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Securities And Exchange Commission
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 30, 2000
VECTOR GROUP LTD.
(Exact name of registrant as specified in its charter)
DELAWARE 1-5759 65-0949535
-------- ------ ----------
(State or other jurisdiction of (Commission File Number) (I.R.S. Employer
incorporation or organization) Identification No.)
100 S.E. SECOND STREET
MIAMI, FLORIDA 33131
305/579-8000
(Address, including zip code and telephone number, including area code,
of the principal executive offices)
------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
At November 13, 2000, Vector Group Ltd. had 25,667,082 shares of common
stock outstanding.
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VECTOR GROUP LTD.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. VECTOR GROUP LTD. CONSOLIDATED FINANCIAL STATEMENTS:
Vector Group Ltd. Consolidated Balance Sheets as of September 30, 2000 and
December 31, 1999............................................................................. 2
Vector Group Ltd. Consolidated Statements of Operations for the three and nine months
ended September 30, 2000 and September 30, 1999............................................... 3
Vector Group Ltd. Consolidated Statement of Stockholders' Equity (Deficit) for the nine
months ended September 30, 2000............................................................... 4
Vector Group Ltd. Consolidated Statements of Cash Flows for the nine months ended
September 30, 2000 and September 30, 1999..................................................... 5
Notes to Consolidated Financial Statements.......................................................... 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.............................................. 31
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................................... 42
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.............................................................................. 43
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS...................................................... 43
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................................................... 43
SIGNATURES............................................................................................. 45
</TABLE>
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VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents ................................................ $ 153,294 $ 20,123
Receivables from clearing brokers ........................................ 20,185 10,903
Investment securities available for sale ................................. 45,465 48,722
Trading securities owned ................................................. 12,599 15,707
Accounts receivable - trade .............................................. 9,049 19,658
Other receivables ........................................................ 2,562 1,290
Inventories .............................................................. 30,841 45,205
Restricted assets ........................................................ 988 3,239
Deferred income taxes .................................................... 3,536 21,374
Other current assets ..................................................... 3,618 2,511
--------- ---------
Total current assets ................................................... 282,137 188,732
Property, plant and equipment, net ......................................... 47,562 154,260
Investment in real estate, net ............................................. 55,342 53,353
Long-term investments, net ................................................. 6,506 8,731
Investment in joint venture ................................................ 35,625 38,378
Restricted assets .......................................................... 4,017 5,195
Deferred income taxes ...................................................... 6,933 45,631
Other assets ............................................................... 5,301 10,168
--------- ---------
Total assets ........................................................... $ 443,900 $ 504,448
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Current portion of notes payable and long-term debt ...................... $ 10,469 $ 41,547
Margin loan payable ...................................................... 6,195 983
Accounts payable ......................................................... 8,063 36,456
Securities sold, not yet purchased ....................................... 4,913 7,625
Accrued promotional expenses ............................................. 23,314 22,473
Income and accrued taxes payable ......................................... 40,627 42,408
Deferred income taxes .................................................... 2,603 2,274
Prepetition claims and restructuring accruals ............................ 11,915 12,279
Other accrued liabilities ................................................ 41,783 60,609
--------- ---------
Total current liabilities .............................................. 149,882 226,654
Notes payable, long-term debt and other obligations,
less current portion ..................................................... 38,982 148,349
Noncurrent employee benefits ............................................... 12,667 23,264
Deferred income taxes ...................................................... 125,964 117,285
Other liabilities .......................................................... 47,133 76,628
Minority interests ......................................................... 60,474 45,366
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock, par value $1.00 per share, authorized 10,000,000 shares.. -- --
Common stock, par value $0.10 per share, authorized 100,000,000 shares,
issued 31,791,728 and 29,213,917 shares, outstanding 25,667,082 and
23,089,271 shares ...................................................... 2,567 2,199
Additional paid-in capital ............................................... 198,381 196,695
Deficit .................................................................. (163,378) (302,155)
Accumulated other comprehensive income ................................... 2,444 1,379
Other .................................................................... (3,743) (3,743)
Less: 6,124,646 shares of common stock in treasury, at cost ............. (27,473) (27,473)
--------- ---------
Total stockholders' equity (deficit) ................................. 8,798 (133,098)
--------- ---------
Total liabilities and stockholders' equity (deficit) ................. $ 443,900 $ 504,448
========= =========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
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VECTOR GROUP LTD. 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,
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Tobacco* .............................................. $ 167,123 $ 135,932 $ 501,915 $ 353,594
Broker-dealer transactions ............................ 13,009 12,711 61,605 18,587
Real estate leasing ................................... 778 1,576 2,369 2,330
------------ ------------ ------------ ------------
Total revenues ...................................... 180,910 150,219 565,889 374,511
Expenses:
Cost of goods sold* ................................... 58,862 47,473 213,004 128,998
Operating, selling, administrative and
general expenses .................................... 114,696 83,384 325,610 190,395
------------ ------------ ------------ ------------
Operating income .................................... 7,352 19,362 27,275 55,118
Other income (expenses):
Interest and dividend income .......................... 3,833 507 7,015 1,239
Interest expense ...................................... (6,073) (16,114) (29,643) (43,200)
Equity in loss of affiliate ........................... (1,969) (908) (4,882) (10,106)
Recognition of deferred gain on sale of assets ........ -- -- -- 7,050
Foreign currency gain ................................. 550 -- 2,085 --
Income from joint venture ............................. 52,427 1,740 52,580 950
Gain on sale of investments, net ...................... 108 151 6,299 478
Gain on sale of assets ................................ 193,779 3,844 193,929 7,969
Gain on brand transaction ............................. -- (189) -- 294,098
Other, net ............................................ 4,644 (427) 5,755 2,494
------------ ------------ ------------ ------------
Income from continuing operations before provision
for income taxes and minority interests ............. 254,651 7,966 260,413 316,090
Provision for income taxes ............................ 76,539 2,782 78,853 86,156
Minority interests .................................... (19,423) 1,046 (19,279) (336)
------------ ------------ ------------ ------------
Income from continuing operations ....................... 158,689 6,230 162,281 229,598
Gain on disposal of discontinued operations ............. -- -- -- 1,249
Loss on extraordinary items ............................. (2,422) (354) (2,652) (1,410)
------------ ------------ ------------ ------------
Net income .............................................. $ 156,267 $ 5,876 $ 159,629 $ 229,437
============ ============ ============ ============
Per basic common share:
Income from continuing operations ..................... $ 6.63 $ 0.27 $ 6.94 $ 9.94
============ ============ ============ ============
Gain from discontinued operations ..................... -- -- -- $ 0.05
============
Loss from extraordinary items ......................... $ (0.10) $ (0.02) $ (0.11) $ (0.06)
============ ============ ============ ============
Net income applicable to common shares ................ $ 6.53 $ 0.25 $ 6.83 $ 9.93
============ ============ ============ ============
Basic weighted average common shares outstanding ........ 23,939,989 23,090,462 23,372,844 23,090,462
============ ============ ============ ============
Per diluted common share:
Income from continuing operations ..................... $ 5.58 $ 0.22 $ 5.82 $ 7.81
============ ============ ============ ============
Gain from discontinued operations ..................... -- -- -- $ 0.04
============
Loss from extraordinary items ......................... $ (0.09) $ (0.01) $ (0.09) $ (0.05)
============ ============ ============ ============
Net income applicable to common shares ................ $ 5.49 $ 0.21 $ 5.73 $ 7.80
============ ============ ============ ============
Diluted weighted average common shares outstanding ...... 28,445,916 27,971,803 27,879,233 29,395,148
============ ============ ============ ============
</TABLE>
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* Tobacco revenues and Cost of goods sold include excise taxes of
$30,923, $17,374, $88,084 and $46,129, respectively.
The accompanying notes are an integral part
of the consolidated financial statements.
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VECTOR 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, 1999 ......... 21,989,782 $ 2,199 $ 196,695 $ (302,155) $ (27,473) $ (3,743) $ 1,379 $(133,098)
Net income ......................... -- -- -- 159,629 -- -- -- 159,629
Total other comprehensive income
related to unrealized gains
on investment securities ......... -- -- -- -- -- -- 1,065 1,065
---------
Total comprehensive income ......... -- -- -- -- -- -- -- 160,694
---------
Exercise of options and
warrants ......................... 2,455,206 246 -- -- -- -- -- 246
Effect of stock
dividend ......................... 1,222,094 122 20,730 (20,852) -- -- -- --
Distributions on
common stock ..................... -- -- (20,249) -- -- -- -- (20,249)
Amortization of deferred
compensation ..................... -- -- 1,205 -- -- -- -- 1,205
---------- ---------- ---------- ---------- ---------- -------- ------- ---------
Balance, September 30, 2000 ........ 25,667,082 $ 2,567 $ 198,381 $ (163,378) $ (27,473) $ (3,743) $ 2,444 $ 8,798
========== ========== ========== ========== ========== ======== ======= =========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
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VECTOR GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
---------------------------
Sept. 30, Sept. 30,
2000 1999
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<S> <C> <C>
Net cash (used in) provided by operating activities ........ $ (11,042) $ 30,750
--------- ---------
Cash flows from investing activities:
Proceeds from sale of businesses and assets, net ......... 327,087 932
Proceeds from brand transaction .......................... -- 145,000
Sale or maturity of investment securities ................ 35,561 3,234
Purchase of investment securities ........................ (24,059) (6,737)
Purchase of long-term investments ........................ (2,358) (2,902)
Proceeds from sale or purchase of real estate, net ....... (2,668) 47,550
Decrease in restricted assets ............................ 3,477 --
Payment of prepetition claims ............................ (363) (67)
Investment in joint venture .............................. (1,916) --
Repurchase by New Valley of common shares ................ (954) --
Capital expenditures ..................................... (26,636) (44,372)
--------- ---------
Net cash provided by investing activities .................. 307,171 142,638
--------- ---------
Cash flows from financing activities:
Proceeds from debt ....................................... 29,133 4,976
Repayments of debt ....................................... (127,315) (187,582)
Borrowings under revolvers ............................... 305,775 262,084
Repayments on revolvers .................................. (287,066) (247,196)
Purchase of preferred stock in subsidiary ................ -- (1,509)
Effect of New Valley recapitalization .................... -- 9,055
Increase (decrease) in margin loan payable ............... 5,212 (5,046)
Increase in cash overdraft ............................... -- 95
Repayment of participating loan and related amounts ...... (68,338) --
Distributions on common stock ............................ (20,249) (8,446)
--------- ---------
Net cash used in financing activities ...................... (162,848) (173,569)
--------- ---------
Effect of exchange rate changes on cash and
cash equivalents ......................................... (110) (901)
Net increase (decrease) in cash and cash equivalents ....... 133,171 (1,082)
Cash and cash equivalents, beginning of period ............. 20,123 7,396
--------- ---------
Cash and cash equivalents, end of period ................... $ 153,294 $ 6,314
========= =========
Supplemental non-cash investing and financing activities:
Issuance of stock dividends ................................ 20,852 25,646
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation:
---------------------
The consolidated financial statements of Vector Group Ltd. (the
"Company" or "Vector") include the accounts of BGLS Inc. ("BGLS"),
Liggett Group Inc. ("Liggett"), Brooke (Overseas) Ltd. ("Brooke
(Overseas)"), through July 31, 2000 Liggett-Ducat Ltd.
("Liggett-Ducat") and other less significant subsidiaries. As of June
1, 1999, New Valley Corporation ("New Valley") became a consolidated
subsidiary of the Company as a result of New Valley's
recapitalization in which the Company's interest in New Valley's
common shares increased to 55.1%. (Refer to Note 4.) All significant
intercompany balances and transactions have been eliminated.
Liggett is engaged primarily in the manufacture and sale of
cigarettes, principally in the United States. Prior to its sale in
August 2000, Liggett-Ducat was engaged in the manufacture and sale of
cigarettes in Russia. (Refer to Note 2.) New Valley is engaged
primarily in the investment banking and brokerage business through
its ownership of Ladenburg Thalmann & Co. Inc. and in the real estate
development business in Russia.
Effective October 1, 1999, the Company was reorganized into a holding
company form of organizational structure. The new corporate structure
was implemented by the merger of a wholly-owned indirect subsidiary
of the former Brooke Group Ltd., the predecessor of the current
Company, with the predecessor, which was the surviving corporation.
As a result of this merger, each share of the common stock of the
predecessor issued and outstanding or held in its treasury was
converted into one share of common stock of the current Company
(formerly known as BGL Successor Inc.). The current Company became
the holding company for the business and operations previously
conducted by the predecessor and its subsidiaries, and the
predecessor became an indirect wholly-owned subsidiary of the
Company. On the effective date of the merger, the name of the current
Company was changed to Brooke Group Ltd. and the name of the
predecessor was changed to Brooke Group Holding Inc. ("Brooke Group
Holding"). The holding company reorganization had no impact on these
consolidated financial statements.
At the Company's annual meeting held on May 24, 2000, stockholders
approved a corporate name change to Vector Group Ltd. The New York
Stock Exchange symbol for the Company's common stock was changed from
"BGL" to "VGR".
The interim consolidated financial statements of the Company are
unaudited and, in the opinion of management, reflect all adjustments
necessary (which are normal and recurring) to present fairly the
Company's consolidated financial position, results of operations and
cash flows. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1999, 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.
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VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
(b) Risks and Uncertainties:
-----------------------
The Russian Federation continues to experience economic difficulties
following the financial crisis of August 1998. Consequently, the
country's currency continues to devalue, there is continued
volatility in the debt and equity market, hyperinflation persists,
confidence in the banking sector has yet to be restored and there
continues to be a general lack of liquidity in the economy. In
addition, laws and regulations affecting businesses operating within
the Russian Federation continue to evolve.
The Russian Federation's return to economic stability is dependent to
a large extent on the effectiveness of the measures taken by the
government, decisions of international lending organizations, and
other actions, including regulatory and political developments, which
are beyond the Company's control.
The Company's assets and operations could be at risk if there are any
further significant adverse changes in the political and business
environment. Management is unable to predict what effect those
uncertainties might have on the future financial position of the
Company. No adjustments related to these uncertainties have been
included in these consolidated financial statements.
(c) Estimates and Assumptions:
-------------------------
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, disclosure of contingent assets and liabilities and the
reported amounts of revenues and expenses. Significant estimates
subject to material changes in the near term include deferred tax
assets, allowance for doubtful accounts, promotional accruals, sales
returns and allowances, actuarial assumptions of pension plans and
litigation and defense costs. Actual results could differ from those
estimates.
(d) Reclassifications:
-----------------
Certain amounts in the 1999 consolidated financial statements have
been reclassified to conform to the 2000 presentation.
(e) Provision for Income Taxes:
--------------------------
The effective tax rate does not bear a customary relationship to
pre-tax accounting income principally as a result of the difference
in the book and tax bases of the Company's investment in
Liggett-Ducat.
(f) Earnings Per Share:
------------------
Information concerning the Company's common stock has been adjusted
to give effect to the 5% stock dividend paid to Company stockholders
on September 30, 1999 and September 28, 2000. In connection with each
of the stock dividends, the Company
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<PAGE> 9
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
increased the number of warrants and stock options by 5% and reduced
the exercise prices accordingly. All share amounts have been
presented as if the stock dividends had occurred on January 1, 1999.
(g) Comprehensive Income:
--------------------
Comprehensive income is a component of stockholders' equity and
includes the Company's net income and other comprehensive income
which includes such items as the Company's proportionate interest in
New Valley's capital transactions, unrealized gains and losses on
investment securities and minimum pension liability adjustments.
Total comprehensive income was $160,694 for the nine months ended
September 30, 2000 and $201,384 for the nine months ended
September 30, 1999.
2. SALE OF WESTERN TOBACCO INVESTMENTS
On August 4, 2000, Brooke (Overseas) completed the sale of all of the
membership interests of Western Tobacco Investments LLC ("Western Tobacco
Investments") to Gallaher Overseas (Holdings) Ltd. ("Gallaher Overseas").
Brooke (Overseas) held its 99.9% equity interest in Liggett-Ducat, one of
Russia's leading cigarette producers, through Western Tobacco Investments.
The purchase price for the sale consisted of $334,100 in cash and $64,400
in assumed debt and capital commitments. The proceeds generated from the
sale were divided among Brooke (Overseas) and Western Realty Development
LLC ("Western Realty Development"), a joint venture of New Valley and
Apollo Real Estate Investment Fund III, L.P. ("Apollo"), in accordance
with the terms of the participating loan. (Refer to Note 5.) Of the cash
proceeds from the transaction after estimated closing expenses, Brooke
(Overseas) received $197,098. New Valley received $57,208 in cash proceeds
from the sale and Apollo received $68,338 in cash proceeds from the sale.
These amounts are subject to revision based on final closing expenses and
adjustments. The Company recorded a gain of $161,000 (including the
Company's share of New Valley's gain), net of income taxes and minority
interests, in connection with the sale in the third quarter of 2000.
On August 4, 2000, with the proceeds of the sale, BGLS repurchased $24,850
principal amount of its 15.75% Senior Secured Notes (the "Notes"),
together with accrued interest of $11,531, for $36,381. On September 5,
2000, BGLS redeemed the remaining Notes for 100% of the principal amount
thereof plus accrued interest. BGLS used a total amount of $106,821 of the
proceeds of the sale to retire the Notes.
Gallaher Overseas has also agreed to purchase for $1,500 additional land
adjacent to the Liggett-Ducat manufacturing facility outside Moscow,
Russia. The seller is a subsidiary of BrookeMil Ltd. ("BrookeMil"), a
wholly-owned subsidiary of New Valley.
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<PAGE> 10
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
3. PHILIP MORRIS BRAND TRANSACTION
In November 1998, the Company and Liggett granted Philip Morris
Incorporated options to purchase interests in Trademarks LLC which holds
three domestic cigarette brands, L&M, CHESTERFIELD and LARK, formerly held
by Liggett's subsidiary, Eve Holdings Inc. ("Eve").
Under the terms of the Philip Morris agreements, Eve contributed the three
brands to Trademarks, a newly-formed limited liability company, in
exchange for 100% of two classes of Trademarks' interests, the Class A
Voting Interest and the Class B Redeemable Nonvoting Interest. Philip
Morris acquired two options to purchase the interests from Eve. In
December 1998, Philip Morris paid Eve a total of $150,000 for the options,
$5,000 for the option for the Class A interest and $145,000 for the option
for the Class B interest.
The Class A option entitled Philip Morris to purchase the Class A interest
for $10,100. On March 19, 1999, Philip Morris exercised the Class A
option, and the closing occurred on May 24, 1999.
The Class B option entitles Philip Morris to purchase the Class B interest
for $139,900. The Class B option will be exercisable during the 90-day
period beginning on December 2, 2008, with Philip Morris being entitled to
extend the 90-day period for up to an additional six months under certain
circumstances. The Class B interest will also be redeemable by Trademarks
for $139,900 during the same period the Class B option may be exercised.
On May 24, 1999, Trademarks borrowed $134,900 from a lending institution.
The loan is guaranteed by Eve and collateralized by a pledge by Trademarks
of the three brands and Trademarks' interest in the trademark license
agreement (discussed below) and by a pledge by Eve of its Class B
interest. In connection with the closing of the Class A option, Trademarks
distributed the loan proceeds to Eve as the holder of the Class B
interest. The cash exercise price of the Class B option and Trademarks'
redemption price were reduced by the amount distributed to Eve. Upon
Philip Morris' exercise of the Class B option or Trademarks' exercise of
its redemption right, Philip Morris or Trademarks, as relevant, will be
required to obtain Eve's release from its guaranty. The Class B interest
will be entitled to a guaranteed payment of $500 each year with the Class
A interest allocated all remaining income or loss of Trademarks. The
proceeds of the loan and the exercise of the Class A option were used to
retire a portion of the BGLS Notes. (Refer to Note 11.)
Trademarks has granted Philip Morris an exclusive license of the three
brands for an 11-year term expiring May 24, 2010 at an annual royalty
based on sales of cigarettes under the brands, subject to a minimum annual
royalty payment equal to the annual debt service obligation on the loan
plus $1,000.
If Philip Morris fails to exercise the Class B option, Eve will have an
option to put its Class B interest to Philip Morris, or Philip Morris'
designees, at a put price that is $5,000 less than the exercise price of
the Class B option (and includes Philip Morris' obtaining Eve's release
from its loan guarantee). The Eve put option is exercisable at any time
during the 90-day period beginning March 2, 2010.
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<PAGE> 11
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
If the Class B option, Trademarks' redemption right and the Eve put option
expire unexercised, the holder of the Class B interest will be entitled to
convert the Class B interest, at its election, into a Class A interest
with the same rights to share in future profits and losses, the same
voting power and the same claim to capital as the entire existing
outstanding Class A interest, i.e., a 50% interest in Trademarks.
Upon the closing of the exercise of the Class A option and the
distribution of the loan proceeds on May 24, 1999, Philip Morris obtained
control of Trademarks, and the Company recognized a pre-tax gain of
$294,078 in its consolidated financial statements to the extent of the
total cash proceeds received from the payment of the option fees, the
exercise of the Class A option and the distribution of the loan proceeds.
4. NEW VALLEY CORPORATION
Until May 31, 1999, the Company was an equity investor in New Valley. The
Class A Senior Preferred Shares and the Class B Preferred Shares of New
Valley that the Company owned were 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
were classified as available for sale. The Common Shares were accounted
for pursuant to APB No. 18, "The Equity Method of Accounting for
Investments in Common Stock".
RECAPITALIZATION. In connection with New Valley's recapitalization on June
4, 1999, New Valley's preferred shares were reclassified and changed into
Common Shares and Warrants to purchase Common Shares. The Company's
ownership of the Common Shares of New Valley increased from 42.3% to
55.1%, and its total voting power increased from 42.3% to 55.1%. As a
result of the increase in ownership, New Valley became a consolidated
subsidiary of the Company as of June 1, 1999.
On October 5, 1999, New Valley's Board of Directors authorized the
repurchase of up to 2,000,000 Common Shares from time to time on the open
market or in privately negotiated transactions depending on market
conditions. As of November 13, 2000, New Valley had repurchased 344,400
shares for approximately $1,354. At September 30, 2000, the Company owned
56.1% of New Valley's Common Shares.
BROOKEMIL LTD. In connection with the sale by Brooke (Overseas) of the
common shares of BrookeMil to New Valley in 1997, a portion of the gain
was deferred in recognition of the fact that the Company retained an
interest in BrookeMil through its 42% equity ownership of New Valley prior
to recapitalization and that a portion of the property sold (the site of
the third phase of the Ducat Place real estate project being developed by
BrookeMil, which was used by Liggett-Ducat for its cigarette factory
operation) was subject to a put option held by New Valley. The option
expired when Liggett-Ducat ceased factory operations at the site in March
1999. The Company recognized that portion of the deferred gain, $7,050, in
March 1999.
-10-
<PAGE> 12
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
5. INVESTMENT IN WESTERN REALTY
WESTERN REALTY DEVELOPMENT LLC. In February 1998, New Valley and Apollo
organized Western Realty Development to make real estate and other
investments in Russia. New Valley agreed to contribute the real estate
assets of BrookeMil, including Ducat Place II and the site for Ducat Place
III, to Western Realty Development and Apollo agreed to contribute up to
$72,021, including the investment in Western Realty Repin discussed below.
The ownership and voting interests in Western Realty Development are held
equally by Apollo and New Valley. Apollo is entitled to a preference on
distributions of cash from Western Realty Development to the extent of its
investment commitment of $43,750, of which $41,916 had been funded,
$41,266 was returned in connection with the sale of Western Tobacco
Investments and $650 was outstanding as of September 30, 2000, together
with a 15% annual rate of return. New Valley is then entitled to a return
of its investment commitment of $23,750, of which $21,916 had been funded,
$21,266 was returned in connection with the sale of Western Tobacco
Investments and $650 was outstanding as of September 30, 2000, together
with a 15% annual rate of return. Subsequent distributions are made 70% to
New Valley and 30% to Apollo. Western Realty Development is managed by a
board of managers consisting of an equal number of representatives chosen
by Apollo and New Valley. Material corporate transactions by Western
Realty Development generally require the unanimous consent of the board of
managers. Accordingly, New Valley accounts for its non-controlling
interest in Western Realty Development using the equity method of
accounting. New Valley recognizes losses incurred by Western Realty
Development to the extent that cumulative earnings of Western Realty
Development are not sufficient to satisfy Apollo's preferred return.
Summarized financial information as of September 30, 2000 and December 31,
1999 and for the three and nine month periods ended September 30, 2000 and
September 30, 1999 for Western Realty Development follows:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ -----------------
<S> <C> <C>
Current assets....................... $ 3,873 $ 3,557
Participating loan receivable........ - 37,849
Real estate, net..................... 76,763 77,988
Furniture and fixtures, net.......... 181 249
Other noncurrent assets.............. 186 320
Goodwill, net........................ 462 722
Notes payable - current.............. 7,233 6,445
Other current liabilities............ 5,121 7,067
Notes payable - long-term............ 2,682 8,211
Other long-term liabilities.......... 799 752
Members' equity...................... 65,630 98,210
</TABLE>
-11-
<PAGE> 13
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Three Months Nine Months Feb. 20, 1998
Ended Ended Ended (date of inception)
Sept. 30, 2000 Sept. 30, 1999 Sept. 30, 2000 to Sept. 30, 1999
-------------- -------------- -------------- -----------------
<S> <C> <C> <C> <C>
Revenues............... $ 2,174 $ 2,194 $ 7,558 $ 8,072
Costs and expenses..... 2,197 3,551 6,655 10,787
Other income........... 85,001 4,218 87,877 4,479
Net income ............ 84,978 2,861 88,780 1,764
</TABLE>
Western Realty Development made a $30,000 participating loan to Western
Tobacco Investments, which held the interests of Brooke (Overseas) in
Liggett-Ducat and its new factory. As a result of the sale of Western
Tobacco Investments, Western Realty Development was entitled to receive
the return of all amounts advanced on the loan, together with a 15% annual
rate of return, and 30% of subsequent distributions. Brooke (Overseas)
recognized net interest expense of $3,460 through August 4, 2000, which
represented a 15% cumulative adjustment to realizable value on the loan
and 30% of any net expense applicable to common interests in Western
Tobacco Investments. The loan, together with the 15% annual rate of return
thereon, was repaid and terminated in connection with the sale of Western
Tobacco Investments in August 2000. (Refer to Note 2.)
WESTERN REALTY REPIN LLC. In June 1998, New Valley and Apollo organized
Western Realty Repin LLC ("Western Realty Repin") to make a loan to
BrookeMil, a wholly-owned subsidiary of New Valley. The proceeds of the
loan have been used by BrookeMil for the acquisition and preliminary
development of the Kremlin sites, two adjoining sites totaling 10.25 acres
located in Moscow across the Moscow River from the Kremlin. BrookeMil is
planning the development of a hotel, office, retail and residential
complex on the Kremlin sites. BrookeMil owned 96.8% of one site and 100%
of the other site at September 30, 2000. Western Realty Repin has three
classes of equity: Class A interests, of which $18,750 were outstanding at
September 30, 2000 and are owned by Apollo; Class B interests, of which
$6,250 were outstanding at September 30, 2000 and are owned by New Valley;
and Class C interests, of which Apollo had subscribed for $9,521 ($7,437
funded) and New Valley had subscribed for $5,712 ($4,463 funded) at
September 30, 2000. Apollo and New Valley are entitled to receive on a
pro-rata basis an amount equal to each party's investment in Class C
interests, together with a 20% annual return. After the distributions to
the Class C interests have been made, Apollo will be entitled to a
preference on distributions of cash from Western Realty Repin to the
extent of its investment of $18,750 in Class A interests, together with a
20% annual rate of return. New Valley will then be entitled to a return of
its investment of $6,250 in Class B interests, together with a 20% annual
rate of return. Subsequent distributions will be made 50% to New Valley
and 50% to Apollo. Western Realty Repin is managed by a board of managers
consisting of an equal number of representatives chosen by Apollo and New
Valley. Material corporate transactions by Western Realty Repin generally
require the unanimous consent of the board of managers.
Through September 30, 2000, Western Realty Repin has advanced $36,900 to
BrookeMil, of which $26,188 was funded by Apollo under the loan and was
classified in other long-term liabilities on the consolidated balance
sheet at September 30, 2000. The loan bears no fixed
-12-
<PAGE> 14
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
interest and is payable only out of distributions by the entities owning
the Kremlin sites to BrookeMil. Such distributions 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 BrookeMil. BrookeMil used a portion
of the proceeds of the loan to repay New Valley for certain expenditures
on the Kremlin sites previously incurred. The loan is due and payable upon
the dissolution of BrookeMil and is collateralized by a pledge of New
Valley's shares of BrookeMil.
As of September 30, 2000, BrookeMil had invested $34,669 in the Kremlin
sites and held $1,304 in cash and receivables from an affiliate, which
were restricted for future investment in the Kremlin sites. In connection
with the acquisition of a 34.8% interest in one of the Kremlin sites,
BrookeMil agreed with the City of Moscow to invest an additional $22,000
by May 2000 in the development of the property. In April 2000, Western
Realty Repin arranged short-term financing to fund the investment. Under
the terms of the investment, BrookeMil is required to make additional
construction expenditures of $22,000 on the site by June 2002. Failure to
make the expenditures could result in forfeiture of the 34.8% interest in
the site. Based on the distribution terms contained in the Western Realty
Repin LLC agreement, the 20% annual rate of return preference to be
received by Apollo on funds advanced to Western Realty Repin is treated as
interest cost in the consolidated statement of operations to the extent of
New Valley's net investment in the Kremlin sites. Because BrookeMil's
investment of $35,973 in the Kremlin sites was less than Apollo's
preference of $37,482 in Western Realty Repin at September 30, 2000, the
Company will recognize future interest costs associated with the
participating loan concurrently with future investments by BrookeMil in
the Kremlin sites.
The development of Ducat Place III and the Kremlin sites will require
significant amounts of debt and other financing. New Valley is considering
potential financing alternatives on behalf of Western Realty Development
and BrookeMil. However, in light of the recent economic turmoil in Russia,
there is a risk that financing will not be available on acceptable terms.
Failure to obtain sufficient capital for the projects would force Western
Realty Development and BrookeMil to curtail or delay the planned
development of Ducat Place III and the Kremlin sites.
6. PRO FORMA RESULTS
The following table presents unaudited pro forma results of operations as
if the Philip Morris brand transaction, the sale of Western Tobacco
Investments, New Valley's recapitalization and the sale of five of New
Valley's shopping centers and the Thinking Machines assets had occurred
immediately prior to January 1, 1999. These pro forma results have been
prepared for comparative purposes only and do not purport to be indicative
of what would have occurred had these transactions been consummated as of
such date.
-13-
<PAGE> 15
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Nine Months
Ended Ended
September 30, 2000 September 30, 1999
------------------ ------------------
<S> <C> <C>
Revenues.................................. $ 458,626 $ 324,242
============= =============
Operating income.......................... $ 25,278 $ 34,529
============= =============
Income from continuing operations before
taxes and minority interest............. $ 33,045 $ 37,691
============= =============
Income from continuing operations......... $ 18,213 $ 13,853
============= =============
Income from continuing operations
per common share:
Basic................................. $ 0.78 $ 0.60
============= =============
Diluted............................... $ 0.65 $ 0.47
============= =============
</TABLE>
7. INVESTMENT SECURITIES AVAILABLE FOR SALE
Investment securities classified as available for sale are carried at fair
value, with net unrealized gains included as a component of stockholders'
equity, net of minority interests. The Company had realized gains on sales
of investment securities available for sale of $108 and $6,299 for the
three and nine months ended September 30, 2000.
The components of investment securities available for sale at
September 30, 2000 are as follows:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Fair
Cost Gain Loss Value
------- ---------- ---------- -------
<S> <C> <C> <C> <C>
Marketable equity
securities ............... $34,973 $ 4,301 $ 3,897 $35,377
Marketable debt securities.. 6,100 250 -- 6,350
Marketable warrants ........ -- 3,738 -- 3,738
------- ------- ------- -------
Investment securities ...... $41,073 $ 8,289 $ 3,897 $45,465
======= ======= ======= =======
</TABLE>
-14-
<PAGE> 16
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
8. INVENTORIES
Inventories consist of:
September 30, December 31,
2000 1999
------------- ------------
Leaf tobacco ............................ $ 7,778 $ 13,599
Other raw materials ..................... 1,947 6,423
Work-in-process ......................... 3,721 3,542
Finished goods .......................... 20,829 20,662
Replacement parts and supplies .......... 1,958 4,795
-------- --------
Inventories at current cost ............. 36,233 49,021
LIFO adjustments ........................ (5,392) (3,816)
-------- --------
$ 30,841 $ 45,205
======== ========
At September 30, 2000, the Company had leaf tobacco purchase commitments
of approximately $1,062.
9. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
September 30, December 31,
2000 1999
------------- ------------
Land and improvements .................. $ 1,646 $ 415
Buildings .............................. 14,649 51,773
Machinery and equipment ................ 70,175 129,693
Construction-in-progress ............... 1,576 14,605
--------- ---------
88,046 196,486
Less accumulated depreciation .......... (40,484) (42,226)
--------- ---------
$ 47,562 $ 154,260
========= =========
10. LONG-TERM INVESTMENTS
At September 30, 2000, long-term investments consisted primarily of
investments in limited partnerships of $4,133. The Company believes the
fair value of the limited partnerships exceeds their carrying amount by
approximately $5,736 based on the indicated market values of the
underlying investment portfolio provided by the partnerships. 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. The Company's investments in
limited partnerships are illiquid, and the ultimate realization of these
investments is subject to the performance of the underlying partnership
and its management by the general partners.
-15-
<PAGE> 17
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Also included in long-term investments are investments in various
Internet-related businesses which are carried at $2,373 at September 30,
2000. The Company accounts for its investment in one of the internet
companies under the equity method.
11. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
BGLS:
15.75% Series B Senior Secured Notes due 2001,
net of unamortized discount of $5,468 .............. -- $ 82,602
Deferred interest on 15.75% Series B Senior Secured
Notes due 2001 ..................................... -- 25,435
New Valley:
Notes payable ............................................ 19,603 19,813
Liggett:
Revolving credit facility ................................ 18,709 --
Term loan under credit facility .......................... 4,500 5,040
Equipment Loans .......................................... 5,936 4,232
Brooke (Overseas):
Foreign credit facilities ................................ -- 29,470
Notes payable ............................................ -- 23,090
Other .................................................... 703 214
--------- ---------
Total notes payable, long-term debt
and other obligations .................................. 49,451 189,896
Less:
Current maturities ................................. (10,469) (41,547)
--------- ---------
Amount due after one year ................................ $ 38,982 $ 148,349
========= =========
</TABLE>
15.75% Series B Senior Secured Notes Due 2001 - BGLS:
-----------------------------------------------------
During 1999, BGLS repurchased $144,794 principal amount of its Notes,
together with accrued interest thereon. The purchases were funded
primarily with proceeds from the Philip Morris brand transaction which
closed on May 24, 1999. In January 2000, BGLS repurchased an additional
$5,500 principal amount of the Notes, together with accrued interest
thereon. In connection with the sale of Western Tobacco Investments on
August 4, 2000, BGLS repurchased a portion of the Notes and redeemed the
remaining Notes on September 5, 2000. (Refer to Note 2.)
Revolving Credit Facility - Liggett:
-----------------------------------
Liggett has a $35,000 credit facility, under which $18,709 was outstanding
at September 30, 2000. Availability under the credit facility was
approximately $8,262 based on eligible collateral at September 30, 2000.
The facility is collateralized by all inventories and receivables of
Liggett. Borrowings under the facility, whose interest is calculated at a
rate equal to 1.0%
-16-
<PAGE> 18
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
above First Union's (the indirect parent of Congress Financial
Corporation, the lead lender) prime rate. The facility's interest rate was
10.5% at September 30, 2000. The facility requires Liggett's compliance
with certain financial and other covenants including a restriction on the
payment of cash dividends unless Liggett's borrowing availability under
the facility for the 30-day period prior to the payment of the dividend,
and after giving effect to the dividend, is at least $5,000. In addition,
the facility, as amended, imposes requirements with respect to Liggett's
adjusted net worth (not to fall below $8,000 as computed in accordance
with the agreement) and working capital (not to fall below a deficit of
$17,000 as computed in accordance with the agreement). At September 30,
2000, Liggett was in compliance with all covenants under the credit
facility; Liggett's adjusted net worth was $14,323 and net working capital
was $23,630, as computed in accordance with the agreement. The facility
expires on March 8, 2003 subject to automatic renewal for an additional
year unless a notice of termination is given by the lender at least 60
days prior to the anniversary date.
In November 1999, 100 Maple Lane LLC, a new company formed by Liggett to
purchase an industrial facility in Mebane, North Carolina, borrowed $5,040
from the lender under Liggett's credit facility. The loan is payable in 59
monthly installments of $60 including annual interest at 1% above the
prime rate with a final payment of $1,500. Liggett has guaranteed the
loan, and a first mortgage on the Mebane property collateralizes the Maple
Lane loan and Liggett's credit facility. Liggett completed the relocation
of its manufacturing operations to this facility in October 2000.
Equipment Loans - Liggett:
-------------------------
In January 1999, Liggett purchased equipment for $5,750 and borrowed
$4,500 to fund the purchase. The loan, which is collateralized by the
equipment and guaranteed by BGLS and the Company, is payable in 60 monthly
installments of $56 including annual interest of 7.67% with a final
payment of $2,550. In March 2000, Liggett purchased equipment for $1,000
under a capital lease which is payable in 60 monthly installments of $21
with an effective annual interest rate of 10.14%. In April 2000, Liggett
purchased equipment for $1,071 under two capital leases which are payable
in 60 monthly installments of $22 with an effective interest rate of
10.20%.
Notes Payable - New Valley:
--------------------------
During the third quarter 1999, New Valley refinanced its notes payable on
its two remaining shopping centers in Florida and West Virginia for
$19,674 in the aggregate. Interest rates range from 7.5% to 9.03% per
annum. The four notes are due between 2002 and 2024.
Notes Payable and Foreign Credit Facilities - Western Tobacco Investments
-------------------------------------------------------------------------
and Liggett-Ducat:
-----------------
In connection with the sale of Western Tobacco Investments on August 4,
2000, all of the credit facilities, notes payable and other obligations of
Western Tobacco Investments and Liggett-Ducat were assumed by the
purchaser.
12. EQUITY
During September 2000, three new employees were awarded a total of 157,500
options to purchase shares of common stock at prices ranging from $18.51
to $18.63, the fair market value on the dates of grant, under the
Company's 1998 Long-Term Incentive Plan.
-17-
<PAGE> 19
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
During August and September 2000, 2,362,947 warrants, exercisable at $.10
per share and 215,019 options exercisable at $5.44 per share were
exercised for cash and the surrender of 107,409 warrants and options.
13. CONTINGENCIES
Smoking-Related Litigation:
--------------------------
OVERVIEW. Since 1954, Liggett and other United States cigarette
manufacturers have been named as defendants in numerous direct and
third-party actions predicated on the theory that cigarette manufacturers
should be liable for damages alleged to have been caused by cigarette
smoking or by exposure to secondary smoke from cigarettes. These cases are
reported here as though having been commenced against Liggett (without
regard to whether such cases were actually commenced against Brooke Group
Holding, the Company's predecessor and a wholly-owned subsidiary of BGLS,
or Liggett). There has been a noteworthy increase in the number of cases
commenced against Liggett and the other cigarette manufacturers in recent
years. The cases generally fall into the following categories: (i) smoking
and health cases alleging injury brought on behalf of individual
plaintiffs ("Individual Actions"); (ii) smoking and health cases alleging
injury and purporting to be brought on behalf of a class of individual
plaintiffs ("Class Actions"); (iii) health care cost recovery actions
brought by various governmental entities ("Governmental Actions"); and
(iv) health care cost recovery actions brought by third-party payors
including insurance companies, union health and welfare trust funds,
asbestos manufacturers and others ("Third-Party Payor Actions"). As new
cases are commenced, defense costs and the risks attendant to the inherent
unpredictability of litigation continue to increase. The future financial
impact of the risks and expenses of litigation and the effects of the
tobacco litigation settlements discussed below is not quantifiable at this
time. For the nine months ended September 30, 2000, Liggett incurred
counsel fees and costs totaling approximately $4,342 compared to $4,210
for the comparable prior year period.
INDIVIDUAL ACTIONS. As of September 30, 2000, there were approximately 285
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 secondary
smoke and seek compensatory and, in some cases, punitive damages. Of
these, 66 were pending in Florida, 91 in New York, 13 in Massachusetts, 13
in Texas and 19 in California. The balance of the individual cases were
pending in 29 states. There are five individual cases pending where
Liggett is the only named defendant. In addition to these cases, during
the third quarter of 2000, an action against cigarette manufacturers
involving hundreds of named individual plaintiffs has been consolidated
before a single West Virginia state court. Liggett is a defendant in most
of the cases pending in West Virginia.
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence,
gross negligence, breach of special duty, strict liability, fraud,
misrepresentation, design defect, failure to warn, breach of express and
implied warranties, conspiracy, aiding and abetting, concert of action,
unjust enrichment, common law public nuisance, property damage, invasion
of privacy, mental anguish, emotional distress, disability, shock,
indemnity and violations of deceptive trade practice laws, the Federal
Racketeer Influenced and Corrupt Organization Act ("RICO"), state RICO
statutes and antitrust statutes.
-18-
<PAGE> 20
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
In many of these cases, in addition to compensatory damages, plaintiffs
also seek other forms of relief including, treble/multiple damages,
disgorgement of profits and punitive damages. Defenses raised by
defendants in these cases include lack of proximate cause, assumption of
the risk, comparative fault and/or contributory negligence, lack of design
defect, statute of limitations, equitable defenses such as "unclean hands"
and lack of benefit, failure to state a claim and federal preemption.
Jury awards in three states have been entered against other companies in
the tobacco industry. The awards in these individual actions are for both
compensatory and punitive damages and represent a material amount of
damages. In each case, both the verdict and damage awards are being
appealed by the defendants.
CLASS ACTIONS. As of September 30, 2000, there were approximately 41
actions pending, for which either a class has been certified or plaintiffs
are seeking class certification, where Liggett, among others, was a named
defendant. Many of these actions purport to constitute statewide class
actions and were filed after May 1996 when the Fifth Circuit Court of
Appeals, in the CASTANO case (discussed below), reversed a Federal
district court's certification of a purported nationwide class action on
behalf of persons who were allegedly "addicted" to tobacco products.
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. 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 were 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 smoking-related class
action litigation is still uncertain. The CASTANO decision has had a
limited effect with respect to courts' decisions regarding narrower
smoking-related classes or class actions brought in state rather than
federal court. For example, since the Fifth Circuit's ruling, a court in
Louisiana (Liggett is not a defendant in this proceeding) has certified
"addiction-as-injury" class actions that covered only citizens in those
states. Two other class actions, BROIN and ENGLE, were certified in state
court in Florida prior to the Fifth Circuit's decision.
-19-
<PAGE> 21
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
In May 1994, an action entitled ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO
COMPANY, ET AL., Circuit Court, Eleventh Judicial Circuit, Dade County,
Florida, was filed against Liggett and others. The class consists of all
Florida residents and citizens, and their survivors, who have suffered,
presently suffer or have died from diseases and medical conditions caused
by their addiction to cigarettes that contain nicotine. Phase I of the
trial commenced in July 1998 and in July 1999, the jury returned the Phase
I verdict. The Phase I verdict concerned certain issues determined by the
trial court to be "common" to the causes of action of the plaintiff class.
Among other things, the jury found that: smoking cigarettes causes 20
diseases or medical conditions, cigarettes are addictive or dependence
producing, defective and unreasonably dangerous, defendants made
materially false statements with the intention of misleading smokers,
defendants concealed or omitted material information concerning the health
effects and/or the addictive nature of smoking cigarettes and agreed to
misrepresent and conceal the health effects and/or the addictive nature of
smoking cigarettes, and defendants were negligent and engaged in extreme
and outrageous conduct or acted with reckless disregard with the intent to
inflict emotional distress. The jury also found that defendants' conduct
"rose to a level that would permit a potential award or entitlement to
punitive damages." The court decided that Phase II of the trial, which
commenced November 1999, would be a causation and damages trial for three
of the class representatives and a punitive damages trial on a class-wide
basis, before the same jury that returned the verdict in Phase I. On April
7, 2000, the jury awarded compensatory damages of $12,704 to the three
plaintiffs, to be reduced in proportion to the respective plaintiff's
fault. The jury also decided that the claim of one of the plaintiffs, who
was awarded compensatory damages of $5,831, was not timely filed. On July
14, 2000, the jury awarded approximately $145,000,000 in the punitive
damages portion of Phase II against all defendants including $790,000
against Liggett. The court entered a final order of judgment against the
defendants on November 6, 2000. The court's final judgment also denied
various of defendants' post-trial motions, which included a motion for new
trial and a motion seeking reduction of the punitive damages award.
Liggett intends to pursue all available post-trial and appellate remedies.
If this verdict is not eventually reversed on appeal, or substantially
reduced by the court, it could have a material adverse effect on the
Company. Phase III of the trial will be conducted before separate juries
to address absent class members' claims, including issues of specific
causation and other individual issues regarding entitlement to
compensatory damages.
On July 14, 2000, the Southeastern Iron Workers Union filed a motion to
intervene in the ENGLE case, seeking to protect its members' subrogation
rights under the federal Employment Retirement Income Security Act. Based
on the federal question raised in that motion, defendants removed the case
to federal court in Miami on July 24, 2000. On November 3, 2000, the
federal court returned the case to the state court on procedural grounds.
Now that the ENGLE jury has awarded punitive damages and final judgment
has been entered, it is unclear how the state court's order regarding the
determination of punitive damages will be implemented. The order provides
that the punitive damage amount should be standard as to each class member
and acknowledges that the actual size of the class will not be known until
the last case has withstood appeal. The order does not address whether
defendants will be required to pay the punitive damage award prior to a
determination of claims of all class members, a process that could take
years to conclude. Recently, legislation has been enacted in Florida that
limits the size of any bond required, pending appeal, to stay execution of
a punitive damages verdict to the lesser of the punitive award plus twice
the statutory rate of interest, $100,000 or 10% of the net worth of the
defendant, but the limitation on the bond does not affect the amount of
the underlying verdict. Liggett has filed the $3,450
-20-
<PAGE> 22
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
bond required by the Florida law in order to stay execution of the ENGLE
judgment. Although the legislation is intended to apply to the ENGLE case,
management cannot predict the outcome of any possible challenges to the
application or constitutionality of this legislation. Similar legislation
has been enacted in Georgia, Kentucky, North Carolina and Virginia.
Class certification motions are pending in a number of putative class
actions. Classes remain certified against Liggett in Florida (ENGLE). A
number of class certification denials are on appeal.
Approximately 38 purported state and federal class action complaints have
been filed against the cigarette manufacturers for alleged antitrust
violations. The actions allege that the cigarette manufacturers have
engaged in a nationwide and international conspiracy to fix the price of
cigarettes in violation of state and federal antitrust laws. Plaintiffs
allege that defendants' price-fixing conspiracy raised the price of
cigarettes above a competitive level. Plaintiffs in the 31 state actions
purport to represent classes of indirect purchasers of cigarettes in each
of the states; plaintiffs in the seven federal actions purport to
represent a nationwide class of wholesalers who purchased cigarettes
directly from the defendants. The federal actions have been consolidated
and, on July 28, 2000, plaintiffs in the federal consolidated action filed
a single consolidated complaint that did not name Liggett or Brooke Group
Holding as defendants. Fourteen California actions have been consolidated
and the consolidated complaint did not name Liggett or Brooke Group
Holding as defendants. In Nevada, an amended complaint was filed that did
not name Liggett or Brooke Group Holding as defendants.
Liggett and plaintiffs have advised the court, in SIMON V. PHILIP MORRIS
ET AL., a putative nationwide smokers class action, that Liggett and the
plaintiffs have engaged in preliminary settlement discussions. There are
no assurances that any settlement will be reached or that the class will
ultimately be certified.
GOVERNMENTAL ACTIONS. As of September 30, 2000, there were approximately
26 Governmental Actions pending against Liggett. In these proceedings,
both foreign and domestic governmental entities seek reimbursement for
Medicaid and other health care expenditures. The claims asserted in these
health care cost recovery actions vary. In most of these cases, plaintiffs
assert the equitable claim that the tobacco industry was "unjustly
enriched" by plaintiffs' payment of health care costs allegedly
attributable to smoking and seek reimbursement of those costs. Other
claims made by some but not all plaintiffs include the equitable claim of
indemnity, common law claims of negligence, strict liability, breach of
express and implied warranty, breach of special duty, fraud, negligent
misrepresentation, conspiracy, public nuisance, claims under state and
federal statutes governing consumer fraud, antitrust, deceptive trade
practices and false advertising, and claims under RICO.
THIRD-PARTY PAYOR ACTIONS. As of September 30, 2000, there were
approximately 56 Third-Party Payor Actions pending against Liggett. The
claims in these cases are similar to those in the Governmental Actions but
have been commenced by insurance companies, union health and welfare trust
funds, asbestos manufacturers and others. Seven United States Circuit
Courts of Appeal have ruled that Third-Party Payors did not have standing
to bring lawsuits against the tobacco companies. In January 2000, the
United States Supreme Court denied
-21-
<PAGE> 23
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
petitions for certiorari filed by several of the union health and welfare
trust funds. However, a number of Third-Party Payor Actions, including an
action brought by 24 Blue Cross/Blue Shield Plans, remain pending.
In other Third-Party Payor Actions claimants have set forth several
additional theories of relief sought: funding of corrective public
education campaigns relating to issues of smoking and health; funding for
clinical smoking cessation programs; disgorgement of profits from sales of
cigarettes; restitution; treble damages; and attorneys' fees.
Nevertheless, no specific amounts are provided. It is understood that
requested damages against the tobacco company defendants in these cases
might be in the billions of dollars.
FEDERAL GOVERNMENT ACTION. In September 1999, the United States government
commenced litigation against Liggett and the other tobacco companies in
the United States District Court for the District of Columbia. The action
seeks to recover an unspecified amount of health care costs paid for and
furnished, and to be paid for and furnished, by the Federal Government for
lung cancer, heart disease, emphysema and other smoking-related illnesses
allegedly caused by the fraudulent and tortious conduct of defendants, and
to restrain defendants and co-conspirators from engaging in fraud and
other unlawful conduct in the future, and to compel defendants to disgorge
the proceeds of their unlawful conduct. The complaint alleges that such
costs total more than $20,000,000 annually. The action asserts claims
under three federal statutes, the Medical Care Recovery Act ("MCRA"), the
Medicare Secondary Payer provisions of the Social Security Act ("MSP") and
RICO. In December 1999, Liggett filed a motion to dismiss the lawsuit on
numerous grounds, including that the statutes invoked by the government do
not provide the basis for the relief sought. In a September 2000 ruling,
the court dismissed the government's claims based on MCRA and MSP, on the
ground, among others, that these statutes do not provide a basis for the
relief sought. The government filed a motion seeking the court's
reconsideration of this ruling, which remains pending. In the September
2000 ruling, the court also determined not to dismiss the government's
claims based on RICO, under which the government continues to seek court
relief to restrain the defendant tobacco companies from allegedly engaging
in fraud and other unlawful conduct and to compel disgorgement. This
action is now moving into the discovery phase.
SETTLEMENTS. In March 1996, Brooke Group Holding and Liggett entered into
an agreement, subject to court approval, to settle the CASTANO class
action tobacco litigation. The CASTANO class was subsequently decertified
by the court.
In March 1996, March 1997 and March 1998, Brooke Group Holding and Liggett
entered into settlements of smoking-related litigation with the Attorneys
General of 45 states and territories. The settlements released both Brooke
Group Holding and Liggett from all smoking-related claims, including
claims for health care cost reimbursement and claims concerning sales of
cigarettes to minors.
In November 1998, Philip Morris, Brown & Williamson Tobacco Corporation,
R.J. Reynolds Tobacco Company and Lorillard Tobacco Company (collectively,
the "Original Participating Manufacturers" or "OPMs") and Liggett
(together with the OPMs and any other tobacco product manufacturer that
becomes a signatory, the "Participating Manufacturers") entered into the
Master Settlement Agreement (the "MSA") with 46 states, the District of
Columbia, Puerto
-22-
<PAGE> 24
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Rico, Guam, the United States Virgin Islands, American Samoa and the
Northern Marianas (collectively, the "Settling States") to settle the
asserted and unasserted health care cost recovery and certain other claims
of those Settling States.
The MSA has been initially approved by trial courts in all Settling
States. The MSA is subject to final judicial approval in each of the
Settling States, which approval has been obtained in all jurisdictions
except for Missouri and Arkansas. If final judicial approval is not
obtained in a jurisdiction by December 31, 2001, then, unless the settling
defendants and the relevant jurisdiction agree otherwise, the MSA will be
terminated with respect to such jurisdiction.
The MSA restricts tobacco product advertising and marketing within the
Settling States and otherwise restricts the activities of Participating
Manufacturers. Among other things, the MSA prohibits the targeting of
youth in the advertising, promotion or marketing of tobacco products; bans
the use of cartoon characters in all tobacco advertising and promotion;
limits each Participating Manufacturer to one tobacco brand name
sponsorship during any 12-month period; bans all outdoor advertising, with
the exception of signs 14 square feet or less in dimension at retail
establishments that sell tobacco products; prohibits payments for tobacco
product placement in various media; bans gift offers based on the purchase
of tobacco products without sufficient proof that the intended recipient
is an adult; prohibits Participating Manufacturers from licensing third
parties to advertise tobacco brand names in any manner prohibited under
the MSA; prohibits Participating Manufacturers from using as a tobacco
product brand name any nationally recognized non-tobacco brand or trade
name or the names of sports teams, entertainment groups or individual
celebrities; and prohibits Participating Manufacturers from selling packs
containing fewer than twenty cigarettes.
The MSA also requires Participating Manufacturers to affirm corporate
principles to comply with the MSA and to reduce underage usage of tobacco
products and imposes requirements applicable to lobbying activities
conducted on behalf of Participating Manufacturers.
Liggett has no payment obligations under the MSA unless its market share
exceeds a base share of 125% of its 1997 market share, or approximately
1.65% of total cigarettes sold in the United States. Liggett believes,
based on published industry sources, that its domestic shipments accounted
for 1.2% of the total cigarettes shipped in the United States during 1999.
In the year following any year in which Liggett's market share does exceed
the base share, Liggett will pay on each excess unit an amount equal (on a
per-unit basis) to that paid during such following year by the OPMs under
the annual and strategic contribution payment provisions of the MSA,
subject to applicable adjustments, offsets and reductions. Under the
annual and strategic contribution payment provisions of the MSA, the OPMs
(and Liggett to the extent its market share exceeds the base share) will
pay the following annual amounts (subject to certain adjustments):
-23-
<PAGE> 25
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
YEAR AMOUNT
---- ------
2000 $4,500,000
2001 $5,000,000
2002 - 2003 $6,500,000
2004 - 2007 $8,000,000
2008 - 2017 $8,139,000
2018 and each $9,000,000
year thereafter
These annual payments will be allocated based on relative unit volume of
domestic cigarette shipments. The payment obligations under the MSA are
the several, and not joint, obligations of each Participating Manufacturer
and are not the responsibility of any parent or affiliate of a
Participating Manufacturer.
The MSA replaces Liggett's prior settlements with all states and
territories except for Florida, Mississippi, Texas and Minnesota. In the
event the MSA does not receive final judicial approval in any state or
territory, Liggett's prior settlement with that state or territory, if
any, will be revived.
The states of Florida, Mississippi, Texas and Minnesota, prior to the
effective date of the MSA, negotiated and executed settlement agreements
with each of the other major tobacco companies separate from those
settlements reached previously with Liggett. Because these states'
settlement agreements with Liggett provided for "most favored nation"
protection for both Brooke Group Holding and Liggett, the payments due
these states by Liggett (with certain possible exceptions) have been
eliminated. With respect to all non-economic obligations under the
previous settlements, both Brooke Group Holding and Liggett are entitled
to the most favorable provisions as between the MSA and each state's
respective settlement with the other major tobacco companies. Therefore,
Liggett's non-economic obligations to all states and territories are now
defined by the MSA.
In April 1999, a putative class action was filed on behalf of all firms
that directly buy cigarettes in the United States from defendant tobacco
manufacturers. The complaint alleges violation of antitrust law, based in
part on the MSA. Plaintiffs seek treble damages computed as three times
the difference between current prices and the price plaintiffs would have
paid for cigarettes in the absence of an alleged conspiracy to restrain
and monopolize trade in the domestic cigarette market, together with
attorneys' fees. Plaintiffs also seek injunctive relief against certain
aspects of the MSA.
In March 1997, Liggett, Brooke Group Holding and a nationwide class of
individuals that allege smoking-related claims 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. In July 1998, Liggett, Brooke Group Holding and plaintiffs filed an
amended class action settlement agreement in FLETCHER which agreement was
preliminarily approved by the court in December 1998. In July 1999, the
court denied approval of the FLETCHER class action settlement. The
parties' motion for reconsideration is still pending.
-24-
<PAGE> 26
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
The Company accrued $16,902 for the present value of the fixed payments
under the March 1998 Attorneys General settlements. As a result of the
Company's treatment under the MSA, $14,928 of net charges accrued for the
prior settlements were reversed in 1998 and $1,051 were reversed in 1999.
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. Cases currently scheduled for trial in 2000 include an action
brought by an asbestos company trust in federal court in New York
(November). An individual action, APOSTOLOU, is scheduled to be tried in
state court in New York in November. A class action seeking medical
monitoring relief for asymptomatic smokers in West Virginia is scheduled
for trial in state court in December. Trial dates, however, are subject to
change.
Management is not able to predict the outcome of the litigation pending
against Brooke Group Holding or Liggett. Litigation is subject to many
uncertainties. An unfavorable verdict was returned in the first phase of
the ENGLE smoking and health class action trial pending in Florida.
Recently, the jury awarded $790,000 in punitive damages against Liggett in
the second phase of the trial, and the court has entered an order of final
judgment. Liggett intends to pursue all available post-trial and appellate
remedies. If this verdict is not eventually reversed on appeal, or
substantially reduced by the court, it could have a material adverse
effect on the Company. Liggett has filed the $3,450 bond required under
recent Florida legislation which limits the size of any bond required,
pending appeal, to stay execution of a punitive damages verdict. Although
the legislation is intended to apply to the ENGLE case, management cannot
predict the outcome of any possible challenges to the application or
constitutionality of this legislation. It is possible that additional
cases could be decided unfavorably and that there could be further adverse
developments in the ENGLE case. Management cannot predict the cash
requirements related to any future settlements and judgments, including
cash required to bond any appeals, and there is a risk that those
requirements will not be able to be met. An unfavorable outcome of a
pending smoking and health case could encourage the commencement of
additional similar litigation. Management is unable to make a meaningful
estimate with respect to the amount or range of loss that could result
from an unfavorable outcome of the cases pending against Brooke Group
Holding or Liggett or the costs of defending such cases. The complaints
filed in these cases rarely detail alleged damages. Typically, the claims
set forth in an individual's complaint against the tobacco industry pray
for money damages in an amount to be determined by a jury, plus punitive
damages and costs. These damage claims are typically stated as being for
the minimum necessary to invoke the jurisdiction of the court.
It is possible that the Company's consolidated financial position, results
of operations or cash flows could be materially adversely affected by an
unfavorable outcome in any such smoking-related litigation.
Liggett's management is unaware of any material environmental conditions
affecting its existing facilities. Liggett's management believes that
current operations are conducted in material compliance with all
environmental laws and regulations and other laws and regulations
governing cigarette manufacturers. Compliance with federal, state and
local
-25-
<PAGE> 27
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
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 and certain of its consolidated subsidiaries unrelated to
smoking or tobacco product liability. Management is of the opinion that
the liabilities, if any, ultimately resulting from such other proceedings,
lawsuits and claims should not materially affect the Company's financial
position, results of operations or cash flows.
Legislation and Regulation:
--------------------------
In 1993, the Environmental Protection Agency ("EPA") released a report on
the respiratory effect of secondary smoke which concludes that secondary
smoke is a known human lung carcinogen in adults and in children, causes
increased respiratory tract disease and middle ear disorders and increases
the severity and frequency of asthma. In June 1993, the two largest of the
major domestic cigarette manufacturers, together with other segments of
the tobacco and distribution industries, commenced a lawsuit against the
EPA seeking a determination that the EPA did not have the statutory
authority to regulate secondary smoke, and that given the current body of
scientific evidence and the EPA's failure to follow its own guidelines in
making the determination, the EPA's classification of secondary smoke was
arbitrary and capricious. Whatever the outcome of this litigation,
issuance of the report may encourage efforts to limit smoking in public
areas. In July 1998, a federal district court vacated those sections of
the report relating to lung cancer, finding that the EPA may have reached
different conclusions had it complied with relevant statutory
requirements. The federal government has appealed the court's ruling.
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 Food and Drug Administration (the "FDA") filed in the
Federal Register a Final Rule classifying tobacco as a "drug" or "medical
device", asserting jurisdiction over the manufacture and marketing of
tobacco products and imposing restrictions on the sale, advertising and
promotion of tobacco products. Litigation was commenced challenging the
legal authority of the FDA to assert such jurisdiction, as well as
challenging the constitutionality of the rules. On March 21, 2000, the
United States Supreme Court ruled that the FDA does not have the power to
regulate tobacco. Liggett supported the FDA Rule and began to phase in
compliance with certain of the proposed FDA regulations.
-26-
<PAGE> 28
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
In August 1996, Massachusetts enacted legislation requiring tobacco
companies to publish information regarding the ingredients in cigarettes
and other tobacco products sold in that state. In December 1997, the
United States District Court for the District of Massachusetts enjoined
this legislation from going into effect on the grounds that it is
preempted by federal law. In November 1999, the First Circuit affirmed
this ruling. Notwithstanding the foregoing, in December 1997, Liggett
began complying with this legislation by providing ingredient information
to the Massachusetts Department of Public Health. Several other states
have enacted, or are considering, legislation similar to that enacted in
Massachusetts.
As part of the 1997 budget agreement approved by Congress, federal excise
taxes on a pack of cigarettes, which are currently 34 cents, were
increased at the beginning of 2000 and will rise 5 cents more in the year
2002. In general, excise taxes and other taxes on cigarettes have been
increasing. These taxes vary considerably and, when combined with sales
taxes and the current federal excise tax, may be as high as $1.66 per pack
in a given locality in the United States. Congress has been considering
significant increases in the federal excise tax or other payments from
tobacco manufacturers, and the Clinton Administration's fiscal year 2001
budget proposal included an additional increase of $.25 per pack in the
federal excise tax, as well as a contingent special assessment related to
youth smoking rates. Increases in other cigarette-related taxes have been
proposed at the state and local level.
In June 2000, the New York state legislature passed legislation charging
the state's Office of Fire Prevention and Control with developing
standards for "fire safe" or self-extinguishing cigarettes. The OFPC has
until July 1, 2002 to issue final regulations. Six months from the
issuance of the standards, but no later than January 1, 2003, all
cigarettes offered for sale in New York state will be required to be
manufactured to those standards. Similar legislation is being considered
by other state legislatures.
In addition to the foregoing, there have been a number of other
restrictive regulatory actions, adverse legislative and political
decisions and other unfavorable developments concerning cigarette smoking
and the tobacco industry, the effects of which, at this time, management
is not able to evaluate. These developments may negatively affect the
perception of potential triers of fact with respect to the tobacco
industry, possibly to the detriment of certain pending litigation, and may
prompt the commencement of additional similar litigation.
Other Matters:
-------------
In March 1997, a stockholder derivative suit was filed in Delaware
Chancery Court against New Valley, as a nominal defendant, its directors
and Brooke Group Holding by a stockholder of New Valley. The suit alleges
that New Valley's purchase of the BrookeMil shares from Brooke (Overseas)
in January 1997 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,
Brooke Group Holding aided and abetted such breaches and such parties are
therefore liable to New Valley, and (ii) unspecified damages to be awarded
to New Valley. In December 1999, another stockholder of New Valley
commenced an action in Delaware Chancery Court substantially similar to
the March 1997 action. This stockholder alleges, among other things, that
the consideration paid by New
-27-
<PAGE> 29
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
Valley for the BrookeMil shares was excessive, unfair and wasteful, that
the special committee of New Valley's board lacked independence, and that
the appraisal by the independent appraisal firm and the fairness opinion
by the independent investment bank were flawed. Brooke Group Holding and
New Valley believe that the allegations in both cases are without merit.
By order of the court, both actions were consolidated. Brooke Group
Holding and New Valley recently filed a motion to dismiss the consolidated
action. Oral argument is scheduled for November 30, 2000. Although there
can be no assurances, Brooke Group Holding and New Valley believe, after
consultation with counsel, that the ultimate resolution of this matter
will not have a material adverse effect on the Company's or New Valley's
consolidated financial position, results of operations or cash flows.
In July 1999, a purported class action was commenced on behalf of New
Valley's former Class B preferred shareholders against New Valley, Brooke
Group Holding and certain directors and officers of New Valley in Delaware
Chancery Court. The complaint alleges that the recapitalization, approved
by a majority of each class of New Valley's stockholders in May 1999, was
fundamentally unfair to the Class B preferred shareholders, the proxy
statement relating to the recapitalization was materially deficient and
the defendants breached their fiduciary duties to the Class B preferred
shareholders in approving the transaction. The plaintiffs seek class
certification of the action and an award of unspecified compensatory
damages as well as all costs and fees. Brooke Group Holding and New Valley
believe that the allegations are without merit. The Court, on the
defendants' motion, recently dismissed six of plaintiff's nine claims
alleging inadequate disclosure in the proxy statement. The surviving
claims are plaintiff's allegations that (i) the fact that the fairness
opinion did not cover the relative fairness to each class of shares should
have been expressly disclosed; (ii) failure to disclose the identity of
shareholders who suggested the recapitalization and their respective
holdings, broken down by share class, was a material omission; and (iii)
the disclosure in the proxy statement was inadequate because it did not
reveal the value of the Company's lines of business or its assets. The
Court speculated that facts might exist under which one or more of the
foregoing alleged non-disclosures might be material and, therefore, the
motion to dismiss as to these three allegations was denied. An answer has
been filed as to the surviving claims. Although there can be no
assurances, Brooke Group Holding and New Valley believe, after
consultation with counsel, that the ultimate resolution of this matter
will not have a material adverse effect on the Company's or New Valley's
consolidated financial position, results of operations or cash flows.
In October 1999, an action was commenced against a subsidiary of Brooke
Group Holding in the Supreme Court of the State of New York, County of New
York. The complaint alleged that under the terms of a 1993 Put Agreement,
Brooke Group Holding's subsidiary was obligated to purchase certain shares
of plaintiff's stock for $7,500. In addition, the complaint sought
prejudgment interest in the amount of approximately $4,000. In September
2000, the litigation was settled for $6,100 and the Company recorded a
gain of $1,400 based on the prior reserves for the matter.
-28-
<PAGE> 30
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
As of September 30, 2000, New Valley had $11,915 of prepetition
bankruptcy-related claims and restructuring accruals including claims for
lease rejection damages and for unclaimed monies that certain states are
seeking on behalf of money transfer customers. The remaining claims may be
subject to future adjustments based on potential settlements or decisions
of the court.
New Valley is a defendant in various lawsuits and may be subject to
unasserted claims primarily concerning its activities as a securities
broker-dealer and its 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 or New Valley's
consolidated financial position, results of operations or cash flows.
-29-
<PAGE> 31
VECTOR GROUP LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
(UNAUDITED)
14. SEGMENT INFORMATION
Financial information for the Company's continuing operations before taxes
and minority interest for the three and nine months ended September 30,
2000 and 1999 follows:
<TABLE>
<CAPTION>
United
States Russian Broker- Real Corporate
Tobacco Tobacco Dealer Estate and Other Total
------- ------- ------ --------- --------- -----
<S> <C> <C> <C> <C> <C> <C>
THREE MONTHS ENDED SEPT. 30, 2000:
---------------------------------
Revenues ......................... $ 149,190 $ 17,933 $ 13,009 $ 778 $ -- $ 180,910
Operating income ................. 24,878 55 80 (1,114) (16,547) 7,352
Depreciation and amortization .... 1,156 1,254 210 147 8 2,775
THREE MONTHS ENDED SEPT. 30, 1999:
---------------------------------
Revenues ......................... 108,676 27,256 12,711 1,576 -- 150,219
Operating income (loss) .......... 19,689 4,262 (2,424) 1,683 (3,848) 19,362
Depreciation and amortization .... 747 1,649 244 450 12 3,102
NINE MONTHS ENDED SEPT. 30, 2000:
--------------------------------
Revenues ......................... 394,652 107,263 61,605 2,369 -- 565,889
Operating income (loss) .......... 49,568 1,998 5,126 (5,210) (24,207) 27,275
Identifiable assets .............. 108,979 -- 49,051 59,195 226,675 443,900
Depreciation and amortization .... 3,162 5,895 647 679 25 10,408
Capital expenditures ............. 11,902 14,394 340 2,668 -- 29,304
NINE MONTHS ENDED SEPT. 30, 1999:
--------------------------------
Revenues ......................... 288,649 64,945 18,587 2,330 -- 374,511
Operating income (loss) .......... 55,904 4,830 (2,531) 1,312 (4,397) 55,118
Identifiable assets .............. 107,785 135,268 39,841 59,872 166,548 509,314
Depreciation and amortization .... 2,567 2,921 144 863 8 6,503
Capital expenditures ............. 8,084 35,915 -- -- 373 44,372
</TABLE>
-----------------
*Broker-Dealer, Real Estate and New Valley's portion of Corporate and
Other are included for the month ended June 30, 1999 when New Valley
became a consolidated subsidiary of the Company. Russian tobacco is
included through July 31, 2000. Western Tobacco Investments was sold on
August 4, 2000. (Refer to Note 2.)
-30-
<PAGE> 32
ITEM 2. 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 Vector Group Ltd. (the
"Company") and its subsidiaries and should be read in conjunction with the
Consolidated Financial Statements and notes thereto of the Company included
elsewhere in this document. The consolidated financial statements include the
accounts of BGLS Inc. ("BGLS"), Liggett Group Inc. ("Liggett"), Brooke
(Overseas) Ltd. ("Brooke (Overseas)"), through July 31, 2000 Liggett-Ducat Ltd.
("Liggett-Ducat") and other less significant subsidiaries. As of June 1, 1999,
New Valley Corporation ("New Valley") became a consolidated subsidiary of the
Company as a result of New Valley's recapitalization in which the Company's
interest in New Valley's common shares increased to 55.1%. New Valley's stock
repurchase program, which began in late 1999, increased the Company's interest
to 56.1% at September 30, 2000.
The Company is a holding company for a number of businesses. It is
engaged principally in the manufacture and sale of cigarettes in the United
States through its subsidiary Liggett and in the investment banking and
brokerage business in the United States and real estate operations in Russia
through its majority-owned subsidiary New Valley. Prior to the sale of Western
Tobacco Investments on August 4, 2000, the Company was engaged in the
manufacture and sale of cigarettes in Russia through Liggett-Ducat.
At the Company's annual meeting held on May 24, 2000, stockholders
approved a corporate name change to Vector Group Ltd. The New York Stock
Exchange symbol for the Company's common stock was changed from "BGL" to "VGR".
RECENT DEVELOPMENTS
SALE OF WESTERN TOBACCO INVESTMENTS. On August 4, 2000, Brooke
(Overseas) completed the sale of all of the membership interests of Western
Tobacco Investments to a subsidiary of Gallaher Group Plc. Brooke (Overseas)
held its 99.9% equity interest in Liggett-Ducat, one of Russia's leading
cigarette producers, through Western Tobacco Investments.
The purchase price for the sale consisted of $334,100 in cash and
$64,400 in assumed debt and capital commitments. Of the cash proceeds from the
transaction after estimated closing expenses, Brooke (Overseas) received
$197,098 and New Valley received $57,208 in accordance with the terms of the
participating loan. These amounts are subject to revision based on final closing
expenses and adjustments. The Company recorded a gain of $161,000 (including the
Company's share of New Valley's gain), net of income taxes and minority
interests, in connection with the transaction in the third quarter of 2000.
BGLS repurchased a portion of its Notes on August 4, 2000 with the
proceeds of the sale, and redeemed the remaining Notes on September 5, 2000.
BGLS used approximately $106,821 of the proceeds of the sale to retire the
Notes.
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<PAGE> 33
RECENT DEVELOPMENTS IN LEGISLATION, REGULATION AND LITIGATION
The cigarette industry continues to be challenged on numerous fronts.
New cases continue to be commenced against Liggett and other cigarette
manufacturers. As of September 30, 2000, there were approximately 285 individual
suits, 41 purported class actions and 82 governmental and other third-party
payor health care reimbursement actions pending in the United States in which
Liggett was a named defendant. In addition to these cases, during the third
quarter of 2000, an action against cigarette manufacturers involving hundreds of
named individual plaintiffs has been consolidated before a single West Virginia
state court. Liggett is a defendant in most of the cases pending in West
Virginia. Approximately 38 other purported class action complaints have been
filed against the cigarette manufacturers for alleged antitrust violations. As
new cases are commenced, the costs associated with defending such cases and the
risks attendant to the inherent unpredictability of litigation continue to
increase. An unfavorable verdict was returned in the first phase of the ENGLE
smoking and health class action trial pending in Florida. Recently, the jury
awarded $790,000 in punitive damages against Liggett in the second phase of the
trial, and the court entered an order of final judgment. Liggett intends to
pursue all available post-trial and appellate remedies. If this verdict is not
eventually reversed on appeal, or substantially reduced by the court, it could
have a material adverse effect on the Company. Liggett has filed the $3,450 bond
required under recent Florida legislation which limits the size of any bond
required, pending appeal, to stay execution of a punitive damages verdict.
Although the legislation is intended to apply to the ENGLE case, management
cannot predict the outcome of any possible challenges to the application or
constitutionality of this legislation. It is possible that additional cases
could be decided unfavorably and that there could be further adverse
developments in the ENGLE case. Management cannot predict the cash requirements
related to any future settlements and judgments, including cash required to bond
any appeals, and there is a risk that those requirements will not be able to be
met. In recent years, there have been a number of restrictive regulatory actions
from various Federal administrative bodies, including the United States
Environmental Protection Agency and the Food and Drug Administration. There have
also been adverse political decisions and other unfavorable developments
concerning cigarette smoking and the tobacco industry, including the
commencement and certification of class actions and the commencement of
third-party payor actions. These developments generally receive widespread media
attention. The Company is not able to evaluate the effect of these developing
matters on pending litigation or the possible commencement of additional
litigation, but the Company's consolidated financial position, results of
operations or cash flows could be materially adversely affected by an
unfavorable outcome in any of such smoking-related litigation. See Part II, Item
1, "Legal Proceedings" and Note 13 to the Company's Consolidated Financial
Statements for a description of legislation, regulation and litigation.
In March 1996, March 1997 and March 1998, the Company and Liggett
entered into settlements of tobacco-related litigation with the Attorneys
General of 45 states and territories. The settlements released the Company and
Liggett from all tobacco claims including claims for health care cost
reimbursement and claims concerning sales of cigarettes to minors. See the
discussions of the tobacco litigation settlements appearing in Note 13 to the
Company's Consolidated Financial Statements.
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<PAGE> 34
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES:
---------
Liggett ................. $ 149,190 $ 108,676 $ 394,652 $ 288,649
Liggett-Ducat(1) ........ 17,933 27,256 107,263 64,945
--------- --------- --------- ---------
Total tobacco ........ 167,123 135,932 501,915 353,594
Broker-dealer(2) ........ 13,009 12,711 61,605 18,587
Real estate(2) .......... 778 1,576 2,369 2,330
--------- --------- --------- ---------
Total revenues ....... $ 180,910 $ 150,219 $ 565,889 $ 374,511
========= ========= ========= =========
OPERATING INCOME:
-----------------
Liggett ................. $ 24,878 $ 19,689 $ 49,568 $ 55,904
Liggett-Ducat(1) ........ 55 4,262 1,998 4,830
--------- --------- --------- ---------
Total tobacco ........ 24,933 23,951 51,566 60,734
Broker-dealer(2) ........ 80 (2,424) 5,126 (2,531)
Real estate(2) .......... (1,114) 1,683 (5,210) 1,312
Corporate and other ..... (16,547) (3,848) (24,207) (4,397)
--------- --------- --------- ---------
Total operating
income ............. $ 7,352 $ 19,362 $ 27,275 $ 55,118
========= ========= ========= =========
</TABLE>
--------------
(1) Due to the sale of Western Tobacco Investments by Brooke (Overseas) on
August 4, 2000, results for Liggett-Ducat are shown through July 31, 2000.
(2) New Valley became a consolidated subsidiary on June 1, 1999. Accordingly,
results of operations include the four months ended September 30, 1999.
Three Months Ended September 30, 2000 Compared to Three Months Ended
September 30, 1999
--------------------------------------------------------------------
REVENUES. Total revenues were $180,910 for the three months ended
September 30, 2000 compared to $150,219 for the three months ended September 30,
1999. This $30,691 or 20.4% increase in revenues was due to a $40,514 or 37.3%
increase in revenues at Liggett, an increase of $298 in broker-dealer revenues
offset by a decrease in Liggett-Ducat's revenues of $9,323 or 34.2% due to the
sale of Western Tobacco Investments on August 4, 2000 and a decrease in real
estate revenues of $798 due to the sale of the shopping centers in August 1999.
TOBACCO REVENUES. In August 1999, the major cigarette manufacturers,
including Liggett, announced a list price increase of $1.50 per carton. In
January 2000, an additional list price increase of $1.30 per carton was
announced. Effective July 31, 2000, a further increase of $0.60 per carton was
announced.
Total tobacco revenues were $167,123 for the three months ended
September 30, 2000 compared to $135,932 for the three months ended September 30,
1999. This $31,191 or 22.9% increase in revenues was due to an increase in
tobacco revenues at Liggett offset by a decrease at Liggett-Ducat due to the
sale on August 4, 2000. Revenues at Liggett increased for both the premium and
discount segments due to price increases of $23,592 and a 29.5% increase in unit
sales volume (approximately 392.0 million units), accounting for $32,093 in
volume variance, partially offset by an unfavorable sales mix of $15,171.
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<PAGE> 35
Premium sales at Liggett for the third quarter of 2000 amounted to
$14,380 and represented 9.6% of Liggett's total sales, compared to $15,114 and
13.9% of total sales in the third quarter of 1999. In the premium segment,
revenues declined by 4.9% ($734) for the three months ended September 30, 2000,
compared to the prior year period, due to an unfavorable volume variance in the
third quarter of 2000 of $2,652, reflecting a 17.5% decline in unit sales volume
(approximately 28.0 million units). This was partially offset by price increases
of $1,918.
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, 2000 amounted to
$134,810 and represented 90.4% of Liggett's total sales, compared to $93,562 and
86.1% of total sales for the three months ended September 30, 1999. In the
discount segment, revenues grew by 44.1% ($41,248) for the three months ended
September 30, 2000 compared to the prior year period, due to price increases of
$21,674, along with a 36.0% increase in unit sales volume (approximately 420.0
million units), accounting for $33,650 in volume variance, partially offset by
an unfavorable product mix among the discount brand categories of $14,076.
For the three months ended September 30, 2000, fixed manufacturing
costs at Liggett on a basis comparable to the same period in 1999 were $1,667
higher with costs of $2.73 per thousand units in the 2000 period, which were
higher by $0.54 (24.7%) compared to costs of $2.19 in the prior year period. The
increase in costs is related to increased payroll expense and factory relocation
charges in the current year. Production volume increased by 19.5% over the prior
year quarter.
TOBACCO GROSS PROFIT. Tobacco consolidated gross profit was $108,261
for the three months ended September 30, 2000 compared to $88,459 for the three
months ended September 30, 1999, an increase of $19,802 or 22.4% when compared
to the same period last year, reflecting an increase in gross profit at Liggett
of $25,340 offset by a decrease of $5,539 at Liggett-Ducat due to the sale of
Western Tobacco Investments. For the three months ended September 30, 2000,
Liggett's premium brands contributed 9.8% and discount brands contributed 87.6%
to the Company's gross tobacco profit. Liggett-Ducat contributed 2.5%. Over the
same period in 1999, Liggett's premium brands contributed 13.0%, Liggett's
discount brands contributed 77.8% and Liggett-Ducat contributed 9.2% to the
Company's gross profit.
Gross profit at Liggett of $105,503 for the three months ended
September 30, 2000 increased $25,340 from gross profit of $80,163 for the third
quarter of 1999, due primarily to the price increases discussed above. As a
percent of revenues (excluding federal excise taxes), gross profit at Liggett
increased to 87.5% for the three months ended September 30, 2000 compared to
85.8% for the same period in 1999, with gross profit for the premium segment at
88.0% in the 2000 period compared to 86.7% in the 1999 period. Gross profit for
the discount segment was 87.5% for the three months ended September 30, 2000 and
85.6% for the three months ended September 30, 1999. This increase is primarily
the result of the January 2000 and July 2000 list price increases.
As a percent of revenues (excluding Russian excise taxes), gross profit
at Liggett-Ducat decreased 15.7% to 16.7% for the month ended July 31, 2000
compared to 32.4% in the third quarter of 1999, due to lower prices offset in
part by higher sales volumes.
BROKER-DEALER AND REAL ESTATE REVENUES. For the three months ended
September 30, 2000, Ladenburg's revenues were $13,009 and real estate revenues
were $778 compared to revenues of $12,711 at Ladenburg and $1,576 from real
estate activities for the three months ended September 30, 1999. Ladenburg's
revenues increased primarily as a result of an increase in principal
transactions and corporate finance fees partially offset by a decrease in
commissions. Revenues from real estate declined due to the sale of the shopping
centers in August 1999.
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<PAGE> 36
EXPENSES. Operating, selling, general and administrative expenses were
$114,696 for the three months ended September 30, 2000 compared to $83,384 for
the same period last year, an increase of $31,312 primarily due to increased
expenses at Liggett of $20,051, increased expenses at Brooke (Overseas) of
$5,669 and an increase of $3,254 at New Valley. The increase in operating
expenses at Liggett was due primarily to higher spending for promotional and
marketing programs, factory relocation costs and increased administrative
expense. The increased expenses at Brooke (Overseas) were principally a result
of closing costs, including commissions, paid in connection with the sale of
Western Tobacco Investments. These increases were partially offset by lower
corporate expense due to a reduction in the Company's obligation under
non-current employee benefits.
OTHER INCOME (EXPENSES). For the three months ended September 30, 2000,
other income was $247,299 compared to expense of $11,396 for the period ended
September 30, 1999. Income in the 2000 period consisted primarily of the gain of
$193,077 recognized by the Company on the sale of Western Tobacco Investments
and the income of $52,580 recognized on the sale by New Valley through its joint
venture, Western Realty Development.
Interest expense was $6,073 for the three months ended September 30,
2000 compared to $16,114 for the same period last year. This decrease of $10,041
was due primarily to a savings at corporate because of the repurchase by BGLS of
all of its outstanding Notes beginning in May 1999 and concluding with the
redemption of the remaining Notes in September 2000.
Interest and dividend income was $3,833 during the three months ended
September 30, 2000 offset by a loss at New Valley in equity in loss of affiliate
of $1,969. This compared to interest and dividend income of $507 in the 1999
period offset by equity in loss of affiliate of $908.
INCOME FROM CONTINUING OPERATIONS. The income from continuing
operations for the three months ended September 30, 2000 was $158,689 compared
to income of $6,230 for the three months ended September 30, 1999 and includes
income tax expense of $76,539 and minority interests in income of subsidiaries
of $19,423 for the third quarter of 2000 compared to taxes of $2,782 and
minority interests in losses of subsidiaries of $1,046 for the for the third
quarter of 1999.
Nine Months Ended September 30, 2000 Compared to Nine Months Ended
September 30, 1999
-------------------------------------------------------------------
REVENUES. Total revenues were $565,889 for the nine months ended
September 30, 2000 compared to $374,511 for the nine months ended September 30,
1999. This 51.1% increase in revenues was due to a $106,003 or 36.7% increase in
revenues at Liggett, a $42,318 increase at Liggett-Ducat and an increase of
$43,057 in revenues from New Valley, due to its inclusion in the consolidated
statements for the full nine months of 2000 compared to four months' inclusion
in the 1999 statements.
TOBACCO REVENUES. Tobacco revenues at Liggett increased for both the
premium and discount segments due to price increases of $65,240 discussed above
and a 27.4% ($79,170) gain in unit sales volume (approximately 977.0 million
units) offset by $38,407 in unfavorable sales mix. The increase in tobacco
revenues of $42,318 or 65.2% at Liggett-Ducat was attributable to increased
volume at the new factory and a favorable product mix offset by continuing
decline in prices compared to the prior year period. Liggett-Ducat's sales
volume during the 1999 period was adversely affected by the move to the new
factory and price declines in Russia, following the continued decline in the
value of the ruble.
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<PAGE> 37
Liggett-Ducat's sales volume during the 1999 period was adversely affected by
the move to the new factory and price declines in Russia, following the
continued decline in the value of the ruble.
Premium sales at Liggett for the nine months ended September 30, 2000
amounted to $44,910 and represented 11.4% of total Liggett sales, compared to
$63,777 and 22.1% of total sales for the same period in 1999. In the premium
segment, revenues declined by 29.6% ($18,867) over the nine months ended
September 30, 2000, compared to the same period in 1999, due to an unfavorable
volume variance of $24,471, reflecting a 38.4% decline in unit sales volume
(approximately 257.5 million units), primarily due to the transfer of Liggett's
premium brands, LARK, CHESTERFIELD and L&M, in connection with the Philip Morris
brand transaction on May 24, 1999. This decline was partially offset by price
increases of $5,604.
Liggett's discount sales over the nine-month period in 2000 amounted to
$349,742 and represented 88.6% of total Liggett sales, compared to $224,872 and
77.9% of total Liggett sales for the same period in 1999. In the discount
segment, revenues grew by 55.5% ($124,870) over the nine months ended September
30, 2000 compared to the same period in 1999, due to price increases of $59,636,
and a 42.7% gain in unit sales volume (approximately 1,234.5 million units)
accounting for $96,024 in volume variance, partially offset by an unfavorable
product mix of $30,790. For the nine months ended September 30, 2000, fixed
manufacturing costs on a basis comparable to the same period in 1999 were $753
higher, although costs per thousand units of $2.62 declined by $0.40 (13.2%)
from the previous period's $3.02, concurrent with a 22.3% increase in production
volume due to the impact of higher volumes on fixed costs.
TOBACCO GROSS PROFIT. Gross profit was $288,911 for the nine months
ended September 30, 2000 compared to $224,596 for the nine months ended
September 30, 1999, an increase of $64,315 or 28.6% when compared to the same
period last year, due primarily to price increases at Liggett offset by the
price declines at Liggett-Ducat discussed above. Liggett's premium brands
contributed 11.4% to the Company's gross profit, the discount segment
contributed 83.3% and Liggett-Ducat contributed 5.3% for the nine months ended
September 30, 2000. Over the same period in 1999, Liggett's premium brands
contributed 21.2%, the discount segment contributed 72.2% and Liggett-Ducat
contributed 6.6%.
Liggett's gross profit of $273,532 for the nine months ended September
30, 2000 increased $64,025 from gross profit of $209,507 for the same period in
1999, due primarily to the price increases discussed above. In the first nine
months of 2000, Liggett's premium brands contributed 12.0% and Liggett's
discount brands contributed 88.0% to Liggett's overall gross profit. Over the
same period in 1999, Liggett's premium brands contributed 22.7% and Liggett's
discount brands contributed 77.3% to Liggett's gross profit. As a percent of
revenues (excluding federal excise taxes), gross profit at Liggett increased to
85.6% for the nine months ended September 30, 2000 compared to 84.7% for the
same period in 1999, with gross profit for the premium segment at 86.7% and
85.4% in the nine months ended September 30 of 2000 and 1999, respectively, and
gross profit for the discount segment at 85.5% and 84.5% in 2000 and 1999,
respectively. This increase is primarily the result of the August 1999, January
2000 and July 2000 list price increases.
As a percentage of revenues (excluding Russian excise taxes), gross
profit at Liggett-Ducat decreased to 15.8% for the seven months ended July 31,
2000 compared to 49.5% in the nine months ended September 30, 1999, due to
decreased selling prices.
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<PAGE> 38
BROKER-DEALER AND REAL ESTATE REVENUES. New Valley's broker-dealer
revenues were $61,605 and real estate revenues were $2,369 for the nine months
ended September 30, 2000. This compares to four months of revenues in the 1999
period of $18,587 at Ladenburg and $2,330 from real estate activities.
EXPENSES. Operating, selling, general and administrative expenses were
$325,610 for the nine months ended September 30, 2000 compared to $190,395 for
the prior year period. The increase of $135,215 was due primarily to a $71,123
increase at Liggett, a $10,231 increase at Brooke (Overseas) and additional
expenses of $51,143 as a result of the consolidation of New Valley. The increase
in operating expenses at Liggett was due primarily to higher spending for
promotional and marketing programs, factory relocation costs and increased
administrative expense. The increased expenses at Brooke (Overseas) were
principally a result of closing costs, including commission, paid in connection
with the sale of Western Tobacco Investments. These increases were partially
offset by lower corporate expense due to a reduction in the Company's obligation
under non-current employee benefits.
OTHER INCOME (EXPENSES). Other income was $233,138 for the nine months
ended September 30, 2000 compared to other income of $260,972 for the nine
months ended September 30, 1999. For the nine months ended September 30, 2000,
the Company recognized a gain of $193,077 on the sale of Western Tobacco
Investments and New Valley recognized $52,512 on the sale through its interest
in the joint venture, Western Realty Development. For the nine months ended
September 30, 1999, the Company recognized a gain of $294,098 in connection with
the closing of the Philip Morris brand transaction. In addition, New Valley
recognized a gain during the 1999 period of $3,801 on the sale of substantially
all of Thinking Machines' assets. During the first nine months of 1999, the
Company also recognized a deferred gain of $7,050 relating to a put obligation
on the site of the old cigarette factory in connection with the sale of the
BrookeMil Ltd. common shares in 1997.
Interest expense was $29,643 for the nine months ended September 30,
2000 compared to $43,200 for the same period in the prior year. The overall
decrease of $13,557 was largely due to the repurchase of all of the BGLS Notes,
which resulted in an interest savings of $16,153. This was offset, in part, by
additional interest expense at Liggett of $700 and at New Valley of $2,255.
Equity in earnings of affiliate was a loss of $4,882 for the nine
months ended September 30, 2000 at New Valley compared to a loss of $10,106 for
the nine months ended September 30, 1999.
INCOME FROM CONTINUING OPERATIONS. The income from continuing
operations for the nine months ended September 30, 2000 was $162,281 compared to
income of $229,598 for the nine months ended September 30, 2000. Income tax
expense was $78,853 and minority interests in income of subsidiaries were
$19,279 for the nine months ended September 30, 2000. This compared to tax
expense of $86,156 and minority interests in income of subsidiaries of $336 for
the nine months ended September 30, 1999.
CAPITAL RESOURCES AND LIQUIDITY
Net cash and cash equivalents increased $133,171 for the nine months
ended September 30, 2000 and decreased $1,082 for the nine months ended
September 30, 1999. Net cash used in operations for the nine months ended
September 30, 2000 was $11,042 compared to net cash provided by operations of
$30,750 for the comparable period of 1999. The decrease from operating
activities of $41,792 reflects an overall decline of $27,843 in operating income
when compared to the nine months ended September 30, 1999 due to the inclusion
of nine months' operating expenses from New Valley when compared with four
months in the prior year period, closing costs associated with the sale of
Western Tobacco Investments and lower operating income at Liggett. Further,
there was the non-cash impact of the gain on the sale of Western Tobacco
Investments at Brooke (Overseas) and New Valley. In addition to the higher
operating income in 1999, there was a reduction in debt service resulting from
Liggett's redemption of debt in December 1998 and, to a lesser degree, BGLS'
repurchase of Notes in May 1999.
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<PAGE> 39
Cash provided by investing activities of $307,171 compares to cash
provided of $142,638 for the periods ended September 30, 2000 and 1999,
respectively. For the nine months ended September 30, 2000, the majority of the
proceeds, $366,125, were attributable to the sale of Western Tobacco Investments
and the sale or maturity of investment securities. This was offset primarily by
capital expenditures at Liggett of $11,902, Liggett-Ducat of $14,394 and New
Valley of $3,008 and the purchase of investment securities. For the nine months
ended September 30, 1999, the majority of the proceeds were from the closing of
the Philip Morris brand transaction in May 1999 and the sale of the shopping
centers at New Valley. In the 1999 period, these proceeds were partially offset
by capital expenditures for machinery and equipment at Liggett of $8,015 and
equipment and construction costs for the new factory of $35,915 at
Liggett-Ducat. Other payments made principally pertained to broker-dealer
transactions and real estate at New Valley.
Cash used in financing activities was $162,848 for the nine months
ended September 30, 2000 as compared with cash used of $173,569 for the nine
months ended September 30, 1999. Cash in the 2000 period was used primarily to
redeem all outstanding BGLS Notes and to repay the participating loan and
amounts related to the sale of Western Tobacco Investments to Western Realty
Development. In addition, distributions on common stock were $20,249. In the
comparable prior year period, BGLS repurchased $149,735 of its outstanding Notes
and New Valley repaid debt associated with the shopping centers it sold in
August 1999. Distributions on common stock in the 1999 period were $8,446.
LIGGETT. Liggett has a $35,000 credit facility under which $18,709 was
outstanding at September 30, 2000. Availability under the credit facility was
approximately $8,262 based on eligible collateral at September 30, 2000. The
facility is collateralized by all inventories and receivables of Liggett.
Borrowings under the facility, whose interest is calculated at a rate equal to
1.0% above First Union's (the indirect parent of Congress Financial Corporation,
the lead lender) prime rate. The facility's interest rate was 10.5% at September
30, 2000. The facility requires Liggett's compliance with certain financial and
other covenants including a restriction on the payment of cash dividends unless
Liggett's borrowing availability under the facility for the 30-day period prior
to the payment of the dividend, and after giving effect to the dividend, is at
least $5,000. In addition, the facility, as amended, imposes requirements with
respect to Liggett's adjusted net worth (not to fall below $8,000 as computed in
accordance with the agreement) and working capital (not to fall below a deficit
of $17,000 as computed in accordance with the agreement). At September 30, 2000,
Liggett was in compliance with all covenants under the facility; Liggett's
adjusted net worth was $14,323 and net working capital was $23,630, as computed
in accordance with the agreement. The facility expires on March 8, 2003 subject
to automatic renewal for an additional year unless a notice of termination is
given by the lender at least 60 days prior to the anniversary date.
In November 1999, 100 Maple Lane LLC, a new company formed by Liggett
to purchase an industrial facility in Mebane, North Carolina, borrowed $5,040
from the lender under Liggett's credit facility. The loan is payable in 59
monthly installments of $60 including annual interest at 1% above the prime rate
with a final payment of $1,500. Liggett has guaranteed the loan, and a first
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<PAGE> 40
mortgage on the Mebane property collateralizes the Maple Lane loan and Liggett's
credit facility. Liggett plans to complete the relocation of its manufacturing
operations to this facility by October 2000.
In January 1999, Liggett purchased equipment for $5,750 and borrowed
$4,500 to fund the purchase. The loan, which is collateralized by the equipment
and guaranteed by BGLS and the Company, is payable in 60 monthly installments of
$56 including annual interest of 7.67% with a final payment of $2,550. In March
2000, Liggett purchased equipment for $1,000 under a capital lease which is
payable in 60 monthly installments of $21 with an effective annual interest rate
of 10.14%. In April 2000, Liggett purchased equipment for $1,071 under two
capital leases which are payable in 60 monthly installments of $22 with an
effective interest rate of 10.20%.
Liggett (and, in certain cases, Brooke Group Holding, the Company's
predecessor and a wholly-owned subsidiary of BGLS) and other United States
cigarette manufacturers have been named as defendants in a number of direct and
third-party actions (and purported class actions) predicated on the theory that
they should be liable for damages from cancer and other adverse health effects
alleged to have been caused by cigarette smoking or by exposure to so-called
secondary smoke from cigarettes. The Company believes, and has been so advised
by counsel handling the respective cases, that Brooke Group Holding and Liggett
have a number of valid defenses to claims asserted against them. Litigation is
subject to many uncertainties. An unfavorable verdict was returned in the first
phase of the ENGLE smoking and health class action trial pending in Florida.
Recently, the jury awarded $790,000 in punitive damages against Liggett in the
second phase of the trial, and the court entered an order of final judgment.
Liggett intends to pursue all available post-trial and appellate remedies. If
this verdict is not eventually reversed on appeal, or substantially reduced by
the court, it could have a material adverse effect on the Company. Liggett has
filed the $3,450 bond required under recent Florida legislation which limits the
size of any bond required, pending appeal, to stay execution of a punitive
damages verdict. Although the legislation is intended to apply to the ENGLE
case, management cannot predict the outcome of any possible challenges to the
application or constitutionality of this legislation. It is possible that
additional cases could be decided unfavorably and that there could be further
adverse developments in the ENGLE case. Management cannot predict the cash
requirements related to any future settlements and judgments, including cash
required to bond any appeals, and there is a risk that those requirements will
not be able to be met. An unfavorable outcome of a pending smoking and health
case could encourage the commencement of additional similar litigation. In
recent years, there have been a number of adverse regulatory, political and
other developments concerning cigarette smoking and the tobacco industry. These
developments generally receive widespread media attention. Neither the Company
nor Liggett is able to evaluate the effect of these developing matters on
pending litigation or the possible commencement of additional litigation or
regulation. (See Note 13 to the Company's Consolidated Financial Statements.)
Management is unable to make a meaningful estimate of the amount or
range of loss that could result from an unfavorable outcome of the cases pending
against Brooke Group Holding or Liggett or the costs of defending such cases. It
is possible that the Company's consolidated financial position, results of
operations or cash flows could be materially adversely affected by an
unfavorable outcome in any such smoking-related litigation.
BROOKE (OVERSEAS). On August 4, 2000, Brooke (Overseas) completed the
sale of Western Tobacco Investments to a subsidiary of Gallaher Group Plc. (See
Recent Developments.) In connection with the sale, all of the credit facilities,
notes payable and other obligations of Western Tobacco Investments and
Liggett-Ducat were assumed by the purchaser.
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BGLS. On August 4, 2000, with the proceeds of the Western Tobacco
Investments sale, BGLS repurchased $24,850 principal amount of its Notes,
together with accrued interest of $11,531, for $36,381. On September 5, 2000,
BGLS redeemed the remaining Notes for 100% of the principal amount thereof plus
accrued interest. BGLS used $106,821 of the proceeds of the sale to retire the
Notes.
THE COMPANY. The Company has aggregate required principal payments of
approximately $10,800 due within the next twelve months. The Company believes
that it will continue to meet its liquidity requirements through 2001. Corporate
expenditures (exclusive of Liggett and New Valley) over the next twelve months
for current operations include dividends on the Company's shares (currently at
an annual rate of approximately $41,000) and corporate expenses. The Company
anticipates funding its expenditures for current operations with the proceeds
from the Western Tobacco Investments sale, public and/or private debt and equity
financing, management fees from subsidiaries and tax sharing and other payments
from Liggett or New Valley. New Valley may acquire or seek to acquire additional
operating businesses through merger, purchase of assets, stock acquisition or
other means, or to make other investments, which may limit its ability to make
such distributions.
MARKET RISK
Vector is exposed to market risks principally from fluctuations in
interest rates, foreign currency exchange rates and equity prices. The Company
seeks to minimize these risks through its regular operating and financing
activities and its long-term investment strategy.
FOREIGN MARKET RISK
BrookeMil's and Western Realty Development's operations are conducted
in Russia. The Russian Federation continues to experience economic difficulties
following the financial crisis of August 1998. Consequently, the country's
currency continues to devalue, there is continued volatility in the debt and
equity markets, hyperinflation persists, confidence in the banking sector has
yet to be restored and there continues to be a general lack of liquidity in the
economy. In addition, laws and regulations affecting businesses operating within
the Russian Federation continue to evolve.
The Russian Federation's return to economic stability is dependent to a
large extent on the effectiveness of the measures taken by the government,
decisions of international lending organizations, and other actions, including
regulatory and political developments, which are beyond Vector's control.
Vector's Russian operations may be significantly affected by these factors for
the foreseeable future.
DOMESTIC MARKET RISK
New Valley's market risk management procedures cover all market risk
sensitive financial instruments.
Current and proposed underwriting, corporate finance, merchant banking
and other commitments at Ladenburg are subject to due diligence reviews by
Ladenburg's senior management, as well as professionals in the appropriate
business and support units involved. Credit risk related to various financing
activities is reduced by the industry practice of obtaining
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and maintaining collateral. Ladenburg monitors its exposure to counterparty risk
through the use of credit exposure information, the monitoring of collateral
values and the establishment of credit limits.
EQUITY PRICE RISK. Ladenburg maintained inventories of trading
securities at September 30, 2000 with fair values of $12,599 in long positions
and $4,913 in short positions. Ladenburg performed an entity-wide analysis of
its financial instruments and assessed the related risk and materiality. Based
on this analysis, in the opinion of management, the market risk associated with
the Ladenburg's financial instruments at September 30, 2000 will not have a
material adverse effect on the consolidated financial position or results of
operations of Vector.
New Valley held investment securities available for sale totaling
$45,465 at September 30, 2000. Approximately 29% of these securities represent
an investment in Nabisco Group Holdings Corp., which is a defendant in numerous
tobacco products-related litigation, claims and proceedings. An adverse outcome
in any of these proceedings could have a significant effect on the value of New
Valley's investment.
New Valley also holds long-term investments in limited partnerships and
limited liability companies. These investments are illiquid, and their ultimate
realization is subject to the performance of the investee entities.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." 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. Originally,
the statement had been effective for all quarters of fiscal years beginning
after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities", which postponed the adoption of
SFAS No. 133 until fiscal years beginning after June 15, 2000. Vector has not
yet determined the impact that the adoption of SFAS 133 will have on its
earnings or statement of financial position.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 "Revenue Recognition" ("SAB 101"), which
provides guidance on the recognition, presentation and disclosure of revenue in
financial statements filed with the SEC. SAB 101 is applicable beginning with
the Company's fourth quarter of 2000. Based on the Company's current analysis,
SAB 101 will not have an impact on the financial results of the Company.
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, 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 SEC and in its reports to stockholders, 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 "safe-harbor" provisions of the Private Securities Reform
Act, the Company has identified under "Risk Factors" in Item 1 of
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the Company's Form 10-K for the year ended December 31, 1999 filed with the SEC
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.
Results actually achieved may differ materially from expected results
included in these forward-looking statements as a result of these or other
factors. Due to such uncertainties and risks, readers are cautioned not to place
undue reliance on such forward-looking statements, which speak only as of the
date on which such statements are made. 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Market Risk" is incorporated
herein by reference.
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PART II
OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Reference is made to Note 13, incorporated herein by reference, to the
Consolidated Financial Statements of Vector Group Ltd. included
elsewhere in this Report on Form 10-Q which contains a general
description of certain legal proceedings to which Brooke Group Holding,
BGLS, Liggett, New Valley or their subsidiaries are a party and certain
related matters. Reference is also made to Exhibit 99.1 for additional
information regarding the pending smoking-related material legal
proceedings to which Brooke Group Holding, 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, have been issued or sold by
the Company during the three months ended September 30, 2000,
except for the grant of stock options to employees of the Company
and/or its subsidiaries as described in Note 12, incorporated
herein by reference, to the Consolidated Financial Statements of
Vector Group Ltd. The foregoing transactions were effected in
reliance on the exemption from registration afforded by Section
4(2) of the Securities Act of 1933 or did not involve a "sale"
under the Securities Act of 1933.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
* 10 Amendment to Purchase and Sale Agreement, dated as of
August 4, 2000, between Gallaher Overseas (Holdings)
Ltd. and Brooke (Overseas) Ltd. (incorporated by
reference to Exhibit 10.3 in the Company's Report on
Form 8-K dated August 4, 2000, Commission File No.
1-5759).
27 Vector Group Ltd.'s Financial Data Schedule (for SEC
use only).
99.1 Material Legal Proceedings.
* 99.2 New Valley Corporation's Interim Consolidated
Financial Statements for the quarterly periods ended
September 30, 2000 and 1999 (incorporated by
reference to New Valley's Quarterly Report on Form
10-Q for the quarterly period ended September 30,
2000, Commission File No. 1-2493).
------------
* Incorporated by reference
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(b) REPORTS ON FORM 8-K
The Company filed the following Reports on Form 8-K during the
third quarter of 2000:
Financial
Date Items Statements
---- ----- ----------
July 14, 2000 5 None
August 4, 2000 2,7 None
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.
VECTOR GROUP LTD.
(Registrant)
By: /s/ Joselynn D. Van Siclen
---------------------------
Joselynn D. Van Siclen
Vice President and Chief
Financial Officer
Date: November 14, 2000
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