<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
Commission File Number 33-75224
LIGGETT GROUP INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1702115
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 SOUTHEAST SECOND STREET, MIAMI, FLORIDA 33131
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (305) 374-7714
EVE HOLDINGS INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1703877
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 SOUTHEAST SECOND STREET, MIAMI, FLORIDA 33131
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (305) 539-9460
Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
As of November 13, 1998 there were outstanding 1,000 shares of common stock,
par value $0.10 per share, of Liggett Group Inc. and 100 shares of common
stock, par value $1.00 per share, of Eve Holdings Inc.
<PAGE> 2
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LIGGETT GROUP INC.:
Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997 ..................................................... 3
Consolidated Statements of Operations for the three and nine
months ended September 30, 1998 and 1997 ............................. 5
Consolidated Statement of Stockholder's Equity (Deficit) for
the nine months ended September 30, 1998 .............................. 6
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1998 and 1997 .................................... 7
Notes to Consolidated Financial Statements ................................ 8
EVE HOLDINGS INC.:
Balance Sheets as of September 30, 1998 and December 31, 1997 ............. 24
Statements of Operations for the three and nine months ended
September 30, 1998 and 1997 ........................................... 25
Statements of Cash Flows for the nine months ended September 30,
1998 and 1997 ......................................................... 26
Notes to Financial Statements ............................................. 27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ..................................................... 29
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS .......................................................... 39
ITEM 6. EXHIBITS ................................................................... 39
SIGNATURES ............................................................................ 40
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LIGGETT GROUP INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------- ----------
ASSETS
<S> <C> <C>
Current assets:
Accounts receivable:
Trade, less allowances of $1,295 and $1,062, respectively $ 10,731 $ 9,572
Other ................................................................. 879 743
Inventories ............................................................... 29,676 35,057
Other current assets ...................................................... 1,535 738
---------- ----------
Total current assets .............................................. 42,821 46,110
Property, plant and equipment, at cost, less accumulated
depreciation of $30,339 and $29,452, respectively ......................... 16,422 17,756
Intangible assets, at cost, less accumulated amortization
of $20,401 and $19,111, respectively ...................................... 319 1,609
Other assets and deferred charges, at cost, less accumulated
amortization of $13,217 and $9,000, respectively .......................... 2,116 3,000
---------- ----------
Total assets ...................................................... $ 61,678 $ 68,475
========== ==========
</TABLE>
(continued)
3
<PAGE> 4
LIGGETT GROUP INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(Unaudited)
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------- ----------
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)
<S> <C> <C>
Current liabilities:
Current maturities of long-term debt ...................................... $ 162,502 $ 28
Cash overdraft ............................................................ 1,405 891
Accounts payable, principally trade ....................................... 4,095 6,413
Accrued expenses:
Promotional ........................................................... 27,534 26,993
Taxes, principally excise taxes ....................................... 970 3,643
Estimated allowance for sales returns ................................. 4,750 4,750
Interest .............................................................. 3,234 8,070
Settlement accruals ................................................... 2,085 4,030
Other ................................................................. 5,317 8,834
---------- ----------
Total current liabilities ......................................... 211,892 63,652
Long-term debt, less current maturities ........................................ -- 168,112
Non-current employee benefits and other liabilities ............................ 10,895 11,168
Other long-term liabilities .................................................... 22,159 18,400
Commitments and contingencies (Notes 5 and 8)
Stockholder's equity (deficit):
Redeemable preferred stock (par value $1.00 per share;
authorized 1,000 shares; no shares issued and outstanding)
Common stock (par value $0.10 per share; authorized
2,000 shares; issued and outstanding 1,000 shares)
and contributed capital ................................................. 56,861 50,218
Accumulated deficit ....................................................... (240,129) (243,075)
---------- ----------
Total stockholder's deficit ....................................... (183,268) (192,857)
---------- ----------
Total liabilities and stockholder's equity (deficit) .............. $ 61,678 $ 68,475
========== ==========
</TABLE>
The accompanying notes are an integral
part of these financial statements.
4
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LIGGETT GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales* ........................................... $ 85,630 $ 79,368 $ 234,654 $ 223,811
Cost of sales* ........................................ 31,383 35,971 91,286 102,444
---------- ---------- ---------- ----------
Gross profit ................................ 54,247 43,397 143,368 121,367
Selling, general and administrative expenses .......... 45,562 38,721 117,657 110,061
Settlement charges .................................... -- -- 1,881 --
Restructuring ......................................... -- 95 -- 1,926
---------- ---------- ---------- ----------
Operating income ............................ 8,685 4,581 23,830 9,380
Other income (expense):
Interest income .................................. -- -- -- 60
Interest expense ................................. (7,270) (5,950) (21,704) (17,920)
Equity in income of affiliate .................... -- 321 -- 506
Sale of assets ................................... (18) (302) 818 3,692
Retirement of debt ............................... -- -- -- 2,963
Miscellaneous, net ............................... 2 (1) 2 (14)
---------- ---------- ---------- ----------
Net income (loss) .......................... $ 1,399 $ (1,351) $ 2,946 $ (1,333)
========== ========== ========== ==========
</TABLE>
- -----------------
*Net sales and cost of sales include federal excise taxes of $16,889, $19,250,
$49,365, and $55,263, respectively.
The accompanying notes are an integral
part of these financial statements.
5
<PAGE> 6
LIGGETT GROUP INC.
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (DEFICIT)
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Common
Stock and Total
Contributed Accumulated Stockholder's
Capital Deficit Deficit
-------- --------- ---------
<S> <C> <C> <C>
Balance at December 31, 1997 ....................... $ 50,218 $(243,075) $(192,857)
Net income ....................................... -- 2,946 2,946
Capital contribution received .................... 3,705 -- 3,705
Effectiveness fee on debt ........................ 4,105 -- 4,105
Transfer of ownership interest in an affiliate ... (1,167) -- (1,167)
-------- --------- ---------
Balance at September 30, 1998 ....................... $ 56,861 $(240,129) $(183,268)
======== ========= =========
</TABLE>
The accompanying notes are an integral
part of these financial statements.
6
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LIGGETT GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------
1998 1997
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ......................................................... $ 2,946 $ (1,333)
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization ........................................... 5,137 5,180
Gain on sale of property, plant and equipment ........................... (818) (3,692)
Gain on retirement of notes ............................................. -- (2,963)
Effectiveness fee on debt ............................................... 2,737 --
Non-cash stock-based expense ............................................ 3,705 --
Deferred finance charges and debt discount written off .................. -- 130
Equity in income of affiliate ........................................... -- (506)
Changes in assets and liabilities:
Accounts receivable ..................................................... (1,295) 8,271
Inventories ............................................................. 5,381 12,329
Accounts payable ........................................................ (4,581) (6,864)
Accrued expenses ........................................................ (10,169) (13,526)
Non-current employee benefits ........................................... (515) (434)
Other, net .............................................................. 3,205 (1,336)
---------- ----------
Net cash provided by (used in) operating activities ............... 5,733 (4,744)
Cash flows from investing activities:
Proceeds from sale of property, plant and equipment ........................ 1,155 4,589
Capital expenditures ....................................................... (1,182) (1,282)
Purchase of an option in affiliate ......................................... -- (2,200)
---------- ----------
Net cash (used in) provided by investing activities ................ (27) 1,107
Cash flows from financing activities:
Repayments of long-term debt ............................................... (28) (4,721)
Borrowings under revolving credit facility ................................. 196,188 209,822
Repayments under revolving credit facility ................................. (201,941) (202,880)
Deferred finance charges ................................................... (439) --
Increase in cash overdraft ................................................. 514 1,416
---------- ----------
Net cash (used in) provided by financing activities ................ (5,706) 3,637
Net increase in cash and cash equivalents ...................................... 0 0
Cash and cash equivalents:
Beginning of period ........................................................ 0 0
---------- ----------
End of period .............................................................. $ 0 $ 0
========== ==========
Supplemental cash flow information:
Cash payments during the period for:
Interest ............................................................... $ 20,921 $ 22,616
Income taxes ........................................................... $ 162 $ 118
</TABLE>
The accompanying notes are an integral
part of these financial statements.
7
<PAGE> 8
LIGGETT GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollars in thousands, except per share amounts)
1. THE COMPANY
Liggett Group Inc. ("Liggett" or the "Company") is a wholly-owned
subsidiary of BGLS Inc. ("BGLS"), a wholly-owned subsidiary of Brooke Group
Ltd. ("BGL"). Liggett is engaged primarily in the manufacture and sale of
cigarettes, principally in the United States. Certain management and
administrative functions are performed by affiliates. (See Note 9.)
The consolidated financial statements included herein 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. The December 31, 1997 balance
sheet has been derived from audited financial statements. These consolidated
financial statements should be read in conjunction with the consolidated
financial statements included in the Company's Annual Report on Form 10-K, as
amended, for the year ended December 31, 1997, as filed with the Securities and
Exchange Commission. The results of operations for interim periods should not
be regarded as necessarily indicative of the results that may be expected for
the entire year.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. Liggett had a net
capital deficiency of $183,268 as of September 30, 1998, is highly leveraged
and has substantial near-term debt service requirements. (See Note 7.) Due to
the many risks and uncertainties associated with the cigarette industry and the
impact of tobacco litigation (see Note 8), there can be no assurance that the
Company will be able to meet its future earnings or cash flow goals.
Consequently, the Company could be in violation of its debt covenants,
including covenants limiting the maximum permitted net worth and working
capital deficiencies, and if its lenders were to exercise acceleration rights
under its revolving credit facility (the "Facility") or the indenture for its
Senior Secured Notes (the "Liggett Notes") or refuse to lend under the
Facility, the Company would not be able to satisfy such demands or its working
capital requirements.
The Liggett Notes mature on February 1, 1999 and the Facility expires
on March 9, 1999. Accordingly, as of September 30, 1998, the current maturities
of the Liggett Notes of $144,828 (net of unamortized discount) and of the
Facility of $17,674 contribute substantially to the working capital deficit of
$169,071.
On January 30, 1998, the Company obtained the consents of the required
majority of the holders of the Liggett Notes to various amendments to the
Indenture governing the Liggett Notes. The amendments provided, among other
things, for a deferral of the February 1, 1998 mandatory redemption of $37,500
principal amount of the Liggett Notes to the date of final maturity, February
1, 1999. (Refer to Note 7.) At maturity, the Liggett Notes will require a
principal payment of $144,891. The Company does not anticipate it will be able
to generate sufficient cash from operations to make such payments. In addition,
the Company has a $40,000 Facility expiring March 8, 1999 under which $17,674
was outstanding at September 30, 1998. While management currently intends to
seek to refinance and/or restructure with the Company's note holders the
maturity requirements on the Liggett Notes and to extend the Facility, there
are no refinancing or restructuring arrangements for the notes or commitments
to extend the Facility at this time, and no assurances can be given in this
regard. If the Company is unable to refinance or restructure the terms of the
Liggett Notes or otherwise make all payments thereon, the Liggett Notes and the
Facility would be in default and holders of such debt could accelerate the
maturity of such debt. In such event, Liggett may be forced to seek protection
from creditors under applicable laws. These matters raise substantial doubt
about
8
<PAGE> 9
the Company meeting its liquidity needs and its ability to continue as a going
concern. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
YEAR 2000 COSTS. Liggett utilizes management information systems and
software technology that may be affected by Year 2000 issues throughout its
operations. The Company has evaluated the costs to implement century date change
compliant systems conversions and is in the process of executing a planned
conversion of its systems prior to the year 2000. To date, the focus of Year
2000 compliance and verification efforts has been directed at the implementation
of new customer service, inventory control and financial reporting systems at
each of the three regional Strategic Business Units, part of the Company's
reorganization which began in January 1997. In January of 1998, Liggett
initiated a major conversion of factory accounting and information systems at
its Durham production facility, with the assistance of outside consultants, to
upgrades that have been successfully tested for Year 2000 compliance. This
project is expected to be completed by the end of November.
All costs incurred to date are considered an integral part of the
normal expenditures required for business systems enhancements and upgrades. It
is anticipated that all factory, corporate, field sales and physical
distribution systems will be completed in sufficient time to support Year 2000
compliance and verification.
Although such costs may be a factor in describing changes in operating
profit in any given reporting period, the Company currently does not believe
that the anticipated costs of Year 2000 systems conversions will have a material
impact on its future consolidated results of operations. Based on the progress
Liggett has made in addressing Year 2000 issues and its strategy and timetable
to complete its compliance program, the Company does not foresee significant
risks associated with its Year 2000 initiatives at this time. However, if the
Company identifies any significant risks related to its Year 2000 compliance
effort, or if its progress deviates from the projected timetable, Liggett will
develop contingency plans it deems necessary to meet compliance deadlines at
that time. Due to the interdependent nature of computer systems, the Company may
be adversely impacted in the year 2000 depending on whether it or its vendors or
customers have addressed this issue successfully.
NEW ACCOUNTING PRONOUNCEMENTS. The Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No. 130"), for the year ending December 31, 1998. SFAS No. 130 requires the
Company to display an amount representing the total comprehensive income for the
period in a financial statement which is displayed with the same prominence as
other financial statements. The Company has no items of other comprehensive
income in any period presented and therefore is not required to report
comprehensive income.
The Company will adopt Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS No. 131"), for the year ending December 31, 1998. SFAS No. 131 requires
the Company to report certain information about operating segments in complete
sets of financial statements and in condensed financial statements of interim
period issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Company does not expect this new pronouncement to have a significant impact
on the financial statements.
The Company will adopt Statement of Financial Accounting Standards No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits"
("SFAS No. 132"), for the year ending December 31, 1998. SFAS No. 132
standardizes the disclosure requirements for pensions and other postretirement
benefits to the extent practicable, requires additional information and changes
in the benefit obligations and fair values of plan assets that will facilitate
financial analysis, and eliminates certain disclosures that are no longer
useful. The Company has not yet determined the impact of this pronouncement.
2. 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, the
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 allowance for doubtful accounts, sales returns and
allowances, actuarial assumptions of pension plans and litigation and defense
costs. Actual results could differ from those estimates.
3. PER SHARE DATA
All of the Company's common shares (1,000 shares, issued and
outstanding for all periods presented herein) are owned by BGLS. Accordingly,
earnings and dividends per share data are not presented in these consolidated
financial statements.
4. SALE OF ASSETS
On March 11, 1997, Liggett sold to Blue Devil Ventures, a North
Carolina limited liability partnership, certain surplus realty in Durham, North
Carolina, for a sale price of $2,200. A gain of $1,147 was recognized, net of
costs required to prepare the properties for sale and selling costs. (See Note
9 for sales to affiliates.)
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5. INVENTORIES
Inventories consist of the following:
September 30, December 31,
1998 1997
-------- --------
Finished goods ............... $ 13,183 $ 13,273
Work-in-process .............. 2,658 1,926
Raw materials ................ 14,626 21,211
Replacement parts and supplies 3,328 3,545
-------- --------
Inventories at current cost .. 33,795 39,955
LIFO adjustment .............. (4,119) (4,898)
-------- --------
Inventories at LIFO cost ..... $ 29,676 $ 35,057
======== ========
The Company has a leaf inventory management program whereby, among
other things, it is committed to purchase certain quantities of leaf tobacco.
The purchase commitments are for quantities not in excess of anticipated
requirements and are at prices, including carrying costs, established at the
date of the commitment. Liggett had leaf tobacco purchase commitments of
approximately $6,134 at September 30, 1998.
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
-------- --------
<S> <C> <C>
Land and improvements ........................ $ 411 $ 411
Buildings .................................... 6,015 6,228
Machinery and equipment ...................... 40,335 40,569
-------- --------
Property, plant and equipment ................ 46,761 47,208
Less accumulated depreciation ................ (30,339) (29,452)
-------- --------
Property, plant and equipment, net ........... $ 16,422 $ 17,756
======== ========
</TABLE>
10
<PAGE> 11
7. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------- ----------
<S> <C> <C>
11.5% Senior Secured Notes due February 1, 1999,
net of unamortized discount of $63 and $206,
respectively ...................................... $ 112,549 $ 112,406
Variable Rate Series C Senior Secured Notes due
February 1, 1999 .................................. 32,279 32,279
Borrowings outstanding under revolving credit
facility .......................................... 17,674 23,427
Other ................................................ -- 28
---------- ----------
162,502 168,140
Current portion ...................................... (162,502) (28)
---------- ----------
Amount due after one year ............................ $ -- $ 168,112
========== ==========
</TABLE>
SENIOR SECURED NOTES
On February 14, 1992, Liggett issued $150,000 in Senior Secured Notes
(the "Series B Notes"). Interest on the Series B Notes is payable semiannually
on February 1 and August 1 at an annual rate of 11.5%. The Series B Notes and
Series C Notes referred to below (collectively, the "Liggett Notes") required
mandatory principal redemptions of $7,500 on February 1 in each of the years
1993 through 1997 and $37,500 on February 1, 1998 with the balance of the
Liggett Notes due on February 1, 1999. In February 1997, $7,500 of the Series B
Notes were purchased using revolver availability and credited against the
mandatory redemption requirements. The transaction resulted in a net gain of
$2,963. The Liggett Notes are collateralized by substantially all of the assets
of the Company, excluding inventories and receivables. Eve is a guarantor for
the Notes. The Liggett Notes may be redeemed, in whole or in part, at a price
equal to 100% of the principal amount at the option of the Company. The Liggett
Notes contain restrictions on Liggett's ability to declare or pay cash
dividends, incur additional debt, grant liens and enter into any new agreements
with affiliates, among others.
The Series C Notes, issued in 1994, have the same terms (other than
interest rate) and stated maturity as the Series B Notes. The Series C Notes
bore a 16.5% interest rate, which was reset on February 1, 1995 to 19.75%.
On January 30, 1998, with the consent of the required majority of the
holders of the Liggett Notes, Liggett entered into various amendments to the
Indenture governing the Liggett Notes, which provided, among other things, for a
deferral of the February 1, 1998 mandatory redemption payment of $37,500 to the
date of final maturity of the Liggett Notes on February 1, 1999. In connection
with the deferral, BGL agreed to issue 483,002 shares of BGL's common stock to
the holders of record on January 15, 1998 of the Liggett Notes. As a result of
this transaction, the Company recorded a non-cash deferred charge of
approximately $4,100 during the first quarter of 1998 reflecting the fair value
of the instruments issued. This deferred charge is being amortized as an
adjustment to interest expense over a period of one year. As of September 30,
1998, $2,737 had been expensed. The Indenture under which the Liggett Notes are
outstanding was also amended to prohibit, with limited exceptions, payments of
dividends and incurrence of new debt by Liggett and to tighten restrictions on
the disposition of proceeds of asset sales. BGL and BGLS also agreed to
guarantee the payment by Liggett of the August 1, 1998 interest payment, which
was made by Liggett, on the Liggett Notes and to subordinate, until repayment in
full of all amounts outstanding in respect of the Liggett Notes, their
reimbursement rights with respect to the guarantee of borrowings under the
Facility made in connection with the Company's August 1, 1997 interest
installment
11
<PAGE> 12
and any future advances in connection with the guarantee of the August 1, 1998
interest payment. In consideration of the contribution of the BGL common stock,
the waiver of certain management and other fees, the guarantee of the interest
payments and subordination of certain reimbursement rights, the Company
transferred its ownership interest in, and options to acquire additional shares
of stock of, Liggett-Ducat Ltd. ("Liggett-Ducat") to Brooke (Overseas) Ltd.
("BOL"), a subsidiary of BGLS. The Company accounted for the transfer of its
ownership interest in, and options to acquire additional shares of stock of,
Liggett-Ducat to BOL as a capital distribution to BGLS. Based on the carrying
value of the investment at January 30, 1998, the capital distribution is
approximately $1,167. In addition, the Liggett Noteholders were granted
additional collateral in the form of a security interest in 16% of the stock of
Liggett-Ducat or a successor entity held by BOL.
On February 1, 1999, all of the Liggett Notes, totaling $144,891, will
reach maturity. There are no refinancing or restructuring arrangements in place
at this time for the notes and no assurances can be given in this regard.
(Refer to Note 1.)
REVOLVING CREDIT FACILITY
On March 8, 1994, Liggett entered into the Facility under which it can
borrow up to $40,000 (depending on the amount of eligible inventory and
receivables as determined by the lenders) from a syndicate of commercial
lenders. Availability under the Facility was approximately $8,091 based upon
eligible collateral at September 30, 1998. The Facility is collateralized by all
inventories and receivables of the Company. Borrowings under the Facility are
charged interest calculated at a rate equal to 1.5% above Philadelphia National
Bank's (the indirect parent of Congress Financial Corporation, the lead lender)
prime rate. As of September 30, 1998, Liggett's interest rate was 10.0%, reduced
to 9.75% on October 1st, and to 9.50% on November 1st, 1998. The Facility
contains certain financial covenants similar to those contained in the Liggett
Notes Indenture, including restrictions on Liggett's ability to declare or pay
cash dividends, incur additional debt, grant liens and enter into any new
agreements with affiliates, among others. In addition, the Facility, as amended
April 8, 1998, imposes requirements with respect to the Company's adjusted net
worth (not to fall below a deficit of $195,000 as computed in accordance with
the agreement, this computation was $179,149 at September 30, 1998) and working
capital (not to fall below a deficit of $17,000 as computed in accordance with
the agreement, this computation was $2,450 at September 30, 1998). The Facility,
as amended, also provides that a default by Liggett or its subsidiaries under
the March 1996 Settlements, March 1997 Settlements and March 1998 Settlements
(all as defined below in Note 8) shall constitute an event of default under the
Facility.
In November 1997, the Facility was extended until March 8, 1999. For
information concerning Liggett's substantial near-term debt service
requirements and other related matters, see Note 1.
8. COMMITMENTS AND CONTINGENCIES
TOBACCO-RELATED LITIGATION:
OVERVIEW. Since 1954, Liggett and other United States cigarette
manufacturers have been named as defendants in numerous direct and third-party
actions predicated on the theory that cigarette manufacturers should be liable
for damages from cancer and other adverse health effects alleged to have been
caused by cigarette smoking or by exposure to secondary smoke (environmental
tobacco smoke, "ETS") from cigarettes. These cases are reported hereinafter as
though having been commenced against Liggett (without regard to whether such
cases were actually commenced against Liggett or BGL). There has been a
noteworthy increase in the number of cases commenced against Liggett and the
other cigarette manufacturers. The cases generally fall into four categories:
(i) smoking and health cases alleging personal injury brought on behalf of
individual smokers ("Individual Actions"), (ii) smoking and health cases
alleging personal injury and purporting to be brought on behalf of a class of
plaintiffs ("Class Actions"), (iii) health care cost recovery actions brought
by state and local governments ("Attorneys General
12
<PAGE> 13
Actions") and (iv) health care cost recovery actions brought by third-party
payors including asbestos manufacturers, unions and taxpayers ("Third-Party
Payor Actions"). As new cases are commenced, defense costs and the risks
attendant to the inherent unpredictability of litigation continue to increase.
Liggett had been receiving assistance from others in the industry in defraying
the costs and other burdens incurred in the defense of smoking and health
litigation and related proceedings, which, for the most part, consisted of the
payment of counsel fees and costs, but this assistance terminated in 1997. The
future financial impact on Liggett of the termination of this assistance and
the effects of the tobacco litigation settlements discussed below is not
quantifiable at this time. For the nine months ended September 30, 1998,
Liggett incurred counsel fees and costs totaling approximately $3,713, compared
to $3,287 for the comparable prior year period.
In June 1992, in an action entitled CIPOLLONE V. LIGGETT GROUP INC.,
ET AL., the United States Supreme Court issued an opinion concluding that The
Federal Cigarette Labeling and Advertising Act did not preempt state common law
damage claims but that The Public Health Cigarette Smoking Act of 1969 (the
"1969 Act") did preempt certain, but not all, state common law damage claims.
The decision bars plaintiffs from asserting claims that, after the effective
date of the 1969 Act, the tobacco companies either failed to warn adequately of
the claimed health risks of cigarette smoking or sought to neutralize those
claimed risks in their advertising or promotion of cigarettes. Bills have been
introduced in Congress on occasion to eliminate the federal preemption defense.
Enactment of any federal legislation with such an effect could result in a
significant increase in claims, liabilities and litigation costs.
INDIVIDUAL ACTIONS. As of September 30, 1998, there were approximately
275 cases pending against Liggett, and in most cases the other tobacco
companies, where individual plaintiffs allege injury resulting from cigarette
smoking, addiction to cigarette smoking or exposure to ETS and seek
compensatory and, in some cases, punitive damages. Of these, 90 were pending in
the State of Florida, 88 in the State of New York, 23 in the Commonwealth of
Massachusetts and 19 in the State of Texas. The balance of individual cases
were pending in 18 states. There are three individual cases pending where
Liggett is the only named defendant.
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for personal injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence, gross
negligence, special duty, voluntary undertaking, strict liability, fraud,
misrepresentation, design defect, failure to warn, breach of express and
implied warranties, conspiracy, aiding and abetting, concert of action, unjust
enrichment, common law public nuisance, indemnity, market share liability, and
violations of deceptive trade practices laws, the Federal Racketeer Influenced
and Corrupt Organization Act ("RICO") and antitrust statutes. In many of these
cases, in addition to compensatory damages, plaintiffs also seek other forms of
relief including disgorgement of profits and punitive damages. Defenses raised
by defendants in these cases include lack of proximate cause, assumption of the
risk, comparative fault and/or contributory negligence, lack of design defect,
statute of limitations, equitable defenses such as "unclean hands" and lack of
benefit, failure to state a claim and federal preemption.
CLASS ACTIONS. As of September 30, 1998, there were approximately 45
actions pending, for which either a class has been certified or plaintiffs are
seeking class certification, where Liggett, among others, was a named
defendant. Two of these cases, FLETCHER, ET AL. V. BROOKE GROUP LTD., ET AL.
and WALKER, ET AL. V. LIGGETT GROUP INC., ET AL. have been settled by Liggett,
subject to court approval. These two settlements are more fully discussed below
under the "Settlements" section.
In October 1991, an action entitled BROIN, ET AL. V. PHILIP MORRIS
INCORPORATED, ET AL., Circuit Court of the Eleventh Judicial District in and
for Dade County, Florida, was filed against Liggett and others. This case was
brought by plaintiffs on behalf of all flight attendants that worked or are
presently working for airlines based in the United States and who never
regularly smoked cigarettes but allege that they have been damaged by
involuntary exposure to ETS. In October 1997, the other major tobacco companies
settled this matter which settlement provides for a release of Liggett and BGL.
In February 1998, the Circuit Court
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approved the settlement; however, an objector filed a Notice of Appeal of the
settlement in the Third District Court of Appeal.
In March 1994, an action entitled CASTANO, ET AL. V. THE AMERICAN
TOBACCO COMPANY INC., ET AL., United States District Court, Eastern District of
Louisiana, was filed against Liggett and others. The class action complaint
sought relief for a nationwide class of smokers based on their alleged
addiction to nicotine. In February 1995, the District Court granted plaintiffs'
motion for class certification (the "Class Certification Order").
In May 1996, the Court of Appeals for the Fifth Circuit reversed the
Class Certification Order and instructed the District Court to dismiss the
class complaint. The Fifth Circuit ruled that the District Court erred in its
analysis of the class certification issues by failing to consider how
variations in state law affect predominance of common questions and the
superiority of the class action mechanism. The appeals panel also held that the
District Court's predominance inquiry did not include consideration of how a
trial on the merits in CASTANO would be conducted. The Fifth Circuit further
ruled that the "addiction-as-injury" tort is immature and, accordingly, the
District Court could not know whether common issues would be a "significant"
portion of the individual trials. According to the Fifth Circuit, any savings
in judicial resources that class certification may bring about is speculative
and would likely be overwhelmed by the procedural problems certification
brings. Finally, the Fifth Circuit held that in order to make the class action
manageable, the District Court would be forced to bifurcate issues in violation
of the Seventh Amendment.
The extent of the impact of the CASTANO decision on tobacco-related
class action litigation is still uncertain, although the decertification of the
CASTANO class by the Fifth Circuit may preclude any federal court from
certifying a nationwide class action for trial purposes with respect to
tobacco-related claims. The CASTANO decision has had, however, only limited
effect with respect to courts' decisions regarding narrower tobacco-related
classes or class actions brought in state rather than federal court. For
example, since the Fifth Circuit's ruling, courts in New York, Louisiana and
Maryland have certified "addiction-as-injury" class actions that covered only
citizens in those states. Two class actions pending in state court in Florida
have also been certified, one of which, the BROIN case, was settled in 1997.
The CASTANO decision has had no measurable impact on litigation brought by or
on behalf of single individual claimants.
ATTORNEY GENERAL ACTIONS. As of September 30, 1998, 40 Attorney
General Actions were filed against Liggett and BGL. As more fully discussed
below, Liggett and BGL have settled 36 of these actions. In addition, Liggett
has reached settlements with nine Attorneys General representing states,
commonwealths or territories that have not yet commenced litigation against
Liggett or BGL. In these proceedings, state and local government entities seek
reimbursement for Medicaid and other health care expenditures allegedly caused
by use of tobacco products. The claims asserted in these health care cost
recovery actions vary. In most of these cases, plaintiffs assert the equitable
claim that the tobacco industry was "unjustly enriched" by plaintiffs' payment
of health care costs allegedly attributable to smoking and seek reimbursement
of those costs. Other claims made by some but not all plaintiffs include the
equitable claim of indemnity, common law claims of negligence, strict
liability, breach of express and implied warranty, violation of a voluntary
undertaking or special duty, fraud, negligent misrepresentation, conspiracy,
public nuisance, claims under state and federal statutes governing consumer
fraud, antitrust, deceptive trade practices and false advertising, and claims
under RICO.
THIRD-PARTY PAYOR ACTIONS. As of September 30, 1998, there were
approximately 70 Third-Party Payor Actions pending. The claims in these cases
are similar to those in the Attorney General Actions. In April 1998, a group
known as the "Coalition for Tobacco Responsibility", which represents Blue
Cross and Blue Shield Plans in more than 35 states, filed federal lawsuits
against the industry seeking payment of health-care costs allegedly incurred as
a result of cigarette smoking and ETS. The lawsuits were filed in Federal
District Courts in New York, Chicago and Seattle and seek billions of dollars
in damages. The lawsuits allege conspiracy, fraud, misrepresentation, and
violation of federal racketeering and anti-trust laws as well as other claims.
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SETTLEMENTS. In March, 1996, Liggett and BGL entered into an
agreement, subject to court approval, to settle the CASTANO class action
tobacco litigation. Under the CASTANO settlement agreement, upon final court
approval of the settlement, the CASTANO class would be entitled to receive up
to five percent of Liggett's pretax income (income before income taxes) each
year (up to a maximum of $50,000 per year) for the next 25 years, subject to
certain reductions provided for in the agreement and a $5,000 payment from
Liggett if Liggett or BGL fail to consummate a merger or similar transaction
with another non-settling tobacco company defendant within three years of the
date of settlement. Liggett and BGL have the right to terminate the CASTANO
settlement under certain circumstances. On March 14, 1996, Liggett, the CASTANO
Plaintiffs Legal Committee and the CASTANO plaintiffs entered into a letter
agreement. According to the terms of the letter agreement, for the period
ending nine months from the date of Final Approval (as defined in the letter),
if granted, of the CASTANO settlement or, if earlier, the completion by Liggett
or BGL of a combination with any defendant in CASTANO, except Philip Morris,
the CASTANO plaintiffs and their counsel agree not to enter into any more
favorable settlement agreement with any CASTANO defendant which would reduce
the terms of the CASTANO settlement agreement. If the CASTANO plaintiffs or
their counsel enter into any such settlement during this period, they shall pay
Liggett $250,000 within 30 days of the more favorable agreement and offer
Liggett and BGL the option to enter into a settlement on terms at least as
favorable as those included in such other settlement. The letter agreement
further provides that during the same time period, and if the CASTANO
settlement agreement has not been earlier terminated by Liggett in accordance
with its terms, Liggett and its affiliates will not enter into any business
transaction with any third party which would cause the termination of the
CASTANO settlement agreement. If Liggett or its affiliates enter into any such
transaction, then the CASTANO plaintiffs will be entitled to receive $250,000
within 30 days from the transacting party. In May 1996, the CASTANO Plaintiffs
Legal Committee filed a motion with the United States District Court for the
Eastern District of Louisiana seeking preliminary approval of the CASTANO
settlement. In September 1996, shortly after the class was decertified, the
CASTANO plaintiffs withdrew the motion for approval of the CASTANO settlement.
In March 1996, Liggett and BGL entered into a settlement of
tobacco-related litigation with the Attorneys General of Florida, Louisiana,
Massachusetts, Mississippi and West Virginia (the "March 1996 Settlements").
The March 1996 Settlements release Liggett and BGL from all tobacco-related
claims including claims for health case cost reimbursement and claims
concerning sales of cigarettes to minors. Certain of the terms of the March
1996 Settlements are summarized below.
Under the March 1996 Settlements, the five settling states would share
an initial payment by Liggett of $5,000, payable over nine years and indexed
and adjusted for inflation, provided that any unpaid amount will be due 60 days
after either a default by Liggett in its payment obligations under the
settlement or a merger or other similar transaction by Liggett or BGL with
another defendant in the lawsuits. In addition, Liggett will be required to pay
the settling states a percentage of Liggett's pretax income (income before
income taxes) each year from the second through the twenty-fifth year. This
annual percentage is 2.5% of Liggett's pretax income, subject to increase to
7.5% depending on the number of additional states joining the settlement. No
additional states have joined this settlement to date. All of Liggett's
payments are subject to certain reductions provided for in the agreement.
Liggett has also agreed to pay to the settling states $5,000 if Liggett or BGL
fails to consummate a merger or other similar transaction with another
defendant in the lawsuits within three years from the date of the March 1996
Settlements.
Settlement funds received by the Attorneys General will be used to
reimburse the states for smoking-related health care costs. Liggett and BGL
also have agreed to phase in compliance with certain of the proposed interim
FDA regulations on the same basis as provided in the CASTANO settlement.
Liggett and BGL have the right to terminate the March 1996 Settlements with
respect to any settling state if any of the remaining defendants in the
litigation succeed on the merits in that state's respective Attorney General
action. Liggett and BGL may also terminate the March 1996 Settlements if they
conclude that too many states have filed Attorney General actions and have not
settled such cases with Liggett and BGL.
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In March 1997, Liggett, BGL and the five settling states executed an
addendum pursuant to which Liggett and BGL agreed to provide to the five
settling states, among other things, the additional cooperation and compliance
with advertising restrictions that is provided for in the March 1997
Settlements (discussed below). Also, pursuant to the addendum, the initial
settling states agreed to use best efforts to ensure that in the event of a
global tobacco settlement enacted through federal legislation or otherwise,
Liggett's and BGL's financial obligations under such a global settlement would
be no more onerous than under this settlement.
During 1997, Liggett and BGL entered into a comprehensive settlement
of tobacco litigation through parallel agreements with the Attorneys General of
21 states and with a nationwide class of individuals and entities that allege
smoking-related claims (settlements with these 21 Attorneys General and with
the nationwide class are hereinafter referred to as the "March 1997
Settlements"). In March 1998, Liggett and BGL announced settlements with the
Attorneys General of 15 states, the District of Columbia, Guam, Northern
Mariana Islands and the U.S. Virgin Islands (the "March 1998 Settlements"). The
foregoing settlements cover all smoking-related claims, including both
addiction-based and tobacco injury claims against Liggett and BGL, brought by
the Attorneys General and, upon court approval, the nationwide class.
The states, commonwealths and territories where settlements have been
reached with Attorneys General are: Alaska, Arizona, Arkansas, California,
Colorado, Connecticut, District of Columbia, Florida, Georgia, Guam, Hawaii,
Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Maryland,
Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska,
Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Northern
Mariana Islands, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Texas,
Utah, U.S. Virgin Islands, Washington, West Virginia, Wisconsin and Wyoming.
Other states have either recently filed health care cost recovery actions or
indicated intentions to do so. Both Liggett and BGL will endeavor to resolve
those actions on substantially the same terms and conditions as the March 1998
Settlements, however, there can be no assurance that any such settlements will
be completed.
As mentioned above, in March 1997, Liggett, BGL and plaintiffs filed
a mandatory class settlement agreement in an action entitled FLETCHER, ET AL.
V. BROOKE GROUP LTD., ET AL., Circuit Court of Mobile County, Alabama, where
the court granted preliminary approval and preliminary certification of the
class, and in May 1997, a similar mandatory class settlement agreement was
filed in an action entitled WALKER, ET AL. V. LIGGETT GROUP INC., ET AL.,
United States District Court, Southern District of West Virginia. On July 2,
1998, Liggett, BGL and plaintiffs filed an amended class action settlement
agreement in FLETCHER. Pursuant to the amended agreement, Liggett is required
to pay to the class 7.5% of Liggett's pre-tax income each year for 25 years,
with a minimum annual payment guarantee of $1,000 over the term of the
agreement. The amended agreement does not set forth a formula with respect to
the distribution of settlement proceeds to the class. On September 10, 1998,
the Circuit Court held a hearing with respect to the parties' motion for
reaffirmance of preliminary approval of the amended agreement. The court has
not yet ruled on this motion. The Company anticipates that should the court in
FLETCHER, after dissemination of notice to the class of the pending limited
fund class action settlement and a full fairness hearing with respect thereto,
issue a final order and judgment approving the settlement, such an order would
preclude further prosecution by class members of tobacco-related claims against
Liggett and BGL. Under the Full Faith and Credit Act, a final judgment entered
in a nationwide class action pending in a state court has a preclusive effect
against any class member with respect to the claims settled and released in the
nationwide class action. As the class definition in FLETCHER encompasses all
persons in the United States who could claim injury as a result of cigarette
smoking or ETS and any third-party payor claimants, it is anticipated that,
upon final order and judgment, all such persons and third-party payor claimants
would be barred from further prosecution of tobacco-related claims against
Liggett and BGL.
In the FLETCHER action, it is anticipated that class members will be
notified of the settlement and will have an opportunity to appear at a later
court hearing. Effectiveness of the mandatory settlement is
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conditioned on final court approval of the settlement after a fairness hearing.
There can be no assurance as to whether, or when, such court approval will be
obtained.
The WALKER court also granted preliminary approval and preliminary
certification of the nationwide class; however, on August 5, 1997, the court
vacated its preliminary certification of the settlement class, which decision
is currently on appeal. The WALKER court relied on the Supreme Court's decision
in AMCHEM PRODUCTS INC. V. WINDSOR in reaching its decision. In AMCHEM, the
Supreme Court affirmed a decision of the Third Circuit vacating the
certification of a settlement class that involved asbestos-exposure claims. The
Supreme Court held that the proposed settlement class did not meet the
requirements for Rule 23 of the Federal Rules of Civil Procedure for
predominance of common issues and adequacy of representation. The Third Circuit
had held that, although classes could be certified for settlement purposes
only, Rule 23's requirements had to be satisfied as if the case were going to
be litigated. The Supreme Court agreed that the fairness and adequacy of the
settlement are not pertinent to the predominance inquiry under Rule 23(b)(3),
and thus, the proposed class must have sufficient unity so that absent class
members can fairly be bound by decisions of class representatives.
After the AMCHEM opinion was issued by the Supreme Court on June 25,
1997, objectors to Liggett's settlement in WALKER moved for decertification.
Although Liggett's settlements, particularly in the WALKER action, are "limited
fund" class action settlements proceeding under Rule 23(b)(1), and AMCHEM was a
Rule 23(b)(3) case, the court in the WALKER action, nonetheless, decertified
the WALKER class. Applying AMCHEM to the WALKER case, the District Court, in a
decision issued on August 5, 1997, determined that while plaintiffs in WALKER
have a common interest in "maximizing the limited fund available from the
defendants," there remained "substantial conflicts among class members relating
to distribution of the fund and other key concerns" that made class
certification inappropriate.
The AMCHEM decision's ultimate effect on the viability of the WALKER
and FLETCHER settlements remains uncertain given the Fifth Circuit's recent
ruling reaffirming the limited fund class action settlement in IN RE ASBESTOS
LITIGATION ("AHEARN"). In June 1997, the Supreme Court remanded AHEARN to the
Fifth Circuit for consideration in light of AMCHEM. On remand, the Fifth
Circuit made two decisive distinctions between AMCHEM and AHEARN. First, the
AHEARN class action proceeded under Rule 23(b)(1) while AMCHEM was a Rule
23(b)(3) case and second, in AHEARN, there was no allocation or difference in
award, according to nature or severity of injury, as there was in AMCHEM. The
Fifth Circuit concluded that all members of the class and all class
representatives share common interests and none of the uncommon questions
abounding in AMCHEM exist. On June 22, 1998, the Supreme Court granted
certiorari to review the Fifth Circuit decision.
The remaining material terms of the March 1996 Settlements, the March
1997 Settlements and the March 1998 Settlements are described below.
Pursuant to each of the settlements, both Liggett and BGL agreed to
cooperate fully with the Attorneys General and the nationwide class in their
respective lawsuits against the tobacco industry. Liggett and BGL agreed to
provide to these parties all relevant tobacco documents in their possession,
other than those subject to claims of joint defense privilege, and to waive,
subject to court order, certain attorney-client privileges and work product
protections regarding Liggett's smoking-related documents to the extent Liggett
and BGL can so waive these privileges and protections. The Attorneys General
and the nationwide class agreed to keep Liggett's documents under protective
order and, subject to final court approval, to limit their use to those actions
brought by parties to the settlement agreements. Those documents that may be
subject to a joint defense privilege with other tobacco companies will not be
produced to the Attorneys General or the nationwide class, but will be,
pursuant to court order, submitted to the appropriate court and placed under
seal for possible IN CAMERA review. Additionally, under similar protective
conditions, Liggett and BGL agreed to offer their employees for witness
interviews and testimony at deposition and trial. Pursuant to both settlement
agreements, Liggett also agreed to place an additional warning on its cigarette
packaging stating that "Smoking is Addictive" and to issue a public statement,
as requested by the Attorneys General. Liggett has commenced distribution of
cigarette packaging which displays the new warning label.
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Pursuant to the March 1996 Settlements, any other tobacco company
defendant, except Philip Morris, merging or combining with Liggett or BGL,
prior to the third anniversary of the settlement, would receive certain
settlement benefits, including limitations on potential liability. Pursuant to
the agreement, any such combining tobacco company would be released from the
lawsuits brought by the five initial settling states. Such combining tobacco
company would be obligated to pay into the settlement fund within sixty days of
becoming bound to the agreement $135,000, and make annual payments of 2.5% of
the combining company's pre-tax income (but not less than $30,000 per year).
Such combining tobacco company would also have to comply with the advertising
and access restrictions provided for in the agreement, and would have to
withdraw their objections to the FDA rule.
Pursuant to the March 1997 Settlements, any other tobacco company
defendant, except Philip Morris, merging or combining with Liggett or BGL,
prior to the fourth anniversary of the settlements, would receive certain
settlement benefits, including limitations on potential liability for
affiliates not engaged in domestic tobacco operations and a waiver of any
obligation to post a bond to appeal any future adverse judgment. In addition,
within 120 days following any such combination, Liggett would be required to
pay the settlement fund $25,000. Under all settlements, the plaintiffs have
agreed not to seek an injunction preventing a defendant tobacco company
combining with Liggett or BGL from spinning off any affiliate which is not
engaged in the domestic tobacco business.
Pursuant to the March 1998 Settlements, Liggett is required to pay each
of settling states and territories their relative share (based on the Medicaid
population of each state over the total Medicaid population of the United
States) of between 27.5% and 30% of Liggett's pre-tax income each year for 25
years, with a minimum payment guarantee of $1,000 per state over the first nine
years of the agreement. The aggregate payments required under the March 1996,
March 1997 and March 1998 Settlements are $45,000, of which $3,639 was paid as
of September 30, 1998. The liability for the settlements has been recorded in
the Company's financial statements using a discount rate of 18%. The annual
percentage is subject to increase, pro rata from 27.5% up to 30%, depending on
the number of additional states joining the settlement. Pursuant to the "most
favored nation" provisions under the March 1996 and March 1997 Settlements, each
of the states settling under those settlements could benefit from the economic
terms of the March 1998 Settlements. In all settlements, Liggett agreed to
phase-in compliance with certain proposed FDA regulations regarding smoking by
children and adolescents, including a prohibition on the use of cartoon
characters in tobacco advertising and limitations on the use of promotional
materials and distribution of sample packages where minors are present. The
March 1998 Settlements provide for additional restrictions and regulations on
Liggett's advertising, including a prohibition on outdoor advertising and
product advertising on the Internet and on payments for product placement in
movies and television.
Under all settlements, Liggett and BGL are also entitled to "most
favored nation" treatment in the event any settling Attorney General reaches a
settlement with any other defendant tobacco company. Pursuant to the March 1996
and March 1997 Settlements, in the event of a global settlement involving
federal legislation with any other defendant tobacco company, the settling
Attorneys General agreed to use their "best efforts" to ensure that Liggett's
and BGL's liability under such legislation should be no more onerous than under
those settlements. Under the March 1998 Settlements, the settling Attorneys
General agreed to write letters to Congress and the President of the United
States to ensure that Liggett's and BGL's liability under any such legislation
should be more onerous than under this settlement.
Liggett accrued approximately $4,000 for the present value of the fixed
payments under the March 1996 Settlements and $16,902 for the present value of
the fixed payments under the March 1998 Settlements. No additional amounts have
been accrued because Liggett cannot quantify the future costs of the settlements
as the amounts Liggett must pay are based, in part, on future operating results.
Possible future payments based on a percentage of pretax income, and other
contingent payments based on the occurrence of a business combination, will be
expensed when considered probable.
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Separately, the other tobacco companies negotiated settlements of the
Attorney General Actions in Mississippi, Florida, Texas, and Minnesota, and it
has been widely publicized that the other companies have engaged in
negotiations to settle with the Attorneys General of the remaining states.
Copies of the various settlement agreements are filed as exhibits to
Liggett's Form 10-K and the discussion herein is qualified in its entirety by
reference thereto.
TRIALS. On July 6, 1998, trial commenced in the ENGLE, ET AL. V.
PHILIP MORRIS INCORPORATED, ET AL. case, a class action pending in Miami Dade
County, Florida, brought on behalf of all Florida residents allegedly injured
by smoking. There are several trial dates scheduled during 1999 for Third-Party
Payor and Individual Actions; however, trial dates are subject to change.
OTHER RELATED MATTERS. In March 1997, RJR, Philip Morris, B&W and
Lorillard obtained a temporary restraining order from a North Carolina state
court preventing Liggett and BGL and their agents, employees, directors,
officers and lawyers from turning over documents allegedly subject to the joint
defense privilege in connection with the settlements, which restraining order
was converted to a preliminary injunction by the court in April 1997. In March
1997, the United States District Court for the Eastern District of Texas and
state courts in Mississippi and Illinois each issued orders enjoining the other
tobacco companies from interfering with Liggett's filing with the courts, under
seal, those documents.
A grand jury investigation is being conducted by the office of the
United States Attorney for the Eastern District of New York (the "Eastern
District Investigation") regarding possible violations of criminal law relating
to the activities of The Council for Tobacco Research - USA, Inc. (the "CTR").
Liggett was a sponsor of the CTR at one time. In May 1996, Liggett received a
subpoena from a Federal grand jury sitting in the Eastern District of New York,
to which Liggett has responded.
In March 1996, and in each of March, July, October and December 1997,
Liggett and/or BGL received subpoenas from a Federal grand jury in connection
with an investigation by the United States Department of Justice (the "DOJ
Investigation") involving the industry's knowledge of the health consequences
of smoking cigarettes; the targeting of children by the industry and the
addictive nature of nicotine and the manipulation of nicotine by the industry.
Liggett has responded to the March 1996, March 1997 and July 1997 subpoenas and
is in the process of responding to the October and December 1997 subpoenas.
Liggett understands that the Eastern District Investigation and the DOJ
Investigation essentially have been consolidated into one investigation
conducted by the Department of Justice (the "DOJ"). Liggett and BGL are unable,
at this time, to predict the outcome of this investigation.
On April 28, 1998, BGL announced that Liggett had reached an agreement
with the United States Department of Justice to cooperate in both the Eastern
District Investigation and the DOJ Investigation. The agreement does not
constitute an admission of any wrongful behavior by Liggett. The DOJ has not
provided immunity to Liggett and has full discretion to act or refrain from
acting with respect to Liggett in the investigation.
In September 1998, Liggett received a subpoena from a federal grand
jury in the Eastern District of Philadelphia investigating possible antitrust
violations in connection with the purchase of tobacco by and for tobacco
companies. Liggett is in the process of responding to this subpoena. Liggett
and BGL are unable, at this time, to predict the outcome of this investigation.
Litigation is subject to many uncertainties, and it is possible that
some of the aforementioned actions could be decided unfavorably against Liggett
or BGL. An unfavorable outcome of a pending smoking and health case could
encourage the commencement of additional similar litigation. Liggett is unable
to evaluate the effect of these developing matters on pending litigation or the
possible commencement of additional litigation. Liggett is also unable to make
a meaningful estimate with respect to the amount of loss that could result from
an unfavorable outcome of many of the cases pending against
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the Company, because the complaints filed in these cases rarely detail alleged
damages. Typically, the claims set forth in an individual's complaint against
the tobacco industry pray for money damages in an amount to be determined by a
jury, plus punitive damages and costs. These damage claims are typically stated
as being for the minimum necessary to invoke the jurisdiction of the court.
Third-party payor claimants and others have set forth several
additional variations on relief sought: funding of corrective public education
campaigns relating to issues of smoking and health; funding for clinical
smoking cessation programs; disgorgement of profits from sales of cigarettes;
restitution; treble damages; and attorneys' fees. Nevertheless, no specific
amounts are provided. It is understood that requested damages against the
tobacco company defendants in these cases might be in the billions of dollars.
It is possible that Liggett's consolidated financial position, results
of operation and cash flow could be materially adversely affected by an
unfavorable outcome in any such tobacco-related litigation.
Liggett has been involved in certain environmental proceedings, none
of which, either individually or in the aggregate, rises to the level of
materiality. Liggett's current operations are conducted in material compliance
with all environmental laws and regulations. Management is unaware of any
material environmental conditions affecting its existing facilities. Compliance
with federal, state and local provisions regulating the discharge of materials
into the environment, or otherwise relating to the protection of the
environment, has not had a material effect on the capital expenditures,
earnings or competitive position of Liggett.
There are several other proceedings, lawsuits and claims pending
against Liggett 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 Liggett's
financial position, results of operations or cash flows.
LEGISLATION AND REGULATION:
In January 1993, the United States Environmental Protection Agency
("EPA") released a report on the respiratory effect of ETS which concludes that
ETS is a known human lung carcinogen in adults and in children, causes increased
respiratory tract disease and middle ear disorders and increases the severity
and frequency of asthma. In June 1993, the two largest of the major domestic
cigarette manufacturers, together with other segments of the tobacco and
distribution industries, commenced a lawsuit against the EPA seeking a
determination that the EPA did not have the statutory authority to regulate ETS,
and that given the current body of scientific evidence and the EPA's failure to
follow its own guidelines in making the determination, the EPA's classification
of ETS was arbitrary and capricious. Whatever the outcome of this litigation,
issuance of the report may encourage efforts to limit smoking in public areas.
In July 1998, the court ruled that the EPA made procedural and scientific
mistakes when it declared in its 1993 report that secondhand smoke caused as
many as 3,000 cancer deaths a year among nonsmokers.
In April 1994, the United States Occupational Safety and Health
Administration ("OSHA") issued a proposed rule that could ultimately ban
smoking in the workplace. Hearings were completed during 1995. OSHA has not yet
issued a final rule or a proposed revised rule. While Liggett cannot predict
the outcome, some form of federal regulation of smoking in workplaces may
result.
In February 1996, the United States Trade representative issued an
"advance notice of rule making" concerning how tobaccos imported under a
previously established tobacco rate quota ("TRQ") should be allocated.
Currently, tobacco imported under the TRQ is allocated on a "first-come,
first-served" basis, meaning that entry is allowed on an open basis to those
first requesting entry in the quota year. Others in the cigarette industry have
suggested an "end-user licensing" system under which the right to
20
<PAGE> 21
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 Liggett.
In August 1996, the FDA filed in the Federal Register a Final Rule
(the "FDA Rule") classifying tobacco as a drug, asserting jurisdiction by the
FDA over the manufacture and marketing of tobacco products and imposing
restrictions on the sale, advertising and promotion of tobacco products.
Litigation was commenced in the United States District Court for the Middle
District of North Carolina challenging the legal authority of the FDA to assert
such jurisdiction, as well as challenging the constitutionality of the rules.
The court, after argument, granted plaintiffs' motion for summary judgment
prohibiting the FDA from regulating or restricting the promotion and
advertising of tobacco products and denied plaintiffs' motion for summary
judgment on the issue of whether the FDA has the authority to regulate access
to, and labeling of, tobacco products. The Fourth Circuit Court reversed the
district court on appeal and on August 14, 1998 held that the FDA cannot
regulate tobacco products because Congress had not given them the authority to
do so. Liggett and BGL support the FDA Rule and have begun to phase in
compliance with certain of the proposed interim FDA regulations. See
discussions of the CASTANO and Attorney General Actions above.
In August 1996, the Commonwealth of Massachusetts enacted legislation
requiring tobacco companies to publish information regarding the ingredients in
cigarettes and other tobacco products sold in that state. In December 1997, the
United States District Court for the District of Massachusetts enjoined this
legislation from going into effect; however, in December 1997, Liggett began
complying with this legislation by providing ingredient information to the
Massachusetts Department of Public Health.
As part of the budget agreement recently approved by Congress, federal
excise taxes on a pack of cigarettes, which are currently 24 cents, would rise
10 cents in the year 2000 and 5 cents more in the year 2002. Additionally, the
citizens of California recently voted in favor of a 50 cent per pack tax on
cigarettes sold in that state.
PROPOSED RESOLUTION. In June 1997, Philip Morris Incorporated ("Philip
Morris"), R. J. Reynolds Tobacco Company ("RJR"), B&W, Lorillard Tobacco
Company ("Lorillard") and the United States Tobacco Company, along with the
Attorneys General for the States of Arizona, Connecticut, Florida, Mississippi,
New York and Washington and the CASTANO Plaintiffs' Litigation Committee
executed a Memorandum of Understanding to support the adoption of federal
legislation and necessary ancillary undertakings, incorporating the features
described in a proposed resolution (the "Resolution"). The proposed Resolution
mandates a total reformation and restructuring of how tobacco products are
manufactured, marketed and distributed in the United States. (The proposed
Resolution is discussed in Liggett's 1997 Form 10-K/A No. 1.)
In a speech in September 1997, President Clinton called for federal
legislation that, among other things, would raise cigarette prices by up to
$1.50 per pack. Since then, several bills have been introduced in Congress,
including bills modeled after the proposed Resolution, that purport to propose
legislation along these lines. The White House, Congress and various public
interest groups are currently reviewing the proposed Resolution along with
other proposed federal tobacco legislation. Management is unable to predict
whether the proposed Resolution or other federal legislation will be enacted or
the form any such enactment might take. The present legislative and litigation
environment is substantially uncertain and could have a material adverse effect
on the business of Liggett.
In addition to the foregoing, there have been a number of other
restrictive regulatory actions, adverse political decisions and other
unfavorable developments concerning cigarette smoking and the tobacco industry,
the effects of which, at this time, Liggett is not able to evaluate.
21
<PAGE> 22
9. RELATED PARTY TRANSACTIONS
During the third quarter of 1998, BGL contributed 470,000 shares of its
common stock to Liggett. On August 28, 1998, Liggett transferred the 470,000
shares of BGL common stock to members of a law firm which represents the Company
and BGL. The Company recognized charges of $1,686 related to this transaction.
On March 12, 1998, BGL granted an option for 1,250,000 shares of BGL's
common stock to a law firm that represents Liggett and BGL. On October 12, 1998,
BGL amended the option agreement by reducing the original exercise price from
$17.50 per share to $6.00 per share and extending the initial exercise date on
all 1,250,000 shares to April 1, 2000, subject to earlier exercise under certain
circumstances. The option expires on March 31, 2003. The fair value of the
equity instrument was estimated based on the Black-Scholes option pricing model
and the following assumptions: volatility 77.6%, risk-free interest rate of
5.47%, expected life of two years and a dividend rate of 0%. Liggett will
recognize expenses of $5,113 over the vesting period.
On July 5, 1996, Liggett purchased 140,000 shares (19.97%) of
Liggett-Ducat's tobacco operations from BOL, for $2,100. Liggett-Ducat produces
and markets cigarettes in Russia. Liggett also acquired on that date for $3,400
a ten-year option to purchase from BOL at the same per share price up to 292,407
additional shares of Liggett-Ducat, thereby entitling Liggett to increase its
interest in Liggett-Ducat to approximately 62%. On March 13, 1997, Liggett
acquired a second ten-year option to purchase BOL's remaining shares in
Liggett-Ducat (an additional 33%) for $2,200. Such amounts were accounted for as
an element of cash flows from investing activities in the Company's consolidated
statements of cash flows. Liggett accounted for its investment in Liggett-Ducat
under the equity method of accounting. The excess of the cost of the option over
the carrying amount of net assets to be acquired under the option has been
charged to stockholder's deficit. On January 30, 1998, in connection with the
restructuring of the Liggett Notes, BOL acquired the Liggett-Ducat shares and
options held by Liggett. (Refer to Note 7 to the Company's consolidated
financial statements.)
On April 28, 1997, BOL purchased excess production equipment from
Liggett for $3,000. The difference of $2,578 between the sale price and the
carrying value is accounted for as a credit to contributed capital.
Liggett is party to a Tax-Sharing Agreement dated June 29, 1990 with
BGL and certain other entities pursuant to which Liggett has paid taxes to BGL
as if it were filing a separate company tax return, except that the agreement
effectively limits the ability of Liggett to carry back losses for refunds.
Liggett is entitled to recoup overpayments in a given year out of future
payments due under the agreement.
Liggett is a party to an agreement dated February 26, 1991, as amended
October 1, 1995, with BGL to provide various management and administrative
services to the Company in consideration for an annual management fee of $900
paid in monthly installments and annual overhead reimbursements of $864 paid in
quarterly installments.
Liggett has entered into an annually renewable Corporate Services
Agreement with BGLS wherein BGLS agreed to provide corporate services to the
Company at an annual fee paid in monthly installments. Corporate services
provided by BGLS under this agreement include the provision of administrative
services related to Liggett's participation in its parent company's
multi-employer benefit plan, external publication of financial results,
preparation of consolidated financial statements and tax returns and such other
administrative and managerial services as may be reasonably requested by
Liggett. The charges for services rendered under the agreement amounted to
$1,377 in the nine months of 1998 and $2,489 in the nine months of 1997. This
fee is in addition to the management fee and overhead reimbursements described
above. In connection with the January 30, 1998 amendment to the Liggett Notes
Indenture, BGL and BGLS agreed to waive corporate services and management fees
above $3,600 per year, effective January 1, 1998.
Since April 1994, the Company has leased equipment from BGLS for $50
per month.
22
<PAGE> 23
10. RESTRUCTURING CHARGES
During 1997, the Company reduced its headcount by 108 full-time
positions and recorded a $1,964 restructuring charge to operations ($407 of
which was included in cost of sales) for severance programs, primarily salary
continuation and related benefits for terminated employees. Of the total
restructuring recorded during 1997, $1,671 was funded during 1997, leaving $293
remaining to be funded in 1998.
For the nine months ending September 30, 1998, restructuring charges
of approximately $241 were funded, leaving $52 to be funded in the remainder of
1998.
23
<PAGE> 24
EVE HOLDINGS INC.
BALANCE SHEETS
(Unaudited)
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
Cash ........................................................................... $ 2 $ 1
Office equipment ............................................................... 2 2
Trademarks, at cost, less accumulated amortization of
$20,270 and $18,995, respectively .......................................... 143 1,418
---------- ----------
Total assets .................................................... $ 147 $ 1,421
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)
Federal income taxes currently payable to parent ............................... $ 68 $ 91
Dividends payable .............................................................. 1,337 1,273
Other current liabilities ...................................................... 7 3
Deferred income taxes .......................................................... 50 496
---------- ----------
Total liabilities ................................................ 1,462 1,863
---------- ----------
Stockholder's equity (deficit):
Common stock (par value $1.00 per share; authorized,
issued and outstanding 100 shares) and contributed
capital ................................................................ 49,341 45,442
Receivables from parent:
Note receivable - interest at 14%, due no sooner
than February 1, 1999 ................................................. (44,520) (44,520)
Other ................................................................... (6,136) (1,364)
---------- ----------
Total stockholder's deficit ...................................... (1,315) (442)
---------- ----------
Total liabilities and stockholder's equity (deficit) ............. $ 147 $ 1,421
========== ==========
</TABLE>
The accompanying notes are an integral
part of these financial statements.
24
<PAGE> 25
EVE HOLDINGS INC.
STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
1998 1997 1998 1997
------ ------- ------- ------
<S> <C> <C> <C> <C>
Revenues:
Royalties - parent ........................... $2,078 $ 1,830 $ 5,649 $5,137
Interest - parent ............................ 1,576 1,576 4,729 4,729
------ ------- ------- ------
3,654 3,406 10,378 9,866
Expenses:
Amortization of trademarks ................... 425 425 1,276 1,276
Miscellaneous, net ........................... 22 18 60 82
------ ------- ------- ------
Income before income taxes .............. 3,207 2,963 9,042 8,508
Income tax provision .............................. 571 486 1,510 1,323
------ ------- ------- ------
Net income .............................. $2,636 $ 2,477 $ 7,532 $7,185
====== ======= ======= ======
</TABLE>
The accompanying notes are an integral
part of these financial statements.
25
<PAGE> 26
EVE HOLDINGS INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------
1998 1997
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income .............................................................. $ 7,532 $ 7,185
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization ....................................... 1,276 1,276
Deferred income taxes ............................................... (447) (447)
Changes in assets and liabilities:
Federal income taxes currently payable to parent .................... (23) 59
Other current liabilities ........................................... 3 (19)
---------- ----------
Net cash provided by operating activities ....................... 8,341 8,054
---------- ----------
Cash flows from financing activities:
Dividends/capital distributions ......................................... (3,573) (6,730)
Increase in cash due from parent ........................................ (4,772) (1,226)
Decrease in cash overdraft .............................................. -- (92)
---------- ----------
Net cash used in financing activities ............................ (8,345) (8,048)
---------- ----------
Net (decrease) increase in cash ............................................. (4) 6
Cash:
Beginning of period ..................................................... 6 --
---------- ----------
End of period ........................................................... $ 2 $ 6
========== ==========
Supplemental cash flow information:
Payments of income taxes through receivable from parent ................. $ 1,887 $ 1,710
Income taxes ............................................................ 27 32
Dividends/capital distributions declared but not paid ................... 1,336 1,178
</TABLE>
The accompanying notes are an integral
part of these financial statements.
26
<PAGE> 27
EVE HOLDINGS INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except per share amounts)
1. THE COMPANY
Eve Holdings Inc. ("Eve") is a wholly-owned subsidiary of Liggett
Group Inc. ("Liggett"). Eve, formed in June 1990, is the proprietor of, and has
all right, title and interest in, certain federal trademark registrations (the
"Trademarks"). Eve has entered into an exclusive licensing agreement with
Liggett (effective until 2010) whereby Eve grants the use of the Trademarks to
Liggett in exchange for royalties, computed based upon Liggett's annual net
sales, excluding excise taxes. The Trademarks are pledged as collateral for
Liggett's borrowings under the notes indentures (see Note 3).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Going Concern
The accompanying financial statements have been prepared assuming that
Eve will continue as a going concern. Eve's revenues are comprised solely of
royalties and interest income from Liggett. In addition, Eve holds a note
receivable from Liggett for $44,520 due no sooner than February 1, 1999.
Liggett had a working capital deficiency of $169,071 and a net capital
deficiency of $183,268 as of September 30, 1998, is highly leveraged and has
substantial near-term debt service requirements. Both the Liggett Series B and
Series C Notes (as defined below) and the revolving credit facility, amounting
in total to approximately $167,500, mature during the first quarter of 1999.
These matters raise substantial doubt about Eve and Liggett meeting their
liquidity needs and their ability to continue as going concerns.
The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
b. Per Share Data
All of Eve's common shares (100 shares authorized, issued and
outstanding for all periods presented herein) are owned by Liggett.
Accordingly, earnings and dividends per share data are not presented in these
financial statements.
3. GUARANTEE OF LIGGETT NOTES
On February 14, 1992, Liggett issued $150,000 of Senior Secured Notes
(the "Series B Notes"). In connection with the issuance of the Series B Notes,
the Trademarks were pledged as collateral. In addition, Eve is a guarantor for
the Series B Notes. At September 30, 1998, a total of $112,612 Series B Notes
remains outstanding.
During 1994, Liggett issued $32,850 of Series C Senior Secured Notes
(the "Series C Notes"). Eve is a guarantor for the Series C Notes. At September
30, 1998, a total of $32,279 Series C Notes remains outstanding.
27
<PAGE> 28
4. INCOME TAXES
Eve qualifies as a company conducting operations exempt from
income taxation under Delaware General Statute Section 1903(b). In recent
years, some states have been aggressively pursuing companies exempt under this
statute. Eve's management believes that certain state income tax rulings
supporting these states' arguments will be ultimately reversed and that Eve's
status as a company not conducting business in these states will be respected.
Consequently, management has not provided a reserve for additional state income
taxes. No assurance can be given with regard to future state income tax rulings
and audit activity with respect to Eve.
28
<PAGE> 29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT SELLING PRICES)
INTRODUCTION
Liggett Group Inc. ("Liggett" or the "Company") is the operating
successor to the Liggett & Myers Tobacco Company formed in 1873. Liggett is the
fifth largest manufacturer of cigarettes in the United States in terms of unit
sales. Liggett is a wholly-owned subsidiary of BGLS Inc. ("BGLS"), a
wholly-owned subsidiary of Brooke Group Ltd. ("BGL").
The following discussion provides an assessment of Liggett's
consolidated results of operations and capital resources and liquidity and
should be read in conjunction with the consolidated financial statements of
Liggett and notes thereto included elsewhere in this Report on Form 10-Q. The
operating results of the periods presented were not significantly affected by
inflation.
Eve Holdings Inc. ("Eve") is a wholly-owned subsidiary of Liggett.
Eve's sole business is to hold certain federal trademark registrations used by,
and to license them on an exclusive basis to, Liggett and to hold a certain
note receivable from Liggett. Accordingly, Management's Discussion and Analysis
of Financial Condition and Results of Operations of Eve are not presented
herein because they are not material to Liggett's operations.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. Liggett had a net
capital deficiency of $183,268 and a working capital deficiency of $169,071 as
of September 30, 1998, is highly leveraged and has substantial near-term debt
service requirements. Due to the many risks and uncertainties associated with
the cigarette industry and the impact of tobacco litigation, there can be no
assurance that the Company will be able to meet its future earnings or cash
flow goals. Consequently, the Company could be in violation of its debt
covenants, including covenants limiting the maximum permitted net worth and
working capital deficiencies, and if the lenders were to exercise acceleration
rights under its revolving credit facility (the "Facility") or the indenture
for its Senior Secured Notes (the "Liggett Notes") or refuse to lend under the
Facility, the Company would not be able to satisfy such demands or its working
capital requirements.
On January 30, 1998, the Company obtained the consents of the required
majority of the holders of the Liggett Notes to various amendments to the
Indenture governing the Liggett Notes. The amendments provided, among other
things, for a deferral of the February 1, 1998 mandatory redemption of $37,500
principal amount of the Liggett Notes to the date of final maturity, February
1, 1999. (Refer to Note 7.) At maturity, the Liggett Notes will require a
principal payment of $144,891. The Company does not anticipate it will be able
to generate sufficient cash from operations to make such payments. In addition,
the Company has the $40,000 Facility expiring March 8, 1999 under which $17,674
was outstanding at September 30, 1998. If the Company is unable to refinance or
restructure the terms of the Liggett Notes or otherwise make all payments
thereon, substantially all of the Company's long-term debt and the Facility
would be in default and holders of such debt could accelerate the maturity of
such debt. In such event, Liggett may be forced to seek protection from
creditors under applicable laws. These matters raise substantial doubt about
the Company meeting its liquidity needs and its ability to continue as a going
concern.
RECENT DEVELOPMENTS IN THE CIGARETTE INDUSTRY
PRICING ACTIVITY. As of November 13, 1998, list price increases during
1998 amount to $1.85 per carton. On January 23, 1998, Philip Morris and RJR
announced a list price increase of $.25 per carton. This action was matched by
Liggett and the other manufacturers during the following week. On April 3,
1998, Philip Morris announced a second list price increase of $.50 per carton.
This action was matched by Liggett and the other manufacturers. On May 11,
1998, Philip Morris and RJR announced a third list price increase of
29
<PAGE> 30
$.50 per carton on all brands. This action was matched by Liggett and the other
manufacturers during the following week. On July 31, 1998, Philip Morris
announced a fourth list price increase of $.60 per carton on all brands. This
action was matched by Liggett and the other manufacturers during the following
week.
LEGISLATION, REGULATION AND LITIGATION. The cigarette industry
continues to be challenged on numerous fronts. New cases continue to be
commenced against Liggett and BGL and other cigarette manufacturers. As of
September 30, 1998, there were approximately 275 individual suits, 45 purported
class actions and 110 state, municipality and other third-party payor health
care reimbursement actions pending in the United States in which Liggett is a
named defendant. As new cases are commenced, the costs associated with
defending such cases and the risks attendant to the inherent unpredictability
of litigation continue to increase. Recently, there have been a number of
restrictive regulatory actions from various Federal administrative bodies,
including the United States Environmental Protection Agency ("EPA") and the
Food and Drug Administration ("FDA"), adverse political decisions and other
unfavorable developments concerning cigarette smoking and the tobacco industry,
including the commencement and certification of class actions and the
commencement of Medicaid reimbursement suits by various states' Attorneys
General. These developments generally receive widespread media attention.
Liggett is not able to evaluate the effect of these developing matters on
pending litigation or the possible commencement of additional litigation, but
it is possible that Liggett's financial position, results of operations and
cash flows could be materially adversely affected by an ultimate unfavorable
outcome in any of such pending litigation. (See Note 8 to the Company's
consolidated financial statements for a description of legislation, regulation
and litigation.)
The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for personal injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence, gross
negligence, special duty, voluntary undertaking, strict liability, fraud,
misrepresentation, design defect, failure to warn, breach of express and
implied warranties, conspiracy, aiding and abetting concert of action, unjust
enrichment, common law public nuisance, indemnity, market share liability, and
violations of deceptive trade practices laws, RICO and antitrust statutes. In
many of these cases, in addition to compensatory damages, plaintiffs also seek
other forms of relief including disgorgement of profits and punitive damages.
Defenses raised by defendants in these cases include lack of proximate cause,
assumption of the risk, comparative fault and/or contributory negligence, lack
of design defect, statutes of limitations or repose, equitable defenses such as
"unclean hands" and lack of benefit, failure to state a claim and federal
preemption.
The claims asserted in the health care cost recovery actions vary. In
most of these cases, plaintiffs assert the equitable claim that the tobacco
industry was "unjustly enriched" by plaintiffs' payment of health care costs
allegedly attributable to smoking and seek reimbursement of those costs. Other
claims made by some but not all plaintiffs include the equitable claim of
indemnity, common law claims of negligence, strict liability, breach of express
and implied warranty, violation of a voluntary undertaking or special duty,
fraud, negligent misrepresentation, conspiracy, public nuisance, claims under
state and federal statutes governing consumer fraud, antitrust, deceptive trade
practices and false advertising, and claims under the RICO.
SETTLEMENTS. In March 1996, Liggett and BGL entered into an agreement
to settle the CASTANO class action tobacco litigation and an agreement with the
Attorneys General of West Virginia, Florida, Mississippi, Massachusetts and
Louisiana to settle certain actions brought against Liggett and BGL by such
states (the "March 1996 Settlements"). Liggett and BGL, while neither
consenting to FDA jurisdiction nor waiving their objections thereto, agreed to
withdraw their objections and opposition to the proposed FDA regulations and to
phase in compliance with certain of the proposed interim FDA regulations.
Under the CASTANO settlement agreement, upon final court approval of
the settlement, the CASTANO class would be entitled to receive up to 5% of
Liggett's pretax income (income before income taxes) each year (up to a maximum
of $50,000 per year) for the next twenty-five years, subject to certain
reductions provided for in the agreement, and a $5,000 payment from Liggett if
Liggett or BGL fail to consummate a merger or similar transaction with another
non-settling tobacco company defendant within three years of the date of the
settlement. Liggett and BGL have the right to terminate the CASTANO settlement
under certain circumstances. On May 11, 1996, the CASTANO Plaintiffs Legal
Committee filed a motion with the United
30
<PAGE> 31
States District Court for the Eastern District of Louisiana seeking preliminary
approval of the CASTANO settlement. On May 23, 1996, the Court of Appeals for
the Fifth Circuit reversed the February 17, 1995 order of the District Court
certifying the CASTANO suit as a nationwide class action and instructed the
District Court to dismiss the class complaint. For additional information
concerning the Fifth Circuit's decision, see Note 8 to the Company's
consolidated financial statements. In September 1996, the CASTANO plaintiffs
withdrew the motion for approval of the CASTANO settlement.
In March 1996, Liggett, the CASTANO Plaintiffs Legal Committee and the
CASTANO plaintiffs entered into a letter agreement. According to the terms of
the letter agreement, for the period ending nine months from the date of Final
Approval (if granted) of the CASTANO settlement or, if earlier, the completion
by Liggett or BGL of a combination with any defendant in CASTANO, except Philip
Morris, the CASTANO plaintiffs and their counsel agree not to enter into any
more favorable settlement agreement with any CASTANO defendant which would
reduce the terms of the CASTANO settlement agreement. If the CASTANO plaintiffs
or their counsel enter into any such settlement during this period, they shall
pay Liggett $250,000 within thirty days of the more favorable agreement and
offer Liggett and BGL the option to enter into a settlement on terms at least
as favorable as those included in such other settlement. The letter agreement
further provides that during the same time period, and if the CASTANO
settlement agreement has not been earlier terminated by Liggett in accordance
with its terms, Liggett and its affiliates will not enter into any business
transaction with any third party which would cause the termination of the
CASTANO settlement agreement. If Liggett or its affiliates enter into any such
transaction, then the CASTANO plaintiffs will be entitled to receive $250,000
within thirty days from the transacting party.
Under the Attorneys General settlement, the five states would share an
initial payment by Liggett of $5,000 ($1,000 of which was paid in March 1996,
with the balance payable over nine years and indexed and adjusted for
inflation), provided that any unpaid amount will be due 60 days after either a
default by Liggett in its payment obligations under the settlement or a merger
or other similar transaction by Liggett or BGL with another defendant in the
lawsuits. In addition, Liggett will be required to pay the states a percentage
of Liggett's pretax income (income before income taxes) each year from the
second through the twenty-fifth year. This annual percentage is 2.5% of
Liggett's pretax income, subject to increase to 7.5% depending on the number of
additional states joining the settlement. No additional states have joined this
settlement to date. All of Liggett's payments are subject to certain reductions
provided for in the agreement. Liggett has also agreed to pay to the states
$5,000 if Liggett or BGL fails to consummate a merger or other similar
transaction with another defendant in the lawsuits within three years of the
date of the settlement.
In 1997, Liggett and BGL entered into a comprehensive settlement of
tobacco litigation through parallel agreements with the Attorneys General of 21
states and with a nationwide class of individuals and entities that allege
smoking-related claims (collectively, the "March 1997 Settlements"). The
settlements cover all smoking-related claims, including both addiction-based
and tobacco injury claims against Liggett and BGL brought by the states and,
upon court approval, the nationwide class. In March 1998, Liggett and BGL
entered into additional settlements with the Attorneys General of 15 states,
the District of Columbia, Guam, the Northern Mariana Islands and the U. S.
Virgin Islands (the "March 1998 Settlements").
In March 1997, Liggett, BGL and plaintiffs filed a mandatory class
settlement agreement in an action entitled FLETCHER, ET AL. V. BROOKE GROUP
LTD., ET AL., Circuit Court of Mobile County, Alabama, where the court granted
preliminary approval and preliminary certification of the class, and in May
1997, a similar mandatory class settlement agreement was filed in an action
entitled WALKER, ET AL. V. LIGGETT GROUP INC., ET AL., United States District
Court, Southern District of West Virginia. On July 2, 1998, the Company and
plaintiffs filed an amended class action settlement agreement in FLETCHER.
Pursuant to the amended agreement, Liggett is required to pay to the class 7.5%
of Liggett's pre-tax income each year for 25 years, with a minimum annual
payment guarantee of $1,000 over the term of the agreement. The amended
agreement does not set forth a formula with respect to the distribution of
settlement proceeds to the class. On September 10, 1998, the Circuit Court held
a hearing with respect to the parties' motion for reaffirmance of preliminary
approval of the amended agreement. The court has not yet ruled on this motion.
The WALKER court also granted preliminary approval and preliminary certification
31
<PAGE> 32
of the nationwide class; however, on August 5, 1997, the court vacated its
preliminary certification of the settlement class, which decision is currently
on appeal.
In the FLETCHER action, it is anticipated that class members will be
notified of the settlement and will have an opportunity to appear at a later
court hearing. Effectiveness of the mandatory settlement is conditioned on
final court approval of the settlement after a fairness hearing. There can be
no assurance as to whether or when court approval will be obtained. For
additional information concerning the FLETCHER action, see Note 8 to the
Company's consolidated financial statements.
Under the March 1998 Settlements, Liggett is required to pay each of
the settling states and territories their relative share (based on the Medicaid
population of each state over the total Medicaid population of the United
States) of between 27.5% and 30% of Liggett's pre-tax income each year for 25
years, with a minimum payment guarantee of $1,000 per state over the first nine
years of the agreement. The annual percentage is subject to increase, pro rata
from 27.5% up to 30%, depending on the number of additional states joining the
settlement. Pursuant to the "most favored nation" provisions under the March
1996 and March 1997 Settlements, each of the states settling under those
settlements could benefit from the economic terms of the March 1998
Settlements.
Liggett accrued approximately $4,000 for the present value of the fixed
payments under the March 1996 Settlements and $16,902 for the present value of
the fixed payments under the March 1998 Settlements. No additional amounts have
been accrued because the Company cannot quantify the future costs of the
settlements as the amounts Liggett must pay are based, in part, on future
operating results. Possible future payments based on a percentage of pretax
income, and other contingent payments based on the occurrence of a business
combination, will be expensed when considered probable. (See the discussions of
the tobacco litigation settlements appearing in Note 8 to the Company's
consolidated financial statements.
Separately, the other tobacco companies negotiated settlements of the
Attorney General Actions in Mississippi, Florida, Texas and Minnesota and it
has been widely publicized that the other companies have engaged in
negotiations to settle with the Attorneys General of the remaining states.
OTHER MATTERS. On June 20, 1997, Philip Morris, RJR, B&W, Lorillard
and the United States Tobacco Company, along with the Attorneys General for the
States of Arizona, Connecticut, Florida, Mississippi, New York and Washington
and the CASTANO Plaintiffs' Litigation Committee executed a Memorandum of
Understanding (the "Resolution") to support the adoption of federal legislation
and necessary ancillary undertakings, incorporating the features described in a
proposed resolution. The proposed Resolution mandates a total reformation and
restructuring of how tobacco products are manufactured, marketed and
distributed in the United States. (For additional information concerning the
proposed Resolution, see Note 8 of the Company's consolidated financial
statements.) The White House, Congress and various public interest groups are
currently reviewing the proposed Resolution along with other proposed federal
tobacco legislation. Management is unable to predict the ultimate effect, if
any, of the enactment of legislation adopting the proposed Resolution.
Management is also unable to predict the ultimate content of any such
legislation. However, adoption of any such legislation could have a material
adverse effect on the business of Liggett.
32
<PAGE> 33
RESULTS OF OPERATIONS
1997 RESTRUCTURING
In January 1997, Liggett underwent a major restructuring from a
centralized organization to a decentralized enterprise with four Strategic
Business Units, each a profit center, and a corporate headquarters. This
restructuring was intended to more closely align sales and marketing strategies
with the unique requirements of regional markets as well as reduce working
capital by improved production planning and inventory control.
During 1997, the Company reduced its headcount by approximately 108
full-time positions and recorded a $1,964 restructuring charge to operations
($407 of which is included in cost of sales) for severance programs, primarily
salary continuation and related benefits for terminated employees. The
anticipated savings of the restructuring relate primarily to reduced payroll
and benefits expenses in future periods. Of the total restructuring recorded
during 1997, $1,671 was funded during 1997, leaving $293 remaining to be funded
in 1998.
For the nine months ending September 30, 1998, restructuring charges
of approximately $241 were funded, leaving $52 to be funded in the remainder of
1998.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997
REVENUES. For the three months ended September 30, 1998, net sales
totaled $85,630, compared to $79,368 for the same period in 1997. Revenues
increased in both the premium and discount segments by 7.9% ($6,262) due to
price increases of $15,723 (see "Recent Developments in the Cigarette Industry
- - Pricing Activity"), partially offset by an 11.7% decline in unit sales volume
(approximately 188.6 million units), accounting for $9,264 in volume variance
and an unfavorable product mix of $197. The decline in Liggett's sales volume
was due to certain competitors' continuing leveraged rebate programs tied to
their products and increased promotional activity by certain other
manufacturers.
Premium sales over this period amounted to $26,986 and represented
31.5% of total revenues, compared to $26,867 and 33.9% of total sales for the
same period in 1997. In the premium segment, revenues grew by 0.4% ($119) over
the three months ended September 30, 1998, compared to the same period in 1997,
due to price increases of $4,010, which were partially offset by a 14.5%
decline in unit sales volume (approximately 64.6 million units), accounting for
$3,891 in volume variance.
Discount sales (comprising the brand categories of branded discount,
private label, control label, generic, international and contract
manufacturing) over this period amounted to $58,644 and represented 68.5% of
total revenues, compared to $52,501 and 66.1% of total sales for the same
period in 1997. In the discount segment, revenues grew by 11.7% ($6,143) over
the three months ended September 30, 1998 compared to the same period in 1997,
due to price increases of $11,713, which were partially offset by a 10.6%
decline in unit sales volume (approximately 124.0 million units), accounting
for $5,566 in volume variance and an unfavorable product mix among the discount
brand categories of $4.
For the three months ended September 30, 1998, fixed manufacturing
costs on a basis comparable to the same period in 1997 were $384 higher, along
with an increase in costs per thousand units of $0.63 per thousand.
GROSS PROFIT. Gross profit of $54,247 for the three months ended
September 30, 1998 increased $10,850 from gross profit of $43,397 for the same
period in 1997, due primarily to the price increases discussed above. In the
1998 period, Liggett's premium and discount brands contributed 33.4% and 66.6%,
respectively, to the Company's overall gross profit. Over the same period in
1997, Liggett's premium and discount brands contributed 37.9% and 62.1%,
respectively, to total gross profit. As a percent of revenues
33
<PAGE> 34
(excluding federal excise taxes), gross profit at Liggett increased to 78.9%
for the three months ended September 30, 1998 compared to 72.2% for the same
period in 1997, with gross profit for the premium segment at 80.8% and 76.5% in
the third quarter of 1998 and 1997, respectively, and gross profit for the
discount segment at 78.0% and 69.8% in 1998 and 1997, respectively. This
increase is the result of the September 1997, January 1998, April 1998, May
1998 and August 1998 list price increases and improved production variances.
These increases were partially offset by increased tobacco costs at Liggett due
to a reduction in the average discount available to the Company from leaf
tobacco dealers on tobacco purchased under prior years' purchase commitments.
EXPENSES. Selling, general and administrative expenses were $45,562 for
the three months ended September 30, 1998 compared to $38,721 for the same
period for the prior year, an increase of $6,841. This increase in expense was
due primarily to $4,059 in higher spending for promotional and marketing
programs and higher legal expenses of $3,657, including non-cash stock-based
expense of $2,019. Such increases were partially offset by decreases in systems
development costs of approximately $648 and reductions in management fees of
$371 over the same prior year period.
OPERATING INCOME. Operating income increased to $8,685 for the three
months ended September 30, 1998 from $4,581 for the same prior year period due
primarily to an increase in gross profits discussed above, partially offset by
increased selling and legal expenses, along with the decline in unit sales
volume discussed above.
OTHER INCOME (EXPENSE). Interest expense was $7,270 for the three
months ended September 30, 1998 compared to $5,950 for the same period in 1997.
This increase in interest expense resulted from the Company recording a non-cash
deferred charge of approximately $4,100 during the first quarter of 1998. This
deferred charge is being amortized over a period of one year. As of September
30, 1998, $2,737 had been expensed. (Refer to Note 7 to the Company's
consolidated financial statements.)
NET INCOME. Net income amounted to $1,399 for the three months ended
September 30, 1998 compared to a net loss of $1,351 for the same period in the
prior year. The increase in net income was primarily the result of the factors
discussed above which resulted in higher operating income, offset by the
non-cash interest charge discussed above and by equity in income from an
affiliate of approximately $321 in the prior year period.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1997
REVENUES. For the nine months ended September 30, 1998, net sales
totaled $234,654, compared to $223,811 for the same period in 1997. Revenues
increased in the premium and discount segments by 4.8% ($10,843) due to price
increases of $33,760 (see "Recent Developments in the Cigarette Industry -
Pricing Activity") and improved product mix of $470, which were partially
offset by a 10.4% decline in unit sales volume (approximately 486.8 million
units), accounting for $23,387 in volume variance. The decline in Liggett's
sales volume was due to certain competitors' continuing leveraged rebate
programs tied to their products and increased promotional activity by certain
other manufacturers.
Premium sales over this period amounted to $76,898 and represented
32.8% of total revenues, compared to $74,780 and 33.4% of total sales for the
same period in 1997. In the premium segment, revenues grew by 2.8% ($2,118)
over the nine months ended September 30, 1998, compared to the same period in
1997, due to price increases of $9,189, which were partially offset by a 9.5%
decline in unit sales volume (approximately 119.3 million units), accounting
for $7,071 in volume variance.
Discount sales (comprising the brand categories of branded discount,
private label, control label, generic, international and contract
manufacturing) over this period amounted to $157,756 and represented 67.2% of
total revenues, compared to $149,031 and 66.6% of total sales for the same
period in 1997. In the discount segment, revenues grew by 5.9% ($8,725) over
the nine months ended September 30, 1998, compared to the same period in 1997,
due to price increases of $24,571 and improved product mix among
34
<PAGE> 35
the discount brand categories of $277, partially offset by a 10.8% decline in
unit sales volume (approximately 367.5 million units), accounting for $16,123
in volume variance.
For the nine months ended September 30, 1998, fixed manufacturing
costs on a basis comparable to the same period in 1997 were $929 lower, along
with a decline in costs per thousand units of $0.01 per thousand in the third
quarter of 1998 compared to the prior year period.
GROSS PROFIT. Gross profit of $143,368 for the nine months ended
September 30, 1998 increased $22,001 from gross profit of $121,367 for the same
period in 1997, due primarily to the price increases discussed above. In the
1998 period, Liggett's premium and discount brands contributed 35.1% and 64.9%,
respectively, to the Company's overall gross profit. Over the same period in
1997, Liggett's premium and discount brands contributed 37.5% and 62.5%,
respectively, to total gross profit. As a percent of revenues (excluding federal
excise taxes), gross profit at Liggett increased to 77.4% for the nine months
ended September 30, 1998 compared to 72.0% for the same period in 1997, with
gross profit for the premium segment at 79.8% and 76.3% in the nine months ended
September 30, 1998 and 1997, respectively, and gross profit for the discount
segment at 76.1% and 69.7% in the 1998 and 1997 periods, respectively. This
increase is the result of the March 1997, September 1997, January 1998, April
1998, May 1998 and August 1998 list price increases and improved production
variances. These increases were partially offset by increased tobacco costs at
Liggett due to a reduction in the average discount available to the Company from
leaf tobacco dealers on tobacco purchased under prior years' purchase
commitments.
EXPENSES. Selling, general and administrative expenses were $117,657
for the nine months ended September 30, 1998 compared to $110,061 for the same
period for the prior year, an increase of $7,596. This increase in expense was
due primarily to $8,055 in higher spending for promotional and marketing
programs and higher legal expenses of $5,042, including non-cash stock-based
expense of $2,019. Such increases were partially offset by decreases in systems
development costs of approximately $3,541, the absence of severance payments of
approximately $1,267 resulting from the 1997 restructuring and reductions in
management fees of $1,112 over the same prior year period.
OPERATING INCOME. Operating income increased to $23,830 for the nine
months ended September 30, 1998 from $9,380 in the same period for the prior
year due primarily to an increase in gross profits discussed above and the
absence of approximately $1,926 in reduced administrative charges resulting
from the 1997 restructuring, partially offset by increased selling and legal
expenses and settlement charges of $1,881, along with the decline in unit sales
volume discussed above.
OTHER INCOME (EXPENSE). Interest expense was $21,704 for the nine
months ended September 30, 1998 compared to $17,920 for the same period in 1997.
This increase in interest expense resulted from the Company recording a non-cash
deferred charge of approximately $4,100 during the first quarter of 1998,
partially offset by lower outstanding revolver balances, in addition to imputed
interest expense resulting from the Attorneys General March 1998 Settlement.
This deferred charge is being amortized over a period of one year. As of
September 30, 1998, $2,737 had been expensed. (Refer to Note 7 to the Company's
consolidated financial statements.)
NET INCOME. Net income amounted to $2,946 for the nine months ended
September 30, 1998 compared to a net loss of $1,333 for the same period in the
prior year. The increase in net income was primarily the result of the factors
discussed above which resulted in higher operating income, offset by the
non-cash interest charge discussed above, by a gain of $3,692 in the 1997
period on the sales of assets, by a gain of $2,963 on the retirement of debt and
by equity in income from an affiliate of approximately $506 in the prior year
period.
35
<PAGE> 36
CAPITAL RESOURCES AND LIQUIDITY
Cash provided by operating activities was $5,733 for the nine months
ended September 30, 1998 compared to cash used in operating activities of
$4,744 for the same period in 1997. The net increase in cash in the nine months
of 1998 when compared to the corresponding period in 1997 was due primarily to
an increase in net income.
Cash used in investing activities amounted to $27 for the nine months
ending September 30, 1998, primarily due to expenditures for capital equipment
of $1,182, which was partially offset by proceeds from the sale of equipment of
approximately $1,155. This compares to cash provided by investing activities of
$1,107 for the nine months of 1997, primarily due to proceeds from the sale of
assets of approximately $4,589, which were partially offset by investments in
affiliates of $2,200 and expenditures for capital equipment of $1,282.
Cash used in financing activities for the nine months of 1998 totaled
$5,706, in contrast to cash provided by financing activities of $3,637 in the
prior year period, resulting primarily from net repayments under the Facility
of $5,753 and an increase in cash overdraft of $514. In 1997, repayments of
long-term debt, amounting to approximately $4,721, were offset by net
borrowings under the Facility of $6,942.
On March 8, 1994, Liggett entered into the Facility under which it can
borrow up to $40,000 (depending on the amount of eligible inventory and
receivables as determined by the lenders) from a syndicate of commercial
lenders. Availability under the Facility was approximately $8,091 based upon
eligible collateral at September 30, 1998. The Facility is collateralized by all
inventories and receivables of the Company. Borrowings under the Facility are
charged interest calculated at a rate equal to 1.5% above Philadelphia National
Bank's (the indirect parent of Congress Financial Corporation, the lead lender)
prime rate. As of September 30, 1998, Liggett's interest rate was 10.0%, reduced
to 9.75% on October 1st, and to 9.50% on November 1st, 1998. The Facility
contains certain financial covenants similar to those contained in the Liggett
Notes indenture, including restrictions on Liggett's ability to declare or pay
cash dividends, incur additional debt, grant liens and enter into any new
agreements with affiliates, among others. In addition, the Facility, as amended
April 8, 1998, imposes requirements with respect to the Company's adjusted net
worth (not to fall below a deficit of $195,000 as computed in accordance with
the agreement, this computation was $179,149 at September 30, 1998) and working
capital (not to fall below a deficit of $17,000 as computed in accordance with
the agreement, this computation was $2,450 at September 30, 1998). The Facility,
as amended, also provides that a default by Liggett or its subsidiaries under
the March 1996 Settlements, March 1997 Settlements and March 1998 Settlements
(all as defined in Note 8 to the Company's consolidated financial statements)
shall constitute an event of default under the Facility.
In November 1997, the Facility was extended until March 8, 1999. At
September 30, 1998 the closing balance on the Facility stood at $17,674.
In 1992, Liggett issued $150,000 in Senior Secured Notes (the "Series
B Notes") and in 1994, the Company issued $32,850 of Variable Rate Series C
Senior Secured Notes (the "Series C Notes"). Interest on the Series B Notes and
the Senior C Notes is payable semiannually on February 1 and August 1 at an
annual rate of 11.5% and 19.75%, respectively. The Series B Notes and Series C
Notes (collectively, the "Liggett Notes") required mandatory principal
redemptions of $7,500 on February 1 in each of the years 1993 through 1997 and
$37,500 on February 1, 1998 with the balance of the Liggett Notes due on
February 1, 1999. In February 1997, $7,500 of Liggett B Notes were purchased
using the Facility and credited against the mandatory redemption requirements.
The Liggett Notes are collateralized by substantially all of the assets of the
Company, excluding accounts receivable and inventory. Eve is a guarantor for
the Liggett Notes. The Liggett Notes may be redeemed, in whole or in part, at a
price equal to 100% of the principal amount at the option of the Company. The
Liggett Notes contain restrictions on Liggett's ability to declare or pay cash
dividends, incur additional debt, grant liens and enter into any new agreements
with affiliates, among others. BGLS or its affiliates, including Liggett, may,
from time to time, based on current market conditions, purchase Liggett Notes
in the open market or in privately negotiated transactions.
36
<PAGE> 37
On January 30, 1998, with the consent of the required majority of the
holders of the Liggett Notes, Liggett entered into various amendments to the
Indenture governing the Liggett Notes, which provided, among other things, for a
deferral of the February 1, 1998 mandatory redemption payment of $37,500 to the
date of final maturity of the Liggett Notes on February 1, 1999. In connection
with the deferral, BGL agreed to issue 483,002 shares of BGL's common stock to
the holders of record on January 15, 1998 of the Liggett Notes. As a result of
this transaction, the Company recorded a non-cash deferred charge of
approximately $4,100 during the first quarter of 1998 reflecting the fair value
of the instruments issued. This deferred charge is being amortized as an
adjustment to interest expense over a period of one year. As of September 30,
1998, $2,737 had been expensed. The Indenture under which the Liggett Notes are
outstanding was also amended to prohibit, with limited exceptions, payments of
dividends and incurrence of new debt by Liggett and to tighten restrictions on
the disposition of proceeds of asset sales. BGL and BGLS also agreed to
guarantee the payment, which was made by Liggett, of the August 1, 1998 interest
payment on the Liggett Notes. In addition, Liggett Noteholders were granted
additional collateral in the form of a security interest in 16% of the stock of
Liggett-Ducat or a successor entity held by BOL. (Refer to Note 7 to the
Company's consolidated financial statements.)
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. Liggett had a net
capital deficiency of $183,268 as of September 30, 1998, is highly leveraged
and has substantial near-term debt service requirements. Due to the many risks
and uncertainties associated with the cigarette industry and the impact of
tobacco litigation (see Note 8 to the Company's consolidated financial
statements), there can be no assurance that the Company will be able to meet
its future earnings or cash flow goals. Consequently, the Company could be in
violation of its debt covenants, including covenants limiting the maximum
permitted net worth and working capital deficiencies, and if its lenders were
to exercise acceleration rights under the Facility or the indenture for the
Liggett Notes or refuse to lend under the Facility, the Company would not be
able to satisfy such demands or its working capital requirements.
As discussed above, the Liggett Notes require payments at maturity on
February 1, 1999 of $144,891. Liggett does not anticipate it will be able to
generate sufficient cash from operations to make such payments. If Liggett is
unable to refinance or restructure the terms of the Liggett Notes or otherwise
make all payments thereon, the Liggett Notes and the Facility would be in
default and holders of such debt could accelerate the maturity of such debt. In
such event, the Company may be forced to seek protection from creditors under
applicable laws. The Company's independent accountants have issued a report
covering the Company's December 31, 1997 consolidated financial statements
containing an explanatory paragraph that states that these facts raise
substantial doubt about the Company's ability to continue as a going concern.
The accompanying consolidated financial statements of the Company do not
include any adjustments that might arise from the outcome of this uncertainty.
(Refer to Note 1 to the Company's consolidated financial statements.)
YEAR 2000
Liggett utilizes management information systems and software technology
that may be affected by Year 2000 issues throughout its operations. The Company
has evaluated the costs to implement century date change compliant systems
conversions and is in the process of executing a planned conversion of its
systems prior to the year 2000. To date, the focus of Year 2000 compliance and
verification efforts has been directed at the implementation of new customer
service, inventory control and financial reporting systems at each of the three
regional Strategic Business Units, part of the Company's reorganization which
began in January 1997. In January of 1998, Liggett initiated a major conversion
of factory accounting and information systems at its Durham production facility,
with the assistance of outside consultants, to upgrades that have been
successfully tested for Year 2000 compliance. This project is expected to be
completed by the end of November.
All costs incurred to date are considered an integral part of the
normal expenditures required for business systems enhancements and upgrades. It
is anticipated that all factory, corporate, field sales and physical
distribution systems will be completed in sufficient time to support Year 2000
compliance and verification.
Although such costs may be a factor in describing changes in operating
profit in any given reporting period, the Company currently does not believe
that the anticipated costs of Year 2000 systems conversions will have a material
impact on its future consolidated results of operations. Based on the progress
Liggett has made in addressing Year 2000 issues and its strategy and timetable
to complete its compliance program, the Company does not foresee significant
risks associated with its Year 2000 initiatives at this time. However, if the
Company identifies any significant risks related to its Year 2000 compliance
effort, or if its progress deviates from the projected timetable, Liggett will
develop contingency plans it deems necessary to meet compliance deadlines at
that time. Due to the interdependent nature of computer systems, the Company may
be adversely impacted in the year 2000 depending on whether it or its vendors or
customers have addressed this issue successfully.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Company and its representatives may from time to time make oral or
written "forward-looking statements" within the meaning of the Private
Securities Reform Act of 1995 (the "Reform Act"), including any statements that
may be contained in the foregoing discussion in "Management's Discussion and
Analysis of Financial Condition and Results of Operations", and elsewhere in
this report and in other filings with the Securities and Exchange Commission
and in its reports to securityholders 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 Reform Act, the Company is hereby
identifying important factors that could cause actual results to differ
materially from those contained in any forward-looking statement made by or on
behalf of the Company. The Company continues to be subject to risk factors
endemic to the domestic tobacco industry including, without limitation, health
concerns relating to the use of tobacco products and exposure to environmental
tobacco smoke, legislation, including tax increases, governmental regulation,
privately imposed smoking restrictions, decline in consumption, governmental
and grand jury investigations and litigation. Furthermore, the Company is
subject to intense competition, changes in consumer preferences, the effects of
changing prices for its raw materials and local economic conditions. In
addition, the Company has a high degree of leverage and substantial near-term
debt service requirements, a payment at maturity of the Liggett Notes of
$144,891 on February 1, 1999, as well as a significant net worth deficiency
37
<PAGE> 38
and working capital deficiency and recent net losses, and is highly dependent
upon its revolving credit facility which currently expires in March 1999. See
"Capital Resources and Liquidity" for a discussion of certain matters which
raise substantial doubt about Liggett meeting its liquidity needs and its
ability to continue as a going concern. The Liggett Notes and the Facility
contain restrictions on the Company's ability to incur additional debt, grant
liens, enter into any new agreements with affiliates and declare or pay cash
dividends, among others. Due to such uncertainties and risks, investors are
cautioned not to place undue reliance on such forward-looking statements, which
speak only as of the date 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.
38
<PAGE> 39
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Reference is made to Note 8, incorporated herein by reference, to the
Company's consolidated financial statements included elsewhere in this Report
on Form 10-Q, which contains a general description of certain legal proceedings
to which Liggett and/or BGL or their subsidiaries are a party and certain
related matters. Reference is also made to Exhibit 99.1, Material Legal
Proceedings incorporated herein by reference, for additional information
regarding the pending material legal proceedings to which Liggett and/or BGL
are party. A copy of Exhibit 99.1 will be provided to security holders of
Liggett without charge upon written request to BGL at its principal executive
offices, 100 S. E. Second Street, Miami, Florida 33131, Attn. Investor
Relations.
ITEM 6. EXHIBITS
(a). EXHIBITS
27.1 Liggett Group Inc.'s Financial Data Schedule (for SEC use only)
27.2 Eve Holdings Inc.'s Financial Data Schedule (for SEC use only)
99.1 Material legal proceedings (incorporated by reference to
Exhibit 99.1 in BGL's Form 10-Q for the quarter ended
September 30, 1998, Commission File No. 1-5759).
(b) REPORTS ON FORM 8-K
None
39
<PAGE> 40
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrants have duly caused this report to be signed on their behalf by
the undersigned thereunto duly authorized on November 13, 1998.
LIGGETT GROUP INC.
By: /s/ Samuel M. Veasey
----------------------------------
Senior Vice President, Chief
Financial Officer and Treasurer
(Principal Financial and Principal
Accounting Officer)
EVE HOLDINGS INC.
By: /s/ Joselynn D. Van Siclen
----------------------------------
Vice President, Treasurer and
Assistant Secretary
(Principal Financial and Principal
Accounting Officer)
40
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