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| VGR > SEC Filings for VGR > Form 10-Q on 10-Aug-2009 | All Recent SEC Filings |
10-Aug-2009
Quarterly Report
• the marketing of the low nicotine and nicotine-free QUEST cigarette products and the development of reduced risk cigarette products through our subsidiary Vector Tobacco Inc., and
• the real estate business through our subsidiary, New Valley LLC, which is seeking to acquire additional operating companies and real estate properties. New Valley owns 50% of Douglas Elliman Realty, LLC, which operates the largest residential brokerage company in the New York metropolitan area.
All of Liggett's unit sales volume in 2008 and the first six months of 2009
was in the discount segment, which Liggett's management believes has been the
primary growth segment in the industry for over a decade. The significant
discounting of premium cigarettes in recent years has led to brands, such as
EVE, that were traditionally considered premium brands to become more
appropriately categorized as discount, following list price reductions.
Liggett's cigarettes are produced in approximately 180 combinations of
length, style and packaging. Liggett's current brand portfolio includes:
• LIGGETT SELECT - a leading brand in the deep discount category,
• GRAND PRIX - re-launched as a national brand in 2005,
• EVE - a leading brand of 120 millimeter cigarettes in the branded discount category,
• PYRAMID - the industry's first deep discount product with a brand identity, and
• USA and various Partner Brands and private label brands.
In 1999, Liggett introduced LIGGETT SELECT, one of the leading brands in the
deep discount category. LIGGETT SELECT's unit volume was 30.1% and 24.5% of
Liggett's unit volume for the year ended December 31, 2008 and for the six
months ended June 30, 2009, respectively. GRAND PRIX is now the largest seller
in Liggett's family of brands with 32.6% and 30.4% of Liggett's unit volume for
the year ended December 31, 2008 and the six months ended June 30, 2009,
respectively. In April 2009, Liggett repositioned PYRAMID as a box only brand in
specific targeted markets with a new low price to specifically compete with
brands which are priced at the lowest level of the deep discount segment.
Under the Master Settlement Agreement reached in November 1998 with 45 states
and various territories, the three largest cigarette manufacturers must make
settlement payments to the states and territories based on how many cigarettes
they sell annually. Liggett, however, is not required to make any payments
unless its market share exceeds approximately 1.65% of the U.S. cigarette
market. Additionally, Vector Tobacco has no payment obligation unless its market
share exceeds approximately 0.28% of the U.S. market. Liggett's and Vector
Tobacco's payments under the Master Settlement Agreement are based on each
company's incremental market share above the
minimum threshold applicable to such company. We believe that Liggett has gained
a sustainable cost advantage over its competitors as a result of the settlement.
The discount segment is a challenging marketplace, with consumers having less
brand loyalty and placing greater emphasis on price. Liggett's competition is
now divided into two segments. The first segment is made up of the three largest
manufacturers of cigarettes in the United States, Philip Morris USA Inc.,
Reynolds America Inc., and Lorillard Tobacco Company, as well as the fourth
largest, Commonwealth Brands, Inc. (which Imperial Tobacco PLC acquired in
2007). The three largest manufacturers, while primarily premium cigarette based
companies, also produce and sell discount cigarettes. The second segment of
competition is comprised of a group of smaller manufacturers and importers, most
of which sell lower quality, deep discount cigarettes.
Recent Developments
5% Variable Interest Senior Convertible Notes Due November 2011. Between
November 2004 and April 2005, we sold $111,864 principal amount of our 5%
Variable Interest Senior Convertible Notes due November 15, 2011 (the "5%
Notes"). In May 2009, the holder of $11,005 principal amount of the 5% Notes
exchanged its 5% Notes for $11,775 principal amount of our 6.75% Variable
Interest Senior Convertible Note due 2014 (the "6.75% Note") as discussed below.
In June 2009, certain holders of $99,944 principal amount of the 5% Notes
exchanged their 5% Notes for $106,940 principal amount of our 6.75% Variable
Interest Senior Convertible Exchange Notes due 2014 (the "6.75% Exchange
Notes"). As of June 30, 2009, a total of $915 principal amount of the 5% Notes
remained outstanding after these exchanges.
We recorded a loss of $18,444 associated with the extinguishment of the 5%
Notes in the second quarter of 2009.
6.75% Variable Interest Senior Convertible Note due 2014. On May 11, 2009, we
issued in a private placement the 6.75% Note in the principal amount of $50,000.
The purchase price was paid in cash ($38,225) and by tendering $11,005 principal
amount of the 5% Notes, valued at 107% of principal amount. We will use the net
proceeds of the offering for general corporate purposes. The note pays interest
("Total Interest") on a quarterly basis at a rate of 3.75% per annum plus
additional interest, which is based on the amount of cash dividends paid during
the prior three-month period ending on the record date for such interest payment
multiplied by the total number of shares of its common stock into which the debt
will be convertible on such record date. Notwithstanding the foregoing, however,
the interest payable on each interest payment date shall be the higher of
(i) the Total Interest or (ii) 6.75% per annum. The note is convertible into our
common stock at the holder's option. The conversion price of $15.04 per share
(approximately 66.4894 shares of common stock per $1,000 principal amount of the
note) is subject to adjustment for various events, including the issuance of
stock dividends. The note matures on November 15, 2014. We will redeem on
May 11, 2014 and at the end of each interest accrual period thereafter an
additional amount, if any, of the note necessary to prevent the note from being
treated as an "Applicable High Yield Discount Obligation" under the Internal
Revenue Code. If a fundamental change (as defined in the note) occurs, we will
be required to offer to repurchase the note at 100% of its principal amount,
plus accrued interest.
The purchaser of this 6.75% Note is an entity affiliated with Dr. Phillip
Frost, who reported, after the consummation of the sale, beneficial ownership of
approximately 11.5% of our common stock.
6.75% Variable Interest Senior Convertible Exchange Notes due 2014. On
June 15, 2009, we entered into agreements with certain holders of the 5% Notes
to exchange their 5% notes for our
6.75% Exchange Notes. On June 30, 2009, we accepted for exchange $99,944
principal amount of the 5% Notes for $106,940 principal amount of our 6.75%
Exchange Notes. We issued the 6.75% Exchange Notes to the holders in reliance on
the exemption from the registration requirements of the Securities Act of 1933,
as amended, afforded by Section 3(a)(9) thereof. The notes pay interest ("Total
Interest") on a quarterly basis beginning August 15, 2009 at a rate of 3.75% per
annum plus additional interest, which is based on the amount of cash dividends
paid during the prior three-month period ending on the record date for such
interest payment multiplied by the total number of shares of its common stock
into which the debt will be convertible on such record date. Notwithstanding the
foregoing, however, the interest payable on each interest payment date shall be
the higher of (i) the Total Interest or (ii) 6.75% per annum. The notes are
convertible into our common stock at the holder's option. The conversion price
of $17.06 per share (approximately 58.6063 shares of common stock per $1,000
principal amount of notes) is subject to adjustment for various events,
including the issuance of stock dividends. The notes will mature on November 15,
2014. We will redeem on June 30, 2014 and at the end of each interest accrual
period thereafter an additional amount, if any, of the notes necessary to
prevent the notes from being treated as an "Applicable High Yield Discount
Obligation" under the Internal Revenue Code. If a fundamental change (as defined
in the indenture) occurs, we will be required to offer to repurchase the notes
at 100% of their principal amount, plus accrued interest and, under certain
circumstances, a "make whole" payment.
Proposed and enacted excise tax increases. Effective April 1, 2009, the
federal cigarette excise tax was increased from $3.90 per carton ($0.39 per
pack) to $10.07 per carton ($1.01 per pack). Wholesale shipment volume for the
six months ended June 30, 2009 compared to the same period in 2008 for Liggett
and for the total industry was negatively impacted by tax-driven trade
purchasing patterns in anticipation of the increase in the federal excise taxes
on cigarettes. This legislation included provisions that imposed this increase
in excise taxes on inventory held as of April 1, 2009. As a result, many
wholesalers and retailers significantly reduced their inventory levels as of
March 31, 2009 to minimize any such taxes owed on such inventory. In 2009, ten
states enacted increases to state excise taxes and further increases in states'
excise taxes are expected.
Family Smoking Prevention and Tobacco Control Act (FDA Legislation). On
June 22, 2009, President Barrack Obama signed into law the Family Smoking
Prevention and Tobacco Control Act, referred to as the FDA Legislation. Under
the FDA Legislation, the U.S. Food and Drug Administration has been granted
broad authority over the manufacture, sale, marketing and packaging of tobacco
products. Provisions of the FDA Legislation are effective over a time period
ranging from 90 days to over 39 months. See "Legislation and Regulation" below.
Long-term Investments. We recorded a loss of $21,900 in 2008 due to the
performance of three of our long-term investments in various investment funds in
2008 and a loss of $567 during the first quarter of 2008 associated with the
liquidation of a long-term investment, which was included as "Other expense" on
our condensed statement of operations for the six months ended June 30, 2008.
Philip Morris Brand Transaction. In November 1998, we and Liggett granted
Philip Morris options to purchase interests in Trademarks LLC which holds three
domestic cigarette brands, L&M, CHESTERFIELD and LARK, formerly held by
Liggett's subsidiary, Eve Holdings Inc.
Under the terms of the Philip Morris agreements, Eve contributed the three
brands to Trademarks, a newly-formed limited liability company, in exchange for
100% of two classes of Trademarks' interests, the Class A Voting Interest and
the Class B Redeemable Nonvoting Interest. Philip Morris acquired two options to
purchase the interests from Eve.
The Class B option became exercisable during the 90-day period beginning
December 2, 2008 and was exercised by Philip Morris on February 19, 2009. This
option entitled Philip Morris to purchase the Class B interest for $139,900,
reduced by the amount previously distributed to Eve of $134,900. In connection
with the exercise of the Class B option, Philip Morris paid to Eve approximately
$5,000 (including a pro-rata share of its guaranteed payment) and Eve was
released from its guaranty. We recognized a gain of $5,000 in connection with
the transaction in the first quarter of 2009.
Vector Tobacco Restructuring. In March 2009, Vector Research eliminated nine
full-time positions in connection with the Board of Directors 2006 decision to
discontinue the genetics operation and, not to pursue FDA approval of QUEST as a
smoking cessation aide, due to the projected significant additional time and
expense involved in seeking such approval.
We recognized pre-tax restructuring charges of $1,000, during the first
quarter of 2009. The restructuring charges relate primarily to employee
severance and benefit costs.
Issuance of Restricted Shares. On April 7, 2009, our President and Chief
Executive Officer was awarded a restricted stock grant of 500,000 shares of our
common stock pursuant to our Amended and Restated 1999 Long-Term Incentive Plan.
Under the terms of the award, one-fifth of the shares vest on September 15,
2010, with an additional one-fifth vesting on each of the four succeeding
one-year anniversaries of the first vesting date through September 15, 2014. In
the event that his employment with us is terminated for any reason other than
his death, his disability or a change of control (as defined in this Restricted
Share Agreement) of ours, any remaining balance of the shares not previously
vested will be forfeited by him. The fair market value of the restricted shares
on the date of grant was $6,467 which is being amortized over the vesting period
as a charge to compensation expense.
Investment in Real Estate. In March 2008, a subsidiary of New Valley
purchased a loan collateralized by a substantial portion of a 450-acre approved
master planned community in Palm Springs, California known as "Escena." The
loan, which was in foreclosure, was purchased for its $20,000 face value plus
accrued interest and other costs of $1,445. The collateral consists of 867
residential lots with site and public infrastructure, an 18-hole golf course, a
substantially completed clubhouse, and a seven-acre site approved for a 450-room
hotel.
In April 2009, New Valley's subsidiary entered into a settlement agreement
with a guarantor of the loan, which requires the guarantor to satisfy its
obligations under a completion guaranty by completing improvements to the
project in settlement, among other things, of its payment guarantees. In
addition, the guarantor agreed to pay approximately $250 in legal fees and
$1,000 of delinquent taxes and penalties and post a letter of credit to secure
its construction obligations. As a result of this settlement, we calculated the
fair market value of the investment as of March 31, 2009, utilizing the most
recent "as is" appraisal of the collateral and the value of the completion
guaranty less estimated costs to dispose of the property. Based on these
estimates, we determined that the fair market value was less than the carrying
amount of the mortgage receivable at March 31, 2009, by approximately $5,000.
Accordingly, the reserve was increased and a charge of $5,000 was recorded in
the first quarter of 2009. On April 15, 2009 New Valley completed the
foreclosure process and on April 16, 2009, took title to the property. We
reclassified the loan from "Mortgage receivable" at March 31, 2009 to
"Investment in real estate" at June 30, 2009 on our condensed consolidated
balance sheet. It was carried at $12,204 as of June 30, 2009.
Aberdeen Townhomes LLC. In June 2008, a subsidiary of New Valley purchased a
preferred equity interest in Aberdeen Townhomes LLC for $10,000. Aberdeen
acquired five town home
residences located in Manhattan, New York, which it is in the process of
rehabilitating and selling. In the event that Aberdeen makes distributions of
cash, New Valley is entitled to a priority preferred return of 15% per annum
until it has recovered its invested capital. New Valley is entitled to 25% of
subsequent cash distributions of profits until it has achieved an annual 18%
internal rate of return. New Valley is then entitled to 20% of subsequent cash
distributions of profits until it has achieved an annual 23% IRR. After New
Valley has achieved an annual 23% IRR, it is then entitled to 10% of any
remaining cash distributions of profits.
In February 2009, the managing member of Aberdeen Townhomes resigned and a
subsidiary of New Valley became the new managing member as of March 1, 2009.
Aberdeen is a variable interest entity; however, even as the managing member, we
are not the primary beneficiary as other parties to the investment would absorb
a majority of the variable interest entity's losses under the current
arrangement. On June 15, 2009, we entered into a line of credit in the amount of
$250 on behalf of Aberdeen, of which $13 was outstanding at June 30, 2009.
In January 2009, we obtained an appraisal of the town home residences and
determined that the value of the properties, less estimated disposal costs, was
approximately $3,500 less than their carrying value and recorded an impairment
charge for $3,500. In the first quarter of 2009, we reevaluated the fair market
value of the town home residences and determined an additional decline in the
value of the properties of $3,500 had occurred and recorded an impairment charge
of $3,500 for the three months ended March 31, 2009. The reduction in value was
attributed to the overall real estate market conditions in New York City
As a result of the impairment charges, our maximum exposure to a loss on our
investment in Aberdeen is $3,013 at June 30, 2009.
Four of the five notes related to the project with a balance of approximately
$36,100 matured on March 1, 2009 and have not been refinanced or paid and are in
default. We are currently in discussion with the lender, Wachovia Bank, N.A. The
remaining mortgage with a balance of approximately $4,550 matures on
September 30, 2009 is also in default as of June 30, 2009 due to non-payment of
interest.
New Valley Oaktree Chelsea Eleven, LLC. In September 2008, a subsidiary of
New Valley LLC ("New Valley Chelsea") purchased for $12,000 a 40% interest in
New Valley Oaktree Chelsea Eleven, LLC, which lent $29,000 and contributed
$1,000 in capital to Chelsea Eleven LLC, which is developing a condominium
project in Manhattan, New York. The development consists of 72 luxury
residential units and one commercial unit. Approximately 75% of the units have
been pre-sold and there is approximately $35,000 in deposits held in escrow. The
loan from New Valley Oaktree is subordinate to a $110,000 construction loan and
a $24,000 mezzanine loan plus accrued interest. The loan from New Valley Oaktree
to Chelsea Eleven bears interest at 60.25% per annum, compounded monthly, with
$3,750 initially being held in an interest reserve, from which five monthly
payments of $300 have been paid to New Valley.
New Valley Chelsea is a variable interest entity; however, we are not the
primary beneficiary. Our maximum exposure to loss as a result of our investment
in Chelsea is $10,506. This investment is being accounted for under the equity
method.
Sale of St. Regis Hotel. In March 2008, 16th and K Holdings LLC closed on the
sale of 90% of the St. Regis Hotel. In addition to retaining a 3% interest, net
of incentives, in the St. Regis Hotel, New Valley received $16,406, of which
$15,822 was received in the six months ended June 30, 2009, upon the sale of the
hotel. New Valley anticipates receiving an additional $3,400 in various
installments between 2009 and 2012. We recorded the $16,446 as an investing
activity in the consolidated statement of cash flows for the six months ended
June 30, 2008. New Valley recorded equity losses of $0 and $3,796 for the three
and six months ended June 30, 2008, respectively, associated with 16th and K
Holdings LLC. For the six months ended June 30, 2008, New Valley also recorded
equity income of $15,779 in connection with the
distributions received in excess of the carrying amount of the investment in St.
Regis and we have no legal obligation to make additional investments to the
investment.
Tobacco Settlement Agreements. In October 2004, the independent auditor under
the Master Settlement Agreement notified Liggett and all other Participating
Manufacturers that their payment obligations under the Master Settlement
Agreement, dating from the agreement's execution in late 1998, had been
recalculated using "net" unit amounts, rather than "gross" unit amounts (which
had been used since 1999 to calculate market share and the allocation of the
base amount of payments under the Master Settlement Agreement). The change in
the method of calculation could, among other things, require additional Master
Settlement Agreement payments by Liggett of approximately $20,875, plus
interest, for 2001 through 2008, require an additional payment of approximately
$3,100 for 2009 and require additional amounts in future periods because the
proposed change from "gross" to "net" units would serve to lower Liggett's
market share exemption under the Master Settlement Agreement. Liggett has
objected to this retroactive change and has disputed the change in methodology.
No amounts have been accrued or expensed in our condensed financial statements
for any potential liability relating to the "gross" versus "net" dispute because
we do not believe an unfavorable outcome is probable.
In 2005, the independent auditor under the Master Settlement Agreement
calculated that Liggett owed $28,668 for its 2004 sales. Liggett paid $11,678
and disputed the balance, as permitted by the Master Settlement Agreement.
Liggett subsequently paid $9,304 of the disputed amount, although Liggett
continues to dispute that this amount is owed. This $9,304 relates to an
adjustment to its 2003 payment obligation claimed by Liggett for the market
share loss to non-participating manufacturers, which is known as the "NPM
Adjustment." At June 30, 2009, included in "Other assets" on our condensed
balance sheet was a receivable of $6,513 relating to such amount. The remaining
balance in dispute of $7,686 is comprised of $5,318 claimed for a 2004 NPM
Adjustment and $2,368 relating to the independent auditor's retroactive change
from "gross" to "net" units in calculating Master Settlement Agreement payments,
which Liggett contends is improper, as discussed above. From its April 2006
payment, Liggett and Vector Tobacco withheld approximately $1,600 claimed for
the 2005 NPM Adjustment and $2,949 relating to the retroactive change from
"gross" to "net" units. Liggett and Vector Tobacco withheld approximately $4,200
from their April 2007 payments related to the 2006 NPM Adjustment and
approximately $3,950 relating to the retroactive change from "gross" to "net"
units. From their April 2008 payment, Liggett and Vector Tobacco withheld
approximately $4,000 for the 2007 NPM Adjustment and approximately $3,696
related to the retroactive change from "gross" to "net" units. Vector Tobacco
paid approximately $200 into the disputed payments account for the 2007 NPM
Adjustment. From their April 2009 payment, Liggett and Vector Tobacco withheld
approximately $6,100 relating to the 2008 NPM adjustment and approximately
$3,300 relating to the retroactive change from "gross" to "net" units.
The following amounts have not primarily been expensed by us as they relate to
Liggett's and Vector Tobacco's claim for an NPM Adjustment: $6,513 for 2003,
$3,789 for 2004 and $800 for 2005.
In March 2006, an economic consulting firm selected pursuant to the Master
Settlement Agreement rendered its final and non-appealable decision that the
Master Settlement Agreement was a "significant factor contributing to" the loss
of market share of Participating Manufacturers for 2003. The economic consulting
firm subsequently rendered the same decision with respect to 2004, 2005 and
2006. As a result, the manufacturers are entitled to potential NPM Adjustments
to their 2003, 2004, 2005 and 2006 Master Settlement Agreement payments. A
Settling State that has diligently enforced its qualifying escrow statute in the
year in question may be able to avoid application of the NPM Adjustment to the
payments made by the manufacturers for the benefit of that state or territory.
Since April 2006, notwithstanding provisions in the Master Settlement Agreement
requiring arbitration, litigation has been filed in 49 Settling States and
territories over the issue of whether the application of the NPM Adjustment for
2003 is to be determined through litigation or arbitration. These actions relate
to the potential NPM Adjustment for 2003, which the independent auditor under
the Master Settlement Agreement previously determined to be as much as
$1,200,000 for all Participating Manufacturers. All 48 courts that have decided
the issue have ruled that the 2003 NPM Adjustment dispute is arbitrable and 47
of these decisions are final. In response to a proposal from the Original
Participating Manufacturers and many of the Subsequent Participating
Manufacturers, 45 of the Settling States, representing approximately 90% of the
allocable share of the Settling States, entered into an agreement providing for
a nationwide arbitration of the dispute with respect to the NPM Adjustment for
2003. The agreement provides for selection of the arbitration panel beginning
October 1, 2009 and that the parties and the arbitrators will thereafter
establish the schedule and procedures for the arbitration. Because states
representing more than 80% of the allocable share signed the agreement, signing
states will receive a 20% reduction of any potential 2003 NPM adjustment. It is
anticipated that the arbitration will begin in 2010. There can be no assurance
that Liggett or Vector Tobacco will receive any adjustment as a result of these
proceedings.
Vector Tobacco does not make MSA payments on sales of its QUEST 3 product as
Vector Tobacco believes that QUEST 3 does not fall within the definition of a
cigarette under the MSA. There can be no assurance that Vector Tobacco's
assessment is correct and that additional payments under the MSA for QUEST 3
will not be owed.
In 2003, in order to resolve any potential issues with Minnesota as to Liggett's
ongoing economic settlement obligations, Liggett negotiated a $100 a year
payment to Minnesota, to be paid any year cigarettes manufactured by Liggett are
sold in that state. In 2004, the Attorneys General for each of Florida,
Mississippi and Texas advised Liggett that they believed that Liggett has failed
to make all required payments under the respective settlement agreements with
these states for the period 1998 through 2003 and that additional payments may
be due for 2004 and subsequent years. Liggett believes these allegations are
without merit, based, among other things, on the language of the most favored
nation provisions of the settlement agreements.
Except for $2,500 accrued as of June 30, 2009, in connection with the foregoing
matters, no other amounts have been accrued in the accompanying condensed
financial statements for any additional amounts that may be payable by Liggett
under the settlement agreements with Florida, Mississippi and Texas. There can
be no assurance that Liggett will resolve these matters and that Liggett will
not be required to make additional material payments, which payments could
adversely affect our condensed consolidated financial position, results of
operations or cash flows.
Recent Developments in Tobacco-Related Litigation
The cigarette industry continues to be challenged on numerous fronts. New
cases continue to be commenced against Liggett and other cigarette
manufacturers. As of June 30, 2009, there were 35 individual cases pending
against Liggett and/or us, where one or more individual plaintiffs allege injury
. . .
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