Overview

We are a holding company and are engaged principally in:

•            the manufacture and sale of cigarettes in the United States through
             our Liggett Group LLC and Vector Tobacco Inc. subsidiaries, and



•            the real estate business through our New Valley LLC subsidiary,
             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 our tobacco operation's unit sales volume in 2011 and for the first six months of 2012 was in the discount segment, which management believes has been the primary growth segment in the industry for more than 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.

Our tobacco subsidiaries' cigarettes are produced in approximately 118 combinations of length, style and packaging. Liggett's current brand portfolio includes:

• PYRAMID - the industry's first deep discount product with a brand identity re-launched in the second quarter of 2009, and

• GRAND PRIX - re-launched as a national brand in 2005,

• LIGGETT SELECT - a leading brand in the deep discount category,

• EVE - a leading brand of 120 millimeter cigarettes in the branded discount category, 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 7.5% for the six months ended June 30, 2012 and 8.7% of Liggett's unit volume for the year ended December 31, 2011. In September 2005, Liggett repositioned GRAND PRIX to distributors and retailers nationwide. GRAND PRIX's unit volume was 10.6% of Liggett's unit volume for the six months ended June 30, 2012 and 12.7% for the year ended December 31, 2011. In April 2009, Liggett repositioned PYRAMID as a box-only brand with a new low price to specifically compete with brands which are priced at the lowest level of the deep discount segment. PYRAMID is now the largest seller in Liggett's family of brands with 61.6% of Liggett's unit volume for the six months ended June 30, 2012 and 56.4% for the year ended December 31, 2011.

Under the Master Settlement Agreement reached in November 1998 with 46 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 our tobacco subsidiaries have gained a sustainable cost advantage over their 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 American Inc., and Lorillard Tobacco Company. 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 deep discount cigarettes. Our largest competitor in this segment is Commonwealth Brands, Inc. (a wholly-owned subsidiary of Imperial Tobacco PLC).

Recent Developments

Senior Secured Notes. In December 2010, we sold an additional $90,000 principal amount of our 11% Senior Secured Notes due 2015 (the "Senior Secured Notes") in private offerings to qualified institutional investors in accordance with Rule 144A of the Securities Act of 1933. In May 2011, we completed an exchange offer to exchange the Senior Secured Notes issued in December 2010 for an equal amount of newly issued 11% Senior Secured Notes due 2015. The new Secured Notes have substantially the same terms as the original notes, except that the new Secured Notes have been registered under the Securities Act.

Variable Interest Senior Convertible Debentures due 2026. We were required to mandatorily redeem 10% of the total aggregate principal amount outstanding, or $11,000, of our 3.875% Variable Interest Senior Convertible Debentures due 2026 (the "Debentures") on June 15, 2011. Other than the holders of $7 principal amount of the Debentures, who had 10% of their aggregate principal amount of Debentures mandatorily redeemed, each holder of the Debentures chose to convert its pro-rata portion of the $11,000 of principal into our common stock. We recorded accelerated interest expense related to the converted debt of $1,217 for the three and six months ended June 30, 2011, on the conversion of the $11,000 of Debentures into 685,005 shares of common stock. The debt conversion resulted in a non-cash financing transaction of $10,993.

In February 2012, a holder of our Debentures converted $2 principal amount of the Debentures into 125 shares of common stock. The debt conversion resulted in a non-cash financing transaction of $2. The holders of the remaining $98,998 principal amount of the Debentures had the option to put all of the remaining Debentures on June 15, 2012. None of the debentures were surrendered for repurchase. The holders of the Debentures next have the option to put all or part of the remaining Debentures on June 15, 2016. Accordingly, we reclassified the Debentures and related fair value of derivatives embedded within convertible debt from current liabilities to long-term liabilities as of June 30, 2012.

In June 2012, the holders of $31,370 principal amount of the Debentures converted the $31,370 of principal amount into 1,955,300 shares of the our common stock. We recorded accelerated interest expense related to the converted debt of $7,888 for the six months ended June 30, 2012 on the conversion of the $31,372 of Debentures into 1,955,425 shares of common stock.

New Valley Oaktree Chelsea Eleven, LLC. In April 2012, Chelsea closed on the two remaining residential units. As of June 30, 2011, all of the 54 residential units have been sold and the project has been completed. We received net distributions of $8,439 and $1,613 from New Valley Oaktree Chelsea Eleven LLC for the six months ended June 30, 2012 and 2011, respectively. New Valley recorded equity income of $451 and $2,118 for the three and six months ended June 30, 2012, related to New Valley Chelsea. New Valley had recorded equity income of $500 and $2,000 for the three and six months ended June 30, 2011, related to New Valley Chelsea.

NV SOCAL LLC. On October 28, 2011, a newly-formed joint venture, between affiliates of New Valley and Winthrop Realty Trust, entered into an agreement with Wells Fargo Bank to acquire a $117,900 C-Note (the "C-Note") for a purchase price of $96,700. The C-Note is the most junior tranche of a $796,000 first mortgage loan originated in July 2007 which is collateralized by a 31 property portfolio of office properties situated throughout southern California, consisting of approximately 4.5 million square feet. The C-Note bears interest at a rate per annum of LIBOR plus 310 basis points, requires payments of interest only prior to maturity and matures on August 9, 2012. On November 3, 2011, New Valley invested $25,000 for an approximate 26% interest in the joint venture. In January 2012, the joint venture entered into a Master Repurchase and Securities contract with BSSF CABI LLC, an affiliate of Blackstone Real Estate Debt Strategies. This transaction secured $40,000 through a non-recourse repurchase facility and all proceeds after expenses (approximately $38,100) were distributed to Winthrop Realty Trust. This distribution increased our ownership interest to approximately 42.19% interest in the joint venture. New Valley recorded an equity loss of $223 and $471 for the three and six months ended June 30, 2012.

Fifty Third-Five Building LLC. In 2010, New Valley, through its NV 955 LLC subsidiary, contributed $18,000 to a joint venture, Fifty Third-Five Building LLC ("JV"), of which it owns 50%. In 2010, the JV acquired a defaulted real estate loan, collateralized by real estate located in New York City for approximately $35,500. The previous lender had commenced proceedings seeking to foreclose its mortgage. Upon acquisition of the loan, the JV succeeded to the rights of the previous lender in the litigation. In April 2011, the court granted the JV's motion for summary judgment,

dismissing certain substantive defenses raised by the borrower and the other named parties. Thereafter, the borrower challenged the validity of the assignment from the previous lender to the JV. In February 2012, the court affirmed the validity of the assignment and its decision to grant summary judgment. Foreclosure proceedings are continuing.

11 Beach Street. NV Beach LLC, a wholly-owned subsidiary of New Valley, invested $9,642 in June 2012 with an additional $1,321 investment to be made in the future for an approximate 49% interest in 11 Beach Street Investor LLC (the "Beach JV"). Beach JV plans to renovate and convert an existing office building in Manhattan into a luxury residential condominium. Beach JV is a variable interest entity; however, New Valley LLC is not the primary beneficiary . New Valley LLC will account for its interest in Beach JV under the equity method of accounting. New Valley's maximum exposure on its investment in 11 Beach Street Investor LLC is $9,642 at June 30, 2012.

Long-term Investments. We received a distribution of $207 from a real estate partnership for the three and six months ended June 30, 2012. Two of our long-term investment liquidated and we received distributions of $62,219 for the six months ended June 30, 2011. We received an additional distribution of $2,775 in July 2011. The Company recognized a gain of $19,475 and $23,611 for the three and six months ended June 30, 2011, respectively.

Recent Developments in Smoking-Related Litigation The cigarette industry continues to be challenged on numerous fronts. New cases continue to be commenced against Liggett and other cigarette manufacturers. Liggett could be subjected to substantial liabilities and bonding requirements from litigation relating to cigarette products. Adverse litigation outcomes could have a negative impact on our ability to operate due to their impact on cash flows. We and our Liggett subsidiary, as well as the entire cigarette industry, continue to be challenged on numerous fronts, particularly with respect to the Engle progeny cases in Florida. New cases continue to be commenced against Liggett and other cigarette manufacturers. It is likely that similar legal actions, proceedings and claims will continue to be filed against Liggett. Punitive damages, often in amounts ranging into the billions of dollars, are specifically pled in certain cases, in addition to compensatory and other damages. It is possible that there could be adverse developments in pending cases including the certification of additional class actions. An unfavorable outcome or settlement of pending smoking-related litigation could encourage the commencement of additional litigation. In addition, an unfavorable outcome in any smoking-related litigation could have a material adverse effect on our consolidated financial position, results of operations and cash flows. Liggett could face difficulties in obtaining a bond to stay execution of a judgment pending appeal.
As of June 30, 2012, there were approximately 5,649 Engle progeny cases, 65 individual suits, five purported class actions and one healthcare cost recovery action pending in the United States in which Liggett or us, or both, were named as a defendant. As of June 30, 2012, 12 Engle progeny cases involving Liggett have resulted in verdicts, exclusive of the Lukacs case. Seven verdicts were returned in favor of the plaintiffs and five were returned in favor of Liggett. As of June 30, 2012, 31 alleged Engle progeny cases, where Liggett is currently named as a defendant, were scheduled for trial through June 30, 2013. Liggett Only Cases. There are currently eight cases pending where Liggett is the only tobacco company defendant. Cases where Liggett is the only defendant could increase substantially as a result of the Engle progeny cases. Engle Progeny Cases. In 2000, a jury in Engle v. R.J. Reynolds Tobacco Co. rendered a $145,000,000 punitive damages verdict in favor of a "Florida Class" against certain cigarette manufacturers, including Liggett. Pursuant to the Florida Supreme Court's July 2006 ruling in Engle, which decertified the class on a prospective basis, and affirmed the appellate court's reversal of the punitive damages award, former class members had one year from January 11, 2007 in which to file individual lawsuits. In addition, some individuals who filed suit prior to January 11, 2007, and who claim they meet the conditions in Engle, are attempting to avail themselves of the Engle ruling. Lawsuits by individuals requesting the benefit of the Engle ruling, whether filed before or after the January 11, 2007 deadline, are referred to as the "Engle progeny cases." Liggett and us have been named in 5,649 Engle progeny cases in both federal (2,642 cases) and state (3,007 cases) courts in Florida. Other cigarette manufacturers have also been named as defendants in these cases, although as a case proceeds, one or more defendants may ultimately be dismissed from the action. These cases include approximately 6,912 plaintiffs. The number of state court Engle progeny cases may increase as multi-plaintiff cases continue to be severed into individual cases. The total number of plaintiffs may also increase as a result of attempts by existing plaintiffs to add additional parties.

Critical Accounting Policies

There are no material changes from the critical accounting policies set forth in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of our Annual Report on Form 10-K, for the year ended December 31, 2011. Please refer to that section and the information below for disclosures regarding the critical accounting policies related to our business.

Results of Operations

The following discussion provides an assessment of our results of operations, capital resources and liquidity and should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this report. The condensed consolidated financial statements include the accounts of VGR Holding, Liggett, Vector Tobacco, Liggett Vector Brands, New Valley and other less significant subsidiaries.

For purposes of this discussion and other consolidated financial reporting, our significant business segments for the three and six months ended June 30, 2012 and 2011 were Tobacco and Real Estate. The Tobacco segment consists of the manufacture and sale of cigarettes and the research related to reduced risk products. The Real Estate segment includes our investments in consolidated and non-consolidated real estate businesses.

                          Three Months Ended           Six Months Ended
                        June 30,      June 30,      June 30,      June 30,
                          2012          2011          2012          2011
Revenues:
Tobacco                $ 276,594     $ 291,180     $ 534,200     $ 551,558
Operating income:
Tobacco                $  44,590     $  42,214     $  82,105     $  78,639
Real Estate                 (249 )        (487 )         272          (330 )
Corporate and other       (3,413 )      (3,760 )      (8,003 )      (8,866 )
Total operating income $  40,928     $  37,967     $  74,374     $  69,443


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Three Months Ended June 30, 2012 Compared to Three Months ended June 30, 2011

Revenues. All of our revenues were from the Tobacco segment for the second quarter of 2012 and 2011. Liggett increased the list price of PYRAMID by $1.30 per carton in January 2011, $1.10 per carton in August 2011 and $1.00 per carton in June 2012. Liggett increased the list price of LIGGETT SELECT, EVE, and GRAND PRIX by $0.80 per carton on October 31, 2011 and $1.00 per carton in June 2012. The list price of LIGGETT SELECT and EVE also increased by $1.00 per carton in June 2011. The list price of GRAND PRIX also increased by $1.10 per carton in June 2011.

All of our sales in 2012 and 2011 were in the discount category. For the three months ended June 30, 2012, revenues were $276,594 compared to $291,180 for the three months ended June 30, 2011. Revenues declined by 5.0% ($14,586) primarily due to an unfavorable sales volume of $28,535 (approximately 237.8 million units) offset by a favorable price variance of $13,949 primarily related to increases in price of the PYRAMID.

Cost of Goods Sold. Our cost of goods sold declined from $231,073 for the three months ended June 30, 2011 to $211,752 for the three months ended June 30, 2012. The major components of our cost of goods sold are federal excise taxes, expenses under the MSA, FDA legislation and tobacco buyout, which are variable costs based on the number of units sold, and tobacco and other manufacturing costs, which are fixed and variable costs. Federal excise taxes declined from $142,934 for the three months ended June 30, 2011 to $130,967 for the three months ended June 30, 2012 as a result of decreased unit sales volume of 8.4%. Tobacco and other manufacturing costs were $33,019 and $34,975 for the three months ended June 30, 2012 and 2011, respectively. Expenses under the MSA were $36,151 and $41,242 for the three months ended June 30, 2012 and 2011, respectively.

Tobacco Gross Profit. Tobacco gross profit was $64,842 for the three months ended June 30, 2012 compared to $60,107 for the three months ended June 30, 2011. This represented an increase of $4,735 (7.9%) from the 2011 period. This increase was due primarily to higher prices. As a percentage of revenues (excluding federal excise taxes), Tobacco gross profit increased to 44.5% in the 2012 period compared to gross profit of 40.5% in the 2011 period due to higher prices.

Expenses. Operating, selling, general and administrative expenses were $23,914 for the three months ended June 30, 2012 compared to $22,140 for the same period last year, an increase of $1,774 (8.0%). Tobacco expenses were $20,252 for the three months ended June 30, 2012 compared to $17,893 for the same period in the prior year. This is an increase of $2,359, which was primarily the result of higher expenses due to an increase in sales force headcount over the last twelve months, increases in legal expenses due to MSA arbitration and Engle progeny cases and an increase in point of sales materials. Tobacco product liability legal expenses and other litigation costs were $2,069 and $1,679 for the three months ended June 30, 2012 and 2011, respectively. Expenses at the corporate level decreased from $3,760 to $3,413 due to the timing of expenses.

Operating income. Operating income was $40,928 for the three months ended June 30, 2012 compared to $37,967 for the same period last year, an increase of $2,961 (7.8%). Tobacco segment operating income increased from $42,214 in 2011 to $44,590 in 2012 primarily due to higher prices in 2012. The real estate segment operating loss was $249 and $487 for the three months ended June 30, 2012 and 2011, respectively, related primarily to Escena's operations.

Other income (expenses). Other expenses were $35,800 for the three months ended June 30, 2012 compared to income of $10,879 for the same period last year. For the three months ended June 30, 2012, other expenses primarily consisted of interest expense of $26,509, accelerated interest expense related to the conversion of debt of $7,888 losses of $6,003 from changes in fair value of derivatives embedded within convertible debt and an equity loss on long-term investments of $1,215. This was offset by equity income on non-consolidated real estate businesses of $5,232 and interest and other income of $583. For the three months ended June 30, 2011, other income primarily consisted of a realized gain on liquidation of long-term investment of $19,475, a realized gain on investments held for sale of $1,506, income of $9,437 from changes in fair value of derivatives embedded within convertible debt, equity income on non-consolidated real estate businesses of $6,197 and a realized gain on sale of a townhome of $577. This income was offset by interest expense of $25,082 and accelerated interest expense related to the conversion of debt of $1,217.

The value of the embedded derivatives is contingent on changes in interest rates of debt instruments maturing over the duration of the convertible debt, our stock price as well as projections of future cash and stock dividends over the term of the debt. The interest rate component of the value of the embedded derivative is computed by comparing the yield on our 11% Senior Secured Notes to the average difference in interest yields on unsecured and subordinated debt. The interest rate component declined from 8.25% at March 31, 2012 to 7.50% at June 30, 2012. The decline was primarily due to the shortened duration of the 11% Senior Secured Notes at June 30, 2012 compared to March 31, 2012. These changes caused the yield (computed on a yield to worst call basis) to decline from approximately 5.6% to approximately 5.3%. Further, the spread between the yield on subordinated debt and comparable risk free investments declined from approximately 2.7% to approximately 2.2% for the three months ended June 30, 2012. These changes significantly reduced the discount rate of future cash flows used to compute the embedded derivative. Thus, improvements in debt markets caused us to recognize an expense of $6,003 related to increases in the embedded derivative for the three months ended June 30, 2012. The gain of $9,437 from the embedded derivatives in the three months ended June 30, 2011, was primarily the result of increasing spreads (from approximately 2.7% to approximately 3.0%) between corporate convertible debt and risk free investments offset by interest payments during the period.

Income before income taxes. Income before income taxes for the three months ended June 30, 2012 was $5,128 compared to $48,846 for the three months ended June 30, 2011.

Income tax provision. The income tax provision was $1,233 and $18,545 for the three months ended June 30, 2012 and 2011, respectively. Our provision for income taxes in interim periods is based on an estimated annual effective income tax rate derived, in part, from estimated annual income before provision for income taxes in accordance with guidance on accounting for income taxes on interim periods. For the three months ended June 30, 2012, our income tax expense was decreased by the impact of the acceleration of interest expense related to the conversion of debt, which decreased the income tax provision by approximately $769.

Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011

Revenues. All of our revenues were from the Tobacco segment in the first six months of 2012 and 2011. Liggett increased the list price of PYRAMID by $1.30 per carton in January 2011, $1.10 per carton in August 2011 and $1.00 per carton in June 2012. Liggett increased the list price of LIGGETT SELECT, EVE, and GRAND PRIX by $0.80 per carton on October 31, 2011 and $1.00 per carton in June 2012. The list price of LIGGETT SELECT and EVE also increased by $1.00 per carton in June 2011. The list price of GRAND PRIX also increased by $1.10 per carton in June 2011.

All of our sales were in the discount category in 2012 and 2011. For the six months ended June 30, 2012, revenues were $534,200 compared to $551,558 for the six months ended June 30, 2011. Revenues declined by 3.1% ($17,358) due to an unfavorable sales volume of $42,992 (approximately 350.8 million units) offset by a favorable price variance of $25,634 primarily related to increases in the price of PYRAMID.

Cost of Goods Sold. Our cost of goods sold declined from $436,250 for the six months ended June 30, 2011 to $411,933 for the six months ended June 30, 2012. The major components of our cost of goods sold are federal excise taxes, expenses under the MSA, FDA legislation and tobacco buyout, which are variable costs based on the number of units sold, and tobacco and other manufacturing costs, which are fixed and variable costs. Federal excise taxes declined from $270,568 for the six months ended June 30, 2011 to $252,892 for the six months ended June 30, 2012 as a result of decreased unit sales volume of 6.5%. Tobacco and other manufacturing costs were $64,154 and $65,955 for the six months ended June 30, 2012 and 2011, respectively. Expenses under the MSA were $69,819 and $74,885 for the six months ended June 30, 2012 and 2011, respectively.

Tobacco gross profit. Tobacco gross profit was $122,267 for the six months ended June 30, 2012 compared to $115,308 for the six months ended June 30, 2011. The $6,959 (6.0%) increase was due primarily to increases in the price of PYRAMID. As a percentage of revenues (excluding federal excise taxes), Tobacco gross profit increased to 43.5% in the 2012 period compared to gross profit of 41.0% in the 2011 period due to price increases.

Expenses. Operating, selling, general and administrative expenses were $47,893 for the six months ended June 30, 2012 compared to $45,865 for the same period last year, an increase of $2,028 (4.4%). Tobacco expenses were $40,162 for the six months ended June 30, 2012 compared to $36,669 for the six months ended June 30, 2011. The increase of $3,493 was primarily the result of higher sales force expenses due to an increase in sales force over the last twelve months, increases in legal expenses due to MSA arbitration and Engle progeny cases and an increase in point of sales materials. Tobacco product liability legal expenses and other litigation costs were $4,030 and $3,718 for the six months ended June 30, 2012 and 2011, respectively. Expenses at the corporate segment declined from $8,866 to $8,003 in 2012 due to the timing of expenses.

Operating income. Operating income was $74,374 for the six months ended June 30, 2012 compared to $69,443 for the same period last year, an increase of $4,931 (7.1%). For the six months ended June 30, 2012, Tobacco segment operating income increased from $78,639 in 2011 to $82,105 in 2012 primarily due to increases in the price of PYRAMID in 2012. The real estate segment's operating income was $272 for the six months ended June 30, 2012 compared to a loss of $330 for the same period in 2011, primarily related to Escena's operations.

Other income (expenses). Other expenses were was $80,428 for the six months ended June 30, 2012 compared to other income of $11,425 for the same period last year. For the six months ended June 30, 2012, other expenses primarily consisted of interest expense of $52,761, a loss of $27,060 from changes in fair value of derivatives embedded within convertible debt, accelerated interest expense related to the conversion of debt of $7,888 and an equity loss on long-term . . .