates, however, are subject to change.
Management is not able to predict the outcome of the litigation pending against Liggett.
Litigation is subject to many uncertainties. In May 2003, a Florida intermediate appellate
court overturned a $790,000 punitive damages award against Liggett and decertified the Engle
smoking and health class action. In May 2004, the Florida Supreme Court agreed to review the
case, and oral argument was held in November 2004. If the intermediate appellate courts
ruling is not upheld on 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 Liggetts 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
- 31 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
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 courts ruling. In April
2004, a jury in a Florida state court action awarded compensatory damages of approximately $540
against Liggett in an individual action. In addition, plaintiffs counsel was awarded legal
fees of $752. Liggett intends to appeal the verdict. It is possible that additional cases
could be decided unfavorably and that there could be further adverse developments in the Engle
case. Liggett may enter into discussions in an attempt to settle particular cases if it
believes it is appropriate to do so. Management cannot predict the cash requirements related
to any future settlements and judgments, including cash required to bond any appeals, and there
is a risk that those requirements will not be able to be met. An unfavorable outcome of a
pending smoking and health case could encourage the commencement of additional similar
litigation. Management is unable to make a meaningful estimate with respect to the amount or
range of loss that could result from an unfavorable outcome of the cases pending against
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 individuals 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 Companys consolidated financial position, results of operations or
cash flows could be materially adversely affected by an unfavorable outcome in any such
smoking-related litigation.
Liggetts and Vector Tobaccos management are unaware of any material environmental conditions
affecting their existing facilities. Liggetts and Vector Tobaccos 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 two 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.
The nine cases were consolidated before the United States District Court for the Northern
District of Illinois. In June 2005, the court granted defendants motion to dismiss the
consolidated action. The plaintiffs intend to appeal.
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 Companys financial position,
results of operations or cash flows.
- 32 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
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.
In January 1993, the Environmental Protection Agency (EPA) released a report on the
respiratory effect of secondary smoke which concludes that secondary smoke is a known human
lung carcinogen in adults and in children, causes increased respiratory tract disease and
middle ear disorders and increases the severity and frequency of asthma. In June 1993, the two
largest of the major domestic cigarette manufacturers, together with other segments of the
tobacco and distribution industries, commenced a lawsuit against the EPA seeking a
determination that the EPA did not have the statutory authority to regulate secondary smoke,
and that given the scientific evidence and the EPAs failure to follow its own guidelines in
making the determination, the EPAs 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 courts
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). 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.
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. In October 2004, the
Senate passed a bill, which did not become law, providing for FDA regulation of tobacco
products. A substantially similar bill was reintroduced in Congress in March 2005. The
ultimate outcome of these proposals cannot be predicted, but FDA regulation of tobacco products
could have a material adverse effect on the Company.
- 33 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
In October 2004, federal legislation was enacted which abolished the federal tobacco quota and
price support program. Pursuant to the legislation, manufacturers of tobacco products will be
assessed $10,140,000 over a ten year period to compensate tobacco growers and quota holders for
the elimination of their quota rights. Cigarette manufacturers will initially be responsible
for 96.3% of the assessment (subject to adjustment in the future), which will be allocated
based on relative unit volume of domestic cigarette shipments. Management currently estimates
that Liggetts assessment will be approximately $25,000 for the first year of the program which
began January 1, 2005, including a special federal quota stock liquidation assessment of
$5,219, which was expensed as cost of goods sold in the third quarter of 2005. The cost of the
legislation to the three largest cigarette manufacturers will likely be less than the cost to
smaller manufacturers, including Liggett and Vector Tobacco, because one effect of the
legislation is that the three largest manufacturers will no longer be obligated to make certain
contractual payments, commonly known as Phase II payments, they agreed in 1999 to make to
tobacco-producing states. The ultimate impact of this legislation cannot be determined, but
there is a risk that smaller manufacturers, such as Liggett and Vector Tobacco, will be
disproportionately affected by the legislation, which could have a material adverse effect on
the Company.
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 courts 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
and the Senate bill providing for FDA regulation also calls for, among other things, ingredient
disclosure.
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. In 2004, 10 states enacted increases
in excise taxes, and nine states have enacted increases in excise taxes in 2005. Congress has
considered significant increases in the federal excise tax or other payments from tobacco
manufacturers, and various states and other jurisdictions have currently under consideration or
pending legislation proposing further state excise tax increases. Management believes
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
ignition propensity standards for cigarettes. Compliance with this legislation could be
burdensome and costly. In June 2000, the New York State legislature passed legislation
charging the states Office of Fire Prevention and Control, referred to as the OFPC, with
developing standards for fire-safe or self-extinguishing cigarettes. All cigarettes
manufactured for sale in New York state must be manufactured to certain self-extinguishment
standards set out in the regulations. Liggett and Vector Tobacco have not historically
provided
- 34 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
products that would be compliant under these new OFPC regulations, and certain design and
manufacturing changes have been 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
complied with these New York regulatory requirements. Effective May 1, 2006 and January 1,
2007, cigarettes sold in Vermont and California, respectively, must meet certain reduced
ignition propensity standards. 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 Tobaccos 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 Tobaccos 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 and Vector Tobacco
has recently agreed to suspend all print advertising for its Quest brand while discussions are
pending. If Vector Tobacco is unable to advertise its Quest brand, it could have a material
adverse effect on sales of Quest. Allegations by federal or state regulators, public health
organizations and other tobacco manufacturers that Vector Tobaccos 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 Tobaccos
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.
- 35 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
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, Inc., the Companys
predecessor, by a stockholder of New Valley. The suit alleged that New Valleys 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 sought a declaration that New
Valleys 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 alleged, 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 Valleys board lacked independence, and that the appraisal and fairness opinion were
flawed. By order of the court, both actions were consolidated. In March 2005, New Valley, its
directors and Brooke Group Holding settled the consolidated action. The defendants did not
admit any wrongdoing as part of the settlement. At a hearing held on June 14, 2005, the court
approved the settlement. No appeal was taken and, therefore, the settlement is final. Under
the settlement, the Company paid New Valley $7,000 in July 2005, and New Valley paid legal fees
and expenses of $2,150. The Company recorded a charge to operating, selling, administrative
and general expense in 2004 of $4,177 (net of minority interests) related to the settlement.
In July 1999, a purported class action was commenced on behalf of New Valleys 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 Valleys 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 court
dismissed six of plaintiffs nine claims alleging inadequate disclosure in the proxy statement.
Brooke Group Holding and New Valley filed a motion for summary judgment on the remaining three
claims which was granted by the court in May 2005. The plaintiffs did not appeal the decision.
See Note 11 for information concerning purported class action lawsuits commenced against the
Company, New Valley and New Valleys directors in connection with the Companys exchange offer
for New Valley.
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. The Company believes that
the fair value of Eves guarantee was negligible at September 30, 2005.
- 36 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
In February 2004, Liggett Vector Brands and another cigarette manufacturer entered into a five
year agreement with a subsidiary of the American Wholesale Marketers Association to support a
program to permit tobacco distributors to secure, on reasonable terms, tax stamp bonds required
by state and local governments for the distribution of cigarettes. Under the agreement,
Liggett Vector Brands has agreed to pay a portion of losses, if any, incurred by the surety
under the bond program, with a maximum loss exposure of $500 for Liggett Vector Brands. To
secure its potential obligations under the agreement, Liggett Vector Brands has delivered to
the subsidiary of the Association a $100 letter of credit and agreed to fund up to an
additional $400. Liggett Vector Brands has incurred no losses to date under this agreement,
and the Company believes the fair value of Liggett Vector Brands obligation under the
agreement was immaterial at September 30, 2005.
As of September 30, 2005, New Valley had $300 of remaining prepetition bankruptcy-related
claims. The remaining claims may be subject to future adjustments based on potential
settlements or decisions of the court.
8.
EQUITY
The Company accounts for employee stock compensation plans under APB Opinion No. 25,
Accounting for Stock Issued to Employees, with the intrinsic value-based method permitted by
SFAS No. 123, Accounting for Stock-Based Compensation as amended by SFAS No. 148.
Accordingly, no compensation expense is recognized when the exercise price is equal to the
market price of the underlying common stock on the date of grant.
Awards under the Companys stock compensation plans generally vest over periods ranging from
four to five years from the date of grant. The expense related to stock option compensation
included in the determination of net income for the three and nine month periods ended
September 30, 2005 and September 30, 2004 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 income (loss) and income (loss) per
share if the Company had applied the fair value provisions of SFAS No. 123:
- 37 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Net income (loss) |
|
$ |
8,975 |
|
|
$ |
8,066 |
|
|
$ |
30,266 |
|
|
$ |
(4,209 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Add: employee stock compensation
expense included in reported net income
(loss), net of related tax effects |
|
|
547 |
|
|
|
42 |
|
|
|
1,031 |
|
|
|
126 |
|
Deduct: total employee stock compensation
expense determined under the fair
value method for all awards, net of
related tax effects |
|
|
(904 |
) |
|
|
(432 |
) |
|
|
(1,938 |
) |
|
|
(1,388 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma net income (loss) |
|
$ |
8,618 |
|
|
$ |
7,676 |
|
|
$ |
29,359 |
|
|
$ |
(5,471 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic as reported |
|
$ |
0.20 |
|
|
$ |
0.18 |
|
|
$ |
0.69 |
|
|
$ |
(0.10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted as reported |
|
$ |
0.19 |
|
|
$ |
0.17 |
|
|
$ |
0.66 |
|
|
$ |
(0.10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic pro forma |
|
$ |
0.19 |
|
|
$ |
0.18 |
|
|
$ |
0.66 |
|
|
$ |
(0.13 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted pro forma |
|
$ |
0.19 |
|
|
$ |
0.17 |
|
|
$ |
0.64 |
|
|
$ |
(0.13 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
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.
On September 27, 2005, the President of the Company was awarded a restricted stock grant of
500,000 shares of Vectors common stock pursuant to Vectors Amended and Restated 1999
Long-Term Incentive Plan. Under the terms of the award, one-fourth of the shares vest on
September 15, 2006, with an additional one-fourth vesting on each of the three succeeding
one-year anniversaries of the first vesting date through September 15, 2009. In the event the
his employment with the Company is terminated for any reason other than his death, his
disability or a change of control (as defined in this Restricted Share Agreement) of the
Company, any remaining balance of the shares not previously vested will be forfeited by him.
The Company recorded deferred compensation of $9,775 representing the fair market value of the
restricted shares on the date of grant. The deferred compensation will be amortized over the
vesting period as a charge to compensation expense.
- 38 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
Vectors
income tax rate for the three and nine months ended September 30, 2005 does not bear a customary
relationship to statutory income tax rates as a result of the impact of nondeductible expenses,
state income taxes, the receipt of the LTS distribution, the intraperiod allocation at New
Valley between income from continuing and discontinued operations and the utilization of
deferred tax assets at New Valley, as applicable. Vectors tax
rate for the three and nine months ended September 30,
2004 does not bear a customary relationship to statutory income tax rates as a result of the
impact of nondeductible expenses, state income taxes and the intraperiod allocation at New
Valley between income from continuing and discontinued operations.
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 September
30, 2005, the Companys deferred income tax liabilities exceeded its deferred income tax assets
by $132,640. The largest component of the Companys deferred tax liabilities exists because of
differences that resulted from a 1998 and 1999 transaction with Philip Morris Incorporated in
which 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. For additional information concerning
the Philip Morris brand transaction, see Note 18 to the consolidated financial statements
included in the Companys Annual Report on Form 10-K for the year ended December 31, 2004.
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 Companys 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 prevail with the proposed adjustment,
it would result in the potential acceleration of tax payments of approximately $126,000,
including interest, net of tax benefits, through September 30, 2005. These amounts have been
previously recognized in the Companys consolidated financial statements as tax liabilities.
As of September 30, 2005, 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
- 39 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
|
|
disputed amounts at a rate of 9%, 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 materially
adversely affected. |
10. NEW VALLEY CORPORATION
|
|
Office Buildings. 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). In February
2005, New Valley completed the sale of the office buildings for $71,500. The mortgage loan on
the properties was retired at closing with the proceeds of the sale. (Refer to Notes 5 and 12.) |
|
|
|
Real Estate Businesses. New Valley accounts for its 50% interests in Douglas Elliman Realty
LLC, Koa Investors LLC and 16th & K Holdings LLC on the equity method. Douglas
Elliman Realty operates a residential real estate brokerage company in the New York
metropolitan area. Koa Investors owns the Sheraton Keauhou Bay Resort & Spa in Kailua-Kona,
Hawaii. Following a major renovation, the property reopened in the fourth quarter 2004 as a
four star resort with 521 rooms. 16th & K Holdings acquired the St. Regis Hotel in
Washington, D.C. in August 2005. |
|
|
|
Residential Brokerage Business. New Valley recorded income of $4,229 and $4,602 for the three
months ended September 30, 2005 and 2004, respectively, and income of $9,689 and $10,015 for
the nine months ended September 30, 2005 and 2004, respectively, associated with Douglas
Elliman Realty. Summarized financial information for Douglas Elliman Realty for the three and
nine months ended September 30, 2005 and 2004 and as of September 30, 2005 and December 31,
2004 is presented below. |
|
|
|
|
|
|
|
|
|
|
|
September 30, 2005 |
|
December 31, 2004 |
Cash |
|
$ |
26,510 |
|
|
$ |
21,375 |
|
Other current assets |
|
|
6,538 |
|
|
|
4,726 |
|
Property, plant and equipment, net |
|
|
16,546 |
|
|
|
15,520 |
|
Trademarks |
|
|
21,663 |
|
|
|
21,663 |
|
Goodwill |
|
|
37,589 |
|
|
|
36,676 |
|
Other intangible assets, net |
|
|
2,241 |
|
|
|
2,748 |
|
Other noncurrent assets |
|
|
1,100 |
|
|
|
1,112 |
|
Notes payable current |
|
|
3,258 |
|
|
|
4,998 |
|
Other current liabilities |
|
|
20,817 |
|
|
|
18,264 |
|
Notes payable long term |
|
|
56,898 |
|
|
|
66,710 |
|
Other long-term liabilities |
|
|
3,288 |
|
|
|
3,125 |
|
Members equity |
|
|
27,926 |
|
|
|
10,723 |
|
- 40 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Revenues |
|
$ |
92,523 |
|
|
$ |
78,379 |
|
|
$ |
254,092 |
|
|
$ |
211,779 |
|
Costs and expenses |
|
|
81,498 |
|
|
|
67,265 |
|
|
|
227,260 |
|
|
|
185,565 |
|
Depreciation expense |
|
|
1,259 |
|
|
|
1,102 |
|
|
|
3,587 |
|
|
|
3,251 |
|
Amortization expense |
|
|
183 |
|
|
|
150 |
|
|
|
550 |
|
|
|
600 |
|
Interest expense, net |
|
|
1,365 |
|
|
|
1,462 |
|
|
|
4,439 |
|
|
|
4,315 |
|
Income tax expense |
|
|
276 |
|
|
|
|
|
|
|
650 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
7,942 |
|
|
$ |
8,400 |
|
|
$ |
17,606 |
|
|
$ |
18,048 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Hawaiian Hotel. New Valley recorded a loss of $58 and $63 for the three months ended September
30, 2005 and 2004, respectively, and a loss of $3,500 and $188 for the nine months ended
September 30, 2005 and 2004, respectively, associated with Koa Investors. Summarized financial
information for Koa Investors for the three and nine months ended September 30, 2005 and 2004
and as of September 30, 2005 and December 31, 2004 is presented below. |
|
|
|
|
|
|
|
|
|
|
|
September 30, 2005 |
|
December 31, 2004 |
Cash |
|
$ |
2,841 |
|
|
$ |
2,062 |
|
Restricted assets |
|
|
2,962 |
|
|
|
5,538 |
|
Other current assets |
|
|
1,837 |
|
|
|
988 |
|
Property, plant and equipment, net |
|
|
74,359 |
|
|
|
77,339 |
|
Deferred financing costs, net |
|
|
2,408 |
|
|
|
1,724 |
|
Accounts payable and other current liabilities |
|
|
8,719 |
|
|
|
11,064 |
|
Notes payable |
|
|
82,000 |
|
|
|
60,356 |
|
Members (deficiency) equity |
|
|
(6,312 |
) |
|
|
16,231 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Revenues |
|
$ |
6,986 |
|
|
$ |
|
|
|
$ |
17,739 |
|
|
$ |
|
|
Costs and operating expenses |
|
|
7,776 |
|
|
|
|
|
|
|
18,991 |
|
|
|
|
|
Management fees |
|
|
200 |
|
|
|
125 |
|
|
|
534 |
|
|
|
375 |
|
Depreciation expense |
|
|
1,347 |
|
|
|
|
|
|
|
3,999 |
|
|
|
|
|
Amortization expense |
|
|
1,452 |
|
|
|
|
|
|
|
1,870 |
|
|
|
|
|
Interest expense, net |
|
|
1,439 |
|
|
|
|
|
|
|
4,457 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(5,228 |
) |
|
$ |
(125 |
) |
|
$ |
(12,112 |
) |
|
$ |
(375 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Koa Investors capitalized all costs related to the acquisition and development of the property
during the construction phase, which ceased in connection with the opening of the hotel in the
fourth quarter of 2004. Koa Investors anticipates that the hotel will continue to experience
operating losses during its opening phase. |
- 41 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
|
|
In August 2005, a wholly-owned subsidiary of Koa Investors borrowed $82,000 at an interest rate
of LIBOR plus 2.45%. Koa Investors used the proceeds of the loan to repay its $57,000
construction loan and distributed a portion of the proceeds to its members, including $5,500 to
New Valley. As a result of the refinancing, New Valley suspended its recognition of equity
losses in Koa Investors to the extent such losses exceed its basis plus any commitment to make
additional investments, which totaled $600 at September 30, 2005. |
|
|
|
St. Regis Hotel, Washington, D.C. In June 2005, affiliates of New Valley and Brickman
Associates formed 16th & K Holdings LLC (Hotel LLC), which acquired the St. Regis
Hotel, a 193 room luxury hotel in Washington, D.C., for $47,000 in August 2005. The Company, which holds a 50% interest
in Hotel LLC, had invested $6,250 in the project and had committed to make additional
investments of up to $3,750 at September 30, 2005. The members of Hotel LLC currently plan to
renovate the hotel commencing in 2006. In connection with the closing of the purchase of the
hotel, a subsidiary of Hotel LLC entered into agreements to borrow up to $50,000 of senior and
subordinated debt. |
|
|
|
New Valley accounts for its interest in Hotel LLC under the equity method and recorded income
of $13 for the three and nine months ended September 30, 2005. Hotel LLC will capitalize all
costs related to the renovation of the property during the renovation phase. |
|
|
|
LTS. In November 2004, New Valley and the other holder of the convertible notes of Ladenburg
Thalmann Financial Services Inc. (LTS) entered into a debt conversion agreement with LTS. New
Valley and the other holder agreed to convert their notes, with an aggregate principal amount
of $18,010, together with the accrued interest, into common stock of LTS. Pursuant to the debt
conversion agreement, the conversion price of the note held by New Valley was reduced from the
previous conversion price of approximately $2.08 to $0.50 per share and New Valley and the
other holder each agreed to purchase $5,000 of LTS common stock at $0.45 per share. |
|
|
|
The note conversion transaction was approved by the LTS shareholders in January 2005 and closed
in March 2005. At the closing, New Valleys note, representing approximately $9,938 of
principal and accrued interest, was converted into 19,876,358 shares of LTS common stock and
New Valley purchased 11,111,111 LTS shares. In the first quarter 2005, New Valley recorded a
gain of $9,461 which represented the fair value of the converted shares as determined by an
independent appraisal firm. |
|
|
|
LTS borrowed $1,750 from New Valley in 2004 and an additional $1,750 in the first quarter 2005.
At the closing of the note conversion agreement, New Valley delivered these notes for
cancellation as partial payment for its purchase of LTS common stock. |
|
|
|
On March 30, 2005, New Valley distributed the 19,876,358 shares of LTS common stock it acquired
from the conversion of the notes to holders of New Valley common shares through a special
distribution. On the same date, the Company distributed the 10,947,448 shares of LTS common
stock that it received from New Valley to the holders of its common stock as a special
distribution. New Valley stockholders of record on March 18, 2005 received 0.852 of a LTS
share for each share of New Valley, and the Companys stockholders of record on that date
received 0.24 ($2,968) of a LTS share for each share of the Company. |
|
|
|
Following the distribution, New Valley continues to hold the 11,111,111 shares of LTS common
stock (approximately 9% of the outstanding shares), the $5,000 of LTSs notes due |
- 42 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
|
|
December 31, 2006 and a warrant to purchase 100,000 shares of its common stock at $1.00 per
share. The shares of LTS common stock held by New Valley have been accounted for as investment
securities available for sale and are carried at $6,778 on the Companys condensed consolidated
balance sheet at September 30, 2005. |
|
|
|
Share Repurchase. In October 1999, New Valleys 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 September 30, 2005, New Valley
had repurchased 1,229,515 shares for approximately $4,895. |
|
|
|
Restricted Share Award. On January 10, 2005, New Valleys President and Chief Operating
Officer, who also serves in the same positions with the Company, was awarded a restricted stock
grant of 1,250,000 New Valley common shares pursuant to New Valleys 2000 Long-Term Incentive
Plan. Under the terms of the award, one-seventh of the shares vested on July 15, 2005, with an
additional one-seventh vesting on each of the five succeeding one-year anniversaries of the
first vesting date through July 15, 2010 and an additional one-seventh vesting on January 15,
2011. On September 27, 2005, the executive renounced and waived, as of that date, the unvested
1,071,429 common shares deliverable by New Valley to him in the future. |
|
|
|
Vector initially recorded deferred compensation of $8,875 ($3,152 net of income taxes and
minority interests), representing the fair market value of the restricted shares on the date of
the grant which was anticipated to be amortized over the vesting period as a charge to
compensation expense. In connection with the executives
renouncement of the unvested common shares, the Company reduced the deferred compensation associated with the award by $7,608
during the third quarter of 2005. The Company recorded expense associated with the grant of
$102 and $1,267 for the three and nine months ended September 30, 2005, respectively. |
11. NEW VALLEY EXCHANGE OFFER
|
|
On October 20, 2005, VGR Holding Inc., a direct wholly-owned subsidiary of Vector, made an
offer to the holders of common shares of New Valley to exchange 0.461 shares of Vectors common
stock (and cash instead of fractional shares) for each outstanding common share of New Valley
validly tendered and not withdrawn in the exchange offer (the Offer). If New Valleys
stockholders choose to tender their shares, Vector would issue approximately 4.4 million shares
of its common stock to complete the transaction. Vector currently owns approximately 57.7% of
all of the outstanding common shares of New Valley. The Offer is subject to the non-waivable
condition that, after giving effect to the Offer, Vector owns at least 90% of the total number
of outstanding common shares of New Valley. If this minimum tender condition is satisfied,
more than a majority of the minority stockholders (i.e., stockholders unaffiliated with Vector
and its subsidiaries and stockholders who are not directors or officers of New Valley) will
have also validly tendered and not properly withdrawn their common shares of New Valley in the
Offer. The Offer is also subject to approval by the Companys stockholders of the issuance of
certain shares of the Companys common stock to be issued in the Offer and to other customary
conditions. The Offer will expire on December
9, 2005, unless it is extended by Vector. If Vector completes the Offer, it intends to effect
a short form merger of New Valley with and into a wholly-owned subsidiary of Vector shortly
thereafter. Each common share of New Valley not acquired in the Offer, other than the shares
owned by |
- 43 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
|
|
Vector, would be converted in the short form merger into 0.461 shares of Vectors
common stock and cash instead of fractional shares. |
|
|
|
On or about September 29, 2005, an individual stockholder of New Valley filed a complaint in
the Delaware Court of Chancery purporting to commence a class action lawsuit against Vector,
New Valley and each of the individual directors of New Valley. The complaint was styled as
Pill v. New Valley Corporation, et al. (C.A. No. 1678-N). On or about September 29, 2005, a
separate action was filed in the Circuit Court of the Eleventh Judicial Circuit in and for
Miami-Dade County, Florida styled as Tombs v. New Valley Corporation, et al. (Case No. 05-19623
CA 22). On or about October 28, 2005, an additional action was filed in the Delaware Court of
Chancery styled as Lindstrom v. LeBow, et al. (C.A. No. 1745-N). In general, the complaints
allege, among other things: (1) breaches of fiduciary duty by Vector, New Valley and the
members of New Valleys board in connection with the Offer and the subsequent merger; (2) that
the consideration Vector is offering is inadequate; and (3) that Vector is acting to further
its own interests at the expense of the holders of New Valleys common shares. Among other
remedies, the complaints seek to enjoin the Offer and the subsequent merger or, alternatively,
damages in an unspecified amount and rescission in the event the merger occurs. Vector is not
aware of any purported class action complaints other than those referenced above. In the Tombs
matter, on or about November 3, 2005, the plaintiffs filed an
amended complaint. On or about October 21, 2005, the plaintiffs
moved to expedite discovery and that motion, which was opposed by the
defendants, was heard on November 8, 2005. Further argument has
been set for November 10, 2005. Plaintiffs have filed a motion to
consolidate the Pill and Lindstrom cases, and the
Pill plaintiff has filed a motion to certify the case, which
motions defendants do not oppose. In the Pill
matter, Vector filed an answer on or about October 25, 2005. On or about November 1, 2005, the
plaintiffs moved (i) to amend their complaint to, among other
things, add VGR Holding Inc. as a defendant, (ii) for a preliminary injunction, and (iii) for
expedited discovery. Defendants have agreed that the amended
complaint may be filed with the Delaware Court of Chancery and have
agreed to a discovery schedule, as a result of which plaintiff is no
longer proceeding with his motion to expedite discovery. Vector
believes that each of these lawsuits is without merit and will defend against each lawsuit. |
12. DISCONTINUED OPERATIONS
|
|
As discussed in Note 10, in February 2005, New Valley completed the sale for $71,500 of its two
office buildings in Princeton, N.J. As a result of the sale, the consolidated financial
statements of the Company reflect New Valleys real estate leasing operations as discontinued
operations for the three and nine months ended September 30, 2005 and 2004. 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 the discontinued operations have been
reported, net of applicable income taxes and minority interests, as Income from discontinued
operations, and the net cash flows of these entities have been reported as Net cash provided
by discontinued operations. The assets of the discontinued operations were recorded as Assets
held for sale in the consolidated balance sheet at December 31, 2004. |
|
|
|
Summarized operating results of the discontinued real estate leasing operations for the three
and nine months ended September, 2005 and 2004 are as follows: |
- 44 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Revenues |
|
$ |
|
|
|
$ |
1,809 |
|
|
$ |
924 |
|
|
$ |
5,401 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses |
|
|
|
|
|
|
1,285 |
|
|
|
515 |
|
|
|
3,658 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from discontinued operations before
income taxes and minority interests |
|
|
|
|
|
|
524 |
|
|
|
409 |
|
|
|
1,743 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense from discontinued
operations |
|
|
|
|
|
|
287 |
|
|
|
223 |
|
|
|
940 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority interests |
|
|
|
|
|
|
125 |
|
|
|
104 |
|
|
|
424 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from discontinued operations |
|
$ |
|
|
|
$ |
112 |
|
|
$ |
82 |
|
|
$ |
379 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company recorded a gain in connection with the sale of the office buildings of $2,952,
net of minority interests ($3,725) and income taxes ($8,008), in the first quarter 2005. |
13. SEGMENT INFORMATION
|
|
The Companys significant business segments for each of the three and nine months ended
September 30, 2005 and 2004 were Liggett and Vector Tobacco. 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. The accounting policies of the segments are the same as those
described in the summary of significant accounting policies. |
- 45 -
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) (Continued)
(Unaudited)
|
|
Financial information for the Companys continuing operations before taxes and minority
interests for the three and nine months ended September 30, 2005 and 2004 follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vector |
|
Real |
|
Corporate |
|
|
|
|
Liggett |
|
Tobacco |
|
Estate |
|
and Other |
|
Total |
Three Months Ended Sept. 30, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
122,718 |
|
|
$ |
2,247 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
124,965 |
|
Operating income (loss) |
|
|
31,478 |
(1) |
|
|
(4,115 |
)(1) |
|
|
|
|
|
|
(7,387 |
) |
|
|
19,976 |
(1) |
Depreciation and amortization |
|
|
1,903 |
|
|
|
143 |
|
|
|
|
|
|
|
691 |
|
|
|
2,737 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended Sept. 30, 2004: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
120,793 |
|
|
$ |
3,458 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
124,251 |
|
Operating income (loss) |
|
|
27,228 |
(2) |
|
|
(3,623 |
)(2) |
|
|
|
|
|
|
(6,890 |
) |
|
|
16,715 |
(2) |
Depreciation and amortization |
|
|
1,906 |
|
|
|
350 |
|
|
|
|
|
|
|
621 |
|
|
|
2,877 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended Sept. 30, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
334,582 |
|
|
$ |
7,669 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
342,251 |
|
Operating income (loss) |
|
|
97,693 |
(1) |
|
|
(11,295 |
)(1) |
|
|
|
|
|
|
(23,412 |
) |
|
|
62,986 |
(1) |
Identifiable assets |
|
|
282,766 |
|
|
|
4,901 |
|
|
|
|
|
|
|
248,740 |
|
|
|
536,407 |
|
Depreciation and amortization |
|
|
5,880 |
|
|
|
539 |
|
|
|
|
|
|
|
1,862 |
|
|
|
8,281 |
|
Capital expenditures |
|
|
4,723 |
|
|
|
12 |
|
|
|
|
|
|
|
429 |
|
|
|
5,164 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended Sept. 30, 2004: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
358,565 |
|
|
$ |
12,304 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
370,869 |
|
Operating income (loss) |
|
|
80,379 |
(3) |
|
|
(56,770 |
)(3) |
|
|
|
|
|
|
(19,952 |
) |
|
|
3,657 |
(3) |
Identifiable assets |
|
|
266,214 |
|
|
|
21,061 |
|
|
|
82,652 |
(4) |
|
|
158,120 |
|
|
|
528,047 |
|
Depreciation and amortization |
|
|
5,916 |
|
|
|
1,485 |
|
|
|
|
|
|
|
1,886 |
|
|
|
9,287 |
|
Capital expenditures |
|
|
2,704 |
|
|
|
62 |
|
|
|
|
|
|
|
239 |
|
|
|
3,005 |
|
|
|
|
(1) |
|
Includes a special federal quota stock liquidation assessment under the
federal tobacco buyout legislation of $5,219 ($5,150 at Liggett and $69 at Vector
Tobacco). |
|
(2) |
|
Includes restructuring and impairment charges of $3,968 at Liggett and $564
at Vector Tobacco. |
|
(3) |
|
Includes restructuring and impairment charges of $6,320 at Liggett and $1,224
at Vector Tobacco and a $37,000 inventory charge at Vector Tobacco. |
|
(4) |
|
Identifiable assets in the real estate segment relate to discontinued
operations. |
- 46 -
ITEM 2. MANAGEMENTS 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. |
In recent years, we have undertaken a number of initiatives to streamline the cost structure
of our tobacco business and improve operating efficiency and long-term earnings. 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 our tobacco operations.
Effective year-end 2003, we closed Vector Tobaccos 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 Tobaccos other cigarette
brands was transferred to Liggetts state-of-the-art manufacturing facility in Mebane, North
Carolina. In July 2004, we completed the sale of the Timberlake facility and equipment.
In April 2004, we eliminated a number of positions in our tobacco operations and subleased
excess office space. In October 2004, we announced a plan to restructure the operations of Liggett
Vector Brands. Liggett Vector Brands has realigned its sales force and adjusted its business model
to more efficiently serve its chain and independent accounts nationwide. In connection with the
restructuring, we eliminated approximately 330 full-time positions and 135 part-time positions as
of December 15, 2004.
We may consider various additional opportunities to further improve efficiencies and reduce
costs. These prior and current initiatives have involved material restructuring and impairment
charges, and any further actions taken are likely to involve material charges as well. Although
management may estimate that substantial cost savings will be associated with these restructuring
actions, there is a risk that these actions could have a serious negative impact on our tobacco
operations and that any estimated increases in profitability cannot be achieved.
Our majority-owned subsidiary, New Valley Corporation, is currently engaged in the real estate
business and is seeking to acquire additional operating companies and real estate properties. In
December 2002, New Valley increased its ownership to 50% in Douglas Elliman Realty, LLC, which
operates the largest residential brokerage company in the New York metropolitan area. In February
2005, New Valley completed the sale for $71,500 of its two office buildings in Princeton, New
Jersey.
All of Liggetts unit sales volume in 2004 and the first nine months of 2005 was in the
discount segment, which Liggetts management believes has been the primary growth segment in the
industry for over a decade. The significant discounting of premium cigarettes in recent years has
led to brands, such as EVE, that were traditionally considered premium brands to become more
- 47 -
appropriately categorized as discount, following list price reductions. Effective February 1,
2004, Liggett reduced the list price for EVE from the premium price level to the branded discount
level and for JADE from the premium price level to the deep discount level.
Liggetts cigarettes are produced in approximately 230 combinations of length, style and
packaging. Liggetts 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, |
|
|
|
|
GRAND PRIX a brand in the lowest price level of the deep discount segment, |
|
|
|
|
JADE a free-standing deep discount menthol brand, |
|
|
|
|
PYRAMID the industrys first deep discount product with a brand identity, and |
|
|
|
|
USA and various control and private label brands. |
In 1999, Liggett introduced LIGGETT SELECT, one of the leading brands in the deep discount
category. LIGGETT SELECT is now the largest seller in Liggetts family of brands, comprising 47.4%
of Liggetts unit volume in the first nine months of 2005 and 55.5% of Liggetts unit volume in
2004. In September 2005, Liggett introduced GRAND PRIX to distributors and retailers nationwide.
GRAND PRIX is marketed as the lowest price fighter and specifically competes with brands which
are priced at the lowest level of the deep 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, the three largest cigarette manufacturers
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 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 gaps between the premium and all discount segments resulting from
aggressive premium price discounts and promotions by larger competitors, including
Philip Morris USA and Reynolds American, and the impact of the MSA-related allocable
share legislation and the tobacco quota buyout, and |
|
|
|
|
Pressure on volume and market share for discount cigarettes such as those sold by
Liggett due to increases in volume and 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 both menthol and non-menthol styles. Each QUEST style
(regular and menthol) offers three different packagings, with decreasing
- 48 -
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 box style packs and are priced comparably 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 point-of-purchase awareness campaigns and other store-related promotions.
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 have taken 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 January 2004, QUEST and QUEST Menthol were
introduced into an expansion market in Arizona, which accounts for approximately 2% of the industry
volume nationwide.
During the second quarter 2004, based on an analysis of the market data obtained since the
introduction of the QUEST product, we determined to postpone indefinitely the national launch of
QUEST. Any determination as to future expansion of the market presence of QUEST will be based on
the ongoing and projected demand for the product, market conditions in the premium segment and the
prevailing regulatory environment, including any restrictions on the advertising of the product.
During the second quarter 2004, we recognized a non-cash charge of $37,000 to adjust the
carrying value of excess leaf tobacco inventory for the QUEST product, based on estimates of future
demand and market conditions. If actual demand for the product or market conditions are less
favorable than those estimated, additional inventory write-downs may be required.
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.
In October 2003, we announced that Jed E. Rose, Ph.D., Director of Duke University Medical
Centers 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. We
have received guidance from the Food and Drug Administration as to the additional clinical research
and regulatory filings necessary to market QUEST as a smoking cessation product. We are currently
conducting a multi-centered clinical trial with QUEST cigarettes, which should be completed by the
end of the first quarter of 2006. Management believes that obtaining the Food and Drug
Administrations approval to market QUEST as a smoking cessation product will be an important
factor in the long-term commercial success of the QUEST brand. No assurance can be given that such
approval can be obtained or as to the timing of any such approval if received.
- 49 -
Recent Developments
New Valley Exchange Offer. On October 20, 2005, VGR Holding Inc., a direct wholly-owned
subsidiary of ours, made an offer to the holders of common shares of New Valley to exchange 0.461
shares of our common stock (and cash instead of fractional shares) for each outstanding common
share of New Valley validly tendered and not withdrawn in the exchange offer. If New Valleys
stockholders choose to tender their shares, we would issue approximately 4.4 million shares of our
common stock to complete the transaction. We currently own approximately 57.7% of all of the
outstanding common shares of New Valley. The offer is subject to the non-waivable condition that,
after giving effect to the offer, we own at least 90% of the total number of outstanding common
shares of New Valley. If this minimum tender condition is satisfied, more than a majority of the
minority stockholders (i.e., stockholders unaffiliated with us and our subsidiaries and
stockholders who are not directors or officers of New Valley) will have also validly tendered and
not properly withdrawn their common shares of New Valley in the offer. The offer is also subject
to approval by our stockholders of the issuance of certain shares of our common stock to be issued
in the offer and to other customary conditions. The offer will expire on December 9, 2005, unless
it is extended by us. If we complete the offer, we intend to effect a short form merger of New
Valley with and into a wholly-owned subsidiary of ours shortly thereafter. Each common share of
New Valley not acquired in the offer, other than the shares owned by us, would be converted in the
short form merger into 0.461 shares of our common stock and cash instead of fractional shares.
On or about September 29, 2005, an individual stockholder of New Valley filed a complaint in
the Delaware Court of Chancery purporting to commence a class action lawsuit against our company,
New Valley and each of the individual directors of New Valley. The complaint was styled as Pill v.
New Valley Corporation, et al. (C.A. No. 1678-N). On or about September 29, 2005, a separate
action was filed in the Circuit Court of the Eleventh Judicial Circuit in and for Miami-Dade
County, Florida styled as Tombs v. New Valley Corporation, et al. (Case No. 05-19623 CA 22). On or
about October 28, 2005, an additional action was filed in the Delaware Court of Chancery styled as
Lindstrom v. LeBow, et al. (C.A. No. 1745-N). In general, the complaints allege, among other
things: (1) breaches of fiduciary duty by our company, New Valley and the members of New Valleys
board in connection with the offer and the subsequent merger; (2) that the consideration we are
offering is inadequate; and (3) that we are acting to further our own interests at the expense of
the holders of New Valleys common shares. Among other remedies, the complaints seek to enjoin the
offer and the subsequent merger or, alternatively, damages in an unspecified amount and rescission
in the event the merger occurs. We are not aware of any purported class action complaints other
than those referenced above. In the Tombs matter, on or about November 3, 2005, the plaintiffs filed an
amended complaint. On or about October 21, 2005, the plaintiffs
moved to expedite discovery and that motion, which was opposed by the
defendants, was heard on November 8, 2005. Further argument has
been set for November 10, 2005. Plaintiffs have filed a motion to
consolidate the Pill and Lindstrom cases, and the
Pill plaintiff has filed a motion to certify the case, which
motions defendants do not oppose. In the Pill matter, we filed an answer on or about October 25, 2005. On or about
November 1, 2005, the plaintiffs moved (i) to amend their
complaint to, among other things, add VGR Holding as a defendant, (ii) for a preliminary
injunction, and (iii) for expedited discovery. Defendants have agreed that the amended
complaint may be filed with the Delaware Court of Chancery and have
agreed to a discovery schedule, as a result of which plaintiff is no
longer proceeding with his motion to expedite discovery. We believe that each of these lawsuits is without merit and will defend against
each lawsuit.
Issuance of Convertible Notes. In November 2004, we sold $65,500 of our 5% variable interest
senior convertible notes due November 15, 2011 in a private offering to qualified institutional
investors in accordance with Rule 144A under the Securities Act of 1933. The buyers of the notes
had the right, for a 120-day period ending March 18, 2005, to purchase an additional $16,375 of the
notes. At December 31, 2004, buyers had exercised their rights to purchase an additional $1,405 of
the notes, and the remaining $14,959 principal amount of notes were purchased during the first
quarter of 2005. In April 2005, we issued an additional $30,000 principal amount of 5% variable
interest senior convertible notes due November 15, 2011 in a separate private offering to qualified
institutional investors in accordance with Rule 144A. These notes, which were issued under a new
indenture at a price of 103.5%, were on the same terms as
- 50 -
the $81,864 principal amount of notes previously issued in connection with the November 2004
placement.
Ladenburg Distribution. In March 2005, New Valley converted a convertible note of Ladenburg
Thalmann Financial Services Inc. into 19,876,358 shares of Ladenburg common stock and purchased
11,111,111 Ladenburg shares for $5,000. In the first quarter 2005, New Valley recorded a gain of
$9,461 which represented the fair value of the converted shares as determined by an independent
appraisal firm. On March 30, 2005, New Valley distributed the 19,876,358 shares of Ladenburg
common stock it acquired from the conversion of the note to holders of New Valley common shares
through a special distribution. On the same date, we distributed the 10,947,448 shares of Ladenburg
common stock that we received from New Valley to the holders of our common stock as a special
distribution. New Valley stockholders of record on March 18, 2005 received 0.852 of a Ladenburg
share for each share of New Valley, and our stockholders of record on that date received 0.24 of a
Ladenburg share for each share of ours.
Lawsuit Settlement. In March 2005, we, along with New Valley and its directors, settled a
stockholder derivative suit that alleged, among other things, that New Valley paid excessive
consideration to purchase our BrookeMil Ltd. subsidiary in 1997. For additional information
concerning the suit, see Note 7 to our consolidated financial statements. The defendants did not
admit any wrongdoing as part of the settlement, which was approved by the court in June 2005.
Under the agreement, we paid New Valley $7,000 in July 2005, and New Valley paid legal fees and
expenses of $2,150. We recorded a charge to operating, selling, administrative and general expense
in 2004 of $4,177 (net of minority interests) related to the settlement.
Tobacco Quota Elimination. In October 2004, federal legislation was enacted which abolished
the federal tobacco quota and price support program. Pursuant to the legislation, manufacturers of
tobacco products will be assessed $10,140,000 over a ten year period to compensate tobacco growers
and quota holders for the elimination of their quota rights. Cigarette manufacturers will
initially be responsible for 96.3% of the assessment (subject to adjustment in the future), which
will be allocated based on relative unit volume of domestic cigarette shipments. Management
currently estimates that Liggetts assessment will be approximately $25,000 for the first year of
the program which began January 1, 2005, including a special federal quota stock liquidation
assessment of $5,219. The cost of the legislation to the three largest cigarette manufacturers
will likely be less than the cost to smaller manufacturers, including Liggett and Vector Tobacco,
because one effect of the legislation is that the three largest manufacturers will no longer be
obligated to make certain contractual payments, commonly known as Phase II payments, they agreed in
1999 to make to tobacco-producing states. The ultimate impact of this legislation cannot be
determined, but there is a risk that smaller manufacturers, such as Liggett and Vector Tobacco,
will be disproportionately affected by the legislation, which could have a material adverse effect
on us.
Effective October 22, 2004, Liggett increased the list price of all its brands by $.65 per
carton. The increase was taken due to the federal tobacco buyout legislation.
Liggett Vector Brands Restructurings. Liggett Vector Brands, as part of the continuing effort
to adjust the cost structure of our tobacco business and improve operating efficiency, eliminated
83 positions during April 2004, sublet its New York office space and relocated several employees.
As a result of these actions, we recognized pre-tax restructuring charges of $2,735 in 2004,
including $798 relating to employee severance and benefit costs and $1,937 for contract termination
and other associated costs. Approximately $503 of these charges represent non-cash items.
On October 6, 2004, we announced an additional plan to restructure the operations of Liggett
Vector Brands, our sales, marketing and distribution agent for our Liggett and Vector Tobacco
subsidiaries. Liggett Vector Brands has realigned its sales force and adjusted its business model
to more efficiently serve its chain and independent accounts nationwide. In
- 51 -
connection with the restructuring, we eliminated approximately 330 full-time positions and 135
part-time positions as of December 15, 2004.
As a result of the actions announced in October 2004, we currently expect to realize annual
cost savings of approximately $30,000 beginning in 2005. Expenses at
Liggett were $39,279 for the nine months ended September 30,
2005, compared to $64,419 for the same period in 2004, a decrease of
$25,140 primarily attributable to the restructuring announced in
October 2004. We recognized pre-tax restructuring
charges of $10,583 in 2004, with $5,659 of the charges related to employee severance and benefit
costs and $4,924 to contract termination and other associated costs. Approximately $2,503 of these
charges represented non-cash items. Additionally, we incurred other charges in 2004 for various
compensation and related payments to employees which were related to the restructuring. These
charges of $1,670 were included in operating, selling, administrative and general expenses.
Timberlake Restructuring. In October 2003, we announced that we would close Vector Tobaccos
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 Tobaccos other
cigarette brands, was moved to Liggetts state-of-the-art manufacturing facility in Mebane, North
Carolina.
Annual cost savings related to the Timberlake restructuring and impairment charges and the
actions taken at Liggett Vector Brands in the first half of 2004 were estimated to be at least
$23,000 beginning in 2004. Management believes the anticipated annual cost savings have been
achieved beginning in 2004. Management will continue to review opportunities for additional cost
savings in our tobacco business.
Tax Matters. In connection with the 1998 and 1999 transaction with Philip Morris Incorporated
in which 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
$126,000, including interest, net of tax benefits, through September 30, 2005. These amounts have
been previously recognized in our consolidated financial statements as tax liabilities. As of
September 30, 2005, 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
9%, 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
- 52 -
payments prior to 2009 or 2010, and if any necessary financing were not available to us, our
liquidity could be materially adversely affected.
Tobacco Settlement Agreements. Liggett has recently been notified that all Participating
Manufacturers payment obligations under the Master Settlement Agreement, dating from the
agreements execution in late 1998, have been recalculated utilizing net unit amounts, rather than
gross unit amounts (which have been utilized since 1999). The change in the method of calculation
could, among other things, require additional payments by Liggett under the Master Settlement
Agreement of approximately $2,300 per year for the period 2001 through 2004, or a total of
approximately $9,200, and require Liggett to pay an additional amount of approximately $2,400 per
year in 2005 and in future periods by lowering Liggetts market share exemption under the Master
Settlement Agreement. Liggett contends that the retroactive change from utilizing gross unit
amounts to net unit amounts is impermissible and has objected to the change. Liggett intends to
challenge the change in methodology.
On March 30, 2005, the Independent Auditor under the Master Settlement Agreement calculated
$28,668 in Master Settlement Agreement payments for Liggetts 2004 sales. On
April 15, 2005, Liggett paid $11,678 of this amount and, in accordance with its rights under
the Master Settlement Agreement, disputed the balance of $16,990. Of the disputed amount, Liggett
paid $9,304 into the disputed payments account under the Master Settlement Agreement and withheld
from payment $7,686. The $9,304 paid into the disputed payments account represents the amount
claimed by Liggett as an adjustment to its 2003 payment obligation under the Master Settlement
Agreement for market share loss to non-participating manufacturers. At
September 30, 2005, included in Other current assets on our balance sheet was a receivable
of $6,513 relating to such amount. The $7,686 withheld from payment represents $5,318 claimed as
an adjustment to Liggetts 2004 Master Settlement Agreement obligation for market share loss to
non-participating manufacturers and $2,368 relating to the retroactive change, discussed above, to
the method for computing payment obligations under the Master Settlement Agreement which Liggett
contends, among other things, is not in accordance with the Master Settlement Agreement. On May
31, 2005, New York State filed a motion on behalf of the Settling States in New York state court
seeking to compel Liggett and the other Subsequent Participating Manufacturers that paid into the
disputed payments account to release to the Settling States the amounts paid into such account.
The Settling States contend that Liggett had no right under the Master Settlement Agreement and
related agreements to pay into the disputed payments account any amount claimed as an adjustment
for market share loss to non-participating manufacturers for 2003, although they acknowledge that
Liggett has the right to dispute such amounts. By stipulation among the parties dated July 25,
2005, New Yorks motion was dismissed and Liggett authorized the release to the Settling States of
the $9,304 it had paid into the account, although Liggett continues to dispute that it owes this
amount.
In 2004, the Attorneys General for each of Florida, Mississippi and Texas advised Liggett that
they believed that Liggett had failed to make all required payments under the settlement agreements
with these three states for the period 1998 through 2003 and that additional payments might be due
for 2004 and subsequent years. Liggett believes these allegations are without merit, based, among
other things, on the language of the most-favored nation provisions of the settlement agreements.
In December 2004, the State of Florida offered to settle all amounts allegedly owed by Liggett for
the period through 2003 for the sum of $13,500. In November 2004, the State of Mississippi offered
to settle all amounts allegedly owed by Liggett for the period through 2003 for the sum of $6,500.
In March 2005, the State of Florida reaffirmed its December 2004 offer to settle and provided
Liggett with a 60 day notice to cure the alleged defaults. In April 2005, the State of Mississippi
reaffirmed its November 2004 offer to settle and provided Liggett with a 60 day notice to cure the
alleged defaults. Liggett has met with representatives of the three states to discuss the issues
relating to the alleged defaults. No resolution has been reached.
- 53 -
No amounts have been accrued in the accompanying financial statements for any additional
amounts that may be payable by Liggett under the Master Settlement Agreement, due to the
recalculation of the Participating Manufacturers payment obligations, or under the settlement
agreements with Florida, Mississippi and Texas. There can be no assurance that Liggett will
prevail in any of these matters and that Liggett will not be required to make additional material
payments, which payments could adversely affect our consolidated financial position, results of
operations or cash flows.
Real Estate Activities. 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). In
February 2005, New Valley completed the sale of the office buildings for $71,500. The mortgage
loan on the properties was retired at closing with the proceeds of the sale.
New Valley accounts for its 50% interests in Douglas Elliman Realty LLC, Koa Investors LLC and
16th & K Holdings LLC on the equity method. Douglas Elliman Realty operates the largest
residential brokerage company in the New York metropolitan area. Koa Investors LLC owns the
Sheraton Keauhou Bay Resort & Spa in Kailua-Kona, Hawaii. Following a major renovation, the
property reopened in the fourth quarter 2004 as a four star resort with 521 rooms. In August 2005,
16th
& K Holdings LLC acquired the St. Regis Hotel, a 193 room luxury
hotel in Washington, D.C., for $47,000.
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
September 30, 2005, there were approximately 278 individual suits, 11 purported class actions
and 8 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 was filed by the United
States federal government seeking disgorgement of approximately $289,000,000 from various cigarette
manufacturers, including Liggett. A federal appellate court ruled in February 2005 that
disgorgement is not an available remedy in the case. In October 2005, the United States Supreme
Court declined to review this decision. Trial of the case concluded on June 15, 2005. On June 27,
2005, the government sought to restructure its potential remedies and filed a proposed Final
Judgment and Order. That relief can be grouped into four categories: (1) $14,000,000 for a
cessation and counter marketing program; (2) so-called corrective statements; (3) disclosures;
and (4) enjoined activities. The parties are expected to complete post-trial submissions during
November 2005. In one of the other cases pending against Liggett, in 2000, an action against
cigarette manufacturers involving approximately 1,000 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. Two purported class actions have been certified in state court in Kansas and New Mexico
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.
There are seven individual smoking-related actions where Liggett is the only defendant, with
trial in one of these cases currently scheduled for November 2005. In April 2004, in one of these
cases, a Florida state court jury awarded compensatory damages of $540 against Liggett. In
addition, plaintiffs counsel was awarded legal fees of $752. Liggett has appealed the verdict.
In February 2005, in another of these cases, a Florida state court jury returned a verdict in favor
of Liggett. In July 2005, the court denied the plaintiffs post-trial motion seeking a new trial.
The plaintiff may appeal. In March 2005, in another case in Florida state court where Liggett is
the
- 54 -
only defendant, the court granted Liggetts motion for summary judgment disposing of the case
in its entirety. The plaintiff has appealed.
In May 2003, a Florida intermediate appellate court overturned a $790,000 punitive damages
award against Liggett and decertified the Engle smoking and health class action. In May 2004, the
Florida Supreme Court agreed to review the case, and oral argument was held in November 2004. If
the intermediate appellate courts ruling is not upheld on 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
agreement, Liggett paid $6,273 into an escrow account to be held for the benefit of the Engle
class, and released, along with Liggetts 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 courts 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. Liggett may
enter into discussions in an attempt to settle particular cases if it believes it is appropriate to
do so. Management cannot predict the cash requirements related to any future settlements and
judgments, including cash required to bond any appeals, and there is a risk that those requirements
will not be able to be met.
Federal or state regulators may object to Vector Tobaccos low nicotine and nicotine-free
cigarette products and reduced risk cigarette products it may develop 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 Tobaccos
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 and Vector Tobacco
has agreed to suspend all print advertising for its QUEST brand while discussions are pending. If
Vector Tobacco is unable to advertise its QUEST brand, it could have a material adverse effect on
sales of QUEST. Allegations by federal or state regulators, public health organizations and other
tobacco manufacturers that Vector Tobaccos 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.
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 7 to our consolidated financial statements for a description of legislation, regulation and
litigation.
- 55 -
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, embedded derivative
liability, the tobacco quota buyout, 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, when 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 any 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.
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 a reduction in revenue in the period in which these programs are offered, based on
estimates of utilization and redemption rates that are developed from historical information.
Restructuring and Asset Impairment Charges. We have recorded charges related to employee
severance and benefits, asset impairments, contract termination and other associated exit costs
during 2002, 2003 and 2004. The calculation of severance pay requires management to identify
employees to be terminated and the timing of their severance from employment. The calculation of
benefits charges requires actuarial assumptions including determination of discount rates. As
discussed further below, the asset impairments were recorded in accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, which requires management to
estimate the fair value of assets to be disposed of. On January 1, 2003, we adopted SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities. Charges related to
restructuring activities initiated after this date were recorded when incurred. Prior to this
date, charges were recorded at the date of an entitys commitment to an exit plan in accordance
with EITF 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to
Exit an Activity (including Certain Costs Incurred in a Restructuring). These restructuring
charges are based on managements best estimate at the time of restructuring. The status of the
restructuring activities is reviewed on a quarterly basis and any adjustments to the reserve, which
could differ materially from previous estimates, are recorded as an adjustment to operating income.
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. The
estimate of fair value of our long-lived assets is based on the best information available,
including prices for similar assets and the results of using other valuation techniques. Since
- 56 -
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.
In October 2003, we announced that we would close Vector Tobaccos Timberlake, North Carolina
cigarette manufacturing facility and produce its cigarette products at Liggetts Mebane, North
Carolina facility. We evaluated the net realizable value of the long-lived assets located at the
Timberlake facility which has been sold. Based on managements estimates of the values, we
initially recognized non-cash asset impairment charges of $18,752 in the third quarter of 2003 on
machinery and equipment. As of June 30, 2004, we decreased the asset impairment accrual to reflect
the actual amounts to be realized from the Timberlake sale and to reduce values of other excess
machinery and equipment in accordance with SFAS No. 144.
Contingencies. We record Liggetts product liability legal expenses and other litigation
costs as operating, selling, general and administrative expenses as those costs are incurred. As
discussed in Note 7 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 7 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 $10,988 for the nine months ended September 30, 2005 and
$14,813 for the nine months ended September 30, 2004. Adjustments to these estimates are recorded
in the period that the change becomes probable and the amount can be reasonably estimated.
Derivatives; Beneficial Conversion Feature. We measure all derivatives, including certain
derivatives embedded in other contracts, at fair value and recognize them in the consolidated
balance sheet as an asset or a liability, depending on our rights and obligations under the
applicable derivative contract. In November 2004, we issued in a private placement 5% variable
interest senior convertible notes due 2011 where a portion of the total interest payable on the
notes is computed by reference to the cash dividends paid on our common stock. (In December 2004
and during the first half of 2005, we issued additional notes on the same terms.) This portion of
the interest payment is considered an embedded derivative. Pursuant to SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for
Certain Derivative Instruments and Certain Hedging Activities, we have bifurcated this dividend
portion of the interest on the notes and, based on a valuation by an independent third party,
estimated the fair value of the embedded derivative liability. At the initial issuance of the
notes in November 2004, the estimated initial fair value of the embedded derivative liability was
$24,738, which was recorded as a discount to the notes and classified as a derivative liability on
the consolidated balance sheet. At September 30, 2005, with the issuance of $46,364 of additional
notes, the derivative liability was estimated at $40,194. Changes to the
- 57 -
fair value of this embedded derivative are reflected quarterly as an adjustment to interest
expense.
After giving effect to the recording of the embedded derivative liability as a discount to the
notes, our common stock had a fair value at the issuance date of the notes in excess of the
conversion price resulting in a beneficial conversion feature. Emerging Issues Task Force (EITF)
No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Convertible Ratios, requires that the intrinsic value of the beneficial
conversion feature ($22,075 at September 30, 2005) be recorded to additional paid-in capital and as
a discount on the notes. The discount is then amortized to interest expense over the term of the
notes using the effective interest rate method.
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. 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. At September 30, 2005, approximately $1,309 of our leaf
inventory was associated with Vector Tobaccos QUEST product. During the second quarter of 2004,
we recognized a non-cash charge of $37,000 to adjust the carrying value of excess leaf tobacco
inventory for the QUEST product, based on estimates of future demand and market conditions. If
actual demand for the product or market conditions are less favorable than those estimated,
additional inventory write-downs may be required.
Employee Benefit Plans. 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.
Net pension expense for defined benefit pension plans and other postretirement benefit expense
aggregated approximately $4,500 for 2004, and we currently anticipate such expense will be
approximately $4,250 for 2005. In contrast, our funding obligations under the pension plans are
governed by ERISA. To comply with ERISAs 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, 2005 and ending on December 31, 2005. 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 Valleys common shares was
57.7% at September 30, 2005.
For purposes of this discussion and other consolidated financial reporting, our significant
business segments for the nine months ended September 30, 2005 and 2004 were Liggett and
- 58 -
Vector Tobacco. 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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
Sept. 30, |
|
|
Sept. 30 |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liggett |
|
$ |
122,718 |
|
|
$ |
120,793 |
|
|
$ |
334,582 |
|
|
$ |
358,565 |
|
Vector Tobacco |
|
|
2,247 |
|
|
|
3,458 |
|
|
|
7,669 |
|
|
|
12,304 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
$ |
124,965 |
|
|
$ |
124,251 |
|
|
$ |
342,251 |
|
|
$ |
370,869 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liggett |
|
$ |
31,478 |
(1) |
|
$ |
27,228 |
(2) |
|
$ |
97,693 |
(1) |
|
$ |
80,379 |
(3) |
Vector Tobacco |
|
|
(4,115 |
)(1) |
|
|
(3,623 |
)(2) |
|
|
(11,295 |
)(1) |
|
|
(56,770 |
)(3) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total tobacco |
|
|
27,363 |
(1) |
|
|
23,605 |
(2) |
|
|
86,398 |
(1) |
|
|
23,609 |
(3) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate and other |
|
|
(7,387 |
) |
|
|
(6,890 |
) |
|
|
(23,412 |
) |
|
|
(19,952 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating income |
|
$ |
19,976 |
(1) |
|
$ |
16,715 |
(2) |
|
$ |
62,896 |
(1) |
|
$ |
3,657 |
(3) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Includes a special federal quota stock liquidation assessment under the
federal tobacco buyout legislation of $5,219 ($5,150 at Liggett and $69 at Vector
Tobacco). |
|
(2) |
|
Includes restructuring and impairment charges of $3,968 at Liggett and $564 at
Vector Tobacco. |
|
(3) |
|
Includes restructuring and impairment charges of $6,320 at Liggett and $1,224
at Vector Tobacco and a $37,000 inventory charge at Vector Tobacco. |
Three Months Ended September 30, 2005 Compared to Three Months Ended September 30,
2004
Revenues. Total revenues were $124,965 for the three months ended September 30, 2005 compared
to $124,251 for the three months ended September 30, 2004. This $714 (0.6%) increase in revenues
was due to a $1,925 (1.6%) increase in revenues at Liggett and a $1,211 (35.0%) decrease in
revenues at Vector Tobacco.
Tobacco Revenues. In August 2004, Liggett increased its list price on LIGGETT SELECT by $1.00
per carton. In October 2004, Liggett increased the list price of all its brands by $.65 per
carton.
Effective February 1, 2004, Liggett reduced the list prices for EVE and JADE from the premium
price level to the branded discount level, in the case of EVE, and the deep discount level, in the
case of JADE. During 2003, the net list price for JADE had been at the deep discount level after
giving effect to off-invoice promotional spending. In August 2004, the list price for JADE was
increased by $1.35 per carton.
All of Liggetts sales for the first nine months of 2005 were in the discount category. For
the three months ended September 30, 2005, net sales at Liggett totaled $122,718, compared to
$120,793 for the three months ended September 30, 2004. Revenues increased by 1.6% ($1,925) due to
a combination of list price increases and reduced promotional spending of $4,111 partially offset
by a 0.4% decrease in sales volume (approximately 8.4 million units) accounting
- 59 -
for $464 in unfavorable volume variance and an unfavorable sales mix of $1,722. Net revenues of the
LIGGETT SELECT brand decreased $12,265 in the third quarter of 2005 compared to the third quarter
of 2004, and its unit volume decreased 23.9% in the 2005 period compared to 2004. Unit sales
volume for Liggett has been affected by the strategic changes in distribution associated with the
restructuring at Liggett Vector Brands in the fourth quarter of 2004, partially offset by the
introduction of GRAND PRIX in September 2005.
Revenues at Vector Tobacco for the three months ended September 30, 2005 were $2,247 compared
to $3,458 for the three months ended September 30, 2004 due to decreased sales volume. Vector
Tobaccos sales in both periods related to sales of QUEST.
Tobacco Gross Profit. Tobacco gross profit was $47,085 for the three months ended September
30, 2005 compared to $53,134 for the three months ended September 30, 2004. This represented a
decrease of $6,049 or 11.4% when compared to the same period last year, due primarily to the
decrease in Liggetts gross profit discussed below. Liggetts brands contributed 98.7% to our
gross profit, and Vector Tobacco contributed 1.3% for the three months ended September 30, 2005.
Over the same period in 2004, Liggett brands contributed 98.6% to our gross profit and Vector
Tobacco contributed 1.4%.
Liggetts gross profit of $46,487 for the three months ended September 30, 2005 decreased
$5,906 from gross profit of $52,393 for the three months ended September 30, 2004. As a percent of
revenues (excluding federal excise taxes), gross profit at Liggett decreased to 57.5% for the three
months ended September 30, 2005 compared to 66.7% for the same period in 2004. This decrease in
Liggetts gross profit in the 2005 period was primarily attributable to costs under the federal
tobacco buyout legislation, including a special federal quota stock liquidation assessment of
$5,150, partially offset by lower Master Settlement Agreement costs and increased prices discussed
above.
Vector Tobacco had gross profit of $598 for the three months ended September 30, 2005 compared
to gross profit of $741 for the same period in 2004. This decrease was due primarily to reduced
sales volume.
Expenses. Operating, selling, general and administrative expenses were $27,109 for the three
months ended September 30, 2005 compared to $31,887 for the same
period last year, a decrease of $4,778 or 15.0%. Expenses at Liggett were
$15,009 for the three months ended September 30, 2005 compared to $21,197 for the same period in
the prior year, a decrease of $6,188 or 29.2%. The decrease in expense for the three months ended
September 30, 2005 was due primarily to the lower expenses of a reduced sales force resulting from
the 2004 restructuring. Liggetts product liability legal expenses and other litigation costs were
$1,264 for the three months ended September 30, 2005 compared to $1,124 for the same period in the
prior year. Expenses at Vector Tobacco for the three months ended September 30, 2005 were $4,713
compared to expenses of $3,800 for the three months ended September 30, 2004, an increase of $913,
due primarily to increased research costs.
Restructuring
and impairment charges for the three months ended September 30,
2004 were $3,968 at Liggett and $564 at Vector Tobacco, a total of
$4,532,
and relate to the closing of the Timberlake facility, sales force reductions and the loss on the
sublease of Liggett Vector Brands New York office space.
For the three months ended September 30, 2005, Liggetts operating income increased to $31,478
compared to $27,228 for the same period in 2004 due primarily to the reduced operating, selling,
general and administrative expenses partially offset by the impact of costs under the federal
tobacco buyout legislation, including the special federal quota stock liquidation assessment
discussed above. Vector Tobaccos operating loss was $4,115 for the three months
- 60 -
ended September 30, 2005 compared to a loss of $3,623 for the same period in 2004. Liggetts
operating income for the 2004 period included restructuring charges of $3,968, and Vector Tobaccos
operating loss included restructuring charges of $564.
Other Income (Expenses). For the three months ended September 30, 2005, other income
(expenses) was a loss of $2,681 compared to a loss of $1,216 for the three months ended September
30, 2004. For the three months ended September 30, 2005, interest expense of $8,266 was offset by
interest and dividend income of $1,380 and equity income from non-consolidated New Valley real
estate businesses of $4,184. The equity income resulted primarily from income of $4,229 related to
New Valleys investment in Douglas Elliman Realty LLC offset by losses at New Valley of $58 related
to its investment in Koa Investors LLC, which owns the Sheraton Keauhou Bay Resort and Spa in
Kailua-Kona, Hawaii. For the three months ended September 30, 2004, interest expense of $6,378,
was partially offset by equity income from non-consolidated New Valley real estate businesses of
$4,539, interest and dividend income of $322 and a gain on investments of $302.
Income from Continuing Operations. The income from continuing operations before income taxes
and minority interests for the three months ended September 30, 2005 was $17,295 compared to income
of $15,499 for the three months ended September 30, 2004. The income tax provision was $7,541 and
minority interests in income of subsidiaries was $779 for the three months ended September 30,
2005. This compared to an income tax provision of $6,708 and minority interests in income of
subsidiaries of $837 for the three months ended September 30, 2004. Our income tax rate for the
three months ended September 30, 2005 does not bear a customary relationship to statutory income
tax rates as a result of the impact of nondeductible expenses and state income taxes. Our tax rate
for the three months ended September 30, 2004 does not bear a customary relationship to statutory
income tax rates as a result of the impact of nondeductible expenses, state income taxes and the
intraperiod allocation at New Valley between income from continuing and discontinued operations.
Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2004
Revenues. Total revenues were $342,251 for the nine months ended September 30, 2005 compared
to $370,869 for the nine months ended September 30, 2004. This $28,618 (7.7%) decrease in revenues
was due to a $23,983 (6.7%) decrease in revenues at Liggett and a $4,635 (37.7%) decrease in
revenues at Vector Tobacco.
Tobacco Revenues. In August 2004, Liggett increased its list price on LIGGETT SELECT by $1.00
per carton. In October 2004, Liggett increased the list price of all its brands by $.65 per
carton.
Effective February 1, 2004, Liggett reduced the list prices for EVE and JADE from the premium
price level to the branded discount level, in the case of EVE, and the deep discount level, in the
case of JADE. During 2003, the net list price for JADE was at the deep discount level after giving
effect to off-invoice promotional spending. In August 2004, the list price for JADE was increased
by $1.35 per carton.
All of Liggetts sales for the first nine months of 2004 and 2005 were in the discount
category. For the nine months ended September 30, 2005, net sales at Liggett totaled $334,582,
compared to $358,565 for the first nine months of 2004. Revenues decreased by 6.7% ($23,983) due
to a 15.0% decrease in unit sales volume (approximately 1,003.7 million units) accounting for
$53,887 in unfavorable volume variance and $7,278 in unfavorable sales mix, partially offset by a
combination of list price increases and reduced promotional spending of $37,182. Net revenues of
the LIGGETT SELECT brand decreased $31,038 for the nine months ended September 30, 2005 compared to
the same period in 2004, and its unit volume decreased 27.4% in the 2005 period
- 61 -
compared to 2004. Unit sales volume for Liggett has been affected by the strategic changes in
distribution associated with the restructuring at Liggett Vector Brands in the fourth quarter of
2004.
Revenues at Vector Tobacco were $7,669 for the nine months ended September 30, 2005 compared
to $12,304 for the nine months ended September 30, 2004 due to decreased sales volume. Vector
Tobaccos revenues in 2005 and 2004 related primarily to sales of QUEST.
Tobacco Gross Profit. Tobacco gross profit was $139,471 for the nine months ended September
30, 2005 compared to $155,824 for the nine months ended September 30, 2004, excluding the inventory
write-off of $37,000 taken by Vector Tobacco in the second quarter of 2004 to adjust the carrying
value of excess leaf tobacco inventory for the QUEST product. This represented a decrease of
$16,353 or 10.5% when compared to the same period last year, due primarily to the reduced sales
volume net of related reduced promotional spending as well as tobacco quota buyout costs which
included a special federal quota stock liquidation assessment of $5,219. Liggetts brands
contributed 98.1% to our gross profit and Vector Tobacco contributed 1.8% for the nine months ended
September 30, 2005. Over the same period in 2004, Liggetts brands contributed 97.2% to tobacco
gross profit and Vector Tobacco contributed 2.8%.
Liggetts gross profit of $136,972 for the nine months ended September 30, 2005 decreased
$14,146 from gross profit of $151,420 for the nine months ended September 30, 2004. As a percent
of revenues (excluding federal excise taxes), gross profit at Liggett decreased to 61.3% for the
nine months ended September 30, 2005 compared to gross profit of
66.6% for the same period in 2004.
This decrease in Liggetts gross profit in the 2005 period was attributable to higher than
anticipated tobacco quota buyout costs discussed above, partially offset by lower Master Settlement
Agreement costs and increased prices.
Vector Tobaccos gross profit was $2,499 for the nine months ended September 30, 2005 compared
to gross profit, excluding the inventory write-down, of $4,404 for the same period in 2004. The
decrease was due primarily to the reduced sales volume.
Expenses. Operating, selling, general and administrative expenses were $76,485 for the nine
months ended September 30, 2005 compared to $107,623 for the same
period last year, a decrease of $31,138, or 28.9%. Expenses at Liggett were
$39,280 for the nine months ended September 30, 2005 compared to $64,419 for the same period last
year, a decrease of $25,139 or 39.0%. The decrease in expense for the nine months ended September
30, 2005 was due primarily to the lower expenses of a reduced sales force resulting from the 2004
restructuring. Liggetts product liability legal expenses and other litigation costs of $3,715 for
the nine months ended September 30, 2005 compared to $3,677 for the same period in the prior year.
Expenses at Vector Tobacco for the nine months ended September 30, 2005 were $13,794 compared to
expenses of $22,950 for the nine months ended September 30, 2004 due to the sale of the Timberlake
facility in 2004 and the reduction in headcount in the fourth quarter of 2004.
Restructuring
and impairment charges for the nine months ended September 30,
2004 were $6,320 at Liggett and $1,224 at Vector Tobacco, a total of
$7,544,
and relate to the closing of the Timberlake facility, sales force reductions and the loss on the
sublease of Liggett Vector Brands New York office space.
For the nine months ended September 30, 2005, Liggetts operating income increased to $97,693
compared to $80,379 for the prior year period. For the nine months ended September 30, 2005,
Vector Tobaccos operating loss was $11,295 compared to a loss of $56,770 in the prior year period.
Liggetts operating income for the 2004 period included restructuring charges of $6,320, and
Vector Tobaccos operating loss for the 2004 period included the non-cash inventory charge of
$37,000 and restructuring charges of $1,224.
- 62 -
Other Income (Expenses). For the nine months ended September 30, 2005, other income
(expenses) was a loss of $4,029 compared to a loss of $1,397 for the nine months ended September
30, 2004. For the nine months ended September 30, 2005, interest expense of $24,155 and equity
loss in operations of LTS of $299 were partially offset by a gain from conversion of the LTS notes
of $9,461, equity income from non-consolidated real estate businesses of $6,202, interest and
dividend income of $3,260 and a net gain on sale of investments of $1,433. The equity income
resulted primarily from $9,689 related to New Valleys investment in Douglas Elliman Realty offset
by losses of $3,500 related to its investment in Koa Investors. For the nine months ended
September 30, 2004, interest expense of $18,650 was partially offset by interest and dividend
income of $1,548, a gain on investments of $5,888 and equity income from non-consolidated New
Valley real estate businesses of $9,827.
Income from Continuing Operations. The income from continuing operations before income taxes
and minority interests for the nine months ended September 30, 2005 was $58,957 compared to income
of $2,260 for the nine months ended September 30, 2004. The income tax provision was $29,322 and
minority interests in income of subsidiaries was $2,403 for the nine months ended September 30,
2005. This compared to a tax provision of $3,562 and minority interests in income of subsidiaries
of $3,286 for the nine months ended September 30, 2004. Our income tax rate for the nine months
ended September 30, 2005 does not bear a customary relationship to statutory income tax rates as a
result of the impact of nondeductible expenses, state income taxes, the receipt of the LTS
distribution, the intraperiod allocation at New Valley between income from continuing and
discontinued operations and the utilization of deferred tax assets at New Valley. Our tax rate for
the nine months ended September 30, 2004 does not bear a customary relationship to statutory income
tax rates as a result of the impact of nondeductible expenses, state income taxes and the
intraperiod allocation at New Valley between income from continuing and discontinued operations.
Discontinued Operations
In February 2005, New Valley completed the sale for $71,500 of its two office buildings in
Princeton, N.J. As a result of the sale, the consolidated financial statements of the Company
reflect New Valleys real estate leasing operations as discontinued operations for the three and
nine months ended September 30, 2005 and 2004. 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 the discontinued operations have been reported, net of applicable income taxes and
minority interests, as Income from discontinued operations, and the net cash flows of these
entities have been reported as Net cash provided by discontinued operations. The assets of the
discontinued operations were recorded as Assets held for sale in the consolidated balance sheet
at December 31, 2004.
Summarized operating results of the discontinued real estate leasing operations for the three
and nine months ended September 30, 2005 and June 30, 2004 are as follows:
- 63 -
|
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|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
Sept. 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Revenues |
|
$ |
|
|
|
$ |
1,809 |
|
|
$ |
924 |
|
|
$ |
5,401 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses |
|
|
|
|
|
|
1,285 |
|
|
|
515 |
|
|
|
3,658 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from discontinued operations before
income taxes and minority interests |
|
|
|
|
|
|
524 |
|
|
|
409 |
|
|
|
1,743 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense from discontinued
operations |
|
|
|
|
|
|
287 |
|
|
|
223 |
|
|
|
940 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority interests |
|
|
|
|
|
|
125 |
|
|
|
104 |
|
|
|
424 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from discontinued operations |
|
$ |
|
|
|
$ |
112 |
|
|
$ |
82 |
|
|
$ |
379 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company recorded a gain in connection with the sale of the office buildings of $2,952, net
of minority interests ($3,725) and income taxes ($8,008) in the first quarter 2005.
Liquidity and Capital Resources
Net
cash and cash equivalents increased $48,960 for the nine months ended September 30,
2005 and increased $22,692 for the nine months ended September 30, 2004.
Net
cash provided by operations for the nine months ended
September 30, 2005 was $27,401
compared to net cash used in operations of $6,194 for the comparable period of 2004. Cash provided
by operations for the 2005 period resulted primarily from the
operating income of $62,986 and depreciation and amortization of
$8,281, and non-cash interest
expense partially offset by a gain on conversion of the LTS notes, a decrease in current liabilities
and an increase in receivables.
Cash used in operations for the 2004 period resulting primarily from
payment of amounts due under the Master Settlement Agreement in March and April of 2004,
a decrease in current liabilities, a non-cash gain in investment
securities and equity income from non-consolidated real estate
business, offset primarily by the non-cash charge on the inventory
write-down of $37,000.
Cash
used in investing activities was $7,366 for the nine months ended September 30, 2005
compared to cash provided of $76,896 for the 2004 period. In the 2005 period, cash was used
primarily for capital expenditures of $5,164, purchase of investment
securities of $500,
investment in non-consolidated real estate businesses at New Valley
of $6,250, issuance of LTS common stock for $1,500 and issuance of
LTS notes for $1,750. This was partially offset by the sale
or maturity of investment securities of $3,268, the distributions
from non-consolidated real estate businesses at New Valley of $5,500 and the
increase in restricted assets of $842. In the nine months ended September 30, 2004, cash
was provided primarily through the sale or maturity of investment securities for $65,454, the sale
of assets for $25,821 and the decrease in restricted cash of $1,832. This was partially offset
by the purchase of investment securities for $10,747, investment in non-consolidated real
estate businesses of $2,500 and capital expenditures of $3,005.
Cash
provided by financing activities was $491 for the nine months ended September 30,
2005 compared to cash used of $49,993 for the 2004 period. In the 2005 period, cash was provided
by proceeds from debt of $44,959 and proceeds from the exercise of
options of $2,778, net borrowings under Liggetts revolver of
$8,727 offset by distributions on common stock of $50,326, repayments on debt
of $3,542 and deferred financing charges of $2,168. In the nine months ended
September 30, 2004, cash was used for dividends of $47,397 and
- 64 -
repayments
of debt of $20,246. These were offset by net borrowings under the revolver of
$15,490 and proceeds from the exercise of options of $2,868.
Liggett. Liggett has a $50,000 credit facility with Wachovia Bank, N.A. A total of $9,092
was outstanding under the facility at September 30, 2005. Availability as determined under the
facility was approximately $21,864 based on eligible collateral at September 30, 2005. The
facility is collateralized by all inventories and receivables of Liggett and a mortgage on its
manufacturing facility. Borrowings under the facility bear interest at a rate equal to 1.0% above
the prime rate of Wachovia. The facility requires Liggetts compliance with certain financial and
other covenants including a restriction on Liggetts ability to pay cash dividends unless Liggetts
borrowing availability under the facility for the 30-day period prior to the payment of the
dividend, and after giving effect to the dividend, is at least $5,000 and no event of default has
occurred under the agreement, including Liggetts compliance with the covenants in the credit
facility, including an adjusted net worth and working capital requirement. In addition, the
facility imposes requirements with respect to Liggetts adjusted net worth (not to fall below
$8,000 as computed in accordance with the agreement) and working capital (not to fall below a
deficit of $17,000 as computed in accordance with the agreement). At September 30, 2005, Liggett
was in compliance with all covenants under the credit facility; Liggetts adjusted net worth was
$64,554 and net working capital was $43,771, as computed in accordance with the agreement.
100 Maple LLC, a company formed by Liggett in 1999 to purchase its Mebane, North Carolina
manufacturing plant, has a term loan of $3,714 outstanding as of September 30, 2005 under Liggetts
credit facility. The remaining balance of the term loan is payable in monthly installments of $77
with a final payment on June 1, 2006 of $3,099. Interest is charged at the same rate as applicable
to Liggetts credit facility, and the outstanding balance of the term loan reduces the maximum
availability under the credit facility. Liggett has guaranteed the term loan, and a first mortgage
on the Mebane property and manufacturing equipment collateralizes the term loan and Liggetts
credit facility.
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 through April 2005 of $22 with an effective interest rate of 10.20%. The notes were
paid in full during the first half of 2005.
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 interest rate of
LIBOR plus 2.8%. 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 interest rate of LIBOR plus 2.8%. 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%. Each
of these equipment loans is collateralized by the purchased equipment.
During 2003, Liggett leased three 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
October 2005, Liggett purchased the equipment for $871.
- 65 -
In July 2003, Liggett granted an unaffiliated third party an option to purchase Liggetts
former manufacturing facility and other excess real estate in Durham, North Carolina with a net
book value at September 30, 2005 of approximately $2,212. The option agreement, as amended in
October 2005, permits the purchaser to acquire the property during the period expiring December 15,
2005, at a purchase price of $15,450. At September 30, 2005, Liggett had received nonrefundable
option fees of $1,625 (increased to $1,775 after the October 2005 amendment to the agreement),
creditable against the purchase price. The purchaser has the right on or prior to December 9, 2005
to further extend the closing date to January 31, 2006, in which event the purchase price will be
increased to $15,700 and the purchasers notice of extension must be accompanied by an additional
option payment of $250. The purchaser is currently seeking to complete the financing for the
transaction, and there can be no assurance the sale of the property will occur.
Liggett 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 Liggett has a
number of valid defenses to claims asserted against it. Litigation is subject to many
uncertainties. In May 2003, a Florida intermediate appellate court overturned a $790,000 punitive
damages award against Liggett and decertified the Engle smoking and health class action. In May
2004, the Florida Supreme Court agreed to review the case, and oral argument was held in November
2004. If the intermediate appellate courts ruling is not upheld on 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 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 Liggetts 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 courts ruling discussed above. In April 2004, a Florida state court jury awarded
compensatory damages of $540 against Liggett in an individual action. In addition, plaintiffs
counsel was awarded legal fees of $752. Liggett has appealed the verdict. It is possible that
additional cases could be decided unfavorably and that there could be further adverse developments
in the Engle case. Liggett may enter into discussions in an attempt to settle particular cases if
it believes it is appropriate to do so. Management cannot predict the cash requirements related to
any future settlements and judgments, including cash required to bond any appeals, and there is a
risk that those requirements will not be able to be met. An unfavorable outcome of a pending
smoking and health case could encourage the commencement of additional similar litigation. 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 7 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 Liggett or the costs of defending
such cases. It is possible that our consolidated financial position, results of operations
- 66 -
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 $2,206,
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 $3,479 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. On April 1, 2002, a subsidiary of ours acquired the stock of The Medallion
Company, Inc., a discount cigarette manufacturer, and related assets from Medallions 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 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 have been repaid with the final quarterly
principal payment of $3,125 made on March 31, 2004. The remaining $35,000 of notes bear interest
at 6.5% per year, payable semiannually, and mature on April 1, 2007.
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 Corporation
(USA). In February 2005, New Valley completed the sale of the office buildings. The mortgage loan
on the properties was retired at closing with the proceeds of the sale.
Vector. We believe that we will continue to meet our liquidity requirements through 2005.
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
$23,100, dividends on our outstanding shares (currently at an annual rate of approximately $71,300)
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 November 2004, we sold $65,500 of our 5% variable interest senior convertible notes due
November 15, 2011 in a private offering to qualified institutional investors in accordance with
Rule 144A under the Securities Act of 1933. The buyers of the notes had the right, for a 120-day
period ending March 18, 2005, to purchase an additional $16,375 of the notes. At December 31,
2004, buyers had exercised their rights to purchase an additional $1,405 of the notes, and the
remaining $14,959 principal amount of notes were purchased during the first quarter of 2005. In
April 2005, we issued an additional $30,000 principal amount of 5% variable interest senior
convertible notes due November 15, 2011 in a separate private offering to qualified institutional
investors in accordance with Rule 144A. These notes, which were issued under a new indenture at a
net price of 103.5%, were on the same terms as the $81,864 principal amount of notes previously
issued in connection with the November 2004 placement.
The notes pay interest on a quarterly basis at a rate of 5% per year with an additional amount
of interest payable on the notes on each interest payment date. This additional amount is
- 67 -
based on the amount of cash dividends actually paid by us per share on our common stock during
the prior three-month period ending on the record date for such interest payment multiplied by the
number of shares of our common stock into which the notes are convertible on such record date
(together, the Total Interest). Notwithstanding the foregoing, however, during the period prior
to November 15, 2006, the interest payable on each interest payment date will be the higher of (i)
the Total Interest and (ii) 6 3/4% per year. The notes are convertible into our common stock, at
the holders option. The conversion price, which was of $18.48 at September 30, 2005, is subject
to adjustment for various events, including the issuance of stock dividends.
The notes will mature on November 15, 2011. We must redeem 12.5% of the total aggregate
principal amount of the notes outstanding on November 15, 2009. In addition to such redemption
amount, we will also redeem on November 15, 2009 and on each interest accrual period thereafter an
additional amount, if any, of the notes necessary to prevent the notes from being treated as an
Applicable High Yield Discount Obligation under the Internal Revenue Code. The holders of the
notes will have the option on November 15, 2009 to require us to repurchase some or all of their
remaining notes. The redemption price for such redemptions will equal 100% of the principal amount
of the notes plus accrued interest. If a fundamental change occurs, we will be required to offer
to repurchase the notes at 100% of their principal amount, plus accrued interest and, under certain
circumstances, a make-whole premium payable in cash and/or common stock.
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 $22.12 at September 30, 2005, 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 in October 2004, $8 of the notes were converted. A total of $132,492 principal amount
of the notes were outstanding at September 30, 2005.
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 September 30, 2005, our deferred income
tax liabilities exceeded our deferred income tax assets by $132,640. The largest component of our
deferred tax liabilities exists because of differences that resulted from a 1998 and 1999
transaction with Philip Morris Incorporated in which 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 18 to our consolidated financial statements in our
Annual Report on Form 10-K for the year ended December 31, 2004.
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 in December 2008
or in March 2010. If the Internal Revenue Service were to ultimately prevail
- 68 -
with the proposed adjustment, it would result in the potential acceleration of tax payments of
approximately $126,000, including interest, net of tax benefits, through September 30, 2005. These
amounts have been previously recognized in our consolidated financial statements as tax
liabilities. As of September 30, 2005, 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 9%,
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 materially
adversely affected.
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 September 30, 2005, 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 Eves guarantee
was negligible at September 30, 2005.
In February 2004, Liggett Vector Brands and another cigarette manufacturer entered into a five
year agreement with a subsidiary of the American Wholesale Marketers Association to support a
program to permit tobacco distributors to secure, on reasonable terms, tax stamp bonds required by
state and local governments for the distribution of cigarettes. Under the agreement, Liggett
Vector Brands has agreed to pay a portion of losses, if any, incurred by the surety under the bond
program, with a maximum loss exposure of $500 for Liggett Vector Brands. To secure its potential
obligations under the agreement, Liggett Vector Brands has delivered to the subsidiary of the
Association a $100 letter of credit and agreed to fund up to an additional $400. Liggett Vector
Brands has incurred no losses to date under this agreement, and we believe the fair value of
Liggett Vector Brands obligation under the agreement was immaterial at September 30, 2005.
At September 30, 2005, we had outstanding approximately, $3,624 of letters of credit,
collateralized by certificates of deposit. The letters of credit have been issued as security
- 69 -
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 September 30, 2005, approximately $30,481 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 September 30, 2005, 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 $196.
We held investment securities available for sale totaling $19,762 at September 30, 2005.
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 underlying entities.
New Accounting Pronouncements
In 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R).
SFAS No. 123R requires companies to measure compensation cost for share-based payments at fair
value. We will adopt this new standard prospectively, on January 1, 2006, and have not yet
determined whether the adoption of SFAS No. 123R will have a material impact on our consolidated
financial position, results of operations or cash flows.
In 2004, the FASB issued SFAS No. 151, Inventory Costs. SFAS No. 151 requires that abnormal
idle facility expense and spoilage, freight and handling costs be recognized as current-period
charges. In addition, SFAS No. 151 requires that allocation of fixed production overhead costs to
inventories be based on the normal capacity of the production facility. We are required to adopt
the provisions of SFAS No. 151 prospectively after January 1, 2006, but the effect of adoption is
not expected to have a material impact on our consolidated financial position, results of
operations or cash flows.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections a
replacement of APB Opinion No. 20 and FASB Statement No. 3 (SFAS No. 154). SFAS No. 154 changes
the requirements for the accounting for and reporting of a change in accounting principle. The
provisions of SFAS No. 154 require, unless impracticable, retrospective application to prior
periods financial statements of (1) all voluntary changes in accounting principles and (2) changes
required by a new accounting pronouncement, if a specific transition is not provided. SFAS No. 154
also requires that a change in depreciation, amortization, or depletion method for long-lived,
non-financial assets be accounted for as a change in accounting estimate, which requires
prospective application of the new method. SFAS No. 154 is effective for all accounting changes
made in fiscal years beginning after December 15,
- 70 -
2005. The application of SFAS No. 154 is not expected to have a material impact on our
consolidated financial position, results of operations or cash flows.
In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset
Retirement Obligations an Interpretation of SFAS Statement No. 143 (FIN 47). FIN 47 clarifies
the timing of liability recognition for legal obligations associated with the retirement of a
tangible long-lived asset when the timing and/or method of settlement are conditional on a future
event. FIN 47 is effective for fiscal years ending after December 15, 2005. The application of
FIN 47 is not expected to have a material impact on our consolidated financial position, results of
operations or cash flows.
In September 2005, the FASBs Emerging Issues Task Force (EITF) reached a consensus on Issue
No. 04-13, Inventory Exchanges. EITF No. 04-13 required two or more inventory transactions with
the same party to be considered a single nonmonetary transaction subject to APB Opinion No. 29,
Accounting for Nonmonetary Transactions, if the transactions were entered into in contemplation
of one another. EITF No. 04-13 is effective for us for new arrangements entered into after April
2, 2006. We do not expect the adoption of EITF No. 04-13 to have a material impact on our
financial position, results of operations or cash flows.
In September 2005, EITF reached a consensus on Issue 05-8, Income Tax Effects of Issuing
Convertible Debt with a Beneficial Conversion Feature, that the issuance of convertible debt with
a beneficial conversion feature creates a temporary difference on which deferred taxes should be
provided. The consensus is required to be applied in fiscal periods (years or quarters) beginning
after December 15, 2005, by retroactive restatement of prior financial statements back to the
issuance of the convertible debt. The requirement to restate applies even if the convertible debt
has been repaid or converted and no longer exists. We have not completed our assessment of the
impact of this issue.
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 Managements 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-harbor provisions of the Private Securities Litigation Reform Act, we have identified
under Risk Factors in Item 1 of our Annual Report on Form 10-K, as amended, for the year ended
December 31, 2004 filed with the Securities and Exchange 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.
- 71 -
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the caption Managements Discussion and Analysis of Financial Condition
and Results of Operations Market Risk is incorporated herein by reference.
ITEM 4. 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.
- 72 -
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
|
|
Reference is made to Note 7, incorporated herein by
reference, to our consolidated financial statements included
elsewhere in this report which contains a general description
of certain legal proceedings to which VGR Holding, New Valley
or their subsidiaries are a party and certain related
matters. Reference is also made to Exhibit 99.1 for
additional information regarding the pending smoking-related
material legal proceedings to which Liggett is a party. A
copy of Exhibit 99 will be furnished without charge upon
written request to us at our principal executive offices, 100
S.E. Second St., Miami, Florida 33131, Attn. Investor
Relations. |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
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No securities of ours which were not registered under the
Securities Act of 1933 have been issued or sold by us during
the three months ended September 30, 2005, except for
approximately 2,099,452 shares of our common stock issued as
a stock dividend on September 29, 2005. |
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|
Our purchases of our common stock during the three months
ended September 30, 2005 were as follows: |
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|
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
Total Number |
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|
Maximum Number |
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|
|
|
|
|
|
|
|
|
of Shares |
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|
of Shares that |
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Total |
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|
|
|
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|
Purchased as |
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|
May Yet Be |
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|
Number of |
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Average |
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Part of Publicly |
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Purchased Under |
|
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Shares |
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Price Paid |
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Announced Plans |
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the Plans |
|
Period |
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Purchased |
|
|
per Share |
|
|
or Programs |
|
|
or Programs |
|
July 1 to July 31, 2005 |
|
|
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
August 1 to August 31,
2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 1 to
September 30, 2005 |
|
|
8,505 |
(1) |
|
|
19.69 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Total |
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8,505 |
|
|
$ |
19.69 |
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|
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|
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|
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(1) |
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Delivery of shares to us in payment of exercise price in connection
with exercise of an employee stock option for 13,399 shares on September 9, 2005. |
Item 6. Exhibits
|
10.1 |
|
Amended and Restated Employment Agreement, dated as of
September 27, 2005, between Vector Group Ltd. and Bennett
S. LeBow (incorporated by reference to Exhibit 10.1 in
Vectors Form 8-K dated September 27, 2005). |
|
|
10.2 |
|
Restricted Share Award Agreement, dated as of September
27, 2005, between Vector Group Ltd. and Howard M. Lorber
(incorporated by reference to Exhibit 10.2 in Vectors
Form 8-K dated September 27, 2005). |
- 73 -
|
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 |
|
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.
|
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|
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.
|
|
|
99.1 |
|
Material Legal Proceedings. |
- 74 -
SIGNATURE
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.
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VECTOR GROUP LTD. |
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(Registrant) |
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By:
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/s/ Joselynn D. Van Siclen |
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Joselynn D. Van Siclen |
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Vice President and Chief Financial Officer |
Date: November 9, 2005
- 75 -