<PAGE> 1
Rule 424(b)(3)
Reg. No. 333-46055
BROOKE GROUP LTD.
SUPPLEMENT DATED NOVEMBER 17, 1998
TO PROSPECTUS DATED MAY 29, 1998
The Prospectus of Brooke Group Ltd. (the "Company") dated May 29, 1998
relating to the Company's common stock, $.10 par value per share (the "Common
Stock"), is hereby supplemented by the information contained in the Company's
Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1998,
a copy of which is set forth herein.
<PAGE> 2
================================================================================
Securities And Exchange Commission
Washington, D.C. 20549
FORM 10-Q
JOINT QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
BROOKE GROUP LTD.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
DELAWARE 1-5759 51-0255124
------------------------------- ---------------------- ------------------------------------
<S> <C> <C>
(State or other jurisdiction of Commission File Number (I.R.S. Employer Identification No.)
incorporation or organization)
</TABLE>
BGLS INC.
(Exact name of registrant as specified in its charter)
<TABLE>
DELAWARE 33-93576 13-3593483
------------------------------- ---------------------- ------------------------------------
<S> <C> <C>
(State or other jurisdiction of Commission File Number (I.R.S. Employer Identification No.)
incorporation or organization)
</TABLE>
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 Registrants (1) have 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 Registrants were required to file such
reports), and (2) have been subject to such filing requirements for the past 90
days. [ X ] Yes [ ] No
At November 13, 1998 Brooke Group Ltd. had 20,943,730 shares of
common stock outstanding, and BGLS Inc. had 100 shares of common stock
outstanding, all of which are held by Brooke Group Ltd.
===============================================================================
<PAGE> 3
BROOKE GROUP LTD.
BGLS INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. BROOKE GROUP LTD./BGLS INC. CONSOLIDATED FINANCIAL STATEMENTS:
Brooke Group Ltd. Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997............................................................................. 2
BGLS Inc. Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997................ 3
Brooke Group Ltd. Consolidated Statements of Operations for the three and nine months
ended September 30, 1998 and September 30, 1997............................................... 4
BGLS Inc. Consolidated Statements of Operations for the three and nine months ended
September, 1998 and September 30, 1997........................................................ 5
Brooke Group Ltd. Consolidated Statement of Stockholders' Equity (Deficit) for the nine
months ended September 30, 1998............................................................... 6
BGLS Inc. Consolidated Statement of Stockholder's Equity (Deficit) for the nine months
ended September 30, 1998...................................................................... 7
Brooke Group Ltd. Consolidated Statements of Cash Flows for the nine months ended
September 30, 1998 and September 30, 1997..................................................... 8
BGLS Inc. Consolidated Statements of Cash Flows for the nine months ended
September 30, 1998 and September 30, 1997..................................................... 9
Notes to Consolidated Financial Statements.......................................................... 10
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations.............................................. 34
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.............................................................................. 48
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS...................................................... 48
Item 3. DEFAULTS UPON SENIOR SECURITIES................................................................ 48
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................................................... 48
SIGNATURES ............................................................................................ 50
</TABLE>
-1-
<PAGE> 4
Item 1. CONSOLIDATED FINANCIAL STATEMENTS
BROOKE GROUP LTD. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
----------------- ----------------
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents........................................... $ 6,390 $ 4,754
Accounts receivable - trade......................................... 10,858 10,462
Other receivables................................................... 1,277 1,239
Inventories......................................................... 47,560 39,312
Other current assets................................................ 6,522 12,218
--------- ---------
Total current assets............................................ 72,607 67,985
Property, plant and equipment, at cost, less accumulated
depreciation of $32,938 and $33,187................................. 57,761 45,943
Intangible assets, at cost, less accumulated amortization
of $20,401 and $19,302.............................................. 319 2,610
Other assets............................................................ 10,643 9,922
--------- ---------
Total assets.................................................... $ 141,330 $ 126,460
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Notes payable and current portion of long-term debt................... $177,461 $ 6,429
Accounts payable...................................................... 19,618 10,461
Dividends payable..................................................... 1,578
Cash overdraft........................................................ 1,405 945
Accrued promotional expenses.......................................... 27,534 26,993
Accrued taxes payable................................................. 11,059 19,998
Accrued interest...................................................... 10,006 39,782
Other accrued liabilities............................................. 22,401 35,896
--------- ---------
Total current liabilities........................................... 271,062 140,504
Notes payable, long-term debt and other obligations, less current portion 238,591 399,835
Noncurrent employee benefits............................................ 25,207 29,366
Other liabilities....................................................... 76,441 45,152
Commitments and contingencies...........................................
Stockholders' equity (deficit):
Preferred Stock, par value $1.00 per share, authorized
10,000,000 shares...................................................
Series G Preferred Stock, 2,184,834 shares, convertible,
participating, cumulative, each share convertible to 1,000
shares of common stock and cash or stock distribution,
liquidation preference of $1.00 per share..........................
Common stock, par value $0.10 per share, authorized 40,000,000
shares, issued 26,498,043 and 24,998,043 shares, outstanding
20,943,730 and 18,097,096 shares.................................... 2,094 1,850
Additional paid-in capital............................................ 122,010 88,290
Deficit............................................................... (580,999) (538,791)
Other................................................................. 14,397 (5,607)
Less: 5,554,313 and 6,900,947 shares of common stock in treasury,
at cost....................................................... (27,473) (34,139)
--------- ---------
Total stockholders' equity (deficit).............................. (469,971) (488,397)
--------- ---------
Total liabilities and stockholders' equity (deficit).............. $ 141,330 $ 126,460
========= =========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
-2-
<PAGE> 5
Item 1. CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------------- ------------------
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents................................................. $ 6,324 $ 4,754
Accounts receivable - trade............................................... 10,858 10,462
Other receivables......................................................... 1,220 1,191
Inventories............................................................... 47,560 39,312
Other current assets...................................................... 6,172 11,647
--------- --------
Total current assets.................................................. 72,134 67,366
Property, plant and equipment, at cost, less accumulated depreciation of
$32,938 and $32,760....................................................... 57,735 45,775
Intangible assets, at cost, less accumulated amortization of
$20,401 and $19,302 ...................................................... 319 2,610
Other assets................................................................ 9,537 13,165
--------- --------
Total assets.......................................................... $ 139,725 $ 128,916
========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT):
Current liabilities:
Notes payable and current portion of long-term debt....................... $ 177,127 $ 6,212
Accounts payable.......................................................... 19,486 10,336
Cash overdraft............................................................ 1,405 891
Due to parent............................................................. 34,981 22,951
Accrued promotional expenses.............................................. 27,534 26,993
Accrued taxes payable..................................................... 11,059 19,998
Accrued interest.......................................................... 10,006 39,782
Other accrued liabilities................................................. 21,776 34,312
--------- ---------
Total current liabilities............................................. 303,374 161,475
Notes payable, long-term debt and other obligations, less current portion... 238,591 399,835
Noncurrent employee benefits................................................ 25,207 29,366
Other liabilities........................................................... 79,877 51,355
Commitments and contingencies...............................................
Stockholder's equity (deficit):
Common stock, par value $0.01 per share; 100 shares authorized,
issued and outstanding..................................................
Additional paid-in capital................................................ 68,775 39,081
Deficit................................................................... (593,429) (550,339)
Other..................................................................... 17,330 (1,857)
--------- ---------
Total stockholder's deficit........................................... (507,324) (513,115)
--------- ---------
Total liabilities and stockholder's equity (deficit).................. $ 139,725 $ 128,916
========= =========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
-3-
<PAGE> 6
Item 1. CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
BROOKE GROUP LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues*................................................. $108,202 $100,308 $304,267 $276,906
Cost of goods sold*....................................... 47,086 53,045 140,422 145,841
-------- -------- -------- --------
Gross profit.............................................. 61,116 47,263 163,845 131,065
Operating, selling and general expenses................... 48,115 40,498 130,241 117,535
-------- -------- -------- --------
Operating income.......................................... 13,001 6,765 33,604 13,530
Other income (expenses):
Interest income....................................... 75 431 325 1,682
Interest expense...................................... (20,138) (15,791) (60,561) (46,757)
Equity in loss of affiliate........................... (8,935) (6,984) (20,383) (21,335)
Sale of assets........................................ 707 2,025 23,086
Retirement of debt.................................... 2,963
Proceeds from legal settlement........................ 4,125
Other, net............................................ 233 (257) (765) (77)
-------- -------- -------- --------
Loss from continuing operations before income taxes....... (15,057) (15,836) (45,755) (22,783)
(Benefit) provision for income taxes...................... (2,447) (248) (1,135) 541
-------- -------- -------- --------
Loss from continuing operations........................... (12,610) (15,588) (44,620) (23,324)
-------- -------- -------- --------
Discontinued operations:
Gain on disposal of discontinued operations............... 3,208 3,208
-------- -------- --------- --------
Net loss.................................................. $ (9,402) $(15,588) $ (41,412) $ (23,324)
======== ======== ========= ========
Basic and diluted common share data:
Loss from continuing operations....................... $(0.61) $(0.86) $(2.20) $(1.28)
====== ====== ====== ======
Income from discontinued operations................... $ 0.15 $ $ 0.16 $
====== ====== ====== ======
Net loss applicable to common shares.................. $(0.46) $(0.86) $(2.04) $(1.28)
====== ====== ====== ======
Weighted average common shares outstanding................ 20,826,231 18,097,096 20,250,199 18,192,233
========== ========== ========== ==========
</TABLE>
- ---------------
* Revenues and Cost of goods sold include federal excise taxes of $20,244 and
$19,250 for the three months ended September 30, 1998 and 1997,
respectively, and $60,589 and $55,263 for the nine months ended September
30, 1998 and 1997, respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
-4-
<PAGE> 7
Item 1. CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues*................................................. $108,202 $100,308 $304,267 $276,906
Cost of goods sold*....................................... 47,086 53,045 140,422 145,841
-------- -------- -------- --------
Gross profit.............................................. 61,116 47,263 163,845 131,065
Operating, selling and general expenses................... 46,838 40,502 127,635 117,159
-------- -------- -------- --------
Operating income ......................................... 14,278 6,761 36,210 13,906
Other income (expenses):
Interest income........................................ 65 431 184 1,670
Interest expense....................................... (21,270) (16,750) (63,832) (49,542)
Equity in loss of affiliate............................ (8,935) (6,984) (20,383) (21,335)
Sale of assets......................................... 1,318 27,663
Retirement of debt..................................... 2,963
Other, net............................................. 71 (257) (930) (84)
-------- -------- -------- --------
Loss from continuing operations before income taxes....... (15,791) (16,799) (47,433) (24,759)
(Benefit) provision for income taxes...................... (2,447) (248) (1,135) 539
-------- -------- -------- --------
Loss from continuing operations........................... (13,344) (16,551) (46,298) (25,298)
-------- -------- -------- --------
Discontinued operations:
Gain on disposal of discontinued operations............... 3,208 3,208
-------- -------- -------- --------
Net loss.................................................. $(10,136) $(16,551) $(43,090) $(25,298)
======== ======== ======== ========
</TABLE>
- -----------------------
* Revenues and Cost of goods sold include federal excise taxes of $20,244 and
$19,250 for the three months ended September 30, 1998 and 1997, respectively,
and $60,589 and $55,263 for the nine months ended September 30, 1998 and 1997,
respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
-5-
<PAGE> 8
Item 1. CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
BROOKE GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Accumulated
Common Stock Additional Other
-------------------- Paid-In Treasury Comprehensive
Shares Amount Capital Deficit Stock Other Income Total
---------- ------ ---------- -------- -------- -------- -------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997........ 18,097,096 $1,850 $ 88,290 $(538,791) $(34,139) $(8,337) $ 2,730 $(488,397)
Net loss.......................... (41,412) (41,412)
Issuance of options and warrants.. 24,442 24,442
Issuance of common stock.......... 1,500,000 150 11,342 11,492
Effectiveness fee on debt......... 483,002 48 1,666 2,391 4,105
Issuance of treasury stock........ 863,632 46 319 (796) 4,275 3,844
Distributions on common stock
($0.15 per share)................ (4,589) (4,589)
Amortization of deferred
compensation..................... 540 817 1,357
Unrealized holding gain on
investment in New Valley......... 25,340 25,340
Effect of New Valley capital
transactions..................... (6,153) (6,153)
---------- ------ -------- --------- -------- ------- ------- ---------
Balance, September 30, 1998....... 20,943,730 $2,094 $122,010 $(580,999) $(27,473) $(7,520) $21,917 $(469,971)
========== ===== ======== ========= ======== ======= ======= =========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
-6-
<PAGE> 9
Item 1. CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Accumulated
Common Stock Additional Other
-------------- Paid-In Comprehensive
Shares Amount Capital Deficit Other Income Total
------ ------ ---------- --------- ------ ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997............. 100 $ $39,081 $(550,339) $1,013 $(2,870) $(513,115)
Net loss............................... (43,090) (43,090)
Effectiveness fee on debt.............. 2,442 2,442
Capital contribution of options
and warrants......................... 24,442 24,442
Payment of interest by parent.......... 2,531 2,531
Amortization of deferred compensation.. 279 279
Unrealized holding gain on investment
In New Valley...................... 25,340 25,340
Effect of New Valley capital
transactions....................... (6,153) (6,153)
--- ----- ------- --------- ------ ------- ---------
Balance, September 30, 1998............ 100 $ $68,775 $(593,429) $1,013 $16,317 $(507,324)
=== ===== ======= ========= ====== ======= =========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
-7-
<PAGE> 10
Item 1. CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
BROOKE GROUP LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
----------------------------------
September 30, September 30,
1998 1997
---------------- -----------------
<S> <C> <C>
Net cash used in operating activities..................................... $ (17,847) $ (30,511)
-------- --------
Cash flows from investing activities:
Proceeds from sale of businesses and assets, net........................ 2,377 43,091
Capital expenditures.................................................... (17,289) (9,857)
-------- ---------
Net cash (used in) provided by investing activities....................... (14,912) 33,234
-------- --------
Cash flows from financing activities:
Proceeds from debt...................................................... 4,425 5,198
Repayments of debt...................................................... (1,520) (10,323)
Borrowings under revolver............................................... 208,434 209,822
Repayments on revolver.................................................. (210,050) (202,881)
Increase in cash overdraft.............................................. 460 1,416
Distributions on common stock........................................... (3,055) (5,535)
Proceeds from participating loan........................................ 25,000
Issuance of common stock................................................ 10,144
--------
Net cash provided by (used in) financing activities....................... 33,838 (2,303)
-------- ---------
Effect of exchange rate changes on cash and cash equivalents.............. 557
Net increase in cash and cash equivalents................................. 1,636 420
Cash and cash equivalents, beginning of period............................ 4,754 1,941
--------- ---------
Cash and cash equivalents, end of period.................................. $ 6,390 $ 2,361
========= =========
Supplemental non-cash investing and financing activities:
Promissory note from New Valley........................................... 33,500
Issuance of stock to Liggett bondholders.................................. 4,105
Issuance of stock to consultants.......................................... 3,705
Issuance of warrants...................................................... 22,421
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
-8-
<PAGE> 11
Item 1. CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
------------------ ------------------
September 30, September 30,
1998 1997
------------------ ------------------
<S> <C> <C>
Net cash used in operating activities....................................... $ (9,783) $ (36,989)
----------- ---------
Cash flows from investing activities:
Proceeds from sale of businesses and assets, net.......................... 1,670 43,091
Capital expenditures...................................................... (17,289) (9,857)
----------- ---------
Net cash (used in) provided by investing activities......................... (15,619) 33,234
----------- ---------
Cash flows from financing activities:
Proceeds from debt........................................................ 3,950 4,723
Repayments of debt........................................................ (1,433) (8,942)
Borrowings under revolver................................................. 208,434 209,822
Repayments on revolver.................................................... (210,050) (202,881)
Increase in cash overdraft................................................ 514 1,416
Proceeds from participating loan.......................................... 25,000
----------- ---------
Net cash provided by (used in) financing activities......................... 26,415 4,138
----------- ---------
Effect of exchange rate changes on cash and cash equivalents................ 557
Net increase in cash and cash equivalents................................... 1,570 383
Cash and cash equivalents, beginning of period.............................. 4,754 1,940
----------- ----------
Cash and cash equivalents, end of period.................................... $ 6,324 $ 2,323
=========== ==========
Supplemental non-cash investing and financing activities:
Promissory note from New Valley........................................... 33,500
Issuance of stock to Liggett bondholders.................................. 4,105
Issuance of stock to consultants.......................................... 3,705
Issuance of warrants...................................................... 22,421
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
-9-
<PAGE> 12
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. PRINCIPLES OF REPORTING
The consolidated financial statements of Brooke Group Ltd. (the "Company")
include the consolidated statements of its wholly-owned subsidiary, BGLS
Inc. ("BGLS"). The consolidated statements of BGLS include the accounts of
Liggett Group Inc. ("Liggett"), Brooke (Overseas) Ltd. ("BOL"), New Valley
Holdings, Inc. ("NV Holdings"), Liggett-Ducat Ltd. ("Liggett-Ducat") and
other less significant subsidiaries. Liggett is engaged primarily in the
manufacture and sale of cigarettes, principally in the United States.
Liggett-Ducat is engaged in the manufacture and sale of cigarettes in
Russia. All significant intercompany balances and transactions have been
eliminated.
The interim consolidated financial statements of the Company and BGLS are
unaudited and, in the opinion of management, reflect all adjustments
necessary (which are normal and recurring) to present fairly the Company's
and BGLS' consolidated financial position, results of operations and cash
flows. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and the notes
thereto included in the Company's and BGLS' Annual Report on Form 10-K, as
amended, for the year ended December 31, 1997, 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.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities and the reported amounts
of revenues and expenses. Actual results could differ from those
estimates.
Certain amounts in the 1997 consolidated financial statements have been
reclassified to conform to the 1998 presentation.
LIQUIDITY:
The Company's sources of liquidity for 1998 include, among other things,
additional public and/or private debt and equity financing, management
fees and certain funds available from New Valley subject to limitations
imposed by BGLS' indenture agreements. 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. New Valley's
ability to make such distributions is subject to risk and uncertainties
attendant to its business. (Refer to Note 2.)
On January 30, 1998, Liggett obtained the consents of the required
majority of the holders of Liggett's 11.50% Series B and 19.75% Series C
Senior Secured Notes due 1999 (the "Liggett Notes") to various amendments
to the Indenture governing the Liggett Notes. The amendments provided,
among other things, for a deferral of the February 1, 1998 mandatory
redemption of $37,500 principal amount of the Liggett Notes to the date of
final maturity, February 1, 1999. (Refer to Note 6.) At maturity, the
Liggett Notes will require a principal payment of $144,891. Liggett does
not anticipate it will be able to generate sufficient cash from operations
to make such payments. In addition, Liggett has a $40,000 revolving credit
facility expiring March 8, 1999 (the "Facility"), under which $17,674 was
outstanding at September 30, 1998. Accordingly, the Liggett Notes and the
balance of the Facility have been reclassified to current liabilities. As
of September 30, 1998, Liggett had net
-10-
<PAGE> 13
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
capital and working capital deficiencies of $183,268 and $169,071,
respectively. The current maturities of the Liggett Notes and the Facility
of approximately $162,500 contribute substantially to the working capital
deficiency. If Liggett is unable to refinance or restructure the terms of
the Liggett Notes or otherwise make all payments thereon, substantially
all of the Liggett Notes and the Facility would be in default. In such
event, Liggett may be forced to seek protection from creditors under
applicable laws. Due to the many risks and uncertainties associated with
the cigarette industry and the impact of tobacco litigation, there can be
no assurance that Liggett will be able to meet its future earnings or cash
flow goals. These matters raise substantial doubt about Liggett meeting
its liquidity needs and its ability to continue as a going concern and may
negatively impact the Company's liquidity.
BOL is in the process of constructing a new tobacco factory in Moscow,
Russia currently scheduled to be operational in May 1999. The remaining
construction costs and equipment required for the new factory will be
financed primarily by equipment lease financing currently in place and
bank or other loans. (Refer to Notes 2 and 3.)
In March 1998, the Company entered into an agreement with significant
holders of the BGLS 15.75% Series B Senior Secured Notes (the "BGLS
Notes") with respect to certain modifications to the terms of such debt.
(Refer to Note 6.)
NET LOSS PER SHARE
Stock options, warrants and contingent shares (both vested and non-vested)
at September 30, 1998 and 1997, respectively (see Note 7), were excluded
from the calculation of diluted per share results presented because their
effect was accretive. Accordingly, diluted net loss per common share is
the same as basic net loss per common share.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income". SFAS No. 130, which the Company adopted in the first quarter of
1998, establishes standards for reporting and displaying comprehensive
income and its components in a full set of general-purpose statements. For
the Company, other components of stockholders' equity include such items
as the Company's proportionate interest in New Valley's capital
transactions and unrealized gains and losses on investment securities. The
implementation of SFAS No. 130 in the first quarter 1998 did not have any
material effect on the consolidated financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information". SFAS No. 131 specifies revised
guidelines for determining an entity's operating segments and the type and
level of financial information to be disclosed. Management believes that
the adoption of this pronouncement will not have a material effect on the
Company's financial statement disclosures. SFAS No. 131 is initially
effective for annual financial statements for fiscal years beginning after
December 15, 1997.
In February 1998, SFAS No. 132, "Employers' Disclosures about Pensions and
Other Postretirement Benefits," was issued which revises required
disclosures about pensions and postretirement benefit plans in order to
facilitate financial analysis. Recognition or measurement issues are not
addressed in the statement. SFAS No. 132 is effective for the Company for
the year ended 1998. Management
-11-
<PAGE> 14
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
believes that the adoption of this pronouncement will not have a material
effect on the Company's financial statement disclosures.
2. INVESTMENT IN NEW VALLEY CORPORATION
At September 30, 1998 and December 31, 1997, the Company's investment in
New Valley consisted of an approximate 42% voting interest. At September
30, 1998 and December 31, 1997, the Company owned 57.7% of the outstanding
$15.00 Class A Increasing Rate Cumulative Senior Preferred Shares ($100
Liquidation Value), $.01 par value (the "Class A Preferred Shares"), 9.0%
of the outstanding $3.00 Class B Cumulative Convertible Preferred Shares
($25 Liquidation Value), $.10 par value (the "Class B Preferred Shares"),
and 41.7% of New Valley's common shares, $.01 par value (the "Common
Shares").
The Class A Preferred Shares and the Class B Preferred Shares are
accounted for as debt and equity securities, respectively, pursuant to the
requirements of SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities", and are classified as available-for-sale. The
Common Shares are accounted for pursuant to APB No. 18, "The Equity Method
of Accounting for Investments in Common Stock".
The Company determines the fair value of the Class A Preferred Shares and
Class B Preferred Shares based on the quoted market price. Through
September 30, 1996, earnings on the Class A Preferred Shares were
comprised of dividends accrued during the period and the accretion of the
difference between the Company's basis and their mandatory redemption
price. During the quarter ended September 30, 1996, the decline in the
market value of the Class A Preferred Shares, the dividend received on the
Class A Preferred Shares and the Company's equity in losses incurred by
New Valley caused the carrying value of the Company's investment in New
Valley to be reduced to zero. Beginning in the fourth quarter of 1996, the
Company suspended the recording of its earnings on the dividends accrued
and the accretion of the difference between the Company's basis in the
Class A Preferred Shares and their mandatory redemption price.
The Company's and BGLS' investment in New Valley at September 30, 1998 is
summarized below:
Number of Fair Carrying
Shares Value Amount
--------- ------- --------
Class A Preferred Shares....... 618,326 $33,390 $ 33,390
Class B Preferred Shares....... 250,885 502 502
Common Shares.................. 3,989,710 1,496 (33,892)
------- --------
$35,388 $ 0
======= ========
In November 1994, New Valley's First Amended Joint Chapter 11 Plan of
Reorganization, as amended ("Joint Plan"), was confirmed by order of the
United States Bankruptcy Court for the District of New Jersey and on
January 18, 1995, New Valley emerged from bankruptcy reorganization
proceedings and completed substantially all distributions to creditors
under the Joint Plan. Pursuant to the Joint Plan, among other things, the
Class A Preferred Shares, the Class B Preferred Shares, the Common Shares
and other equity interests were reinstated and retained all of their
legal, equitable and contractual rights.
-12-
<PAGE> 15
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
The Class A Preferred Shares of New Valley are required to be redeemed on
January 1, 2003 for $100.00 per share plus dividends accrued to the
redemption date. The shares are redeemable, at any time, at the option of
New Valley, at $100.00 per share plus accrued dividends. The holders of
Class A Preferred Shares are entitled to receive a quarterly dividend, as
declared by the Board of Directors, payable at the rate of $19.00 per
annum. At September 30, 1998, the accrued and unpaid dividends arrearage
was $204,050 ($190.44 per share).
Holders of the Class B Preferred Shares are entitled to receive a
quarterly dividend, as declared by the Board, at a rate of $3.00 per
annum. At September 30, 1998, the accrued and unpaid dividends arrearage
was $158,907 ($56.94 per share). No dividends on the Class B Preferred
Shares have been declared since the fourth quarter of 1988.
Summarized financial information for New Valley as of September 30, 1998
and December 31, 1997 and for the three and nine months ended September
30, 1998 and 1997 follows:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Current assets, primarily cash and marketable
securities................................... $ 73,864 $ 118,642
Non-current assets.............................. 177,017 322,749
Current liabilities............................. 67,238 128,128
Non-current liabilities......................... 75,654 185,024
Redeemable preferred stock...................... 300,711 258,638
Shareholders' deficit........................... (192,722) (130,399)
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues .................................... $ 19,440 $ 26,704 $ 78,552 $ 76,652
Costs and expenses.............................. 28,664 33,782 95,633 100,020
Loss from continuing operations................. (8,739) (6,574) (15,458) (21,944)
Income from discontinued operations............. 6,860 7,740
Net loss applicable to common shares(A)......... (22,622) (24,141) (67,051) (72,241)
</TABLE>
- ------------------
(A) Considers all preferred accrued dividends, whether or not
declared.
On January 31, 1997, New Valley acquired substantially all the common
shares of BML from BOL for $55,000. (Refer to Note 3.)
In February 1998, New Valley and Apollo Real Estate Investment Fund III,
L.P. ("Apollo") organized Western Realty Development LLC ("Western Realty
Ducat") to make real estate and other investments in Russia. In connection
with the formation of Western Realty Ducat, New Valley agreed, among other
things, to contribute the real estate assets of BML, including Ducat Place
II and the site for Ducat Place III, to Western Realty Ducat and Apollo
agreed to contribute up to $58,750, including the investment in Western
Realty Repin discussed below. Through September 30, 1998, Apollo had
funded $30,550 of its investment in Western Realty Ducat.
-13-
<PAGE> 16
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
The ownership and voting interests in Western Realty Ducat will be held
equally by Apollo and New Valley. Apollo will be entitled to a preference
on distributions of cash from Western Realty Ducat to the extent of its
investment ($40,000), together with a 15% annual rate of return, and New
Valley will then be entitled to a return of $16,300 of BML-related
expenses incurred and cash invested by New Valley since March 1, 1997,
together with a 15% annual rate of return; subsequent distributions will
be made 70% to New Valley and 30% to Apollo. Western Realty Ducat will be
managed by a Board of Managers consisting of an equal number of
representatives chosen by Apollo and New Valley. All material corporate
transactions by Western Realty Ducat generally require the unanimous
consent of the Board of Managers. Accordingly, New Valley has accounted
for its non-controlling interest in Western Realty Ducat using the equity
method of accounting.
New Valley recorded its basis in the investment in Western Realty Ducat in
the amount of $60,169 based on the carrying value of assets less
liabilities transferred. There was no difference between the carrying
value of the investment and New Valley's proportionate interest in the
underlying value of net assets of Western Realty Ducat.
Western Realty Ducat will seek to make additional real estate and other
investments in Russia. Western Realty Ducat has made a $26,300
participating loan to, and payable out of a 30% profits interest in, a
company organized by BOL which, among other things, acquired an interest
in a new factory being constructed on the outskirts of Moscow by a
subsidiary of BOL. (Refer to Note 3.)
In June 1998, New Valley and Apollo organized Western Realty Repin LLC
("Western Realty Repin") to make a $25,000 participating loan (the "Repin
Loan") to BML. The proceeds of the loan will be used by BML for the
acquisition and preliminary development of two adjoining sites totaling
10.25 acres (the "Kremlin Sites") located in Moscow across the Moscow
River from the Kremlin. BML, which is planning the development of a 1.1
million sq. ft. hotel, office, retail and residential complex on the
Kremlin Sites, owned 94.6% of one site and 52% of the other site at
September 30, 1998. Apollo will be entitled to a preference on
distributions of cash from Western Realty Repin to the extent of its
investment ($18,750) together with a 20% annual rate of return, and New
Valley will then be entitled to a return of its investment ($6,250),
together with a 20% annual rate of return; subsequent distributions will
be made 50% to New Valley and 50% to Apollo. Western Realty Repin will be
managed by a Board of Managers consisting of an equal number of
representatives chosen by Apollo and New Valley. All material corporate
transactions by Western Realty Repin will generally require the unanimous
consent of the Board of Managers.
Through September 30, 1998, Western Realty Repin has advanced $19,067 (of
which $14,300 was funded by Apollo) under the Repin Loan to BML. The Repin
Loan, which bears no fixed interest, is payable only out of 100% of the
distributions, if made, by the entities owning the Kremlin Sites to BML.
Such distributions shall be applied first to pay the principal of the
Repin Loan and then as contingent participating interest on the Repin
Loan. Any rights of payment on the Repin Loan are subordinate to the
rights of all other creditors of BML. BML used a portion of the proceeds
to repay New Valley for certain expenditures on the Kremlin Sites
previously incurred. The Repin Loan is due and payable upon the
dissolution of BML and is collateralized by a pledge of New Valley's
shares of BML.
As of September 30, 1998, BML had invested $15,171 in the Kremlin sites
and held $809, in cash, which was restricted for future investment. In
connection with the acquisition of its interest in one of the Kremlin
Sites, BML has agreed with the City of Moscow to invest an additional
$6,000 in 1998 and $22,000 in 1999 in the development of the property.
-14-
<PAGE> 17
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
The development of Ducat Place III and the Kremlin Sites will require
significant amounts of debt and other financing. New Valley is actively
pursuing various financing alternatives on behalf of Western Realty Ducat
and BML. However, in light of the recent economic turmoil in Russia, no
assurance can be given that such financing will be available on acceptable
terms. Failure to obtain sufficient capital for the projects would force
Western Realty Ducat and BML to curtail or delay the planned development
of Ducat Place III and the Kremlin Sites.
3. INVESTMENT IN BROOKE (OVERSEAS) LTD.
At September 30, 1998, BOL owned approximately 96% of the stock of
Liggett-Ducat through its subsidiary, Western Tobacco Investments LLC
("Western Tobacco"), including shares of such stock acquired from Liggett
in connection with Liggett's debt restructuring (refer to Note 6) and
purchases of stock from other shareholders. (Refer to Note 6 for
information concerning pledges of interests in Western Tobacco.)
Liggett-Ducat is in the process of constructing a new cigarette factory on
the outskirts of Moscow which is currently scheduled to be operational in
the second quarter 1999. Liggett-Ducat has entered into a construction
contract for the plant. The remaining liability under that contract, as
amended, at September 30, 1998 is approximately $10,300. Equipment
purchase agreements in place at September 30, 1998 total $34,355, of which
$28,791 is being financed by the manufacturers.
Western Realty has made a $26,300 participating loan to Western Tobacco
which holds BOL's interests in Liggett-Ducat, as discussed above, and the
industrial site and manufacturing facility being constructed by
Liggett-Ducat on the outskirts of Moscow. The loan, which bears no fixed
interest, is payable only out of 30% of distributions, if any, made by
Western Tobacco to BOL. After the prior payment of debt service on loans
to finance the construction of the new facility, 30% of distributions from
Western Tobacco to BOL will be applied first to pay the principal of the
loan and then as contingent participating interest on the loan. Any rights
of payment on the loan are subordinate to the rights of all other
creditors of Western Tobacco. The loan is classified in other long-term
liabilities on the consolidated balance sheet at September 30, 1998.
(Refer to Note 2.)
The performance of Liggett-Ducat's cigarette operations in Russia is
affected by uncertainties in Russia which may include, among others,
political or diplomatic developments, regional tensions, currency
repatriation restrictions, foreign exchange fluctuations, inflation, and
an undeveloped system of commercial laws and legislative reform relating
to foreign ownership in Russia.
On January 31, 1997, BOL sold all its shares of BML to New Valley for
$21,500 in cash and a promissory note of $33,500 payable $21,500 on June
30, 1997 and $12,000 on December 31, 1997 with interest at 9%. The note
was paid in full as of December 31, 1997. The consideration received
exceeded the carrying value of its investment in BML by $43,700. The
Company recognized a gain on the sale in 1997 in the amount of $21,300.
The remaining $22,400 was deferred in recognition of the fact that the
Company retains an interest in BML through its 42% equity ownership in New
Valley and that a portion of the property sold (the site of the third
phase of the Ducat Place real estate project being developed by BML, which
is currently used by Liggett-Ducat for its existing cigarette factory), is
subject to a put option held by New Valley. The option allows New Valley
to put this site back to the Company at the greater of the appraised fair
value of the property at the date of exercise or $13,600, during the
period Liggett-Ducat operates the factory on such site.
-15-
<PAGE> 18
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
4. INVENTORIES
Inventories consist of:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------------ -------------------
<S> <C> <C>
Finished goods................................... $17,008 $13,273
Work-in-process.................................. 2,886 1,976
Raw materials.................................... 22,662 24,495
Replacement parts and supplies................... 9,123 4,466
------- -------
Inventories at current cost...................... 51,679 44,210
LIFO adjustments................................. (4,119) (4,898)
------- -------
$47,560 $39,312
====== ======
</TABLE>
At September 30, 1998, Liggett and Liggett-Ducat had leaf tobacco
purchase commitments of approximately $6,134 and $8,599, respectively.
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Land and improvements............................ $ 411 $ 411
Buildings........................................ 6,042 6,521
Machinery and equipment.......................... 53,063 53,717
Leasehold improvements........................... 302
Construction-in-progress......................... 31,183 18,179
-------- --------
90,699 79,130
Less accumulated depreciation.................... (32,938) (33,187)
-------- --------
$ 57,761 $ 45,943
======== ========
</TABLE>
-16-
<PAGE> 19
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
6. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
15.75% Series B Senior Secured Notes due 2001,
net of unamortized discount of $19,259 and $1,511..... $213,606 $231,723
Deferred interest on 15.75% Series B Senior Secured
Notes due 2001........................................ 24,985
14.500% Subordinated Debentures due 1998.................. 800
Notes payable - Foreign................................... 10,000 5,000
Other..................................................... 4,959 629
Liggett:
11.500% Senior Secured Series B Notes due 1999, net of
unamortized discount of $63 and $206.................. 112,549 112,406
Variable Rate Series C Senior Secured Notes due 1999...... 32,279 32,279
Revolving credit facility................................. 17,674 23,427
-------- --------
Total notes payable, long-term debt and other obligations. 416,052 406,264
Less:
Current maturities.................................... 177,461 6,429
-------- --------
Amount due after one year................................. $238,591 $399,835
======== ========
</TABLE>
The 14.500% Subordinated Debentures due 1998 in principal amount of $800
were paid at maturity on April 1, 1998.
STANDSTILL AGREEMENT - BGLS:
During negotiations with the holders of more than 83% of the BGLS Notes
concerning certain modifications to the terms of such debt, BGLS entered
into a standstill agreement with such holders on August 28, 1997. Pursuant
to the standstill agreement, as amended, such holders agreed that they
would be entitled to receive their portion of the July 31, 1997 interest
payment on the BGLS Notes (in total, $15,340) only after giving BGLS 20
days' notice but in any event by February 6, 1998.
On February 6, 1998, BGLS entered into a further amendment to the
standstill agreement with AIF II, LP and an affiliated investment manager
on behalf of a managed account (together, the "Apollo Holders"), who held
approximately 41.8% of the $232,864 principal amount of the BGLS Notes
then outstanding, which extended the termination date of such agreement
with respect to the Apollo Holders to March 2, 1998. Also on February 6,
1998, the holder of 41.9% of the BGLS Notes, who had previously been a
party to the standstill agreement, was paid its pro rata share of the July
31, 1997 interest payment on the BGLS Notes. The Company also sold stock
on January 16, 1998 to an affiliate of this holder in which it recorded an
expense of $2,531 for the first quarter 1998, representing the difference
between the cost and fair market value of the shares sold. (Refer to Note
7.)
On March 2, 1998, the Company entered into an agreement with the Apollo
Holders in which the Apollo Holders agreed to defer the payment of
interest on the BGLS Notes held by them,
-17-
<PAGE> 20
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
commencing with the interest payment that was due July 31, 1997, which
they had previously agreed to defer, through the interest payment due July
31, 2000. The deferred interest payments together with interest compounded
semi-annually thereon will be payable at final maturity of the BGLS Notes
on January 31, 2001 or upon an event of default under the Indenture for
the BGLS Notes. Accordingly, accrued interest as of March 2, 1998 was
reclassified and included in long-term debt. In connection with the
agreement, the Company pledged 50.1% of Western Tobacco to collateralize
the BGLS Notes held by the Apollo Holders.
In connection with the March 2, 1998 agreement with the Apollo Holders,
the Company issued to the Apollo Holders a five-year warrant to purchase
2,000,000 shares of the Company's common stock at a price of $5.00 per
share. The Apollo Holders were also issued a second warrant expiring
October 31, 2004 to purchase an additional 2,150,000 shares of the
Company's common stock at a price of $0.10 per share. The second warrant
will become exercisable on October 31, 1999, and the Company will have the
right under certain conditions prior to that date to substitute for that
warrant a new warrant for 9.9% of the common stock of Liggett.
Based on the fair value of the equity instruments given to the holders of
the debt, and the difference between the fair value of the modified debt
and the carrying value of the debt held by the Apollo Holders prior to the
transaction, no gain or loss was recorded on the transaction. The fair
value of the equity instruments was estimated based on the Black-Scholes
option pricing model and the following assumptions: volatility of 77%,
risk-free interest rate of 6%, expected life of five to seven years and a
dividend rate of 0%. Imputed interest of approximately $23,000 is being
accreted over the term of the modified debt based on its recorded fair
value.
15.75% SERIES B SENIOR SECURED NOTES DUE 2001
The Series B Notes are collateralized by substantially all of BGLS'
assets, including a pledge of BGLS' equity interests in Liggett, BOL and
NV Holdings as well as a pledge of all of the New Valley securities held
by BGLS and NV Holdings. The BGLS Series B Notes Indenture contains
certain covenants, which among other things, limit the ability of BGLS to
make distributions to the Company to $6,000 per year ($12,000 if less than
50% of the Series B Notes remain outstanding), limit additional
indebtedness of BGLS to $10,000, limit guaranties of subsidiary
indebtedness by BGLS to $50,000, and restrict certain transactions with
affiliates that exceed $2,000 in any year subject to certain exceptions
which include payments to the Company not to exceed $6,500 per year for
permitted operating expenses, payment of the Chairman's salary and bonus
and certain other expenses, fees and payments. In addition, the Indenture
contains certain restrictions on the ability of the Chairman and certain
of his affiliates to enter into certain transactions with, and receive
payments above specified levels from, New Valley. The Series B Notes may
be redeemed, in whole or in part, through December 31, 1999, at a price of
101% of the principal amount and thereafter at 100%. Interest is payable
at the rate of 15.75% per annum on January 31 and July 31 of each year.
LIGGETT 11.50% SENIOR SECURED SERIES B NOTES DUE 1999:
On February 14, 1992, Liggett issued $150,000 in Senior Secured Notes (the
"Liggett Series B Notes"). Interest on the Liggett Series B Notes is
payable semiannually on February 1 and August 1 at an annual rate of
11.50%. The Liggett Series B Notes and Series C Notes referred to below
(collectively, the "Liggett Notes") required mandatory principal
redemptions of $7,500 on February 1 in each of the years 1993 through 1997
and $37,500 on February 1, 1998 with the balance of the Liggett Notes due
on February 1, 1999. In February 1997, $7,500 of Liggett Series B Notes
were purchased using the Facility and credited against the mandatory
redemption requirements. The
-18-
<PAGE> 21
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
transaction resulted in a net gain of $2,963. The Liggett Notes are
collateralized by substantially all of the assets of Liggett, excluding
inventories and receivables. Eve Holdings Inc. is a guarantor for the
Liggett Notes. The Liggett Notes may be redeemed, in whole or in part, at
a price equal to 100% of the principal amount at the option of Liggett.
The Liggett Notes contain restrictions on Liggett's ability to declare or
pay cash dividends, incur additional debt, grant liens and enter into any
new agreements with affiliates, among others.
On January 30, 1998, with the consent of the required majority of the
holders of the Liggett Notes, Liggett entered into various amendments to
the Indenture governing the Liggett Notes, which provided, among other
things, for a deferral of the February 1, 1998 mandatory redemption
payment of $37,500 to the date of final maturity of the Liggett Notes on
February 1, 1999. In connection with the consent to the deferral, the
Company agreed to issue 483,002 shares of the Company's common stock to
the holders of record on January 15, 1998 of the Liggett Notes. As a
result of this transaction, Liggett recorded a deferred charge of $4,105
during the first quarter of 1998 reflecting the fair value of the
instruments issued. This deferred charge is being amortized over a period
of one year. The Indenture under which the Liggett Notes are outstanding
was also amended to prohibit, with limited exceptions, payments of
dividends and incurrence of new debt by Liggett and to tighten
restrictions on the disposition of proceeds of asset sales. The Company
and BGLS also agreed to guarantee the payment, which was made by Liggett,
of the August 1, 1998 interest payment on the Liggett Notes. In addition,
Liggett noteholders were granted additional collateral in the form of a
security interest in 16% of Western Tobacco.
On February 1, 1999, all of the Liggett Notes, in principal amount of
$144,891, will reach maturity. There are no refinancing or restructuring
arrangements in place at this time for the notes and no assurances can be
given in this regard. (Refer to Note 1.)
LIGGETT SERIES C VARIABLE RATE NOTES:
The Series C Notes have the same terms (other than interest rate, which is
19.75%) and stated maturity as the Liggett Series B Notes.
REVOLVING CREDIT FACILITY - LIGGETT:
On March 8, 1994, Liggett entered into the Facility for $40,000 with a
syndicate of commercial lenders. The Facility is collateralized by all
inventories and receivables of Liggett. At September 30, 1998, $8,091 was
available under the Facility based on eligible collateral. Borrowings
under the Facility, whose interest is calculated at a rate equal to 1.5%
above the Philadelphia National Bank's prime rate, bear a rate of 10.0% at
September 30, 1998, reduced to 9.75% and 9.50% in October and November
1998, respectively. The Facility requires Liggett's compliance with
certain financial and other covenants, including restrictions on the
payment of cash dividends and distributions by Liggett. In addition, the
Facility, as amended April 8, 1998, imposes requirements with respect to
Liggett's permitted maximum adjusted net worth (not to fall below a
deficit of $195,000 as computed in accordance with the agreement, this
computation was $179,149 at September 30, 1998) and net working capital
deficiencies (not to fall below a deficit of $17,000 as computed in
accordance with the agreement, this computation was $2,450 at September
30, 1998). The Facility, as amended, also provides that a default by
Liggett or its subsidiaries under the March 1996 Settlements, March 1997
Settlements and March 1998 Settlements (all as defined below in Note 8)
shall constitute an event of default under the Facility. In November 1997,
the Facility was extended for an additional year until March 8, 1999.
-19-
<PAGE> 22
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
On August 29, 1997, the Facility was amended to permit Liggett to borrow
an additional $6,000 which was used on that date in making the interest
payment of $9,700 due on August 1, 1997 to the holders of the Liggett
Notes. BGLS guaranteed the additional $6,000 advance under the Facility
and collateralized the guarantee with $6,000 in cash, deposited with
Liggett's lender, $3,000 of which was released in November, 1998. At
September 30, 1998, this amount is classified in other assets on the
consolidated balance sheet.
FOREIGN LOANS:
At September 30, 1998, Liggett-Ducat had one credit facility outstanding
for $10,000 with an interest rate of 21% which expires in May of 1999. On
August 26, 1998, the interest rate over the remaining term of the facility
increased to 25%.
7. EQUITY
As of January 1, 1998, the Company granted to employees of the Company
non-qualified stock options to purchase 42,500 shares of the Company's
common stock at an exercise price of $5.00 per share. The options have a
ten-year term and vest in six equal annual installments. The Company will
recognize compensation expense of $154 over the vesting period.
On January 16, 1998, the Company entered into a Stock Purchase Agreement
in which High River Limited Partnership purchased 1,500,000 shares of the
Company's common stock for $9,000.
In connection with the March 2, 1998 agreement with the Apollo Holders,
the Company issued warrants to purchase the Company's common stock. (Refer
to Note 6.)
On March 12, 1998, the Company granted an option for 1,250,000 shares of
the Company's common stock to a law firm that represents the Company and
Liggett. On May 1, 1998 and April 1, 1999, options for 250,000 and
1,000,000 shares, respectively, of common stock were exercisable at $17.50
per share. The option expired on March 31, 2003. The fair value of the
equity instruments was estimated based on the Black-Scholes option pricing
model and the following assumptions: volatility 77.6%, risk-free interest
rate of 5.47%, expected life of two years and dividend rate of 0%. The
Company recognized expense of $1,495 in the second quarter of 1998. On
October 12, 1998, the Company amended the option to reduce the exercise
price from $17.50 per share to $6.00 per share and extended the initial
exercise date on all 1,250,000 shares to April 1, 2000, subject to earlier
exercise under certain circumstances. The expense at the initial grant
date was $3,063. Incremental expense incurred due to the modifications of
the grant was $2,050. At September 30, 1998, $2,019 had been expensed and
the remaining amount of $3,095 will be recognized over the period of
vesting.
During April and May 1998, the Company granted 10,000 shares of the
Company's common stock to each of its three outside directors. Of these
shares, 7,500 vested immediately and the remaining 22,500 shares will vest
in three equal annual installments. The Company will recognize
compensation expense of $404 over the vesting period.
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<PAGE> 23
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
On October 15, 1998, shareholders of the Company approved the adoption of
the 1998 Long-Term Incentive Plan (the "Plan"). The Plan, adopted on May
8, 1998, authorizes the granting of up to 5,000,000 shares of the
Company's common stock through awards of stock options (which may include
incentive stock options and/or nonqualified stock options), stock
appreciation rights and shares of restricted Company common stock. All
officers, employees and consultants of the Company and its subsidiaries
are eligible to receive awards under the Plan.
On July 20, 1998, the Company granted a non-qualified stock option to each
of Bennett S. LeBow, the Chairman and Chief Executive Officer of the
Company, and Howard M. Lorber, a consultant to the Company (the "Option
Holders"), pursuant to the Plan, which grants had been conditioned upon
the approval of the Plan by the Company's stockholders. Under the options,
Messrs. LeBow and Lorber have the right to purchase 2,500,000 shares and
500,000 shares, respectively, of the Company's common stock at an exercise
price of $9.75 per share (the fair market value of a share of common stock
on the date of grant). The options have a ten-year term and become
exercisable as to one-fourth of the aggregate shares covered thereby on
each of the first four anniversaries of the date of grant. However, any
then unexercisable portion of the option will immediately vest and become
exercisable upon (i) the occurrence of a "Change in Control," or (ii) the
termination of the Option Holder's employment or consulting arrangement
with the Company due to death or disability.
The fair value of the equity instruments issued to the consultant was
estimated based on the Black-Scholes option pricing model and the
following assumptions: volatility of 82.18%, risk-free interest rate of
5.47%, expected option life of 10 years and dividend rate of 0%. The
Company will recognize expense of $3,260 over the vesting period.
On August 28, 1998, the Company granted 470,000 shares of its common stock
as part of a performance fee to members of a law firm which represents the
Company and Liggett. The shares generally are not transferable prior to
September 1, 1999. The Company recognized an expense of $1,686 in the
third quarter 1998.
On October 15, 1998, the Company obtained shareholder approval to increase
the number of authorized shares of the Company's common stock from
40,000,000 to 100,000,000 shares.
8. CONTINGENCIES
TOBACCO-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 from cancer and other adverse health effects
alleged to have been caused by cigarette smoking or by exposure to
secondary smoke (environmental tobacco smoke, "ETS") from cigarettes.
These cases are reported hereinafter as though having been commenced
against Liggett (without regard to whether such cases were actually
commenced against the Company or Liggett). There has been a noteworthy
increase in the number of cases commenced against Liggett and the other
cigarette manufacturers. The cases generally fall into four categories:
(i) smoking and health cases alleging personal injury brought on behalf of
individual smokers ("Individual Actions"); (ii) smoking and health cases
alleging personal injury and purporting to be brought on behalf of a class
of plaintiffs ("Class Actions"); (iii) health care cost recovery actions
-21-
<PAGE> 24
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
brought by state and local governments ("Attorney General Actions"); and
(iv) health care cost recovery actions brought by third-party payors
including asbestos manufacturers, unions and taxpayers ("Third-Party Payor
Actions"). As new cases are commenced, defense costs and the risks
attendant to the inherent unpredictability of litigation continue to
increase. Liggett had been receiving assistance from others in the
industry in defraying the costs and other burdens incurred in the defense
of smoking and health litigation and related proceedings, which, for the
most part, consisted of the payment of counsel fees and costs, but this
assistance terminated in 1997. The future financial impact on the Company
of the termination of this assistance and the effects of the tobacco
litigation settlements discussed below is not quantifiable at this time.
For the nine months ended September 30, 1998, Liggett incurred counsel
fees and costs totaling approximately $3,713, compared to $3,287 for the
comparable prior year period.
In June 1992, in an action entitled CIPOLLONE V. LIGGETT GROUP INC., ET
AL., the United States Supreme Court issued an opinion concluding that The
Federal Cigarette Labeling and Advertising Act did not preempt state
common law damage claims but that The Public Health Cigarette Smoking Act
of 1969 (the "1969 Act") did preempt certain, but not all, state common
law damage claims. The decision bars plaintiffs from asserting claims
that, after the effective date of the 1969 Act, the tobacco companies
either failed to warn adequately of the claimed health risks of cigarette
smoking or sought to neutralize those claimed risks in their advertising
or promotion of cigarettes. Bills have been introduced in Congress on
occasion to eliminate the federal preemption defense. Enactment of any
federal legislation with such an effect could result in a significant
increase in claims, liabilities, and litigation costs.
INDIVIDUAL ACTIONS. As of September 30, 1998, there were approximately 275
cases pending against Liggett, and in most cases the other tobacco
companies, where individual plaintiffs allege injury resulting from
cigarette smoking, addiction to cigarette smoking or exposure to ETS and
seek compensatory and, in some cases, punitive damages. Of these, 90 were
pending in the State of Florida, 88 in the State of New York, 23 in the
Commonwealth of Massachusetts and 19 in the State of Texas. The balance of
individual cases was pending in 18 states. There are three individual
cases pending where Liggett is the only named defendant.
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for personal injuries allegedly caused by
cigarette smoking are based on various theories of recovery, including
negligence, gross negligence, special duty, voluntary undertaking, 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,
indemnity, market share liability and violations of deceptive trade
practices laws, the Federal Racketeer Influenced and Corrupt Organization
Act ("RICO") and antitrust statutes. In many of these cases, in addition
to compensatory damages, plaintiffs also seek other forms of relief
including 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.
CLASS ACTIONS. As of September 30, 1998, there were approximately 45
actions pending, for which either a class has been certified or plaintiffs
are seeking class certification, where Liggett, among others, was a named
defendant. Two of these cases, FLETCHER, ET AL. V. BROOKE GROUP LTD., ET
AL. and WALKER, ET AL. V. LIGGETT GROUP INC., ET AL., have been settled by
the Company, subject to court approval. These two settlements are more
fully discussed below under the "Settlements" section.
-22-
<PAGE> 25
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
In October 1991, an action entitled BROIN, ET AL. V. PHILIP MORRIS
INCORPORATED, ET AL., Circuit Court of the Eleventh Judicial District in
and for Dade County, Florida, was filed against Liggett and others. This
case was brought by plaintiffs on behalf of all flight attendants that
worked or are presently working for airlines based in the United States
and who never regularly smoked cigarettes but allege that they have been
damaged by involuntary exposure to ETS. In October 1997, the other major
tobacco companies settled this matter, which settlement provides for a
release of the Company and Liggett. In February 1998, the Circuit Court
approved the settlement; however, an objector filed a Notice of Appeal of
the settlement in the Third District Court of Appeal.
In March 1994, an action entitled CASTANO, ET AL. V. THE AMERICAN TOBACCO
COMPANY INC., ET AL., United States District Court, Eastern District of
Louisiana, was filed against Liggett and others. The class action
complaint sought relief for a nationwide class of smokers based on their
alleged addiction to nicotine. In February 1995, the District Court
granted plaintiffs' motion for class certification (the "Class
Certification Order").
In May 1996, the Court of Appeals for the Fifth Circuit reversed the Class
Certification Order and instructed the District Court to dismiss the class
complaint. The Fifth Circuit ruled that the District Court erred in its
analysis of the class certification issues by failing to consider how
variations in state law affect predominance of common questions and the
superiority of the class action mechanism. The appeals panel also held
that the District Court's predominance inquiry did not include
consideration of how a trial on the merits in CASTANO would be conducted.
The Fifth Circuit further ruled that the "addiction-as-injury" tort is
immature and, accordingly, the District Court could not know whether
common issues would be a "significant" portion of the individual trials.
According to the Fifth Circuit's decision, any savings in judicial
resources that class certification may bring about is speculative and
would likely be overwhelmed by the procedural problems certification
brings. Finally, the Fifth Circuit held that in order to make the class
action manageable, the District Court would be forced to bifurcate issues
in violation of the Seventh Amendment.
The extent of the impact of the CASTANO decision on tobacco-related class
action litigation is still uncertain, although the decertification of the
CASTANO class by the Fifth Circuit may preclude other federal courts from
certifying a nationwide class action for trial purposes with respect to
tobacco-related claims. The CASTANO decision has had to date, however,
only limited effect with respect to courts' decisions regarding narrower
tobacco-related classes or class actions brought in state rather than
federal court. For example, since the Fifth Circuit's ruling, courts in
New York, Louisiana and Maryland have certified "addiction-as-injury"
class actions that covered only citizens in those states. Two class
actions pending in state court in Florida have also been certified one of
which, the BROIN case, was settled in 1997. The CASTANO decision has had
no measurable impact on litigation brought by or on behalf of single
individual claimants.
ATTORNEY GENERAL ACTIONS. As of September 30, 1998, 40 Attorney General
Actions were filed against Liggett and the Company. As more fully
discussed below, Liggett and the Company have settled 36 of these actions.
In addition, the Company and Liggett have reached settlements with nine
Attorneys General representing states, commonwealths or territories that
have not commenced litigation against the Company or Liggett. In these
proceedings, state and local government entities seek reimbursement for
Medicaid and other health care expenditures allegedly caused by use of
tobacco products. The claims asserted in these health care cost recovery
actions vary. In most of these
-23-
<PAGE> 26
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
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, violation of a voluntary undertaking or
special duty, fraud, negligent misrepresentation, conspiracy, public
nuisance, claims under state and federal statutes governing consumer
fraud, antitrust, deceptive trade practices and false advertising, and
claims under RICO.
THIRD-PARTY PAYOR ACTIONS. As of September 30, 1998, there were
approximately 70 Third-Party Payor Actions pending. The claims in these
cases are similar to those in the Attorney General Actions. In April 1998,
a group known as the "Coalition for Tobacco Responsibility", which
represents Blue Cross and Blue Shield Plans in more than 35 states, filed
federal lawsuits against the industry seeking payment of health-care costs
allegedly incurred as a result of cigarette smoking and ETS. The lawsuits
were filed in Federal District Courts in New York, Chicago, and Seattle
and seek billions of dollars in damages. The lawsuits allege conspiracy,
fraud, misrepresentation, and violation of federal racketeering and
anti-trust laws as well as other claims.
SETTLEMENTS. In March 1996, the Company and Liggett entered into an
agreement, subject to court approval, to settle the CASTANO class action
tobacco litigation. Under the CASTANO settlement agreement, upon final
court approval of the settlement, the CASTANO class would be entitled to
receive up to five percent of Liggett's pretax income (income before
income taxes) each year (up to a maximum of $50,000 per year) for the next
25 years, subject to certain reductions provided for in the agreement and
a $5,000 payment from Liggett if the Company or Liggett fail to consummate
a merger or similar transaction with another non-settling tobacco company
defendant within three years of the date of settlement. The Company and
Liggett have the right to terminate the CASTANO settlement under certain
circumstances. On March 14, 1996, the Company, the CASTANO Plaintiffs
Legal Committee and the CASTANO plaintiffs entered into a letter
agreement. According to the terms of the letter agreement, for the period
ending nine months from the date of Final Approval (as defined in the
letter), if granted, of the CASTANO settlement or, if earlier, the
completion by the Company or Liggett of a combination with any defendant
in CASTANO, except Philip Morris, the CASTANO plaintiffs and their counsel
agree not to enter into any more favorable settlement agreement with any
CASTANO defendant which would reduce the terms of the CASTANO settlement
agreement. If the Castano plaintiffs or their counsel enter into any such
settlement during this period, they shall pay the Company $250,000 within
30 days of the more favorable agreement and offer the Company and Liggett
the option to enter into a settlement on terms at least as favorable as
those included in such other settlement. The letter agreement further
provides that during the same time period, and if the CASTANO settlement
agreement has not been earlier terminated by the Company in accordance
with its terms, the Company and its affiliates will not enter into any
business transaction with any third party which would cause the
termination of the CASTANO settlement agreement. If the Company or its
affiliates enter into any such transaction, then the CASTANO plaintiffs
will be entitled to receive $250,000 within 30 days from the transacting
party. In May 1996, the CASTANO Plaintiffs Legal Committee filed a motion
with the United States District Court for the Eastern District of
Louisiana seeking preliminary approval of the CASTANO settlement. In
September 1996, shortly after the class was decertified, the CASTANO
plaintiffs withdrew the motion for approval of the CASTANO settlement.
In March 1996, the Company and Liggett entered into a settlement of
tobacco-related litigation with the Attorneys General of Florida,
Louisiana, Massachusetts, Mississippi and West Virginia (the "March 1996
Settlements"). The March 1996 Settlements release the Company and Liggett
from all
-24-
<PAGE> 27
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
tobacco-related claims including claims for health care cost reimbursement
and claims concerning sales of cigarettes to minors. Certain of the terms
of the March 1996 Settlements are summarized below.
Under the March 1996 Settlements, the five settling states would share an
initial payment by Liggett of $5,000, payable over nine years and indexed
and adjusted for inflation, provided that any unpaid amount will be due 60
days after either a default by Liggett in its payment obligations under
the settlement or a merger or other similar transaction by the Company or
Liggett with another defendant in the lawsuits. In addition, Liggett will
be required to pay the settling states a percentage of Liggett's pretax
income (income before income taxes) each year from the second through the
twenty-fifth year. This annual percentage is 2.5% of Liggett's pretax
income, subject to increase to 7.5% depending on the number of additional
states joining the settlement. No additional states have joined this
settlement to date. All of Liggett's payments are subject to certain
reductions provided for in the agreement. Liggett has also agreed to pay
to the settling states $5,000 if the Company or Liggett fails to
consummate a merger or other similar transaction with another defendant in
the lawsuits within three years from the date of the March 1996
Settlement.
Settlement funds received by the Attorneys General will be used to
reimburse the states for smoking-related health care costs. The Company
and Liggett also have agreed to phase in compliance with certain of the
proposed interim FDA regulations on the same basis as provided in the
CASTANO settlement. The Company and Liggett have the right to terminate
the March 1996 Settlements with respect to any settling state if any of
the remaining defendants in the litigation succeed on the merits in that
state's respective Attorney General action. The Company and Liggett may
also terminate the March 1996 Settlements if they conclude that too many
states have filed Attorney General actions and have not settled such cases
with the Company and Liggett.
In March 1997, Liggett, the Company and the five settling states executed
an addendum pursuant to which Liggett and the Company agreed to provide to
the five settling states, among other things, the additional cooperation
and compliance with advertising restrictions that is provided for in the
March 1997 Settlements (discussed below). Also, pursuant to the addendum,
the initial settling states agreed to use best efforts to ensure that in
the event of a global tobacco settlement enacted through federal
legislation or otherwise, Liggett's and the Company's financial
obligations under such a global settlement would be no more onerous than
under this settlement.
During 1997, Liggett and the Company entered into a comprehensive
settlement of tobacco litigation through parallel agreements with the
Attorneys General of 21 states and with a nationwide class of individuals
and entities that allege smoking-related claims (settlements with these 21
Attorneys General and with the nationwide class are hereinafter referred
to as the "March 1997 Settlements"). In March 1998, Liggett and the
Company announced settlements with the Attorneys General of 15 states, the
District of Columbia, Guam, Northern Mariana Islands and the U.S. Virgin
Islands (the "March 1998 Settlements"). The foregoing settlements cover
all smoking-related claims, including both addiction-based and tobacco
injury claims against the Company and Liggett, brought by the Attorneys
General and, upon court approval, the nationwide class.
The states, commonwealths and territories where settlements have been
reached with Attorneys General are: Alaska, Arizona, Arkansas, California,
Colorado, Connecticut, District of Columbia, Florida, Georgia, Guam,
Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine,
Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri,
Montana, Nebraska, Nevada, New
-25-
<PAGE> 28
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
Hampshire, New Jersey, New Mexico, New York, North Dakota, Northern
Mariana Islands, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island,
Texas, Utah, U.S. Virgin Islands, Washington, West Virginia, Wisconsin and
Wyoming. Other states have either recently filed health care cost recovery
actions or indicated intentions to do so. Both Liggett and the Company
will endeavor to resolve those actions on substantially the same terms and
conditions as the March 1998 Settlements, however, there can be no
assurance that any such settlements will be completed.
As mentioned above, in March 1997, Liggett, the Company and plaintiffs
filed a mandatory class settlement agreement in an action entitled
FLETCHER, ET AL. V. BROOKE GROUP LTD., ET AL., Circuit Court of Mobile
County, Alabama, where the court granted preliminary approval and
preliminary certification of the class, and in May 1997, a similar
mandatory class settlement agreement was filed in an action entitled
WALKER, ET AL. V. LIGGETT GROUP INC., ET AL., United States District
Court, Southern District of West Virginia. On July 2, 1998, Liggett, the
Company and plaintiffs filed an amended class action settlement agreement
in FLETCHER. Pursuant to the amended agreement, Liggett is required to pay
to the class 7.5% of Liggett's pre-tax income each year for 25 years, with
a minimum annual payment guarantee of $1,000 over the term of the
agreement. The amended agreement does not set forth a formula with respect
to the distribution of settlement proceeds to the class. On September 10,
1998, the Circuit Court held a hearing with respect to the parties' motion
for reaffirmance of preliminary approval of the amended agreement. The
court has not yet ruled on this motion. The Company anticipates that
should the court in FLETCHER, after dissemination of notice to the class
of the pending limited fund class action settlement and a full fairness
hearing with respect thereto, issue a final order and judgment approving
the settlement, such an order would preclude further prosecution by class
members of tobacco-related claims against both Liggett and the Company.
Under the Full Faith and Credit Act, a final judgment entered in a
nationwide class action pending in a state court has a preclusive effect
against any class member with respect to the claims settled and released.
As the class definition in FLETCHER encompasses all persons in the United
States who could claim injury as a result of cigarette smoking or ETS and
any third-party payor claimants, it is anticipated that, upon final order
and judgment, all such persons and third-party payor claimants would be
barred from further prosecution of tobacco-related claims against Liggett
and the Company.
In the FLETCHER action, it is anticipated that class members will be
notified of the settlement and will have an opportunity to appear at a
later court hearing. Effectiveness of the mandatory settlement is
conditioned on final court approval of the settlement after a fairness
hearing. There can be no assurance as to whether, or when, such court
approval will be obtained.
The WALKER court also granted preliminary approval and preliminary
certification of the nationwide class, however, in August 1997, the court
vacated its preliminary certification of the settlement class, which
decision is currently on appeal. The WALKER court relied on the Supreme
Court's decision in AMCHEM PRODUCTS INC. V. WINDSOR in reaching its
decision to vacate preliminary certification of the class. In AMCHEM, the
Supreme Court affirmed a decision of the Third Circuit vacating the
certification of a settlement class that involved asbestos-exposure
claims. The Supreme Court held that the proposed settlement class did not
meet the requirements of Rule 23 of the Federal Rules of Civil Procedure
for predominance of common issues and adequacy of representation. The
Third Circuit had held that, although classes could be certified for
settlement purposes, Rule 23's requirements had to be satisfied as if the
case were going to be litigated. The Supreme Court agreed that the
fairness and adequacy of the settlement are not pertinent to the
predominance inquiry under Rule 23(b)(3), and thus, the proposed class
must have sufficient unity so that absent class members can fairly be
bound by decisions of class representatives.
-26-
<PAGE> 29
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
After the AMCHEM opinion was issued by the Supreme Court in June 1997,
objectors to Liggett's settlement in WALKER moved for decertification.
Although Liggett's settlement in the WALKER action is a "limited fund"
class action settlement proceeding under Rule 23(b)(1) and AMCHEM was a
Rule 23 (b)(3) case, the court in the WALKER action, nonetheless,
decertified the WALKER class. Applying AMCHEM to the WALKER case, the
District Court, in a decision issued in August 1997, determined that while
plaintiffs in WALKER have a common interest in "maximizing the limited
fund available from the defendants," there remained "substantial conflicts
among class members relating to distribution of the fund and other key
concerns" that made class certification inappropriate.
The AMCHEM decision's ultimate affect on the viability of both the WALKER
and FLETCHER settlements remains uncertain given the Fifth Circuit's
recent ruling reaffirming a limited fund class action settlement in IN RE
ASBESTOS LITIGATION ("AHEARN"). In June 1997, the Supreme Court remanded
AHEARN to the Fifth Circuit for consideration in light of AMCHEM. On
remand, the Fifth Circuit made two decisive distinctions between AMCHEM
and AHEARN. First, the AHEARN class action proceeded under Rule 23(b)(1)
while AMCHEM was a Rule 23(b)(3) case, and second, in AHEARN, there was no
allocation or difference in award, according to nature or severity of
injury, as there was in AMCHEM. The Fifth Circuit concluded that all
members of the class and all class representatives share common interests
and none of the uncommon questions abounding in AMCHEM exist. On June 22,
1998, the Supreme Court granted certiorari to review the Fifth Circuit
decision.
The remaining material terms of the March 1996 Settlements, the March 1997
Settlements and the March 1998 Settlements are described below.
Pursuant to each of the settlements, both the Company and Liggett agreed
to cooperate fully with the Attorneys General and the nationwide class in
their respective lawsuits against the tobacco industry. The Company and
Liggett agreed to provide to these parties all relevant tobacco documents
in their possession, other than those subject to claims of joint defense
privilege, and to waive, subject to court order, certain attorney-client
privileges and work product protections regarding Liggett's
smoking-related documents to the extent Liggett and the Company can so
waive these privileges and protections. The Attorneys General and the
nationwide class agreed to keep Liggett's documents under protective order
and, subject to final court approval, to limit their use to those actions
brought by parties to the settlement agreements. Those documents that may
be subject to a joint defense privilege with other tobacco companies will
not be produced to the Attorneys General or the nationwide class, but will
be, pursuant to court order, submitted to the appropriate court and placed
under seal for possible IN CAMERA review. Additionally, under similar
protective conditions, the Company and Liggett agreed to offer their
employees for witness interviews and testimony at deposition and trial.
Pursuant to the settlement agreements, Liggett also agreed to place an
additional warning on its cigarette packaging stating that "Smoking is
Addictive" and to issue a public statement, as requested by the Attorneys
General. Liggett has commenced distribution of cigarette packaging, which
displays the new warning label.
Pursuant to the March 1996 Settlements, any other tobacco company
defendant, except Philip Morris, merging or combining with Liggett or the
Company, prior to the third anniversary of the settlement, would receive
certain settlement benefits, including limitations on potential liability.
Pursuant to the agreement, any such combining tobacco company would be
released from the lawsuits brought by the five initial settling states.
Such combining tobacco company would be obligated to pay into the
settlement fund within sixty days of becoming bound to the agreement
-27-
<PAGE> 30
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
$135,000, and make annual payments of 2.5% of the combining company's
pre-tax income (but not less than $30,000 per year). Such combining
tobacco company would also have to comply with the advertising and access
restrictions provided for in the agreement, and would have to withdraw
their objections to the FDA rule.
Pursuant to the March 1997 Settlements, any other tobacco company
defendant, except Philip Morris, merging or combining with Liggett or the
Company, prior to the fourth anniversary of the settlements, would receive
certain settlement benefits, including limitations on potential liability
for affiliates not engaged in domestic tobacco operations and a waiver of
any obligation to post a bond to appeal any future adverse judgment. In
addition, within 120 days following any such combination, Liggett would be
required to pay the settlement fund $25,000. Under all settlements, the
plaintiffs have agreed not to seek an injunction preventing a defendant
tobacco company combining with Liggett or the Company from spinning off
any affiliate which is not engaged in the domestic tobacco business.
Pursuant to the March 1998 Settlements, Liggett is required to pay each of
the settling states and territories their relative share (based on the
Medicaid population of each state over the total Medicaid population of
the United States) of between 27.5% and 30% of Liggett's pre-tax income
each year for 25 years, with a minimum payment guarantee of $1,000 per
state over the first nine years of the agreement. The aggregate payments
required under the March 1996, March 1997 and March 1998 Settlements are
$45,000, of which $3,639 has been paid as of September 30, 1998. The
annual percentage is subject to increase, pro rata from 27.5% up to 30%,
depending on the number of additional states joining the settlement.
Pursuant to the "most favored nation" provisions under the March 1996
Settlement and the March 1997 Settlements, each of the states settling
under those settlements could benefit from the economic terms of the March
1998 Settlements. In all settlements, Liggett agreed to phase-in
compliance with certain proposed FDA regulations regarding smoking by
children and adolescents, including a prohibition on the use of cartoon
characters in tobacco advertising and limitations on the use of
promotional materials and distribution of sample packages where minors are
present. The March 1998 Settlements provide for additional restrictions
and regulations on Liggett's advertising, including a prohibition on
outdoor advertising and product advertising on the Internet and on
payments for product placement in movies and television.
Under all settlements, the Company and Liggett are also entitled to "most
favored nation" treatment in the event any settling Attorney General
reaches a settlement with any other defendant tobacco company. Pursuant to
the March 1996 and March 1997 Settlements, in the event of a global
settlement involving federal legislation with any other defendant tobacco
company, the settling Attorneys General agreed to use their "best efforts"
to ensure that the Company and Liggett's liability under such legislation
should be no more onerous than under those settlements. Under the March
1998 Settlements, the settling Attorneys General agreed to write letters
to Congress and the President of the United States to ensure that the
Company and Liggett's liability under any such legislation should be no
more onerous than under this settlement.
The Company accrued approximately $4,000 for the present value of the
fixed payments under the March 1996 Settlements and $16,902 for the
present value of the fixed payments under the March 1998 Settlements. No
additional amounts have been accrued because the Company cannot quantify
the future costs of the settlements as the amounts Liggett must pay are
based, in part, on
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<PAGE> 31
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
future operating results. Possible future payments based on a percentage
of pretax income, and other contingent payments based on the occurrence of
a business combination, will be expensed when considered probable.
Separately, the other tobacco companies negotiated settlements of the
Attorney General Actions in Mississippi, Florida, Texas, and Minnesota and
it has been widely publicized that the other companies have engaged in
negotiations to settle with the Attorneys General of the remaining states.
Copies of the various settlement agreements are filed as exhibits to the
Company's Form 10-K and the discussion herein is qualified in its entirety
by reference thereto.
TRIALS. On July 6, 1998, trial commenced in the ENGLE, ET AL. V. PHILIP
MORRIS INCORPORATED, ET AL., case, a class action pending in Miami Dade
County, Florida, brought on behalf of all Florida residents allegedly
injured by smoking. There are several trial dates scheduled during 1999
for Third-Party Payor and Individual Actions; however, trial dates are
subject to change.
OTHER RELATED MATTERS. In March 1997, RJR, Philip Morris, B&W and
Lorillard obtained a temporary restraining order from a North Carolina
state court preventing the Company and Liggett and their agents,
employees, directors, officers and lawyers from turning over documents
allegedly subject to the joint defense privilege in connection with the
settlements, which restraining order was converted to a preliminary
injunction by the court in April 1997. In March 1997, the United States
District Court for the Eastern District of Texas and state courts in
Mississippi and Illinois each issued orders enjoining the other tobacco
companies from interfering with Liggett's filing with the courts, under
seal, those documents.
A grand jury investigation is being conducted by the office of the United
States Attorney for the Eastern District of New York (the "Eastern
District Investigation") regarding possible violations of criminal law
relating to the activities of The Council for Tobacco Research - USA, Inc.
(the "CTR"). Liggett was a sponsor of the CTR at one time. In May 1996,
Liggett received a subpoena from a Federal grand jury sitting in the
Eastern District of New York, to which Liggett has responded.
In March 1996, and in each of March, July, October and December 1997, the
Company and/or Liggett received subpoenas from a Federal grand jury in
connection with an investigation by the United States Department of
Justice (the "DOJ Investigation") involving the industry's knowledge of:
the health consequences of smoking cigarettes; the targeting of children
by the industry; and the addictive nature of nicotine and the manipulation
of nicotine by the industry. Liggett has responded to the March 1996,
March 1997 and July 1997 subpoenas and is in the process of responding to
the October and December 1997 subpoenas. The Company understands that the
Eastern District Investigation and the DOJ Investigation essentially have
been consolidated into one investigation conducted by the Department of
Justice (the "DOJ"). The Company and Liggett are unable, at this time, to
predict the outcome of this investigation.
On April 28, 1998, the Company announced that Liggett had reached an
agreement with the DOJ to cooperate in both the Eastern District
Investigation and the DOJ Investigation. The agreement does not constitute
an admission of any wrongful behavior by Liggett. The DOJ has not provided
immunity to Liggett and has full discretion to act or refrain from acting
with respect to Liggett in the investigation.
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<PAGE> 32
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
In September 1998, Liggett received a subpoena from a federal grand jury
in the Eastern District of Philadelphia investigating possible antitrust
violations in connection with the purchase of tobacco by and for tobacco
companies. Liggett is in the process of responding to this subpoena.
Liggett and the Company are unable, at this time, to predict the outcome
of this investigation.
Litigation is subject to many uncertainties, and it is possible that some
of the aforementioned actions could be decided unfavorably against the
Company or Liggett. An unfavorable outcome of a pending smoking and health
case could encourage the commencement of additional similar litigation.
The Company is unable to evaluate the effect of these developing matters
on pending litigation or the possible commencement of additional
litigation. The Company is also unable to make a meaningful estimate with
respect to the amount of loss that could result from an unfavorable
outcome of many of the cases pending against the Company, because the
complaints filed in these cases rarely detail alleged damages. Typically,
the claims set forth in an individual's complaint against the tobacco
industry pray for money damages in an amount to be determined by a jury,
plus punitive damages and costs. These damage claims are typically stated
as being for the minimum necessary to invoke the jurisdiction of the
court.
Third-party payor claimants and others have set forth several additional
variations on 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.
It is possible that the Company's consolidated financial position, results
of operation and cash flow could be materially adversely affected by an
unfavorable outcome in any such tobacco-related litigation.
Liggett has been involved in certain environmental proceedings, none of
which, either individually or in the aggregate, rises to the level of
materiality. Liggett's management believes that current operations are
conducted in material compliance with all environmental laws and
regulations. Management is unaware of any material environmental
conditions affecting its existing facilities. 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, earnings or
competitive position of Liggett.
There are several other proceedings, lawsuits and claims pending against
the Company unrelated to smoking or tobacco product liability. Management
is of the opinion that the liabilities, if any, ultimately resulting from
such other proceedings, lawsuits and claims should not materially affect
the Company's financial position, results of operations or cash flows.
LEGISLATION AND REGULATION:
In January 1993, the United States Environmental Protection Agency ("EPA")
released a report on the respiratory effect of ETS which concludes that
ETS 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
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<PAGE> 33
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
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 ETS, and that given the current body of scientific evidence and
the EPA's failure to follow its own guidelines in making the
determination, the EPA's classification of ETS was arbitrary and
capricious. Whatever the outcome of this litigation, issuance of the
report may encourage efforts to limit smoking in public areas. In July
1998, the court ruled that the EPA made procedural and scientific mistakes
when it declared in its 1993 report that secondhand smoke caused as many
as 3,000 cancer deaths a year among nonsmokers.
In April 1994, the United States Occupational Safety and Health
Administration ("OSHA") issued a proposed rule that could ultimately ban
smoking in the workplace. Hearings were completed during 1995. OSHA has
not yet issued a final rule or a proposed revised rule. While the Company
cannot predict the outcome, some form of federal regulation of smoking in
workplaces may result.
In February 1996, the United States Trade representative issued an
"advance notice of rule making" concerning how tobaccos imported under a
previously established tobacco rate quota ("TRQ") should be allocated.
Currently, tobacco imported under the TRQ is allocated on a "first-come,
first-served" basis, meaning that entry is allowed on an open basis to
those first requesting entry in the quota year. Others in the cigarette
industry have suggested an "end-user licensing" system under which the
right to import tobacco under the quota would be initially assigned based
on domestic market share. Such an approach, if adopted, could have a
material adverse effect on the Company and Liggett.
In August 1996, the FDA filed in the Federal Register a Final Rule (the
"FDA Rule") classifying tobacco as a drug, asserting jurisdiction by the
FDA over the manufacture and marketing of tobacco products and imposing
restrictions on the sale, advertising and promotion of tobacco products.
Litigation was commenced in the United States District Court for the
Middle District of North Carolina challenging the legal authority of the
FDA to assert such jurisdiction, as well as challenging the
constitutionality of the rules. The court, after argument, granted
plaintiffs' motion for summary judgment prohibiting the FDA from
regulating or restricting the promotion and advertising of tobacco
products and denied plaintiffs' motion for summary judgment on the issue
of whether the FDA has the authority to regulate access to, and labeling
of, tobacco products. The Fourth Circuit Court reversed the district court
on appeal and on August 14, 1998 held that the FDA cannot regulate tobacco
products because Congress had not given them the authority to do so. The
Company and Liggett support the FDA Rule and have begun to phase in
compliance with certain of the proposed interim FDA regulations. See
discussions of the CASTANO and Attorney General Actions settlements above.
In August 1996, the Commonwealth of Massachusetts enacted legislation
requiring tobacco companies to publish information regarding the
ingredients in cigarettes and other tobacco products sold in that state.
In December 1997, the United States District Court for the District of
Massachusetts enjoined this legislation from going into effect, however,
in December 1997, Liggett began complying with this legislation by
providing ingredient information to the Massachusetts Department of Public
Health.
As part of the budget agreement recently approved by Congress, federal
excise taxes on a pack of cigarettes, which are currently 24 cents, would
rise 10 cents in the year 2000 and 5 cents more in the year 2002.
Additionally, the citizens of California recently voted in favor of a 50
cents per pack tax on cigarettes sold in that state.
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<PAGE> 34
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
PROPOSED RESOLUTION. In June 1997, Philip Morris Incorporated ("Philip
Morris"), R. J. Reynolds Tobacco Company ("RJR"), B&W, Lorillard Tobacco
Company ("Lorillard") and the United States Tobacco Company, along with
the Attorneys General for the States of Arizona, Connecticut, Florida,
Mississippi, New York and Washington and the CASTANO Plaintiffs'
Litigation Committee executed a Memorandum of Understanding to support the
adoption of federal legislation and necessary ancillary undertakings,
incorporating the features described in a proposed resolution (the
"Resolution"). The proposed Resolution mandates a total reformation and
restructuring of how tobacco products are manufactured, marketed and
distributed in the United States. (The proposed Resolution is discussed in
the Company's 1997 Form 10-K/A No. 1.)
In a speech in September 1997, President Clinton called for federal
legislation that, among other things, would raise cigarette prices by up
to $1.50 per pack. Since then, several bills have been introduced in
Congress, including bills modeled after the proposed Resolution, that
purport to propose legislation along these lines. The White House,
Congress, and various public interest groups are currently reviewing the
proposed Resolution along with other proposed federal tobacco legislation.
Management is unable to predict whether the proposed Resolution or other
federal legislation will be enacted or the form any such enactment might
take. The present legislative and litigation environment is substantially
uncertain and could have a material adverse effect on the business of the
Company and Liggett.
In addition to the foregoing, there have been a number of other
restrictive regulatory actions, adverse political decisions and other
unfavorable developments concerning cigarette smoking and the tobacco
industry, the effects of which, at this time, the Company is not able to
evaluate.
OTHER MATTERS:
In June 1993, the Company obtained expropriation and forced abandonment
insurance coverage for its investment in its Ducat Place I real estate
project in Moscow, Russia. Shortly thereafter, the Company submitted a
Notice of Loss to the insurer, under and pursuant to the policy. The
insurer denied the claim and, in July 1994, arbitration proceedings were
commenced in the United Kingdom. In January 1997, the Company recognized a
gain of $4,125 in settlement of the dispute.
On or about March 13, 1997, a shareholder derivative suit was filed
against New Valley, as a nominal defendant, its directors and the Company
in the Delaware Chancery Court, by a shareholder of New Valley. The suit
alleges that New Valley's purchase of the BML shares constituted a
self-dealing transaction which involved the payment of excessive
consideration by New Valley. The plaintiff seeks (i) a declaration that
New Valley's directors breached their fiduciary duties, the Company aided
and abetted such breaches and such parties are therefore liable to New
Valley, and (ii) unspecified damages to be awarded to New Valley. The
Company's time to respond to the complaint has not yet expired. The
Company believes that the allegations are without merit. Although there
can be no assurances, management is of the opinion, after consultation
with counsel, that the ultimate resolution of this matter will not have a
material adverse effect on the Company's consolidated financial position,
results of operations or cash flows.
On or about September 18, 1998, a lawsuit was commenced against the
Company, New Valley, certain officers, directors and shareholders and
others in the United States District Court, Southern District of Texas,
Houston Division. The defendants have moved for a more definite statement
and for an extension of time to answer the complaint.
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<PAGE> 35
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (Continued)
9. RELATED PARTY TRANSACTIONS
On January 31, 1997, New Valley entered into a stock purchase agreement
with BOL pursuant to which New Valley acquired 10,483 shares of BML common
stock (99.1%) for a purchase price of $55,000, consisting of $21,500 in
cash and a $33,500 promissory note with an interest rate of 9%. The note
was paid in full in 1997. (Refer to Notes 3 and 8.)
In January 1998, the Company entered into an amendment to the Amended and
Restated Consulting Agreement dated as of January 1, 1996 with a
consultant who also serves as a director and President of New Valley. The
amendment provides that the consultant is entitled on an annual basis to
receive additional payments in an amount necessary to reimburse him, on an
after-tax basis, for all applicable taxes incurred by him during the prior
calendar year as a result of the grant to him, or vesting, of a 1994 award
of 500,000 restricted shares of the Company's Common Stock and 1995 and
1996 awards of 500,000 and 1,000,000, respectively, options to acquire
shares of the Company's common stock. The consultant received an
additional consulting payment of $425,000 in January 1998, which the
consultant and the Company have agreed will constitute full satisfaction
of the Company's obligations under the amendment with respect to 1997.
Effective May 1, 1998, a former officer of the Company entered into a
consulting agreement in which the Company will pay him a total of $2,254
in stock or cash in quarterly installments over a period of 6 years. The
Company recognized the expense during the second quarter 1998.
In September 1998, New Valley made a one-year $950 loan to BGLS which
bears interest at 14% per annum.
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<PAGE> 36
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
INTRODUCTION
The following discussion provides an assessment of the consolidated
results of operations, capital resources and liquidity of Brooke Group Ltd. (the
"Company") and its subsidiaries and should be read in conjunction with the
Consolidated Financial Statements and notes thereto of the Company and BGLS Inc.
("BGLS") included elsewhere in this document. BGLS is a wholly owned subsidiary
of the Company. The consolidated financial statements include the accounts of
BGLS, Liggett Group Inc. ("Liggett"), Brooke (Overseas) Ltd. ("BOL"), New Valley
Holdings, Inc. ("NV Holdings"), Liggett-Ducat Ltd. ("Liggett-Ducat") and other
less significant subsidiaries. The Company holds an equity interest in New
Valley Corporation ("New Valley") through NV Holdings.
The Company is a holding company for a number of businesses which it
holds through its wholly-owned subsidiary BGLS. Accordingly, a separate
Management's Discussion and Analysis of Financial Condition and Results of
Operations for BGLS is not presented herein as it would not differ materially
from the discussion of the Company's consolidated results of operations, capital
resources and liquidity.
For purposes of this discussion and other consolidated financial
reporting, the Company's significant business segment is tobacco in the United
States and Russia for the nine months ended September 30, 1998 and September 30,
1997.
RECENT DEVELOPMENTS
THE COMPANY
STANDSTILL AGREEMENT. On March 5, 1998, BGLS entered into an agreement
(the "Standstill Agreement") with AIF II, L.P. and an affiliated investment
manager on behalf of a managed account (the "Apollo Holders"), who together held
approximately 41.8% of the $232,864 principal amount of BGLS' 15.75% Senior
Secured Notes due 2001 (the "BGLS Notes") then outstanding.
Pursuant to the terms of the Standstill Agreement, the Apollo Holders
agreed to defer the payment of interest on the BGLS Notes held by them,
commencing with the interest payment that was due July 31, 1997, which they had
previously agreed to defer, through the interest payment due on July 31, 2000.
The deferred interest payments will be payable at final maturity of the BGLS
Notes on January 31, 2001 or upon an Event of Default under the Indenture for
the BGLS Notes. In connection with the Standstill Agreement, the Company issued
to the Apollo Holders a five-year warrant to purchase 2,000,000 shares of the
Company's common stock at a price of $5.00 per share. The Apollo Holders were
also issued a second warrant expiring October 31, 2004 to purchase an additional
2,150,000 shares of the Company's common stock at a price of $0.10 per share.
The second warrant will become exercisable on October 31, 1999 and the Company
will have the right under certain conditions prior to that date to substitute
for that warrant a new warrant for 9.9% of the common stock of Liggett.
On February 6, 1998, the holder of 41.9% of the BGLS Notes, who had
previously been a party to the Standstill Agreement, was paid its pro-rata share
of the July 31, 1997 interest payment on the BGLS Notes. On March 2, 1998, BGLS
made the interest payment due on January 31, 1998 to all holders of the BGLS
Notes other than the Apollo Holders.
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<PAGE> 37
SALE OF STOCK. On January 16, 1998, the Company entered into a Stock
Purchase Agreement with High River Limited Partnership ("High River") in which
High River purchased 1,500,000 shares of the Company's common stock for $9,000.
LIGGETT
NOTES RESTRUCTURING. On January 30, 1998, with the consent of the
required majority of the holders of the Liggett 11.50% Series B and 19.75%
Series C Senior Secured Notes due 1999 (the "Liggett Notes"), Liggett entered
into various amendments to the Indenture governing the Liggett Notes which
provided, among other things, for a deferral of the February 1, 1998 mandatory
redemption payment of $37,500 to the date of final maturity of the Liggett Notes
on February 1, 1999. In connection with the deferral, the Company agreed to
issue 483,002 shares of the Company's common stock to the holders of record on
January 15, 1998 of the Liggett Notes. The Indenture under which the Liggett
Notes are outstanding was also amended to prohibit, with limited exceptions,
payments of dividends and incurrence of new debt by Liggett and to tighten
restrictions on the disposition of proceeds of asset sales.
NEW VALLEY
WESTERN REALTY DUCAT. In February 1998, New Valley and Apollo Real
Estate Investment Fund III, L.P. ("Apollo") organized Western Realty Development
LLC ("Western Realty Ducat") to make real estate and other investments in
Russia. In connection with the formation of Western Realty Ducat, New Valley
agreed, among other things, to contribute the real estate assets of BrookeMil
Ltd. ("BML") to Western Realty Ducat and Apollo agreed to contribute up to
$58,750, including the investment in Western Realty Repin discussed below.
Western Realty Ducat will seek to make additional real estate and other
investments in Russia. Western Realty Ducat has made a $26,300 participating
loan to, and payable out of a 30% profits interest in, a company organized by
BOL which, among other things, acquired an interest in an industrial site and
manufacturing facility being constructed on the outskirts of Moscow by a
subsidiary of BOL.
THE KREMLIN SITES. BML is planning the development of two adjoining
sites totaling 10.25 acres (the "Kremlin Sites") located in Moscow across the
Moscow River from the Kremlin. BML, which is planning to develop a 1.1 million
sq. ft. hotel, office, retail and residential complex on the Kremlin Sites,
owned 94.6% of one site and 52% of the other site at September 30, 1998. In June
1998, New Valley and Apollo organized Western Realty Repin LLC to make a $25,000
participating loan to BML. The proceeds of the loan will be used by BML for the
acquisition and preliminary development of the Kremlin Sites, including the
repayment to New Valley for certain expenditures on the Kremlin Sites previously
incurred (see Note 3 to the Company's Consolidated Financial Statements).
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income". SFAS No. 130, which the Company adopted in the first quarter of 1998,
establishes standards for reporting and displaying comprehensive income and its
components in a full set of general-purpose statements. For the Company, other
components of stockholders' equity include such items as the Company's
proportionate interest in New Valley's capital transactions and unrealized gains
and losses on investment securities. The implementation of SFAS No. 130 in the
first quarter 1998 did not have any material effect on the consolidated
financial statements.
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<PAGE> 38
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information". SFAS No. 131 specifies revised
guidelines for determining an entity's operating segments and the type and level
of financial information to be disclosed. Management believes that the adoption
of this pronouncement will not have a material effect on the Company's financial
statement disclosures. SFAS No. 131 is effective for fiscal years beginning
after December 15, 1997, with earlier application encouraged.
In February 1998, SFAS No. 132, "Employers' Disclosures about Pensions
and Other Postretirement Benefits," was issued which revises required
disclosures about pensions and postretirement benefit plans in order to
facilitate financial analysis. Recognition or measurement issues are not
addressed in the statement. SFAS No. 132 is effective for the Company for the
year ended 1998. Management believes that the implementation of this
pronouncement will not have a material effect on the Company's financial
statement disclosures.
YEAR 2000 COSTS
The Company utilizes management information systems and software
technology that may be affected by Year 2000 issues throughout its operations.
Liggett has evaluated the costs to implement century date change compliant
systems conversions and is in the process of executing a planned conversion of
its systems prior to the Year 2000. To date, the focus of Year 2000 compliance
and verification efforts has been directed at the implementation of new customer
service, inventory control and financial reporting systems at each of the three
regional Strategic Business Units, part of the Company's reorganization which
began in January 1997. In January of 1998, Liggett initiated a major conversion
of factory accounting and information systems at its Durham production facility,
with the assistance of outside consultants, to upgrades that have been
successfully tested for Year 2000 compliance. This project is expected to be
completed by the end of November.
All costs incurred to date are considered an integral part of the
normal expenditures required for business systems enhancements and upgrades. It
is anticipated that all factory, corporate, field sales and physical
distribution systems will be completed in sufficient time to support Year 2000
compliance and verification.
Although such costs may be a factor in describing changes in operating
profit in any given reporting period, the Company currently does not believe
that the anticipated costs of Year 2000 systems conversions will have a material
impact on its future consolidated results of operations. Based on the progress
Liggett has made in addressing Year 2000 issues and its strategy and timetable
to complete its compliance program, the Company does not foresee significant
risks associated with its Year 2000 initiatives at this time. However, if the
Company identifies any significant risks related to its Year 2000 compliance
effort, or if its progress deviates from the projected timetable, Liggett will
develop contingency plans it deems necessary to meet compliance deadlines at
that time. Due to the interdependent nature of computer systems, the Company may
be adversely impacted in the year 2000 depending on whether it or its vendors or
customers have addressed this issue successfully.
RECENT DEVELOPMENTS IN THE CIGARETTE INDUSTRY
PRICING ACTIVITY. As of November 13, 1998, list price increases during
1998 amount to $1.85 per carton. On January 23, 1998, Philip Morris and RJR
announced a list price increase of $.25 per carton. This action was matched by
Liggett and the other manufacturers during the following week. On April 3, 1998,
Philip Morris announced a second list price increase of $.50 per carton. This
action was matched by Liggett and the other manufacturers. On May 11, 1998,
Philip Morris and RJR announced a third list price increase of $.50 per carton
on all brands. This action
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<PAGE> 39
was matched by Liggett and the other manufacturers during the following week. On
July 31, 1998, Philip Morris announced a fourth list price increase of $.60 per
carton on all brands. This action was matched by Liggett and the other
manufacturers during the following week.
LEGISLATION, REGULATION AND LITIGATION. The cigarette industry
continues to be challenged on numerous fronts. New cases continue to be
commenced against Liggett and the Company and other cigarette manufacturers. As
of September 30, 1998, there were approximately 275 individual suits, 45
purported class actions and 110 state, municipality and other third-party payor
health care reimbursement actions pending in the United States in which Liggett
is a named defendant. As new cases are commenced, the costs associated with
defending such cases and the risks attendant to the inherent unpredictability of
litigation continue to increase. Recently, there have been a number of
restrictive regulatory actions from various Federal administrative bodies,
including the United States Environmental Protection Agency ("EPA") and the Food
and Drug Administration ("FDA"), 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 Medicaid reimbursement suits by various states' Attorneys
General. These developments generally receive widespread media attention. The
Company is not able to evaluate the effect of these developing matters on
pending litigation or the possible commencement of additional litigation, but it
is possible that Company's financial position, results of operations and cash
flows could be materially adversely affected by an ultimate unfavorable outcome
in any of such pending litigation. (See Note 8 to the Company's Consolidated
Financial Statements for a description of legislation, regulation and
litigation.)
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for personal injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence, gross
negligence, special duty, voluntary undertaking, 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, indemnity, market share liability, and
violations of deceptive trade practices laws, RICO and antitrust statutes. In
many of these cases, in addition to compensatory damages, plaintiffs also seek
other forms of relief including disgorgement of profits and punitive damages.
Defenses raised by defendants in these cases include lack of proximate cause,
assumption of the risk, comparative fault and/or contributory negligence, lack
of design defect, statutes of limitations or repose, equitable defenses such as
"unclean hands" and lack of benefit, failure to state a claim and federal
preemption.
The claims asserted in the health care cost recovery actions vary. In
most of these cases, plaintiffs assert the equitable claim that the tobacco
industry was "unjustly enriched" by plaintiffs' payment of health care costs
allegedly attributable to smoking and seek reimbursement of those costs. Other
claims made by some but not all plaintiffs include the equitable claim of
indemnity, common law claims of negligence, strict liability, breach of express
and implied warranty, violation of a voluntary undertaking or 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 the RICO.
SETTLEMENTS. In March 1996, Liggett and the Company entered into an
agreement to settle the CASTANO class action tobacco litigation and an agreement
with the Attorneys General of West Virginia, Florida, Mississippi, Massachusetts
and Louisiana to settle certain actions brought against Liggett and the Company
by such states (the "March 1996 Settlements"). Liggett and the Company, while
neither consenting to FDA jurisdiction nor waiving their objections thereto,
agreed to withdraw their objections and opposition to the proposed FDA
regulations and to phase in compliance with certain of the proposed interim FDA
regulations.
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<PAGE> 40
Under the CASTANO settlement agreement, upon final court approval of
the settlement, the CASTANO class would be entitled to receive up to 5% of
Liggett's pretax income (income before income taxes) each year (up to a maximum
of $50,000 per year) for the next twenty-five years, subject to certain
reductions provided for in the agreement, and a $5,000 payment from Liggett if
the Company or Liggett fails to consummate a merger or similar transaction with
another non-settling tobacco company defendant within three years of the date of
the settlement. The Company and Liggett have the right to terminate the CASTANO
settlement under certain circumstances. On May 11, 1996, the CASTANO Plaintiffs
Legal Committee filed a motion with the United States District Court for the
Eastern District of Louisiana seeking preliminary approval of the CASTANO
settlement. On May 23, 1996, the Court of Appeals for the Fifth Circuit reversed
the February 17, 1995 order of the District Court certifying the CASTANO suit as
a nationwide class action and instructed the District Court to dismiss the class
complaint. (For additional information concerning the Fifth Circuit's decision,
see Note 8 to the Company's Consolidated Financial Statements.) In September
1996, the CASTANO plaintiffs withdrew the motion for approval of the CASTANO
settlement.
In March 1996, the Company, the CASTANO Plaintiffs Legal Committee and
the CASTANO plaintiffs entered into a letter agreement. According to the terms
of the letter agreement, for the period ending nine months from the date of
Final Approval (if granted) of the CASTANO settlement or, if earlier, the
completion by the Company or Liggett of a combination with any defendant in
CASTANO, except Philip Morris, the CASTANO plaintiffs and their counsel agree
not to enter into any more favorable settlement agreement with any CASTANO
defendant which would reduce the terms of the CASTANO settlement agreement. If
the CASTANO plaintiffs or their counsel enter into any such settlement during
this period, they shall pay the Company $250,000 within thirty days of the more
favorable agreement and offer the Company and Liggett the option to enter into a
settlement on terms at least as favorable as those included in such other
settlement. The letter agreement further provides that during the same time
period, and if the CASTANO settlement agreement has not been earlier terminated
by the Company in accordance with its terms, the Company and its affiliates will
not enter into any business transaction with any third party which would cause
the termination of the CASTANO settlement agreement. If the Company or its
affiliates enter into any such transaction, then the CASTANO plaintiffs will be
entitled to receive $250,000 within thirty days from the transacting party.
Under the Attorneys General settlement, the five states would share an
initial payment by Liggett of $5,000 ($1,000 of which was paid in March 1996,
with the balance payable over nine years and indexed and adjusted for
inflation), provided that any unpaid amount will be due 60 days after either a
default by Liggett in its payment obligations under the settlement or a merger
or other similar transaction by the Company or Liggett with another defendant in
the lawsuits. In addition, Liggett will be required to pay the states a
percentage of Liggett's pretax income (income before income taxes) each year
from the second through the twenty-fifth year. This annual percentage is 2-1/2%
of Liggett's pretax income, subject to increase to 7-1/2% depending on the
number of additional states joining the settlement. No additional states have
joined this settlement to date. All of Liggett's payments are subject to certain
reductions provided for in the agreement. Liggett has also agreed to pay to the
states $5,000 if the Company or Liggett fails to consummate a merger or other
similar transaction with another defendant in the lawsuits within three years of
the date of the settlement.
In 1997, Liggett and the Company entered into a comprehensive
settlement of tobacco litigation through parallel agreements with the Attorneys
General of 21 states and with a nationwide class of individuals and entities
that allege smoking-related claims (collectively, the "March 1997 Settlements").
In March 1998, the Company and Liggett entered into additional settlements with
the Attorneys General of 15 states, the District of Columbia, Guam, the Northern
Mariana Islands and the U. S. Virgin Islands (the "March 1998 Settlements"). The
foregoing settlements cover all smoking-related claims, including both
addiction-based and tobacco injury claims against the Company and Liggett
brought by the states and, upon court approval, the nationwide class.
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<PAGE> 41
In March 1997, Liggett, the Company and plaintiffs filed a mandatory
class settlement agreement in an action entitled FLETCHER, ET AL. V. BROOKE
GROUP LTD., ET AL., Circuit Court of Mobile County, Alabama, where the court
granted preliminary approval and preliminary certification of the class, and in
May 1997, a similar mandatory class settlement agreement was filed in an action
entitled WALKER, ET AL. V. LIGGETT GROUP INC., ET al., United States District
Court, Southern District of West Virginia. On July 2, 1998, the Company and
plaintiffs filed an amended class action settlement agreement in FLETCHER.
Pursuant to the amended agreement, Liggett is required to pay to the class 7.5%
of Liggett's pre-tax income each year for 25 years, with a minimum annual
payment guarantee of $1,000 over the term of the agreement. The amended
agreement does not set forth a formula with respect to the distribution of
settlement proceeds to the class. On September 10, 1998, the Circuit Court held
a hearing with respect to the parties' motion for reaffirmance of preliminary
approval of the amended agreement. The court has not yet ruled on this motion.
The WALKER court also granted preliminary approval and preliminary certification
of the nationwide class; however, on August 5, 1997, the court vacated its
preliminary certification of the settlement class, which decision is currently
on appeal.
In the FLETCHER action, it is anticipated that class members will be
notified of the settlement and will have an opportunity to appear at a later
court hearing. Effectiveness of the mandatory settlement is conditioned on final
court approval of the settlement after a fairness hearing. There can be no
assurance as to whether or when court approval will be obtained. (For additional
information concerning the FLETCHER action, see Note 8 to the Company's
Consolidated Financial Statements.)
Under the March 1998 Settlements, Liggett is required to pay each of
the settling states and territories their relative share (based on the Medicaid
population of each state over the total Medicaid population of the United
States) of between 27.5% and 30% of Liggett's pre-tax income each year for 25
years, with a minimum payment guarantee of $1,000 per state over the first nine
years of the agreement. The annual percentage is subject to increase, pro rata
from 27.5% up to 30%, depending on the number of additional states joining the
settlement. Pursuant to the "most favored nation" provisions under the March
1996 and March 1997 Settlements, each of the states settling under those
settlements could benefit from the economic terms of the March 1998 Settlements.
The Company accrued approximately $4,000 for the present value of the
fixed payments under the March 1996 Settlements and $16,902 for the present
value of the fixed payments under the March 1998 Settlements. No additional
amounts have been accrued because the Company cannot quantify the future costs
of the settlements as the amounts Liggett must pay are based, in part, on future
operating results. Possible future payments based on a percentage of pretax
income, and other contingent payments based on the occurrence of a business
combination, will be expensed when considered probable. (See the discussions of
the tobacco litigation settlements appearing in Note 8 to the Company's
Consolidated Financial Statements.)
Separately, the other tobacco companies negotiated settlements of the
Attorney General Actions in Mississippi, Florida, Texas and Minnesota and it has
been widely publicized that the other companies have engaged in negotiations to
settle with the Attorneys General of the remaining states.
OTHER MATTERS. On June 20, 1997, Philip Morris, RJR, B&W, Lorillard and
the United States Tobacco Company, along with the Attorneys General for the
States of Arizona, Connecticut, Florida Mississippi, New York and Washington and
the CASTANO Plaintiffs' Litigation Committee executed a Memorandum of
Understanding to support the adoption of federal legislation and necessary
ancillary undertakings, incorporating the features described in a proposed
resolution. The proposed
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<PAGE> 42
resolution mandates a total reformation and restructuring of how tobacco
products are manufactured, marketed and distributed in the United States. (For
additional information concerning the proposed resolution, see Note 8 of the
Company's Consolidated Financial Statements.) The White House, Congress and
various public interest groups are currently reviewing the proposed resolution
along with other proposed federal tobacco legislation. Management is unable to
predict the ultimate effect, if any, of the enactment of legislation adopting
the proposed resolution. Management is also unable to predict the ultimate
content of any such legislation. However, adoption of any such legislation could
have a material adverse effect on the business of the Company and Liggett.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
REVENUES OPERATING INCOME REVENUES OPERATING INCOME
------------------- ------------------- ------------------- ------------------
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------- ------------------- ------------------
1998 1997 1998 1997 1998 1997 1998 1997
--------- --------- ------- ------ -------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liggett $ 85,630 $ 79,368 $ 8,685 $4,581 $234,654 $223,811 $23,830 $ 9,380
Liggett-Ducat 22,572 20,940 2,200 1,398 69,613 53,095 9,679 3,012
Other 2,116 786 95 1,138
-------- -------- ------- ------ -------- -------- ------- -------
Total $108,202 $100,308 $13,001 $6,765 $304,267 $276,906 $33,604 $13,530
======== ======== ======= ====== ======== ======== ======= =======
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997.
REVENUES. Total revenues were $108,202 for the three months ended
September 30, 1998 compared to $100,308 for the three months ended September 30,
1997. This 7.9% increase in revenues was due to a $6,262 or 7.9% increase in
revenues at Liggett and an increase of $1,632 or 7.8% in revenues at
Liggett-Ducat. The increases in revenues in both the premium and discount
segments at Liggett were due to price increases of $15,723 (see "Recent
Developments in the Cigarette Industry - Pricing Activity") partially offset by
an 11.7% decrease in Liggett's unit sales volume (188.6 million units)
accounting for $9,264 in volume variance and an unfavorable product mix of $197.
The decline in premium and discount unit sales volume was due to certain
competitors continuing leveraging rebate programs tied to their products and
increased promotional activity by certain other manufacturers.
Premium sales at Liggett for the three months ended September 30, 1998
amounted to $26,986 and represented 31.5% of Liggett's total revenues, compared
to $26,867 and 33.9% of total sales for the same period in 1997. In the premium
segment, revenues increased by 0.4% ($119) over the three months ended September
30, 1998, compared to the same period in 1997, due to price increases of $4,010,
partially offset by a 14.5% decline in unit sales volume (64.6 million units)
accounting for $3,891 in volume variance.
Discount sales at Liggett (comprising the brand categories of branded
discount, private label, control label, generic, international and contract
manufacturing) for the three months ended September 30, 1998 amounted to $58,644
and represented 68.5% of Liggett's total revenues, compared to $52,501 and 66.1%
of total sales for the same period in 1997. In the discount segment, revenues
increased by 11.7% ($6,143) over the three months ended September 30, 1998,
compared to the same period in 1997, due to price increases of $11,713 partially
offset by a 10.6% decline in unit sales volume (approximately 124.0 million
units) accounting for $5,566 in volume variance and an unfavorable product mix
among the discount brand categories of $4. For the three months ended September
30, 1998, fixed manufacturing costs on a basis comparable to the same period in
1997 were $384 higher, with costs per thousand units increasing $0.63 per
thousand.
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<PAGE> 43
Net sales at Liggett-Ducat for the three months ended September 30,
1998 increased 7.9% ($1,632) over the same period in 1997 due primarily to an
increase of 33.4% ($6,998) in unit sales volume (1,240.6 million units) and
favorable product mix of 1.9% ($400). This increase was partially offset by
price decreases of 27.5% ($5,766) due to devaluation of the Russian currency.
GROSS PROFIT. Gross profit was $61,116 for the three months ended
September 30, 1998 compared to $47,263 for the three months ended September 30,
1997, an increase of $13,853 when compared to the same period last year,
reflecting an increase in gross profit at Liggett of $10,850 and an increase at
Liggett-Ducat of $3,002 for the three months ended September 30, 1998 compared
to the same period in the prior year.
In the three months ended September 30, 1998, Liggett's premium and
discount brands contributed 30% and 59%, respectively, to the Company's overall
gross profit. Over the same period in 1997, Liggett's premium and discount
brands contributed 35% and 57%, respectively, to total Company gross profit.
Liggett-Ducat contributed 11% to the Company's overall gross profit for the
three months ended September 30, 1998 compared to 8.0% in the same period in
1997.
Gross profit at Liggett of $54,247 for the three months ended September
30, 1998 increased due primarily to the price increases discussed above. (See
"Recent Developments in the Cigarette Industry - Pricing Activity".) As a
percent of revenues (excluding federal excise taxes), gross profit at Liggett
increased to 78.9% for the three months ended September 30, 1998 compared to
72.2% for the same period in 1997, with gross profit for the premium segment at
80.8% and 76.5% in the third quarter of 1998 and 1997, respectively, and gross
profit for the discount segment at 78.0% and 69.8% in the third quarter of 1998
and 1997, respectively. This increase is the result of the September 1997,
January 1998, April 1998, May 1998 and August 1998 list price increases and
improved production variances. These increases were partially offset by
increased tobacco costs at Liggett due to a reduction in the average discount
available to the Company from leaf tobacco dealers on tobacco purchased under
prior years' purchase commitments.
As a percent of revenues (excluding Russian excise taxes), gross profit
at Liggett-Ducat increased to 35.0% for the three months ended September 30,
1998 compared to 21.2% in the same period in 1997.
EXPENSES. Operating, selling and general expenses were $48,115 for the
three months ended September 30, 1998 compared to $40,498 for the same period
last year due to increases in expenses at Liggett of $6,841 and at Liggett-Ducat
of $1,186 and higher expenses at corporate resulting from non-cash charges for
consulting services. Selling, general and administrative expenses at Liggett
were $45,562 for the three months ended September 30, 1998 compared to $38,721
for the same period for the prior year. This increase in expense was due
primarily to $4,059 in higher promotional and marketing costs as well as higher
legal expenses, including non-cash stock-based expense of $2,019 at Liggett,
partially offset by reductions in systems development costs of $648
and reduced administrative costs.
OTHER INCOME (EXPENSE). Interest expense was $20,138 for the three
months ended September 30, 1998 compared to $15,791 for the same period last
year, an increase of $4,347 primarily due to the debt restructuring at BGLS and
Liggett. (See Note 6 to the Company's Consolidated Financial Statements.)
Additional interest expense of $821 at Liggett-Ducat and BOL was reported for
the three months ended September 30, 1998, compared with the same period in
1997.
Equity in earnings of affiliate was a loss of $8,935 for the three
months ended September 30, 1998 compared to a loss of $6,984 for the three
months ended September 30, 1997 and relates in both periods to New Valley's net
loss applicable to common shares of $22,622 and $24,141, respectively.
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<PAGE> 44
For the three months ended September 30, 1998, the losses from
continuing operations were partially offset by the income from discontinued
operations at New Valley of $3,208.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1997.
REVENUES. Total revenues were $304,267 for the nine months ended
September 30, 1998 compared to $276,906 for the nine months ended September 30,
1997. This 9.9% increase in revenues was due to a $10,843 or 4.8% increase in
revenues at Liggett and an increase of $16,740 or 31.7% at Liggett-Ducat.
Revenues at Liggett increased in both the premium and discount segments due to
price increases of $33,760 (see "Recent Developments in the Cigarette Industry -
Pricing Activity") and improved product mix of $470 offset by a 10.4% decline in
unit sales volume (486.8 million units) accounting for $23,387 in volume
variance. The decline in premium and discount unit sales volume was due to
certain competitors continuing leveraging rebate programs tied to their products
and increased promotional activity by certain other manufacturers.
Premium sales at Liggett for the nine months ended September 30, 1998
amounted to $76,898 and represented 32.8% of Liggett's total revenues, compared
to $74,780 and 33.4% of total sales for the same period in 1997. In the premium
segment, revenues grew by 2.8% ($2,118) due to price increases of $9,189 offset
by a 9.5% decline in unit sales volume (119.3 million units) accounting for
$7,071 in volume variance over the nine months ended September 30, 1998,
compared to the same period in 1997.
Liggett's discount sales (comprising the brand categories of branded
discount, private label, control label, generic, international and contract
manufacturing) over this period amounted to $157,756 and represented 67.2% of
Liggett's total revenues, compared to $149,031 and 66.6% of total sales for the
same period in 1997. In the discount segment, revenues grew by 5.9% ($8,725)
over the nine months ended September 30, 1998, compared to the same period in
1997, due to price increases of $24,751 and improved product mix among the
discount brand categories of $277 offset by a 10.8% decline in unit sales volume
(367.5 million units) accounting for $16,123 in volume variance. For the nine
months ended September 30, 1998, fixed manufacturing costs on a basis comparable
to the same period in 1997 were $929 lower, and costs per thousand units
decreased $0.01 per thousand.
The increase in tobacco revenues at Liggett-Ducat is attributable to
increased unit sales volume of 35.9% ($18,962) and a favorable product mix of
0.5% ($262). This increase was slightly offset by price decreases of 4.7%
($2,485) due to devaluation of the Russian currency.
GROSS PROFIT. Gross profit was $163,845 for the nine months ended
September 30, 1998 compared to $131,065 for the nine months ended September 30,
1997, an increase of $32,780 or 25.0% when compared to the same period last
year, due to price increases at Liggett and volume and price increases at
Liggett-Ducat discussed above.
Liggett's premium and discount brands contributed 31% and 57%,
respectively, to the Company's overall gross profit for the nine months ended
September 30, 1998 compared to the same period in 1997 during which Liggett's
premium and discount brands contributed 35% and 58%, respectively. Liggett-Ducat
contributed 12% to total Company gross profit for the nine months ended
September 30, 1998 compared to 7% in the same period in 1997.
Gross profit at Liggett for the nine months ended September 30, 1998
was $143,968 compared to $121,367 for the same period in the prior year.
Liggett's gross profit as a percentage of its revenues (excluding federal excise
taxes) for the period increased to 77.4% compared to 72.0% in the same period in
the prior year. Gross profit for the premium segment was 79.8% and
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<PAGE> 45
76.3%, respectively, in the nine months ended September 30 of 1998 and 1997,
respectively, and gross profit for the discount segment was 76.1% and 69.7% in
1998 and 1997, respectively. These increases are the result of the March 1997,
September 1997, January 1998, April 1998, May 1998 and August 1998 list price
increases and improved production variances. See "Recent Developments in the
Cigarette Industry - Pricing Activity". These increases were partially offset by
increased tobacco costs at Liggett due to a reduction in the average discount
available to Liggett from leaf tobacco dealers on tobacco purchased under prior
years' purchase commitments.
As a percentage of revenues (excluding Russian excise taxes), gross
profit at Liggett-Ducat increased to 33.3% for the nine months ended September
30, 1998 compared to 20.4% in the same period in 1997.
EXPENSES. Operating, selling, general and administrative expenses were
$130,241 for the nine months ended September 30, 1998 compared to $117,535 for
the same period last year. The increase of $12,706 is due primarily to $8,055 in
higher spending for promotional and marketing programs, higher legal expenses of
$5,042 including non-cash stock-based expense of $2,019 at Liggett. Such
expenses were partially offset by the absence of the 1997 restructuring expenses
which had included systems development costs of $3,541, and the absence of
severance payments made in the comparable prior period.
OTHER INCOME (EXPENSE). Interest expense was $60,561 for the nine months
ended September 30, 1998 compared to $46,757 for the same period last year. The
increase in interest expense was primarily due to charges for debt restructuring
of approximately $9,000 at corporate and $3,800 at Liggett as well as an
increase of $1,315 at BOL and Liggett-Ducat offset by lower interest expense due
to lower outstanding balances on the revolving credit facility at Liggett.
Equity in earnings of affiliate was a loss of $20,383 for the nine
months ended September 30, 1998 compared to a loss of $21,335 for the nine
months ended September 30, 1997 and relates to the decline in market value of
the Class A Preferred Shares and to New Valley's net loss applicable to common
shares of $67,051 in 1998 compared to its net loss of $72,241 in 1997. The loss
is offset by income from New Valley's discontinued operations of $3,208 for the
nine months ended September 30, 1998.
For the nine months ended September 30, 1998, a gain on the sale of
various assets of $2,025 is compared to the gain of $23,086 for the same period
in 1997 which included the sale of the BML shares and surplus realty at Liggett,
and proceeds from a legal settlement. See Notes 3 and 8 to the Company's
Consolidated Financial Statements.
CAPITAL RESOURCES AND LIQUIDITY
Net cash and cash equivalents increased $1,636 and $420 for the nine
months ended September 30, 1998 and September 30, 1997, respectively. Net cash
used in operating activities was $17,847 and $30,511 for the nine months ended
September 30, 1998 and 1997, respectively. Net cash used in the 1998 period was
$12,664 lower than in the same period in 1997, primarily due to a reduction in
cash interest payments of approximately $7,000 at BGLS and an increase in net
income at Liggett over the prior year of approximately $4,200. For the nine
months ended September 30, 1997, net cash used in operations was due to a
decrease in accounts payable and accrued expenses of approximately $21,600, and
an increase in notes receivable of $32,500 due to the sale of the BML shares
partially offset by a decrease in receivables at Liggett, equity in loss of
affiliate of $14,400 and the impact of the deferred gain on the sale of the BML
shares of approximately $22,000.
Cash used in investing activities of $14,912 compares to cash provided
of $33,234 for the periods ended September 30, 1998 and 1997, respectively. In
1998, capital expenditures of
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<PAGE> 46
$17,289, principally at Liggett-Ducat for construction of the new factory in
Russia were partially offset by proceeds from sales of equipment. In 1997,
proceeds included cash of $43,000 received in the sale of the BML shares to New
Valley partially offset by capital expenditures of $9,857 at Liggett-Ducat, BOL
and Liggett.
Cash provided by financing activities was $33,838 for the nine months
ended September 30, 1998 as compared with cash used in financing activities of
$2,303 for the nine months ended September 30, 1997. Proceeds in the 1998 period
include proceeds from the participating loan made by Western Realty Ducat of
$25,000, cash of $10,144 received from the sale of common stock and exercise of
stock options, proceeds from notes payable at BOL and corporate of $4,425 and an
increase in cash overdraft at Liggett. Such proceeds were offset by net
repayments of $1,616 on credit facilities at Liggett and Liggett-Ducat and
distributions on common stock of $3,055. Distributions of common stock for the
third quarter 1998 were paid on October 2, 1998. Proceeds from financing
activities in 1997 include net borrowings under credit facilities at BOL and
Liggett of $7,849. These proceeds were offset by repayments on debt including
principally the required repurchase of $7,500 face amount of Liggett bonds on
February 1, 1997 at a net gain of $2,963. Distributions on common stock of
$4,102 in the 1997 period include distributions declared in the fourth quarter
1996 which were paid in January 1997 and distributions declared and paid in the
first two quarters of 1997.
LIGGETT. Liggett had a net capital deficiency of $183,268 at September
30, 1998 and is highly leveraged. In addition, the Liggett Notes mature on
February 1, 1999 and the revolving credit facility (the "Facility") expires on
March 8, 1999. Due to the many risks and uncertainties associated with the
cigarette industry, the impact of recent tobacco litigation settlements (see
"Recent Developments in the Cigarette Industry - Legislation and Litigation")
and increased tobacco costs, there can be no assurance that Liggett will be able
to meet its future earnings goals. Consequently, Liggett could be in violation
its debt covenants, including covenants limiting the maximum permitted adjusted
net worth and net working capital deficiencies, and if its lenders were to
exercise acceleration rights under the Facility or the Liggett Notes' Indenture
or refuse to lend under the Facility, Liggett would not be able to satisfy such
demands or its working capital requirements. (See below for additional
information concerning these covenants.)
The Liggett Series B Notes ($150,000) and Liggett C Notes ($32,279)
issued in 1992 and in 1994, respectively, pay interest semiannually at an annual
rate of 11.5% and 19.75%, respectively. The Liggett Notes required mandatory
principal redemptions of $7,500 on February 1 in each of the years 1993 through
1997 and $37,500 on February 1, 1998 with the balance of the Liggett Notes due
on February 1, 1999 (see below). The Liggett Notes are collateralized by
substantially all of the assets of Liggett, excluding accounts receivable and
inventory. Eve is guarantor for the Liggett Notes. The Liggett Notes may be
redeemed, in whole or in part, at a price equal to 100% of the principal amount,
at the option of Liggett. The Liggett Notes contain restrictions on Liggett's
ability to declare or pay cash dividends, incur additional debt, grant liens and
enter into any new agreements with affiliates, among others.
On January 30, 1998, Liggett obtained the consents of the required
majority of the holders of the Liggett Notes to various amendments to the
Indenture governing the Liggett Notes. The amendments provide, among other
things, for a deferral of the February 1, 1998 mandatory redemption of $37,500
principal amount of the Liggett Notes to the date of final maturity, February 1,
1999. In addition, the amendments prohibit, with limited exceptions, payments of
dividends and incurrence of new debt by Liggett and tighten restrictions on the
disposition of proceeds of asset sales. The interest payment on the Liggett
Notes, which was paid on August 1, 1998, was guaranteed by the Company and BGLS.
(Refer to Note 6 to the Company's Consolidated Financial Statements.)
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<PAGE> 47
At maturity, the Liggett Notes will require a principal payment of
$144,891. Liggett does not anticipate it will be able to generate sufficient
cash from operations to make such payments. In addition, Liggett also has a
$40,000 Facility expiring March 8, 1999, under which $17,674 was outstanding at
September 30, 1998. While Liggett's management currently intends to seek to
refinance and/or restructure with Liggett's note holders the maturity
requirements on the Liggett Notes and to extend the Facility, there are no
refinancing or restructuring arrangements for the notes or commitments to extend
the Facility at this time, and no assurances can be given in this regard. If
Liggett is unable to refinance or restructure the terms of the Liggett Notes or
otherwise make all payments thereon, the Liggett Notes and the Facility would be
in default and holders of such debt could accelerate the maturity of such debt.
In such event, Liggett may be forced to seek protection from creditors under
applicable laws. (Refer to Note 1 to the Company's Consolidated Financial
Statements.)
On August 29, 1997, the Facility was amended to permit Liggett to
borrow an additional $6,000 which was used on that date in making the interest
payment of $9,700 due on August 1, 1997 to the holders of the Liggett Notes.
BGLS guaranteed the additional $6,000 advance under the Facility and
collateralized the guarantee with $6,000 in cash, deposited with Liggett's
lender, $3,000 of which was released in November 1998. At September 30, 1998,
the amount of $6,000 was classified in other assets on the Company's balance
sheet. Availability under the Facility was approximately $8,091 based on
eligible collateral at September 30, 1998. The Facility is collateralized by all
inventories and receivables of Liggett. Borrowings under the Facility, whose
interest is calculated at a rate equal to 1.5% above Philadelphia National
Bank's (the indirect parent of Congress Financial Corporation, the lead lender)
prime rate, bear a rate of 10.0% at September 30, 1998, which was reduced to
9.75% and 9.50% in October and November 1998, respectively. The Facility
contains certain financial covenants similar to those contained in the Liggett
Notes' Indenture including restrictions on Liggett's ability to declare or pay
cash dividends, incur additional debt, grant liens and enter into any new
agreements with affiliates, among others. In addition, the Facility, as amended
on April 8, 1998, imposes requirements with respect to Liggett's adjusted net
worth (not to fall below a deficit of $195,000 as computed in accordance with
the agreement, this computation was $179,149 at September 30, 1998) and working
capital (not to fall below a deficit of $17,000 as computed in accordance with
the agreement, this computation was $2,450 at September 30, 1998). At September
30, 1998, Liggett was in compliance with all covenants under the Facility. The
Facility, as amended, also provides that a default by Liggett under the March
1996 Settlements, March 1997 Settlements and March 1998 Settlements shall
constitute an event of default under the Facility.
Liggett (and, in certain cases, the Company) 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 (environmental tobacco smoke) from cigarettes.
The Company believes, and has been so advised by counsel handling the
respective cases, that the Company and Liggett have a number of valid defenses
to the claim or claims asserted against them. Litigation is subject to many
uncertainties, and it is possible that some of these actions could be decided
unfavorably. An unfavorable outcome of a pending smoking and health case could
encourage the commencement of additional similar litigation. Recently, there
have been a number of adverse regulatory, political and other developments
concerning cigarette smoking and the tobacco industry, including the
commencement of the purported class actions referred to above. These
developments generally receive widespread media attention. Neither the Company
nor Liggett is able to evaluate the effect of these developing matters on
pending litigation or the possible commencement of additional litigation. (See
"Recent Development in the Cigarette Industry - Legislation, Regulation and
Litigation" and "--Settlements" above and Note 8 to the Company's Consolidated
Financial Statements.)
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<PAGE> 48
The Company 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 the Company and Liggett. It is possible that the Company's consolidated
financial position, results of operations or cash flows could be materially
affected by an ultimate unfavorable outcome in any such pending litigation.
BGLS. On March 5, 1998, BGLS entered into the Standstill Agreement
whereby the Apollo Holders agreed to the deferral of interest payments,
commencing with the interest payment due July 31, 1997 through the interest
payment due July 31, 2000. (See "Recent Developments - The Company - Standstill
Agreement".) At September 30, 1998, the carrying value of BGLS' long-term debt
(net of unamortized discount of $19,259) was approximately $238,591, based on
modification of the terms of the debt with the Apollo Holders.
The 14.500% Subordinated Debentures due 1998 in principal amount of
$800 were paid at maturity on April 1, 1998.
Liggett-Ducat is building a new cigarette factory on the outskirts of
Moscow. The new factory, which will utilize Western cigarette making technology
and have a capacity of 30 billion units per year, will produce American and
international blend cigarettes, as well as traditional Russian cigarettes.
Western Realty Ducat has made a $26,300 participating loan to, and payable out
of a 30% profits interest, in a company organized by BOL, Western Tobacco, which
holds BOL's interests in Liggett-Ducat and the new manufacturing facility. (See
"Recent Developments - New Valley" and Note 3 to the Company's Consolidated
Financial Statements.) In addition, BOL has entered into equipment purchases of
approximately $35,400, of which $28,800 will be financed over five years
beginning in 1998. The Company is a guarantor of one of the purchases for which
the remaining obligation is approximately $7,000.
THE COMPANY. The Company has remaining scheduled debt maturities of
approximately $1,807 due in the year 1998. Liggett has a payment due on the
Liggett Notes at maturity on February 1, 1999 of approximately $145,000 and the
Facility expires on March 8, 1999. The Company believes that it will continue to
meet its liquidity requirements through 1998, although the BGLS Notes Indenture
limits the amount of restricted payments BGLS is permitted to make to the
Company during the calendar year. At September 30, 1998, the remaining amount
available through December 31, 1998 in the Restricted Payment Basket related to
BGLS' payment of dividends to the Company (as defined by the BGLS Notes
Indenture) is $11,086. Company expenditures remaining in 1998 at September 30,
1998 include dividends on the Company's shares (currently at an annual rate of
approximately $6,100) and corporate expense. Third quarter distributions on
common stock were made on October 2, 1998 in the amount of $1,534. The Company
anticipates funding 1998 current operations and long-term growth with the
proceeds from public and/or private debt and equity financing, management fees
and other payments from subsidiaries of approximately $3,600 and distributions
from 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.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Company and its representatives may from time to time make oral or
written "forward-looking statements" within the meaning of the Private
Securities Reform Act of 1995 (the "Reform Act"), including any statements that
may be contained in the foregoing discussion in "Management's Discussion and
Analysis of Financial Condition and Results of Operations", in this report and
in other filings with the Securities and Exchange Commission and in its reports
to shareholders, which reflect management's current views with respect to future
events and financial performance. These forward-looking statements are subject
to certain risks and uncertainties and, in connection with the
-46-
<PAGE> 49
"safe-harbor" provisions of the Reform Act, the Company is hereby identifying
important factors that could cause actual results to differ materially from
those contained in any forward-looking statement made by or on behalf of the
Company. Liggett continues to be subject to risk factors endemic to the domestic
tobacco industry including, without limitation, health concerns relating to the
use of tobacco products and exposure to ETS, legislation, including tax
increases, governmental regulation, privately imposed smoking restrictions,
governmental and grand jury investigations and litigation. Each of the Company's
operating subsidiaries, namely Liggett and Liggett-Ducat, are subject to intense
competition, changes in consumer preferences, the effects of changing prices for
its raw materials and local economic conditions. Furthermore, the performance of
Liggett-Ducat's operations in Russia are affected by uncertainties in Russia
which include, among others, political or diplomatic developments, regional
tensions, currency repatriation restrictions, foreign exchange fluctuations,
inflation, and an undeveloped system of commercial laws and legislative reform
relating to foreign ownership in Russia. Liggett has a high degree of leverage
and substantial near-term debt service requirements, including a payment at
maturity of the Liggett Notes of $144,891 on February 1, 1999, as well as a
significant net worth deficiency and working capital deficiency, and is highly
dependent upon its revolving credit facility which currently expires in March
1999. In addition, the Company has a high degree of leverage and substantial
near-term debt service requirements, as well as a net worth deficiency and
recent losses from continuing operations. The Indenture for the BGLS Notes
provides for, among other things, the restriction of certain affiliated
transactions between the Company and its affiliates, as well as for certain
restrictions on the use of future distributions received from New Valley. 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. The Company does not undertake to update any
forward-looking statement that may be made from time to time by or on behalf of
the Company.
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<PAGE> 50
PART II
OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Reference is made to Note 8, incorporated herein by reference, to
the Consolidated Financial Statements of Brooke Group Ltd. and
BGLS Inc. (collectively, the "Companies") included elsewhere in
this report on Form 10-Q which contains a general description of
certain legal proceedings to which the Company and/or BGLS or
their subsidiaries are a party and certain related matters.
Reference is also made to Exhibit 99.1 for additional information
regarding the pending material legal proceedings to which the
Company, BGLS and/or Liggett are party. A copy of Exhibit 99.1
will be furnished to security holders of the Company and its
subsidiaries without charge upon written request to the Company at
its principal executive offices, 100 S.E. Second St., Miami,
Florida 33131, Attn. Investor Relations.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
No securities of the Company which were not registered under the
Securities Act of 1933, as amended (the "Securities Act"), have
been issued or sold by the Company during the three months ended
September 30, 1998, except as follows: On August 28, 1998, the
Company awarded to four members of a law firm that represents the
Company and Liggett 470,000 shares of its common stock.
The foregoing transactions were effected in reliance on the
exemption from registration afforded by Section 4(2) of the
Securities Act or did not involve a "sale" under the Securities
Act.
Item 3. DEFAULTS UPON SENIOR SECURITIES
As of September 30, 1998, New Valley Corporation, the Companies'
affiliate, had the following respective accrued and unpaid
dividend arrearages on its 1,071,462 outstanding shares of $15.00
Class A Increasing Rate Cumulative Senior Preferred Shares ($100
Liquidation Value), $.01 par value per share (the "Class A
Shares") and 2,790,776 outstanding shares of $3.00 Class B
Cumulative Convertible Preferred Shares ($25 Liquidation Value),
$.10 par value per share (the "Class B Shares): (1) $204.1 million
or $190.44 per Class A Share; and (2) $158.9 million or $56.94 per
Class B Share.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
3.1 Certificate of Amendment of the Restated Certificate
of Incorporation of the Company.
*10.1 Brooke Group Ltd. 1998 Long-Term Incentive Plan
(incorporated by reference to the Appendix to the
Company's Proxy Statement dated September 15, 1998,
Commission File No. 1-5759).
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<PAGE> 51
*10.2 Stock Option Agreement, dated July 20, 1998, between
the Company and Bennett S. LeBow (incorporated by
reference to Exhibit 6 in the amendment no. 5 to the
Schedule 13D filed by Bennett S. LeBow on October 16,
1998 with respect to the common stock of the
Company).
10.3 Stock Option Agreement, dated July 20, 1998, between
the Company and Howard M. Lorber.
10.4 Amended and Restated Stock Option Agreement, dated as
of October 12, 1998, by and between the Company and
Kasowitz, Benson, Torres & Friedman LLP, Marc E.
Kasowitz and Daniel R. Benson.
27.1 Brooke Group Ltd.'s Financial Data Schedule (for SEC
use only).
27.2 BGLS Inc.'s Financial Data Schedule (for SEC use
only).
99.1 Material Legal Proceedings.
99.2 Liggett Group Inc.'s Interim Consolidated Financial
Statements for the quarterly periods ended September
30, 1998 and 1997.
99.3 New Valley Corporation's Interim Consolidated
Financial Statements for the quarterly periods ended
September 30, 1998 and 1997.
99.4 Brooke (Overseas) Ltd.'s Interim Consolidated
Financial Statements for the quarterly periods ended
September 30, 1998 and 1997.
99.5 New Valley Holdings, Inc.'s Interim Consolidated
Financial Statements for the quarterly periods ended
September 30, 1998 and 1997.
(b) REPORTS ON FORM 8-K
None.
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<PAGE> 52
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.
BROOKE GROUP LTD.
(REGISTRANT)
By: /s/ Joselynn D. Van Siclen
----------------------------
Joselynn D. Van Siclen
Vice President and Chief
Financial Officer
Date: November 13, 1998
BGLS INC.
(REGISTRANT)
By: /s/ Joselynn D. Van Siclen
----------------------------
Joselynn D. Van Siclen
Vice President and Chief
Financial Officer
Date: November 13, 1998
-50-
<PAGE> 53
Exhibit 99.3
NEW VALLEY CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
<PAGE> 54
NEW VALLEY CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of September 30,
1998 and December 31, 1997.................................... 3
Condensed Consolidated Statements of Operations for the
three months and nine months ended September 30, 1998
and 1997...................................................... 4
Condensed Consolidated Statement of Changes in
Stockholders' Deficiency for the nine months
ended September 30, 1998...................................... 5
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 1998 and 1997................. 6
Notes to the Condensed Quarterly Consolidated Financial
Statements.................................................... 7
</TABLE>
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<PAGE> 55
NEW VALLEY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------- ----------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents ...................................... $ 25,463 $ 11,606
Investment securities available for sale ....................... 26,420 51,993
Trading securities owned ....................................... 15,703 49,988
Restricted assets .............................................. 1,843 232
Receivable from clearing brokers ............................... 1,854 1,205
Other current assets ........................................... 2,581 3,618
---------- ----------
Total current assets ...................................... 73,864 118,642
---------- ----------
Investment in real estate, net ..................................... 80,479 256,645
Furniture and equipment, net ....................................... 10,845 12,194
Restricted assets .................................................. 5,767 5,484
Long-term investments, net ......................................... 9,689 27,224
Investment in joint venture ........................................ 63,713 --
Other assets ....................................................... 6,524 21,202
---------- ----------
Total assets .............................................. $ 250,881 $ 441,391
========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Margin loan payable ............................................ $ 1,470 $ 13,012
Current portion of notes payable and other long-term obligations -- 760
Accounts payable and accrued liabilities ....................... 31,466 57,722
Prepetition claims and restructuring accruals .................. 12,379 12,611
Income taxes ................................................... 18,715 18,413
Securities sold, not yet purchased ............................. 3,208 25,610
---------- ----------
Total current liabilities ................................. 67,238 128,128
---------- ----------
Notes payable ...................................................... 55,083 173,814
Other long-term obligations ........................................ 20,571 11,210
Redeemable preferred shares ........................................ 300,711 258,638
Commitments and Contingencies ...................................... -- --
Stockholders' deficiency:
Cumulative preferred shares; liquidation preference of $69,769;
dividends in arrears, $158,908 and $139,412 ................. 279 279
Common Shares, $.01 par value; 850,000,000 shares authorized;
9,577,624 shares outstanding ................................ 96 96
Additional paid-in capital ..................................... 564,234 604,215
Accumulated deficit ............................................ (750,145) (742,427)
Unearned compensation on stock options ......................... (15) (158)
Accumulated other comprehensive income ......................... (7,171) 7,596
---------- ----------
Total stockholders' deficiency ............................ (192,722) (130,399)
---------- ----------
Total liabilities and stockholders' deficiency ............ $ 250,881 $ 441,391
========== ==========
</TABLE>
See accompanying Notes to Quarterly Condensed Consolidated Financial Statements
-3-
<PAGE> 56
NEW VALLEY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Principal transactions, net ........................... $ (860) $ 6,131 $ 7,476 $ 11,857
Commissions ........................................... 6,510 4,235 20,663 11,059
Corporate finance fees ................................ 259 3,555 4,541 8,202
Gain on sale of investments, net ...................... 1,815 1,466 10,377 8,518
Loss in joint venture ................................. (1,746) -- (2,233) --
Real estate leasing ................................... 4,767 7,079 18,488 19,664
Gain on sale of real estate ........................... 4,682 -- 4,682 --
Interest and dividends ................................ 2,033 2,554 7,424 6,677
Computer sales and service ............................ 40 70 499 3,750
Other income .......................................... 1,940 1,614 6,635 6,925
----------- ----------- ----------- -----------
Total revenues .................................... 19,440 26,704 78,552 76,652
----------- ----------- ----------- -----------
Cost and expenses:
Operating, general and administrative ................. 25,109 29,553 84,466 84,090
Interest .............................................. 3,555 4,229 11,167 12,134
Provision for loss on long-term investment ............ -- -- -- 3,796
----------- ----------- ----------- -----------
Total costs and expenses .......................... 28,664 33,782 95,633 100,020
----------- ----------- ----------- -----------
Loss from continuing operations before income taxes
and minority interests ................................ (9,224) (7,078) (17,081) (23,368)
Income tax provision ....................................... 10 24 31 119
Minority interests in loss from continuing operations
of consolidated subsidiaries .......................... 495 528 1,654 1,543
----------- ----------- ----------- -----------
Loss from continuing operations ............................ (8,739) (6,574) (15,458) (21,944)
Discontinued operations:
Gain on disposal of discontinued operations ........... 6,860 -- 7,740 --
----------- ----------- ----------- -----------
Income from discontinued operations ................... 6,860 -- 7,740 --
----------- ----------- ----------- -----------
Net loss ................................................... (1,879) (6,574) (7,718) (21,944)
Dividend requirements on preferred shares .................. (20,743) (17,567) (59,333) (50,297)
----------- ----------- ----------- -----------
Net loss applicable to Common Shares ....................... $ (22,622) $ (24,141) $ (67,051) $ (72,241)
=========== =========== =========== ===========
Loss per Common Share (basic and diluted):
Continuing operations ................................. $ (3.08) $ (2.52) $ (7.81) $ (7.54)
Discontinued operations ............................... 0.72 -- .81 --
----------- ----------- ----------- -----------
Net loss per Common Share ............................. $ (2.36) $ (2.52) $ (7.00) $ (7.54)
=========== =========== =========== ===========
Number of shares used in computation ....................... 9,577,624 9,577,624 9,577,624 9,577,624
=========== =========== =========== ===========
</TABLE>
See accompanying Notes to Quarterly Condensed Consolidated Financial Statements
-4-
<PAGE> 57
NEW VALLEY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES
IN SHAREHOLDERS' DEFICIENCY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Unearned
Class B Compensation
Preferred Common Paid-In Accumulated on Stock Unrealized
Shares Shares Capital Deficit Options Gain
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 .......... $ 279 $ 96 $ 604,215 $(742,427) $ (158) $ 7,596
Net loss ......................... (7,718)
Undeclared dividends and accretion
on redeemable preferred shares . (39,838)
Unrealized gain on investment
securities ..................... (14,767)
Adjustment to unearned
compensation on stock options .. -- -- (143) -- 143 --
--------- --------- --------- --------- --------- ---------
Balance, September 30, 1998 ......... $ 279 $ 96 $ 564,234 $(750,145) $ (15) $ (7,171)
========= ========= ========= ========= ========= =========
</TABLE>
See accompanying Notes to Quarterly Condensed Consolidated Financial Statements
-5-
<PAGE> 58
NEW VALLEY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------
1998 1997
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net loss .................................................................... $ (7,718) $ (21,944)
Adjustments to reconcile net loss to net cash
used for operating activities:
Income from discontinued operations ....................................... (7,740) --
Loss in joint venture ..................................................... 2,233 --
Depreciation and amortization ............................................. 5,472 6,635
Provision for loss on long-term investment ................................ -- 3,796
Gain on sales of real estate and liquidation of long-term investments ..... (9,452) --
Stock based compensation expense .......................................... 2,215 2,213
Changes in assets and liabilities, net of effects from
acquisitions and dispositions:
Decrease (increase) in receivables and other assets .................... 39,804 (6,881)
Increase in income taxes payable ....................................... 409 86
(Decrease) increase in accounts payable and accrued liabilities ........ (35,831) 5,951
---------- ----------
Net cash used for continuing operations ........................................ (10,608) (10,144)
Net cash provided from discontinued operations ................................. 7,740 --
---------- ----------
Net cash used for operating activities ......................................... (2,868) (10,144)
---------- ----------
Cash flows from investing activities:
Sale or maturity of investment securities ................................. 21,286 37,697
Purchase of investment securities ......................................... (13,352) (20,999)
Sale or liquidation of long-term investments .............................. 25,895 2,807
Purchase of long-term investments ......................................... (8,590) (11,404)
Sale of real estate, net of closing costs ................................. 111,292 --
Purchase of real estate ................................................... (18,387) (6,208)
Sale of other assets ...................................................... 226 5,561
Payment of prepetition claims ............................................. (676) (1,199)
Return of prepetition claims paid ......................................... -- 1,396
Decrease in restricted assets ............................................. (1,894) 2,251
Cash transferred to joint venture ......................................... (487) --
Other ..................................................................... (1,411) --
Payment for acquisitions, net of cash acquired ............................ -- (20,014)
---------- ----------
Net cash provided from (used for) investing activities ......................... 113,902 (10,112)
---------- ----------
Cash flows from financing activities:
Increase in margin loan payable, net ...................................... (11,541) --
Sale of subsidiary's common stock ......................................... -- 5,417
Proceeds from participating loan .......................................... 14,300 --
Proceeds from notes payable ............................................... -- 19,993
Repayment of notes payable to related party ............................... -- (21,500)
Repayment of notes payable ................................................ (99,373) (20,703)
Repayment of other obligations ............................................ (563) (3,526)
---------- ----------
Net cash used for financing activities ......................................... (97,177) (20,319)
---------- ----------
Net increase (decrease) in cash and cash equivalents ........................... 13,857 (40,575)
Cash and cash equivalents, beginning of period ................................. 11,606 57,282
---------- ----------
Cash and cash equivalents, end of period ....................................... $ 25,463 $ 16,707
========== ==========
</TABLE>
See accompanying Notes to Quarterly Condensed Consolidated Financial Statements
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<PAGE> 59
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED QUARTERLY CONSOLIDATED
FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
1. PRINCIPLES OF REPORTING
The consolidated financial statements include the accounts of New Valley
Corporation and Subsidiaries (the "Company"). The consolidated financial
statements as of September 30, 1998 presented herein have been prepared
by the Company without an audit. In the opinion of management, all
adjustments, consisting only of normal recurring adjustments, necessary
to present fairly the financial position as of September 30, 1998 and
the results of operations and cash flows for all periods presented have
been made. Results for the interim periods are not necessarily
indicative of the results for an entire year.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
These financial statements should be read in conjunction with the
consolidated financial statements in the Company's Annual Report on Form
10-K, as amended, for the year ended December 31, 1997 as filed with the
Securities and Exchange Commission (Commission File No. 1-2493).
Certain reclassifications have been made to prior interim period
financial information to conform with current year presentation.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130"). The Statement, which the Company adopted in
the first quarter of 1998, establishes standards for reporting and
displaying comprehensive income and its components in a full set of
general-purpose financial statements. Where applicable, earlier periods
have been restated to conform to the standards established by SFAS No.
130. The adoption of SFAS 130 did not have a material impact on the
Company's financial statements.
For transactions entered into in fiscal years beginning after December
15, 1997, the Company adopted and is reporting in accordance with SOP
97-2, "Software Revenue Recognition". The adoption of SOP 97-2 did not
have a material impact on the Company's financial statements.
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1
provides guidance that the carrying value of software developed or
obtained for internal use is assessed based upon an analysis of
estimated future cash flows on an undiscounted basis and before interest
charges. SOP 98-1 is effective for transactions entered into in fiscal
years beginning after December 15, 1998. The Company believes that
adoption of SOP 98-1 will not have a material impact on the Company's
financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information", which establishes standards
for the way that public business enterprises report information about
operating segments. SFAS No. 131 is effective for financial statements
for fiscal years beginning after December 15, 1997. The Company is
currently reviewing its operating segment disclosures and will adopt
SFAS No. 131 in the fourth quarter of 1998.
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<PAGE> 60
In June, 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 is effective for all
fiscal quarters of all fiscal years beginning after June 15, 1999. SFAS
133 requires that all derivative instruments be recorded on the balance
sheet at fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. The Company
has not yet determined the impact that the adoption of SFAS 133 will
have on its earnings or statement of financial position.
2. WESTERN REALTY
On January 31, 1997, the Company entered into a stock purchase agreement
with Brooke (Overseas) Ltd. ("Brooke (Overseas)"), a wholly-owned
subsidiary of Brooke Group Ltd. ("Brooke"), an affiliate of the Company,
pursuant to which the Company acquired 10,483 shares (the "BML Shares")
of the common stock of BrookeMil Ltd. ("BML") from Brooke (Overseas) for
a purchase price of $55,000, consisting of $21,500 in cash and a $33,500
9% promissory note of the Company (the "Note"). The BML Shares comprise
99.1% of the outstanding shares of BML, a real estate development
company in Russia. The Note, which was collateralized by the BML Shares,
was paid during 1997.
WESTERN REALTY DEVELOPMENT LLC
In February 1998, the Company and Apollo Real Estate Investment Fund
III, L.P. ("Apollo") organized Western Realty Development LLC ("Western
Realty Ducat") to make real estate and other investments in Russia. In
connection with the formation of Western Realty Ducat, the Company
agreed, among other things, to contribute the real estate assets of BML,
including Ducat Place II and the site for Ducat Place III, to Western
Realty Ducat and Apollo agreed to contribute up to $58,750, including
the investment in Western Realty Repin discussed below. Through
September 30, 1998, Apollo had funded $30,550 of its investment in
Western Realty Ducat.
The ownership and voting interests in Western Realty Ducat will be held
equally by Apollo and the Company. Apollo will be entitled to a
preference on distributions of cash from Western Realty Ducat to the
extent of its investment ($40,000), together with a 15% annual rate of
return, and the Company will then be entitled to a return of $16,300 of
BML-related expenses incurred and cash invested by the Company since
March 1, 1997, together with a 15% annual rate of return; subsequent
distributions will be made 70% to the Company and 30% to Apollo. Western
Realty Ducat will be managed by a Board of Managers consisting of an
equal number of representatives chosen by Apollo and the Company. All
material corporate transactions by Western Realty Ducat will generally
require the unanimous consent of the Board of Managers. Accordingly, the
Company has accounted for its non-controlling interest in Western Realty
Ducat using the equity method of accounting.
The Company recorded its basis in the investment in the joint venture in
the amount of $60,169 based on the carrying value of assets less
liabilities transferred. There was no difference between the carrying
value of the investment and the Company's proportionate interest in the
underlying value of net assets of the joint venture.
-8-
<PAGE> 61
Western Realty Ducat will seek to make additional real estate and other
investments in Russia. Western Realty Ducat has made a $26,300
participating loan to, and payable out of a 30% profits interest in, a
company organized by Brooke (Overseas) which, among other things, owns
an industrial site and manufacturing facility being constructed on the
outskirts of Moscow by a subsidiary of Brooke (Overseas).
WESTERN REALTY REPIN LLC
In June 1998, the Company and Apollo organized Western Realty Repin LLC
("Western Realty Repin") to make a $25,000 participating loan (the
"Repin Loan") to BML. The proceeds of the loan will be used by BML for
the acquisition and preliminary development of two adjoining sites
totaling 10.25 acres (the "Kremlin Sites") located in Moscow across the
Moscow River from the Kremlin. BML, which is planning the development of
a 1.1 million sq. ft. hotel, office, retail and residential complex on
the Kremlin Sites, owned 94.6% of one site and 52% of the other site at
September 30, 1998. Apollo will be entitled to a preference on
distributions of cash from Western Realty Repin to the extent of its
investment ($18,750), together with a 20% annual rate of return, and the
Company will then be entitled to a return of its investment ($6,250),
together with a 20% annual rate of return; subsequent distributions will
be made 50% to the Company and 50% to Apollo. Western Realty Repin will
be managed by a Board of Managers consisting of an equal number of
representatives chosen by Apollo and the Company. All material corporate
transactions by Western Realty Repin will generally require the
unanimous consent of the Board of Managers.
Through September 30, 1998, Western Realty Repin has advanced $19,067
(of which $14,300 was funded by Apollo) under the Repin Loan to BML,
which is classified in other long-term obligations on the condensed
consolidated balance sheet at September 30, 1998. The Repin Loan, which
bears no fixed interest, is payable only out of 100% of the
distributions, if made, by the entities owning the Kremlin Sites to BML.
Such distributions shall be applied first to pay the principal of the
Repin Loan and then as contingent participating interest on the Repin
Loan. Any rights of payment on the Repin Loan are subordinate to the
rights of all other creditors of BML. BML used a portion of the proceeds
of the Repin Loan to repay the Company for certain expenditures on the
Kremlin Sites previously incurred. The Repin Loan is due and payable upon
the dissolution of BML and is collateralized by a pledge of the Company's
shares of BML.
As of September 30, 1998, BML had invested $15,171 in the Kremlin Sites
and held $809, in cash, which was restricted for future investment. In
connection with the acquisition of its interest in one of the Kremlin
Sites, BML has agreed with the City of Moscow to invest an additional
$6,000 in 1998 and $22,000 in 1999 in the development of the property.
The development of Ducat Place III and the Kremlin Sites will require
significant amounts of debt and other financing. The Company is actively
pursuing various financing alternatives on behalf of Western Realty
Ducat and BML. However, in light of the recent economic turmoil in
Russia, no assurance can be given that such financing will be available
on acceptable terms. Failure to obtain sufficient capital for the
projects would force Western Realty Ducat and BML to curtail or delay
the planned development of Ducat Place III and the Kremlin Sites.
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3. INVESTMENT SECURITIES AVAILABLE FOR SALE
Investment securities classified as available for sale are carried at
fair value, with net unrealized gains included as a separate component
of stockholders' deficiency. The Company had realized gains on sales of
investment securities available for sale of $191 and $5,725 for the
three and nine months ended September 30, 1998, respectively.
The components of investment securities available for sale at September
30, 1998 are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Short-term investments ..... $ 10 $ -- $ -- $ 10
Marketable equity securities 30,396 364 6,181 24,579
Marketable ................. -- 1,831 -- 1,831
warrants
Marketable debt securities . 3,185 -- 3,185 --
---------- ---------- ---------- ----------
Investment securities ...... $ 33,591 $ 2,195 $ 9,366 $ 26,420
========== ========== ========== ==========
</TABLE>
4. LONG-TERM INVESTMENTS
At September 30, 1998, long-term investments consisted primarily of
investments in limited partnerships of $9,689. The Company believes the
fair value of the limited partnerships exceeds its carrying amount by
approximately $2,500 based on the indicated market values of the
underlying investment portfolio provided by the partnerships. The
Company recognized gains of $1,624 and $4,652 on liquidations of
investments of certain limited partnerships for the three and nine
months ended September 30, 1998, respectively. The Company's investments
in limited partnerships are illiquid and the ultimate realizations of
these investments are subject to the performance of the underlying
partnership and its management by the general partners. The Company sold
an interest in a limited partnership in September, 1998 and may sell or
liquidate certain other limited partnership interests in the future. Any
sale of such interests would be subject to the approval of the general
partner.
In the first quarter of 1997, the Company determined that an other than
temporary impairment in the value of its investment in a joint venture
had occurred and wrote down this investment to zero with a charge to
operations of $3,796 for the three month period. The Company's estimates
of the fair value of its long-term investments are subject to judgment
and are not necessarily indicative of the amounts that could be realized
in the current market.
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5. REAL ESTATE
On September 28, 1998, the Company completed a sale to institutional
investors of four commercial office buildings (the "Office Buildings")
located in Troy, Michigan and Bernards Township, New Jersey for an
aggregate purchase price of $112.4 million before closing adjustments
and expenses. The Company received approximately $13.0 million in cash
from the transaction before closing adjustments and expenses. The Office
Buildings were subject to approximately $99.0 million of mortgage
financing which was retired at closing. The Company recorded a gain of
$4,682 associated with the sale of the Office Buildings. The Company may
seek to dispose of other U.S. real estate holdings in the future.
6. INCOME FROM DISCONTINUED OPERATIONS
The Company recorded a gain on disposal of discontinued operations of
$6,860 and $7,740 for the three and nine months ended September 30, 1998
related to the settlement of a lawsuit originally initiated by the
Company's predecessor, Western Union Telegraph Company.
7. REDEEMABLE PREFERRED SHARES
At September 30, 1998, the Company had authorized and outstanding
2,000,000 and 1,071,462, respectively, of its Class A Senior Preferred
Shares. At September 30, 1998 and December 31, 1997, respectively, the
carrying value of such shares amounted to $300,711 and $258,638,
including undeclared dividends of $204,050 and $163,302 or $190.44 and
$152.41 per share. As of September 30, 1998, the unamortized discount on
the Class A Senior Preferred Shares was $7,090.
For the three and nine months ended September 30, 1998, the Company
recorded $757 and $2,215 in compensation expense, respectively, related
to certain Class A Senior Preferred Shares awarded to an officer of the
Company in 1996. At September 30, 1998, the balance of the deferred
compensation and the unamortized discount related to these award shares
was $3,396 and $2,628, respectively.
8. PREFERRED SHARES NOT SUBJECT TO REDEMPTION REQUIREMENTS
The undeclared dividends cumulatively amounted to $158,908 and $139,412
at September 30, 1998 and December 31, 1997, respectively. These
undeclared dividends represent $56.94 and $49.95 per share as of the end
of each period. No accrual was recorded for such undeclared dividends as
the Class B Preferred Shares are not mandatorily redeemable.
9. CONTINGENCIES
LITIGATION
On or about March 13, 1997, a shareholder derivative suit was filed
against the Company, as a nominal defendant, its directors and Brooke in
the Delaware Chancery Court, by a shareholder of the Company. The suit
alleges that the Company's purchase of the BML Shares constituted a
self
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<PAGE> 64
dealing transaction which involved the payment of excessive
consideration by the Company. The plaintiff seeks (i) a declaration that
the Company's directors breached their fiduciary duties, Brooke aided
and abetted such breaches and such parties are therefore liable to the
Company, and (ii) unspecified damages to be awarded to the Company. The
Company's time to respond to the complaint has not yet expired. The
Company believes that the allegations were without merit. Although there
can be no assurances, management is of the opinion, after consultation
with counsel, that the ultimate resolution of this matter will not have
a material adverse effect on the Company's consolidated financial
position, results of operations or cash flows.
The Company is a defendant in various lawsuits and may be subject to
unasserted claims primarily in connection with its activities as a
securities broker-dealer and participation in public underwritings.
These lawsuits involve claims for substantial or indeterminate amounts
and are in varying stages of legal proceedings. In the opinion of
management, after consultation with counsel, the ultimate resolution of
these matters will not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
PREPETITION CLAIMS UNDER CHAPTER 11 AND RESTRUCTURING ACCRUALS
The prepetition claims remaining as of September 30, 1998 of $12,379 may
be subject to future adjustments depending on pending discussions with
the various parties and the decisions of the Bankruptcy Court.
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