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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A No.1
JOINT ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Year Ended December 31, 1996
BROOKE GROUP LTD.
(Exact name of registrant as specified in its charter)
DELAWARE 1-5759 51-0255124
(State or other jurisdiction of Commission File Number (I.R.S. Employer
incorporation Identification No.)
or organization)
BGLS INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-93576 13-3593483
(State or other jurisdiction of Commission File Number (I.R.S. Employer
incorporation or organization) Identification No.)
100 S.E. Second Street
Miami, Florida 33131
305/579-8000
(Address, including zip code and telephone number, including area code,
of the principal executive offices)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on
which registered
Brooke Group Ltd.
Common Stock, par value $.10 per share New York
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), during the preceding 12 months (or for
such shorter period that the Registrants were required to file such reports),
and (2) have been subject to such filing requirements for the past 90 days.
[ X ] Yes [ ] No
Explanatory Note: BGLS Inc. is required to file all reports required by
Section 13 or 15(d) of the Exchange Act in connection with its 15.75% Series B
Senior Secured Notes due 2001. BGLS Inc. meets the conditions set forth in
General Instruction I(l)(a) and (b) of Form 10-K and is therefore filing this
form with the reduced disclosure format.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ] Yes [ ] No
The aggregate market value of the voting stock held by non-affiliates of
Brooke Group Ltd. as of March 21, 1997 was approximately $33,640,000. Directors
and officers and ten percent or greater stockholders of Brooke Group Ltd. are
considered affiliates for purposes of this calculation but should not
necessarily be deemed affiliates for any other purpose.
At March 21, 1997, Brooke Group Ltd. had 18,097,096 shares of common
stock outstanding, and BGLS Inc. had 100 shares of common stock outstanding,
all of which are held by Brooke Group Ltd.
Documents Incorporated by Reference:
Part III (items 10, 11, 12 and 13) from the definitive Proxy Statement of
Brooke Group Ltd. for the 1997 Annual Meeting of Stockholders to be filed with
the Securities and Exchange Commission no later than 120 days after the end of
the Registrant's fiscal year covered by this report.
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BROOKE GROUP LTD.
BGLS INC.
FORM 10-K
T A B L E O F C O N T E N T S
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Page
PART I
Item 1. Business.................................................. 1
Item 2. Properties................................................ 16
Item 3. Legal Proceedings......................................... 17
Item 4. Submission of Matters to a Vote of
Security-Holders; Executive Officers
of the Registrant..................................... 17
PART II
Item 5. Market for Registrants' Common Equity and Related
Stockholder Matters................................... 19
Item 6. Selected Financial Data................................... 20
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................................ 21
Item 8. Financial Statements and Supplementary Data............... 35
Item 9. Changes In and Disagreements with Accountants
on Accounting and Financial Disclosure................ 35
PART III
Item 10. Directors and Executive Officers of the
Registrants........................................... 35
Item 11. Executive Compensation.................................... 35
Item 12. Security Ownership of Certain Beneficial
Owners and Management................................. 35
Item 13. Certain Relationships and Related Transactions............ 35
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K................................... 36
SIGNATURES.......................................................... 47
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PART I
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ITEM 1. BUSINESS
GENERAL
Brooke Group Ltd. (the "Company"), a Delaware corporation founded in 1980,
is a holding company for a number of businesses. The Company is principally
engaged, through its subsidiary Liggett Group Inc. ("Liggett"), in the
manufacture and sale of cigarettes in the United States; through its subsidiary
Brooke (Overseas) Ltd. ("BOL"), in the manufacture and sale of cigarettes in
Russia; and through its investment in New Valley Corporation ("New Valley"), in
the investment banking and brokerage business, in real estate development in
Russia and the Ukraine, in the ownership and management of commercial real
estate in the United States and in the acquisition of operating companies. The
Company holds such businesses through its wholly-owned subsidiary, BGLS Inc., a
Delaware corporation organized in 1990 ("BGLS").
The Company is controlled by Bennett S. LeBow, the Chairman and Chief
Executive Officer of the Company, BGLS and New Valley, who owns directly or
indirectly approximately 53% of the Company's common stock. The principal
executive offices of the Company and BGLS are located at 100 S.E. Second Street,
Miami, Florida 33131 and the telephone number is (305) 579-8000.
LIGGETT GROUP INC.
GENERAL. The Company's tobacco business in the United States is conducted
through its indirect wholly-owned subsidiary Liggett, which is the operating
successor to the Liggett & Myers Tobacco Company. Substantially all of
Liggett's manufacturing facilities are located in or near Durham, North
Carolina. Liggett is registered under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), and files periodic reports and other information
with the Securities and Exchange Commission (the "SEC").
Liggett is engaged in the manufacture and sale of cigarettes, primarily in
the United States. According to The Maxwell Consumer Report, a recognized
industry publication (the "Maxwell Report"), Liggett's domestic shipments of
approximately 8.95 billion cigarettes during 1996 accounted for 1.9% of the
total cigarettes shipped in the United States during such year. This represents
a market share decline of 0.3% from 1995 and 0.4% from 1994. Liggett produces
both premium cigarettes as well as discount cigarettes (which include among
others, control label, branded discount and generic cigarettes). Premium
cigarettes are generally marketed under well-recognized brand names at full
retail prices to adult smokers with strong preference for branded products,
whereas discount cigarettes are marketed at lower retail prices to adult smokers
who are more cost conscious. Liggett's cigarettes are produced in over 325
combinations of length, style and packaging.
Liggett produces four premium cigarette brands: L&M, Chesterfield, Lark and
Eve. Liggett's premium cigarettes represented approximately 33%, 32% and 33% of
net sales (excluding federal excise taxes) in 1996, 1995 and 1994, respectively,
and contributed a substantial portion of Liggett's operating profits for the
respective periods. Liggett's share of the premium market segment was
approximately 0.7% for 1996, compared to 0.8% and 0.9% for 1995 and 1994,
respectively, according to the Maxwell Report.
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In 1980, Liggett was the first major domestic cigarette manufacturer to
successfully introduce discount cigarettes as an alternative to premium
cigarettes. In 1989, Liggett established a new price point within the discount
market segment by introducing Pyramid, a branded discount product which, at that
time, sold for less than most other discount cigarettes. Liggett continues to
produce discount cigarettes with a share of approximately 4.9% of the discount
market segment for 1996, according to the Maxwell Report, compared to 5.5% and
5.4% for 1995 and 1994, respectively.
At the present time, Liggett has no foreign operations other than through
its investment in Liggett-Ducat Ltd. ("Liggett-Ducat"), which is engaged in the
manufacture and sale of cigarettes in Russia (see "Brooke (Overseas) Ltd.").
Liggett does not own the international rights to its premium cigarette brands.
Liggett does, however, export cigarettes which are sold primarily in Eastern
Europe and the Middle East. Export sales of approximately 473 million units
accounted for approximately 5% of Liggett's 1996 total unit sales volume.
Revenues from export sales were $3.3 million for 1996, compared to $5.4 million
and $4.7 million for 1995 and 1994, respectively. Operating loss attributable to
export sales for each of the years 1996, 1995 and 1994 was $1.8 million, $2.1
million and $1.1 million, respectively. Management's strategy is to increase
volume in foreign markets only where Liggett can sell its brands at a profit.
BUSINESS STRATEGY. Liggett's near-term business strategy is to reduce
further certain operating and selling costs in order to increase the
profitability of both its premium and discount products at their current unit
sales volume and to reduce further its investment in working capital. As part of
this strategy, Liggett restructured its headquarters and manufacturing
operations and reduced its workforce by 235 positions in 1993 and reorganized
its sales force in early 1994, reducing its field sales force by 150 permanent
positions and adding approximately 300 part-time positions. Liggett has also
reduced costs in both administrative and manufacturing functions by making
additional modifications to its manufacturing operations and significantly
curtailing employee benefit programs. In 1995, Liggett continued its efforts
towards reducing costs by, among other things, offering voluntary retirement
programs to eligible employees and reducing headcount by an additional 120
positions.
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 is
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. As a result of this reorganization,
Liggett will further reduce its salaried, hourly and part-time headcount by a
total of 273 positions (35%) over an eight-month transition period.
Liggett's long-term business strategy in the premium segment of the market
is to maintain or improve its profit margins in the face of declining unit sales
and market share by improving operating efficiencies and implementing further
cost reduction programs. Liggett's long-term business strategy in the discount
segment of the market is to maintain its market share or improve its profit
margins by consistently providing high-quality products and services at prices
and on terms comparable to those available elsewhere in the market.
SALES, MARKETING AND DISTRIBUTION. Liggett's products are distributed from
a central distribution center in Durham, North Carolina to 27 public warehouses
located throughout the United States. These warehouses serve as local
distribution centers for Liggett's customers. Liggett's products are transported
from the central distribution center to the warehouses via third-party trucking
companies to meet pre-existing contractual obligations to its customers.
Liggett's customers are primarily candy and tobacco distributors, the
military and large grocery, drug and convenience store chains. Liggett offers
its customers discount payment terms,
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traditional rebates and promotional incentives. Customers typically pay for
purchased goods within two weeks following delivery from Liggett. Liggett's
largest single customer accounted for approximately 13.7% of net sales in 1996,
and approximately 11.6% of net sales in 1995, the majority of which were in the
private label discount segment. No single customer accounted for more than 10%
of Liggett's net sales in 1994.
Following the January 1997 restructuring, Liggett's marketing and sales
functions will be performed by approximately 100 direct sales representatives
calling on national and regional customer accounts, together with approximately
145 part-time retail sales consultants who service retail outlets. In addition,
Liggett employs food broker groups in certain geographic locations to perform
these marketing and sales functions.
TRADEMARKS. All of the major trademarks used by Liggett are federally
registered or are in the process of being registered in the United States and
other markets where Liggett's products are sold. Trademarks typically have a
duration of ten years and can be renewed at Liggett's option prior to their
expiration date. In view of the significance of cigarette brand awareness among
consumers, management believes that the protection afforded by these trademarks
is material to the conduct of its business. All of Liggett's trademarks are
owned by its wholly-owned subsidiaries, Eve Holdings Inc. ("Eve") and Cigarette
Exporting Company of America, Ltd. ("CECOA"). Liggett does not own the
international rights to its premium cigarette brands.
MANUFACTURING. Liggett purchases and maintains leaf tobacco inventory to
support its cigarette manufacturing requirements. Liggett believes that there is
a sufficient supply of tobacco within the worldwide tobacco market to satisfy
its current production requirements. Liggett stores its leaf tobacco inventory
in warehouses in North Carolina and Virginia. There are several different types
of tobacco, including flue-cured leaf, burley leaf, Maryland leaf, oriental
leaf, cut stems and reconstituted sheet. Leaf components of cigarettes are
generally the flue-cured and burley tobaccos. While premium and discount brands
use many of the same tobacco products, input ratios of tobacco products account
for the differences between premium and discount products. Domestically grown
tobacco is an agricultural commodity subject to United States government
production controls and price supports which can substantially affect its market
price. Foreign flue-cured and burley tobaccos, some of which are used in the
manufacture of Liggett's cigarettes, are generally 10% to 15% less expensive
than comparable domestic tobaccos. Liggett normally purchases all of its tobacco
requirements from domestic and foreign leaf tobacco dealers, much of it, under
long-term purchase commitments. As of December 31, 1996, approximately 73% of
Liggett's commitments were for the purchase of foreign tobacco. Increasing
tobacco costs due to reduced worldwide supply of tobacco, a reduction in the
average discount available to Liggett from leaf tobacco dealers on tobacco
purchased under prior years' purchase commitments and capitalized interest on
leaf inventory will have an unfavorable impact on Liggett's operations during
1997.
Liggett's cigarette manufacturing facilities are designed for the execution
of short production runs in a cost-effective manner, which enables Liggett to
manufacture and market a wide variety of cigarette brand styles. Liggett's
cigarettes are produced in over 325 different brand styles under Eve's and
CECOA's trademarks and brand names as well as private labels for other
companies, typically retail or wholesale distributors who supply supermarkets
and convenience stores. Liggett believes that its existing facilities are
sufficient to accommodate a substantial increase in production.
While Liggett pursues product development, its total expenditures for
research and development on new products have not been financially material over
the past three years.
COMPETITION. Liggett is the smallest of the five major manufacturers of
cigarettes in the United States. The four largest manufacturers of cigarettes
are Philip Morris, Inc. ("Philip Morris"),
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R.J. Reynolds Tobacco Company ("RJR"), Brown & Williamson Tobacco Corporation,
and Lorillard Tobacco Company, Inc.
There are substantial barriers to entry into the cigarette business,
including extensive distribution organizations, large capital outlays for
sophisticated production equipment, substantial inventory investment, costly
promotional spending, regulated advertising and strong brand loyalty. In this
industry, the major cigarette manufacturers compete among themselves for market
share on the basis of brand loyalty, advertising and promotional activities and
trade rebates and incentives. Liggett's four major competitors all have
substantially greater financial resources than Liggett, and most of these
competitors' brands have greater sales and consumer recognition than Liggett's
brands.
According to the Maxwell Report, Philip Morris' and RJR's sales together
accounted for approximately 72.4% of the domestic cigarette market in 1996.
Liggett's domestic shipments of approximately 8.95 billion cigarettes during
1996 accounted for 1.9% of the approximately 483 billion cigarettes shipped in
the United States during such year, compared to 10.52 billion cigarettes (2.2%)
and 11.32 billion cigarettes (2.3%) during 1995 and 1994, respectively.
Industry-wide shipments of cigarettes in the United States have been
declining for a number of years, although this trend reversed itself in 1996.
While the Maxwell Report estimates that domestic industry-wide shipments
increased by approximately 0.5% in 1996, Liggett's management believes that
industry-wide shipments of cigarettes in the United States will continue to
remain flat or decline as a result of numerous factors, including health
considerations, diminishing social acceptance of smoking, legislative
limitations on smoking in public places and federal and state excise tax
increases which have augmented cigarette price increases.
Historically, because of their dominant market share, Philip Morris and RJR
have been able to determine cigarette prices for the various pricing tiers
within the industry, and the other cigarette manufacturers have brought their
prices into line with the levels established by the two industry leaders.
Off-list price discounting by manufacturers, however, has substantially affected
the average price differential at retail, which can be significantly greater
than the manufacturers' list price gap.
LEGISLATION, REGULATION AND LITIGATION. Reports with respect to the alleged
harmful physical effects of cigarette smoking have been publicized for many
years and, in the opinion of Liggett's management, have had and may continue to
have an adverse effect on cigarette sales. Since 1964, the Surgeon General of
the United States and the Secretary of Health and Human Services have released a
number of reports which claim that cigarette smoking is a causative factor with
respect to a variety of health hazards, including cancer, heart disease and lung
disease, and have recommended various government actions to reduce the incidence
of smoking.
Since 1966, federal law has required that cigarettes manufactured, packaged
or imported for sale or distribution in the United States include specific
health warnings on their packaging . Since 1972, Liggett and the other cigarette
manufacturers have included the federally required warning statements in print
advertising, on billboards and on certain categories of point-of-sale display
materials relating to cigarettes.
The Comprehensive Smoking Education Act ("CSEA"), which became effective
October 12, 1985, requires that packages of cigarettes distributed in the United
States and cigarette advertisements (other than billboard advertisements) in the
United States bear one of the following four warning statements, in lieu of the
prior warning notice, on a quarterly rotating basis: "SURGEON GENERAL'S
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WARNING: Smoking Causes Lung Cancer, Heart Disease, Emphysema, and May
Complicate Pregnancy"; "SURGEON GENERAL'S WARNING: Quitting Smoking Now Greatly
Reduces Serious Risks to Your Health"; "SURGEON GENERAL'S WARNING: Smoking by
Pregnant Women May Result in Fetal Injury, Premature Birth, and Low Birth
Weight"; and "SURGEON GENERAL'S WARNING: Cigarette Smoke Contains Carbon
Monoxide". Shortened versions of these statements are also required, on a
rotating basis, on billboard advertisements. By a limited eligibility amendment
to the CSEA for which Liggett qualifies, Liggett is allowed to display all four
required package warnings for the majority of its brand packages on a
simultaneous basis (such that the packages at any time may carry any one of the
four required warnings), although it rotates the required warnings for
advertising on a quarterly basis in the same manner as do the other major
cigarette manufacturers. The law also requires that each person who
manufactures, packages or imports cigarettes annually provide to the Secretary
of Health and Human Services a list of ingredients added to tobacco in the
manufacture of cigarettes. Annual reports to the United States Congress are also
required from the Secretary of Health and Human Services as to current
information on the health consequences of smoking and from the Federal Trade
Commission on the effectiveness of cigarette labeling and current practices and
methods of cigarette advertising and promotion. Both federal agencies are also
required annually to make such recommendations as they deem appropriate with
regard to further legislation.
On August 28, 1996, the Food and Drug Administration ("FDA") filed in the
Federal Register a Final 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. The FDA's stated objective and focus for its initiative is to limit
access to cigarettes by minors by measures beyond the restrictions either
mandated by existing federal, state and local laws or voluntarily implemented by
major manufacturers in the industry. Litigation has been 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. A hearing on the tobacco industry's motion
for summary judgment in that case was held on February 10, 1997 and a decision
by the court is expected soon. The FDA's proposed restrictions, some of which
became effective as early as February 28, 1997, purport to: (i) limit access to
tobacco products and (ii) limit advertising and marketing. Management is unable
to predict whether the Final Rule will be upheld as enforceable against the
industry. Management is also unable to predict the effects of the proposed
restrictions, if implemented, on Liggett's operations, but such actions could
have an unfavorable impact thereon.
The Company and Liggett, while neither consenting to FDA jurisdiction nor
waiving their objections thereto, agreed to withdraw their objections and
opposition to the proposed rule making and to phase in compliance with certain
of the proposed interim FDA regulations. See discussions of the tobacco
litigation settlements in Note 16 to the Consolidated Financial
Statements of the Company and BGLS (the "Company's Consolidated Financial
Statements") included elsewhere in this report.
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. Regulations adopted
pursuant to this legislation are scheduled to become effective on July 1, 1997.
On February 7, 1997, the United States District Court for the District of
Massachusetts denied an attempt to block the new legislation on the ground that
it is preempted by federal law.
In 1993, the United States Congress amended the Agricultural Adjustment Act
of 1938 to require each United States cigarette manufacturer to use at least 75%
domestic tobacco in the aggregate of the cigarettes manufactured by it in the
United States, effective January 1, 1994, on an annualized basis or pay a
domestic marketing assessment ("DMA") based upon price differentials between
foreign and domestic tobacco and, under certain circumstances, make purchases of
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domestic tobacco from the tobacco stabilization cooperatives organized by the
United States government.
After an audit, the United States Department of Agriculture ("USDA")
informed Liggett that it did not satisfy the 75% domestic tobacco usage
requirement for 1994 and was subject to a DMA of approximately $5.5 million.
Liggett has agreed to pay this assessment in quarterly installments, with
interest, over a five-year period. Since the levels of domestic tobacco
inventories on hand at the tobacco stabilization organizations are below reserve
stock levels, Liggett was not obligated to make purchases of domestic tobacco
from the tobacco stabilization cooperatives.
On September 13, 1995, the President of the United States issued
Presidential Proclamation 6821, which established a tariff rate quota ("TRQ") on
certain imported tobacco, imposing extremely high tariffs on imports of
flue-cured and burley tobacco in excess of certain levels which vary from
country to country. Oriental tobacco is exempt from the quota as well as all
tobacco originating from Canada, Mexico or Israel. Management believes that the
TRQ levels are sufficiently high to allow Liggett to operate without material
disruption to its business. In addition, the Presidential Proclamation served to
limit the application of the legislation establishing the DMA to only those
activities occurring in calendar year 1994.
On February 20, 1996, the United States Trade representative issued an
"advance notice of rule making" concerning how tobaccos imported under the TRQ
should be allocated. Currently, tobacco imported under the TRQ is allocated on a
"first-come, first-served" basis, meaning that entry is allowed on an open basis
to those first requesting entry in the quota year. Others in the cigarette
industry have suggested an "end-user licensing" system under which the right to
import tobacco under the quota would be initially assigned on the basis of
domestic market share. Such an approach, if adopted, could have a material
adverse effect on Liggett.
In April 1994, the United States Occupational Safety and Health
Administration ("OSHA") issued a proposed rule that could ultimately ban smoking
in the workplace. Hearings were completed during 1995. OSHA has not yet issued a
final rule or a proposed revised rule. While the Company cannot predict the
outcome, some form of federal regulation of smoking in workplaces may result.
In January 1993, the United States Environmental Protection Agency ( "EPA")
released a report on the respiratory effect of environmental tobacco smoke
("ETS") which concluded 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 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.
The State of Florida enacted legislation, effective July 1, 1994, allowing
certain state authorities or entities to commence litigation seeking recovery of
certain Medicaid payments made on behalf of Medicaid recipients as a result of
diseases (including, but not limited to, diseases allegedly caused by cigarette
smoking) allegedly caused by liable third parties (including, but not limited
to, the tobacco industry). This statute purportedly abrogates certain defenses
typically available to defendants. This legislation would impose on the tobacco
industry, if ultimate liability of the industry is established in litigation,
liability based upon market share for such payments made by the state as a
result of such smoking-related diseases. On February 22, 1995, suit was
commenced by the State of Florida, acting through the Agency for Health Care
Administration, against Liggett and
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others, seeking restitution of monies expended in the past and which may be
expended in the future, by the State of Florida, to provide health care to
Medicaid recipients for injuries and ailments allegedly caused by the use of
cigarettes and other tobacco products. Plaintiffs also seek a variety of other
forms of relief including a disgorgement of all profits from the sale of
cigarettes in Florida. The Florida action is scheduled for trial in August 1997.
In addition to Florida, 21 states (and several municipalities) have brought
actions against Liggett and other cigarette manufacturers seeking restitution
and indemnity for medical payments and expenses allegedly made or incurred for
tobacco related illnesses. Other states are contemplating initiating similar
litigation. See Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Recent Developments in the Cigarette
Industry - Legislation and Litigation" and Note 16 to the Company's Consolidated
Financial Statements for a discussion of such legislation and related
litigation, and of the Company's and Liggett's recent Attorneys General
settlements.
All radio and television advertising of cigarettes has been prohibited by
federal statute since 1971 and federal law now prohibits smoking aboard aircraft
for domestic flights of six hours or less. The United States Interstate Commerce
Commission has banned smoking on buses transporting passengers interstate. In
addition, the United States Congress and a number of states and local government
units have enacted or are considering legislation which is intended to
discourage smoking through educational efforts or which imposes various
restrictions or requirements relating to smoking including restrictions on
public smoking. Certain employers have initiated programs restricting or
eliminating smoking in the workplace. Other proposals previously presented to or
currently before Congress and certain states and local government units include,
but are not limited to, legislative efforts to further restrict or ban the
advertising and promotion of cigarettes, to eliminate the income tax
deductibility of expenses incurred for such advertising and promotion, to
restrict or prohibit smoking in public buildings and other areas, to increase
excise taxes, to require additional warnings on cigarette packaging and
advertising, to ban vending machine sales, to eliminate the federal preemption
defense in product liability actions, to place cigarettes under the regulatory
jurisdiction of the FDA and to require that cigarettes meet certain fire safety
standards. If adopted, at least certain of the foregoing legislative proposals
could have a material adverse impact on Liggett's operations.
While attitudes toward cigarette smoking vary around the world, a number of
foreign countries have also taken steps to discourage cigarette smoking, to
restrict or prohibit cigarette advertising and promotion and to increase taxes
on cigarettes. Such restrictions are, in some cases, more onerous than
restrictions imposed in the United States. Due to Liggett's lack of foreign
operations with the exception of its investment in Liggett-Ducat, and minimal
export sales to foreign countries, the risks of foreign limitations or
restrictions on the sale of cigarettes are limited to entry barriers into
additional foreign markets and the inability to grow the existing markets.
The price of cigarettes includes federal excise taxes at the rate of $12.00
per 1,000 cigarettes. A substantial excise tax increase could accelerate the
trend away from smoking.
The cigarette industry continues to be challenged on numerous fronts. New
cases continue to be commenced against Liggett and other cigarette
manufacturers. As of March 14, 1997, there were 108 individual suits, 12
purported class actions and 22 state (and several municipality) Medicaid
reimbursement actions pending in the United States in which Liggett is a 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, strict liability, fraud, misrepresentation, design defect, failure
to warn, breach of express and implied warranties, conspiracy, concert of
action, unjust enrichment, common law public nuisance, indemnity, market share
liability, and violations of deceptive trade practice laws and antitrust
statutes. Plaintiffs also
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seek punitive damages in many of these cases. The claims asserted in the
Medicaid recovery actions vary. All 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 Federal Racketeer
Influenced and Corrupt Organization Act.
On March 12, 1996, Liggett, together with the Company, entered into an
agreement to settle the CASTANO class action tobacco litigation, and on March
15, 1996, Liggett, together with the Company, entered into an agreement with the
Attorneys General of West Virginia, Florida, Mississippi, Massachusetts and
Louisiana to settle certain actions brought against Liggett and the Company by
such states. On March 20, 1997, Liggett, together with the Company, entered into
comprehensive settlements with each of the remaining 17 states which have filed
Medicaid actions and with a nationwide class of individuals and entities that
allege smoking-related claims. See the discussion of the settlements in Note 16
to the Company's Consolidated Financial Statements.
Liggett has been involved in certain environmental proceedings, none of
which, either individually or in the aggregate, rise to the level of
materiality. Liggett's current operations are conducted in accordance 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,
have not had a material effect on the capital expenditures, earnings or
competitive position of Liggett.
Management believes that Liggett is in compliance in all material respects
with the laws regulating cigarette manufacturers.
See Note 16 to the Company's Consolidated Financial Statements for a
description of legislation, regulation and litigation.
BROOKE (OVERSEAS) LTD.
LIGGETT-DUCAT LTD. Brooke (Overseas) Ltd. ("BOL"), a wholly-owned
subsidiary of BGLS, is engaged in the manufacture and sale of cigarettes in
Russia through Liggett-Ducat, a Russian joint stock company. BOL owns a 75.33%
equity interest in Liggett-Ducat, and Liggett owns a 19.97% interest in
Liggett-Ducat acquired on July 5, 1996. On that date, Liggett purchased from BOL
140,000 shares of Liggett-Ducat's tobacco operations for $2.1 million. Liggett
also acquired from BOL a ten-year option to purchase up to 292,407 additional
shares of Liggett-Ducat stock at the same per share price ($15.00) for $3.4
million, thereby entitling Liggett to increase its interest in Liggett-Ducat to
approximately 62%. The option fee is to be credited against the purchase price.
In addition, on March 13, 1997, Liggett acquired another ten-year option from
BOL for $2.2 million entitling Liggett to purchase the remaining shares of
Liggett-Ducat owned by BOL on the same terms. See Note 4 to the Company's
Consolidated Financial Statements.
Liggett-Ducat, one of Russia's leading cigarette producers since 1892,
manufactured and marketed 11.4 billion cigarettes in 1996. Liggett-Ducat
produces or has rights to produce 19 different brands of cigarettes, including
Russian brands such as PEGAS, PRIMA, NOVOSTI AND BALOMORKANAL.
Liggett-Ducat manufactures three types of cigarettes: filter, non-filter
and papirossi. Paparosi is a traditional type of Russian cigarette featuring a
long paper filter comprising two-
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thirds of the cigarette with tobacco filling up the balance. In 1996,
Liggett-Ducat sold 3.1 billion filter cigarettes (27%), 6.7 billion non-filter
cigarettes (59%) and 1.6 billion papirossi (14%).
The long-term strategy of Liggett-Ducat is to upgrade the quality of its
traditional Russian cigarette brands to international standards and to expand
the range of cigarettes it offers to include the higher-margin American blend
and international blend cigarettes. The new types of cigarettes will appeal to
the growing segment of the market that prefers American blend cigarettes over
traditional Russian blended cigarettes. Russian blend cigarettes have a very
strong flavored oriental tobacco blend with a heavy pungent odor, while the
American blend is a lighter flavored Virginia tobacco blend. The international
blend will be a mix between Russian and American blends. As markets have
developed in Eastern Europe, consumer preferences have typically shifted toward
international and American blend cigarettes.
Liggett-Ducat produces its cigarettes in a 150,000 square foot factory
complex located on Gasheka Street in downtown Moscow and operates a 150,000
square foot warehouse outside of the city. Liggett-Ducat plans to build a new
cigarette factory on the outskirts of Moscow on land it has leased for a term of
49 years. The new factory, which will utilize Western cigarette making
technology and have a capacity of 24 billion units per year, will produce
American and international blend cigarettes, as well as traditional Russian
cigarettes. Preliminary construction has commenced, and management is actively
pursuing various potential financing alternatives that would permit the new
factory to be operational by the end of 1998, although no assurance can be given
that such financing can be obtained on satisfactory terms.
Liggett-Ducat currently manufactures its cigarettes on four production
lines, comprised of both Russian-made and imported machinery. Liggett-Ducat is
currently upgrading the equipment at the existing factory to improve its
operations, and all upgraded equipment will be utilized at the new factory.
During 1996, Liggett-Ducat installed an upgraded primary processing complex
manufactured by GBE Tobacco which will enable the factory to produce
international standard cigarettes. In addition, Liggett-Ducat recently acquired
a new filter-making complex from Hoechst Celanese which allows Liggett-Ducat to
produce Western quality filters, previously purchased from outside vendors, and
installed a new rejected cigarette tobacco reclamation machine to reduce waste.
The Russian cigarette market is one of the largest and fastest growing
cigarette markets in the world. Annual consumption of cigarettes is estimated at
250 billion units in Russia (1996 estimate), making the market the third largest
in the world after the United States and China. The potential size of the market
is estimated by management at up to 450 billion units per year. Approximately
61% of Russian men and 17% of Russian women are estimated to smoke cigarettes.
The market has been growing rapidly over the past several years (particularly
the female market) as imported cigarettes have become available to satisfy
increasing demand.
Growth in consumption has been restrained historically by static domestic
cigarette making capacity. In 1996, approximately 150 billion cigarettes (68% of
the market) were produced domestically. Excess demand and demand for Western
style cigarettes were satisfied by approximately 100 billion units of imported
cigarettes (40% of the market).
New Russian customs legislation has served to support local producers.
During the past twelve months, the Russian Government raised the duties on
imported cigarettes several times to a current effective rate of 115% of cost.
In the past, many imported cigarettes were sold illegally without payment of
required duties. Recent efforts to improve enforcement of import duties, if
successful, will further increase the differential between the price of imported
and domestic cigarettes. Imported cigarettes currently range in price at retail
from approximately 2,000 to
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18,000 rubles ($.35 to $3.16) per pack, as compared to domestically produced
cigarettes which sell for approximately 650 to 8,000 rubles ($.11 to $1.40) per
pack.
Liggett-Ducat's brands currently compete primarily against those of other
Russian cigarette makers. Liggett-Ducat as well as other Russian producers sell
their cigarettes at the lowest price points in the market. Competition in this
sector of the market is generally based on price and name recognition of the
producing factory. There is very limited advertising of these products,
typically only in trade publications and wholesale catalogs. Liggett-Ducat's
brands also compete to a lesser extent against lower priced imported cigarettes
from Eastern Europe and Asia.
In order to increase their presence in the vast Russian market and avoid
import duties, several of the major international cigarette manufacturers have
begun to produce American and international blend cigarettes domestically. Such
activities by companies with well established, international brands will provide
significant additional competition to Liggett-Ducat as its seeks to increase its
sales of such higher margin products upon completion of the new factory.
SALE OF BROOKEMIL LTD. Until January 31, 1997, BOL was also engaged in the
real estate development business in Moscow through its subsidiary BrookeMil Ltd.
("BML"). On January 31, 1997, BOL entered into a stock purchase agreement (the
"Purchase Agreement") with New Valley, pursuant to which BOL sold 10,483 shares
of the common stock of BML to New Valley, comprising 99.1% of the outstanding
shares of BML (the "BML Shares"). The following description of the BML sale is
qualified in its entirety by reference to the Purchase Agreement and the annexes
thereto, copies of which are incorporated by reference as an exhibit to this
report and are incorporated herein by reference. See Note 4 to the Company's
Consolidated Financial Statements for a discussion of the transaction and
information regarding a pending lawsuit relating to New Valley's purchase of the
BML Shares.
New Valley paid to BOL, for the BML Shares, a purchase price of $55
million, consisting of $21.5 million in cash and a $33.5 million 9% promissory
note of New Valley (the "Note"). The Note is collateralized by the BML Shares
and is payable $21.5 million on June 30, 1997 and $12 million on December 31,
1997. The transaction was approved by the independent members of the Board of
Directors of the Company. The Company retained independent legal counsel in
connection with the evaluation and negotiation of the transaction.
BML is developing the three-phase Ducat Place complex on 2.2 acres of land
in downtown Moscow, for which it has a 98-year lease. In 1993, the first phase
of the project, Ducat Place I, a 46,500 square foot Class-A office building, was
successfully built and leased. Tenants include Citicorp, the G-7 Group of
Nations and the European Bank for Reconstruction and Development. In 1995, BML
began construction of Ducat Place II, a premier 150,000 square foot office
building. Ducat Place II has been pre-leased to a number of leading
international companies including Motorola, Conoco, Lukoil-Arco and Morgan
Stanley. The third phase, Ducat Place III, is planned as a 400,000 square foot
mixed-use complex, with construction anticipated to commence in 1998.
In connection with the purchase of the BML Shares by New Valley, certain
specified liabilities of BML, aggregating approximately $ 40.8 million, remained
as liabilities of BML after the closing. These liabilities include a $20.4
million loan due in 1997 to Vneshtorgbank, a Russian bank, for the construction
of Ducat Place II, which is collateralized by a mortgage on the building. In
addition, the liabilities of BML include approximately $13.8 million of rents
and related payments prepaid by tenants in Ducat Place II for periods generally
ranging from 15 to 18 months.
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The site of the proposed third phase of the Ducat project is currently used
by Liggett-Ducat as the site for its existing cigarette factory. In connection
with the sale of the BML Shares, Liggett-Ducat entered into a Use Agreement with
BML whereby Liggett-Ducat is permitted to continue to utilize the site on the
same basis as in the past. The Use Agreement is terminable by BML on 270 days'
prior notice. In addition, New Valley has the right under the Purchase Agreement
to require BOL and BGLS to repurchase this site for the then appraised fair
market value, but in no event less than $13.6 million, during the period
Liggett-Ducat operates the factory on such site.
NEW VALLEY CORPORATION
New Valley is engaged, through its ownership of Ladenburg Thalmann & Co.
Inc. ("Ladenburg"), in the investment banking and brokerage business, through
its ownership of BML, in the real estate development business in Russia and the
Ukraine, through its New Valley Realty division, in the ownership and management
of commercial real estate in the United States, and in the acquisition of
operating companies. New Valley is registered under the Exchange Act and files
periodic reports and other information with the SEC.
The Company indirectly holds, through BGLS and BGLS' wholly-owned
subsidiary, New Valley Holdings, Inc. ("NV Holdings"), approximately 42% of the
voting interest in New Valley. This approximate 42% interest consists, as of
March 25, 1997, of (i) 19,748 shares of common stock (the "New Valley Common
Shares") (approximately 0.2% of the class) and 250,885 shares of $3.00 Class B
Cumulative Convertible Shares (the "Class B Preferred Shares") (approximately
9.0% of the class) held directly by BGLS and (ii) 3,969,962 New Valley Common
Shares (approximately 41.4% of the class) and 618,326 $15.00 Class A Increasing
Rate Cumulative Senior Preferred Shares (the "Class A Preferred Shares")
(approximately 57.7% of the class) held by NV Holdings. See Note 2 to the
Company's Consolidated Financial Statements.
Bennett S. LeBow, Chairman of the Board, President and Chief Executive
Officer of the Company and of BGLS and the controlling stockholder of the
Company, serves as Chairman of the Board and Chief Executive Officer of New
Valley. Howard M. Lorber, a consultant to the Company and its subsidiaries and a
stockholder of the Company, serves as President and Chief Operating Officer, and
is a director, of New Valley. Richard J. Lampen, Executive Vice President of the
Company and of BGLS, serves as Executive Vice President, and is a director, of
New Valley. Richard S. Ressler, a greater than 5% stockholder of the Company and
a former consultant to the Company and its subsidiaries, serves as a director of
New Valley.
On January 18, 1995, New Valley emerged from bankruptcy reorganization
proceedings and completed substantially all distributions to creditors under its
First Amended Joint Chapter 11 Plan of Reorganization, as amended (the "Joint
Plan"). The Joint Plan was confirmed by the United States Bankruptcy Court for
the District of New Jersey, Newark Division on November 1, 1994, and pursuant
thereto, New Valley effected certain related asset dispositions. For further
information with respect to the asset dispositions, see "Dispositions Pursuant
to the Joint Plan", below.
Acquisitions by New Valley
LADENBURG THALMANN & CO. INC. On May 31, 1995, New Valley acquired all of
the outstanding shares of common stock and other equity interests of Ladenburg
for $25.8 million, net of cash acquired, subject to adjustment. Ladenburg is a
full service broker-dealer which has been a member of the New York Stock
Exchange since 1876. Its specialties include investment
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banking, trading, research, market making, client services, institutional sales
and asset management.
Ladenburg's investment banking area maintains relationships with businesses
and provides them with research, advisory and investor relations support.
Services include merger and acquisition consulting, management of and
participation in underwriting of equity and debt financing, private debt and
equity financing, and rendering appraisals, financial evaluations and fairness
opinions. Ladenburg's listed securities and over-the-counter trading areas
include trading a variety of financial instruments in both national and
international markets. Ladenburg's client services and institutional sales
departments serve over 20,000 accounts worldwide and its asset management area
provides investment management and financial planning services to individuals
and institutions.
Ladenburg is a wholly-owned subsidiary of Ladenburg Thalmann Group Inc.
("Ladenburg Group"), which has other subsidiaries specializing in merchant
banking, venture capital and investment banking activities on an international
level. Ladenburg Thalmann International ("LTI"), a wholly-owned subsidiary of
Ladenburg Group, is engaged in establishing a corporate finance and capital
markets presence in Russia and the Ukraine, seeking, among other things,
mandates to raise capital for local corporate issuers in the international
capital markets. LTI, headquartered in New York City, has offices in Kiev,
Ukraine and Moscow, Russia.
BROOKEMIL LTD. On January 31, 1997, New Valley acquired the BML Shares,
representing 99.1% of the outstanding shares of BML from BOL. The Company paid
to BOL a purchase price of $55 million, consisting of $21.5 million in cash and
the $33.5 million 9% Note of New Valley. The Note is collateralized by the BML
Shares and is payable $21.5 million on June 30, 1997 and $12 million on December
31, 1997. For further information with respect to this transaction, see "Brooke
(Overseas) Ltd. - Sale of BrookeMil Ltd.".
NEW VALLEY REALTY DIVISION. On January 10 and January 11, 1996, New Valley
acquired four commercial office buildings (the "Office Buildings") and eight
shopping centers (the "Shopping Centers"), respectively, for an aggregate
purchase price of $183.9 million, consisting of $23.9 million in cash and $160
million in non-recourse mortgage financing. The Office Buildings and Shopping
Centers are being operated through New Valley's New Valley Realty division.
The Office Buildings consist of two adjacent commercial office buildings in
Troy, Michigan and two adjacent commercial office buildings in Bernards
Township, New Jersey. New Valley acquired the Office Buildings in Michigan from
Bellemead of Michigan, Inc. ("Bellemead Michigan") and the Office Buildings in
New Jersey from Jared Associates, L.P (each, a "Seller"), for an aggregate
purchase price of $111.4 million. Each Seller is an affiliate of Bellemead
Development Corporation, which is indirectly wholly-owned by The Chubb
Corporation. The purchase price was paid for the Office Buildings as follows:
(i) $23.5 million for the 700 Tower Drive property, located in Troy, Michigan;
(ii) $28.1 million for the 800 Tower Drive property, located in Troy, Michigan;
(iii) $48.3 million for the Westgate I property, located in Bernards Township,
New Jersey; and (iv) $11.4 million for the Westgate II property, located in
Bernards Township, New Jersey. The two Michigan buildings were constructed in
1987 and the two New Jersey buildings were constructed in 1991. The gross square
footage of the Office Buildings ranges from approximately 50,300 square feet to
approximately 244,000 square feet.
New Valley acquired a fee simple interest in each Office Building (subject
to certain rights of existing tenants), together with a fee simple interest in
the land underlying three of the Office Buildings and a 98-year ground lease
(the "Ground Lease") underlying one of the Office Buildings. Under the Ground
Lease, Bellemead Michigan, as lessor, is entitled to receive rental payments of
a fixed monthly amount and a specified portion of the income received from the
700 Tower Drive
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property. Space in the Office Buildings is leased to commercial tenants and, as
of March 25, 1997, the Office Buildings were fully occupied.
Concurrently with the acquisition of the Office Buildings, New Valley
engaged a property-management affiliate of Sellers that had previously managed
the Office Buildings to act as the managing agent and leasing agent for the
Office Buildings. The agreement has a fifteen-year term, but may be terminated
by either party on 60 days' notice without cause or economic penalty.
On January 11, 1996, New Valley acquired the Shopping Centers from various
limited partnerships (AP Century I., L.P., AP Century II, L.P., AP Century III,
L.P., AP Century IV, L.P., AP Century V, L.P., AP Century VI, L.P., AP Century
VIII, L.P., and AP Century IX, L.P.) (each, a "Partnership") for an aggregate
purchase price of $72.5 million. Each Partnership is an affiliate of Apollo Real
Estate Investment Fund, L.P ("Apollo"). The Shopping Centers are located in
Marathon and Royal Palm Beach, Florida; Lincoln, Nebraska; Santa Fe, New Mexico;
Milwaukee, Oregon; Richland and Marysville, Washington; and Charleston, West
Virginia. New Valley acquired a fee simple interest in each Shopping Center and
the underlying land for each property. Space in the Shopping Center is leased to
a variety of commercial tenants and, as of March 25, 1997, the aggregate
occupancy of the Shopping Centers was approximately 92%. The Shopping Centers
were constructed at various times during the period 1963-1988. The gross square
footage of the Shopping Centers ranges from approximately 108,500 square feet to
approximately 222,500 square feet.
The purchase price paid for the Shopping Centers was as follows: (i) $3.9
million for the Marathon Shopping Center property, located in Marathon, Florida;
(ii) $9.8 million for the Village Royale Plaza Shopping Center property, located
in Royal Palm Beach, Florida; (iii) $6.0 million for the University Place
property, located in Lincoln, Nebraska; (iv) $9.6 million for the Coronado
Shopping Center property, located in Santa Fe, New Mexico; (v) $7.3 million for
the Holly Farm Shopping Center property, located in Milwaukee, Oregon; (vi)
$10.6 million for the Washington Plaza property, located in Richland,
Washington; (vii) $12.4 million for the Marysville Towne Center property,
located in Marysville, Washington; and (viii) $12.9 million for the Kanawha Mall
property, located in Charleston, West Virginia (the properties described in
clauses (i), (ii), (v), (vii) and (viii) are subject to an underlying mortgage
in favor of a single lender and are referred to collectively as the
"Properties"). See Notes 3 and 7 to New Valley's Consolidated Financial
Statements accompanying this report.
Concurrently with the acquisition of the Shopping Centers, New Valley
engaged a property-management firm, whose principals were the former minority
partners in the Partnerships, that had previously operated the Shopping Centers
to act as the managing agent and leasing agent for the Shopping Centers.
Effective December 31, 1996, such firm's engagement was terminated, and Kravco
Company was engaged as managing agent and leasing agent for the Kanawha Mall and
Insignia Commercial Group, Inc. as managing agent and leasing agent for the
remaining Shopping Centers.
The acquisition of the Office Buildings was effected pursuant to a purchase
agreement dated January 10, 1996. The acquisition of the Shopping Centers was
effected pursuant to a purchase agreement dated January 11, 1996. As of March
25, 1997, an affiliate of Apollo and the Partnerships was the holder of debt
securities of BGLS. The foregoing description of these acquisitions by New
Valley is qualified in its entirety by reference to the purchase agreements,
copies of which are incorporated by reference as exhibits to New Valley's Annual
Report on Form 10-K for the year ended December 31, 1996, and are incorporated
by reference herein.
RJR NABISCO HOLDINGS CORP. As of March 14, 1997, New Valley held
approximately 1.06 million shares of common stock of RJR Nabisco Holdings Corp.
("RJR Nabisco") with a market value of approximately $36.0 million (cost of
$32.6 million). For additional information concerning
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New Valley's investment in RJR Nabisco and the Company's and BGLS' involvement
with respect thereto and related matters, see "Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Recent
Developments - Certain Matters Relating to RJR Nabisco" and Note 3 to the
Company's Consolidated Financial Statements.
THINKING MACHINES CORPORATION. On January 11, 1996, Ladenburg Thalmann
Capital Corp. ("Ladenburg Capital"), the merchant banking subsidiary of
Ladenburg Group, in connection with the First Amended Joint Plan of
Reorganization (the "TMC Plan") of Thinking Machines Corporation ("Thinking
Machines") made a $10.6 million convertible bridge loan (the "Loan") to TMCA
Acquisition Corp. ("TMCA"). TMCA is an entity formed to invest the Loan proceeds
(net of certain expenses) in Thinking Machines, currently a developer and
marketer of data mining and knowledge discovery software and, through 1996, of
parallel software for high-end and networked computer systems (discontinued in
1996).
On February 8, 1996, the date of confirmation of the TMC Plan, Thinking
Machines emerged from bankruptcy and merged with TMCA pursuant to the TMC Plan.
As a result of the merger, the Loan was converted into a controlling interest in
a partnership which holds approximately 61% of the outstanding common stock of
Thinking Machines. Thinking Machines has used the Loan proceeds to help fund its
advanced product development and marketing.
Thinking Machines produces, markets and sells data mining and knowledge
discovery software and services. Darwin(TM), the company's open, scaleable data
mining application, enables businesses to reveal patterns, trends and
correlations that exist hidden in very large corporate databases. With this
information, organizations can (i) improve the effectiveness and profitability
of marketing programs, including telemarketing, direct mail and cross-selling;
(ii) formulate strategies to strengthen vendor and customer relationships; (iii)
identify fraudulent transactions or situations; and (iv) perform risk-assessment
for credit programs. Thinking Machines has initially focused on marketing Darwin
to the financial (e.g., banking, credit card, insurance, securities) and
telecommunications industries. To date, no material revenues have been
recognized by Thinking Machines with respect to the sale or licensing of such
software and services.
During the fourth quarter of 1996, Thinking Machines adopted a plan to
terminate its parallel processing computer sales and service business. As a
result, Thinking Machines wrote-down certain assets, principally inventory,
related to these operations to their net realizable value by $6.1 million.
Thinking Machines sold its parallel processing software business on November 19,
1996 for $4.3 million and intends to sell the remaining parallel processing
service business in 1997.
MISCELLANEOUS INVESTMENTS. In 1995, New Valley made an investment of $1
million in convertible preferred stock of PC411, Inc. ("PC411"), a development
stage company which provides on-line electronic directory assistance to personal
computer users. PC411 is currently offering a limited version of the PC411
service over the Internet. PC411's long-term strategy is to position itself as
an Internet/intranet (private server based networks) information publishing and
distribution company.
In June 1996, New Valley determined that, based on PC411's operating losses
incurred, an other than temporary impairment in the value of its investment had
occurred and, accordingly, $1.0 million was provided as an impairment charge. In
June 1996, New Valley entered into a loan agreement with PC411 pursuant to which
New Valley agreed from time to time to lend PC411 up to an aggregate of
$750,000. Through March 14, 1997, New Valley has advanced PC411 approximately
$538,000 thereunder. In connection with the loan agreement, the conversion ratio
on the preferred stock was increased and, upon conversion of the preferred stock
in January
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1997, New Valley held 67% of the outstanding common shares of PC411. In February
1997, PC411 filed a registration statement with the SEC relating to a proposed
initial public offering.
In addition, as of December 31, 1996, New Valley's long-term investments
included investments in limited partnerships of $7.1 million, equity in a joint
venture of $3.8 million, an equity investment in a foreign corporation of $2.0
million (which New Valley has subsequently sold for an amount approximating its
cost), and other investments of $.42 million. See Note 8 to New Valley's
Consolidated Financial Statements accompanying this report.
New Valley may acquire additional operating businesses through merger,
purchase of assets, stock acquisition or other means, or seek to acquire control
of operating companies through one of such means. There can be no assurance that
New Valley will be successful in targeting or consummating any such
acquisitions.
Dispositions Pursuant to the Joint Plan
Pursuant to the Joint Plan, on November 15, 1994, New Valley sold the
assets and operations with which it provided domestic and international money
transfer services, bill payment services, telephone cards, money orders and bank
card services (collectively, the "Money Transfer Business") which included the
capital stock of its subsidiary, Western Union Financial Services, Inc. ("FSI")
and certain related assets, to First Financial Management Corporation ("FFMC"),
and, on January 13, 1995, it sold to FFMC all of the trademarks and tradenames
used in the Money Transfer Business and constituting the Western Union name and
trademark. The aggregate purchase price was approximately $1.193 billion,
including $893 million in cash and $300 million representing the assumption by
FFMC of substantially all of New Valley's obligations under its pension plan.
Pursuant to the Joint Plan, all of New Valley's debt and allowed claims were
satisfied in full and all classes of equity and other equity interests were
reinstated and retained all of their legal, equitable and contractual rights.
Through October 1, 1995, New Valley was engaged in the messaging services
business through its wholly-owned subsidiary, Western Union Data Services
Company, Inc. ("DSI"). On October 31, 1995, New Valley completed the sale of
substantially all of the assets (exclusive of certain contracts) and conveyance
of substantially all of the liabilities of DSI to FFMC for $20 million, subject
to certain adjustments. This transaction was effective as of October 1, 1995.
CERTAIN DISPOSITIONS AND OTHER MATTERS
On July 15, 1996, BGLS sold substantially all of the non-cash assets and
certain liabilities of COM Products Inc., a subsidiary engaged in the sale of
micrographics equipment and supplies, for approximately $4.2 million. See Note 8
to the Company's Consolidated Financial Statements. On January 31, 1997, BOL
sold the BML Shares to New Valley for $55 million. See "Brooke (Overseas) Ltd. -
Sale of BrookeMil Ltd.".
The Company and BGLS are presently considering a reorganization in which,
among other things, substantially all of the assets of BGLS other than Liggett,
would be transferred to a newly formed holding company that would hold all of
the capital stock of the Company ("Holdco"). Holdco would retain an indirect
interest in Liggett through its ownership of the Company.
EMPLOYEES
At December 31, 1996, the Company and its consolidated subsidiaries had
approximately 1,545 full-time employees, of whom approximately 584 were employed
by Liggett and
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approximately 952 were employed by Liggett-Ducat. Additionally, Liggett employs
approximately 145 people on a part-time basis. Approximately 21% of the
Company's (including its consolidated subsidiaries) employees are hourly
employees and are represented by unions. The Company and its consolidated
subsidiaries have not experienced any significant work stoppages since 1977, and
the Company believes that relations with its employees and their unions are
satisfactory.
ITEM 2. PROPERTIES
The Company's and BGLS' principal executive offices are located in Miami,
Florida. The Company subleases 12,356 square feet of office space from an
unaffiliated company in an office building in Miami, which it shares with BGLS
and New Valley and various of their subsidiaries. New Valley has entered into an
expense-sharing arrangement for use of such office space. The sublease expires
on February 28, 1999.
Substantially all of Liggett's tobacco manufacturing facilities, consisting
principally of factories, distribution and storage facilities, are located in or
near Durham, North Carolina. Such facilities are both owned and leased. As of
December 31, 1996, the principal properties owned or leased by Liggett are as
follows:
Owned Approximate
or Total
Type Location Leased Footage
---- -------- ------ -----------
Office and
Manufacturing Complex Durham, NC Owned 1,231,000
Warehouse Durham, NC Owned 203,000
Storage Facilities Danville, VA Owned 578,000
Distribution Center Durham, NC Leased 240,000
Liggett's Durham, North Carolina complex consists of 15 major structures
over approximately 20 acres. Included are Liggett's manufacturing plant,
research facility and corporate offices. Liggett's management believes its
property, plant and equipment are well maintained and in good condition and that
its existing facilities are sufficient to accommodate a substantial increase in
production.
Liggett leases the Durham, North Carolina distribution center pursuant to a
lease which expires in May 1999. Liggett has an option to purchase the leased
property at any time during the term of the lease. Liggett utilizes
approximately 40% of the distribution center and subleases the remaining 60% to
a third party. Liggett also leases excess space in its research facility and
corporate offices to third parties.
On May 14, 1996, Liggett sold certain surplus realty in Durham, North
Carolina to the County of Durham for a sale price of $4.3 million. The Company
recognized a gain of approximately $3.6 million on the sale.
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 $2.2 million. The Company will recognize a gain of
approximately $1.6 million on the sale.
Ligget-Ducat has a 49-year land lease on a site on the outskirts of
Moscow, Russia where Liggett-Ducat plans to build a new cigarette factory.
Liggett-Ducat utilizes the site for its existing cigarette factory in Moscow
pursuant to a Use Agreement with BML. See Item 1. "Business - Brooke (Overseas)
Ltd. - Sale of BrookeMil Ltd."
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ITEM 3. LEGAL PROCEEDINGS
Reference is made to Notes 4 and 16 to the Company's Consolidated Financial
Statements, which contain a description of certain legal proceedings to which
the Company and/or BGLS or their subsidiaries are a party and certain related
matters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
During the last quarter of 1996 no matter was submitted to the Company's
stockholders for their vote or approval, through the solicitation of proxies or
otherwise. Such information with respect to BGLS is omitted due to the fact that
BGLS meets the conditions set forth in General Instruction (I)(1)(a) and (b) of
Form 10-K and is therefore filing this report with the reduced disclosure
format.
EXECUTIVE OFFICERS OF THE REGISTRANTS
The table below, together with the accompanying text, present certain
information regarding all current executive officers of the Company and of BGLS
as of March 25, 1997. Each of the executive officers of the Company and of BGLS
serves until the election and qualification of such individual's successor or
until such individual's death, resignation or removal by the Board of Directors
of the respective company.
Year individual
became an
Name Age Position executive officer
---- --- -------- -----------------
Bennett S. LeBow 59 Chairman of the Board, 1990
President and Chief
Executive Officer of the
Company and of BGLS
Richard J. Lampen 43 Executive Vice President 1996
of the Company and
of BGLS
Joselynn D. Van Siclen 56 Vice President, Chief 1996
Financial Officer and
Treasurer of the
Company and of BGLS
Ronald S. Fulford 62 Chairman of the Board, 1996
President and Chief
Executive Officer of
Liggett
BENNETT S. LEBOW has been the Chairman of the Board, President and Chief
Executive Officer of the Company, a New York Stock Exchange-listed holding
company, since June 1990, and has been a director of the Company since October
1986. Since November 1990, he has been Chairman of the Board, President and
Chief Executive Officer of BGLS, which directly or indirectly holds the
Company's equity interests in several private and public companies. Each of the
public companies have been, directly or indirectly, operating companies.
Mr. LeBow has been a director of Liggett since June 1990 and Chairman of
the Board of Liggett from July 1990 to May 1993. He served as one of three
interim Co-Chief Executive Officers from March 1993 to May 1993.
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He has been Chairman of the Board of New Valley, in which the Company holds
an indirect voting interest of approximately 42%, since January 1988, and Chief
Executive Officer since November 1994. In November 1991, an involuntary petition
seeking an order for relief under Chapter 11 of Title 11 of the United States
Code was commenced against New Valley by certain of its bondholders. New Valley
emerged from bankruptcy reorganization proceedings in January 1995. He has been
Chairman of the Board, President and Chief Executive Officer of NV Holdings
since September 1994.
He was a director of MAI Systems Corporation ("MAI"), the Company's former
indirect majority-owned subsidiary from September 1984 to October 1995, Chairman
of the Board from November 1990 to May 1995 and the Chief Executive Officer from
November 1990 to April 1993. In April 1993, MAI filed for protection under
Chapter 11 of Title 11 of the United States Code. In November 1993, MAI emerged
from bankruptcy reorganization proceedings. MAI is engaged in the development,
sale and service of a variety of computer and software products.
RICHARD J. LAMPEN has served as the Executive Vice President of the Company
and of BGLS since July 1996. Since October 1995, Mr. Lampen has been the
Executive Vice President of New Valley. From May 1992 to September 1995, Mr.
Lampen was a partner at Steel Hector & Davis, a law firm located in Miami,
Florida. From January 1991 to April 1992, Mr. Lampen was a Managing Director at
Salomon Brothers Inc., an investment bank, and was an employee at Salomon
Brothers Inc. from 1986 to April 1992. Mr. Lampen is a director of New Valley,
Thinking Machines and PC411. Mr. Lampen has served as a director of a number of
other companies, including U.S. Can Corporation and The International Bank of
Miami, N.A., as well as a court-appointed independent director of Trump Plaza
Funding, Inc.
JOSELYNN D. VAN SICLEN has been Vice President, Chief Financial Officer and
Treasurer of the Company and of BGLS since May 1996, and currently holds various
positions with certain of BGLS' subsidiaries, including Vice President and
Treasurer of Eve Holdings, Inc., a wholly-owned subsidiary of Liggett, since
April 1994 and May 1996, respectively. Prior to May 1996, Ms. Van Siclen served
as Director of Finance of the Company and was employed in various accounting
capacities for various subsidiaries of the Company since 1992. Since before 1990
to November 1992, Ms. Van Siclen was an audit manager for the accounting firm of
Coopers & Lybrand L.L.P.
RONALD S. FULFORD has served as Chairman of the Board, President and Chief
Executive Officer of Liggett since September 1996. Mr. Fulford has also served
as a consultant to the Company since March 1996. From June, 1986 until February
1996, Mr. Fulford served as Executive Chairman of Imperial Tobacco ("Imperial"),
the British tobacco unit of the British conglomerate Hanson PLC ("Hanson").
Before Imperial, Mr. Fulford was chief executive of three other Hanson
companies: London Brick, British EverReady UK & South Africa and United Gas
Industries UK & Europe.
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PART II
ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock, $.10 par value per share, is listed and traded
on the New York Stock Exchange ("NYSE") under the symbol "BGL". The high and low
sale prices for a share of the Company's common stock on the NYSE, as reported
by the NYSE, for each fiscal quarter of 1996 and 1995 were as follows (in
dollars):
Year High Low
---- ---- ---
1996:
----
Fourth Quarter 5 3/4 4 1/4
Third Quarter 6 1/4 4 5/8
Second Quarter 8 7/8 5 5/8
First Quarter 10 1/8 7 3/4
1995:
----
Fourth Quarter 9 7/8 6 5/8
Third Quarter 11 3/8 4 3/8
Second Quarter 5 1/2 3 1/8
First Quarter 4 1/4 3 15/64
There is no public market for BGLS' common stock, $.01 par value per share,
as all of such common stock is held by the Company.
HOLDERS
At March 14, 1997, there were 338 holders of record of the Company's common
stock.
DIVIDENDS
During 1996 and 1995, the Company declared and paid regular quarterly cash
dividends of $.075 per share on its common stock. The declaration of future cash
dividends is within the discretion of the Board of Directors of the Company and
is subject to a variety of contingencies such as market conditions, earnings and
the financial condition of the Company as well as the availability of cash. The
payment of dividends and other distributions to the Company by BGLS are subject
to the Indenture. See Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Capital Resources and Liquidity".
RECENT SALES OF UNREGISTERED SECURITIES
Since 1994, the Company has issued an aggregate of 500,000 shares of its
common stock and granted stock options to purchase 500,000 and 1,000,000 shares
of common stock at $2.00 per share and $1.00 per share, respectively, to a
consultant who serves as a director and President of New Valley. In addition, in
1997, the Company granted stock options to purchase 422,000 shares of common
stock at $5.00 per share to certain employees. These transactions did not
involve public offerings of the Company's securities and were exempt from the
registration requirements of the Securities Act of 1933, as amended, pursuant to
Section 4(2) thereunder. See Note 15 to the Company's Consolidated Financial
Statements.
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ITEM 6. SELECTED FINANCIAL DATA
-------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
-------------------------------------------------------------------------------------
(dollars in thousands, except per share amounts)
Statement of Operations Data:
Revenues(1)................................ $452,656 $461,459 $479,343 $493,041 $632,791
Restructuring charges...................... (11,913)
(Loss) income from continuing operations... (64,918) (45,344) (17,991) (69,228) (7,724)
Income (loss) from discontinued
operations(2)......................... 2,385 21,229 174,683 62,001 (232,397)
(Loss) income from extraordinary items..... (9,810) (46,597) 153,741 7,994
Net (loss) income.......................... (62,533) (33,925) 110,095 106,780 (232,127)
(Loss) income from continuing operations
per share(3)............................ (3.41) (1.56) (1.02) (4.19) (1.10)
Income (loss) from discontinued operations
per share............................... 0.13 1.16 9.92 3.45 (11.01)
(Loss) income from extraordinary items
per share............................... (0.54) (2.65) 8.55 0.38
Net (loss) income per share(3)............. (3.28) (0.94) 6.25 5.60 (11.73)
Cash distributions declared per common
share(4)................................ 0.30 0.30 0.42
Balance Sheet Data:
Current assets............................. $ 80,552 $ 96,615 $ 87,504 $114,411 $256,160
Total assets .............................. 177,677 225,620 229,425 164,819 366,206
CVR liability(5)........................... 44,943
Current liabilities........................ 204,463 119,177 144,351 220,207 493,631
Notes payable, long-term debt and
other obligations, less current portion. 378,243 406,744 405,798 389,671 452,188
Noncurrent employee benefits, deferred
credits and other long-term liabilities. 49,960 55,803 54,128 69,623 65,332
Stockholders' equity (deficit)............. (454,989) (356,104) (374,852) (514,682) (644,945)
- ------------------------
(1) Revenues include federal excise taxes of $104,518, $123,420, $131,877,
$127,341 and $147,701, respectively.
(2) See Note 5 to the Company's Consolidated Financial Statements.
(3) Per share computations include the impact of New Valley's repurchase of
Class A Preferred Shares in 1996 and 1995 and the impact of the CVR
liability in the years 1993 and 1992.
(4) Cash dividends declared per common share exclude other distributions. See
Note 5 to the Company's Consolidated Financial Statements.
(5) See Note 16 to the Company's Consolidated Financial Statements.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(Dollars in Thousands, Except Per Share Amounts)
INTRODUCTION
The following discussion provides an assessment of the results of operations,
capital resources and liquidity of the Company and should be read in conjunction
with the Company's Consolidated Financial Statements and notes thereto included
elsewhere in this report. The operating results of the periods presented were
not significantly affected by inflation. The consolidated financial statements
include the accounts of BGLS, Liggett, BOL, NV Holdings, other less significant
subsidiaries and, as of December 29, 1995, Liggett-Ducat.
The Company holds an equity interest in New Valley, which sold its money
transfer business in November 1994 and its messaging service business in 1995.
See Notes 2 and 5 to the Company's Consolidated Financial Statements.
Accordingly, the Company's earnings from discontinued operations for the year
ended December 31, 1994 and 1995 reflect its portion of the gains ($139,935 and
$5,231, respectively) on disposal of those operations. The Company accounts for
its share of earnings based on its ownership of New Valley Common Shares, Class
B Preferred Shares and Class A Preferred Shares, which at December 31, 1996 was
approximately 42%, 58% and 9%, respectively. The Common Shares are accounted for
pursuant to the equity method; the Class A Preferred Shares and the Class B
Preferred Shares (which Class B shares were acquired in 1995) are accounted for
under Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting
for Certain Investments in Debt and Equity Securities".
On February 13, 1995, the Board of Directors of the Company distributed a
special dividend of one share of MAI common stock for every six shares of the
Company's common stock (the "MAI Distribution"). In 1995, the Company sold its
remaining shares in SkyBox International Inc. ("SkyBox"), its former subsidiary
whose shares were distributed to the holders of the Company's common stock in
1993. Results of MAI and SkyBox have been reclassified as discontinued
operations for all periods presented. See Note 5 to the Company's Consolidated
Financial Statements.
On January 31, 1997, BOL sold its interest in BML, a real estate investment
company doing business in Russia, to New Valley. See Item 1. "Business - Brooke
(Overseas) Ltd. - Sale of BrookeMil Ltd." and Note 4 to the Company's
Consolidated Financial Statements.
For purposes of this discussion and other consolidated financial reporting, the
Company's significant business segments are tobacco and real estate.
RECENT DEVELOPMENTS
Certain Matters Relating to RJR Nabisco
As of December 31, 1996, New Valley held 1,741,000 shares of RJR Nabisco common
stock with a market value of $59,199 (cost of $53,372). From the period January
1, 1997 to March 14, 1997, New Valley sold approximately 678,000 shares of RJR
Nabisco common stock and recognized a gain on sales of $2,243. At March 14,
1997, New Valley held 1,063,000 shares of RJR Nabisco common stock with a market
value of $35,997 (cost of $32,574). New Valley's unrealized gain on its
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investment in RJR Nabisco common stock decreased from $5,827 at December 31,
1996 to $3,423 at March 14, 1997.
For the year ended December 31, 1996, New Valley had expensed $11,724 for costs
relating to the investment in RJR Nabisco common stock. Pursuant to a December
27, 1995 agreement, New Valley agreed, among other things to pay directly or
reimburse the Company and its subsidiaries for out-of-pocket expenses in
connection with the Company's solicitation of consents and proxies from the
shareholders of RJR Nabisco. Pursuant to this agreement, New Valley reimbursed
the Company and its subsidiaries $2,453, of which $1,034 was expensed in 1996.
On February 29, 1996, New Valley entered into a total return equity swap
transaction (the "Swap") with an unaffiliated company relating to an additional
1,000,000 shares of RJR Nabisco common stock. The Swap was terminated during the
third quarter of 1996. New Valley realized a loss of $7,305 on the Swap.
New Valley
On July 29, 1996, New Valley completed its reincorporation from the State of New
York to the State of Delaware and effected a one-for-twenty reverse stock split
of New Valley's Common Shares. After giving effect to this reverse stock split,
the Company now holds 3,989,710 (41.7%) Common Shares.
On January 11, 1996, a subsidiary of New Valley made a $10,600 convertible
bridge loan to finance Thinking Machines, a developer and marketer of parallel
software for high-end and networked computer systems. In February 1996, the loan
was converted into a controlling interest in a partnership which holds
approximately 61% of the outstanding common stock of Thinking Machines.
In October 1996, Thinking Machines adopted a plan to dispose of its parallel
processing computer segment. A gain on disposal of $2,386 was offset by a net
loss from discontinued operations of $3,818 for the year ended December 31,
1996, net of minority interests benefit.
On January 11, 1996, New Valley Realty, a division of New Valley, completed the
acquisition of four office buildings and eight shopping centers for an aggregate
purchase price of $183,900 which consisted of $23,900 in cash and $160,000 in
non-recourse mortgage financing.
In the first quarter of 1996, New Valley repurchased 72,104 Class A Preferred
Shares for a total amount of $10,530. New Valley declared and paid cash
dividends on the Class A Preferred Shares of $40 per share in 1996. At December
31, 1996, the Company owned 618,326 (57.71%) of the New Valley Class A Preferred
Shares.
BOL
On January 31, 1997, New Valley acquired from BOL 10,483 shares (99.1%) of
common stock of BML for a purchase price of $55,000, consisting of $21,500 in
cash and a $33,500 9% promissory note of New Valley (the "Note"). The Note is
collateralized by the BML Shares and is payable $21,500 on June 30, 1997 and
$12,000 on December 31, 1997. The Company anticipates it will recognize in 1997
a gain of approximately $21,300 on the sale. See Note 4 to the Company's
Consolidated Financial Statements.
Liggett
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 is
intended to more closely align sales and marketing strategies
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with the unique requirements of regional markets as well as reduce working
capital by improved production planning and inventory control. As a result of
this reorganization, Liggett will further reduce its salaried, hourly and
part-time headcount by a total of 273 positions (35%) over an eight-month
transition period. During 1996, Liggett recorded a $3,428 restructuring charge
to operations.
On March 11, 1997, Liggett sold to Blue Devil Ventures, a North Carolina limited
liability partnership, certain surplus realty for $2,200. The Company will
recognize a gain of approximately $1,600.
New Accounting Pronouncements
Effective January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of".
SFAS No. 121 establishes accounting standards for the impairment of long-lived
assets, certain identifiable intangibles, and goodwill related to those assets.
There was no material effect on the financial position or results of operations
from the adoption because the Company's prior impairment recognition practice
was consistent with the major provisions of SFAS No. 121. Under provisions of
SFAS No. 121, impairment losses are recognized when expected future cash flows
are less than the assets' carrying value. Accordingly, when indicators of
impairment are present, the Company evaluates the carrying value of property,
plant and equipment and intangibles in relation to the operating performance and
estimates of future discounted cash flows of the underlying business.
Effective January 1, 1996, SFAS No. 123, "Accounting for Stock-Based
Compensation" was adopted by the Company as required for its fiscal 1996
financial statements and will not have a material effect on the Company's
financial position or results of operations for the year ended 1996. Upon
adoption of SFAS 123, the Company will continue to measure compensation expense
for stock-based employee compensation plans using the intrinsic value method
prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees,"
and will provide pro forma disclosures of net income as if the fair value-based
method prescribed by SFAS No. 123 had been applied in measuring compensation
expense. For grants extended to nonemployees, compensation expense will be
measured and disclosed in accordance with SFAS No. 123.
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings Per Share". SFAS No. 128 specifies new standards designed to improve
the earnings per share ("EPS") information provided in financial statements by
simplifying the existing computational guidelines, revising the disclosure
requirements and increasing the comparability of EPS data on an international
basis. Some of the changes made to simplify the EPS computations include: (a)
eliminating the presentation of primary EPS and replacing it with basic EPS,
with the principal difference being that common stock equivalents are not
considered in computing basic EPS, (b) eliminating the modified treasury stock
method and the three percent materiality provision and (c)
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26
revising the contingent share provisions and the supplemental EPS data
requirements. SFAS No. 128 also makes a number of changes to existing disclosure
requirements. SFAS No. 128 is effective for financial statements issued for
periods ending after December 15, 1997, including interim periods. The Company
has not yet determined the impact of the implementation of SFAS No. 128.
RECENT DEVELOPMENTS IN THE CIGARETTE INDUSTRY
Pricing Activity
On May 5, 1995, R. J. Reynolds Tobacco Company ("RJR") initiated a list price
increase on all brands of $.30 per carton. Philip Morris, Inc. and Brown &
Williamson Tobacco Corporation ("B&W"), which together with RJR comprise 90% of
the market, matched the price increase on the same day. Liggett followed on May
9, 1995.
On April 8, 1996, Philip Morris announced a list price increase on all brands of
$.40 per carton. The other manufacturers, including Liggett, matched the price
increase.
On March 7, 1997, RJR initiated another list price increase on all brands of
$.40 per carton (approximately 4%). B&W, Lorillard and Liggett have matched this
increase, and, on March 21, 1997, Philip Morris announced a price increase of
$.50 per carton.
Legislation, Regulation and Litigation
The cigarette industry continues to be challenged on numerous fronts. New cases
continue to be commenced against Liggett and the Company and other cigarette
manufacturers. As of March 14, 1997, there were 108 individual suits, 12
purported class actions and 22 state (and several municipality) Medicaid
reimbursement actions pending in the United States in which Liggett is a named
defendant. As new cases are commenced, the costs associated with defending such
cases and the risks attendant to the inherent unpredictability of litigation
continue to increase. Recently, there have been a number of restrictive
regulatory actions from various Federal administrative bodies, including the
United States Environmental protection Agency ("EPA") and the Food and Drug
Administration ("FDA"), adverse political decisions and other unfavorable
developments concerning cigarette smoking and the tobacco industry, including
the commencement and certification of class actions and the commencement of
Medicaid reimbursement suits by various states' Attorneys General. These
developments generally receive widespread media attention. The Company is not
able to evaluate the effect of these developing matters on pending litigation or
the possible commencement of additional litigation, but it is possible that
Company's financial position, results of operations and cash flows could be
materially adversely affected by an ultimate unfavorable outcome in any of such
pending litigation. See Note 16 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,
strict liability, fraud, misrepresentation, design defect, failure to warn,
breach of express and implied warranties, conspiracy, concert of action, unjust
enrichment, common law public nuisance, indemnity, market share liability, and
violations of deceptive trade practices laws and antitrust statutes. Plaintiffs
also seek punitive damages in many of these cases. Defenses raised by defendants
in these cases include lack of design defect, statutes of limitations or
response, equitable defenses such as "unclean hands" and lack of benefit,
failure to state a claim and preemption by the Federal Cigarette Labeling and
Advertising Act, as amended.
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The claims asserted in the Medicaid recovery actions vary. All 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 Federal Racketeer Influenced and Corrupt Organization Act.
On March 12, 1996, Liggett, together with the Company, entered into an agreement
to settle the CASTANO class action tobacco litigation, and on March 15, 1996,
Liggett, together with the Company, entered into an agreement with the Attorneys
General of West Virginia, Florida, Mississippi, Massachusetts and Louisiana to
settle certain actions brought against Liggett and the Company by such states.
Liggett and the Company, while neither consenting to FDA jurisdiction nor
waiving their objections thereto, agreed to withdraw their objections and
opposition to the proposed FDA regulations and to phase in compliance with
certain of the proposed interim FDA regulations.
Under the CASTANO settlement agreement, upon final court approval of the
settlement, the CASTANO class would be entitled to receive up to 5% of Liggett's
pretax income (income before income taxes) each year (up to a maximum of $50,000
per year) for the next twenty-five years, subject to certain reductions provided
for in the agreement, and a $5,000 payment from Liggett if the Company or
Liggett fails to consummate a merger or similar transaction with another
non-settling tobacco company defendant within three years of the date of the
settlement. The Company and Liggett have the right to terminate the CASTANO
settlement under certain circumstances. On May 11, 1996, the CASTANO Plaintiffs
Legal Committee filed a motion with the United States District Court for the
Eastern District of Louisiana seeking preliminary approval of the CASTANO
settlement. On May 23, 1996, the Court of Appeals for the Fifth Circuit reversed
the February 17, 1995 order of the District Court certifying the CASTANO suit as
a nationwide class action and instructed the District Court to dismiss the class
complaint. On September 6, 1996, the CASTANO plaintiffs withdrew the motion for
approval of the CASTANO settlement.
On March 14, 1996, the Company, CASTANO Plaintiffs Legal Committee and the
CASTANO plaintiffs entered into a letter agreement. According to the terms of
the letter agreement, for the period ending nine months from the date of Final
Approval (if granted) of the CASTANO settlement or, if earlier, the completion
by the Company or Liggett of a combination with any defendant in CASTANO, except
Philip Morris, the CASTANO plaintiffs and their counsel agree not to enter into
any more favorable settlement agreement with any CASTANO defendant which would
reduce the terms of the CASTANO settlement agreement. If the CASTANO plaintiffs
or their counsel enter into any such settlement during this period, they shall
pay the Company $250,000 within thirty days of the more favorable agreement and
offer the Company and Liggett the option to enter into a settlement on terms at
least as favorable as those included in such other settlement. The letter
agreement further provides that during the same time period, and if the CASTANO
settlement agreement has not been earlier terminated by the Company in
accordance with its terms, the Company and its affiliates will not enter into
any business transaction with any third party which would cause the termination
of the CASTANO settlement agreement. If the Company or its affiliates enter into
any such transaction, then the CASTANO plaintiffs will be entitled to receive
$250,000 within thirty days from the transacting party.
Under the Attorneys General settlement, the five states would share an initial
payment by Liggett of $5,000 ($1,000 of which was paid on March 22, 1996, with
the balance payable over nine years and indexed and adjusted for inflation). In
addition, Liggett will be required to pay the states a percentage of Liggett's
pretax income (income before income taxes) each year from the second through the
twenty-fifth year. This annual percentage is 2-1/2% of Liggett's pretax income,
subject to increase to 7-1/2% depending on the number of additional states
joining the settlement. No additional states have joined this settlements to
date. All of Liggett's payments are subject to certain reductions provided for
in the agreement. Liggett has also agreed to pay to the states $5,000 if the
Company or Liggett fails to consummate a merger or other similar transaction
with another defendant in the lawsuits within three years of the date of the
settlement.
RECENT SETTLEMENTS. On March 20, 1997, Liggett, together with the Company,
entered into a comprehensive settlement of tobacco litigation through parallel
agreements with the Attorneys General of 17 states and with a nationwide class
of individuals and entities that allege smoking-related claims. The Company and
Liggett have now obtained settlements with each of the 22 states that have
commenced suit against them. The settlements cover all smoking-related claims,
including both addiction-based and tobacco injury claims against the Company and
Liggett, brought by the 22 states and, upon court approval, the nationwide
class.
The settlement with the Attorneys General, which does not require court
approval, includes the states of Arizona, Connecticut, Hawaii, Illinois,
Indiana, Iowa, Kansas, Maryland, Michigan, Minnesota, New Jersey, New York,
Oklahoma, Texas, Utah, Washington and Wisconsin. The Company's and Liggett's
previous settlements on March 15, 1996 with the Attorneys General of Florida,
Louisiana, Massachusetts, Mississippi and West Virginia remain in full force and
effect.
The settlement with the nationwide class covers all smoking-related claims. On
March 20, 1997, Liggett, the Company and plaintiffs filed the mandatory class
settlement agreement in an action entitled FLETCHER, ET AL. v. BROOKE LTD., ET
AL., Circuit Court of Mobile County, Alabama where the court granted preliminary
approval and preliminary certification of the class. 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. There are no
opt out provisions in this settlement, except for Medicaid claims by states that
are not party to the Attorneys General settlements.
Pursuant to the settlements, the Company and Liggett have agreed to cooperate
fully with the Attorneys General and the nationwide class in their lawsuits
against the tobacco industry. The Company and Liggett have agreed to provide to
these parties all relevant
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tobacco documents in their possession, other than those subject to claims of
joint defense privilege, and to waive, subject to court order, certain
attorney-client privileges and work product protections regarding Liggett's
smoking-related documents to the extent Liggett and the Company can so waive
these privileges and protections. The Attorneys General and the nationwide class
have 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, the Company and Liggett have agreed to offer their
employees for witness interviews and testimony at deposition and trial. Pursuant
to both settlement agreements, Liggett has 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.
Under the terms of the new settlement agreements, Liggett will pay on an annual
basis 25% of its pretax income for the next 25 years into a settlement fund,
commencing with the first full fiscal year starting after the date of the
agreements. Monies collected in the settlement fund will be overseen by a
court-appointed committee and utilized to compensate state health care programs
and settlement class members and to provide counter-market advertising. Liggett
has also 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.
Under both settlement agreements, any other tobacco company defendant, except
Philip Morris, merging or combining with Liggett or the Company, prior to the
fourth anniversary of the settlement agreements, would receive certain
settlement benefits, including limitations on potential liability and not having
to post a bond to appeal any future adverse judgment. In addition, within 120
days following such a combination, Liggett would be required to pay the
settlement fund $25 million. Both the Attorneys General and the nationwide class
have also agreed not to seek an injunction preventing a defendant tobacco
company combining with Liggett or the Company from spinning off any of its
affiliates which are not engaged in the domestic tobacco business.
The Company and Liggett are also entitled to certain "most favored nation"
benefits not available to the other defendant tobacco companies. In addition,
in the event of a "global" tobacco settlement enacted through Federal
legislation or otherwise, the Attorneys General and tobacco plaintiffs have
agreed to use their "best efforts" to ensure that the Company and Liggett's
liability under such a plan should be no more onerous than under these new
settlements.
On March 20, 1997, RJR, Philip Morris, B & W and Lorillard obtained a temporary
restraining order from a North Carolina state court preventing, the Company and
Liggett and their agents, employees, directors, officers and lawyers from
turning over documents allegedly subject to the joint defense privilege in
connection with the settlements. On March 24, 1997, the United States District
Court for the Eastern District of Texas and state courts in Mississippi and
Illinois each issued orders enjoining these four companies from interfering
with Liggett's filing with the courts, under seal, those documents.
At December 31, 1995, the Company had accrued approximately $4,000 for the
present value of the fixed payments under the initial Attorneys General
settlement and no additional amounts have been accrued with respect to the
recent settlements discussed above. The Company cannot quantify the future costs
of the settlements at this time as the amount Liggett must pay is 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 16
to the Company's Consolidated Financial Statements.
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RESULTS OF OPERATIONS
1996 compared to 1995
REVENUES. Consolidated revenues were $452,656 for the year ended December 31,
1996 compared to $461,459 for the year ended December 31, 1995, a decrease of
$8,803 primarily due to a decline in sales of $54,604 at Liggett offset by an
increase in tobacco revenues at Liggett-Ducat of $45,677. Results of operations
for Liggett-Ducat were not included in 1995 since consolidation occurred as of
December 29, 1995. Net sales at Liggett were $401,062 for the year ended
December 31, 1996 versus $455,666 for the same period for the prior year. The
12% decrease in revenues was due primarily to a 15.3% decline in domestic unit
sales volume, partially offset by the effects of the April 1996 list price
increase (see "Recent Developments in the Cigarette Industry - Pricing
Activity"). This change in unit sales volume was comprised of declines within
the premium and discount market segments of 13.7% and 16.2%, respectively. The
decline in premium and discount unit sales volume was due to certain competitors
continuing leveraging rebate programs tied to their products and increased
promotional activity by certain other manufacturers. Liggett experienced a
significant increase in volume at the end of the fourth quarter of 1996, in part
due to ongoing trade programs based on quarterly volume targets for its
customers and to consumer promotional programs consisting of coupons and
variable price reductions. The effects of these trade programs may have a
negative impact on sales in future periods.
Liggett-Ducat (not included in the prior year results) increased unit sales
volume over the prior year by 8.7% to approximately 11.4 billion units and
increased revenues by $9,832 driven by the expanding market in Russia.
GROSS PROFIT. Consolidated gross profit of $217,023 for the year ended December
31, 1996 decreased $28,249 from gross profit of $245,272 for the same period in
1995, reflecting a decrease in gross profit at Liggett of $30,089 for the year
ended December 31, 1996 compared to the same period in the prior year. Gross
profit margin was further reduced by restructuring charges of $1,595, the major
portion of which was pension curtailment expense. This was somewhat offset by
gross margin at Liggett-Ducat of $4,036 which margins were not included in the
prior year's results. The decrease at Liggett was due primarily to the decline
in unit sales volume discussed above. As a percent of revenues (excluding
federal excise taxes), Liggett's gross profit decreased to 72.0% for 1996
compared to 73.2% for 1995. This decrease is the result of increased tobacco
costs due to reduced worldwide supply of tobacco, and a reduction in the average
discount available to Liggett from leaf tobacco dealers on tobacco purchased
under prior years' purchase commitments, partially offset by the April 1996 list
price increase. Gross profit for 1995 was reduced by an accrual of approximately
$4,900 for the United States Department of Agriculture ("USDA") domestic
marketing assessment. See Note 16 to the Company's Consolidated Financial
Statements.
EXPENSES. Consolidated operating, selling, general and administrative expenses
were $220,950 for the year ended December 31, 1996 compared to $237,212 for the
same period for the prior year, a decrease of $16,262. The decrease was due
primarily to Liggett's decrease in sales volume with corresponding reductions in
spending on promotional programs offset by charges for restructuring of $3,428
for severance programs ($132 of which is included in cost of sales). The
anticipated savings of the restructuring relate primarily to reduced payroll and
benefits expenses in future periods. Of the total restructuring expense recorded
during 1996, $1,416 was funded during 1996 and $2,012 remains to be funded in
subsequent years. In addition, corporate expenses, primarily legal fees,
decreased by approximately $4,000. In 1995, expenses increased due to increased
spending on trade and promotional programs and the accrual of approximately
$4,000 for the settlement of certain tobacco litigations with the Attorneys
General of certain states. See Note 16 to the Company's Consolidated Financial
Statements.
OTHER INCOME (EXPENSE). Consolidated interest expense was $60,556 for the year
ended December 31, 1996 compared to $57,505 for the same period for the prior
year. The increase of $3,051 relates
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to interest expense at Liggett-Ducat not reflected in the prior year's
consolidation, increased interest accrued for the USDA domestic marketing
assessment expense at Liggett partially offset by redemption of $7,000 of the
Liggett Senior Secured Notes (the "Liggett Series B Notes") and an increase in
interest expense at corporate due to an increase in outstanding indebtedness of
approximately $9,000. Equity in loss of affiliates of $7,211 represents the
Company's proportionate share of losses from continuing operations at New
Valley. This is partially offset in discontinued operations in which the Company
reflected its portion of New Valley's loss from discontinued operations ($1,591)
and the gain on disposal ($3,976). Other income includes the sale of assets of
COM Products Inc. and the sale of surplus realty at Liggett as a result of which
the Company realized gains of $3,047 and $3,669, respectively.
LOSS FROM CONTINUING OPERATIONS. The loss from continuing operations for the
year ended December 31, 1996 was $64,918 compared with a loss of $45,344 for the
same period in the prior year. A tax provision of $1,402 in 1996 and $342 in
1995 relates to foreign income taxes at the subsidiary level in 1996 and state
income taxes at the subsidiary level in 1995.
OTHER. At December 31, 1996, the Company and its consolidated group had net
operating loss carryforwards for tax purposes of approximately $114,000 which
may be subject to certain restrictions and limitations and which will generally
expire in the years 2006 to 2009.
DISCONTINUED OPERATIONS. Income from discontinued operations of $2,385 for the
year ended December 31, 1996 and $21,229 for the prior year reflects the
Company's proportionate interest in the discontinued operations of Thinking
Machines, a subsidiary of New Valley, in 1996 and the redemption/sale of SkyBox
preferred and common stock and the sale of New Valley's message servicing
business in 1995.
1995 compared to 1994
REVENUES. Consolidated revenues were $461,459 for the year ended December 31,
1995 compared to $479,341 for the year ended December 31, 1994, a decrease of
$17,882 primarily due to a decline in sales at Liggett and other less
significant subsidiaries. Net sales at Liggett were $455,666 for the year ended
December 31, 1995 versus $465,676 for the same period for the prior year. This
2.1% decrease in revenues was primarily due to a 5.6% decrease in unit sales
volume, partially offset by the effects of the May 9, 1995 list price increase
(see "Recent Developments in the Cigarette Industry - Pricing Activity"). The
decrease in unit sales volume was comprised of decreases in the premium,
discount and military categories, partially offset by an increase in the
international category. Both premium and discount products suffered a temporary
decline in volume as a result of the implementation of a new distribution and
marketing program in one of Liggett's sales zones and national accounts during
1995. Also, heavy discounting of a competitor's product within the premium
segment contributed to the premium volume decline. The decrease in discount
volume was due to decreases in generic and branded discount brands as a result
of leveraged rebate programs tied to the premium products of other cigarette
manufacturers and trade and promotional programs for new brands offered by
competitors on branded discount products. The decrease in discount volume was
partially offset by the continued growth of Liggett's control label brands since
their introduction in 1993. The decrease in the military volume is primarily due
to heavy discounting of a competitor's product within this category. The overall
decline in unit sales volume would have been much greater except for aggressive
trade programs offered near the end of the fourth quarter of 1995.
GROSS PROFIT. Consolidated gross profit of $245,272 for the year ended December
31, 1995 decreased $4,264 from gross profit of $249,536 for the same period in
1994, reflecting a decrease in gross profit at smaller subsidiaries somewhat
offset by Liggett which had a slight increase in gross profit ($450) for the
year ended December 31, 1995 compared to the prior year. Gross profit at Liggett
as a percent of revenue (excluding federal excise taxes) for the period
increased to 73.2% compared to 72.8% for the prior year, due primarily to the
May 9, 1995 list price
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increase and lower per unit cost of sales. The reduction in cost of sales is a
result of the effects of Liggett's continuing cost reduction programs begun in
1993. The cost reductions were offset by the accrual of approximately $4,900 for
the USDA marketing assessment.
EXPENSES. Consolidated operating, selling, general and administrative expenses
were $237,212 for the year ended December 31, 1995 compared to $235,374 for the
same period for the prior year, an increase of $1,838. The increase was
primarily caused by increased spending on trade and promotional programs at
Liggett to combat heavy competition by other cigarette manufacturers for unit
sales volume along with the accrual of approximately $4,000 for the settlement
of certain tobacco litigations with the Attorneys General of certain states.
Such increases were partially offset by expense reductions at corporate which,
in 1994, included charges of $7,500 for debt restructuring and $7,682 of stock
compensation expense. Expenses in 1995 were only partially offset by the net
effects of the restructuring program at Liggett discussed above.
OTHER INCOME (EXPENSE). Consolidated interest expense was $57,505 for the year
ended December 31, 1995 compared to $55,952 for the prior year. The increase of
$1,553 relates to the incurrence of additional indebtedness by the Company for
the Series 1 Notes (which were redeemed on June 12, 1995), increases in the
interest rate on the Series 1 Notes and the Series 2 Notes from February 1
through September 6, 1995 (or, in the case of the Series 1 Notes, through June
12, 1995) and an increase in the interest rate of the Liggett Series C Notes,
which were reset from 16.50% to 19.75% on February 1, 1995 as well as the
issuance of additional Series C Notes in November 1994, such notes being
outstanding for all of 1995.
LOSS FROM CONTINUING OPERATIONS. The loss from continuing operations for the
year ended December 31, 1995 was $45,344 compared with a loss of $17,991 for the
same period in the prior year. A tax provision of $342 in 1995 relating to state
income taxes at the subsidiary level increased the 1995 loss while the loss in
1994 was mitigated by a tax benefit of $24,487 related to the completion of an
audit by the Internal Revenue Service through December 31, 1991.
DISCONTINUED OPERATIONS. Income of discontinued operations of $21,229 for the
year ended December 31, 1995 and $174,683 for the prior year reflects the
redemption/sale of SkyBox preferred and common stock and the sale of New
Valley's message servicing business in 1995 and the redemption/sale of SkyBox
preferred and common stock and the sale of New Valley's money transfer
business in 1994.
CAPITAL RESOURCES AND LIQUIDITY
Net cash and cash equivalents decreased $1,429, $906 and $11,497 for the twelve
months ended December 31, 1996, 1995 and 1994, respectively.
Net cash used in operations in 1996 of $3,705 was lower than cash used last
year, primarily due to the declining sales volume at Liggett resulting in lower
working capital requirements, decreasing trade receivables and increases in
accrual of promotional expense. This is compared to net cash used in 1995 of
$22,986, primarily the impact of non-cash adjustments relating to discontinued
operations and an increase in inventory levels. Such effects on the uses of cash
were offset by an increase in liabilities for various legal settlements, debt
issuance costs and unearned revenue.
Net cash used in operations in 1994 was $44,060. Net income of $110,095 in 1995
was due principally to earnings from discontinued operations at SkyBox and New
Valley. Cash received from sales and redemptions of SkyBox equities of $31,120
was offset by the non-cash impact of the gain on disposal of $117,275 at the
Company's equity investee, New Valley.
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Net cash used in investing activities in 1996 of $4,279 was principally due to
continuing capital expenditures for real estate development in Russia of $29,800
and expenditures at Liggett of $4,300 for equipment modernization and to
maintain production facilities partially offset by dividends received from New
Valley on the Class A Preferred Shares held by the Company and the proceeds from
the sale of assets at both Liggett and the Company.
Net cash provided by investing activities was $66,874 for the year ended
December 31, 1995 compared to cash provided by investing activities of $23,861
for the same period in 1994. In the year ended December 31, 1995, cash was
provided through dividends from New Valley on the Class A Preferred Shares of
$61,832, the redemption of SkyBox preferred stock for $4,000 and the sale of the
SkyBox common stock for $9,282. These amounts were offset by capital
expenditures, particularly for building improvements related to real estate
development in Russia. At Liggett, capital expenditures in 1995 and 1994 to
maintain production facilities and for operational efficiencies at Liggett were
minimal. Capital expenditures at Liggett declined in 1994 and 1995 because of
significant equipment modernization occurring in the 1980s and early 1990s. In
the year ended December 31, 1994, cash provided by investing activities was
largely the result of the sale/redemption of SkyBox common and preferred stock
(approximately $29,000) offset by the impact of the Company's discontinuation of
its investment in MAI and capital expenditures of $3,023.
Net cash provided by financing activities in 1996 was $6,680, primarily due to
bank loans for Russian real estate development, the sale by BGLS of additional
15.75% Series A Senior Secured Notes Due 2001 (the "Series A Notes") later
exchanged for the 15.75% Series B Senior Secured Notes Due 2001 (the "Series B
Notes") and an increase in borrowings under Liggett's revolving credit facility
(the "Facility"). Cash provided was offset by redemption of BGLS' 16.125% Senior
Subordinated Reset Notes Due 1997 (the "Reset Notes"), a decrease in the cash
overdraft and distributions to the Company's stockholders of $4,162.
Cash used in financing activities for the year ended December 31, 1995 was
$44,794 reflecting the redemption of BGLS' Series 1 Senior Secured Notes on June
12, 1995 in the amount of $23,594, repayments and redemptions of Liggett's
long-term debt of $7,983, repayments under Liggett's revolver of $3,830,
distributions by the Company of $5,475 to stockholders and a decrease in cash
overdraft of $594 partially offset by proceeds from debt of $2,568.
Cash flows provided by financing activities in 1994 was $8,765. Proceeds from
financing activities in 1994 included proceeds from issuance of the Liggett
Series C Notes by Liggett, stockholder loan repayments with interest offset
principally by decreases in cash overdrafts and payment of Series G Preferred
dividends.
Liggett
Liggett had a net capital deficiency of $176,478 as of December 31, 1996, is
highly leveraged and has substantial near-term service requirements. Due to the
many risks and uncertainties associated with the cigarette industry, the impact
of recent tobacco litigation settlements (see "Recent Developments in the
Cigarette Industry - Legislation and Litigation") and increased tobacco costs,
there can be no assurance that Liggett will be able to meet its future earnings
goals. Consequently, Liggett could be in violation of certain debt covenants,
and if its lenders were to exercise acceleration
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33
rights under the Facility or senior secured notes indentures or refuse to lend
under the Facility, Liggett would not be able to satisfy such demands or its
working capital requirements.
Further, Liggett's senior secured notes require a mandatory principal redemption
of $37,500 on February 1, 1998 and a payment at maturity on February 1, 1999 of
$107,400 and its Facility expires on March 8, 1998 unless extended by its
lenders. The Facility is classified as a short-term debt thereby creating a
working capital deficit of approximately $40,694 at December 31, 1996.
While Liggett management currently intends to seek to refinance and/or
restructure with Liggett's note holders the redemption and maturity requirements
on the senior secured 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. Based on
Liggett's net loss for 1996 and projected 1997 operating results, 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 such
obligations, renegotiate the payment terms of the senior secured notes, extend
the Facility or otherwise make such payments, substantially all of its 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 Liggett meeting its liquidity needs and Liggett's
ability to continue as a going concern.
On May 14, 1996, Liggett sold certain surplus realty in Durham, North Carolina
to the County of Durham for a sale price of $4,300. A gain of approximately
$3,600 was recognized on this sale.
On March 11, 1997, Liggett sold certain surplus realty in Durham, North Carolina
to Blue Devil Ventures, a North Carolina limited liability partnership, for a
sale price of $2,200. A gain of approximately $1,600 was recognized on this
sale.
Liggett has acquired from BOL for $7,700 shares (19.97%) of Liggett-Ducat and
options to acquire additional shares of Liggett-Ducat which entitle Liggett to
increase its ownership to 95%. The transactions were funded principally with the
proceeds of the May 1996 and March 1997 sales of surplus reality. See Item 1.
"Business - Brooke (Overseas) Ltd. - Liggett-Ducat Ltd."
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 $13,098 based on eligible collateral at
December 31, 1996. The Facility is collateralized by all inventories and
receivables of Liggett. Borrowings under the Facility, whose interest is
calculated at a rate equal to 1.5% above Philadelphia National Bank's (the
indirect parent of Congress Financial Corporation, the lead lender) prime rate,
bear a rate of 9.75% at December 31, 1996. The Facility contains certain
financial covenants similar to those contained in Liggett's Note 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 imposes requirements with
respect to Liggett's adjusted net worth (not to fall below a deficit of $175,000
as computed in accordance with the agreement) and working capital (not to fall
below a deficit of $35,000 as computed in accordance with the agreement). At
December 31, 1996, Liggett was in compliance with all covenants under the
Facility.
During the first quarter of 1997, Liggett violated the working capital covenant
contained in the Facility as a result of the 1998 mandatory redemption payment
on the Senior Secured Notes becoming due within one year. On March 19, 1997,
the lead lender agreed to waive this covenant default, and the Facility was
amended as follows: (i) the working capital definition was changed to exclude
the Senior Secured Notes; (ii) the maximum permitted working capital deficit
was reduced to $12,000; (iii) the maximum permitted adjusted net worth deficit
was increased to $180,000; and (iv) the permitted advance rates under the
Facility for eligible inventory were reduced by five percent.
On February 14, 1992, Liggett issued $150,000 in Senior Secured Notes (the
"Liggett Series B Notes"). Interest on the Liggett Series B Notes is payable
semiannually on February 1 and August 1 at an annual rate of 11.5%. The Liggett
Series B Notes and Series C Notes referred to below (collectively, the "Liggett
Notes") require 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. The Liggett Notes are
collateralized by substantially all of
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the assets of Liggett, excluding accounts receivable and inventory. Eve is
guarantor for the Liggett Notes. The Liggett Notes may be redeemed, in whole or
in part, at a price equal to 102% and 100% of the principal amount in the years
1997 and 1998, respectively, at the option of Liggett. The Liggett Notes contain
restrictions on Liggett's ability to declare or pay cash dividends, incur
additional debt, grant liens and enter into any new agreements with affiliates,
among others. At December 31, 1996, Liggett was in compliance with all debt
covenants under the Liggett Notes indentures.
On January 31, 1994, Liggett issued a total of $22,500 of Variable Rate Series C
Senior Secured Notes ("Liggett Series C Notes"). The Liggett Series C Notes have
the same terms (other than interest rate) and stated maturity as the Liggett
Series B Notes. The Liggett Series C Notes bore a 16.5% interest rate, which was
reset on February 1, 1995 to 19.75%. On November 20, 1994, Liggett issued the
remaining $7,508 of Liggett Series C Notes in exchange for an equal amount of
Liggett Series B Notes and cash of $375. The Liggett Series B Notes were
credited against the mandatory redemption requirements for February 1, 1995. In
December 1995, $7,000 of Liggett Series B Notes were purchased using revolver
availability and credited against the mandatory redemption requirements for
February 1, 1996. The transaction resulted in a net gain of $1,114. The
remaining $500 mandatory redemption requirement for February 1, 1996 was met by
retiring the $500 Series C Notes held in treasury. In February 1997, Liggett
purchased $7,500 of Series B Notes using revolver availability and credited such
Notes against the mandatory redemption requirement. Liggett will record a net
gain of $2,963 for this transaction in the first quarter, 1997.
Liggett (and, in certain cases, the Company) and other United States cigarette
manufacturers have been named as defendants in a number of direct and
third-party actions (and purported class actions) predicated on the theory that
they should be liable for damages from cancer and other adverse health effects
alleged to have been caused by cigarette smoking or by exposure to so-called
secondary smoke (environmental tobacco smoke) from cigarettes. As new cases are
commenced, the costs associated with defending such cases and the risk attendant
to the inherent unpredictability of litigation continue. Liggett had been
receiving certain financial and other 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, but these benefits have recently
ended. Certain joint defense arrangements, and the financial benefits incident
thereto, have also ended. The future financial impact on the Company of the
termination of this assistance and the effects of the tobacco litigation
settlements discussed above is not quantifiable at this time. For a discussion
of the recent settlements, see "Recent Developments in the Cigarette Industry -
Legislation and Litigation" and Note 16 to the Company's Consolidated Financial
Statements.
The Company believes, and has been so advised by counsel handling the respective
cases, that the Company and Liggett have a number of valid defenses to the claim
or claims asserted against them. Litigation is subject to many uncertainties,
and it is possible that some of these actions could be decided unfavorably. An
unfavorable outcome of a pending smoking and health case could encourage the
commencement of additional similar litigation. Recently, there have been a
number of adverse regulatory, political and other developments concerning
cigarette smoking and the tobacco industry, including the commencement of the
purported class actions referred to above. These developments generally receive
widespread media attention. Neither the Company nor Liggett is able to evaluate
the effect of these developing matters on pending litigation or the possible
commencement of additional litigation.
The Company is unable to make a meaningful estimate of the amount or range of
loss that could result from an unfavorable outcome of the cases pending against
the Company and Liggett. It is possible that the Company's consolidated
financial position, results of operations or cash flows could be materially
affected by an ultimate unfavorable outcome in any such pending litigation.
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BGLS
At December 31, 1996, BGLS' long-term debt was approximately $233,000.
On November 27, 1995, BGLS commenced an offer to exchange a total of $232,864
principal amount of 15.75% Senior Secured Notes due January 31, 2001, for all
its outstanding 13.75% Series 2 Senior Secured Notes Due 1997 ("Series 2
Notes"), Reset Notes and 14.50% Subordinated Debentures Due 1998 ("Subordinated
Debentures"). The exchange ratio was $1,087.47 principal amount of new Series A
Notes for each $1,000 principal amount of Series 2 Notes exchanged, $1,132.28
principal amount of Series B Notes for each $1,000 principal amount of Reset
Notes exchanged and $1,000 principal amount of new Series B Notes for each
$1,000 principal amount of Subordinated Debentures exchanged. The new Series A
Notes and the new Series B Notes were identical except that the Series B Notes
were not subject to restrictions on transfer.
The exchange offer closed on January 30, 1996. All $91,179 of the Series 2 Notes
and $125,495 of the Subordinated Debentures were exchanged. In addition, BGLS
cancelled all of the Subordinated Debentures ($13,705) held by the Company.
Subordinated Debentures in the amount of $800 remain outstanding. As part of the
exchange offer, substantially all of the covenants and events of default were
eliminated pertaining to the Subordinated Debentures.
Holders of Reset Notes did not exchange, and the Reset Notes were redeemed on
March 29, 1996 for a total amount of $5,785, including premium, together with
accrued interest of $452. On March 7, 1996, an additional $7,397 face amount of
Series A Notes were sold for $6,300 including accrued interest with the proceeds
being used for the redemption of the Reset Notes.
Pursuant to a registered exchange offer, holders of the Series A Notes exchanged
all of the $107,373 outstanding principal amount for an equal principal amount
of Series B Notes. The exchange closed March 21, 1996. The Company has cancelled
all the Series A Notes.
The new Series B Notes are collateralized by substantially all of BGLS' assets,
including a pledge of BGLS' equity interests in Liggett, BOL and NV Holdings as
well as a pledge of all of the New Valley securities held by BGLS and NV
Holdings. The BGLS Series B Notes Indenture contains certain covenants, which
among other things, limit the ability of BGLS to make distributions to the
Company to $6,000 per year ($12,000 if less than 50% of the Series B Notes
remain outstanding), limit additional indebtedness of BGLS to $10,000, limit
guaranties of subsidiary indebtedness by BGLS to $50,000, and restrict certain
transactions with affiliates that exceed $2,000 in any year subject to certain
exceptions which include payments to the Company not to exceed $6,500 per year
for permitted operating expenses, payment of the Chairman's salary and bonus and
certain other expenses, fees and payments. In addition, the Indenture contains
certain restrictions on the ability of the Chairman and certain of his
affiliates to enter into certain transactions with, and receive payments above
specified levels from, New Valley. Interest is payable at the rate of 15.75% per
annum on January 31 and July 31 of each year, except for the period ended July
31, 1996 when interest was payable at 13.75% from October 1, 1995 to January 30,
1996 and at 15.75% from January 31, 1996 through July 31, 1996.
The Company recorded an extraordinary charge of approximately $9,700 for the
year ended December 31, 1995 relating to the exchanged debt securities discussed
above.
BOL
On January 31, 1997, BOL sold its 99.1% interest in BML to New Valley for
$55,000. The purchase price paid was $21,500 in cash and a 9% promissory note of
$33,500, payable $21,500 on June 30,
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1997 and $12,000 on December 31, 1997. See Item 1. "Business - Brooke (Overseas)
Ltd. - Sale of BrookeMil Ltd."
In October 1995, Liggett-Ducat entered into a loan agreement with Vneshtorgbank,
Moscow, Russia, to borrow up to $20,400 to fund real estate development.
Interest on the note is based on the London Interbank Offered Rate plus 10%.
Principal repayments are due over the period April through October of 1997.
Deferred financing fees of $4,044 are being amortized over the term of the loan.
The Company has guaranteed the payment of the note. In December 1996, the loan
was assigned by Liggett-Ducat to BML which has pledged Ducat Place II, the
second phase of BML's Ducat Place real estate development, as collateral for the
loan. On January 31, 1997, New Valley purchased BOL's 99.1% interest in BML and
indemnified the Company and its subsidiaries with respect to the loan.
Liggett-Ducat plans to build a new cigarette factory on the outskirts of Moscow.
The new factory, which will utilize Western cigarette making technology and have
a capacity of 24 billion units per year, will produce American and international
blend cigarettes, as well as traditional Russian cigarettes. Preliminary
construction has begun, and management is actively pursuing various potential
financing alternatives that would permit the new factory to be operational by
the end of 1998, although no assurance can be given that such financing can be
obtained on satisfactory terms.
The Company
Prior to the 1995 exchange offer, the Company had substantial near-term
consolidated debt service requirements, with aggregate required principal
payments of $318,106 due in the years 1995 through 1998. As a result of the 1995
exchange offer, the redemption of the Reset Notes in 1996 and the sale of the
BML shares to New Valley in January 1997, the Company decreased its scheduled
debt maturities to $94,758 due in the years 1997-1998; approximately $91,800 of
this debt relates to Liggett and BOL. At March 25, 1997, such scheduled debt
maturities have been reduced to $63,793 because of Liggett's sinking fund
payment on February 1, 1997 and the assumption of the foreign bank loan by New
Valley through the purchase of BML on January 31, 1997. In addition, Liggett
has a payment at maturity on February 1, 1999 of $107,400. The Company believes
that it will continue to meet its liquidity requirements through 1997, although
the BGLS Series B Notes Indenture limits the amount of restricted payments BGLS
is permitted to make to the Company during the calendar year. At December 31,
1996, the remaining amount available through December 31, 1997 in the Restricted
Payment Basket related to BGLS' payment of dividends to the Company (as defined
by BGLS' Series B Notes Indenture) is $9,225. In September 1996, the
Company provided for its quarterly dividend of $1,387 with proceeds from the CVR
distribution received in July 1996. Company expenditures (exclusive of Liggett
and Liggett-Ducat) in 1997 for current operations include debt service estimated
at $36,800, dividends on the Company's shares (currently at an annual rate of
approximately $5,500) and corporate expense. The Company anticipates funding
1997 current operations with the proceeds from the sale of BML, management fees
and other payments from subsidiaries of approximately $5,000 and proceeds from a
legal settlement of $4,100. The Company expects to finance its long-term growth,
working capital requirements, capital expenditures and debt service requirements
through a combination of cash provided from operations, proceeds from the sale
of certain assets, additional public or private debt and/or equity financing and
distributions from New Valley. New Valley may acquire or seek to acquire
additional operating businesses through merger, purchase of assets, stock
acquisition or other means, or to make other investments which may limit its
ability to make such distributions.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Company and its representatives may from time to time make oral or written
"forward-looking statements" within the meaning of the Private Securities Reform
Act of 1995 (the "Reform Act"),
34
37
including any statements that may be contained in the foregoing discussion in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", in this report and in other filings with the Securities and
Exchange Commission and in its reports to shareholders, which reflect
management's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties and, in connection with the "safe-harbor" provisions of the Reform
Act, the Company is hereby identifying important factors that could cause actual
results to differ materially from those contained in any forward-looking
statement made by or on behalf of the Company. Liggett continues to be subject
to risk factors endemic to the domestic tobacco industry including, without
limitation, health concerns relating to the use of tobacco products and exposure
to ETS, legislation, including tax increases, governmental regulation, privately
imposed smoking restrictions, governmental and grand jury investigations and
litigation. Each of the Company's operating subsidiaries, namely Liggett and
Liggett-Ducat, are subject to intense competition, changes in consumer
preferences, the effects of changing prices for its raw materials and local
economic conditions. Furthermore, the performance of Liggett-Ducat's cigarette
and real estate development operations in Russia are each affected by
uncertainties in Russia which include, among others, political or diplomatic
developments, regional tensions, currency repatriation restrictions, foreign
exchange fluctuations, inflation, and an undeveloped system of commercial laws
and legislative reform relating to foreign ownership in Russia. In addition, the
Company has a high degree of leverage and substantial near-term debt service
requirements, as well as a net worth deficiency and recent losses from
continuing operations. The Indenture for BGLS' Series B Notes provides for,
among other things, the restriction of certain affiliated transactions between
the Company and its affiliates, as well as for certain restrictions on the use
of future distributions received from New Valley. Due to such uncertainties and
risks, readers are cautioned not to place undue reliance on such forward-looking
statements, which speak only as of the date on which such statements are made.
The Company does not undertake to update any forward-looking statement that may
be made from time to time by or on behalf of the Company.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements and Notes thereto, together
with the report thereon of Coopers & Lybrand L.L.P. ("Coopers & Lybrand") dated
March 27, 1997, and quarterly financial results are set forth beginning on page
F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEMS 10, 11, 12 and 13.
The information called for by Items 10, 11, 12 and 13 with respect to the
Company will be contained in the Company's definitive Proxy Statement for its
1997 annual meeting of stockholders, to be filed with the SEC not later than 120
days after the end of the Company's fiscal year covered by this report pursuant
to Regulation 14A under the Exchange Act, and incorporated herein by reference.
Such information with respect to BGLS is omitted due to the fact that
BGLS meets the conditions set forth in General Instruction (I)(1)(a) and (b) of
Form 10-K and is therefore filing this report with the reduced disclosure
format.
35
38
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) INDEX TO 1996 CONSOLIDATED FINANCIAL STATEMENTS:
The Company's Consolidated Financial Statements and the Notes thereto,
together with the report thereon of Coopers & Lybrand dated March 27, 1997,
appears beginning on page F-1 of this report. Financial statement schedules not
included in this report have been omitted because they are not applicable or the
required information is shown in the Consolidated Financial Statements or the
Notes thereto.
(a)(2) FINANCIAL STATEMENT SCHEDULES:
Schedule II - Valuation and Qualifying Accounts .....................Page F-50
36
39
(a)(3) EXHIBITS
(a) The following is a list of exhibits filed herewith as part of the report on
Form 10-K:
INDEX OF EXHIBITS
EXHIBIT
NO. DESCRIPTION
------------------ ------------------------------------------------------------------------------
* 2.1 Stock Purchase Agreement dated as of January 31, 1997 among
BrookeMil Ltd. ("BML"), Brooke (Overseas) Ltd. ("BOL"), BGLS Inc.
("BGLS") and New Valley Corporation ("New Valley") (incorporated
by reference to exhibit 2.1 in New Valley's Current Report on
Form 8-K dated January 31, 1997, Commission File No. 1-2493
(the "New Valley Form 8-K")).
* 3.1 Restated Certificate of Incorporation of Liggett Group Inc. (the
predecessor to Brooke Group Ltd. (the "Company"))
(incorporated by reference to the Company's Registration
Statement on Form S-1, Commission File No. 33-16868).
* 3.2 Certificate of Amendment of the Restated
Certificate ofIncorporation of the Company
(incorporated by reference to the Company's Form
10-Q for the quarter ended June 30, 1990,
Commission File No. 1-5759).
* 3.3 Amended and Restated By-Laws of the Company,
effective December 5, 1995 (incorporated by
reference to the Company's current Report on Form
8-K dated December 5, 1995, Commission File No.
1-5759).
* 3.4 Certificate of Designations of Series A Junior Convertible
Participating PIK Preferred Stock, Series B Junior Convertible
Participating Reset Preferred Stock, Series C Junior Convertible
Participating Reset Preferred Stock and Series D Junior
Convertible Participating Reset Preferred Stock (incorporated
by reference to the Company's Form 10-Q for the quarter
ended September 30, 1990, Commission File No. 1-5759).
* 3.5 Certificate of Designation of Series E Junior
Convertible Participating Preferred Stock of the
Company (incorporated by reference to the Company's
Report on Form 8-K dated October 29, 1993).
* 3.6 Certificate of Designation of Series F Junior
Convertible Participating Preferred Stock of the
Company (incorporated by reference to the Company's
Report on Form 8-K dated October 29, 1993,
Commission File No. 1-5759).
* 3.7 Certificate of Designation of Series G Junior
Convertible Participating Preferred Stock of the
Company (incorporated by reference to the Company's
Form 10-K for the fiscal year ended 1993,
Commission File No. 1-5759).
37
40
EXHIBIT
NO. DESCRIPTION
------------------ -------------------------------------------------------------------------------
* 3.8 Certificate of Incorporation of BGLS
(incorporated by reference to exhibit 3.1 in BGLS'
Registration Statement on Form S-4 dated December
19, 1995, Commission File Number 33-80593).
* 3.9 By-Laws of BGLS (incorporated by reference to
exhibit 3.2 in BGLS' Registration Statement on Form
S-4 dated December 19, l995, Commission File Number
33-80593).
* 4.1 Indenture, dated as of January 1, 1996, between BGLS Inc.
("BGLS") and Fleet National Bank of Massachusetts ("Fleet"),
as Trustee, relating to the "Series A Notes" and the 15.75%
Series B Senior Secured Notes due 2001 (the "Series B
Notes"), including the form of Series A Note and the form of
Series B Note (the "Series A and Series B Indenture")
(incorporated by reference to exhibit 4.1 in BGLS'
Registration Statement on Form S-4 dated December 19, 1995,
Commission File No. 33-80593).
* 4.2 Pledge and Security Agreement, dated as of
January 1, 1996, between BGLS and Fleet, as
Trustee, under the Series A and Series B Indenture
(incorporated by reference to exhibit 4.2 in BGLS'
Registration Statement on Form S-4 dated December
19, 1995, Commission File No. 33-80593).
* 4.3 A/B Exchange and Registration Rights Agreement,
dated as of November 21, 1995, among the Company,
BGLS, AIF II L.P., Artemis America Partnership,
Tortoise Corp., and Mainstay High Yield Corporate
Bond Fund (incorporated by reference to exhibit 4.3
in BGLS' Registration Statement on Form S-4 dated
December 19, 1995, Commission File No. 33-80593).
* 4.4 Pledge and Security Agreement, dated as of
January 1, 1996, between New Valley Holdings, Inc.
and Fleet, as Trustee, under the Series A and
Series B Indenture (incorporated by reference to
exhibit 4.4 in BGLS' Registration Statement on Form
S-4 dated December 19, 1995, Commission File No.
33-80593).
* 4.5 Indenture, dated as of September 30, 1994, between BGLS and
Shawmut Bank, N.A. ("Shawmut"), as Trustee, relating to the
13.75% Series 2 Senior Secured Notes due 1995 (the "Series 2
Notes"), including the form of Series 2 Note (the "Series 2
Indenture") (incorporated by reference to exhibit 4(ii) in the
Company's Form 8-K dated September 2, 1994, Commission
File Number 1-5759).
* 4.6 Pledge Agreement, dated as of September 30,
1994, between BGLS and Shawmut, as Trustee, under
the Series 2 Indenture (incorporated by reference
to exhibit 10(ae) in the Company's Form 8-K dated
September 2, 1994, Commission File No. 1-5759).
38
41
EXHIBIT
NO. DESCRIPTION
------------------ -------------------------------------------------------------------------------
* 4.7 Indenture, dated April 1, 1988, between BGLS
and First Trust National Association ("First
Trust"), as Trustee, relating to the Subordinated
Debentures (the "14.5% Debenture Indenture")
(incorporated by reference to exhibit 4(ff) in the
Company's Form 10-Q for the quarter ended September
30, 1990, Commission File No. 1-5759).
* 4.8 First Supplemental Indenture, dated September
4, 1990, to the 14.5% Debenture Indenture, between
BGLS and First Trust, as Trustee (incorporated by
reference to exhibit 4(f) in the Company's Form
10-K for the year ended December 31, 1990,
Commission File No. 1-5759).
* 4.9 Second Supplemental Indenture, dated November
19, 1990, to the 14.5% Debenture Indenture, between
BGLS and First Trust, as Trustee (incorporated by
reference to exhibit 4(g) in the Company's Form
10-K for the year ended December 31, 1990,
Commission File No. 1-5759).
* 4.10 Third Supplemental Indenture, dated November
19, 1990, to the 14.5% Debenture Indenture, between
BGLS and First Trust, as Trustee (incorporated by
reference to exhibit 4(i) in the Company's Form
10-K for the year ended December 31, 1990,
Commission File No. 1-5759).
* 4.11 Fourth Supplemental Indenture, dated October
22, 1993, to the 14.5% Debenture Indenture, between
BGLS and First Trust, as Trustee (incorporated by
reference to exhibit 4(y) in the Company's Form
10-Q for the quarter ended September 30, 1993,
Commission File No. 1-5759).
* 4.12 Fifth Supplemental Indenture, dated January
18, 1995, to the 14.5% Debenture Indenture, between
BGLS and First Trust, as Trustee (incorporated by
reference to exhibit 4(e) in the Company's Form
10-K for the year ended December 31, 1994,
Commission File No. 1-5759).
* 4.13 Sixth Supplemental Indenture, dated as of
January 26, 1996, to the 14.5% Debenture Indenture,
between BGLS and First Trust, as Trustee
(incorporated by reference to exhibit 4.13 in BGLS'
Registration Statement on Form S-4 dated December
19, 1995, Commission File No. 33-80593).
* 4.14 Indenture, dated February 14, 1992, among Liggett Group Inc.
("Liggett"), Eve Holdings Inc. ("Eve") and Bankers Trust
Company, as Trustee ("Bankers Trust"), including the Forms of
Series A Notes and Series B Notes and the Guaranty thereon
(the "Liggett Indenture") (incorporated by reference to exhibit
4(m) in the Company's Form 10-K for the year ended
December 31, 1991, Commission File No. 1-5759).
39
42
EXHIBIT
NO. DESCRIPTION
------------------ -------------------------------------------------------------------------------
* 4.15 First Supplemental Indenture, dated January
26, 1994, including the Form of Series C Variable
Rate Senior Secured Note and the Guaranty thereon
(incorporated by reference to exhibit 4.2 in
Liggett's Registration Statement on Form S-1,
Commission File No. 33-75224).
* 4.16 Security Agreement, dated February 14, 1992,
among Liggett, Eve and Bankers Trust (the "Security
Agreement") (incorporated by reference to exhibit
4(n) in the Company's Form 10-K for the year ended
December 31, 1991, Commission File No. 1-5759).
* 4.17 Amendment No. 1 to the Security Agreement, dated January
26, 1994 (incorporated by reference to exhibit 4.4 in
Liggett's Registration Statement on Form S-1, Commission File
No. 33-75224).
* 4.18 Deed of Trust and Assignment of Rents, Leases
and Leasehold Interests, dated February 14, 1992,
by Liggett to Bankers Trust relating to each of the
Virginia and North Carolina properties (the "Deed
of Trust") (incorporated by reference to exhibit
4(o) in the Company's Form 10-K for the year ended
December 31, 1991, Commission File No. 1-5759).
* 4.19 Amendment No. 1 to the Deed of Trust (North Carolina),
dated January 26, 1994 (incorporated by reference to exhibit
4.6 in Liggett's Registration Statement on Form S-1,
Commission File No. 33-75224).
* 4.20 Amendment No. 1 to the Deed of Trust (Virginia), dated
January 26, 1994 (incorporated by reference to exhibit 4.7 in
Liggett's Registration Statement on Form S-1, Commission File
No. 33-75224).
* 4.21 Loan and Security Agreement, dated as of March
8, 1994, in the amount of $40,000,000 between
Liggett and Congress Financial Corporation
(incorporated by reference to exhibit 10(xx) in the
Company's Form 10-K for the year ended December 31,
1993, Commission File No. 1-5759).
* 4.22 First Amended Joint Chapter 11 Plan of Reorganization for
New Valley Corporation ("New Valley") dated September 27,
1994, Notice of Modification to the First Amended Joint
Chapter 11 Plan of Reorganization dated October 20, 1994 and
Plan Amendment dated October 28, 1994, as confirmed by
the United States Bankruptcy Court for the District of New
Jersey, Newark Division, on November 1, 1994 (incorporated by
reference to exhibit 2 in New Valley's Form 10-Q for the
quarter ended September 30, 1994, Commission File No. 1-2493).
40
43
EXHIBIT
NO. DESCRIPTION
------------------ -------------------------------------------------------------------------------
* 4.23 Order Confirming First Amended Joint Chapter
11 Plan of Reorganization for New Valley entered by
the Bankruptcy Court on November 1, 1994
(incorporated by reference to exhibit 99(b) in New
Valley's Form 10-Q for the quarter ended September
30, 1994, Commission File No. 1-2493).
* 10.1 Corporate Services Agreement, dated as of June
29, 1990, between the Company and Liggett
(incorporated by reference to exhibit 10.10 in
Liggett's Registration Statement on Form S-1,
Commission File No. 33-47482).
* 10.2 Corporate Services Agreement, dated June 29,
1990, between the Company and Liggett (incorporated
by reference to exhibit 10.11 in Liggett's
Registration Statement on Form S-1, Commission File
No. 33-47482).
* 10.3 Services Agreement, dated as of February 26, 1991,
between Brooke Management Inc. ("BMI") and Liggett
(the "Liggett Services Agreement") (incorporated by
reference to exhibit 10.5 in BGLS' Registration
Statement on Form S-1, Commission File No. 33-93576).
* 10.4 First Amendment to Liggett Services Agreement,
dated as of November 30, 1993, between Liggett and
BMI (incorporated by reference to exhibit 10.6 of
BGLS' Registration Statement on Form S-1,
Commission File No. 33-93576).
* 10.5 Second Amendment to Liggett Services
Agreement, dated as of October 1, 1995, between
BMI, the Company and Liggett (incorporated by
reference to exhibit 10(c) in the Company's Form
10-Q for the quarter ended September 30, 1995,
Commission File No. 1-5759).
* 10.6 Corporate Services Agreement, dated January 1,
1992, between BGLS and Liggett (the "Liggett
Services Agreement") (incorporated by reference to
exhibit 10.13 of Liggett's Registration Statement
on Form S-1, Commission File No. 33-47482).
* 10.7 Employment Agreement, dated February 21, 1992,
between the Company and Bennett S. LeBow
(incorporated by reference to exhibit 10(xx) in the
Company's Form 10-K for the year ended December 31,
1991, Commission File No. 1-5759).
* 10.8 Employment Agreement, dated June 1, 1994, between Liggett
and Rouben V. Chakalian (incorporated by reference to exhibit
10.13 of Liggett's Registration Statement on Form S-1,
Commission File No. 33-75224).
* 10.9 Amended Employment Agreement, dated January
9, 1996, between Rouben V. Chakalian and Liggett
(incorporated by reference to exhibit 10.20 in
Liggett's Form 10-K for the year ended December 31,
1996, Commission File No. 33-75224).
41
44
EXHIBIT
NO. DESCRIPTION
------------------ -------------------------------------------------------------------------------
* 10.10 Tax-Sharing Agreement, dated June 29, 1990,
among the Company, Liggett and certain other
entities (incorporated by reference to exhibit
10.12 in Liggett's Registration Statement on Form
S-1, Commission File No. 33-47482).
* 10.11 Lease with respect to Liggett's distribution
center in Durham, North Carolina, including letter
agreement extending term of Lease (incorporated by
reference to exhibit 10.15 in Liggett's
Registration Statement on Form S-1, Commission File
No. 33- 47482).
* 10.12 Tax Indemnity Agreement, dated as of October
6, 1993, among the Company, Liggett and certain
other entities (incorporated by reference to
exhibit 10.2 in SkyBox International Inc.'s Form
10-Q for the quarter ended September 30, 1993,
Commission File No. 0-22126).
* 10.13 Exchange and Termination Agreement, dated as
of September 30, 1994, among the Company, BGLS,
AIF, Artemis America LLC and Mainstay (incorporated
by reference to exhibit 10(ac) in the Company's
Form 8-K dated September 2, 1994, Commission File
No. 1-5759).
* 10.14 Exchange Agreement, dated as of November 21,
1995, among the Company, BGLS, AIF, Artemis
Partnership, Tortoise, Starfire Holding Corporation
and Mainstay (incorporated by reference to exhibit
10.13 in BGLS' Registration Statement on Form S-4
dated December 19, 1995, Commission File No.
33-80593).
* 10.15 Registration Rights Agreement, dated as of
January 1, 1996, among the Company, New Valley,
BGLS and Fleet, as Trustee (incorporated by
reference to exhibit 10.14 in BGLS' Registration
Statement on Form S-4 dated December 19, 1995,
Commission File No. 33-80593).
* 10.16 Agreement among BGLS, the Company and High
River Limited Partnership ("High River"), dated
October 17, 1995 (incorporated by reference to
exhibit 10(b) in the Company's Form 10-Q for the
quarter ended September 30, 1995, Commission File
No. 1-5759).
* 10.17 Letter Agreement among BGLS, the Company and
High River dated November 5, 1995 (incorporated by
reference to exhibit 10(a) in the Company's Form
10-Q for the quarter ended September 30, 1995,
Commission File No. 1-5759).
* 10.18 Termination and Release Agreement, dated as of December 13,
1995, by and between BGLS, Gary Winnick Trust No. 3, CAL-W
Associates and M.D.C. Holdings, Inc. (incorporated by reference to
exhibit 10.18 in BGLS' Registration Statement on Form S-4 dated
December 19, 1995, Commission File No. 33-80593).
42
45
EXHIBIT
NO. DESCRIPTION
------------------ -------------------------------------------------------------------------------
* 10.19 Agreement between New Valley and the Company,
dated as of December 27, 1995 (incorporated by
reference to exhibit 10.19 in BGLS' Registration
Statement on Form S-4 dated December 19, 1995,
Commission File No. 33-80593).
* 10.20 Expense Sharing Agreement, dated as of
January 18, 1995, between the Company and New
Valley (incorporated by reference to exhibit 10(d)
in the Company's Form 10-Q for the quarter ended
September 30, 1995, Commission File No. 1-5759).
* 10.21 Stock Option Agreement, dated January 25,
1995, between the Company and Howard M. Lorber
(incorporated by reference to exhibit 10(g) in the
Company's Form 10-K for the year ended December 31,
1994, Commission File No. 1-5759).
* 10.22 Agreement among New Valley, ALKI and High
River, dated October 17, 1995 (the "High River
Agreement") (incorporated by reference to exhibit
10(d) in New Valley's Form 10-Q for the quarter
ended September 30, 1995, Commission File No.
1-2493).
* 10.23 Letter Amendment, dated October 17, 1995, to
the High River Agreement (incorporated by reference
to exhibit 10(e) in the New Valley's Form 10-Q for
the quarter ended September 30, 1995, Commission
File No. 1-2493).
* 10.24 Letter Amendment, dated November 5, 1995, to
the High River Agreement (incorporated by reference
to exhibit 10(f) in New Valley's Form 10-Q for the
quarter ended September 30, 1995, Commission File
No. 1-2493).
* 10.25 Agreement, dated December 28, 1995, between
Jefferies, the Company, BGLS and Liggett (the
"Jefferies Agreement") (incorporated by reference
to exhibit 7 in the Schedule 13D filed by, among
others, the Company with the Commission on March
11,1996, as amended, with respect to the common
stock of RJR Nabisco Holdings Corp. (the "Schedule
13D")).
* 10.26 Letter Amendment, dated February 28, 1996, to the
Jefferies Agreement (incorporated by reference to Exhibit 7
in the Schedule 13D).
* 10.27 Agreement of Termination, dated June 5, 1996,
between New Valley, ALKI, High River, the Company
and BGLS (incorporated by reference to exhibit 16
in the Schedule 13D).
* 10.28 Amended and Restated Consulting Agreement,
dated as of March 1, 1996, between the Company and
Howard M. Lorber (incorporated by reference to
exhibit 10.25 in the Company's Form 10-K for the
year ended December 31, 1995, Commission File No.
1-5759).
43
46
EXHIBIT
NO. DESCRIPTION
------------------ -------------------------------------------------------------------------------
* 10.29 Settlement Agreement, dated March 12, 1996, by and between Dianne
Castano and Ernest Perry, the putative representative plaintiffs in
Dianne Castano, et al. v. The American Tobacco Company, Inc. et al.,
Civil No. 94-1044, United States District Court for the Eastern District
of Louisiana, for themselves and on behalf of the plaintiff settlement
class, and the Company and Liggett, as supplemented by the letter
agreement dated March 14, 1996 (the ""Settlement Agreement'')
(incorporated by reference to exhibit 13 in the
Schedule 13D).
10.30 Addendum to Settlement Agreement.
* 10.31 Settlement Agreement, dated March 15, 1996,
by and among the State of West Virginia, State of
Florida, State of Mississippi, Commonwealth of
Massachusetts, and State of Louisiana, the Company
and Liggett (incorporated by reference to exhibit
15 in the Schedule 13D).
* 10.32 Stock Purchase Agreement, dated April 3,
1996, among Liggett-Ducat Ltd. ("Liggett-Ducat"),
Belgrave Limited ("Belgrave"), Eduard Z. Nakhamkin
("Nakhamkin") and BOL (incorporated by reference to
exhibit 10.28 in the Company's Form 10-K for the
year ended December 31, 1995, Commission File No.
1-5759).
* 10.33 Consulting Agreement, dated April 3, 1996,
among BOL, Belgrave and Nakhamkin (incorporated by
reference to exhibit 10.29 in the. Company's Form
10-K for the year ended December 31, 1995,
Commission File No. 1-5759).
* 10.34 Pledge Agreement, dated April 3, 1996,
between BOL and Belgrave (incorporated by reference
to exhibit 10.30 in the Company's Form 10-K for the
year ended December 31, 1995, Commission File No.
1-5759).
* 10.35 Stock Option Agreement, dated December 16, 1996, between the
Company and Howard M. Lorber (incorporated by reference to
exhibit 10.34 in the Company's Form 10-K for the year ended
December 31, 1996, Commission File No. 1-5759 (the "1996
Form 10-K")).
* 10.36 Stock Option Agreement, dated January 1, 1997 between the
Company and Richard J. Lampen (incorporated by reference
to exhibit 10.35 in the 1996 Form 10-K).
* 10.37 Letter Agreement dated September 5, 1996
between Ronald S. Fulford and Liggett (incorporated
by reference to exhibit 10.23 in Liggett's Form
10-K for the year ended December 31, 1996,
Commission File No. 33-75224).
* 10.38 Promissory Note of New Valley dated January
31, 1997 in favor of BOL (incorporated by reference
to exhibit 10.1 in the New Valley Form 8-K).
* 10.39 Pledge Agreement dated as of January 31, 1997
entered into by and between BOL and New Valley
(incorporated by reference to exhibit 10.2 in the
New Valley Form 8-K).
* 10.40 Use Agreement dated as of January 31, 1997,
entered into by and between BML and Liggett-Ducat
Joint Stock Company (incorporated by reference to
exhibit 10.3 in the New Valley Form 8-K).
44
47
EXHIBIT
NO. DESCRIPTION
------------------ -------------------------------------------------------------------------------
* 10.41 Settlement Agreement, dated March 20, 1997, by and among the
States listed in Appendix A thereto, the Company and Liggett
(incorporated by reference to exhibit 10.40 in the 1996
Form 10-K).
* 10.42 Settlement Agreement, dated March 20, 1997,
by and between the named and representative
plaintiffs in Fletcher, et al. v. Brooke Group Ltd.,
et al., for themselves and on behalf of the plaintiff
settlement class, and the Company and Liggett. (incorporated
by reference to exhibit 10.41 in the 1996 Form 10-K).
* 21 Subsidiaries of the Company (incorporated by reference to
exhibit 21 in the 1996 Form 10-K).
* 23.1 Consent of Coopers and Lybrand L.L.P. relating to the Company's
Registration Statements on Form S-3 (Commission File No. 33-38869
and Commission File No. 33-63119) (incorporated by reference to
exhibit 23.1 in the 1996 Form 10-K).
* 23.2 Consent of Price Waterhouse LLP relating to the Company's
Registration Statements on Form S-3 (Commission File No. 33-38869
and Commission File No. 33-63119) (incorporated by reference to
exhibit 23.2 in the 1996 Form 10-K).
* 23.3 Consent of KPMG Peat Marwick LLP relating to the Company's
Registration Statements on Form S-3 (Commission File No. 33-38869
and Commission File No. 33-63119) (incorporated by reference to
exhibit 23.3 in the 1996 Form 10-K).
* 23.4 Consent of Arthur Anderson LLP relating to the Company's
Registration Statements on Form S-3 (Commission File No. 33-38869
and Commission File No. 33-63119) (incorporated by reference to
exhibit 23.4 in the 1996 Form 10-K).
* 27.1 Financial Data Schedule of the Company (incorporated by reference
to exhibit 27.1 in the 1996 Form 10-K).
* 27.2 Financial Data Schedule of BGLS (incorporated by reference to
exhibit 27.2 in the 1996 Form 10-K).
* 99.1 Stipulation and Agreement of Compromise and
Settlement in connection with an action in the
Court of Chancery of the State of Delaware in and
for New Castle County entitled Gyetyan v. Bennett
S. LeBow et al., Civil Action No. 12998
(incorporated by reference to exhibit A in the
Company's Form 8-K dated June 2, 1994, Commission
File No. 1-5759).
99.2 Liggett Group Inc.'s Consolidated Financial
Statements for the fiscal year ended December 31,
1996.
* 99.3 New Valley Holdings, Inc.'s Financial Statements
for the fiscal year ended December 31, 1996 (incorporated by
reference to exhibit 99.3 in the 1996 Form 10-K).
45
48
EXHIBIT
NO. DESCRIPTION
------------------ -------------------------------------------------------------------------------
*99.4 Brooke (Overseas) Ltd.'s Consolidated Financial
Statements for the fiscal year ended December 31,
1996 (incorporated by reference to exhibit 99.4 in
the 1996 Form 10-K).
- -------------------
* Incorporated by reference
Each management contract or compensatory plan or arrangement required to be
filed as an exhibit to this report pursuant to Item 14(c) is listed in exhibit
nos. 10.7, 10.8, 10.9, 10.36 and 10.37.
(B) REPORTS ON FORM 8-K:
No current reports on Form 8-K were filed by either the Company or BGLS
during the fourth quarter of 1996.
46
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.
BROOKE GROUP LTD.
(Registrant)
By: /s/ Joselynn D. Van Siclen
------------------------------
Joselynn D. Van Siclen
Vice President and
Chief Financial Officer
Date: April 11, 1997
BGLS INC.
(Registrant)
By: /s/ Joselynn D. Van Siclen
------------------------------
Joselynn D. Van Siclen
Vice President and
Chief Financial Officer
Date: April 11, 1997
47
50
BROOKE GROUP LTD.
BGLS INC.
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996
ITEMS 8, 14(a) (1) AND (2), AND 14(d)
INDEX TO FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Financial Statements and Schedule of the Registrant and its
subsidiaries, required to be included in Items 8, 14(a) (1) and (2),
and 14(d) are listed below:
Page
FINANCIAL STATEMENTS: ----
Brooke Group Ltd./BGLS Inc. Consolidated Financial Statements
-------------------------------------------------------------
Reports of Independent Accountants................................................. F-3
Brooke Group Ltd. Consolidated Balance Sheets as of December 31, 1996 and 1995 F-5
BGLS Inc. Consolidated Balance Sheets as of December 31, 1996 and 1995............. F-6
Brooke Group Ltd. Consolidated Statements of Operations for the years ended
December 31, 1996, 1995 and 1994............................................... F-7
BGLS Inc. Consolidated Statements of Operations for the years ended December
31, 1996, 1995 and 1994........................................................ F-8
Brooke Group Ltd. Consolidated Statements of Stockholders' Equity (Deficit) for the
years ended December 31, 1996, 1995 and 1994................................... F-9
BGLS Inc. Consolidated Statements of Stockholder's Equity (Deficit) for the years
ended December 31, 1996, 1995 and 1994......................................... F-10
Brooke Group Ltd. Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994............................................... F-11
BGLS Inc. Consolidated Statements of Cash Flows for the years ended December
31, 1996, 1995 and 1994........................................................ F-13
Notes to Consolidated Financial Statements......................................... F-15
FINANCIAL STATEMENT SCHEDULE:
Schedule II -- Valuation and Qualifying Accounts................................... F-50
Financial Statement Schedules not listed above have been omitted
because they are not applicable or the required information is
contained in the Company's Consolidated Financial Statements or
accompanying Notes.
New Valley Corporation
----------------------
Reports of Independent Accountants................................................. F-51
Consolidated Balance Sheets as of December 31, 1996, 1995 and 1994................. F-53
Consolidated Statements of Operations for the years ended December 31, 1996,
1995 and 1994.................................................................. F-54
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 1996, 1995 and 1994............................................... F-55
Consolidated Statements of Cash Flows for the years ended December 31, 1996,
1995 and 1994.................................................................. F-56
Notes to Consolidated Financial Statements......................................... F-57
MAI Systems Corporation
-----------------------
Report of Independent Accountants.................................................. F-79
F-1
51
Liggett Group Inc.
------------------
The consolidated financial statements of Liggett Group Inc. are
incorporated herein by reference from Liggett Group Inc.'s Form 10-K for the
year ended December 31, 1996, and are filed as exhibit 99.2 to this report.
New Valley Holdings, Inc.
-------------------------
The financial statements of New Valley Holdings, Inc. are filed as exhibit
99.3 to this report and are incorporated herein by reference.
Brooke (Overseas) Ltd.
----------------------
The consolidated financial statements of Brooke (Overseas) Ltd. are filed
as exhibit 99.4 to this report and are incorporated herein by reference.
F-2
52
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of Brooke Group Ltd. and BGLS Inc.
We have audited the accompanying consolidated balance sheets of Brooke Group
Ltd. and Subsidiaries (the "Company") and BGLS Inc. and Subsidiaries ("BGLS") as
of December 31, 1996 and 1995 and the related consolidated statements of
operations, stockholders equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1996. These financial statements are the
responsibility of the the Company's and BGLS' management. Our responsibility is
to express an opinion on these financial statements based on our audits. We did
not audit the financial statements of MAI Systems Corporation ("MAI"), a
discontinued subsidiary (Note 5), which statements reflect net income comprising
4% of the Company's and BGLS' consolidated net income for the year ended
December 31, 1994. Further, we did not audit the financial statements of New
Valley Corporation ("New Valley") for the year ended December 31, 1994, the
investment in which is being accounted for by the Company and BGLS using
the equity method of accounting (Note 2). The equity in the net income of New
Valley represents 85% and 88% of the Company's and BGLS' consolidated net
income for the year ended December 31, 1994, respectively. Those statements
were audited by other auditors whose reports have been furnished to us and our
opinion on the consolidated financial statements, insofar as it relates to the
amounts included for MAI and New Valley, are based solely upon the reports of
the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Brooke Group Ltd. and
Subsidiaries and BGLS Inc. and Subsidiaries at December 31, 1996 and 1995 and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1996 in conformity with
generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Miami, Florida
March 27, 1997
F-3
53
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of Brooke Group Ltd. and BGLS Inc.
Our report on the consolidated financial statements of Brooke Group Ltd. and
Subsidiaries and BGLS Inc. and Subsidiaries is included on Page F-3 of this
Form 10-K. In connection with our audits of such financial statements, we have
also audited the related financial statement schedule on page F-50 of this Form
10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
Miami, Florida
March 27, 1997
F-4
54
BROOKE GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, Except Per Share Amounts)
December 31, December 31,
1996 1995
---------------- -----------------
ASSETS:
Current assets:
Cash and cash equivalents............................................. $ 1,941 $ 3,370
Accounts receivable - trade........................................... 19,475 23,844
Other receivables..................................................... 1,217 1,448
Receivables from affiliates........................................... 47 1,502
Inventories........................................................... 53,691 60,522
Deferred tax assets................................................... 1,061
Other current assets.................................................. 4,181 4,868
--------- -------
Total current assets................................................ 80,552 96,615
Property, plant and equipment, at cost, less accumulated
depreciation of $31,047 and $27,323................................... 80,282 48,352
Intangible assets, at cost, less accumulated amortization
of $17,457 and $15,679................................................ 4,421 5,453
Investment in affiliate................................................. 3,051 63,901
Other assets............................................................ 9,371 11,299
--------- --------
Total assets........................................................ $177,677 $225,620
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities:
Notes payable and current portion of long-term debt................... $ 55,242 $ 2,387
Accounts payable...................................................... 32,461 22,762
Due to affiliates..................................................... 990
Dividends payable..................................................... 1,387
Cash overdraft........................................................ 6 4,266
Accrued promotional expenses.......................................... 30,257 25,519
Accrued taxes payable................................................. 26,379 22,846
Accrued interest...................................................... 24,354 16,863
Other accrued liabilities............................................. 33,387 24,534
-------- --------
Total current liabilities........................................... 204,463 119,177
Notes payable, long-term debt and other obligations,
less current portion.................................................. 378,243 406,744
Noncurrent employee benefits............................................ 31,256 31,672
Other liabilities....................................................... 18,704 24,131
Commitments and contingencies...........................................
Stockholders' equity (deficit):
Preferred Stock, par value $1.00 per share, authorized 10,000,000
shares ............................................................
Series G Preferred Stock, 2,184.834 shares, convertible, participating,
cumulative, each share convertible to 1,000 shares of common
stock and cash or stock distribution, liquidation preference
of $1.00 per share .................................................
Common stock, par value $0.10 per share, authorized 40,000,000
shares, issued 24,998,043 shares, outstanding 18,497,096 shares..... 1,850 1,850
Additional paid-in capital............................................ 94,169 93,186
Deficit............................................................... (490,706) (428,173)
Other................................................................. (27,963) 9,372
Less: 6,500,947 shares of common stock in treasury, at cost.......... (32,339) (32,339)
-------- --------
Total stockholders' equity (deficit).............................. (454,989) (356,104)
-------- --------
Total liabilities and stockholders' equity (deficit).............. $177,677 $225,620
======== ========
The accompanying notes are an integral part
of the consolidated financial statements
F-5
55
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars In Thousands, Except Per Share Amounts)
December 31, December 31,
1996 1995
----------------- ------------------
ASSETS:
Current assets:
Cash and cash equivalents................................................. $ 1,940 $ 3,370
Accounts receivable - trade............................................... 19,475 23,844
Other receivables......................................................... 1,166 1,481
Receivables from affiliates............................................... 47 1,130
Inventories............................................................... 53,691 60,522
Deferred tax assets....................................................... 4,861
Other current assets...................................................... 3,878 4,435
--------- --------
Total current assets.................................................. 80,197 99,643
Property, plant and equipment, at cost, less accumulated
depreciation of $30,762 and $27,181....................................... 79,972 47,900
Intangible assets, at cost, less accumulated amortization
of $17,457 and $15,679.................................................... 4,421 5,453
Investment in affiliate..................................................... 3,051 63,901
Other assets................................................................ 10,467 12,345
-------- --------
Total assets.......................................................... $178,108 $229,242
======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT):
Current liabilities:
Notes payable and current portion of long-term debt....................... $ 53,945 $ 2,132
Accounts payable.......................................................... 32,336 22,637
Cash overdraft............................................................ 6 3,761
Due to parent............................................................. 29,598 26,054
Accrued promotional expenses.............................................. 30,257 25,519
Accrued taxes payable..................................................... 26,379 22,846
Accrued interest.......................................................... 24,354 16,863
Other accrued liabilities................................................. 32,861 23,073
-------- --------
Total current liabilities............................................. 229,736 142,885
Notes payable, long-term debt and other obligations, less current portion... 378,243 420,449
Noncurrent employee benefits................................................ 31,256 31,672
Other liabilities........................................................... 21,958 24,131
Commitments and contingencies...............................................
Stockholder's equity (deficit):
Common stock, par value $0.01 per share; authorized 100 shares,
issued 100 shares, outstanding 100 shares...............................
Additional paid-in capital................................................ 39,081 23,594
Deficit................................................................... (499,264) (423,424)
Other..................................................................... (22,902) 9,935
-------- ---------
Total stockholder's equity (deficit).................................. (483,085) (389,895)
-------- --------
Total liabilities and stockholder's equity (deficit).................. $178,108 $229,242
======== ========
The accompanying notes are an integral part
of the consolidated financial statements
F-6
56
BROOKE GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Amounts)
---------------------------------------------------
Year Ended December 31,
---------------------------------------------------
1996 1995 1994
---------------------------------------------------
Revenues*.................................................. $452,656 $461,459 $479,343
Cost of goods sold*........................................ 235,633 216,187 229,807
------- ------- -------
Gross profit...................................... 217,023 245,272 249,536
Operating, selling, administrative and general expenses.... 220,950 237,212 235,374
------- ------- -------
Operating (loss) income........................... (3,927) 8,060 14,162
Other income (expenses):
Interest income........................................ 220 989 533
Interest expense....................................... (60,556) (57,505) (55,952)
Equity in (loss) earnings of affiliate................. (7,211) 678
Sale of assets......................................... 6,716
Other, net............................................. 1,242 2,776 (1,221)
--------- -------- -------
(Loss) from continuing operations before
income taxes........................................... (63,516) (45,002) (42,478)
Provision (benefit) for income taxes....................... 1,402 342 (24,487)
--------- -------- ------
(Loss) from continuing operations.......................... (64,918) (45,344) (17,991)
-------- ------- ------
Discontinued operations:
(Loss) income from discontinued operations............. (1,591) 2,860 23,693
Gain on disposal....................................... 3,976 18,369 150,990
--------- ------- -------
Income from discontinued operations........................ 2,385 21,229 174,683
--------- ------- -------
(Loss) income before extraordinary items................... (62,533) (24,115) 156,692
-------- ------- -------
Extraordinary items:
(Loss) resulting from the early extinguishment of debt. (9,810) (47,513)
Gain on reorganization of MAI.......................... 916
--------- ----------- ----------
(Loss) from extraordinary items................... (9,810) (46,597)
--------- ------- --------
Net (loss) income................................. (62,533) (33,925) 110,095
Proportionate share of New Valley capital transactions,
retirement of Class A Preferred Shares................. 1,782 16,802
--------- -------- --------
Net (loss) income applicable to common shares..... $ (60,751) $ (17,123) $110,095
========= ========= ========
Per common share:
(Loss) from continuing operations...................... $(3.41) $(1.56) $(1.02)
====== ====== ======
Income from discontinued operations.................... $ 0.13 $ 1.16 $ 9.92
====== ====== ======
Extraordinary items.................................... $ $(0.54) $(2.65)
====== ====== ======
Net (loss) income applicable to common shares...... $(3.28) $(0.94) $ 6.25
====== ====== ======
Weighted average common shares and common stock equivalents
outstanding............................................ 18,497,096 18,301,186 17,610,898
========== ========== ==========
- ----------------------
* Revenues and Cost of goods sold include federal excise taxes of $104,518,
$123,420 and $131,877 for the years ended December 31, 1996, 1995 and 1994,
respectively.
The accompanying notes are an integral part
of the consolidated financial statements
F-7
57
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Amounts)
---------------------------------------------------
Year Ended December 31,
---------------------------------------------------
1996 1995 1994
---------------------------------------------------
Revenues*............................................................... $452,656 $461,459 $479,341
Cost of goods sold*..................................................... 235,633 216,187 229,803
------- ------- -------
Gross profit................................................... 217,023 245,272 249,538
Operating, selling, administrative and
general expenses.................................................... 219,039 236,961 235,792
------- ------- -------
Operating (loss) income........................................ (2,016) 8,311 13,746
Other income (expenses):
Interest income..................................................... 157 989 225
Interest expense.................................................... (64,417) (61,036) (58,625)
Equity in (loss) earnings of affiliate.............................. (7,211) 678
Sale of assets...................................................... 6,716
Other, net.......................................................... (2,579) 2,292 (2,136)
--------- --------- --------
(Loss) from continuing operations before income taxes................... (69,350) (48,766) (46,790)
Provision (benefit) for income taxes.................................... 5,254 1,736 (24,943)
--------- --------- ------
(Loss) from continuing operations....................................... (74,604) (50,502) (21,847)
-------- -------- ------
Discontinued operations:
(Loss) income from discontinued operations.......................... (1,591) 2,860 23,693
Gain on disposal.................................................... 3,976 18,369 150,990
------ -------- -------
Income from discontinued operations..................................... 2,385 21,229 174,683
------ -------- -------
(Loss) income before extraordinary items................................ (72,219) (29,273) 152,836
-------- -------- -------
Extraordinary items:
(Loss) resulting from the early extinguishment of debt.............. (9,810) (47,513)
Gain on reorganization of MAI....................................... 916
--------- --------- --------
(Loss) from extraordinary items................................ (9,810) (46,597)
--------- --------- --------
Net (loss) income............................................ $(72,219) $(39,083) $106,239
======== ======== ========
- ---------------------
* Revenues and Cost of goods sold include federal excise taxes of $104,518,
$123,420 and $131,877 for the years ended December 31, 1996, 1995 and 1994,
respectively.
The accompanying notes are an integral part
of the consolidated financial statements
F-8
58
BROOKE GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(Dollars in Thousands, Except Per Share Amounts)
-----------------------------------------------------------------------------------------
Preferred Stock Additional
Series G Common Stock Paid-In Treasury
Shares Amount Shares Amount Capital Deficit Stock Other Total
-----------------------------------------------------------------------------------------
Balance, December 31, 1993 ........... 2,184,834 $ 2 15,259,762 $ 1,526 $ 60,578 $(540,942) $(35,846) $(514,682)
Foreign currency adjustment .......... $ 201 201
Preferred stock exchanged for common . (2,184,834) (2) 2,184,834 218 (216)
Reclassification of former Vice
Chairman's loan to other receivables 1,500 1,500
Contingent Value Rights settlement ... 1,875 1,875
Repayment by Chairman of interest .... 1,163 1,163
Waiver of dividends, shareholder
settlement .......................... 6,250 3,200 9,450
Transfer of pension liability to
SkyBox .............................. 4,305 4,305
Stock grant to consultant ............ 250,000 25 (739) 1,182 468
Contract settlement .................. (371) (371)
Exercise of warrant .................. 607,889 61 (2,875) 2,875 61
Net income ........................... 110,095 110,095
Unrealized holding gain on
investment in New Valley............. 11,164 11,164
Treasury stock, at cost............... (41,641) (4) 4 1,672 (1,753) (81)
---------- --- ---------- ------ ----- ------- ----- -------- ---------
Balance, December 31, 1994 ........... 18,260,844 1,826 66,245 (420,746) (33,542) 11,365 (374,852)
Net loss ............................. (33,925) (33,925)
Consolidation of foreign subsidiary .. 14,435 14,435
Distributions on common stock
($0.30 per share).................... (5,474) (5,474)
Stock grant to directors ............. 20,000 2 (2) 94 94
Stock grant to consultant ............ 250,000 25 (800) 1,244 469
Stock options granted to consultant .. 938 (563) 375
MAI spin-off ......................... 27,286 (201) 27,085
Unrealized holding loss on investment
in New Valley ....................... (2,332) (2,332)
Effect of New Valley capital
transactions ........................ 17,043 1,103 18,146
Treasury stock, at cost .............. (33,748) (3) 3 (135) (135)
Other, net ........................... (2) 12 10
---------- --- ---------- ------ ------ --------- ------- ------- ---------
Balance, December 31, 1995 ........... 18,497,096 1,850 93,186 $(428,173) (32,339) 9,372 (356,104)
Net loss ............................. (62,533) (62,533)
Distributions on common stock
($0.30 per share) ................... (5,549) (5,549)
Amortization of deferred compensation 252 252
Stock options granted to consultant .. 4,750 (4,750)
Unrealized holding loss on investment
in New Valley ....................... (33,936) (33,936)
Effect of New Valley capital
transactions ........................ 1,782 1,099 2,881
---------- --- ---------- ------ ------- --------- -------- -------- ---------
Balance, December 31, 1996 ........... $ 18,497,096 $1,850 $94,169 $(490,706) $(32,339) $(27,963) $(454,989)
========== === ========== ====== ======= ========= ======== ======== =========
The accompanying notes are an integral part
of the consolidated financial statements
F-9
59
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)
(Dollars in Thousands, Except Per Share Amounts)
Common Stock Additional
------------ Paid-in
Shares Amount Capital Deficit Other Total
------ ------ ------- ------- ----- -----
Balance, December 31, 1993........................... 100 $(508,675) $(508,675)
Distributions paid to parent......................... (9,212) (9,212)
Reclassification of former Vice
Chairman's loan to other receivables............... 1,500 1,500
Transfer of pension liability to SkyBox.............. 4,305 4,305
Repayment of loan.................................... 3,200 3,200
Net income........................................... 106,239 106,239
Unrealized holding gain on investment in New Valley.. $11,164 11,164
Foreign currency adjustment.......................... 201 201
------ --------- --------- ---------- ------- ----------
Balance, December 31, 1994........................... 100 (402,643) 11,365 (391,278)
Distributions paid to parent......................... (5,872) (5,872)
Distribution of MAI to parent........................ 24,942 (201) 24,741
Net loss............................................. (39,083) (39,083)
Unrealized loss on investment in New Valley.......... (2,332) (2,332)
Effect of New Valley capital transactions............ $17,043 1,103 18,146
Forgiveness of debt by parent........................ 4,565 4,565
Capital contribution................................. 1,986 1,986
Other, net........................................... (768) (768)
------ --------- ---------- ---------- -------- ----------
Balance, December 31, 1995........................... 100 23,594 (423,424) 9,935 (389,895)
Distributions paid to parent......................... (3,621) (3,621)
Net loss............................................. (72,219) (72,219)
Unrealized holding loss on investment in New Valley.. (33,936) (33,936)
Effect of New Valley capital transactions............ 1,782 1,099 2,881
Forgiveness of debt by parent........................ 13,705 13,705
------ --------- ------ ---------- --------- --------
Balance, December 31, 1996........................... 100 $ $39,081 $(499,264) $(22,902) $(483,085)
====== ========= ======= ========= ======== =========
The accompanying notes are an integral part
of the consolidated financial statements
F-10
60
BROOKE GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands, Except Per Share Amounts)
----------------------------------------------------
Year Ended December 31,
----------------------------------------------------
1996 1995 1994
----------------------------------------------------
Cash flows from operating activities:
Net (loss) income......................................... $(62,533) $(33,925) $110,095
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization......................... 8,819 9,076 6,821
Noncash compensation expense.......................... 252 559 8,463
Deferred income taxes................................. 1,061 (24,487)
Gain on sale of assets................................ (6,716) (1,042) (11,925)
Extraordinary item.................................... 9,810
Impact of discontinued operations..................... (2,385) (21,229) (117,275)
Other, net............................................ 7,211 4,167 6,265
Changes in assets and liabilities, net:
Receivables........................................... 6,222 6,561 (4,002)
Inventories........................................... 6,830 (7,490) (9,574)
Accounts payable and accrued liabilities.............. 27,716 (5,445) (8,576)
Other assets and liabilities, net..................... 9,818 15,972 135
----- ------ --------
Net cash used in operating activities....................... (3,705) (22,986) (44,060)
------ ------ ------
Cash flows from investing activities:
Proceeds from sale of business and assets................. 8,040 14,152 29,542
Impact of discontinued operations......................... (4,555)
Investments............................................... (2,811) (1,965)
Capital expenditures...................................... (34,241) (8,805) (3,023)
Dividends from New Valley................................. 24,733 61,832
Other, net................................................ 1,660 1,897
------- ------- -------
Net cash (used in) provided by investing activities......... (4,279) 66,874 23,861
------- ------ ------
The accompanying notes are an integral part
of the consolidated financial statements
F-11
61
BROOKE GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(Dollars in Thousands, Except Per Share Amounts)
--------------------------------------------
Year Ended December 31,
--------------------------------------------
1996 1995 1994
--------------------------------------------
Cash flows from financing activities:
Proceeds from debt.............................................. 20,702 2,568 9,261
Repayments of debt.............................................. (8,864) (37,196) (2,027)
Borrowings under revolver....................................... 353,365 397,873 369,806
Repayments on revolver.......................................... (350,105) (401,703) (366,544)
(Decrease) increase in cash overdraft........................... (4,256) (594) (12,669)
Series G preferred dividend..................................... (75) (5,923)
Distributions on common stock................................... (4,162) (5,475)
CVR settlement.................................................. 1,875
Treasury stock purchases........................................ (135) (21)
Deferred financing costs........................................ (2,705)
Stockholder loan and interest repayments........................ 17,774
Impact of discontinued operations............................... (437)
Other, net...................................................... (57) 375
------ ------- -------
Net cash provided by (used in) financing activities............... 6,680 (44,794) 8,765
------ ------- -----
Effect of exchange rate changes on cash and cash equivalents...... (125) (63)
------ ------- --------
Net decrease in cash and cash equivalents......................... (1,429) (906) (11,497)
Cash and cash equivalents, beginning of period.................... 3,370 4,276 15,773
------- ------- --------
Cash and cash equivalents, end of period.......................... $ 1,941 $ 3,370 $ 4,276
======= ======= ========
The accompanying notes are an integral part
of the consolidated financial statements
F-12
62
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands, Except Per Share Amounts)
--------------------------------------------
Year Ended December 31,
--------------------------------------------
1996 1995 1994
--------------------------------------------
Cash flows from operating activities:
Net (loss) income................................................... $(72,219) $(39,083) $106,239
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization................................... 8,677 8,946 6,807
Noncash compensation expense.................................... 8,268
Gain on sale of assets.......................................... (6,716)
Deferred income taxes........................................... 4,861 (26,334)
Extraordinary item.............................................. 9,810
Impact of discontinued operations............................... (2,385) (21,229) (128,998)
Other, net...................................................... 7,211 (558) 6,014
Changes in assets and liabilities:
Receivables..................................................... 5,863 7,261 (5,768)
Inventories..................................................... 6,830 (7,489) (9,573)
Accounts payable and accrued liabilities........................ 34,461 1,001 9,518
Other assets and liabilities, net............................... 9,712 16,970 (1,970)
----- ------ -----
Net cash used in operating activities................................... (3,705) (24,371) (35,797)
------ ------ ------
Cash flows from investing activities:
Proceeds from sale of business and assets........................... 8,040 13,852 29,317
Impact of discontinued operations................................... (4,408)
Investments......................................................... (2,811) (2,765)
Capital expenditures................................................ (34,241) (8,569) (2,652)
Dividends from New Valley........................................... 24,733 61,832
Other, net.......................................................... 1,660 1,897
------ ------ ------
Net cash (used in) provided by investing activities..................... (4,279) 66,010 24,154
------ ------ ------
The accompanying notes are an integral part
of the consolidated financial statements
F-13
63
BGLS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(Dollars in Thousands, Except Per Share Amounts)
-----------------------------------------
Year Ended December 31,
-----------------------------------------
1996 1995 1994
-----------------------------------------
Cash flows from financing activities:
Proceeds from debt................................................... 19,060 2,568 8,261
Repayments of debt................................................... (8,265) (37,166) (1,790)
Borrowings under revolver............................................ 353,365 397,873 369,806
Repayments on revolver............................................... (350,105) (401,703) (366,544)
(Decrease) increase in cash overdraft................................ (3,755) (215) 1,331
Deferred financing costs............................................. (2,705)
Distributions paid to parent......................................... (3,621) (5,871) (6,012)
Repayment to parent.................................................. (16,357)
Repayment from parent................................................ 12,500
Stockholder loan and interest repayments............................. 1,911
Impact of discontinued operations.................................... (437)
Other, net........................................................... 1,986 375
------- ------- --------
Net cash provided by (used in) financing activities.................... 6,679 (42,528) 339
------- ------ --------
Effect of exchange rate changes on cash and cash equivalents........... (125) (63)
-------- -------- --------
Net decrease in cash and cash equivalents.............................. (1,430) (889) (11,367)
Cash and cash equivalents, beginning of period......................... 3,370 4,259 15,626
------- ------ --------
Cash and cash equivalents, end of period............................... $ 1,940 $ 3,370 $ 4,259
======== ======== ========
The accompanying notes are an integral part
of the consolidated financial statements
F-14
64
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation:
The consolidated financial statements of Brooke Group Ltd. (the
"Company") include the consolidated statements of its wholly-owned
subsidiary, BGLS Inc. ("BGLS"). The consolidated statements of BGLS
include the accounts of Liggett Group Inc. ("Liggett"), Brooke
(Overseas) Ltd. ("BOL"), New Valley Holdings, Inc. ("NV Holdings") and
other less significant subsidiaries. Based on the Company's ability to
assert sufficient control, the Company consolidated the accounts of
Liggett-Ducat Ltd. ("Liggett-Ducat") at December 31, 1995. (Refer to
Note 4.) Liggett is engaged primarily in the manufacture and sale of
cigarettes, principally in the United States. Liggett-Ducat is engaged
in the manufacture and sale of cigarettes in Russia. All significant
intercompany balances and transactions have been eliminated.
(b) Liquidity:
The Company believes it will have sufficient liquidity for 1997. This
is based on, among other things, forecasts of cash flow for the
principal operating companies which indicate that they will be
self-sufficient, the sale of BrookeMil Ltd. ("BML"), a subsidiary of
BOL, to an affiliate, New Valley Corporation ("New Valley"), on
January 31, 1997, and certain funds available from New Valley subject
to limitations imposed by BGLS' indenture agreements. Liggett had net
capital and working capital deficiencies of $176,478 and $40,694,
respectively, at December 31, 1996, is highly leveraged and has
substantial near-term debt service requirements. These matters raise
substantial doubt about Liggett meeting its liquidity needs and its
ability to continue as a going concern. (Refer to Notes 2, 4 and 9.)
(c) Estimates and Assumptions:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities and the
reported amounts of revenues and expenses. Significant estimates
subject to material changes in the near term include deferred tax
assets, allowance for doubtful accounts, sales return and allowances,
actuarial assumptions of pension plans and litigation and defense
costs. Actual results could differ from those estimates.
(d) Cash and Cash Equivalents:
For purposes of the statements of cash flows, cash includes cash on
hand, cash on deposit in banks and cash equivalents, comprised of
short-term investments which have an original maturity of 90 days or
less. Interest on short-term investments is recognized when earned.
(e) Financial Instruments:
The estimated fair value of the Company's long-term debt is as
follows:
At December 31, 1996 1995
--------------------- ---------------------------------- ----------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ----- -------- -----
Long-term debt $433,485 $294,451 $409,131 $343,517
F-15
65
SHORT-TERM DEBT - The carrying amounts reported in the Consolidated
Balance Sheets approximate fair value because of the variable interest
rates and the short maturity of these instruments.
LONG-TERM DEBT - Fair value is estimated based on current market
quotations, where available or based on an evaluation of the debt in
relation to market prices of the Company's publicly traded debt.
The methods and assumptions used by the Company's management in
estimating fair values for financial instruments as required by
Statement of Financial Accounting Standards ("SFAS") No. 107,
"Disclosures About Fair Value of Financial Instruments," presented
herein are not necessarily indicative of the amounts the Company could
realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect
on the estimated fair values.
(f) Significant Concentrations of Credit Risk:
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash
equivalents and trade receivables. The Company places its temporary
cash in money market securities (investment grade or better) with what
management believes are high credit quality financial institutions.
Liggett's customers are primarily candy and tobacco distributors, the
military and large grocery, drug and convenience store chains. One
customer accounted for approximately 13.7% of net sales for the year
ended December 31, 1996 and 11.6% of net sales for the year ended
December 31, 1995, the majority of which were in the private label
discount segment. No single customer accounted for more than 10% of
the Company's net sales in 1994. Concentrations of credit risk with
respect to trade receivables are limited due to the large number of
customers, located primarily throughout the United States, comprising
Liggett's customer base. Ongoing credit evaluations of customers'
financial condition are performed and, generally, no collateral is
required. Liggett maintains reserves for potential credit losses and
such losses, in the aggregate, have generally not exceeded
management's expectations.
(g) Accounts Receivable:
The allowance for doubtful accounts and cash discounts was $1,280 and
$1,536 at December 31, 1996 and 1995, respectively.
(h) Inventories:
Liggett tobacco inventories, which comprise 93.4% and 83.3% of total
inventory in 1996 and 1995, respectively, are stated at the lower of
cost or market and are determined primarily by the last-in, first-out
(LIFO) method. Although portions of leaf tobacco inventories may not
be used or sold within one year because of the time required for
aging, they are included in current assets, which is common practice
in the industry. It is not practicable to determine the amount that
will not be used or sold within one year.
Remaining inventories are determined primarily on a first-in,
first-out (FIFO) basis.
F-16
66
(i) Property, Plant and Equipment:
Property, plant and equipment are depreciated using the straight-line
method over the estimated useful lives of the respective assets, which
are 20 years for buildings and 3 to 10 years for machinery and
equipment.
Interest costs are capitalized in connection with the construction of
major facilities. Capitalized interest is recorded as part of the
asset to which it relates and is amortized over the asset's estimated
useful life. In 1996 and 1995, interest costs of $6,387 and $1,004,
respectively, were capitalized. No interest was capitalized in 1994.
Expenditures for repairs and maintenance are charged to expense as
incurred. The costs of major renewals and betterments are capitalized.
The cost and related accumulated depreciation of property, plant and
equipment are removed from the accounts upon retirement or other
disposition and any resulting gain or loss is reflected in operations.
(j) Intangible Assets:
Intangible assets, consisting principally of trademarks and goodwill,
are amortized using the straight-line method over 10-12 years.
Amortization expense for the years ended December 31, 1996, 1995 and
1994 was $1,778, $1,725 and $1,722, respectively. Management
periodically reviews the carrying value of such assets to determine
whether asset values are impaired.
(k) Other Assets:
Other assets consist primarily of debt issuance costs. Such costs are
being amortized over the life of the debt.
(l) Impairment of Long-Lived Assets:
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of". The
Statement establishes accounting standards for the impairment of
long-lived assets, certain identifiable intangibles, and goodwill
related to those assets. There was no material effect on the financial
position or results of operations from the adoption because the
Company's prior impairment recognition practice was consistent with
the major provisions of the Statement. Under provisions of the
Statement, impairment losses are recognized when expected future cash
flows are less than the assets' carrying value. Accordingly, when
indicators of impairment are present, the Company evaluates the
carrying value of property, plant and equipment and intangibles in
relation to the operating performance and estimates of future
discounted cash flows of the underlying business.
(m) Employee Benefits:
Liggett sponsors self-insured health and dental insurance plans for
all eligible employees. As a result, the expense recorded for such
benefits involves an estimate of unpaid claims as of December 31, 1996
and 1995 which are subject to significant fluctuations in the near
term.
F-17
67
(n) Postretirement Benefits other than Pensions:
Under SFAS No. 106, "Employers' Accounting for Postretirement Benefits
Other Than Pensions", the cost of providing retiree health care and
life insurance benefits is actuarially determined and accrued over the
service period of the active employee group.
(o) Postemployment Benefits:
SFAS No. 112, "Employers' Accounting for Postemployment Benefits",
establishes standards of financial accounting and reporting for the
estimated cost of benefits provided by an employer to former or
inactive employees after employment but before retirement. No expense
was associated with the adoption since the Company's previous policies
accounted for all items required by SFAS No. 112.
(p) Stock Options:
Effective January 1, 1996, SFAS No. 123, "Accounting for Stock-Based
Compensation", was adopted by the Company as required for its fiscal
1996 financial statements. The Company has elected to continue to
measure compensation expense for stock-based employee compensation
plans using the intrinsic value method prescribed by APB Opinion No.
25, "Accounting for Stock Issued to Employees," and will provide pro
forma disclosures of net income as if the fair value-based method
prescribed by SFAS No. 123 had been applied in measuring compensation
expense.
(q) Income Taxes:
Under SFAS No. 109, "Accounting for Income Taxes", deferred taxes
reflect the impact of temporary differences between the amounts of
assets and liabilities recognized for financial reporting purposes and
the amounts recognized for tax purposes as well as tax credit
carryforwards and loss carryforwards. These deferred taxes are
measured by applying currently enacted tax rates. A valuation
allowance reduces deferred tax assets when it is deemed more likely
than not that some portion or all of the deferred tax assets will not
be realized.
(r) Revenue Recognition:
Revenues from sales are recognized upon the shipment of finished goods
to customers. The Company provides an allowance for expected sales
returns, net of related inventory cost recoveries. Since the Company's
primary line of business is tobacco, the Company's financial position
and its results of operations and cash flows could be materially
adversely affected by significant unit sales volume declines,
litigation and defense costs, increased tobacco costs or reductions in
the selling price of cigarettes in the near term.
(s) Earnings Per Share:
Per share calculations are based on the weighted average shares of
common stock outstanding and dilutive common stock equivalents. For
the years ended December 31, 1996 and 1995, per share calculations
include the Company's proportionate share of excess carrying value of
New Valley redeemable preferred shares over the cost of shares
repurchased of $1,782 and $16,802, respectively.
F-18
68
New Accounting Pronouncement. In February 1997, the Financial
Accounting Standards Board issued SFAS No. 128, "Earnings Per Share".
SFAS No. 128 specifies new standards designed to improve the earnings
per share ("EPS") information provided in financial statements by
simplifying the existing computational guidelines, revising the
disclosure requirements and increasing the comparability of EPS data
on an international basis. Some of the changes made to simplify the
EPS computations include: (a) eliminating the presentation of primary
EPS and replacing it with basic EPS, with the principal difference
being that common stock equivalents are not considered in computing
basic EPS, (b) eliminating the modified treasury stock method and the
three percent materiality provision and (c) revising the contingent
share provisions and the supplemental EPS data requirements. SFAS No.
128 also makes a number of changes to existing disclosure
requirements. SFAS No. 128 is effective for financial statements
issued for periods ending after December 15, 1997, including interim
periods. The Company has not yet determined the impact of the
implementation of SFAS No. 128.
(t) Foreign Currency Translation:
The Company accounts for translation of foreign currency in accordance
with SFAS No. 52, "Foreign Currency Translation." The Company's
Russian subsidiary operates in a "highly inflationary" economy and
uses the U.S. dollar as the functional currency. Therefore, certain
assets of this entity (principally inventories and property and
equipment) are translated at historical exchange rates with all other
assets and liabilities translated at year end exchange rates and all
translation adjustments are reflected in the consolidated statements
of operations.
(u) Reclassifications:
Certain amounts in prior years' financial statements have been
reclassified to conform to the current year's presentation.
2. INVESTMENT IN NEW VALLEY CORPORATION
The Company's and BGLS' investment in New Valley at December 31, 1996
and 1995, respectively, is summarized below:
Number of Fair Carrying Unrealized
Shares Value Amount Holding Gain (Loss)
--------- ----- -------- -------------------
1996
----
Class A Preferred Shares....... 618,326 $ 72,962 $ 72,962 $(24,881)
Class B Preferred Shares....... 250,885 1,631 1,631 (223)
Common Shares.................. 3,989,710(A) 5,985 (71,542)
-------- -------- --------
$ 80,578 $ 3,051 $(25,104)
======== ======== ========
1995
----
Class A Preferred Shares....... 618,326 $109,386 $109,386 $ 7,424
Class B Preferred Shares....... 250,885 3,262 3,262 1,408
Common Shares.................. 79,794,229 21,544 (48,747)
-------- -------- --------
$134,192 $ 63,901 $ 8,832
======== ======== ========
---------
(A) Gives effect to July 1996 one-for-twenty stock split.
The $15.00 Class A Increasing Rate Cumulative Senior Preferred Shares
($100 Liquidation Value), $.01 par value (the "Class A Preferred
Shares") and the $3.00 Class B Cumulative Convertible Preferred Shares
($25 Liquidation Value), $.10 par value (the "Class B Preferred
Shares") are accounted for as debt and equity securities,
respectively, pursuant to the requirements of SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities,"
and are classified as available-for-sale. Prior to January 1, 1996,
the Class A Preferred Shares' fair value had been estimated with
reference to the securities' preference features, including dividend
and liquidation
F-19
69
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
preferences, and the composition and nature of the underlying net
assets of New Valley. During 1996, however, New Valley became engaged
in the ownership and management of commercial real estate and acquired
a controlling interest in Thinking Machines Corporation ("Thinking
Machines"). Because these businesses affected the composition and
nature of the underlying net assets of New Valley, the Company
determined the fair value of the Class A and Class B Preferred Shares
based on the quoted market price commencing with the quarter ended
March 31, 1996. Through September 1996 earnings on the Class A
Preferred Shares were comprised of dividends accrued during the period
and the accretion of the difference between the Company's basis and
their mandatory redemption price. New Valley's Common Shares, $.01 par
value (the "Common Shares") were accounted for pursuant to APB No. 18,
"The Equity Method of Accounting for Investments in Common Stock."
During the quarter ended September 30, 1996, the decline in the market
value of the Class A Preferred Shares, the dividend received on the
Class A Preferred Shares and the Company's equity in losses incurred
by New Valley caused the carrying value of the Company's investment in
New Valley to be reduced to zero. Beginning in the fourth quarter of
1996, the Company suspended the recording of its earnings on the
dividends accrued and the accretion of the difference between the
Company's basis in the Class A Preferred Shares and their mandatory
redemption price.
In November 1994, New Valley's First Amended Joint Chapter 11 Plan of
Reorganization, as amended ("Joint Plan"), was confirmed by order of
the United States Bankruptcy Court for the District of New Jersey and
on January 18, 1995, New Valley emerged from bankruptcy reorganization
proceedings and completed substantially all distributions to creditors
under the Joint Plan. Pursuant to the Joint Plan, among other things,
the Class A Preferred Shares, the Class B Preferred Shares and the
Common Shares, and other equity interests, were reinstated and
retained all of their legal, equitable and contractual rights.
At December 31, 1996 and 1995, the Company's investment in New Valley
consisted of an approximate 42% voting interest. The Company's
investment in 1996 and 1995 was represented by 618,326 Class A
Preferred Shares, 3,989,710 Common Shares (41.7%) (giving effect to a
one-for-twenty reverse stock split by New Valley in July 1996) and
250,885 Class B Preferred Shares (9.0%). At December 31, 1996, the
Company owns 57.7% of the outstanding Class A Preferred Shares.
In February 1995, New Valley repurchased 54,445 Class A Preferred
Shares pursuant to a tender offer made as part of the Joint Plan.
During 1995, New Valley repurchased 339,400 additional Class A
Preferred Shares on the open market at an aggregate cost of $43,405.
During 1996, New Valley repurchased 72,104 Class A Preferred Shares
for a total amount of $10,530. The Company has recorded its
proportionate interest in the excess of the carrying value of the
shares over the cost of the shares repurchased as a credit to
additional paid-in capital in the amount of $1,782 and $16,802, along
with other New Valley capital transactions of $0 and $241, for the
years ended December 31, 1996 and December 31, 1995, respectively.
The Class A Preferred Shares of New Valley are required to be redeemed
on January 1, 2003 for $100.00 per share plus dividends accrued to the
redemption date. The shares are redeemable, at any time, at the option
of New Valley, at $100.00 per share plus accrued dividends. The
holders of Class A Preferred Shares are entitled to receive a
quarterly dividend, as declared by the Board of Directors, payable at
the rate of $19.00 per annum. At December 31, 1996 and 1995,
respectively, the accrued and unpaid dividends arrearage was $117,117
($109.31 per share) and $121,893 ($110.06 per share). The Company
received $24,733 ($40.00 per share) and $61,832 ($100.00 per share) in
dividend distributions in 1996 and 1995, respectively.
F-20
70
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
Holders of the Class B Preferred Shares are entitled to receive a quarterly
dividend, as declared by the Board, at a rate of $3.00 per annum. At
December 31, 1996 and 1995, respectively, the accrued and unpaid dividends
arrearage was $115,944 ($41.55 per share) and $95,118 ($34.08 per share).
No dividends on the Class B Preferred Shares have been declared since the
fourth quarter of 1988.
Summarized financial information for New Valley follows:
1996 1995 1994
---- ---- ----
Current assets, primarily cash and marketable
securities........................................... $183,720 $333,485
Noncurrent assets....................................... 222,820 52,337
Current liabilities..................................... 98,110 177,920
Noncurrent liabilities.................................. 170,223 11,967
Redeemable preferred stock.............................. 210,571 226,396
Shareholders' equity (deficit).......................... (72,364) (30,461)
Revenues ............................................. 111,954 67,730 $ 10,381
Costs and expenses...................................... 128,209 66,064 26,146
(Loss) income from continuing operations................ (13,216) 1,374 (15,265)
Income from discontinued operations..................... 5,726 16,873 1,135,706(A)
Extraordinary items..................................... (110,500)
Net (loss) income applicable to Common Shares(C)........ (65,160) (13,714) 929,904
Company's share of discontinued operations.............. 2,385 7,031 139,935(B)
Company's share of extraordinary item................... (46,487)(B)
------------------
(A) Includes gain on sale of New Valley's money transfer business of $1,056,081, net of income taxes of $52,000.
(B) The Company's share of the extraordinary item ($46,487) was related to extinguishment of debt in 1994.
The Company's share of income from discontinued operations in 1994 was determined after accounting for losses
not recognized in prior years as follows:
42.1% of income from discontinued operations................. $ 477,791
Losses not recognized in prior periods....................... (337,856)
Company's share of equity in discontinued ---------
operations of New Valley.................................... $ 139,935
=========
(C) Considers all preferred accrued dividends, whether or not declared and, in 1995 and 1996, the excess of carrying
value of redeemable preferred shares over cost of shares purchased.
On January 31, 1997, New Valley acquired substantially all the common
shares of BML from BOL for $55,000. (Refer to Note 4.)
3. RJR NABISCO HOLDINGS CORP.
On October 17, 1995, New Valley and its subsidiary, ALKI Corp. ("ALKI"),
entered into an agreement, as amended (the "New Valley Agreement"), with
High River Limited Partnership ("High River"), an entity owned by Carl C.
Icahn. Pursuant to the New Valley Agreement, New Valley sold approximately
1,600,000 shares of common stock of RJR Nabisco Holdings Corp. ("RJR
Nabisco") to
F-21
71
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
High River for an aggregate purchase price of $51,000. The New
Valley Agreement also provided for the parties to pay certain other fees to
each other under certain circumstances, including a payment to High River
equal to 20% of New Valley's profit on its RJR Nabisco common stock, after
certain expenses as defined in the New Valley Agreement.
On October 17, 1995, the Company and BGLS entered into a separate
agreement, as amended (the "High River Agreement"), with High River.
Pursuant to each of these agreements, the parties agreed to take certain
actions designed to cause RJR Nabisco to effectuate a spinoff of its food
business, Nabisco Holdings Corp. ("Nabisco"), at the earliest possible
date. Among other things, the Company agreed to solicit the holders of RJR
Nabisco common stock to adopt the Spinoff Resolution, which was an advisory
resolution to the Board of Directors of RJR Nabisco seeking a spinoff of
the 80.5% of Nabisco held by RJR Nabisco to stockholders. The High River
Agreement also provided that BGLS pay certain other fees to High River
under certain circumstances.
As of June 5, 1996, High River, the Company and BGLS terminated the High
River Agreement and New Valley, ALKI and High River terminated the New
Valley Agreement by mutual consent. The terminations leave in effect for
one year certain provisions of both the High River and New Valley
Agreements concerning payments to be made to High River in the event New
Valley achieves a profit (after deducting certain expenses) on the sale of
the shares of RJR Nabisco common stock which are held by it or they are
valued at the end of such year at higher than their purchase price or in
the event the Company or its affiliates engage in certain transactions with
RJR Nabisco.
On December 27, 1995, New Valley entered into an agreement with the Company
pursuant to which New Valley agreed to pay directly or reimburse the
Company and its subsidiaries for reasonable out-of-pocket expenses incurred
in connection with the Company's solicitation of consents and proxies from
the stockholders of RJR Nabisco. New Valley has also agreed to pay to BGLS
a fee of 20% of the net profit received by New Valley or its subsidiaries
from the sale of shares of RJR Nabisco common stock after New Valley and
its subsidiaries have achieved a rate of return of 20% and after deduction
of certain expenses incurred by New Valley and its subsidiaries, including
the costs of the consent and proxy solicitations and of acquiring the
shares of common stock. New Valley has also agreed to indemnify the Company
and its affiliates against certain liabilities arising out of the
solicitations. During 1996, New Valley has reimbursed the Company and its
subsidiaries $2,370 pursuant to this agreement.
On December 28, 1995, New Valley, the Company and Liggett engaged Jefferies
& Company, Inc. ("Jefferies") to act as financial advisor in connection
with New Valley's investment in RJR Nabisco and the Company's solicitation
of consents and proxies. In connection with this engagement, New Valley
paid Jefferies $1,500 in 1995 and $1,538 in 1996. These companies also have
agreed to pay Jefferies 10% of the net profit (up to a maximum of $15,000)
with respect to RJR Nabisco common stock (including any distributions made
by RJR Nabisco) held or sold by these companies and their affiliates after
deduction of certain expenses, including the costs of the solicitations and
the costs of acquiring the shares of the common stock.
On December 29, 1995, the Company commenced solicitation of consents from
stockholders of RJR Nabisco seeking, among other things, the approval of
the Spinoff Resolution. In March 1996, the Company was informed that the
Spinoff Resolution was approved by the holders of a majority of RJR Nabisco
common stock.
On February 29, 1996, New Valley entered into a total return equity swap
transaction (the "Swap") with an unaffiliated company relating to 1,000,000
shares of RJR Nabisco common stock. During the
F-22
72
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
third quarter of 1996, the Swap was terminated. New Valley recognized a
loss on the Swap of $7,305 for the year ended December 31, 1996.
On March 4, 1996, the Company commenced solicitation of proxies in favor of
its previously nominated slate of directors to replace RJR Nabisco's
incumbent Board of Directors at its 1996 annual meeting of stockholders. On
April 16, 1996, the Company announced that, based on the analysis of its
proxy solicitors, its nominees for election to the RJR Nabisco Board of
Directors would not be elected at RJR Nabisco's 1996 annual meeting of
stockholders. On November 5, 1996, the Company submitted to RJR Nabisco, in
order to comply with the requirements of RJR Nabisco's by-laws, a notice of
intent to nominate a slate of directors for election at the RJR Nabisco
1997 annual meeting of stockholders.
As of December 31, 1996, New Valley held approximately 1,700,000 shares of
RJR Nabisco common stock with a market value of $59,200 (cost of
approximately $53,400). As of March 14, 1997, New Valley held approximately
1,063,000 shares of RJR Nabisco common stock with a market value of $35,997
(cost of $32,574). During 1996 and 1995, New Valley expensed $11,724 and
$3,879, respectively, for costs relating to its RJR Nabisco investment.
Based on the market price of RJR Nabisco common stock at March 14, 1997, no
amounts are payable by the Company or New Valley under any of its net
profit-sharing arrangements with respect to the RJR Nabisco common stock
discussed above.
4. INVESTMENT IN BROOKE (OVERSEAS) LTD.
Prior to December 29, 1995, the Company did not consolidate Liggett-Ducat,
a Russian joint stock company, due to certain events continuing through
1995 which impaired the Company's ability to control the operations of
Liggett-Ducat. The amount invested in Russian ventures of $5,723 in 1994
was expensed, based on the determination that there was significant
uncertainty as to the recoverability of these amounts. The Company
reexamined the issue of consolidating Liggett-Ducat and at December 29,
1995 determined that a series of events in the latter part of 1995 (see
below) enabled the Company to exert sufficient control so that the
recoverability of its investment appeared reasonable.
During 1995, the Company increased its investment in Liggett-Ducat from
approximately 58% to 68% through a direct purchase of stock from other
shareholders. The Company recorded goodwill in the amount of $435 which is
being amortized over a ten-year period.
In October 1995, Liggett-Ducat entered into a loan agreement with
Vneshtorgbank, Moscow, Russia, pursuant to which Liggett-Ducat borrowed
$20,400 to fund real estate development. Interest on the note is based on
the London Interbank Offered Rate ("LIBOR") plus 10%. Principal repayments
are due from April through October of 1997. At December 31, 1996,
approximately $20,418 had been drawn down under the loan.
Also in October 1995, BML purchased certain buildings, which it had
previously leased from the Moscow Property Committee, for $4,369 excluding
related transaction costs. BML has developed, or is in the process of
developing, these buildings for commercial use.
On December 29, 1995, Liggett-Ducat relinquished its 59.4% ownership in a
joint real estate venture in exchange for 100% ownership of a partially
constructed manufacturing facility owned by the venture on the outskirts of
Moscow where Liggett-Ducat plans to build a new cigarette factory. In
connection with this exchange, a 49-year land lease was renegotiated in
1996 for the site on which
F-23
73
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
the factory is to be built. Liggett-Ducat's cost basis in the joint real
estate venture of $2,675 was transferred to its basis in the new
manufacturing facility.
The additional amounts included in the financial statements as a result of
consolidating Liggett-Ducat at December 31, 1995 are as follows:
Current assets.................... $12,321
Total assets...................... 35,359
Current liabilities............... 10,602
Total liabilities................. 20,924
Stockholders' equity.............. 14,435
Revenues during 1995 from the date of consolidation (December 29, 1995) are
not material.
During the second quarter of 1996, the Company entered into stock purchase
agreements with the chairman of Liggett-Ducat and the former Director of
Liggett-Ducat's tobacco operations (the "Sellers"). Under the stock
purchase agreements, the Company acquired 142,558 shares held by the
Sellers for $2,143. The purchase price was payable in installments during
1996 and certain shares of Liggett-Ducat collateralize the Company's
obligation under both the purchase agreements and the consulting agreements
(described below).
Concurrently, the Company entered into consulting and non-compete
agreements with the Sellers. Under the terms of these agreements, the
Company will pay the Sellers a total of approximately $8,357 over five
years.
In December 1996, the Company purchased 46,337 additional shares of
Liggett-Ducat stock from other shareholders for $695. At December 31, 1996,
the Company's subsidiaries owned 95% of the stock of Liggett-Ducat.
In 1996, Russian tax authorities assessed Liggett-Ducat $7,600 for
outstanding tax liabilities, which amount was accrued in 1996. The
liability is payable in two parts, 50% within 2 1/2 years, the remaining
50% over the succeeding five years.
The performance of Liggett-Ducat's cigarette operations in Russia is
affected by uncertainties in Russia which may include, among others,
political or diplomatic developments, regional tensions, currency
repatriation restrictions, foreign exchange fluctuations, inflation, and an
undeveloped system of commercial laws and legislative reform relating to
foreign ownership in Russia.
F-24
74
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
SUBSEQUENT EVENT:
Sale of BrookeMil:
On January 31, 1997, BOL sold all its shares of BML to New Valley for
$21,500 in cash and a promissory note of $33,500 payable $21,500 on June
30, 1997 and $12,000 on December 31, 1997 with interest at 9%. The
consideration received exceeded the carrying value of its investment in BML
by $43,700. The Company expects to recognize a gain on the sale in 1997 in
the amount of $21,300. The remaining $22,400 will be deferred in
recognition of the fact that the Company retains an interest in BML through
its 42% equity ownership in New Valley and that a portion of the property
sold is subject to a put option held by New Valley. The option allows New
Valley under certain circumstances, to put a portion of the property sold
back to the Company at the greater of the appraised fair value of the
property at the date of exercise or $13,600.
In connection with the sale of its BML shares to New Valley, certain
specified liabilities aggregating $40,800, including the Vneshtorgbank loan
with a balance of $20,419, remained with BML, and New Valley indemnified
the Company and its subsidiaries with respect to such liabilities.
On or about March 13, 1997, a shareholder derivative suit was filed against
New Valley, as a nominal defendant, its directors and the Company in the
Delaware Chancery Court, by a shareholder of New Valley. The suit alleges
that New Valley's purchase of the BML Shares constituted a self-dealing
transaction which involved the payment of excessive consideration by New
Valley. The plaintiff seeks (i) a declaration that New Valley's directors
breached their fiduciary duties, the Company aided and abetted such
breaches and such parties are therefore liable to New Valley, and (ii)
unspecified damages to be awarded to New Valley. The Company's time to
respond to the complaint has not yet expired. The Company believes that the
allegations are without merit, and it intends to defend the suit
vigorously.
5. DISCONTINUED OPERATIONS
A summary of discontinued operations follows:
Year Ended December 31,
1996 1995 1994
----------------- ---------------- -----------------
(Loss) income from discontinued operations:
New Valley........................................ $(1,591) $ 1,800
MAI............................................... 698 $ 3,628
SkyBox............................................ 362 20,065
------- ------ --------
(1,591) 2,860 23,693
------- ------ --------
Gain from disposal of operations:
New Valley........................................ 3,976 5,231 139,935
SkyBox............................................ 13,138 11,055
------- ------ --------
3,976 18,369 150,990
------- ------ --------
Income from discontinued operations................... $ 2,385 $21,229 $174,683
======= ======= ========
F-25
75
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
Net revenues of MAI Systems Corporation ("MAI") for the period January 1,
1995 to February 6, 1995 were $6,652 and for the year ended December 31,
1994 was $66,095.
New Valley:
During the fourth quarter of 1994, New Valley sold or was in the process of
selling virtually all of its current operations. In connection with the
implementation of the provisions of the Joint Plan, New Valley completed
the sale of Western Union Financial Services Inc. and certain other assets
to First Financial Management Corporation ("FFMC"). Accordingly, the
financial statements of the Company reflect its portion of the gain
($139,935) in gain on disposal of discontinued operations in 1994.
On October 31, 1995, New Valley sold substantially all the assets of its
wholly-owned subsidiary, Western Union Data Services Company, Inc. (the
"Messaging Service Business"), and conveyed substantially all of the
liabilities of the Messaging Service Business to FFMC for $17,540 in cash
and $2,460 in cancellation of intercompany indebtedness. The financial
statements of the Company reflect its portion of the gain ($5,231) in gain
on disposal of discontinued operations in 1995.
In October 1996, Thinking Machines adopted a plan to terminate its parallel
processing computer sales and service business. Consequently, the operating
results of this segment, including the write-down of certain assets,
principally inventory, to their net realizable value by $6,100 have been
classified as discontinued operations. The financial statements of the
Company reflect its portion of the loss from operations ($1,591) and the
gain on disposal ($3,976) in discontinued operations.
MAI:
On February 1, 1994, the Company renegotiated a December 21, 1992 agreement
with an unrelated third party which enabled the Company to purchase
additional MAI equity for $3,565 in the reorganized entity which had
emerged from bankruptcy on November 18, 1993. When combined with the
interest originally received in the MAI reorganization, total common
ownership held by the Company at December 31, 1994 was approximately 65.2%.
In addition, in connection with a transaction wherein MAI's United States
and Canadian bank lenders took title to the stock of MAI's European
subsidiaries in satisfaction of a total of approximately $84,000 of
indebtedness owed by MAI to such bank lenders, the Company may be required,
under certain limited circumstances, to purchase an equity interest of up
to $7,500 in a holding company controlled by the bank lenders. The $7,500
is recorded as a liability.
On January 25, 1995, the Board of Directors of BGLS determined to declare a
dividend of the stock of MAI to the Company with the intention of the
Company distributing a special dividend of MAI common stock to its
stockholders (the "MAI Distribution"). Accordingly, the Company approved
the MAI Distribution of the 65.2% equity interest in MAI through a special
dividend to its stockholders of one share of MAI for every six shares of
the Company's common stock. The distribution occurred on February 13, 1995.
As a result, MAI has been treated as a discontinued operation in the
financial statements for all periods presented. The MAI Distribution
reduced the Company's stockholders' equity (deficit) by $27,085 in the
first quarter of 1995.
F-26
76
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
SkyBox:
During 1994 and the first quarter of 1995, the Company sold all of its
remaining common stock of its former subsidiary, SkyBox International Inc.
("SkyBox"), for approximately $20,000. In addition, during the same period
SkyBox redeemed the 220 shares of SkyBox Series A Preferred Stock which the
Company held for $22,000.
6. INVENTORIES
Inventories consist of:
December 31,
1996 1995
----------------- -----------------
Finished goods....................................... $15,304 $19,129
Work-in-process...................................... 4,435 3,570
Raw materials........................................ 34,002 29,021
Replacement parts and supplies....................... 4,406 4,903
------- -------
Inventories at current cost.......................... 58,147 56,623
LIFO adjustments..................................... (4,456) 3,899
------- -------
$53,691 $60,522
======= =======
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. At December 31, 1996, Liggett had leaf tobacco
purchase commitments of approximately $20,116.
7. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
December 31,
1996 1995
----------------- -----------------
Land and improvements................................ $ 455 $ 542
Buildings............................................ 14,205 13,661
Machinery and equipment.............................. 49,401 42,877
Leasehold improvements............................... 302 309
Construction-in-progress............................. 46,966 18,286
-------- --------
111,329 75,675
Less accumulated depreciation........................ (31,047) (27,323)
-------- --------
$ 80,282 $ 48,352
======== ========
The amounts provided for depreciation for the years ended December 31,
1996, 1995 and 1994 were $4,412, $4,699 and $4,609, respectively.
F-27
77
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
The amount of capitalized interest included in property, plant and
equipment is $6,387 and $1,004 in 1996 and 1995, respectively.
8. SALE OF ASSETS
On July 15, 1996, the Company sold substantially all of the non-cash assets
and certain liabilities of COM Products, Inc. ("COM"), a subsidiary engaged
in the business of selling micrographics equipment and supplies, for
approximately $3,700 cash and a promissory note for $500. The Company
recognized a gain of approximately $3,000 on this transaction.
On May 14, 1996, Liggett sold to the County of Durham certain surplus
realty for $4,300. The Company recognized a gain of approximately $3,600.
Subsequent Event:
On January 31, 1997, BOL sold BML to New Valley for $21,500 in cash and a
promissory note of $33,500 payable $21,500 on June 30, 1997 and $12,000 on
December 31, 1997. (Refer to Note 4.)
On March 11, 1997, Liggett sold to Blue Devil Ventures, a North Carolina
limited liability partnership, additional surplus realty for $2,200. A gain
of approximately $1,600 is expected to be recognized in 1997.
9. NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS
Notes payable, long-term debt and other obligations consist of:
December 31,
1996 1995
----------------- -----------------
15.75% Series B Senior Secured Notes due 2001,
net of unamortized discount of $1,511................. $231,353
13.75% Series 2 Senior Secured Notes due 1997............. $ 91,179
16.125% Senior Subordinated Reset Notes due 1997.......... 5,670
14.500% Subordinated Debentures due 1998.................. 800 126,295
Notes payable - Foreign................................... 22,668 11,122
Other..................................................... 2,425 2,084
Liggett:
11.500% Senior Secured Series B Notes due 1999, net of
unamortized discount of $0 and $424, respectively..... 119,688 119,485
Variable Rate Series C Senior Secured Notes due 1999...... 32,279 32,279
Revolving credit facility................................. 24,272 21,017
-------- --------
Total notes payable and long-term debt.................... 433,485 409,131
Less:
Current maturities.................................... 55,242 2,387
-------- --------
Amount due after one year................................. $378,243 $406,744
======== ========
F-28
78
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
OFFER TO EXCHANGE:
15.75% SERIES A SENIOR SECURED NOTES DUE 2001 FOR 13.75% SERIES 2
SENIOR SECURED NOTES DUE 1997, AND
15.75% SERIES B SENIOR SECURED NOTES DUE 2001 FOR 16.125% SENIOR
SUBORDINATED RESET NOTES DUE 1997 AND 14.500% SUBORDINATED DEBENTURES:
On November 27, 1995, BGLS commenced an offer to exchange a total of
$232,864 principal amount of 15.75% Senior Secured Notes due January 31,
2001, for all its outstanding Series 2 Notes, Reset Notes and Subordinated
Debentures. The exchange ratio was $1,087.47 principal amount of new 15.75%
Series A Senior Secured Notes ("Series A Notes") for each $1,000 principal
amount of Series 2 Notes exchanged, $1,132.28 principal amount of new
Series B Notes for each $1,000 principal amount of Reset Notes exchanged
and $1,000 principal amount of new Series B Notes for each $1,000 principal
amount of Subordinated Debentures exchanged. The new Series A Notes and the
new Series B Notes were identical except that the Series B Notes were not
subject to restrictions on transfer.
The exchange offer closed on January 30, 1996. All $91,179 of the Series 2
Notes and $125,495 of the Subordinated Debentures were exchanged. In
addition, BGLS cancelled all of the Subordinated Debentures ($13,705) held
by the Company. Subordinated Debentures in the amount of $800 remain
outstanding. As part of the exchange offer, substantially all of the
covenants and events of default were eliminated pertaining to the
Subordinated Debentures.
Holders of Reset Notes did not exchange, and the Reset Notes were redeemed
on March 29, 1996 for a total amount of $5,785, including premium, together
with accrued interest of $452. On March 7, 1996, an additional $7,397 face
amount of Series A Notes were sold for $6,300 including accrued interest
with the proceeds being used for the redemption of the Reset Notes.
Pursuant to a registered exchange offer, holders of the Series A Notes
exchanged all of the $107,373 outstanding principal amount for an equal
principal amount of Series B Notes. The exchange closed March 21, 1996. The
Company has cancelled all the Series A Notes.
The new Series B Notes are collateralized by substantially all of BGLS'
assets, including a pledge of BGLS' equity interests in Liggett, BOL and NV
Holdings as well as a pledge of all of the New Valley securities held by
BGLS and NV Holdings. The BGLS Series B Notes Indenture contains certain
covenants, which among other things, limit the ability of BGLS to make
distributions to the Company to $6,000 per year ($12,000 if less than 50%
of the Series B Notes remain outstanding), limit additional indebtedness of
BGLS to $10,000, limit guaranties of subsidiary indebtedness by BGLS to
$50,000, and restrict certain transactions with affiliates that exceed
$2,000 in any year subject to certain exceptions which include payments to
the Company not to exceed $6,500 per year for permitted operating expenses,
payment of the Chairman's salary and bonus and certain other expenses, fees
and payments. In addition, the Indenture contains certain restrictions on
the ability of the Chairman and certain of his affiliates to enter into
certain transactions with, and receive payments above specified levels
from, New Valley. The Series B Notes may be redeemed, in whole or in part,
through December 31, 1999 at a price of 101% of the principal amount and
thereafter at 100%. Interest is payable at the rate of 15.75% per annum on
January 31 and July 31 of each year, except for the period ended July 31,
1996 when interest was payable at 13.75% from October 1, 1995 to January
30, 1996 and at 15.75% from January 31, 1996 through July 31, 1996.
The Company recorded an extraordinary charge of approximately $9,700 for
the year ended December 31, 1995 relating to the exchanged debt securities
discussed above.
F-29
79
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
13.75% SERIES 1 SENIOR SECURED NOTES DUE 1995
13.75% SERIES 2 SENIOR SECURED NOTES DUE 1997:
An Exchange and Termination Agreement (the "1994 Exchange Agreement") was
entered into as of September 30, 1994 among the Company, BGLS and certain
holders ("Participating Holders") of the 16.125% Senior Subordinated Reset
Notes due 1997 ("Reset Notes") and the 14.500% Subordinated Debentures due
1998 ("Subordinated Debentures") pursuant to which certain prior agreements
among the parties were terminated. The Participating Holders had advanced
$13,702 to BGLS under the prior agreements. In related transactions with
the same Participating Holders, BGLS issued $23,594 of 13.75% Series 1
Senior Secured Notes due 1995 ("Series 1 Notes") to the same Participating
Holders in consideration of the transfer to BGLS of previously issued
Senior Secured Notes, on account of new loans by the same holders in
respect of certain interest payable and to cover certain expenses of the
Participating Holders. On June 12, 1995, BGLS redeemed all the Series 1
Notes in the amount of $23,594 plus accrued interest of $670.
Under the 1994 Exchange Agreement, on October 3, 1994 BGLS exchanged an
aggregate of $49,900 of new BGLS 13.75% Series 2 Senior Secured Notes due
1997 ("Series 2 Notes") for an equal principal amount of Reset Notes. In
connection with the 1995 Exchange Offer, all of the Series 2 Notes were
exchanged for Senior Secured Notes and no Series 2 Notes remain
outstanding. BGLS and the Company also agreed, subject to applicable
securities laws, to offer the other holders of the Reset Notes the
opportunity to exchange the Reset Notes for the Series 2 Notes. That offer
commenced October 21, 1994 and was closed December 12, 1994. An additional
$33,675 of the Reset Notes were exchanged.
LIGGETT 11.500% SENIOR SECURED SERIES B NOTES DUE 1999:
On February 14, 1992, Liggett issued $150,000 in Senior Secured Notes (the
"Liggett Series B Notes"). Interest on the Liggett Series B Notes is
payable semiannually on February 1 and August 1 at an annual rate of 11.5%.
The Liggett Series B Notes and Series C Notes referred to below
(collectively, the "Liggett Notes") require 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 transaction resulted in a net gain of $2,963. The Liggett Notes are
collateralized by substantially all of the assets of Liggett, excluding
inventories and receivables. Eve Holdings Inc. is a guarantor for the
Liggett Notes. The Liggett Notes may be redeemed, in whole or in part, at a
price equal to 102% and 100% of the principal amount in the years 1997 and
1998, respectively, at the option of Liggett. The Liggett Notes contain
restrictions on Liggett's ability to declare or pay cash dividends, incur
additional debt, grant liens and enter into any new agreements with
affiliates, among others. While Liggett management currently intends to
seek to refinance and/or restructure with Liggett's note holders the
February 1, 1998 mandatory redemption payment of $37,500 and the $107,400
payment due on February 1, 1999 on maturity of the Liggett Notes and to
extend its revolving credit 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.
ISSUANCE OF LIGGETT SERIES C VARIABLE RATE NOTES:
On January 31, 1994, Liggett issued $22,500 of Variable Rate Series C
Senior Secured Notes Due 1999 (the "Liggett Series C Notes"). The Liggett
Series C Notes bore a 16.5% interest rate, which
F-30
80
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
was reset on February 1, 1995 to 19.75%, the maximum reset rate. Liggett
had received the necessary consents from the required percentage of holders
of Liggett Series B Notes allowing for an aggregate principal amount up to
but not exceeding $32,850 of Liggett Series C Notes to be issued under the
Liggett Series C Notes indenture. The Series C Notes have the same terms
(other than interest rate) and stated maturity as the Liggett Series B
Notes. In connection with the consents, holders of Liggett Series B Notes
received Liggett Series C Notes totaling $2,842 or 2% of their then current
Liggett Series B Notes holdings. Liggett issued the remaining $7,508 of
Series C Notes in November 1994.
On January 26, 1995, the Company sold the Series C Notes it held in face
amount of $2,935.
REVOLVING CREDIT FACILITY - LIGGETT:
On March 8, 1994, Liggett entered into a revolving credit facility (the
"Facility") for $40,000 with a syndicate of commercial banks. The Facility
is collateralized by all inventories and receivables of Liggett. At
December 31, 1996, $24,272 was outstanding and $13,098 was available under
the Facility. Borrowings under the Facility bore interest at the rate of
9.75%, a rate which is equal to 1.5% above the Philadelphia National Bank's
prime rate (8.25%) at December 31, 1996. The Facility requires Liggett's
compliance with certain financial and other covenants. The Facility also
limits the amount of cash dividends and distributions by Liggett. In
addition, the Facility imposes requirements with respect to Liggett's
adjusted net worth (not to fall below a deficit of $175,000 as computed in
accordance with the agreement) and working capital (not to fall below a
deficit of $35,000 as computed in accordance with the agreement). The
Facility is classified as short-term at December 31, 1996, as it was due on
March 8, 1997. In January 1997, the Facility was extended for a one-year
period ending March 8, 1998. No assurances can be given that the Facility
will be further extended.
During the first quarter of 1997, Liggett violated the working capital
covenant contained in the Facility as a result of the 1998 mandatory
redemption payment on the Liggett Notes becoming due within one year.
On March 19, 1997, the lead lender agreed to waive this covenant default,
and the Facility was amended as follows: (i) the working capital definition
was changed to exclude the Liggett Notes; (ii) the maximum permitted
working capital deficit was reduced to $12,000; (iii) the maximum permitted
adjusted net worth deficit was increased to $180,000; and (iv) the
permitted advance rates under the Facility for eligible inventory were
reduced by five percent.
FOREIGN LOANS:
In October, 1995, Liggett-Ducat, a subsidiary of BOL, entered into a
construction loan agreement with Vneshtorgbank, Moscow, Russia for a period
of two years on behalf of BML for $20,400. The interest rate is the London
Interbank Offered Rate, which was 5.55% and 5.66% at December 31, 1996 and
1995, respectively, plus 10%. The outstanding balance at December 31, 1996
on the loan, which was assigned to BML on December 19, 1996, was $20,400.
Deferred financing fees of approximately $4,044 were recorded and are being
amortized over the term of the loan. (Refer to Note 4.)
In January 1996, Liggett-Ducat entered into a revolving credit facility for
$1,667 with the same bank. The facility was denominated in rubles and is
due within 180 days with an automatic renewal. Because the credit facility
exists in a hyperinflationary economy, it bore interest at a rate of 85%
per annum. During September 1996, this facility was fully retired.
F-31
81
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
Scheduled Maturities:
Scheduled maturities of long-term debt for each of the next five years are
as follows:
1997..................... $55,242
1998..................... 39,516
1999..................... 107,374
2000.....................
2001..................... 231,353
Thereafter...............
--------
$433,485
========
10. RESTRUCTURING CHARGES
Liggett:
During the years ended December 31, 1996 and 1995, Liggett offered
severance and benefit programs to reduce personnel costs on an ongoing
basis. These programs resulted in a charge to operations of $3,428 and
$2,548, respectively.
11. EMPLOYEE BENEFIT PLANS
Defined Benefit Retirement Plans:
The Company sponsors several defined benefit pension plans, covering
virtually all of Liggett's full-time employees. These plans provide pension
benefits for eligible employees based primarily on their compensation and
length of service. Contributions are made to the pension plans in amounts
necessary to meet the minimum funding requirements of the Employee
Retirement Income Security Act of 1974 ("ERISA").
In a continuing effort to reduce operating expenses, all defined benefit
plans were frozen between 1993 and 1995 and several early retirement
windows were offered in 1995 and 1996. As a result of these actions, the
Company recorded a curtailment charge (see table below).
The Company's net pension expense consists of the following components:
Year Ended December 31,
---------------------------------------------------
1996 1995 1994
---------------------------------------------------
Service cost - benefits earned during the period..... $ 350 $ 454 $ 1,140
Interest cost on projected benefit obligation........ 12,241 12,850 12,363
Actual return on assets.............................. (21,143) (23,501) (5,144)
Curtailment related to plan restructuring............ 1,463 1,550 691
Net amortization and deferral........................ 7,384 9,547 (8,337)
--------- --------- ----------
$ 295 $ 900 $ 713
========= ========= ==========
In accordance with SFAS No. 87, "Employers' Accounting for Pensions," the
overfunded and underfunded plans with respect to the accumulated benefit
obligation at December 31, 1996 have been segregated for financial
statement presentation. All plans were underfunded with respect to the
F-32
82
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts)
accumulated benefit obligation at December 31, 1995. An analysis of the
funded status of the Company's defined benefit pension plans and amounts
recognized in the balance sheets at December 31, 1996 and 1995 for the
pension plans are as follows:
December 31, December 31,
1996 1995
---------------------------------- ------------
Assets Exceed Accumulated Accumulated
Accumulated Benefits Exceed Benefits Exceed
Benefits Assets Assets
---------------- ----------------- ---------------
Actuarial present value of benefit obligations:
Vested benefit obligation............... $155,612 $2,900 $166,448
======== ====== ========
Accumulated benefit obligation.......... $160,587 $2,915 $172,317
======== ====== ========
Projected benefit obligation............ $160,587 $2,915 $172,317
Plan assets at fair value..................... 169,845 163,913
-------- ------ --------
Projected benefit obligation (less than) in
excess of plan assets................... (9,258) 2,915 8,404
Unrecognized net gain (loss).................. 28,221 (976) 14,449
Curtailment liability......................... 1,463
Adjustment required to recognize minimum
liability............................... 976 976
-------- ------ --------
Pension liability before purchase accounting
valuation adjustments................... 20,426 2,915 23,829
Purchase accounting valuation adjustments
related to income taxes................. (3,425) (3,773)
-------- ------ --------
Net pension liability included in the balance
sheets.................................. $ 17,001 $2,915 $ 20,056
======== ====== ========
Assumptions used in the determination of net pension expense and the
actuarial present value of benefit obligations were as follows:
1996 1995
---- ----
Discount rates............................................ 6.25 - 8.00% 6.25 - 8.50%
Accrued rates of return on invested assets................ 9.0% 9.0%
Salary increase assumptions............................... N/A N/A
per annum per annum
Plan assets consist of commingled funds, marketable equity securities and
corporate and government debt securities.
Postretirement Medical and Life Insurance Plans:
BGLS and Liggett
Substantially all of Liggett's United States employees are eligible for
certain postretirement benefits if they reach retirement age while working
for the Company. Effective January 1, 1995, retirees are required to fund
100% of participant medical premiums.
The components of net periodic postretirement benefit cost for the years
ended December 31, 1996, 1995 and 1994 are as follows:
F-33
83
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
1996 1995 1994
---- ---- ----
Service cost, benefits attributed to employee
service during the year...................................... $ 68 $ 68 $ 63
Interest cost on accumulated postretirement
benefit obligation........................................... 829 970 1,037
Charge for special termination benefits........................... 489
Amortization of net (gain) loss................................... (92) (26) 33
---- ------ ------
Net periodic postretirement benefit expense....................... $805 $1,501 $1,133
==== ====== ======
The following sets forth the actuarial present value of the Accumulated
Postretirement Benefit Obligation ("APBO") at December 31, 1996 and 1995
applicable to each employee group for benefits:
1996 1995
---- ----
Retired employees................................................. $ 7,899 $ 8,673
Active employees - fully eligible................................. 674 1,707
Active employees - not fully eligible............................. 515 1,078
------- --------
APBO......................................................... 9,088 11,458
Unrecognized net gain............................................. 3,324 1,339
Purchase accounting valuation adjustment related to
income taxes................................................. (1,072) (1,181)
------- -------
Postretirement liability.......................................... $11,340 $11,616
======= =======
The APBO at December 31, 1996 was determined using a discount rate of 8%
and health care cost trend rates of 4%. A 1% increase in the trend rate for
health care costs would have increased the APBO and net periodic
postretirement benefit cost by $419 and $32, respectively, for the year
ended December 31, 1996. The Company does not hold any assets reserved for
use in the plan.
Profit Sharing Plan:
Liggett
The 401(k) plans originally called for Liggett contributions matching up to
a 3% employee contribution, plus additional Liggett contributions of up to
6% of salary based on the achievement of Liggett's profit objectives.
Effective January 1, 1994, Liggett suspended the 3% match for the salaried
employees' 401(k) Plan, but reinstated it on April 1, 1996. Liggett
contributed and expensed $2,712, $900 and $420 to the 401(k) plans for the
years ended December 31, 1996, 1995 and 1994, respectively.
12. INCOME TAXES
The Company files a consolidated federal income tax return that includes
its more than 80%-owned United States subsidiaries. At December 31, 1996,
the Company had $90,646 of unrecognized net deferred tax assets, comprised
primarily of net operating loss carryforwards, available to offset future
taxable income for federal tax purposes. A valuation allowance has been
provided against this deferred tax asset as it is presently deemed more
likely than not that the benefit of the tax asset will not be utilized. The
Company continues to evaluate the realizability of its deferred tax assets
and its estimate is subject to change.
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84
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts)
The amounts provided for income taxes are as follows:
Year Ended December 31,
---------------------------------------------------
1996 1995 1994
---------------- ----------------- ----------------
Current:
U.S. Federal..................................... $ $(24,714)
Foreign.......................................... 1,454
State............................................ (52) $ 342 227
-------- ----- --------
Total provision (benefit) for
continuing operations............................. $ 1,402 $ 342 $(24,487)
======== ===== ========
The tax effect of temporary differences which give rise to a significant
portion of deferred tax assets and liabilities are as follows:
December 31, 1996 December 31, 1995
----------------------------- -----------------------------
Deferred Tax Deferred Tax Deferred Tax Deferred Tax
Assets Liabilities Assets Liabilities
------------ ------------ ------------ -----------
Sales and product allowances....... $ 2,504 $ 2,337
Inventory.......................... 1,270 683 831 $ 1,280
Coupon accruals.................... 4,492 3,198
Property, plant and equipment...... 5,218 6,200
Employee benefit plan accruals..... 13,193 13,249
Debt restructuring charges......... 22,334 5,702
Excess of tax basis over book basis-
non-consolidated entities....... 9,467 4,327
Excess of book basis over tax basis-
non-consolidated entities....... 5,166 5,564
Legal settlements.................. 2,910 3,556
Net operating loss carryforwards... 45,543 54,860
Valuation allowance................ (90,646) (73,955)
Reclassifications.................. (11,067) (11,067) (13,044) (13,044)
-------- --------- -------- --------
$ $ $ 1,061 $
======== ========= ======== ========
Differences between the amounts provided for income taxes and amounts
computed at the federal statutory tax rate are summarized as follows:
Year Ended December 31,
---------------------------------------------------
1996 1995 1994
---------------- ----------------- ----------------
(Loss) from continuing operations
before income taxes................................ $(63,516) $(45,002) $(42,478)
======== ======== ========
Federal income tax (benefit) at statutory rate....... (22,231) (15,751) (14,867)
Increases (decreases) resulting from:
State income taxes, net of federal income tax
benefits.......................................... (34) 342 148
Foreign taxes...................................... 1,454
Changes in valuation allowance..................... 21,471 11,810 14,432
Other.............................................. 742 3,941
Reduction of reserves.............................. (24,200)
-------- --------- --------
Provision (benefit) for income tax................ $ 1,402 $ 342 $(24,487)
======== ========= ========
The Company favorably settled an audit with the Internal Revenue Service in
the third quarter of 1994 and has adjusted its reserves accordingly.
At December 31, 1996, the Company and its consolidated group had net
operating loss carryforwards for tax purposes of approximately $114,000
which may be subject to certain restrictions and limitations and which will
expire in the years 2006 to 2009.
F-35
85
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
13. COMMITMENTS
Certain of the Company's subsidiaries lease certain facilities and
equipment used in its operations under both month-to-month and fixed-term
agreements. The aggregate minimum rentals under operating leases with
noncancelable terms for one year or more are as follows:
Year ending December 31:
1997.......................... $ 5,578
1998.......................... 4,130
1999.......................... 2,120
2000.......................... 1,310
2001.......................... 650
2002 and thereafter........... 33,918
-------
$47,706
=======
Lease commitments for 2002 and thereafter relate primarily to the remaining
45 years of a land lease and 23 years of an equipment lease in
Russia.
The total of minimum rentals to be received in the future by certain of the
Company's subsidiaries under noncancelable subleases are $126 for the year
ending December 31, 1997.
The Company's rental expense for the years ended December 31, 1996, 1995
and 1994 was $5,471, $4,449 and $4,808, respectively.
14. EQUITY
Series G Preferred Stock:
During 1993 and 1994, special dividends payable on the Series G Preferred
Stock in connection with the distribution of SkyBox shares to the Company's
shareholders were accelerated and paid in two parts. To the extent that
such dividends were utilized to facilitate the repayment or defrayal of
certain debt obligations to the Company, cash dividends were disbursed or
dividends were waived to satisfy such obligations. The remaining portion of
the special dividend was payable in four installments on January 1, April
1, July 1 and October 1, 1994 payable in cash or shares of common stock at
the option of the Company using the prime rate announced by Citibank, N.A.
discounted by the number of days between the installment payment date and
October 6, 1994, the date the special dividend was to have been paid out.
(Refer to Note 17.) At December 31, 1994, all Series G Preferred Stock had
been converted into Company common stock.
Treasury Stock:
For information concerning the exercise in 1994 of a warrant for 607,889
shares of the Company's common stock. (Refer to Note 17.)
In 1995 and 1994, pursuant to a Stock Grant Agreement, the Company
purchased 33,748 and 41,641 shares of common stock, respectively, from two
former employees at market price. During 1995, the Company issued, in the
aggregate, 270,000 shares from treasury.
F-36
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BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
15. STOCK PLANS
The Company's Stock Option Plan (the "Plan") provides that options and
stock appreciation rights ("SAR's") for up to 400,000 shares of common
stock may be granted to officers and other key employees of the Company.
All options must be granted on or before the tenth anniversary of the
effective date of the Plan (September 1, 1997) and at prices not less than
the fair market value of the stock on the date of grant. The exercise price
may be paid in cash or in shares of the Company's common stock having a
fair market value equal to the cash amount for which it was substituted.
Shares received upon exercise of a portion of an option may be applied
automatically at their fair market value to purchase additional portions of
the option. Shares relating to options that expire or are canceled are
added back to shares authorized for future grants. At December 31, 1996,
1995 and 1994, no options were outstanding; however, there were 212,400
shares available to be granted under this Plan.
On December 16, 1996, the Company entered into a Stock Option Agreement
(the "Agreement") with a consultant who serves as a director and President
of New Valley. The Agreement granted such consultant non-qualified stock
options to purchase 1,000,000 shares of the Company's common stock at an
exercise price of $1.00 per share. The options, which will become
exercisable over a ten-year term, vest in six equal annual installments
beginning on July 1, 1997. Pursuant to the Agreement, common stock dividend
equivalents are paid on each vested and unexercised option. The Company
estimated the fair value of such grants on the date of grant using the
Black-Scholes option-pricing model with the following assumptions: a
risk-free interest rate of 6.4%, expected life of 10 years, volatility of
81.4% and no expected dividends or forfeiture. Under this model the fair
value of stock options granted in 1996 was $4,750. The Company recognized
expense of $64 for the year ended 1996.
As of January 1, 1994, the Company had granted 500,000 shares of restricted
common stock to the same consultant. Of the total number of shares granted,
250,000 were immediately vested and issued during the third quarter. The
remaining 250,000 shares were issued in 1995 and will vest in 1997. In
addition, on January 25, 1995, the Company entered into a nonqualified
stock option agreement with the same consultant. Under the agreement,
options to purchase 500,000 shares were granted at $2.00 per share. The
options are exercisable over a ten-year period, beginning with 20% on the
grant date and 20% on each of the four anniversaries of the grant date. The
grant provides for dividend equivalent rights on all the shares underlying
the options.
During 1996, 1995 and 1994, the Company recorded charges to income of $222,
$557 and $781, respectively, for compensation based on estimates of the
fair market value for the shares and options granted. In 1996 and 1995, the
Company also recorded charges to income of $150 and $150 for the dividend
equivalent rights.
Subsequent Event:
As of January 1, 1997, the Company granted to employees of the Company
non-qualified stock options to purchase 422,000 shares of the Company's
common stock at an exercise price of $5.00 per share. The options, which
will become exercisable over a ten-year term, vest in six equal annual
installments.
F-37
87
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
16. CONTINGENCIES
Tobacco-Related Litigation:
Since 1954, Liggett and other United States cigarette manufacturers have
been named as defendants in a number of direct and third-party actions
predicated on the theory that they should be liable for damages from cancer
and other adverse health effects alleged to have been caused by cigarette
smoking or by exposure to 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
actually were commenced against the Company or Liggett). New cases continue
to be commenced against Liggett and other cigarette manufacturers. 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. Liggett had been receiving certain financial and other 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, but these benefits have recently ended. Certain joint defense
arrangements, and the financial benefits incident thereto, have also ended.
The future financial impact on the Company of the termination of this
assistance and the effects of the tobacco litigation settlements discussed
below is not quantifiable at this time.
As of March 14, 1997, there were 108 cases pending against Liggett 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, 58 are pending in the State
of Florida and 19 are pending in the State of New York. The balance of
individual cases are pending in 13 different states. The next individual
case scheduled for trial where Liggett is a defendant is CHUTZ-REYMERS V.
LIGGETT GROUP INC., ET AL, United States District Court, Middle District of
Florida, Tampa Division, which is scheduled for trial in June 1997. In
light of the settlements discussed below, this case will not proceed
against Liggett on that date. In addition to the foregoing, there are four
individual cases scheduled for trial in 1997 where Liggett is a defendant,
although trial dates are subject to change.
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, strict liability, fraud, misrepresentation,
design defect, failure to warn, breach of express and implied warranties,
conspiracy, concert of action, unjust enrichment, common law public
nuisance, indemnity, market share liability, and violations of deceptive
trade practices laws and antitrust statutes. Plaintiffs also seek punitive
damages in many of these cases. 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 preemption by the Federal
Cigarette Labeling and Advertising Act, as amended (the "Act"). Several
representative cases are described below.
On June 24, 1992, in the action entitled CIPOLLONE V. LIGGETT GROUP INC.,
ET AL., the United States Supreme Court issued an opinion concluding that
the 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
F-38
88
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
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.
On March 27, 1987, an action entitled YVONNE ROGERS V. LIGGETT GROUP INC.
ET AL., Superior Court, Marion County, Indiana, was filed against Liggett
and others. The plaintiff sought compensatory and punitive damages for
cancer alleged to have been caused by cigarette smoking. Trial commenced on
January 31, 1995. The trial ended on February 22, 1995 when the trial court
declared a mistrial due to the jury's inability to reach a verdict. The
Court directed a verdict in favor of the defendants as to the issue of
punitive damages during the trial of this action. A second trial commenced
on August 5, 1996 and, on August 23, 1996, the jury returned a verdict in
favor of the defendants. A Notice of Appeal has been filed by the
plaintiff.
On October 31, 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 the first class action commenced against the industry, and has
been brought by plaintiffs on behalf of all flight attendants that have
worked or are presently working for airlines based in the United States and
who have never regularly smoked cigarettes but allege that they have been
damaged by involuntary exposure to ETS. Plaintiff's motion to certify the
action as a class action was granted. The suit is scheduled to go to trial
on June 2, 1997. In addition to Broin, as of March 25, 1997 there were 12
actions which have either been certified as a class or are seeking class
certification. One of these actions, ENGLE, ET AL. V. R. J. REYNOLDS
TOBACCO COMPANY, ET AL., Circuit Court of the Eleventh Judicial Circuit in
and for Dade County, Florida, involving a certified class of smokers in the
State of Florida, is scheduled to commence trial on September 8, 1997.
On May 12, 1992, an action entitled CORDOVA V. LIGGETT GROUP INC., ET AL.,
Superior Court of the State of California, City of San Diego, was filed
against Liggett and others. In her complaint, plaintiff, purportedly on
behalf of the general public, alleges that defendants have been engaged in
unlawful, unfair and fraudulent business practices by allegedly
misrepresenting and concealing from the public scientific studies
pertaining to smoking and health funded by, and misrepresenting the
independence of, the Council on Tobacco Research ("CTR") and its
predecessor. The complaint seeks equitable relief against the defendants,
including the imposition of a corrective advertising campaign, restitution
of funds, disgorgement of revenues and profits and the imposition of a
constructive trust. The case is presently in the discovery phase. This
action is scheduled for trial on December 12, 1997. A similar action has
been filed in the Superior Court for the State of California, City of San
Francisco.
On September 10, 1993, an action entitled SACKMAN V. LIGGETT GROUP INC.,
UNITED STATES DISTRICT COURT, Eastern District of New York, was filed
against Liggett alleging as injury lung cancer. On May 25, 1996, the
District Court granted Liggett summary judgment on plaintiffs' fraud and
breach of warranty claims. In addition, the District Court vacated the
Magistrate's March 19, 1996 order compelling Liggett to produce certain CTR
documents with respect to which Liggett had asserted various privilege
claims, and allowed the other cigarette manufacturers and the CTR to
intervene in order to assert their interests and privileges with respect to
those same documents. The Magistrate Judge is presently reconsidering
plaintiffs' motion to compel production of documents. No trial date has
been set.
On March 25, 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. The District Court granted plaintiffs'
motion for class certification. On May 23, 1996, the Fifth Circuit Court of
Appeals decertified the class and instructed the District Court to
F-39
89
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
dismiss the class complaint. On March 12, 1996, the Company and Liggett
entered into an agreement, subject to court approval, to settle the CASTANO
class action tobacco litigation.
Under the CASTANO settlement agreement, upon final court approval of the
settlement, the CASTANO class would be entitled to receive up to 5% of
Liggett's pretax income (income before income taxes) each year (up to a
maximum of $50,000 per year) for the next twenty-five years, subject to
certain reductions provided for in the agreement, and a $5,000 payment
from Liggett if the Company or Liggett fails to consummate a merger or
similar transaction with another non-settling tobacco company defendant
within three years of the date of the settlement. The Company and Liggett
have the right to terminate the CASTANO settlement under certain
circumstances. On May 11, 1996, the CASTANO Plaintiffs Legal Committee
filed a motion with the District Court seeking preliminary approval of the
CASTANO settlement. On September 6, 1996, the CASTANO plaintiffs withdrew
the motion for approval of the CASTANO settlement.
On March 14, 1996, the Company, CASTANO Plaintiffs Legal Committee and the
CASTANO plaintiffs entered into a letter agreement. According to the terms
of the letter agreement, for the period ending nine months from the date of
Final Approval (if granted) of the CASTANO settlement or, if earlier, the
completion by the Company or Liggett of a combination with any defendant in
CASTANO, except Philip Morris, the CASTANO plaintiffs and their counsel
agree not to enter into any more favorable settlement agreement with any
CASTANO defendant which would reduce the terms of the CASTANO settlement
agreement. If the CASTANO plaintiffs or their counsel enter into any such
settlement during this period, they shall pay the Company $250,000 within
thirty days of the more favorable agreement and offer the Company and
Liggett the option to enter into a settlement on terms at least as
favorable as those included in such other settlement. The letter agreement
further provides that during the same time period, and if the CASTANO
settlement agreement has not been earlier terminated by the Company in
accordance with its terms, the Company and its affiliates will not enter
into any business transaction with any third party which would cause the
termination of the CASTANO settlement agreement. If the Company or its
affiliates enter into any such transaction, then the CASTANO plaintiffs
will be entitled to receive $250,000 within thirty days from the
transacting party.
In February 1995, an action entitled GRADY CARTER, ET AL. V. THE AMERICAN
TOBACCO COMPANY, ET AL., Superior Court for the State of Florida, Duval
County, was filed against Liggett and others. Plaintiff sought compensatory
damages, including, but not limited to, reimbursement for medical costs.
Both American Tobacco and Liggett were subsequently dismissed from this
action. On August 9, 1996, a jury returned a verdict against the remaining
defendant, Brown & Williamson Tobacco Corp., in the amount of $750. Brown &
Williamson has filed a Notice of Appeal.
On May 23, 1994, an action entitled MOORE, ATTORNEY GENERAL, EX REL STATE
OF MISSISSIPPI V. THE AMERICAN TOBACCO COMPANY, ET AL., Chancery Court of
Jackson County, Mississippi, was commenced against Liggett and others
seeking restitution and indemnity for medical payments and expenses
allegedly made or incurred for tobacco related illnesses. In May 1994, the
State of Florida enacted legislation, effective July 1, 1994, allowing
certain state authorities or entities to commence litigation seeking
recovery of certain Medicaid payments made on behalf of Medicaid recipients
as a result of diseases (including, but not limited to, diseases allegedly
caused by cigarette smoking) allegedly caused by liable third parties
(including, but not limited to, the tobacco industry). On February 21,
1995, the State of Florida commenced an action pursuant to this statutory
scheme. In addition to the foregoing, similar actions have been filed on
behalf of 20 states and several municipalities. The Mississippi, Florida
and Texas Medicaid recovery actions are scheduled for trial in 1997.
Legislation similar to that enacted in Florida has been introduced in the
Massachusetts and New Jersey legislatures.
In certain of the pending proceedings, state and local government entities
and others seek reimbursement for Medicaid and other health care
expenditures allegedly caused by tobacco products. The claims asserted in
these Medicaid recovery actions vary. All 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 Federal Racketeer
Influenced and Corrupt Organization Act.
On March 15, 1996, the Company and Liggett entered into a settlement of
tobacco-related litigation with the Attorneys General of Florida,
Louisiana, Mississippi, West Virginia and Massachusetts. The settlement
with the Attorneys General releases the Company and Liggett from all
tobacco-related claims by these states including claims for Medicaid
reimbursement and concerning sales of cigarettes to minors. The settlement
provides that additional states which commence similar Attorney General
actions may agree to be bound by the settlement prior to six months from
the date thereof (subject to extension of such period by the settling
defendants). Certain of the terms of the settlement are summarized below.
Under the settlement, the states would share an initial payment by Liggett
of $5,000 ($1,000 of which was paid on March 22, 1996, with the balance
payable over nine years and indexed and adjusted for inflation), provided
that any unpaid amount will be due sixty days after either a default by
Liggett in its payment obligations under the settlement or a merger or
other similar transaction by the Company or Liggett with another defendant
in the lawsuits. In addition, Liggett will be required to pay the states a
F-40
90
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
percentage of Liggett's pretax income (income before income taxes) each
year from the second through the twenty-fifth year. This annual percentage
is 2-1/2% of Liggett's pretax income, subject to increase to 7-1/2%
depending on the number of additional states joining the settlement. No
additional states have joined this settlement to date. All of Liggett's
payments are subject to certain reductions provided for in the agreement.
Liggett has also agreed to pay to the states $5,000 if the Company or
Liggett fails to consummate a merger or other similar transaction with
another defendant in the lawsuits within three years of the date of the
settlement.
Settlement funds received by the Attorneys General will be used to
reimburse the states' smoking-related healthcare costs. While neither
consenting to FDA jurisdiction nor waiving their objections thereto, the
Company and Liggett also have agreed to phase in compliance with certain of
the proposed interim FDA regulations on the same basis as provided in the
CASTANO settlement.
The Company and Liggett have the right to terminate the settlement with
respect to any state participating in the settlement if any of the
remaining defendants in the litigation succeed on the merits in that
state's Attorney General action. The Company and Liggett may also terminate
the settlement if they conclude that too many states have filed Attorney
General actions and have not resolved such cases as to the settling
defendants by joining in the settlement.
At December 31, 1995, the Company had accrued approximately $4,000 for the
present value of the fixed payments under the March 1996 Attorneys General
settlement, and no additional amounts have been accrued with respect to the
recent settlements discussed below. The Company cannot quantify the future
costs of the settlements at this time as the amount Liggett must pay is
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.
The Company understands that a grand jury investigation is being conducted
by the office of the United States Attorney for the Eastern District of New
York regarding possible violations of criminal law relating to the
activities of The Council for Tobacco Research - USA, Inc. Liggett was
a sponsor of The Council for Tobacco Research - USA, Inc. at one time. The
Company is unable, at this time, to predict the outcome of this
investigation.
In March 1996, Liggett received a subpoena from a Federal grand jury
sitting in the Southern District of New York. Documents have been produced
in response to the subpoena. The Company understands that this
investigation has been transferred to the main office of the United States
Department of Justice. In addition, in May 1996, Liggett was served with a
subpoena by a grand jury sitting in the District of Columbia. Liggett is in
the process of responding to that subpoena. The Company and Liggett are
unable, at this time, to predict the outcome of these investigations.
The Antitrust Division of the United States Department of Justice
investigation into the United States tobacco industry activities in
connection with product development efforts regarding "fire-safe" or
self-extinguishing cigarettes has been concluded. No action by the
Department of Justice was taken.
Litigation is subject to many uncertainties, and it is possible that some
of the aforementioned actions could be decided unfavorably against the
Company. An unfavorable outcome of a pending smoking and health case could
encourage the commencement of additional similar litigation. The Company is
not able to evaluate the effect of these developing matters on pending
litigation or the possible commencement of additional litigation.
The Company is unable to make a meaningful estimate of the amount or range
of loss that could result from an unfavorable outcome of the cases pending
against the Company and Liggett. It is possible that the Company's
consolidated financial position, results of operations and cash flows could
be materially adversely affected by an ultimate unfavorable outcome in any
of such pending litigation.
There are several other proceedings, lawsuits and claims pending against
the Company unrelated to product liability. Management is of the opinion
that the liabilities, if any, ultimately resulting from such
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91
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
other proceedings, lawsuits and claims should not materially affect
the Company's financial position, results of operations or cash flows.
Subsequent Events:
On March 20, 1997, Liggett, together with the Company, entered into a
comprehensive settlement of tobacco litigation through parallel agreements
with the Attorneys General of 17 states and with a nationwide class of
individuals and entities that allege smoking-related claims. The Company
and Liggett have now obtained settlements with each of the 22 states that
have commenced suit against them. The settlements cover all smoking-related
claims, including both addiction-based and tobacco injury claims against
the Company and Liggett, brought by the 22 states and, upon court approval,
the nationwide class.
The settlement with the Attorneys General, which does not require court
approval, includes the states of Arizona, Connecticut, Hawaii, Illinois,
Indiana, Iowa, Kansas, Maryland, Michigan, Minnesota, New Jersey, New York,
Oklahoma, Texas, Utah, Washington and Wisconsin. The Company's and
Liggett's previous settlements on March 15, 1996 with the Attorneys General
of Florida, Louisiana, Massachusetts, Mississippi and West Virginia remain
in full force and effect.
The settlement with the nationwide class covers all smoking-related claims.
On March 20, 1997, Liggett, the Company and plaintiffs filed the 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. Class members will be notified of the settlement and will have an
opportunity to appear at a later court hearing. Effectiveness of the
mandatory settlement is conditioned on final court approval of the
settlement after a fairness hearing. There can be no assurance as to
whether or when such court approval will be obtained. There are no opt out
provisions in this settlement, except for Medicaid claims by states that
are not party to the Attorneys General settlements.
Pursuant to the settlements, the Company and Liggett have agreed to
cooperate fully with the Attorneys General and the nationwide class in
their lawsuits against the tobacco industry. The Company and Liggett have
agreed to provide to these parties all relevant tobacco documents in their
possession, other than those subject to claims of joint defense privilege,
and to waive, subject to court order, certain attorney-client privileges
and work product protections regarding Liggett's smoking-related documents
to the extent Liggett and the Company can so waive these privileges and
protections. The Attorneys General and the nationwide class have agreed to
keep Liggett's documents under protective order and, subject to final court
approval, to limit their use to those actions brought by parties to the
settlement agreements. Those documents that may be subject to a joint
defense privilege with other tobacco companies will not be produced to the
Attorneys General or the nationwide class, but will be, pursuant to court
order, submitted to the appropriate court and placed under seal for
possible in camera review. Additionally, under similar protective
conditions, the Company and Liggett have agreed to offer their employees
for witness interviews and testimony at deposition and trial. Pursuant to
both settlement agreements, Liggett has 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.
Under the terms of the new settlement agreements, Liggett will pay on an
annual basis 25% of its pretax income for the next 25 years into a
settlement fund, commencing with the first full fiscal year starting after
the date of the agreements. Monies collected in the settlement fund will be
overseen by a court-appointed committee and utilized to compensate state
health care programs and settlement class members and to provide
counter-market advertising. Liggett has also agreed to phase-in
F-42
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BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
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.
Under both settlement agreements, any other tobacco company defendant,
except Philip Morris, merging or combining with Liggett or the Company,
prior to the fourth anniversary of the settlement agreements, would receive
certain settlement benefits, including limitations on potential liability
and not having to post a bond to appeal any future adverse judgment. In
addition, within 120 days following such a combination, Liggett would be
required to pay the settlement fund $25 million. Both the Attorneys General
and the nationwide class have also agreed not to seek an injunction
preventing a defendant tobacco company combining with Liggett or the
Company from spinning off any of its affiliates which are not engaged in
the domestic tobacco business.
The Company and Liggett are also entitled to certain "most favored nation"
benefits not available to the other defendant tobacco companies. In
addition, in the event of a "global" tobacco settlement enacted through
Federal legislation or otherwise, the Attorneys General and tobacco
plaintiffs have agreed to use their "best efforts" to ensure that the
Company and Liggett's liability under such a plan should be no more onerous
than under these new settlements.
On March 20, 1997, RJR, Philip Morris, B & W and Lorillard obtained a
temporary restraining order from a North Carolina state court preventing,
the Company and Liggett and their agents, employees, directors, officers
and lawyers from turning over documents allegedly subject to the joint
defense privilege in connection with the settlements. On March 24, 1997,
the United States District Court for the Eastern District of Texas and
state courts in Mississippi and Illinois each issued orders enjoining these
four companies from interfering with Liggett's filing with the courts,
under seal, those documents.
Legislation and Regulation:
On August 28, 1996, the FDA filed in the Federal Register a Final 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. The FDA's stated
objective and focus for its initiative is to limit access to cigarettes by
minors by measures beyond the restrictions either mandated by existing
federal, state and local laws or voluntarily implemented by major
manufacturers in the industry. Litigation has been 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. A hearing on the tobacco
industry's motion for summary judgment in that case was held on February
10, 1997, and a decision by the Court is expected soon. The FDA's proposed
restrictions, some of which became effective as early as February 28, 1997,
purport to (i) limit access to tobacco products and (ii) limit advertising
and marketing. Management is unable to predict whether the Final Rule will
be upheld as enforceable against the industry. Management is also unable to
predict the effects of the proposed restrictions, if implemented, on
Liggett's operations, but such actions could have an unfavorable impact
thereon.
The Company and Liggett, while neither consenting to FDA jurisdiction nor
waiving their objections thereto, agreed to withdraw their objections and
opposition to the proposed rule making and to phase in compliance with
certain of the proposed interim FDA regulations. See discussions of the
Castano and Attorneys General settlements above.
In August 1996, the Commonwealth of Massachusetts enacted legislation
requiring tobacco companies to publish information regarding the
ingredients in cigarettes and other tobacco products sold in that state.
Regulations adopted pursuant to this legislation are scheduled to become
effective on July 1, 1997. On February 7, 1997, the United States District
Court for the District of
F-43
93
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
Massachusetts denied an attempt to block the new legislation on the ground
that it is preempted by federal law.
In 1993, the United States Congress amended the Agricultural Adjustment Act
of 1938 to require each United States cigarette manufacturer to use at
least 75% domestic tobacco in the aggregate of the cigarettes manufactured
by it in the United States, effective January 1, 1994, on an annualized
basis or pay a domestic marketing assessment ("DMA") based upon price
differentials between foreign and domestic tobacco and, under certain
circumstances, make purchases of domestic tobacco from the tobacco
stabilization cooperatives organized by the United States government.
After an audit, the USDA informed Liggett that it did not satisfy the 75%
domestic tobacco usage requirement for 1994 and was subject to a DMA of
approximately $5,500. Liggett has agreed to pay this assessment in
quarterly installments with interest over a five-year period, and $4,900
was accrued for the assessment in 1995. Since the levels of domestic
tobacco inventories on hand at the tobacco stabilization organizations are
below reserve stock levels, Liggett was not obligated to make purchases
of domestic tobacco from the tobacco stabilization cooperatives.
On September 13, 1995, the President of the United States issued
Presidential Proclamation 6821, which established a tariff rate quota
("TRQ") on certain imported tobacco, imposing extremely high tariffs on
imports of flue-cured and burley tobacco in excess of certain levels which
vary from country to country. Oriental tobacco is exempt from the quota as
well as all tobacco originating from Canada, Mexico or Israel. Management
believes that the TRQ levels are sufficiently high to allow Liggett to
operate without material disruption to its business. In addition the
Presidential Proclamation served to limit the application of the DMA to
only those activities occurring in calendar year 1994.
On February 20, 1996, the United States Trade representative issued an
"advance notice of rule making" concerning how tobaccos imported under the
TRQ should be allocated. Currently, tobacco imported under the TRQ is
allocated on a "first-come, first-served" basis, meaning that entry is
allowed on an open basis to those first requesting entry in the quota year.
Others in the cigarette industry have suggested an "end-user licensing"
system under which the right to import tobacco under the quota would be
initially assigned on the basis of domestic market share. Such an approach,
if adopted, could have a material adverse effect on the Company.
In April 1994, the United States Occupational Safety and Health
Administration ("OSHA") issued a proposed rule that could ultimately ban
smoking in the workplace. Hearings were completed during 1995. OSHA has not
yet issued a final rule or a proposed revised rule. While the Company
cannot predict the outcome, some form of federal regulation of smoking in
workplaces may result.
In January 1993, the 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.
Liggett has been involved in certain environmental proceedings, none of
which, either individually or in the aggregate, rise to the level of
materiality. Liggett's current operations are
F-44
94
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
conducted in accordance 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, have not had a
material effect on the capital expenditures, earnings or competitive
position 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 the Company is not able to evaluate.
Other Matters:
As a conclusion to the litigation commenced by a group of Contingent Value
Right ("CVR") Holders on September 20, 1993, the Delaware Court of Chancery
approved a settlement at a hearing conducted on June 4, 1996. The
settlement became final and nonappealable on or about July 8, 1996.
Distributions to the Company and to CVR Holders, pursuant to the
settlement, have been substantially completed. Under the terms of the
settlement, both the Company and the plaintiff CVR Holders may pursue
claims, in certain circumstances, against the CVR trustee. In connection
with the settlement, the Company recognized a gain of $2,263 during the
third quarter 1996.
At December 31, 1996, there were several other proceedings, lawsuits and
claims pending against the Company and its subsidiaries. The Company is of
the opinion that the liabilities, if any, ultimately resulting from such
other proceedings, lawsuits and claims should not materially affect its
consolidated financial position, results of operations or cash flows.
Subsequent Events:
In June 1993, the Company obtained expropriation and forced abandonment
insurance coverage for its investment in its Ducat Place I real estate
project in Moscow, Russia. Shortly thereafter, the Company submitted a
Notice of Loss to the insurer, under and pursuant to the policy. The
insurer denied the claim and, in July 1994, arbitration proceedings were
commenced in the United Kingdom. In January 1997, the Company recognized a
gain of $4,125 in settlement of the dispute.
17. RELATED PARTY TRANSACTIONS
On January 5, 1994, the Company's Chairman, President and Chief Executive
Officer and controlling stockholder (the "Chairman") repaid his principal
indebtedness of $14,692 and that of certain of his affiliates in the total
amount of $15,695 with the use of dividends paid on December 31, 1993 on
Series G Preferred Stock. (Refer to Note 14.) On March 21, 1994, the
Chairman repaid all interest due on the various debts in the amount of
$1,163 and accordingly, the stock collateralizing the loans was released.
Effective July 1, 1990, a former executive transferred all of his equity in
the Company to the Chairman and resigned from substantially all of his
positions with the Company and its affiliates. In consideration for this
transfer, a partnership (the "Partnership") controlled by the Chairman
agreed, among other things, to make certain payments to the Company on
account of the former executive's outstanding indebtedness of $8,677
(deducted from equity). In connection with this transaction, the
Partnership had pledged 1,681,715 of the shares it held of the Company's
common stock to secure this non-recourse obligation, except as to the
pledged shares. In May 1994, the Partnership paid
F-45
95
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
$3,200 in partial satisfaction of the obligation. In consideration thereof,
the Company released 1,281,715 of the pledged shares. On March 7, 1997, the
Partnership transferred to the Company the remaining 400,000 pledged shares
in final satisfaction of the obligation.
In conjunction with the transfer of 607,889 shares of the Company's common
stock in 1992, the former Vice Chairman of the Company was granted a
warrant (the "Warrant") to purchase 607,889 shares of common stock for an
exercise price of $7.60 a share, subsequently reduced to $0.10 per share as
a result of the SkyBox distribution. The Warrant was exercised in November
1994. The former Vice Chairman has served on the Board of Directors of New
Valley since 1990 and has been a consultant to Liggett in 1996 for which he
received $220 of consulting fees.
On December 16, 1996, the Company entered into a Stock Option Agreement
relating to 1,000,000 shares of the Company's common stock with a
consultant who serves as a director and President of New Valley. In
addition, the Company granted the same consultant 500,000 shares of
restricted common stock in 1994 and options to purchase 500,000 shares in
1995. (Refer to Note 15.) During 1996, the consultant received $480 of
consulting fees from the Company and a subsidiary.
An outside director of the Company is a stockholder of and serves as the
secretary and treasurer of a registered broker-dealer that has performed
services for the Company and its affiliates since before December 31, 1993.
The broker-dealer received brokerage commissions and other income of
approximately $317, $584 and $121 from the Company and/or its affiliates
during 1996, 1995, and 1994, respectively. The broker-dealer, in the
ordinary course of its business, engages in brokerage activities with New
Valley's broker-dealer subsidiary on customary terms. In connection with
the acquisition of certain office buildings by New Valley on January 10,
1996, this director received a commission of $220 from the seller.
During 1995, the Company and New Valley entered into an expense sharing
agreement whereby certain lease, legal and administrative expenses are
allocated to the entity incurring the expense. Expense reimbursements
amounted to $462 and $571 for the years ended December 31, 1996 and 1995,
respectively.
During 1996, the Company and BGLS entered into a court-approved Stipulation
and Agreement (the "Settlement") with New Valley relating to the Company's
and BGLS' application under the Federal Bankruptcy Code for reimbursement
of legal fees and expenses incurred by them in connection with New Valley's
bankruptcy reorganization proceedings. Pursuant to the Settlement, New
Valley reimbursed the Company and BGLS $655,217 for such legal fees and
expenses. The terms of the Settlement were substantially similar to the
terms of previous settlements between New Valley and other applicants who
had sought reimbursement of reorganization-related legal fees and expenses.
On December 18, 1996, New Valley loaned BGLS $990 under a short-term
promissory note due January 31, 1997 and bearing interest at 14%. On
January 2, 1997, New Valley loaned BGLS an additional $975 under another
short-term promissory note due January 31, 1997 and bearing interest at
14%. Both loans including interest were repaid on January 31, 1997. At
December 31, 1996, the loan and accrued interest thereon of $996 was
included in current liabilities as notes payable.
In connection with their agreement to serve as the Company's nominees at
RJR Nabisco's Annual Meeting, two directors of New Valley were each paid
$30 by the Company during the fourth quarter of 1995. In addition, the
Company also entered into an agreement with each of the Company nominees
whereby it has agreed to indemnify such nominees against certain
liabilities arising out of the solicitation of proxies in support of the
nominees' election at the annual meeting. As discussed in
F-46
96
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (Continued)
--------------------------------------------------------------
Note 3, the Company has entered into certain other agreements with New
Valley in connection with RJR Nabisco.
Subsequent Events:
On January 31, 1997, New Valley entered into a stock purchase agreement
with BOL pursuant to which New Valley acquired 10,483 shares of BML common
stock (99.1%) for a purchase price of $55,000, consisting of $21,500 in
cash and a $33,500 promissory note with an interest rate of 9%. (Refer to
Note 4.)
18. SEGMENT INFORMATION
The Company's major operations are in tobacco products, principally
cigarettes, and real estate development. The tobacco segment operates in
the United States and in Russia; real estate activities are conducted in
Russia. Total assets of the foreign real estate and tobacco operations
included in the consolidated balance sheet at December 31, 1996 and 1995
were approximately $72,296 and $45,400, respectively. (Refer to Note 4.)
Industry Segment:
Real Corporate
1996 Tobacco Estate and Others Consolidated
---- ------- ------ ---------- ------------
Net sales.................. $447,522 $ 2,675 $ 2,459 $452,656
Operating income........... 4,805 99 (8,831) (3,927)
Identifiable assets........ 114,648 55,012 8,017 177,677
Capital expenditures....... 8,861 25,318 62 34,241
Depreciation and
amortization............. 8,185 253 381 8,819
Real Corporate
1995 Tobacco Estate and Others Consolidated
---- ------- ------ ---------- ------------
Net sales.................. $455,666 $ 5,793 $461,459
Operating income........... 16,725 $ (1,990) (6,675) 8,060
Identifiable assets........ 123,144 31,149 71,327 225,620
Capital expenditures....... 1,104 7,229 472 8,805
Depreciation and
amortization............. 7,972 1,104 9,076
F-47
97
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (continued)
--------------------------------------------------------------
Geographic Area:
United
1996 States Russia Consolidated
---- -------- ------ ------------
Net sales.............................. $403,521 $49,135 $452,656
Operating income....................... 6,045 (9,972) (3,927)
Identifiable assets.................... 105,381 72,296 177,677
19. SUPPLEMENTAL CASH FLOW INFORMATION
In accordance with the requirements of SFAS No. 95, "Statement of Cash
Flows," supplemental cash flow information is disclosed below:
Year Ended December 31,
---------------------------------------------------
1996 1995 1994
---- ---- ----
I. Cash paid during the period for:
Interest........................................ $57,362 $60,158 $39,429
Income taxes, net of refunds.................... 582 1,735 605
II. Non-cash investing and financing activities:
Dividends payable............................... $ 1,387 $ 131
Issuance and exchange of long-term debt......... 114,888
Distribution of MAI to stockholders............. $27,085
Series G dividend............................... 3,200
Shareholder settlement.......................... 6,250
Transfer of pension liability to SkyBox......... 4,305
Exchange of Series 2 Senior Secured Notes
for Series A Notes............................ 99,154
Exchange of 14.50% Subordinated Debentures
for Series B Notes............................ 125,495
Issuance of Series A Notes for options.......... 822
Exchange of Series A Notes for Series B Notes... 99,976
Issuance of promissory notes for shares
of Liggett-Ducat.............................. 1,643
F-48
98
BROOKE GROUP LTD.
BGLS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts) - (continued)
--------------------------------------------------------------
20. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
Quarterly data for the years ended December 31, 1996 and 1995 are as
follows:
December 31, September 30, June 30, March 31,
1996 1996 1996 1996
----------------- ---------------- ----------------- ----------------
Revenues........................... $122,292 $114,635 $125,213 $90,516
Gross profit....................... 55,590 56,274 61,691 43,468
Loss from continuing operations.... (22,732) (13,737) (10,672) (17,777)
Income from discontinued
operations....................... 2,385
Net loss applicable to
common shares.................... (20,347) (13,737) (10,672) (15,995)
Per share data:
Loss from continuing operations.... $(1.23) $(0.74) $(0.58) $(0.86)
====== ====== ====== ======
Income from discontinued
operations....................... $ 0.13 $ $ $
====== ======== ======= =======
Net loss applicable to
common shares.................... $(1.10) $(0.74) $(0.58) $(0.86)
====== ======== ======= =======
SHARE PRICES:
High............................. 5 3/4 6 1/4 8 7/8 10 1/8
Low.............................. 4 1/4 4 5/8 5 5/8 7 3/4
December 31, September 30, June 30, March 31,
1995 1995 1995 1995
----------------- ---------------- ----------------- ----------------
Revenues........................... $119,741 $124,100 $122,328 $95,290
Gross profit....................... 62,320 69,474 64,566 48,912
Loss from continuing operations.... (17,671) (1,124) (13,639) (12,910)
Income from discontinued
operations....................... 5,231 98 1,114 14,786
Extraordinary items................ (9,810)
Net (loss) income applicable to
common shares.................... (22,269) 1,772 (1,571) 4,945
Per share data:
(Loss) income from continuing
operations....................... $(0.97) $ 0.09 $(0.15) $(0.53)
====== ====== ====== ======
Income from discontinued
operations....................... $ 0.29 $ 0.01 $ 0.06 $ 0.80
====== ====== ====== ======
Extraordinary items................ $(0.54) $ $ $
====== ====== ====== ======
Net (loss) income applicable to
common shares.................... $(1.22) $ 0.10 $(0.09) $ 0.27
====== ====== ====== ======
SHARE PRICES:
High............................. 9 7/8 11 3/8 5 1/2 4 1/4
Low.............................. 6 5/8 4 3/8 3 1/8 3 15/64
F-49
99
BROOKE GROUP LTD.
BGLS INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(Dollars in Thousands)
Additions
------------------------
Balance at Charged to Charged to Balance
Beginning Costs and Other at End
Description of Period Expenses Accounts Deductions of Period
- ----------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1996
Allowances for:
Doubtful accounts .................... $ 921 $ 903 $ 1,074 $ 750
Cash discounts ....................... 615 13,929 14,014 530
Sales returns ........................ 5,000 5,000
-------- -------- -------- -------- -------
Total ............................. $ 6,536 $14,832 $ $ 15,088 $ 6,280
======== ======== ======== ======== =======
Provision for inventory obsolescence ....... $ 2,641 $ 1,341 $ $ 764 $ 3,218
======== ======== ======== ======== =======
YEAR ENDED DECEMBER 31, 1995
Allowances for:
Doubtful accounts .................... $ 249 $ 260 $ 692(b) $ 280 $ 921
Cash discounts ....................... 720 14,579 14,684 615
Sales returns ........................ 5,800 1,030 (800)(a) 1,030 5,000
-------- ------- ------- ------- -------
Total ............................. $ 6,769 $15,869 $ (108) $15,994 $ 6,536
======== ======= ======= ======= =======
Provision for inventory obsolescence ....... $ 1,369 $ 1,072 $ 630(b) $ 430 $ 2,641
======== ======= ======= ======= =======
YEAR ENDED DECEMBER 31, 1994
Allowances for:
Doubtful accounts .................... $ 235 $ 21 $ 7 $ 249
Cash discounts ....................... 745 12,337 12,362 720
Sales returns ........................ 6,300 $ 2,800(a) 3,300 5,800
-------- -------- -------- ------- -------
Total ............................. $ 7,280 $ 12,358 $ 2,800 $15,669 $ 6,769
======== ======== ======== ======= =======
Provision for inventory obsolescence ....... $ 1,418 $ 520 $ $ 569 $ 1,369
======== ======== ======== ======= =======
(a) Charged to net sales.
(b) Amounts include impact of consolidating Liggett-Ducat.
F-50
100
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and the
Shareholders of New Valley Corporation
We have audited the accompanying consolidated balance sheets of New Valley
Corporation and subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of operations, changes in shareholders' equity
(deficit), and cash flows for the years then ended. We have also audited the
financial statement schedule of New Valley Corporation (Schedule III - Real
Estate and Accumulated Depreciation as of December 31, 1996) listed in the index
on page 26 of this Form 10-K. These financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We did not audit the financial statements of
Thinking Machines Corporation, a consolidated subsidiary, which
statements reflect total assets constituting 3% of consolidated total assets at
December 31, 1996 and a net loss (net of minority interest therein) constituting
90% of the consolidated net loss for the year ended December 31, 1996.
Those statements were audited by other auditors whose report has been furnished
to us, and our opinion, insofar as it relates to the amounts included for
Thinking Machines Corporation, are based solely on the report of the other
auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provides a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of New Valley Corporation
and subsidiaries at December 31, 1996 and 1995, and the consolidated results of
their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles. In addition, in our opinion, the
financial statement schedule referred to above, when considered in relation to
the basic financial statements taken as a whole, presents fairly, in all
material respects, the information required to be included therein.
/s/ Coopers & Lybrand L.L.P.
--------------------------------------
COOPERS & LYBRAND L.L.P.
Miami, Florida
March 24, 1997
F-51
101
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and the
Shareholders of New Valley Corporation
In our opinion, the consolidated financial statements for the year ended
December 31, 1994, appearing under Item 14(a)(1) and (2) present fairly, in all
material respects, the results of operations and cash flows of New Valley
Corporation and its subsidiaries (the "Company"), for the year, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audit. We conducted our
audit of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for the opinion expressed above.
/s/ Price Waterhouse LLP
--------------------------------------
PRICE WATERHOUSE LLP
Morristown, New Jersey
March 24, 1995
F-52
102
NEW VALLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
--------------------
1996 1995
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 57,282 $ 51,742
Investment securities available for sale.................. 61,454 210,315
Trading securities owned.................................. 29,761 31,211
Restricted assets......................................... 2,080 22,919
Receivable from clearing brokers.......................... 23,870 13,752
Other current assets...................................... 9,273 3,546
-------- --------
Total current assets.............................. 183,720 333,485
-------- --------
Investment in real estate................................... 179,571 --
Investment securities available for sale.................... 2,716 517
Restricted assets........................................... 6,766 15,086
Long-term investments, net.................................. 13,270 29,512
Other assets................................................ 20,497 7,222
-------- --------
Total assets...................................... $406,540 $385,822
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued liabilities.................. $ 44,888 $ 27,712
Prepetition claims and restructuring accruals............. 15,526 33,392
Income taxes.............................................. 18,243 20,283
Securities sold, not yet purchased........................ 17,143 13,047
Margin loan payable....................................... -- 75,119
Current portion of notes payable and long-term
obligations............................................ 2,310 8,367
-------- --------
Total current liabilities......................... 98,110 177,920
-------- --------
Notes payable............................................... 157,941 --
Other long-term liabilities................................. 12,282 11,967
Redeemable preferred shares................................. 210,571 226,396
Commitments and contingencies
Shareholders' equity (deficit):
Cumulative preferred shares; liquidation preference of
$69,769, dividends in arrears: 1996 -- $115,944;
1995 -- $95,118........................................ 279 279
Common Shares, $.01 par value; 850,000,000 shares
authorized; 9,577,624 and 191,551,586 shares
outstanding............................................ 96 1,916
Additional paid-in capital................................ 644,789 679,058
Accumulated deficit....................................... (721,854) (714,364)
Unearned compensation on stock options.................... (731) --
Unrealized gain on investment securities, net of taxes of
$294 in 1995........................................... 5,057 2,650
-------- --------
Total shareholders' equity (deficit).............. (72,364) (30,461)
-------- --------
Total liabilities and shareholders' equity
(deficit)....................................... $406,540 $385,822
======== ========
See accompanying Notes to Consolidated Financial Statements
F-53
103
NEW VALLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
---------- ---------- -----------
Revenues:
Principal transactions, net............................... $ 28,344 $ 18,237
Commissions............................................... 17,755 9,888
Real estate leasing....................................... 23,559 --
Interest and dividends.................................... 16,951 21,047 $ 7,104
Other income.............................................. 25,345 18,558 3,277
---------- ---------- -----------
Total revenues..................................... 111,954 67,730 10,381
---------- ---------- -----------
Costs and expenses:
Employee compensation and benefits........................ 60,884 30,994 219
Interest.................................................. 17,760 2,102 643
Provision for (recovery of) restructuring charges......... (9,706) (2,044) 22,734
Write-down of long-term investments (Note 8).............. 1,001 11,790 --
Other expenses............................................ 58,270 23,222 2,550
---------- ---------- -----------
Total costs and expenses........................... 128,209 66,064 26,146
---------- ---------- -----------
Income (loss) from continuing operations before income
taxes, minority interests and extraordinary item.......... (16,255) 1,666 (15,765)
Income tax provision (benefit).............................. 300 292 (500)
Minority interests in loss from continuing operations of
consolidated subsidiary................................... 3,339 -- --
---------- ---------- -----------
Income (loss) from continuing operations before
extraordinary item........................................ (13,216) 1,374 (15,265)
Discontinued operations (Note 4):
Income (loss) from discontinued operations, net of
minority interests of $2,404 in 1996, and income taxes
of $480 in 1995 and $5,500 in 1994...................... (3,818) 4,315 79,625
Gain on disposal of discontinued operations, net of
minority interests of $1,502 in 1996, and income taxes
of $1,400 in 1995 and $52,000 in 1994................... 9,544 12,558 1,056,081
---------- ---------- -----------
Income from discontinued operations................ 5,726 16,873 1,135,706
---------- ---------- -----------
Income (loss) before extraordinary item..................... (7,490) 18,247 1,120,441
Extraordinary loss on extinguishment of debt, net of income
taxes of $3,475 (Note 17)................................. -- -- (110,500)
---------- ---------- -----------
Net income (loss)........................................... (7,490) 18,247 1,009,941
Dividend requirements on preferred shares................... (61,949) (72,303) (80,037)
Excess of carrying value of redeemable preferred shares over
cost of shares purchased.................................. 4,279 40,342 --
---------- ---------- -----------
Net income (loss) applicable to Common Shares...... $ (65,160) $ (13,714) $ 929,904
========== ========== ===========
Income (loss) per common share:
Continuing operations before extraordinary item........... $ (7.40) $ (3.20) $ (10.12)
Discontinued operations................................... .60 1.77 120.63
---------- ---------- -----------
Before extraordinary item................................. (6.80) (1.43) 110.51
Extraordinary item........................................ -- -- (11.74)
---------- ---------- -----------
Net income (loss).................................. $ (6.80) $ (1.43) $ 98.77
========== ========== ===========
Number of shares used in computation........................ 9,578,000 9,554,000 9,415,000
========== ========== ===========
Income (loss) per common share assuming full dilution:
Continuing operations before extraordinary item........... $ (7.40) $ (3.20) $ (9.00)
Discontinued operations................................... .60 1.77 107.36
---------- ---------- -----------
Before extraordinary item................................. (6.80) (1.43) 98.36
Extraordinary item........................................ -- -- (10.45)
---------- ---------- -----------
Net income (loss).................................. $ (6.80) $ (1.43) $ 87.91
========== ========== ===========
Number of shares used in computation........................ 9,578,000 9,554,000 10,578,000
========== ========== ===========
Supplemental information:
Additional interest expense, absent the Chapter 11
filing.................................................. $ 2,314 $ 46,927
========== ===========
See accompanying Notes to Consolidated Financial Statements.
F-54
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NEW VALLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNEARNED
CLASS B ADDITIONAL COMPENSATION
PREFERRED COMMON PAID-IN ACCUMULATED ON STOCK UNREALIZED
SHARES SHARES CAPITAL DEFICIT OPTIONS GAINS
--------- ------- ---------- ------------ ------------ ----------
Balance December 31, 1993.................... $279 $1,881 $755,521 $(1,742,552)
Net income................................. 1,009,941
Undeclared dividends and accretion on
redeemable preferred shares.............. (63,635)
Conversion of preferred shares.............
Exercise of stock options.................. 6 115
---- ------- -------- -----------
Balance, December 31, 1994................... 279 1,887 692,001 (732,611)
Net income................................. 18,247
Undeclared dividends and accretion on
redeemable preferred shares.............. (53,821)
Purchase of redeemable preferred shares.... 40,342
Exercise of stock options.................. 29 536
Unrealized gain on investment securities,
net of taxes............................. $2,650
---- ------- -------- ----------- ------
Balance, December 31, 1995................... 279 1,916 679,058 (714,364) 2,650
Net loss................................... (7,490)
Undeclared dividends and accretion on
redeemable preferred shares.............. (41,123)
Purchase of redeemable preferred shares.... 4,279
Effect of 1-for-20 reverse stock split..... (1,820) 1,820
Issuance of stock options.................. 755 $(755)
Compensation expense on stock option
grants................................... 24
Unrealized gain on investment securities... 2,407
---- ------- -------- ----------- ----- ------
Balance, December 31, 1996................... $279 $ 96 $644,789 $ (721,854) $(731) $5,057
==== ======= ======== =========== ===== ======
See accompanying Notes to Consolidated Financial Statements
F-55
105
NEW VALLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
-----------------------------------
1996 1995 1994
--------- --------- -----------
Cash flows from operating activities:
Net income (loss)......................................... $ (7,490) $ 18,247 $ 1,009,941
Adjustments to reconcile net income (loss) to net cash
used for operating activities:
Gain on disposal of business............................ (9,544) (12,558) (1,056,081)
Loss (income) from discontinued operations.............. 3,818 (4,315) (79,625)
Depreciation and amortization........................... 4,757 608 --
Provision for loss on long-term investments............. 1,001 11,790 --
Reversal of restructuring accruals...................... (9,706) (2,044) (318)
Extraordinary loss...................................... -- -- 110,500
Financial restructuring costs........................... -- -- 23,052
Changes in assets and liabilities, net of effects from
acquisition:
Decrease (increase) in receivables and other assets... (16,069) 11,684 (7,571)
Decrease in income taxes payable and deferred taxes... (2,040) (32,517) --
Increase (decrease) in securities sold not yet
purchased............................................ 4,096 (9,359) --
Increase (decrease) in accounts payable and accrued
liabilities.......................................... 6,437 5,223 (16,896)
--------- --------- -----------
Net cash used for continuing operations............. (24,740) (13,241) (16,998)
Net cash provided from discontinued operations...... 2,041 6,105 139,410
--------- --------- -----------
Net cash used for operating activities.............. (22,699) (7,136) 122,412
--------- --------- -----------
Cash flows from investing activities:
Sale or maturity of investment securities................. 160,088 250,129 --
Purchase of investment securities......................... (12,825) (458,017) --
Sale or liquidation of long-term investments.............. 18,292 36,109 --
Purchase of long-term investments......................... (3,051) (77,411) --
Decrease (increase) in restricted assets.................. 29,159 341,634 (367,378)
Purchase of furniture and equipment....................... (5,240) -- --
Purchase of and additions to real estate.................. (24,496) -- --
Payment of prepetition claims and restructuring
accruals................................................ (8,160) (584,397) --
Payment for acquisitions, net of cash acquired............ 1,915 (25,750) --
Collection of contract receivable......................... -- 300,000 --
Net proceeds from disposal of business.................... 10,174 17,540 467,822
--------- --------- -----------
Net cash provided from (used for) investing activities...... 165,856 (200,163) 100,444
--------- --------- -----------
Cash flows from financing activities:
Payment of preferred dividends............................ (41,419) (132,162)
Purchase of redeemable preferred shares................... (10,530) (47,761)
Increase (decrease) in margin loan payable................ (75,119) 75,119
Payment of long-term notes and other liabilities.......... (10,549) (12,890)
Exercise of stock options................................. -- 565
--------- ---------
Net cash used for financing activities...................... (137,617) (117,129)
--------- ---------
Expenses of financial restructuring......................... -- -- (23,052)
-----------
Net increase (decrease) in cash and cash equivalents........ 5,540 (324,428) 199,804
Cash and cash equivalents, beginning of year................ 51,742 376,170 176,366
--------- --------- -----------
Cash and cash equivalents, end of year...................... $ 57,282 $ 51,742 $ 376,170
========= ========= ===========
Supplemental cash flow information:
Cash paid during the year for:
Interest............................................ $ 17,482 $ 2,105 $ 476
Income taxes........................................ 2,341 33,662 882
Non-cash investing and financing activities:
Contract receivable................................. 300,000
Pension liability discharge......................... 245,000
Detail of acquisitions:
Fair value of assets acquired............................. $ 27,301 $ 59,066
Liabilities assumed....................................... 16,701 32,316
--------- ---------
Cash paid................................................. 10,600 26,750
Less cash acquired........................................ 12,515 1,000
--------- ---------
Net cash paid (received) for acquisition.................. $ (1,915) $ 25,750
========= =========
See accompanying Notes to Consolidated Financial Statements.
F-56
106
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. BASIS OF PRESENTATION
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of New Valley
Corporation and its majority owned subsidiaries (the "Company"). All significant
intercompany transactions are eliminated in consolidation.
Certain amounts in the 1994 and 1995 financial statements have been
reclassified to conform to the 1996 presentation.
NATURE OF OPERATIONS
The Company and its subsidiaries are engaged in the investment banking and
brokerage business, in the ownership and management of commercial real estate,
and in the acquisition of operating companies.
REORGANIZATION
On November 15, 1991, an involuntary petition under Chapter 11 of Title 11
of the United States Code (the "Bankruptcy Code") was commenced against the
Company in the United States Bankruptcy Court for the District of New Jersey
(the "Bankruptcy Court"). On March 31, 1993, the Company consented to the entry
of an order for relief placing it under the protection of Chapter 11 of the
Bankruptcy Code.
On November 1, 1994, the Bankruptcy Court entered an order confirming the
First Amended Joint Chapter 11 Plan of Reorganization, as amended (the "Joint
Plan"). The terms of the Joint Plan provided for, among other things, the sale
of Western Union Financial Services Company, Inc. ("FSI"), a wholly-owned
subsidiary of the Company, and certain other Company assets related to FSI's
money transfer business, payment in cash of all allowed claims, payment of
postpetition interest in the amount of $178,000 to certain creditors, a $50 per
share cash dividend to the holders of the Company's $15.00 Class A Increasing
Rate Cumulative Senior Preferred Shares ($100 Liquidation Value), $.01 par value
per share (the "Class A Senior Preferred Shares"), a tender offer by the Company
for up to 150,000 shares of the Class A Senior Preferred Shares, at a price of
$80 per share, and the reinstatement of all of the Company's equity interests.
On November 15, 1994, pursuant to the Asset Purchase Agreement, dated as of
October 20, 1994, as amended (the "Purchase Agreement"), by and between the
Company and First Financial Management Corporation ("FFMC"), FFMC purchased all
of the common stock of FSI and other assets relating to FSI's money transfer
business for $1,193,000 (the "Purchase Price"). The Purchase Price consisted of
$593,000 in cash, $300,000 representing the assumption of the Western Union
Pension Plan obligation, and $300,000 paid on January 13, 1995 for certain
intangible assets of FSI. The Purchase Agreement contained various terms and
conditions, including the escrow of $45,000 of the Purchase Price, a put option
by the Company to sell to FFMC, and a call option by FFMC to purchase, Western
Union Data Services Company, Inc., a wholly-owned subsidiary of the Company
engaged in the messaging service business (the "Messaging Services Business"),
for $20,000, exercisable during the first quarter of 1996, and various services
agreements between the Company and FFMC.
On January 18, 1995, the effective date of the Joint Plan, the Company paid
approximately $550,000 on account of allowed prepetition claims and emerged from
bankruptcy. At December 31, 1996, the Company had accrued $15,526 for unsettled
prepetition claims and restructuring accruals (see Note 17).
On October 31, 1995, the Company completed the sale of substantially all of
the assets (exclusive of certain contracts), and conveyed substantially all of
the liabilities of the Messaging Services Business to FFMC for $20,000, which
consisted of $17,540 in cash and $2,460 in cancellation of intercompany
F-57
107
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
indebtedness. The sale of the Messaging Services Business was effective as of
October 1, 1995, and the Company recognized a gain on the sale of such business
of $12,558, net of income taxes of $1,400.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Reincorporation and Reverse Stock Split. On July 29, 1996, the Company
completed its reincorporation from the State of New York to the State of
Delaware and effected a one-for-twenty reverse stock split of the Company's
Common Shares. In connection with the reverse stock split, all per share data
have been restated to reflect retroactively the reverse stock split.
Cash and Cash Equivalents. The Company considers all highly liquid
financial instruments with an original maturity of less than three months to be
cash equivalents.
Fair Value of Financial Instruments. Investments in securities and
securities sold, not yet purchased traded on a national securities exchange or
listed on NASDAQ are valued at the last reported sales prices of the reporting
period. Futures contracts are valued at their last reported sales price.
Investments in securities, principally warrants, which have exercise or holding
period restrictions, are valued at fair value as determined by the Company's
management based on the intrinsic value of the warrants discounted for such
restrictions. For cash and cash equivalents, restricted assets, receivable from
clearing brokers, and short-term loan, the carrying value of these amounts is a
reasonable estimate of their fair value. The fair value of long-term debt,
including current portion, is estimated based on current rates offered to the
Company for debt of the same maturities. The fair value of the Company's
redeemable preferred shares is based on their last reported sales price.
Investment Securities. The Company follows the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities", which requires certain investments
in debt and marketable equity securities be classified as either trading,
available for sale, or held to maturity. Trading securities are carried at fair
value, with unrealized gains and losses included in income. Investments
classified as available for sale are carried at fair value, with net unrealized
gains and losses included as a separate component of shareholders' equity
(deficit). Debt securities classified as held to maturity are carried at
amortized cost. Realized gains and losses are included in other income, except
for those relating to the Company's broker-dealer subsidiary which are included
in principal transactions revenues. The cost of securities sold is determined
based on average cost.
Restricted Assets. Restricted assets at December 31, 1996 consisted
primarily of $5,266 pledged as collateral for a $5,000 letter of credit which is
used as collateral for a long-term lease of commercial office space, and $3,275
pledged as collateral for a letter of credit which is used as collateral for an
insurance policy. At December 31, 1995, the current and noncurrent portions of
restricted assets consisted primarily of $28,200 held in escrow pursuant to the
sale of FSI to FFMC, which have been classified based on the terms of the
Purchase Agreement and the anticipated release of the escrow. Restricted assets
consisted of investments in U.S. government bonds. In 1996, the Company reached
an agreement with FFMC whereby FFMC released all of the remaining restricted
assets held in escrow. In addition, the agreement required the Company to pay
FFMC $7,000 in connection with the termination of the various service agreements
the Company had with FFMC. The Company recognized a gain on the termination of
these service agreements of $1,285, which amount is included in other income.
F-58
108
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Property and Equipment. Buildings are depreciated over periods
approximating 40 years, the estimated useful life, using the straight-line
method (see Note 7). Furniture and equipment (including equipment subject to
capital leases) is depreciated over the estimated useful lives, using the
straight-line method. Leasehold improvements are amortized on a straight-line
basis over their estimated useful lives or the lease term, if shorter. The cost
and the related accumulated depreciation are eliminated upon retirement or other
disposition and any resulting gain or loss is reflected in operations. As of
December 31, 1996 and 1995, furniture, equipment and leasehold improvements had
a carrying value of $9,225 and $1,032, respectively. Depreciation and
amortization expense was $4,757, $608 and $9,000 in 1996, 1995 and 1994,
respectively. Depreciation and amortization expense for 1994 is included in
discontinued operations.
Income Taxes. Under SFAS 109, "Accounting for Income Taxes", deferred
taxes reflect the impact of temporary differences between the amounts of assets
and liabilities recognized for financial reporting purposes and the amounts
recognized for tax purposes as well as tax credit carryforwards and loss
carryforwards. These deferred taxes are measured by applying currently enacted
tax rates. A valuation allowance reduces deferred tax assets when it is deemed
more likely than not that some portion or all of the deferred tax assets will
not be realized.
Securities Sold, Not Yet Purchased. Securities sold, not yet purchased
represent obligations of the Company to deliver a specified security at a
contracted price and thereby create a liability to repurchase the security in
the market at prevailing prices. Accordingly, these transactions involve, to
varying degrees, elements of market risk, as the Company's ultimate obligation
to satisfy the sale of securities sold, not yet purchased may exceed the amount
recognized in the consolidated balance sheet.
Real Estate Leasing Revenues. The real estate properties are being leased
to tenants under operating leases. Base rental revenue is generally recognized
on a straight-line basis over the term of the lease. The lease agreements for
certain properties contain provisions which provide for reimbursement of real
estate taxes and operating expenses over base year amounts, and in certain cases
as fixed increases in rent. In addition, the lease agreements for certain
tenants provide additional rentals based upon revenues in excess of base
amounts, and such amounts are accrued as earned. The future minimum rents on
non-cancelable operating leases at December 31, 1996 are $18,620, $18,492,
$14,827, $12,073, $9,319 for the years 1997, 1998, 1999, 2000, 2001,
respectively, and $38,246 for subsequent years.
Income (Loss) Per Common Share. Net income (loss) per common share is
based on the weighted average number of Common Shares outstanding. Net income
(loss) per common share represents net income (loss) after dividend requirements
on redeemable and non-redeemable preferred shares (undeclared) and any
adjustment for the difference between excess of carrying value of redeemable
preferred shares over the cost of the shares purchased. Net income (loss) per
common share assuming full dilution is based on the weighted average number of
Common Shares outstanding plus the additional common shares resulting from the
conversion of convertible preferred shares if such conversion was dilutive.
Recoverability of Long-Lived Assets. An impairment loss is recognized
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Beginning in 1995 with the adoption of SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of", assets are grouped and evaluated at the lowest level
for which there are identifiable cash flows that are largely independent of the
cash flows of other groups of assets. The Company considers historical
performance and future estimated results in its evaluation of potential
impairment and then compares the carrying amount of the asset to the estimated
future cash flows expected to result from the use of the asset. If the carrying
amount of the asset exceeds estimated expected undiscounted future cash flows,
the Company measures the amount of the impairment by comparing the carrying
amount of the asset to its fair value. The estimation of fair value is generally
measured by discounting expected future cash flows at the rate the Company
utilizes to evaluate potential investments. The Company estimates fair value
based on the best information available making whatever estimates, judgments and
projections are considered necessary.
F-59
109
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
New Accounting Pronouncements. In February 1997, the Financial Accounting
Standards Board issued SFAS No. 128, "Earnings Per Share". SFAS 128 specifies
new standards designed to improve the earnings per share ("EPS") information
provided in financial statements by simplifying the existing computational
guidelines, revising the disclosure requirements, and increasing the
comparability of EPS data on an international basis. Some of the changes made to
simplify the EPS computations include: (a) eliminating the presentation of
primary EPS and replacing it with basic EPS, with the principal difference being
that common stock equivalents (CSEs) are not considered in computing basic EPS,
(b) eliminating the modified treasury stock method and the three percent
materiality provision, and (c) revising the contingent share provisions and the
supplemental EPS data requirements. SFAS 128 also makes a number of changes to
existing disclosure requirements. SFAS 128 is effective for financial statements
issued for periods ending after December 15, 1997, including interim periods.
The Company has not yet determined the impact of the implementation of SFAS 128.
3. ACQUISITIONS
On May 31, 1995, the Company consummated its acquisition of Ladenburg,
Thalmann & Co. Inc. ("Ladenburg"), a registered broker-dealer and investment
bank, for $25,750, net of cash acquired. The acquisition was treated as a
purchase for financial reporting purposes and, accordingly, these consolidated
financial statements include the operations of Ladenburg from the date of
acquisition. The excess of the consideration paid over the estimated fair value
of net assets acquired of $1,342 has been recorded as goodwill to be amortized
on a straight-line basis over 15 years.
On January 10 and January 11, 1996, the Company acquired four commercial
office buildings (the "Office Buildings") and eight shopping centers (the
"Shopping Centers") for an aggregate purchase price of $183,900, consisting of
$23,900 in cash and $160,000 in non-recourse mortgage financing. In addition,
the Company has capitalized approximately $800 in costs related to the
acquisitions. The Company paid $11,400 in cash and executed four promissory
notes aggregating $100,000 for the Office Buildings. The Shopping Centers were
acquired for an aggregate purchase price of $72,500, consisting of $12,500 in
cash and $60,000 in eight promissory notes.
On January 11, 1996, the Company provided a $10,600 convertible bridge loan
to finance Thinking Machines Corporation ("Thinking Machines"), a developer and
marketer of data mining and knowledge discovery software and services. In
February 1996, the bridge loan was converted into a controlling interest in a
partnership which holds 3.3 million common shares of Thinking Machines which
represent 61.4% of Thinking Machines' outstanding common shares. The acquisition
of Thinking Machines through the conversion of the bridge loan was accounted for
as a purchase for financial reporting purposes, and accordingly, the operations
of Thinking Machines subsequent to January 31, 1996 are included in the
operations of the Company. The fair value of assets acquired, including goodwill
of $1,726, was $27,301 and liabilities assumed totaled $7,613. In addition,
minority interests in the amount of $9,088 were recognized at the time of
acquisition. Thinking Machines is also subject to uncertainties relating to,
without limitation, the development and marketing of computer products,
including customer acceptance and required funding, technological changes,
capitalization, and the ability to utilize and exploit its intellectual property
and propriety software technology.
F-60
110
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table presents unaudited pro forma and actual results of
continuing operations as if the acquisitions of Ladenburg, Thinking Machines,
and the Office Buildings and Shopping Centers, had occurred on January 1, 1995.
These pro forma results have been prepared for comparative purposes only and do
not purport to be indicative of what would have occurred had each of these
acquisitions been consummated as of such date.
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995
---------- ---------
Revenues.................................................... $ 111,954 $116,315
========= ========
Loss from continuing operations............................. $ (13,532) $ (3,715)
========= ========
Loss from continuing operations applicable to common
shares.................................................... $ (71,202) $(35,676)
========= ========
Loss from continuing operations per common share............ $ (7.43) $ (3.73)
========= ========
4. DISCONTINUED OPERATIONS
As noted above, the Company sold FSI during the fourth quarter of 1994 and
sold the Messaging Services Business effective October 1, 1995. During the
fourth quarter of 1996, Thinking Machines adopted a plan to terminate its
parallel processing computer sales and service business. Consequently, the
operating results of this segment have been classified as discontinued
operations. Thinking Machines wrote-down certain assets, principally inventory,
related to these operations to their net realizable value and recorded a charge
of $6,100 for these reserves, which is included in the loss on discontinued
operations. Accordingly, the financial statements reflect the financial position
and the results of operations of the discontinued operations of FSI, the
Messaging Services Business, and Thinking Machines separately from continuing
operations.
Summarized operating results of the discontinued operations, as shown
below, include the discontinued operations of Thinking Machines for the eleven
months ended December 31, 1996, the Messaging Services Business for the nine
months ended September 30, 1995 and the operations of FSI and Messaging Services
Business for the year ended December 31, 1994.
YEAR ENDED DECEMBER 31,
------------------------------
1996 1995 1994
------- ------- --------
Revenues.................................................... $15,017 $37,771 $489,916
======= ======= ========
Operating (loss) income..................................... $(6,222) $ 4,795 $ 85,125
======= ======= ========
Income before income taxes and minority interests........... $(6,222) $ 4,795 $ 85,125
Provision for income taxes.................................. -- 480 5,500
Minority interests.......................................... 2,404 -- --
------- ------- --------
Net (loss) income........................................... $(3,818) $ 4,315 $ 79,625
======= ======= ========
In December 1996, Thinking Machines sold part of its discontinued
operations for $4,300 in cash which resulted in the Company recording a gain on
disposal of discontinued operations of $2,386, net of minority interests of
$1,502. No material gain or loss in the disposal of Thinking Machines' remaining
discontinued operations is anticipated.
During the fourth quarter of 1996, the Company received $5,774 in cash and
$600 in a promissory note in settlement of a receivable claim originally began
by Western Union Telegraph Company. The promissory note is payable $100 per
month for six months. In addition, the Company reduced its liability related to
certain Western Union retirees by $784. The Company recorded the gain on
settlement of $6,374 and liability reduction of $784 as gain on disposal of
discontinued operations.
F-61
111
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. INVESTMENT SECURITIES AVAILABLE FOR SALE
Investment securities classified as available for sale are carried at fair
value, with net unrealized gains included as a separate component of
shareholders' equity (deficit). The Company had net realized gains on sales of
investment securities available for sale of $1,347 ($6,114 of realized gains and
$4,767 of realized losses) for the year ended December 31, 1996, and $6,736
($9,223 of realized gains and $2,487 of realized losses) for the year ended
December 31, 1995.
The components of investment securities available for sale are as follows:
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
-------- ---------- ---------- --------
1996
Marketable equity securities:
RJR Nabisco common stock.................... $ 53,372 $5,827 $ 59,199
Other marketable securities................. 2,057 674 $ 476 2,255
-------- ------ ------ --------
Total marketable equity
securities........................ 55,429 6,501 476 61,454
Marketable debt securities (long-term)........ 3,685 969 2,716
-------- ------ ------ --------
Total securities available for sale........... 59,114 6,501 1,445 64,170
Less long-term portion of investment
securities.................................. (3,685) (969) (2,716)
-------- ------ ------ --------
Investment securities -- current portion...... $ 55,429 $6,501 $ 476 $ 61,454
======== ====== ====== ========
1995
Marketable equity securities:
RJR Nabisco common stock.................... $149,005 $1,441 $150,446
Other marketable securities................. 9,147 1,667 $ 308 10,506
-------- ------ ------ --------
Total marketable equity
securities........................ 158,152 3,108 308 160,952
U.S. government securities.................... 49,219 144 -- 49,363
Marketable debt securities (long-term)........ 517 -- -- 517
-------- ------ ------ --------
Total investment securities................... 207,888 3,252 308 210,832
Less long-term portion of investment
securities.................................. (517) -- -- (517)
-------- ------ ------ --------
Investment securities -- current portion...... $207,371 $3,252 $ 308 $210,315
======== ====== ====== ========
As of December 31, 1996, the long-term portion of investment securities
available for sale consisted of marketable debt securities which mature in two
years. In December 1996, the Company acquired marketable debt securities with a
face amount of $14,900 for a cost of $3,185 of a company that was in default at
the time of purchase and is currently in default under its various debt
obligations.
As of December 31, 1996, the Company, through a wholly-owned subsidiary,
held approximately 1.7 million shares of RJR Nabisco Holdings Corp. ("RJR
Nabisco") common stock with a market value of $59,199 (cost of $53,372). On
December 31, 1995, the Company held approximately 4.9 million shares of RJR
Nabisco common stock which collateralized margin loan financing of $75,119.
On October 17, 1995, the Company entered into an agreement, as amended (the
"Agreement"), with High River Limited Partnership ("High River"), an entity
owned by Carl C. Icahn. Pursuant to the Agreement, the Company sold
approximately 1.6 million shares of RJR Nabisco common stock to High River for
an aggregate purchase price of $51,000. The Agreement also provided for the
parties to pay certain other fees to each other under certain circumstances,
including a fee to High River equal to 20% of the Company's profit on its RJR
Nabisco common stock, after certain expenses as defined in the Agreement.
F-62
112
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On December 27, 1995, the Company entered into an agreement with Brooke
Group Ltd. ("Brooke"), an affiliate of the Company, pursuant to which it agreed
to pay directly or reimburse Brooke and its subsidiaries for reasonable
out-of-pocket expenses incurred in connection with Brooke's solicitation of
consents and proxies from the shareholders of RJR Nabisco. The Company also
agreed to pay to a wholly-owned subsidiary of Brooke a fee of 20% of the net
profit received by the Company or its subsidiaries from the sale of shares of
RJR Nabisco common stock after the Company and its subsidiaries have achieved a
rate of return of 20% and after deduction of certain expenses incurred by the
Company and its subsidiaries, including the cost of the consent and proxy
solicitations and of acquiring the shares of common stock. The Company has also
agreed to indemnify Brooke and its affiliates against certain liabilities
arising out of the solicitations.
On December 28, 1995, the Company, Brooke and Liggett, a wholly-owned
subsidiary of Brooke, engaged Jefferies & Company, Inc. ("Jefferies") to act as
a financial advisor in connection with the Company's investment in RJR Nabisco
and Brooke's solicitation of consents and proxies. In connection with this
engagement, the Company paid Jefferies $1,538 and $1,500 in 1996 and 1995,
respectively. The companies also have agreed to pay Jefferies 10% of the net
profit (up to a maximum of $15,000) with respect to RJR Nabisco common stock
(including the distributions made by RJR Nabisco) held or sold by these
companies and their affiliates after deduction of certain expenses, including
the costs of the solicitations and the costs of acquiring the RJR Nabisco common
stock.
As of June 5, 1996, the Company and High River terminated the Agreement by
mutual consent. The termination leaves in effect for one year certain provisions
of the Agreement concerning payments to be made to High River in the event the
Company achieves a profit (after deducting certain expenses) on its shares of
RJR Nabisco common stock or such shares are valued at the end of such year at
higher than their purchase price or in the event the Company or Brooke engage in
certain transactions with RJR Nabisco.
The Company expensed $11,724 in 1996 and $3,879 in 1995 relating to the RJR
Nabisco investment. Included in this amount is $2,370 in out-of-pocket expenses
paid to Brooke in 1996 pursuant to the Brooke agreement. At March 14, 1997, the
Company held approximately 1,063,000 shares of RJR Nabisco common stock with a
market value of $35,997 (cost of $32,574). The Company's investment in RJR
Nabisco decreased from a $5,827 unrealized gain at December 31, 1996 to a $3,423
unrealized gain at March 14, 1997. Based on the market price of the RJR Nabisco
common stock at March 14, 1997, no amounts are payable by the Company under any
of its net profit-sharing arrangements with respect to the RJR Nabisco common
stock discussed above.
On February 29, 1996, the Company entered into a total return equity swap
transaction (the "Swap") with an unaffiliated company relating to 1,000,000
shares of RJR Nabisco common stock. The Swap was for a period of six months and
the Company realized a loss on the Swap of $7,305 for the year ended December
31, 1996.
6. TRADING SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED
The components of trading securities owned and securities sold, not yet
purchased are as follows:
DECEMBER 31, 1996 DECEMBER 31, 1995
-------------------------- --------------------------
TRADING SECURITIES TRADING SECURITIES
SECURITIES SOLD, NOT YET SECURITIES SOLD, NOT YET
OWNED PURCHASED OWNED PURCHASED
---------- ------------- ---------- -------------
Common stock............................... $21,248 $ 5,900 $21,828 $ 2,754
Equity and index options................... 6,241 11,243 6,134 10,293
Other...................................... 2,272 -- 3,249 --
------- ------- ------- -------
$29,761 $17,143 $31,211 $13,047
======= ======= ======= =======
F-63
113
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. INVESTMENT IN REAL ESTATE AND NOTES PAYABLE
The components of the Company's investment in real estate and the related
non-recourse notes payable collateralized by such real estate at December 31,
1996 are as follows:
OFFICE SHOPPING
BUILDINGS CENTERS TOTAL
--------- -------- --------
Land.................................................... $ 19,450 $16,710 $ 36,160
Buildings............................................... 92,332 54,468 146,800
Construction-in-progress................................ -- 233 233
-------- ------- --------
Total......................................... 111,782 71,411 183,193
Less accumulated depreciated............................ (2,308) (1,314) (3,622)
-------- ------- --------
Net investment in real estate................. $109,474 $70,097 $179,571
======== ======= ========
Notes payable........................................... $ 99,704 $58,547 $158,251
Current portion of notes payable........................ 310 -- 310
-------- ------- --------
Notes payable -- long-term portion...................... $ 99,394 $58,547 $157,941
======== ======= ========
At December 31, 1996, the Company's investment in real estate
collateralized four promissory notes aggregating $99,704 related to the Office
Buildings and eight promissory notes aggregating $58,547 related to the Shopping
Centers. The Office Building notes bear interest at 7.5%, require principal
amortization over approximately 40 years, with maturity dates ranging from 2006
to 2011. The Office Building notes have fixed monthly principal and interest
payments aggregating $648. Each Shopping Center note has a term of five years,
requires no principal amortization, and bears interest payable monthly at the
rate of 8% for the first two and one-half years and at the rate of 9% for the
remainder of the term.
Required principal payments on the notes payable over the next five years
are $310 in 1997, $336 in 1998, $361 in 1999, $390 in 2000, and $58,967 in 2001.
8. LONG-TERM INVESTMENTS
Long-term investments consisted of investments in the following:
DECEMBER 31, 1996 DECEMBER 31, 1995
------------------ ------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- ------- -------- -------
Limited partnerships.............................. $ 7,054 $ 7,914 $18,715 $23,200
Foreign corporations.............................. 2,000 2,000 6,000 6,000
Joint venture..................................... 3,796 3,796 3,796 3,796
Other............................................. 420 420 1,001 1,001
------- ------- ------- -------
Total................................... $13,270 $14,130 $29,512 $33,997
======= ======= ======= =======
The principal business of the limited partnerships is investing in
investment securities. The estimated fair value of the limited partnerships was
provided by the partnerships based on the indicated market values of the
underlying investment portfolio. During 1996, the Company liquidated its
position in two limited partnerships with an aggregate carrying amount of
$14,500 and recognized a gain on such liquidations of $4,201. At December 31,
1996, the Company had committed to fund one of the limited partnerships up to an
additional $17,000. At December 31, 1995, the investment in foreign corporations
was comprised of an indirect ownership of a 1.9% interest in a Brazilian
airplane manufacturer acquired for $12,698, and a 10% equity interest in a
company that owns an interest in a Russian commercial bank acquired for $2,000
(which the Company has sold subsequent to December 31, 1996 for an amount
approximating its cost). The joint venture represents an investment of $6,888 in
bonds of a foreign republic with a face amount of approximately
F-64
114
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$12,000. The joint venture partner is in the process of litigation to collect
the amounts owed under these bonds. During 1995, the Company determined that an
other than temporary impairment in the value of its Brazilian investment and its
investment in the joint venture had occurred. Accordingly, $11,790 was provided
for the Brazilian investment and for the investment in the joint venture as an
impairment charge in 1995.
During 1996, the Company sold its Brazilian investment for $8,285 in cash,
which included $1,300 as reimbursement of the Company's expenses related to this
investment. The Company, after writing down this investment by $8,698 in 1995,
recognized a gain on the sale of the Brazilian investment of $4,285 in 1996
representing a partial recovery of the impaired carrying value. In 1996, the
Company determined that an other than temporary impairment in the value of its
equity interest in a computer software company had occurred and, accordingly,
$1,001 was provided as an impairment charge.
The fair value of the Company's long-term investments approximates its
carrying amount. The Company's estimate of the fair value of its long-term
investments are subject to judgment and are not necessarily indicative of the
amounts that could be realized in the current market.
9. PENSIONS AND RETIREE BENEFITS
Ladenburg has a Profit Sharing Plan (the "Plan") for substantially all its
employees. The Plan includes two features: profit sharing and a deferred
compensation vehicle. Contributions to the profit sharing portion of the Plan
are made by Ladenburg on a discretionary basis. The deferred compensation
feature of the Plan enables non-salaried employees to invest up to 15% of their
pre-tax annual compensation. For the years ended December 31, 1996 and 1995,
employer contributions to the Plan were approximately $200 in each year,
excluding those made under the deferred compensation feature described above.
The Company maintains 401(k) plans for substantially all employees, except
those employees of Thinking Machines. These 401(k) plans allow eligible
employees to invest a percentage of their pre-tax compensation. The Company made
no discretionary contributions to these 401(k) plans in 1996.
During 1994, the Company maintained a suspended defined benefit plan and
two defined contribution plans which covered virtually all full-time employees.
Total pension costs accrued under all plans were $18,900 in 1994 and are
included in the results of the discontinued operations. Contributions were made
to the pension plans in amounts necessary to meet the minimum funding
requirements of the Employee Retirement Income Security Act of 1974 ("ERISA").
As discussed in Note 1, the liabilities related to these pension plans were
assumed by FFMC on November 15, 1994. These liabilities aggregated approximately
$245,000 at the date of sale.
Net pension cost accrued under defined benefit plans for 1994 was:
YEAR ENDED
DECEMBER 31,
1994
------------
Service cost................................................ $ 1,250
Interest cost............................................... 35,490
Return on assets............................................ (21,448)
Net amortization and deferral............................... --
--------
Net pension cost.................................. $ 15,292
========
Actuarial assumptions underlying the above data for financial statement
purposes were as follows:
1994
-------
Discounted rates............................................ 7.5-8.5%
Assumed rates of return on invested assets.................. 10.0%
F-65
115
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The change in discount rates from 7.5% to 8.5% as of March 31, 1994
resulted in a $29,200 decrease in the minimum pension liability.
The Company made contributions to its suspended defined benefit pension
plans in amounts necessary to meet minimum funding requirements under ERISA.
Cash contributions to such suspended plans were $20,300 in 1994. Pension expense
for defined contribution plans was $3,100 in 1994. Effective November 15, 1994,
sponsorship of these defined contribution plans were assumed by FFMC.
10. COMMITMENT AND CONTINGENCIES
Leases
The Company and Ladenburg are currently obligated under two noncancelable
lease agreements for office space, expiring in September 2000 and December 2015,
respectively. The following is a schedule by fiscal year of future minimum
rental payments required under the agreements that have noncancelable terms of
one year or more at December 31, 1996:
1997........................................................ $ 5,098
1998........................................................ 5,095
1999........................................................ 4,831
2000........................................................ 4,661
2001........................................................ 3,234
2002 and thereafter......................................... 52,973
-------
$75,892
=======
During 1994, the Company leased certain real properties for use as customer
service centers, corporate headquarters and sales offices. It also leased
certain data communications terminals, electronic data processing equipment and
automobiles. Effective November 15, 1994, virtually all of these leases were
assumed by FFMC as part of the sale of FSI.
Rental expense for operating leases for the years ended 1996, 1995, and
1994 was $3,914, $1,677, and $3,600, respectively. Virtually all of the rental
expense for the year ended 1994 is included in the results of the discontinued
operations.
Lawsuits
The Company is a defendant in various lawsuits and may be subject to
unasserted claims primarily in connection with its activities as a securities
broker-dealer and participation in public underwritings. These lawsuits involve
claims for substantial or indeterminate amounts and are in varying stages of
legal proceedings. In the opinion of management, after consultation with
counsel, the ultimate resolution of these matters will not have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows.
11. FEDERAL INCOME TAX
At December 31, 1996, the Company had $91,272 of unrecognized net deferred
tax assets, comprised primarily of net operating loss carryforwards, available
to offset future taxable income for federal tax purposes. A valuation allowance
has been provided against this deferred tax asset as it is presently deemed more
likely than not that the benefit of the tax asset will not be utilized. The
Company continues to evaluate the realizability of its deferred tax assets and
its estimate is subject to change. The provision for income taxes, which
represented the effect of the Alternative Minimum Tax and state income taxes,
for the three years ended December 31, 1996, 1995 and 1994, does not bear a
customary relationship with pre-tax accounting income from continuing operations
principally as a consequence of the change in the valuation allowance
F-66
116
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
relating to deferred tax assets. The provision for income taxes on continuing
operations differs from the amount of income tax determined by applying the
applicable U.S. statutory federal income tax rate (35%) to pretax income from
continuing operations as a result of the following differences:
1996 1995 1994
-------- ------- --------
(Loss) income from continuing operations................ $(13,216) $ 1,374 $(15,265)
-------- ------- --------
(Credit) provision under statutory U.S. tax rates....... (4,626) 583 (5,518)
(Decrease) increase in taxes resulting from:
Nontaxable items...................................... (119) 543 2,100
State taxes, net of Federal benefit................... 195 180 (122)
Increase (decrease) in valuation reserve................ 4,850 (1,014) 3,040
-------- ------- --------
Income tax provision (benefit)................ $ 300 $ 292 $ (500)
======== ======= ========
Income taxes associated with discontinued operations and extraordinary
items have been shown net of the utilization of the net operating loss
carryforward and the change in other deferred tax assets.
Deferred tax amounts are comprised of the following at December 31:
1996 1995
-------- --------
Deferred tax assets:
Net operating loss carryforward:
Restricted net operating loss.......................... $ 18,675 $ 21,786
Unrestricted net operating loss........................ 65,237 51,156
Other..................................................... 10,399 14,592
-------- --------
Total deferred tax assets......................... 94,311 87,534
Deferred tax liabilities:
Other..................................................... (3,039) (2,856)
-------- --------
Total deferred tax liabilities.................... (3,039) (2,856)
-------- --------
Net deferred tax assets..................................... 91,272 84,678
Valuation allowance......................................... (91,272) (84,678)
-------- --------
Net deferred taxes................................ $ -- $ --
======== ========
In December 1987, the Company consummated certain restructuring
transactions that included certain changes in the ownership of the Company's
stock. The Internal Revenue Code restricts the amount of future income that may
be offset by losses and credits incurred prior to an ownership change. The
Company's annual limitation on the use of its net operating losses is
approximately $7,700, computed by multiplying the "long-term tax exempt rate" at
the time of change of ownership by the fair market value of the company's
outstanding stock immediately before the ownership change. The limitation is
cumulative; any unused limitation from one year may be added to the limitation
of a following year. Operating losses incurred subsequent to an ownership change
are generally not subject to such restrictions.
As of December 31, 1996, the Company had consolidated net operating loss
carryforwards of approximately $208,000 for tax purposes, which expire at
various dates through 2007. Approximately $46,000 of net
F-67
117
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
operating loss carryforwards constitute pre-change losses and $162,000 of net
operating losses were unrestricted.
12. OTHER LONG-TERM LIABILITIES
The components of other long-term liabilities, excluding notes payable, are
as follows:
DECEMBER 31,
1996 1995
------------------- -------------------
LONG-TERM CURRENT LONG-TERM CURRENT
PORTION PORTION PORTION PORTION
--------- ------- --------- -------
Amount payable to FFMC pursuant to the purchase
contract........................................ $ 3,500 $6,567
Retiree and disability obligations................ $ 6,774 $1,700 8,467 1,800
Minority interests................................ 4,775 -- -- --
Other long-term liabilities....................... 733 300 -- --
------- ------ ------- ------
Total other long-term liabilities....... $12,282 $2,000 $11,967 $8,367
======= ====== ======= ======
13. REDEEMABLE PREFERRED SHARES
At December 31, 1996, the Company had authorized and outstanding 2,000,000
and 1,071,462, respectively, of its Class A Senior Preferred Shares. At December
31, 1995, there were 1,107,566 Class A Senior Preferred Shares outstanding. At
December 31, 1996 and 1995, respectively, the carrying value of such shares
amounted to $210,571 and $226,396, including undeclared dividends of $117,117
and $121,893, or $109.31 and $110.06 per share.
The holders of Class A Senior Preferred Shares are currently entitled to
receive a quarterly dividend, as declared by the Board, payable at the rate of
$19.00 per annum. The Class A Senior Preferred Shares are mandatorily redeemable
on January 1, 2003 at $100 per share plus accrued dividends. The Class A Senior
Preferred Shares were recorded at their market value ($80 per share) at December
30, 1987, the date of issuance. The discount from the liquidation value is
accreted, utilizing the interest method, as a charge to additional paid-in
capital and an increase to the recorded value of the Class A Senior Preferred
Shares, through the redemption date. As of December 31, 1996, the unamortized
discount on the Class A Senior Preferred Shares was $5,430.
In the event a required dividend or redemption is not made on the Class A
Senior Preferred Shares, no dividends shall be paid or declared and no
distribution made on any junior stock other than a dividend payable in junior
stock. If at any time six quarterly dividends payable on the Class A Senior
Preferred Shares shall be in arrears or such shares are not redeemed when
required, the number of directors will be increased by two and the holders of
the Class A Senior Preferred Shares, voting as a class, will have the right to
elect two directors until full cumulative dividends shall have been paid or
declared and set aside for payment. Such directors were designated pursuant to
the Joint Plan in November 1994.
Pursuant to the Joint Plan, the Company made an $80 per share cash tender
offer for a maximum of 150,000 Class A Senior Preferred Shares. This tender
offer expired February 17, 1995 and resulted in a payment of $4,355 for 54,445
shares tendered and increased the Company's additional paid-in capital by
$7,358.
Pursuant to the Joint Plan, the Company declared a cash dividend in
December 1994 on the Class A Senior Preferred Shares of $50 per share which was
paid in January 1995. The Company declared and paid cash dividends on the Class
A Senior Preferred Shares of $40 per share in 1996 and $50 per share in 1995.
Undeclared dividends are accrued quarterly and such accrued and unpaid dividends
shall accrue additional
F-68
118
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
dividends in respect thereof compounded monthly at the rate of 19% per annum,
both of which accruals are included in the carrying amount of redeemable
preferred shares, offset by a charge to additional paid-in capital.
On April 6, 1995, the Company's Board of Directors (the "Board") authorized
the Company to repurchase as many as 200,000 shares of its Class A Senior
Preferred Shares. The Company completed the repurchase for an aggregate
consideration of $18,674 and thereafter, on June 21, 1995, the Board authorized
the Company to repurchase as many as 300,000 additional shares. The Company
repurchased in the open market 33,000 of such shares in July 1995 and 106,400 of
such shares in September 1995 for an aggregate consideration of $24,732. During
the first quarter of 1996, the Company repurchased 72,104 of such shares for an
aggregate consideration of $10,530. The repurchase of the Class A Senior
Preferred Shares increased the Company's additional paid-in capital by $4,279
for the 72,104 shares acquired in 1996 and by $32,984 for the 339,400 shares
acquired in 1995 based on the difference between the purchase price and the
carrying values of the shares.
On November 18, 1996, the Company granted to an officer of the Company
36,000 Class A Senior Preferred Shares (the "Award Shares"). The Award Shares
are identical with all other Class A Senior Preferred Shares issued and
outstanding as of July 1, 1996, including undeclared dividends of $3,776 and
declared dividends of $1,080. The Award Shares vest one-sixth on July 1, 1997
and one-sixth on each of the five succeeding one-year anniversaries thereof
through and including July 1, 2002. The Company recorded deferred compensation
of $5,436 representing the fair market value of the Award Shares on November 18,
1996 and $3,020 of original issue discount representing the difference between
the book value of the Award Shares on November 18, 1996 and their fair market
value. The deferred compensation will be amortized over the vesting period and
the original issue discount will be accreted, utilizing the interest method,
through the redemption date, both through a charge to compensation expense.
During 1996, the Company recorded $359 in compensation expense related to the
Award Shares and, at December 31, 1996, the balance of the deferred compensation
and the unamortized discount related to the Award Shares was $8,097.
For information on Class A Senior Preferred Shares owned by Brooke, see
Note 18.
14. PREFERRED SHARES NOT SUBJECT TO REDEMPTION REQUIREMENTS
The holders of the $3.00 Class B Cumulative Convertible Preferred Shares
($25 Liquidation Value), $.10 par value per share (the "Class B Preferred
Shares"), 12,000,000 shares authorized and 2,790,776 shares outstanding as of
December 31, 1996 and 1995, are entitled to receive a quarterly dividend, as
declared by the Board, at a rate of $3.00 per annum. Undeclared dividends are
accrued quarterly at a rate of 12% per annum, and such accrued and unpaid
dividends shall accrue additional dividends in respect thereof, compounded
monthly at the rate of 12% per annum.
Each Class B Preferred Share is convertible at the option of the holder
into .41667 Common Shares based on a $25 liquidation value and a conversion
price of $60 per Common Share. During 1994, 155 Common Shares were issued upon
conversion of 372 Class B Preferred Shares.
At the option of the Company, the Class B Preferred Shares are redeemable
in the event that the closing price of the Common Shares equals or exceeds 140%
of the conversion price at a specified time prior to the redemption. If redeemed
by New Valley, the redemption price would equal $25 per share plus accrued
dividends.
In the event a required dividend is not paid on the Class B Preferred
Shares, no dividends shall be paid or declared and no distribution made on any
junior stock other than a dividend payable in junior stock. If at any time six
quarterly dividends on the Class B Preferred Shares are in arrears, the number
of directors will be increased by two, and the holders of Class B Preferred
Shares and any other classes of preferred shares similarly entitled to vote for
the election of two additional directors, voting together as a class, will have
the
F-69
119
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
right to elect two directors to serve until full cumulative dividends shall have
been paid or declared and set aside for payment. Such directors were designated
pursuant to the Joint Plan in November 1994.
No dividends on the Class B Preferred Shares have been declared since the
fourth quarter of 1988. The undeclared dividends, as adjusted for conversions of
Class B Preferred Shares into Common Shares, cumulatively amounted to $115,944
and $95,100 at December 31, 1996 and 1995, respectively. These undeclared
dividends represent $41.55 and $34.08 per share as of the end of each period. No
accrual was recorded for such undeclared dividends as the Class B Preferred
Shares are not mandatorily redeemable.
15. COMMON SHARES
Stock Warrants. In 1996, 1995 and 1994, no warrants were exercised. Stock
warrants outstanding at December 31, 1996 are as follows:
COMMON SHARES
SUBJECT TO EXERCISE
DATE ISSUED WARRANTS PRICE EXPIRATION DATE
----------- ------------- -------- -----------------
September 30, 1987.......................... 11,000 $50.00 November 13, 1997
October 30, 1987............................ 11,000 $50.00 November 13, 1997
------
22,000
======
Stock Options. Under the 1987 Stock Option Plan (the "1987 Plan"), options
to purchase up to 1,500,000 Common Shares may be offered to key employees,
including officers, and non-employee directors. Options may be issued at an
exercise price of not less than 35% of the fair market value of the Common
Shares at date of grant.
A summary of transactions during 1995 with respect to options is as
follows:
NUMBER
OF SHARES
OPTIONED PRICE RANGE
--------- -----------
Outstanding at January 1, 1995.............................. 849,298 $4.00-$9.60
Exercised................................................... (141,250) $4.00
Canceled, expired or terminated............................. (708,048) $4.00-$9.60
--------
Outstanding at December 31, 1995............................ --
========
On November 18, 1996, the Company granted an officer of the Company
nonqualified options to purchase 330,000 Common Shares at a price of $.58 per
share and 97,000 Class B Preferred Shares at a price of $1.85 per share. These
options may be exercised on or prior to July 1, 2006 and vest one-sixth on July
1, 1997 and one-sixth on each of the five succeeding anniversaries thereof
through and including July 1, 2002. The Company recognized compensation expense
of $24 in 1996 from these option grants and recorded deferred compensation of
$755 representing the intrinsic value of these options on December 31, 1996.
The Company applies APB Opinion No. 25 and related Interpretations in
accounting for its stock options. In 1995, the FASB issued SFAS No. 123,
"Accounting for Stock-Based Compensation", which, if fully adopted, changes the
methods of recognition of cost on certain stock options. Had compensation cost
for the nonqualified stock options been determined based upon the fair value at
the grant date consistent with SFAS 123, the Company's net loss in 1996 would
have been increased by $33. The fair value of the nonqualified stock options was
estimated at $1,774 using the Black-Scholes option-pricing model with the
following assumptions: volatility of 171% for the Class B Preferred Shares and
101% for the Common Shares, a risk free interest rate of 6.2%, an expected life
of 10 years, and no expected dividends or forfeiture.
F-70
120
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
16. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
The composition of accounts payable and accrued liabilities is as follows:
DECEMBER 31,
------------------
1996 1995
------- -------
Accounts payable and accrued liabilities:
Accrued compensation...................................... $10,378 $ 6,981
Excise tax payable(a)..................................... 6,000 6,000
Subordinated loan payable(b).............................. 4,000 --
Deferred rent............................................. 4,388 --
Taxes (property and miscellaneous)........................ 2,637 2,637
Accrued expenses and other liabilities.................... 17,485 10,675
Due to affiliates......................................... -- 1,419
------- -------
Total............................................. $44,888 $27,712
======= =======
- ---------------
(a) Represents an estimated liability related to excise taxes imposed on
annual contributions to retirement plans that exceed a certain percentage
of annual payroll. The Company intends to vigorously contest this tax
liability. Management's estimate of such amount is potentially subject to
material change in the near term.
(b) Represents a subordinated note payable held by Ladenburg's clearing broker.
The note paid interest at the rate of prime plus two percent and was paid
in full on January 14, 1997.
17. PREPETITION CLAIMS UNDER CHAPTER 11 AND RESTRUCTURING ACCRUALS
On January 18, 1995, approximately $550,000 of the approximately $620,000
of prepetition claims were paid pursuant to the Joint Plan. Another $54,000 of
prepetition claims and restructuring accruals have been settled and paid since
January 18, 1995. The remaining prepetition claims may be subject to future
adjustments depending on pending discussions with the various parties and the
decisions of the Bankruptcy Court.
DECEMBER 31,
------------------
1996 1995
------- -------
Restructuring accruals(a)................................... $ 9,024 $18,759
Money transfer payable(b)................................... 6,502 7,444
Accrued interest -- postpetition(c)......................... -- 3,634
Payable to connecting carriers.............................. -- 3,405
Other, miscellaneous........................................ -- 150
------- -------
Total............................................. $15,526 $33,392
======= =======
- ---------------
(a) Restructuring accruals at December 31, 1996 consisted of $7,972 of disputed
claims, primarily related to leases and former employee benefits, and
$1,052 of other restructuring accruals. In 1996, 1995 and 1994, the Company
reversed $9,706, $2,044 and $300, respectively, of prior year restructuring
accruals as a result of settlements on certain of its prepetition claims
and vacated real estate lease obligations. In 1994, the Company incurred
financial restructuring costs of $23,100 which consisted of professional
fees related to its financial restructuring.
(b) Represents unclaimed money transfers issued by the Company prior to January
1, 1990. The Company is currently in litigation in Bankruptcy Court seeking
a determination that these monies are not an obligation of the Company.
There can be no assurance as to the outcome of the litigation.
(c) Prior to the Joint Plan being confirmed on November 1, 1994, no interest
expense had been accrued on prepetition claims since December 31, 1992. The
terms of the Joint Plan provided for the payment of
F-71
121
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
postpetition interest in the amount of $178,000 of which $174,366 was paid
in 1995 and $3,634 was paid in 1996. An extraordinary loss of $110,500 was
recorded for the extinguishment of this debt in 1995.
18. RELATED PARTY TRANSACTIONS
At December 31, 1996, Brooke, a company under the control of Bennett S.
LeBow, Chairman of the Company's Board of Directors, held 3,989,710 Common
Shares (approximately 41.7% of such class), 618,326 Class A Senior Preferred
Shares (approximately 57.7% of such class), and 250,885 Class B Preferred Shares
(approximately 8.9% of such class) which represented in the aggregate 42.1% of
all voting power. Several of the other officers and directors of the Company are
also affiliated with Brooke. In 1995, the Company signed an expense sharing
agreement with Brooke pursuant to which certain lease, legal and administrative
expenses are allocated to the entity incurring the expense. The Company expensed
approximately $462 and $571 under this agreement in 1996 and 1995, respectively.
The Joint Plan imposes a number of restrictions on transactions between the
Company and certain affiliates of the Company, including Brooke, and establishes
certain restrictions on proposed investments.
On December 18, 1996, the Company loaned BGLS Inc. ("BGLS"), a wholly-owned
subsidiary of Brooke, $990 under a short-term promissory note due January 31,
1997 and bearing interest at 14%. On January 2, 1997, the Company loaned BGLS an
additional $975 under another short-term promissory note due January 31, 1997
and bearing interest at 14%. Both loans including interest were repaid on
January 31, 1997. At December 31, 1996, the loan and accrued interest thereon of
$996 was included in other current assets.
Two directors of the Company are affiliated with law firms that rendered
legal services to the Company. The Company paid these firms $4,141 and $1,083
during 1996 and 1995, respectively, for legal services. An executive officer and
director of the Company is a shareholder and registered representative in a
broker-dealer to which the Company paid $317 and $584 in 1996 and 1995,
respectively, in brokerage commissions and other income, and is also a
shareholder in an insurance company that received ordinary and customary
insurance commissions of $43 in 1996. The broker-dealer, in the ordinary course
of its business, engages in brokerage activities with Ladenburg on customary
terms. In 1995, a director of the Company received a commission of $800 on the
purchase of Ladenburg, of which $400 was paid by the Company and $400 was paid
by the selling shareholders.
In connection with their agreement to serve as Brooke nominees at RJR
Nabisco's 1996 annual meeting, two directors of the Company were each paid $30
by Brooke during the fourth quarter of 1995. In addition, Brooke also entered
into an agreement with each of the Brooke nominees whereby it agreed to
indemnify them against certain liabilities arising out of the solicitation of
proxies in support of the nominees' election at the annual meeting. As discussed
in Note 5, the Company has entered into certain other agreements with Brooke in
connection with its investment in RJR Nabisco.
During 1996, the Company entered into a court-approved Stipulation and
Agreement (the "Settlement") with Brooke and BGLS relating to Brooke's and
BGLS's application under the Federal Bankruptcy code for reimbursement of legal
fees and expenses incurred by them in connection with the Company's bankruptcy
reorganization proceedings. Pursuant to the Settlement, the Company reimbursed
to Brooke and BGLS $655 for such legal fees and expenses. The terms of the
Settlement were substantially similar to the terms of previous settlements
between the Company and other applicants who had sought reimbursement of
reorganization-related legal fees and expenses.
In connection with the acquisition of the Office Buildings by the Company
in 1996, a director of Brooke received a commission of $220 from the seller.
F-72
122
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
See Note 22 for information concerning the purchase by the Company on
January 31, 1997 of BrookeMil Ltd. from a subsidiary of Brooke.
19. OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
Ladenburg -- As a nonclearing broker, Ladenburg's transactions are cleared
by other brokers and dealers in securities pursuant to clearance agreements.
Although Ladenburg clears its customers through other brokers and dealers in
securities, Ladenburg is exposed to off-balance-sheet risk in the event that
customers or other parties fail to satisfy their obligations. In accordance with
industry practice, agency securities transactions are recorded on a
settlement-date basis. Should a customer fail to deliver cash or securities as
agreed, Ladenburg may be required to purchase or sell securities at unfavorable
market prices.
The clearing operations for Ladenburg's securities transactions are
provided by several brokers. At December 31, 1996, substantially all of the
securities owned and the amounts due from brokers reflected in the consolidated
balance sheet are positions held at and amounts due from one clearing broker.
Ladenburg is subject to credit risk should this broker be unable to fulfill its
obligations.
In the normal course of its business, Ladenburg enters into transactions in
financial instruments with off-balance-sheet risk. These financial instruments
consist of financial futures contracts and written index option contracts.
Financial futures contracts provide for the delayed delivery of a financial
instrument with the seller agreeing to make delivery at a specified future date,
at a specified price. These futures contracts involve elements of market risk in
excess of the amounts recognized in the consolidated statement of financial
condition. Risk arises from changes in the values of the underlying financial
instruments or indices. At December 31, 1996, Ladenburg had commitments to
purchase and sell financial instruments under futures contracts of $738 and
$3,120, respectively.
Equity index options give the holder the right to buy or sell a specified
number of units of a stock market index, at a specified price, within a
specified time from the seller ("writer") of the option and are settled in cash.
Ladenburg generally enters into these option contracts in order to reduce its
exposure to market risk on securities owned. Risk arises from the potential
inability of the counterparties to perform under the terms of the contracts and
from changes in the value of a stock market index. As a writer of options,
Ladenburg receives a premium in exchange for bearing the risk of unfavorable
changes in the price of the securities underlying the option. Financial
instruments have the following notional amounts as December 31, 1996:
LONG SHORT
-------- --------
Equity and index options.................................... $351,126 $406,355
Financial futures contracts................................. 561 3,120
The table below discloses the fair value at December 31, 1996 of these
commitments, as well as the average fair value during the period, based on
monthly observations.
DECEMBER 31, 1996 AVERAGE
----------------- -----------------
LONG SHORT LONG SHORT
------ ------- ------ -------
Equity and index options.............................. $6,241 $11,243 $9,967 $14,578
Financial futures contracts........................... 33 25 15 31
For the year ended December 31, 1996, the net loss arising from options and
futures contracts included in net gain on principal transactions was $6,012. The
measurement of market risk is meaningful only when related and offsetting
transactions are taken into consideration.
F-73
123
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
20. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of the Company's financial instruments have been
determined by the Company using available market information and appropriate
valuation methodologies described below. However, considerable judgment is
required to develop the estimates of fair value and, accordingly, the estimates
presented herein are not necessarily indicative of the amounts that could be
realized in a current market exchange.
DECEMBER 31, 1996 DECEMBER 31, 1995
-------------------- --------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
Financial assets:
Cash and cash equivalents....................... $ 57,282 $ 57,282 $ 51,742 $ 51,742
Investments available for sale.................. 64,170 64,170 210,832 210,832
Trading securities owned........................ 29,761 29,761 31,211 31,211
Restricted assets............................... 8,846 8,846 38,005 38,005
Receivable from clearing brokers................ 23,870 23,870 13,752 13,752
Long-term investments (Note 8).................. 13,270 14,130 29,512 33,997
Financial liabilities:
Short-term loan................................. -- -- 75,119 75,119
Notes payable................................... 158,251 158,251
Redeemable preferred shares..................... 210,571 132,908 226,396 161,704
21. BUSINESS SEGMENT INFORMATION
Prior to the acquisition of Ladenburg on May 1, 1995, virtually all of the
Company's operating businesses were reported as discontinued operations. The
following table presents certain financial information of the Company's
continuing operations before taxes and minority interests as of and for the
years ended December 31, 1996 and 1995:
SOFTWARE
BROKER- REAL ESTATE SALES AND CORPORATE
DEALER OPERATIONS SERVICES AND OTHER TOTAL
------- ----------- --------- --------- --------
1996
Revenues.............................. $71,960 $ 23,559 $ -- $ 16,435 $111,954
Operating income (loss)............... (345) (745) (8,860) (6,305) (16,255)
Identifiable assets................... 76,302 182,645 11,686 135,787 406,540
Depreciation and amortization......... 600 3,622 532 3 4,757
Capital expenditures.................. 3,644 183,193 1,596 18 188,451
1995
Revenues.............................. $40,418 $ 27,312 $ 67,730
Operating income...................... 1,475 191 1,666
Identifiable assets................... 61,175 324,647 385,822
Depreciation and amortization......... 608 -- 608
Capital expenditures.................. 372 -- 372
22. SUBSEQUENT EVENTS
Acquisition -- On January 31, 1997, the Company entered into a stock
purchase agreement (the "Purchase Agreement") with Brooke (Overseas) Ltd.
("Brooke (Overseas)"), a wholly-subsidiary of Brooke, pursuant to which the
Company acquired 10,483 shares (the "BML Shares") of the common stock of
BrookeMil Ltd. ("BML") from Brooke (Overseas) for a purchase price of $55,000,
consisting of $21,500 in
F-74
124
NEW VALLEY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
cash and a $33,500 9% promissory note of the Company (the "Note"). The BML
Shares comprise 99.1% of the outstanding shares of BML, a real estate
development company in Russia. The Note is collateralized by the BML Shares and
is payable $21,500 on June 30, 1997 and $12,000 on December 31, 1997.
BML is developing a three-phase complex on 2.2 acres of land in downtown
Moscow, for which it has a 98-year lease. In 1993, the first phase of the
project, Ducat Place I, a 46,500 sq. ft. Class-A office building, was
constructed and leased. On February 5, 1997, BML entered into an agreement to
sell Ducat Place I to one of its tenants for approximately $7,500, which
purchase price has been reduced to reflect prepayments of rent. The closing of
the sale is subject to a number of contingencies. If the transaction does not
occur by April 5, 1997, the tenant has the right to terminate the agreement and
apply its $1,000 down payment to its future rental obligations. In 1995, BML
began construction of Ducat Place II, a 150,000 sq. ft. office building. Ducat
Place II has been pre-leased to a number of leading international companies. The
third phase, Ducat Place III, is planned as a 400,000 sq. ft. mixed-use complex,
with construction anticipated to commence in 1998.
In connection with the Purchase Agreement, certain specified liabilities of
BML aggregating approximately $40,000 remained as liabilities of BML after the
purchase of the BML Shares of the Company. These liabilities include a $20,400
loan to a Russian bank for the construction of Ducat Place II. The loan, which
matures $6,100 in April 1997, $4,100 in July 1997 and $10,200 in October 1997,
is collateralized by a mortgage On Ducat Place II. In addition, the liabilities
of BML include approximately $13,800 of rents and related payments prepaid by
tenants of Ducat Place II for periods generally ranging from 15 to 18 months.
The Company is currently seeking long-term financing to replace the $20,400
construction loan related to Ducat Place II due in 1997 and for the development
of Ducat Place III. There is no assurance that the Company can obtain such
financing particularly in light of the political and economic risks associated
with investments in real estate in Russia.
On or about March 13, 1997, a shareholder derivative suit was filed against
the Company, as a nominal defendant, its directors and Brooke in the Delaware
Chancery Court, by a shareholder of the Company. The suit alleges that the
Company's purchase of the BML Shares constituted a self-dealing transaction
which involved the payment of excessive consideration by the Company. The
plaintiff seeks (i) a declaration that the Company's directors breached their
fiduciary duties, Brooke aided and abetted such breaches and such parties are
therefore liable to the Company, and (ii) unspecified damages to be awarded to
the Company. The Company's time to respond to the complaint has not yet expired.
The Company believes that the allegations are without merit, and it intends to
defend the suit vigorously.
The following unaudited pro forma condensed balance sheet gives effect to
the purchase of BML as if it had occurred on December 31, 1996.
AS REPORTED PRO FORMA
----------- ---------
Assets:
Current assets............................................ $183,720 $172,867
Investment in real estate, net............................ 179,571 258,771
Other non-current assets.................................. 43,249 49,035
-------- --------
$406,540 $480,673
======== ========
Liabilities:
Current liabilities....................................... $ 98,110 $165,394
Long-term debt............................................ 157,942 157,942
Other long-term liabilities............................... 12,282 19,130
Redeemable preferred shares................................. 210,571 210,571
Shareholders' equity (deficit).............................. (72,364) (72,364)
-------- --------
$406,540 $480,673
======== ========
F-75
125
SCHEDULE II
NEW VALLEY CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1996
(THOUSANDS)
LOSSES
ADDITIONS CHARGED TO
BALANCE AT CHARGED TO RESERVE, NET OTHER BALANCE AT
DESCRIPTION JANUARY 1, EXPENSES OF COLLECTIONS CHARGES(A) DECEMBER 31,
- ----------- ---------- ---------- -------------- ---------- ------------
Year 1994
Allowance for uncollectible
receivables....................... $8,820 $4,614 $(4,946) $(8,488) $ --
- ---------------
(a) The receivable and related allowance for uncollectible receivables were
sold to FFMC on November, 1994.
F-76
126
SCHEDULE III
NEW VALLEY CORPORATION
REAL ESTATE AND ACCUMULATED DEPRECIATION
AS OF DECEMBER 31, 1996
(AMOUNTS IN THOUSANDS)
GROSS AMOUNT CARRIED
COST AT CLOSE OF PERIOD
INITIAL COST CAPITALIZED --------------------------------
DESCRIPTION ----------------- NET OF BUILDINGS AND
AND LOCATION ENCUMBRANCES LAND BUILDING DELETIONS LAND IMPROVEMENTS TOTAL
------------ ------------ ------ -------- ----------- ------ ------------- -------
Office Buildings:
Bernards Township, NJ............... $ 43,960 $ 10,059 $ 38,432 -- $10,059 $ 38,432 $ 48,491
Bernards Township, NJ............... 10,312 2,342 9,172 -- 2,342 9,172 11,514
Troy, MI............................ 22,447 23,581 -- -- 23,581 23,581
Troy, MI............................ 22,985 7,049 21,147 -- 7,049 21,147 28,196
-------- -------- ------- ------- ------- -------- --------
99,704 19,450 92,332 -- 19,450 92,332 111,782
-------- -------- ------- ------- ------- -------- --------
Shopping Centers:
Tri Cities, WA...................... 7,957 2,981 7,692 -- 2,981 7,692 10,673
Santa Fe, NM........................ 8,073 3,233 6,423 4 3,233 6,427 9,660
Portland, OR........................ 4,669 949 6,374 $(1,725) 722 4,876 5,598
Marathon, FL........................ 3,279 624 3,299 37 624 3,336 3,960
Seattle, WA......................... 10,386 3,354 9,069 35 3,354 9,104 12,458
Charleston, WV...................... 10,886 2,510 10,516 132 2,510 10,648 13,158
Royal Palm Beach, FL................ 8,274 2,032 7,867 1 2,032 7,868 9,900
Lincoln, NE......................... 5,020 1,254 4,750 -- 1,254 4,750 6,004
-------- -------- ------- ------- ------- -------- --------
58,547 16,937 55,990 (1,516) 16,710 54,701 71,411
-------- -------- ------- ------- ------- -------- --------
Total................................. $158,251 $ 36,387 $148,322 $(1,516) $36,160 $147,033 $183,193
======== ======== ======= ======= ======= ======== ========
DESCRIPTION ACCUMULATED DATE DATE DEPRECIABLE
AND LOCATION DEPRECIATION CONSTRUCTED ACQUIRED LIFE
------------ ------------ ----------- --------- -------------
Office Buildings:
Bernards Township, NJ............... $ 961 1991 Jan 1996 40
Bernards Township, NJ............... 229 1994 Jan 1996 40
Troy, MI............................ 590 1987 Jan 1996 40
Troy, MI............................ 528 1990 Jan 1996 40
-------
$ 2,308
-------
Shopping Centers:
Tri Cities, WA...................... 192 1980 Jan 1996 40
Santa Fe, NM........................ 152 1964 Jan 1996 40
Portland, OR........................ 135 1978 Jan 1996 40
Marathon, FL........................ 79 1972 Jan 1996 40
Seatle, WA.......................... 187 1988 Jan 1996 40
Charleston, WV...................... 256 1985 Jan 1996 40
Royal Palm Beach, FL................ 195 1985 Jan 1996 40
Lincoln, NE......................... 118 1964 Jan 1996 40
-------
1,314
-------
Total................................. $ 3,622
=======
(1) The Office Buildings were acquired on January 10, 1996 and the Shopping
Centers were acquired on January 11, 1996.
(2) The amounts shown for accumulated depreciation represents depreciation
expense for the year ended December 31, 1996.
(3) The only sale occurred at the shopping center located at Portland, OR. The
sale was for $1,750 and no gain or loss was recognized on the sale.
(4) Capital expenditures were approximately $234 for the year ended
December 31, 1996.
F-77
127
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Thinking Machines Corporation:
We have audited the accompanying consolidated balance sheet of Thinking
Machines Corporation and subsidiaries as of December 31, 1996, and the related
consolidated statements of operations, stockholders' investment and cash flows
for the period February 8, 1996 (Inception) to December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
presents fairly, in all material respects, the financial position of Thinking
Machines Corporation and subsidiaries as of December 31, 1996, and the results
of their operations and their cash flows for the period February 8, 1996
(Inception) to December 31, 1996, in conformity with generally accepted
accounting principles.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 11, 1997
F-78
128
Independent Auditors' Report
The Board of Directors
MAI Systems Corporation:
We have audited the accompanying consolidated statements of operations,
shareholders' deficiency and cash flows of MAI Systems Corporation and
subsidiaries for the year ended December 31, 1994. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows of
MAI Systems Corporation and subsidiaries for the year ended December 31, 1994,
in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
- ------------------------
KPMG Peat Marwick LLP
Orange County, California
March 9, 1995
F-79
1
EXHIBIT 10.30
ADDENDUM TO CASTANO SETTLEMENT AGREEMENT
This Addendum to the Settlement Agreement entered into on March 12,
1996 (the "Agreement") is intended to modify certain terms and conditions of
the Agreement and to become a part of the Agreement effective as of the date of
the Agreement. In consideration of the promises and covenants set forth in the
Agreement and in this addendum, plaintiffs on their own behalf and on behalf of
the Settlement Class, and Brooke Group and Liggett hereby stipulate and agree
that the Agreement shall be modified as follows:
1. DEFINITIONS.
The following definition of Attorney General Actions shall be
added:
"Attorney General Actions" means the Mississippi Action, the
West Virginia Action, the Florida Action, the Massachusetts Action, and the
Louisiana Action (as defined in the Attorneys General Settlement Agreement
dated March 15, 1996) or any similar action commenced by or on behalf of the
other states against the defendants.
The definition of Future Affiliate shall be deleted in its
entirety and replaced by the following definition:
"Future Affiliate" means any entity, other than an entity with
a market share greater than thirty percent as of the date of this Agreement,
which is a defendant in CASTANO and which, with the prior written approval of
Brooke Group, subsequent to the date, and during the term, of this agreement
but prior to the fifth anniversary (subject to the $5 million payment required
by Section 6.8) of the date of this Agreement: directly or indirectly acquires
or is acquired by Liggett or Brooke Group; which directly or indirectly
acquires all or substantially all of the stock or assets of Liggett or Brooke
Group; all or substantially all of whose stock or
-1-
ADDENDUM
2
assets are directly or indirectly acquired by Brooke Group or Liggett: or
directly or indirectly merges with Brooke Group or Liggett or otherwise
combines on any basis with Liggett or Brooke Group.
6. CASTANO BOARD: CASTANO CTCIR: SETTLEMENT FUND
The following sections shall be added:
6.8. If the Brooke Group or Liggett fails to consummate a merger or
other transaction with a non-settling defendant which results in the creation
or acquisition of a future affiliate within three years of the date of the
execution of this Agreement, Liggett shall pay into the Settlement Fund $5
million.
6.9. No non-settling defendant may become a future affiliate if
after the date of this Agreement that non-settling defendant has by spinoff,
sale or other transaction substantially changed its Domestic Tobacco Operations
so as to result in a material reduction in Market Share caused by such
voluntary corporate action. No settling defendant shall sell, dispose or
transfer any of its cigarette brands or business without first causing the
acquirer, on behalf of itself and its successors, to be bound by all of the
obligations of a settling defendant hereunder as to such transferred brand or
business.
-2-
ADDENDUM
3
IN WITNESS WHEREOF the parties have executed this Addendum effective as
of March 12, 1996.
CASTANO PLAINTIFFS LEGAL COMMITTEE BROOKE GROUP LTD.
By:__________________________ By:___________________________
Don Barrett Bennett S. Lebow
Date:________________________ Date:_________________________
LIGGETT GROUP, INC.
By:__________________________ By:___________________________
Richard M. Heinmann Bennett S. Lebow
Date:________________________ Date:_________________________
By:__________________________
Russ M. Hermann
Date:________________________
-3-
ADDENDUM
1
Exhibit 99.2
LIGGETT GROUP INC.
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
2
LIGGET GROUP, INC.
INDEX TO
FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Page
-------
FINANCIAL STATEMENTS - LIGGETT GROUP INC.:
Report of Independent Accountants . . . . . . . . . . . . . . . . . . . . . . 2
Consolidated Balance Sheets as of December 31, 1996 and 1995 . . . . . . . . 3
Consolidated Statements of Operations for the years ended December 31,
1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Consolidated Statements of Stockholder's Equity (Deficit) for the years
ended December 31, 1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . 6
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . 8
FINANCIAL STATEMENTS - EVE HOLDINGS INC.:
Report of Independent Accountants . . . . . . . . . . . . . . . . . . . . . . 26
Balance Sheets as of December 31, 1996 and 1995 . . . . . . . . . . . . . . . 27
Statements of Operations for the years ended December 31, 1996,
1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Statements of Stockholder's Equity (Deficit) for the years ended
December 31, 1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . 29
Statements of Cash Flows for the years ended December 31, 1996,
1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Notes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . 31
FINANCIAL STATEMENT SCHEDULES:
Schedule II - Valuation and Qualifying Accounts . . . . . . . . . . . . . . . 33
1
3
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors
Liggett Group, Inc.
We have audited the consolidated financial statements and the financial
statement schedule of Liggett Group Inc. listed in the index on page 15 of this
Form 10-K. These financial statements and the financial statement schedule are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and the financial statement
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Liggett Group,
Inc. as of December 31, 1996 and 1995 and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
In addition, in our opinion, the financial statement schedule referred to
above, when considered in relation to the basic financial statements taken as a
whole, present fairly, in all material respects, the information required to be
included therein.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2a to the
financial statements, the Company suffered a loss of $18,372,000 for the year
ended December 31, 1996 and had net capital and working capital deficiencies of
$176,478,000 and $40,694,000, respectively, at December 31, 1996. The Company
also has a $37,500,000 principal payment due on its Senior Secured Notes on
February 1, 1998 and payment due at maturity of the Senior Secured Notes on
February 1, 1999 of $107,400,000 and the Company's revolving credit facility
(the "Facility"), which had a balance of $24,272,000 at December 31, 1996, is
due on March 8, 1998. The Company's financial resources are not sufficient to
repay the Senior Secured Notes when they become due, nor will the Company be
able to repay the Facility when it becomes due. These facts raise substantial
doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 2a.
The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.
COOPERS & LYBRAND L.L.P.
Miami, Florida
March 20, 1997
2
4
LIGGETT GROUP INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
ASSETS
December 31,
---------------------------
1996 1995
------- --------
Current assets:
Accounts receivable:
Trade, less allowances of $1,280 and $815, respectively. . . $19,316 $ 22,279
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 644 1,367
Affiliates . . . . . . . . . . . . . . . . . . . . . . . . 100 1,105
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . 50,122 54,342
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . - 3,800
Other current assets (Note 6) . . . . . . . . . . . . . . . . 1,205 1,703
------- --------
Total current assets . . . . . . . . . . . . . . . . . . 71,387 84,596
Property, plant and equipment, at cost, less accumulated
depreciation of $29,511 and $26,545, respectively . . . . . . . 18,705 18,352
Intangible assets, at cost, less accumulated amortization
of $17,388 and $15,661, respectively . . . . . . . . . . . . . 3,327 5,036
Other assets and deferred charges, at cost, less accumulated
amortization of $7,410 and $5,440, respectively . . . . . . . 4,258 5,330
------- --------
Total assets . . . . . . . . . . . . . . . . . . . . . $97,677 $113,314
======= ========
(continued)
3
5
LIGGETT GROUP INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(Dollars in thousands, except per share amounts)
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)
December 31,
-----------------------
1996 1995
--------- ---------
Current liabilities:
Current maturities of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . $ 31,807 $ 50
Cash overdraft . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 3,761
Accounts payable, principally trade . . . . . . . . . . . . . . . . . . . . . . . . . . 18,949 18,921
Accrued expenses:
Promotional . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,257 25,519
Compensation and related items . . . . . . . . . . . . . . . . . . . . . . . . . . . 682 1,175
Taxes, principally excise taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,565 7,006
Estimated allowance for sales returns . . . . . . . . . . . . . . . . . . . . . . . . 5,000 5,000
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,435 8,412
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,380 5,728
--------- -----------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 112,081 75,572
Long-term debt, less current maturities . . . . . . . . . . . . . . . . . . . . . . . . . 144,698 173,251
Non-current employee benefits and other long-term liabilities . . . . . . . . . . . . . . 17,376 19,197
Commitments and contingencies (Notes 5 and 12)
Stockholder's equity (deficit):
Redeemable preferred stock (par value $1.00 per share;
authorized 1,000 shares; no shares issued and out-
standing)(Note 14)
Common stock (par value $0.10 per share; authorized
2,000 shares; issued and outstanding 1,000 shares)
and contributed capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49,840 53,240
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (226,318) (207,946)
--------- -----------
Total stockholder's deficit . . . . . . . . . . . . . . . . . . . . . . . . . (176,478) (154,706)
--------- -----------
Total liabilities and stockholder's equity (deficit) . . . . . . . . . . . . $ 97,677 $ 113,314
========= ===========
The accompanying notes are an integral part
of these financial statements.
4
6
LIGGETT GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands)
Year Ended December 31,
-------------------------------
1996 1995 1994
-------- -------- --------
Net sales* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $401,062 $455,666 $465,676
Cost of sales* . . . . . . . . . . . . . . . . . . . . . . . . . . . 187,799 212,314 222,774
-------- -------- --------
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . 213,263 243,352 242,902
Selling, general and administrative expenses . . . . . . . . . . . . 203,214 216,806 209,306
Restructuring . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,296 1,927 -
-------- -------- --------
Operating income . . . . . . . . . . . . . . . . . . . . . . 6,753 24,619 33,596
Other income (expense):
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . 23 3 -
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . (23,901) (23,449) (21,704)
Equity in loss of affiliate . . . . . . . . . . . . . . . . . . . (1,116) - -
Sale of assets . . . . . . . . . . . . . . . . . . . . . . . . . . 3,669 - -
Miscellaneous, net . . . . . . . . . . . . . . . . . . . . . . . - 1,133 (458)
-------- -------- --------
Income (loss) before income taxes and extra-
ordinary item . . . . . . . . . . . . . . . . . . . . . . . (14,572) 2,306 11,434
Income tax provision (benefit) . . . . . . . . . . . . . . . . . . . 3,800 1,751 (5,000)
-------- -------- --------
Income (loss) before extraordinary item . . . . . . . . . . . (18,372) 555 16,434
Extraordinary loss from the early
extinguishment of debt . . . . . . . . . . . . . . . . . . . . . . - - (1,028)
-------- -------- --------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . $(18,372) $ 555 $ 15,406
======== ======== ========
*Net sales and cost of sales include federal excise taxes of $104,518, $123,420
and $131,877 respectively.
The accompanying notes are an integral part
of these financial statements.
5
7
LIGGETT GROUP INC.
STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)
(Dollars in thousands)
Common Retained Total
Stock and Earnings Stockholder's
Contributed (Accumulated Translation Equity
Capital Deficit) Adjustments (Deficit)
----------- ------------ ----------- -----------
Balance at December 31, 1993 . . . . . . . . . . . . . . . . . . . $53,240 $(223,109) $ (3) $(169,872)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . - 15,406 - 15,406
Translation adjustments . . . . . . . . . . . . . . . . . . . . - - 3 3
------- --------- --------- ---------
Balance at December 31, 1994 . . . . . . . . . . . . . . . . . . . 53,240 (207,703) - (154,463)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . - 555 - 555
Excess of investment over cost basis of
net assets acquired from indirect parent . . . . . . . . . . . - (798) - (798)
------- --------- --------- ---------
Balance at December 31, 1995 . . . . . . . . . . . . . . . . . . . 53,240 (207,946) - (154,706)
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (18,372) - (18,372)
Consideration for option to acquire affiliate
stock in excess of its net assets (Note 13) . . . . . . . . . . (3,400) - - (3,400)
------- --------- --------- ---------
Balance at December 31, 1996 . . . . . . . . . . . . . . . . . . . $49,840 $(226,318) $ - $(176,478)
======= ========= ========= =========
The accompanying notes are an integral part
of these financial statements.
6
8
LIGGETT GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
---------------------------------------------
1996 1995 1994
---------------------------------------------
Cash flows from operating activities:
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (18,372) $ 555 $ 15,406
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . 7,969 7,972 8,310
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,800 1,259 (5,781)
(Gain) loss on sale of property, plant and equipment . . . . . . . . . . . . . (3,669) (375) 114
(Gain) on retirement of notes . . . . . . . . . . . . . . . . . . . . . . . . - (1,273) (375)
Deferred finance charges and debt discount written off . . . . . . . . . . . - 160 1,404
Equity in loss of affiliate . . . . . . . . . . . . . . . . . . . . . . . . . 1,116 - -
Changes in assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,691 7,060 (3,381)
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,220 (7,658) (9,712)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (330) 7,671 (480)
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,479 (10,638) (10,474)
Non-current employee benefits . . . . . . . . . . . . . . . . . . . . . . . . (276) (225) (290)
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,461) 9,079 1,492
--------- --------- ---------
Net cash provided by (used in) operating activities . . . . . . . . . . . . 6,167 13,587 (3,767)
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sale of property, plant and equipment . . . . . . . . . . . . . . 4,424 570 78
Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,319) (1,104) (1,036)
Investment in affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,500) (800) -
--------- --------- ---------
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . (5,395) (1,334) (958)
--------- --------- ---------
Cash flows from financing activities:
Repayments of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . (254) (8,208) (1,690)
Issuance of Senior Secured Notes . . . . . . . . . . . . . . . . . . . . . . . - - 15,000
Borrowings under revolving credit facility . . . . . . . . . . . . . . . . . . 351,428 397,873 362,955
Repayments under revolving credit facility. . . . . . . . . . . . . . . . . . . (348,173) (401,703) (366,544)
Proceeds from retirement of notes . . . . . . . . . . . . . . . . . . . . . . - - 375
Deferred finance charges . . . . . . . . . . . . . . . . . . . . . . . . . . . (18) - (2,705)
Cumulative translation adjustment . . . . . . . . . . . . . . . . . . . . . . . - - 3
Changes in advances to affiliate . . . . . . . . . . . . . . . . . . . . . . . - - (4,000)
Increase (decrease) in cash overdraft . . . . . . . . . . . . . . . . . . . . . (3,755) (215) 1,331
--------- --------- ---------
Net cash provided by (used in) financing activities . . . . . . . . . . . . (772) (12,253) 4,725
--------- --------- ---------
Net change in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . - - -
Cash and cash equivalents:
Beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - -
--------- --------- ---------
End of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ - $ -
========= ========= =========
Supplemental cash flow information:
Cash payments during the period for:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 23,228 $ 23,196 $ 20,287
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 189 $ 130 $ 123
The accompanying notes are an integral part
of these financial statements.
7
9
LIGGETT GROUP INC.
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
1. Basis of Presentation
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 13).
2. Summary of Significant Accounting Policies
a. Going Concern
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 $176,478 as of December 31, 1996, is highly leveraged and
has substantial near-term debt service requirements. Due to the many risks and
uncertainties associated with the cigarette industry, the impact of recent
tobacco litigation settlements (see Note 12) and the anticipated increased
tobacco costs, there can be no assurance that the Company will be able to meet
its future earnings goals. Consequently, the Company could be in violation of
certain debt covenants, and if its lenders were to exercise acceleration rights
under the revolving credit facility or senior secured notes indentures or
refuse to lend under the revolving credit facility, the Company would not be
able to satisfy such demands or its working capital requirements.
Further, the Company's senior secured notes require a mandatory principal
redemption of $37,500 on February 1, 1998 and a payment at maturity on February
1, 1999, of $107,400, and its revolving credit facility expires on March 8,
1998 unless extended by its lenders. The revolving credit facility is
classified as a short-term debt thereby creating a working capital deficit of
approximately $40,694 at December 31, 1996.
While management currently intends to seek to refinance and/or restructure
with the Company's note holders the redemption and maturity requirements on the
Senior Secured Notes and to extend the revolving credit 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. Based
on the Company's net loss for 1996 and anticipated 1997 operating results, the
Company does not anticipate it will be able to generate sufficient cash from
operations to make such payments. If the Company is unable to refinance or
restructure such obligations, renegotiate the payment terms of the senior
secured notes, extend the revolving credit facility or otherwise make such
payments, substantially all of its long-term debt and revolving credit 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. These matters raise substantial doubt about
the Company meeting its liquidity needs and its ability to continue as a going
concern.
The consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
b. Principles of Consolidation
8
10
The consolidated financial statements include the accounts of Liggett and
its wholly-owned subsidiaries, Eve Holdings Inc. ("Eve"), Cigarette Exporting
Company of America Ltd. ("CECOA") and Carolina Tobacco Express Company
("CTEC"). Intercompany accounts and transactions have been eliminated.
c. Estimates and Assumptions
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at December 31, 1996 and 1995
and the reported amounts of revenues and expenses during the three year period
ended December 31, 1996. Significant estimates subject to material changes in
the near term include deferred tax assets, 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.
d. 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.
e. Inventories
Inventories are valued at the lower of cost (LIFO) or market. Although
portions of leaf tobacco inventories may not be used or sold within one year
because of the time required for aging, they are included in current assets,
which is common practice in the industry. It is not practicable to determine
the amount that will not be used or sold within one year.
f. Property, Plant and Equipment
Property, plant and equipment are depreciated using the straight-line
method over the estimated useful lives of the respective assets which are
twenty years for buildings and four to ten years for machinery and equipment.
Expenditures for repairs and maintenance are charged to expense as
incurred. The costs of major renewals and betterments are capitalized. The
cost and related accumulated depreciation of property, plant and equipment are
removed from the accounts upon retirement or other disposition and any
resulting gain or loss is reflected in operations.
The Company is required to review long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable, in accordance with the provisions of
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
("SFAS 121"). Accordingly, when indicators of impairment are present, the
Company evaluates the carrying value of property, plant and equipment and
intangibles in relation to the operating performance and estimates of future
discounted cash flows of the underlying business.
g. Trademarks
Trademarks are amortized using the straight-line method over twelve years.
Amortization expense for the years ended December 31, 1996, 1995 and 1994
amounted to $1,727, $1,725 and $1,722, respectively. Management periodically
reviews the carrying value of trademarks to determine whether asset values are
impaired.
9
11
h. Sales and Sales Returns
Revenue from sales is recognized upon the shipment of finished goods to
customers. The Company provides for expected sales returns, net of related
inventory cost recoveries. As Liggett does not have any other lines of
business, the Company's financial position and its results of operations could
be materially adversely affected by significant unit sales volume declines,
increased tobacco costs or reductions in the selling price of cigarettes.
i. Employee Benefits
The Company sponsors self-insured health and dental insurance plans for
all eligible employees. As a result, the expense recorded for such benefits
involves an estimate of unpaid claims as of December 31, 1996 and 1995 which
are subject to significant fluctuations in the near term.
BGLS maintains defined benefit retirement plans for substantially all of
the Company's employees. The Company records as an expense the portion of
BGLS' annual funding requirements applicable to the Company.
The Company sponsors a postretirement benefit plan and, in accordance with
Statement of Financial Accounting Standards No. 106, "Employers Accounting for
Postretirement Benefits Other than Pensions" ("SFAS 106"), records an
actuarially determined liability and charges operations for the estimated cost
of postretirement benefits for current employees and retirees.
j. Income Taxes
Under SFAS No. 109, "Accounting for Income Taxes", deferred taxes reflect
the impact of temporary differences between the amounts of assets and
liabilities recognized for financial reporting purposes and the amounts
recognized for tax purposes as well as tax credit carryforwards and loss
carryforwards. These deferred taxes are measured by applying currently enacted
tax rates. A valuation allowance reduces deferred tax assets when it is deemed
more likely than not that future taxable income will be insufficient to realize
some portion or all of the deferred tax assets.
k. Legal Costs
The Company's accounting policy is to accrue legal and other costs related
to contingencies as services are performed.
l. Fair Value of Financial Instruments
The fair values of the Company's Senior Secured Notes have been based upon
market quotations (see Note 10). The carrying amount of borrowings outstanding
under the revolving credit facility and other long-term debt is a reasonable
estimate of fair value, based upon estimated current borrowing rates for loans
with similar terms and maturities. The estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair values.
3. Changes in Accounting Estimates
In September 1995, the Company adjusted an accrual estimate recorded in
prior years which had the effect of increasing operating income by
approximately $1,214 for the year ended December 31, 1995.
As a consequence of certain litigation settlements and marketing
assessment contingencies (see Note 12), Liggett charged approximately $8,846
to operations in the fourth quarter of 1995. Possible
10
12
future payments under the litigation settlements which are based on a
percentage of Liggett's pretax income, if any, will be charged to operations
in the period that the Company's operating results are known. Liggett increased
its valuation allowance for deferred tax assets by $443 in the fourth quarter
of 1995.
Liggett increased its valuation allowance for deferred tax assets by
$3,800 in the third quarter of 1996. In December 1996, Liggett increased its
estimate of coupon promotions which resulted in a decrease in the Company's
operating income of $1,800 for the year ended December 31, 1996.
4. Concentrations of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of trade receivables.
Liggett's customers are primarily candy and tobacco distributors, the
military and large grocery, drug and convenience store chains. Liggett's
largest single customer accounted for approximately 13.7% of net sales in 1996,
and approximately 11.6% of net sales in 1995, the majority of which were in the
private label discount market segment. No single customer accounted for more
than 10% of the Company's net sales in 1994. Concentrations of credit risk with
respect to trade receivables are limited due to the large number of customers
comprising the remainder of the Company's customer base. Ongoing credit
evaluations of customers' financial condition are performed and, generally, no
collateral is required. The Company maintains reserves for potential credit
losses and such losses, in the aggregate, have not exceeded management's
estimates.
5. Inventories
Inventories consist of:
December 31,
------------------
1996 1995
------ -------
Finished goods . . . . . . . . . . . . . . . . . . . . . . $15,304 $18,240
Work-in-process . . . . . . . . . . . . . . . . . . . . . . 4,382 3,331
Raw materials . . . . . . . . . . . . . . . . . . . . . . . 31,338 24,946
Replacement parts and supplies . . . . . . . . . . . . . . 3,554 3,926
------- -------
Inventories at current cost . . . . . . . . . . . . . . . 54,578 50,443
LIFO adjustment . . . . . . . . . . . . . . . . . . . . . (4,456) 3,899
------- -------
Inventories at LIFO cost . . . . . . . . . . . . . . . . $50,122 $54,342
======= =======
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 $20,116 at December 31, 1996.
11
13
6. Assets Under Agreement for Sale
On April 9, 1996, Liggett executed a definitive agreement with the County
of Durham for the sale by Liggett to the County of Durham of certain surplus
realty in Durham, North Carolina, for a sale price of $4,300. The net book
value of those assets ($713) for which the agreement was signed is classified
as current assets on the Company's Consolidated Balance Sheet as of December
31, 1995. The transaction closed on May 14, 1996, at which time a gain of
approximately $3,600 was recognized.
On April 29, 1996, Liggett executed a definitive agreement (as amended)
with Blue Devil Ventures, a North Carolina limited liability partnership, for
the sale by Liggett to Blue Devil Ventures of certain surplus realty in Durham,
North Carolina, for a sale price of $2,200. The net book value of those assets
($309) for which the agreement was signed is classified as current assets on
the Company's Consolidated Balance Sheet as of December 31, 1996. The
transaction closed on March 11, 1997. A gain of approximately $1,600 is
expected to be recognized in 1997.
7. Property, Plant and Equipment
Property, plant and equipment consists of the following:
December 31,
------------------
1996 1995
------- -------
Land and improvements ....................................... $ 455 $ 542
Buildings ................................................... 5,848 6,011
Machinery and equipment ..................................... 41,913 38,344
------- -------
Property, plant and equipment ............................... 48,216 44,897
Less accumulated depreciation ............................... (29,511) (26,545)
------- -------
Property, plant and equipment, net .......................... $18,705 $18,352
======= =======
8. Employee Benefits Plans
Defined Benefit Retirement Plans
Prior to 1994, substantially all of Liggett's employees participated in
two noncontributory defined benefit retirement plans sponsored by BGLS. The
Company records as an expense the portion of BGLS' annual funding requirements
applicable to the Company. There was no pension expense recorded in 1996, 1995
or 1994.
12
14
Future Pension Benefits to be Funded by BGLS
Actuarial estimates of the total future minimum pension benefits to be
funded by BGLS, prior to the effect of unamortized purchase accounting
adjustments, are as follows:
1997 ...................... $ 350
1998 ...................... 350
1999 ...................... 350
2000 ...................... 250
2001 ...................... 150
Thereafter ................. 1,500
------
Total ................... $2,950
======
Postretirement Medical and Life Insurance Plans
The components of net periodic postretirement benefit cost are as follows:
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Service cost, benefits attributed to employee
service during the year .................... $ 68 $ 68 $ 63
Interest cost on accumulated postretirement
benefit obligation ......................... 829 970 1,037
Charge for special termination benefits ...... -- 489 --
Amortization of net (gain) loss .............. (92) (26) 33
----- ------- ------
Net periodic postretirement benefit expense .. $ 805 $ 1,501 $1,133
===== ======= ======
The following sets forth the actuarial present value of the Accumulated
Postretirement Benefit Obligation ("APBO") applicable to each employee group
for benefits:
December 31,
--------------
1996 1995
---- ----
Retired employees ........................................... $ 7,899 $ 8,673
Active employees - fully eligible ........................... 674 1,707
Active employees - not fully eligible ....................... 515 1,078
------- -------
APBO ........................................................ 9,088 11,458
Unrecognized net gain ....................................... 3,324 1,339
Purchase accounting valuation adjustment
related to income taxes ..................................... (1,072) (1,181)
------- -------
Postretirement liability .................................... $11,340 $11,616
======= =======
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The APBO at December 31, 1996 was determined using a discount rate of 8%
and health care cost trend rates of 4%. A 1% increase in the trend rate for
health care costs would have increased the APBO and net periodic postretirement
benefit cost by $419 and $32, respectively, for the year ended December 31,
1996. The Company does not hold any assets reserved for use in the plan.
Profit Sharing Plans
Liggett's 401(k) plans originally called for Company contributions
matching up to a 3% employee contribution, plus additional Company
contributions of up to 6% of salary based on the achievement of Company profit
objectives. Effective January 1, 1994, the Company suspended the 3% match for
the salaried employees' 401(k) Plan, but reinstated it on April 1, 1996. The
Company contributed and expensed $2,712, $900 and $420 to the 401(k) plans for
the years ended December 31, 1996, 1995 and 1994, respectively.
9. Income Taxes
Liggett's operations are included in the consolidated federal income tax
return of its indirect parent, BGL. Pursuant to a tax allocation agreement,
the Company's federal income tax provision is calculated as if the Company
filed a separate federal income tax return except that the tax sharing
agreement with BGL effectively limits the ability of the Company to carry back
losses for refunds.
The amounts provided for income taxes are as follows:
Year Ended December 31,
-------------------------------
1996 1995 1994
------- ------- -------
Current:
Federal ...................................... $ -- $ (233) $ 341
State ........................................ -- 216 227
Deferred:
Federal ...................................... 3,800 1,768 (5,568)
State ........................................ -- -- --
------- ------ -------
Total tax provision (benefit) ................ $ 3,800 $ 1,751 $(5,000)
======= ======= =======
Temporary differences which give rise to a significant portion of deferred
tax assets and liabilities are as follows:
1996 1995
---------------------- ----------------------
Deferred Tax Deferred Tax
Asset Liability Asset Liability
-------- --------- ------- ---------
Sales and product allowances ........ $ 2,504 $ -- $ 2,293 $ --
Inventory ........................... 1,269 683 816 1,256
Coupon accruals ..................... 4,492 -- 3,138 --
Property, plant and equipment ....... -- 4,890 -- 5,778
Employee benefit plan accruals ...... 5,303 -- 4,886 --
USDA marketing assessment ........... 1,681 -- 1,920 --
Tobacco litigation settlements ...... 1,229 -- 1,568 --
Difference in basis in investment ... 1,864 -- -- --
Net operating loss carryforward ..... 7,244 -- 5,022 --
Valuation allowance ................. (20,013) -- (8,809) --
Reclassifications ................... (5,573) (5,573) (7,034) (7,034)
-------- ------- ------- ---------
Total deferred taxes................. $ -- $ -- $ 3,800 $ ----
======== ======= ======= =========
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The $20,013 net valuation allowance at December 31, 1996 is composed of
$18,590 for net deferred assets arising from items which have been reflected in
book income or loss and $1,423 for deferred assets arising for basis
differences in the investments which were reflected as direct entries to
equity.
Differences between the amounts provided for income taxes and amounts
computed at the federal statutory tax rates are summarized as follows:
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Income before taxes .......................... $ (14,572) $ 2,306 $ 11,434
========= ========= =========
Federal income tax at statutory rates ........ $ (5,100) $ 807 $ 4,002
Increases (decreases) resulting from:
State income tax expense (benefit) net of
federal income tax benefit (expense) ..... (634) 216 743
Other, net ................................. (247) 285 516
Change in valuation allowance .............. 9,781 443 (10,261)
--------- --------- ---------
Total tax provision (benefit) ................ $ 3,800 $ 1,751 $ (5,000)
========= ========= =========
As of December 31, 1996, the Company's net operating loss ("NOL")
carryforward pursuant to its tax sharing agreement with BGL is approximately
$18,250 which expires from 2008 to 2011. However, if the Company were
deconsolidated from BGL, its allocable share of NOL could be significantly
different. In 1993 a valuation allowance was established for the net deferred
tax assets because of the lack of recoverability of NOLs against prior years'
taxable income and the Company's 1993 loss. The Company has adjusted its
valuation allowance in subsequent years based upon its assessment of whether it
is more likely than not that taxable income will be sufficient to realize the
deferred tax assets.
10. Long-Term Debt
Long-term debt consists of the following:
December 31,
------------
1996 1995
----------------------- ------
Estimated Carrying Carrying
Fair Value Value Value
---------- -------- --------
11.5% Senior Secured Notes due February 1, 1999
net of unamortized discount of $0, $424 and $627,
respectively .................................... $ 74,805 $ 119,688 $ 119,485
Variable Rate Series C Senior Secured Notes due
February 1, 1999 ................................ 23,402 32,279 32,279
Borrowings outstanding under revolving credit
facility ........................................ 24,272 24,272 21,017
Other ............................................ 266 266 520
--------- --------- ---------
122,745 176,505 173,301
Current portion .................................. (31,807) (31,807) (50)
--------- --------- ---------
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Amount due after one year ....................... $ 90,938 $ 144,698 $ 173,251
========= ========= =========
Maturities of long-term debt, net of discount, at December 31, 1996 are as
follows:
1997 ................................. $ 31,807
1998 ................................. 37,324
1999 ................................. 107,374
--------
Total .............................. $176,505
========
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 "Notes") require 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 Notes due on
February 1, 1999. In February 1997, $7,500 of 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 Notes are
collateralized by substantially all of the assets of the Company, excluding
inventories and receivables. Eve is a guarantor for the Notes. The Notes may
be redeemed, in whole or in part, at a price equal to 102% and 100% of the
principal amount in the years 1997 and 1998, respectively, at the option of
the Company. The Notes contain restrictions on Liggett's ability to declare or
pay cash dividends, incur additional debt, grant liens and enter into any new
agreements with affiliates, among others.
On January 31, 1994, the Company issued $22,500 of Variable Rate Series C
Senior Secured Notes (the "Series C Notes"). The Series C Notes 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%. The Company had received the necessary consents from the
required percentage of holders of its Series B Notes allowing for an aggregate
principal amount up to but not exceeding $32,850 of Series C Notes to be issued
under the Series C Notes indenture. In connection with the consents, holders
of Series B Notes received Series C Notes totaling two percent of their current
Series B Notes holdings. The total principal amount of such Series C Notes
issued was $2,842. On November 20, 1994, the Company issued the remaining
$7,508 of Series C Notes in exchange for an equal amount of Series B Notes and
cash of $375. The Series B Notes so exchanged were credited against the
mandatory redemption requirements for February 1, 1995.
BGLS purchased $4,500 of the Series C Notes which were subsequently sold.
Revolving Credit Facility
On March 8, 1994, Liggett entered into a revolving credit facility (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 $13,098 based upon eligible collateral at December 31, 1996. The
Facility is collateralized by all inventories and receivables of the Company.
Borrowings under the Facility, whose interest is calculated at a rate equal to
1.5% above Philadelphia National Bank's (the indirect parent of Congress
Financial Corporation, the lead lender) prime rate of 8.25%, bore a rate of
9.75% on December 31, 1996. The Facility contains certain financial covenants
similar to those contained in the Note 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 imposes
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requirements with respect to the Company's adjusted net worth (not to fall
below a deficit of $175,000 as computed in accordance with the agreement) and
working capital (not to fall below a deficit of $35,000 as computed in
accordance with the agreement). The Facility is classified as short-term debt
as of December 31, 1996, as it was due on March 8, 1997. On January 7, 1997,
the Facility was extended for a one-year period ending March 8, 1998.
During the first quarter of 1997, the Company violated the working capital
covenant contained in the Facility as a result of the 1998 mandatory redemption
payment on the Senior Secured Notes becoming due within one year. On March 19,
1997, the lead lender agreed to waive this covenant default, and the Facility
was amended as follows: (i) the working capital definition was changed to
exclude the Senior Secured Notes; (ii) the maximum permitted working capital
deficit was reduced to $12,000; (iii) the maximum permitted adjusted net worth
deficit was increased to $180,000; and (iv) the permitted advance rates under
the Facility for eligible inventory were reduced by five percent. (See Note
2a).
11. Operating Leases
At December 31, 1996, the Company has operating leases for building space
and computer equipment. The future minimum lease payments are as follows:
1997 .......................... $ 1,672
1998 .......................... 1,118
1999 .......................... 361
2000 .......................... 6
--------
Total ....................... $ 3,157
========
Rental expense for the years ended December 31, 1996, 1995 and 1994
amounted to approximately $3,121, $3,112 and $2,854, respectively.
12. Commitments and Contingencies
Litigation
Since 1954, Liggett and other United States cigarette manufacturers have
been named as defendants 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 actually were commenced against Brooke Group Ltd. in its former
name or in its present name or against Liggett). New cases continue to be
commenced against Liggett and other cigarette manufacturers. 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.
Liggett had been receiving certain financial and other 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, but these
benefits have recently ended. Certain joint defense arrangements, and the
financial benefits incident thereto, have also ended. The future financial
impact on the Company of the termination of this assistance and the effects of
the tobacco litigation settlements discussed below is not quantifiable at this
time.
As of March 14, 1997, there were 108 cases pending against Liggett 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, 58 are pending in the State of Florida and
19 are pending in the State of New York. The balance of individual cases are
pending in 13 different states. The next individual case scheduled for trial
where Liggett is a defendant is Chutz-Reymers v. Liggett Group Inc., et al.
United States District Court, Middle District of Florida, Tampa Division, which
is scheduled for trial in June 1997. In light of the settlements discussed
below, this case will not proceed against Liggett on that date. In addition to
the foregoing, there are four individual cases scheduled for trial in 1997
where Liggett is a defendant, although trial dates are subject to change.
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, strict liability, fraud, misrepresentation, design defect, failure
to
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warn, breach of express and implied warranties, conspiracy, concert of action,
unjust enrichment, common law public nuisance, indemnity, market share
liability, and violations of deceptive trade practices laws and antitrust
statutes. Plaintiffs also seek punitive damages in many of these cases.
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 preemption by the
Federal Cigarette Labeling and Advertising Act, as amended (the "Act").
Several representative cases are described below.
On June 24, 1992, in the 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.
On March 27, 1987, an action entitled Yvonne Rogers v. Liggett Group Inc.
et al., Superior Court, Marion County, Indiana, was filed against Liggett and
others. The plaintiff sought compensatory and punitive damages for cancer
alleged to have been caused by cigarette smoking. Trial commenced on January
31, 1995. The trial ended on February 22, 1995 when the trial court declared a
mistrial due to the jury's inability to reach a verdict. The Court directed a
verdict in favor of the defendants as to the issue of punitive damages during
the trial of this action. A second trial commenced on August 5, 1996 and, on
August 23, 1996, the jury returned a verdict in favor of the defendants. A
Notice of Appeal has been filed by the plaintiff.
On October 31, 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
the first class action commenced against the industry, and has been brought by
plaintiffs on behalf of all flight attendants that have worked or are presently
working for airlines based in the United States and who have never regularly
smoked cigarettes but allege that they have been damaged by involuntary
exposure to ETS. Plaintiffs' motion to certify the action as a class action
was granted. The suit is scheduled to go to trial on June 2, 1997. In
addition to Broin, as of March 25, 1997 there were 12 other actions which have
either been certified as a class or are seeking class certification. One of
these actions, Engle, et al. v. R. J. Reynolds Tobacco Company, et al.,
Circuit Court of the Eleventh Judicial Circuit in and for Dade County, Florida,
involving a certified class of smokers in the State of Florida, is scheduled to
commence trial on September 8, 1997.
On May 12, 1992, an action entitled Cordova v. Liggett Group Inc., et al.,
Superior Court of the State of California, City of San Diego, was filed against
Liggett and others. In her complaint, plaintiff, purportedly on behalf of the
general public, alleges that defendants have been engaged in unlawful, unfair
and fraudulent business practices by allegedly misrepresenting and concealing
from the public scientific studies pertaining to smoking and health funded by,
and misrepresenting the independence of, the Council on Tobacco Research
("CTR") and its predecessor. The complaint seeks equitable relief against the
defendants, including the imposition of a corrective advertising campaign,
restitution of funds, disgorgement of revenues and profits and the imposition
of a constructive trust. The case is presently in the discovery phase. This
action is scheduled for trial on December 12, 1997. A similar action has been
filed in the Superior Court for the State of California, City of San Francisco.
On September 10, 1993, an action entitled Sackman v. Liggett Group Inc.,
United States District Court, Eastern District of New York, was filed against
Liggett alleging as injury lung cancer. On May 25, 1996, the District Court
granted Liggett summary judgment on plaintiffs' fraud and breach of warranty
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claims. In addition, the District Court vacated the Magistrate's March 19,
1996 order compelling Liggett to produce certain CTR documents with respect to
which Liggett had asserted various privilege claims, and allowed the other
cigarette manufacturers and the CTR to intervene in order to assert their
interests and privileges with respect to those same documents. The Magistrate
Judge is presently reconsidering plaintiffs' motion to compel production of
documents. No trial date has been set.
On March 25, 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. The District Court granted plaintiffs' motion for class
certification. On May 23, 1996, the Fifth Circuit Court of Appeals decertified
the class and instructed the District Court to dismiss the class complaint.
On March 12, 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 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
BGL or Liggett fails to consummate a merger or similar transaction with another
non-settling tobacco company defendant within three years of the date of the
settlement. BGL and Liggett have the right to terminate the Castano settlement
under certain circumstances. On May 11, 1996, the Castano Plaintiffs Legal
Committee filed a motion with the District Court seeking preliminary approval
of the Castano settlement. On September 6, 1996, the Castano plaintiffs
withdrew the motion for approval of the Castano settlement.
On March 14, 1996, BGL, 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 BGL or Liggett of a combination with any defendant in Castano, exept 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 BGL $250,000 within thirty days of the more favorable agreement
and offer BGL and Liggett the option to enter into a settlement on terms at
least as favorable as those included in such other settlement. The letter
agreement further provides that during the same time period, and if the Castano
settlement agreement has not been earlier terminated by BGL in accordance
with its terms, BGL 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 BGL 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.
In February 1995, an action entitled Grady Carter, et al. v. The American
Tobacco Company, et al., Superior Court for the State of Florida, Duval County,
was filed against Liggett and others. Plaintiff sought compensatory damages,
including, but not limited to, reimbursement for medical costs. Both American
Tobacco and Liggett were subsequently dismissed from this action. On August 9,
1996, a jury returned a verdict against the remaining defendant, Brown &
Williamson Tobacco Corp., in the amount of $750. Brown & Williamson has filed
a Notice of Appeal.
On May 23, 1994, an action entitled Moore, Attorney General, ex rel State
of Mississippi v. The American Tobacco Company, et al., Chancery Court of
Jackson County, Mississippi, was commenced against Liggett and others seeking
restitution and indemnity for medical payments and expenses allegedly made or
incurred for tobacco related illnesses. In May 1994, the State of Florida
enacted legislation, effective July 1, 1994, allowing certain state authorities
or entities to commence litigation seeking recovery of certain Medicaid
payments made on behalf of Medicaid recipients as a result of diseases
(including, but not limited to, diseases allegedly caused by cigarette smoking)
allegedly caused by liable third parties (including, but not limited to, the
tobacco industry). On February 21, 1995, the State of Florida commenced an
action pursuant to this statutory scheme. In addition to the foregoing,
similar actions have been filed on behalf of 20 states and several
municipalities. The Mississippi, Florida and Texas Medicaid recovery actions
are scheduled for trial in 1997. Legislation similar to that enacted in Florida
has been introduced in the Massachusetts and New Jersey legislatures.
In certain of the pending proceedings, state and local government entities
and others seek reimbursement for Medicaid and other health care expenditures
allegedly caused by tobacco products. The claims asserted in these Medicaid
recovery actions vary. All 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 Federal Racketeer
Influenced and Corrupt Organization Act.
On March 15, 1996, Liggett and BGL entered into a settlement of
tobacco-related litigation with the Attorneys General of Florida, Louisiana,
Mississippi, West Virginia and Massachusetts. The settlement with the
Attorneys General releases Liggett and BGL from all tobacco-related claims by
these states including claims for Medicaid reimbursement and concerning sales
of cigarettes to minors. The settlement provides that additional states which
commence similar Attorney General actions may agree to be bound by the
settlement prior to six months from the date thereof (subject to extension of
such period by the settling defendants). Certain of the terms of the
settlement are summarized below.
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21
Under the settlement, the states would share an initial payment by Liggett
of $5,000 ($1,000 of which was paid on March 22, 1996, with the balance payable
over nine years and indexed and adjusted for inflation), provided that any
unpaid amount will be due sixty 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 2-1/2% of Liggett's
pretax income, subject to increase to 7-1/2% depending on the number of
additional states joining the settlement. No additional states have joined
this settlement to date. All of Liggett's payments are subject to certain
reductions provided for in the agreement. Liggett has also agreed to pay to
the states $5,000 if Liggett or BGL fails to consummate a merger or other
similar transaction with another defendant in the lawsuits with in three years
of the date of the settlement.
Settlement funds received by the Attorneys General will be used to
reimburse the states' smoking-related healthcare costs. While neither
consenting to FDA jurisdiction nor waiving their objections thereto, 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 settlement with respect to
any state participating in the settlement if any of the remaining defendants in
the litigation succeed on the merits in that state's Attorney General action.
Liggett and BGL may also terminate the settlement if they conclude that too
many states have filed Attorney General actions and have not resolved such
cases as to the settling defendants by joining in the settlement.
At December 31, 1995, the Company had accrued approximately $4,000 for the
present value of the fixed payments under the March 1996 Attorneys General
settlement, and no additional amounts have been accrued with respect to the
recent settlements discussed above. The Company cannot quantify the future
costs of the settlements at this time as the amount Liggett must pay is based,
in part, on future operating results. Possible future payments based on a
percentage of pretax income, and other contingent payments, based on occurrence
of a business combination, will be expensed when considered probable.
The Company understands that a grand jury investigation is being
conducted by the office of the United States Attorney for the Eastern District
of New York regarding possible violations of criminal law relating to the
activities of The Council for Tobacco Research - USA, Inc. The Company was a
sponsor of The Council for Tobacco Research - USA, Inc. at one time. The
Company is unable at this time to predict the outcome of this investigation.
In March 1996, Liggett received a subpoena from a Federal grand jury
sitting in the Southern District of New York. Documents have been produced in
response to the subpoena. The Company understands that this investigation has
been transferred to the main office of the United States Department of Justice.
In addition, in May 1996, Liggett was served with a subpoena by a grand jury
sitting in the District of Columbia. Liggett is in the process of responding
to that subpoena. Liggett and BGL are unable, at this time, to predict the
outcome of these investigations.
The Antitrust Division of the United States Department of Justice
investigation into the United States tobacco industry activities in connection
with product development efforts regarding "fire-safe" or self-extinguishing
cigarettes has been concluded. No action by the Department of Justice was
taken.
On March 15, 1996, an action entitled Spencer J. Volk v. Liggett Group
Inc. was filed in the United States District court for the Southern District of
New York, Case No. 96-CIV-1921, wherein the plaintiff, who was formerly
employed as Liggett's President and Chief Executive Officer, seeks recovery of
certain monies allegedly owing by Liggett to him for long-term incentive
compensation. At a September 19, 1996 hearing, the court dismissed the
plaintiff's alternate claim for recovery under a fraud theory and by order
dated March 10, 1997, the court dismissed the balance of plaintiff's claims. A
notice of appeal has been filed by the plaintiff.
Litigation is subject to many uncertainties, and it is possible that some
of aforementioned actions could be decided unfavorably against the Company.
An unfavorable outcome of a pending smoking and health case could encourage the
commencement of additional similar litigation. The Company is not able to
evaluate the effect of these developing matters on pending litigation or the
possible commencement of additional litigation.
There are several other proceedings, lawsuits and claims pending against
Liggett unrelated to product liability. Management is of the opinion that the
liabilities, if any, ultimately resulting from such
20
22
other proceedings, lawsuits and claims should not materially affect Liggett's
financial position, results of operations or cash flows.
The Company is unable to make a meaningful estimate of the amount or range
of loss that could result from an unfavorable outcome of the cases pending
against Liggett and BGL. It is possible that the Company's consolidated
financial position, results of operations and cash flows could be materially
adversely affected by an ultimate unfavorable outcome in any of such pending
litigation.
Subsequent Events:
On March 20, 1997, Liggett, together with BGL, entered into a
comprehensive settlement of tobacco litigation through parallel agreements with
the Attorneys General of 17 states and with a nationwide class of individuals
and entities that allege smoking-related claims. Liggett and BGL have now
obtained settlements with each of the 22 states have commenced suit against
them. The settlements cover all smoking-related claims, including both
addiction-based and tobacco injury claims against Liggett and BGL, brought by
the 22 states, and upon court approval, the nationwide class.
The settlement with the Attorneys General, which does not require court
approval, includes the states of Arizona, Connecticut, Hawaii, Illinois,
Indiana, Iowa, Kansas, Maryland, Michigan, Minnesota, New Jersey, New York,
Oklahoma, Texas, Utah, Washington and Wisconsin. Liggett and BGL's previous
settlements on March 15, 1996, with the Attorneys General of Florida,
Louisiana, Massachusetts, Mississippi and West Virginia remain in full force
and effect.
The settlement with the nationwide class covers all smoking-related
claims. On March 20, 1997, Liggett, BGL and plaintiffs filed the 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. 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. There are no opt out provisions in this settlement, except for
Medicaid claims by states that are not party to the Attorneys General
settlements.
Pursuant to the settlements, Liggett and BGL have agreed to cooperate
fully with the Attorneys General and the nationwide class in their lawsuits
against the tobacco industry. Liggett and BGL have 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 have 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 have
agreed to offer their employees for witness interviews and testimony at
deposition and trial. Pursuant to both settlement agreements, Liggett has 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.
Under the terms of the new settlement agreements, Liggett will pay on a
annual basis 25% of its pretax income for the next 25 years into a settlement
fund, commencing with the first full fiscal year starting after the date of the
agreements. Monies collected in the settlement fund will be overseen by a
court-appointed committee and utilized to compensate state health care programs
and settlement class members and to provide counter-market advertising. Liggett
has also 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.
Under both settlement agreements, any other tobacco company defendant,
except Philip Morris, merging or combining with Liggett or BGL, prior to the
fourth anniversary of the settlement agreements, would receive certain
settlement benefits, including limitations on potential liability and not
having to post a bond to appeal any further adverse judgment. In addition,
within 120 days following such a combination, Liggett would be required to pay
the settlement fund of $25 million. Both the Attorneys General and the
nationwide class have also agreed not to seek an injunction preventing a
defendant tobacco company combining with Liggett or BGL from spinning off any
of its affiliates which are not engaged in the domestic tobacco business.
Liggett and BGL are also entitled to certain "most favored nation"
benefits not available to the other defendant tobacco companies. In addition,
in the event of a "global" tobacco settlement enacted through Federal
legislation or otherwise, the Attorneys General and tobacco plaintiffs have
agreed to use their "best efforts" to ensure that Liggett's and BGL's liability
under such a plan should be no more onerous than under these new settlements.
On March 20, 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. On March 24, 1997, the United States District
Court for the Eastern District of Texas and state courts in Mississippi and
Illinois each issued orders enjoining these four companies from interfering
with Liggett's filing with the courts, under seal, those documents.
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Legislation and Regulation
On August 28, 1996, the Food and Drug Administration ("FDA") filed in
the Federal Register a Final 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. The FDA's stated objective and focus for its initiative is to limit
access to cigarettes by minors by measures beyond the restrictions either
mandated by existing federal, state and local laws or voluntarily implemented by
major manufacturers in the industry. Litigation has been 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. A hearing on the tobacco industry's motion
for summary judgment in that case was held on February 10, 1997 and a decision
by the Court is expected soon. The FDA's proposed restrictions, some of which
became effective as early as February 28, 1997, purport to: (i) limit access to
tobacco products and (ii) limit advertising and marketing. Management is unable
to predict whether the Final Rule will be upheld as enforceable against the
industry. Management is also unable to predict the effects of the proposed
restrictions, if implemented, on Liggett's operations, but such actions could
have an unfavorable impact thereon.
Liggett and BGL, while neither consenting to FDA jurisdiction nor
waiving their objections thereto, agreed to withdraw their objections and
opposition to the proposed rule making and to phase in compliance with certain
of the proposed interim FDA regulations. See discussions of the Castano and
Attorneys General settlements above.
In August 1996, the Commonwealth of Massachusetts enacted legislation
requiring tobacco companies to publish information regarding the ingredients in
cigarettes and other tobacco products sold in that state. Regulations adopted
pursuant to this legislation are scheduled to become effective on July 1, 1997.
On February 7, 1997, the United States District Court for the District of
Massachusetts denied an attempt to block the new legislation on the ground that
it is preempted by federal law.
In 1993, the United States Congress amended the Agricultural Adjustment
Act of 1938 to require each United States cigarette manufacturer to use at least
75% domestic tobacco in the aggregate of the
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cigarettes manufactured by it in the United States, effective January 1, 1994,
on an annualized basis or pay a domestic marketing assessment ("DMA") based
upon price differentials between foreign and domestic tobacco and, under
certain circumstances, make purchases of domestic tobacco from the tobacco
stabilization cooperatives organized by the United States government.
After an audit, the United States Department of Agriculture ("USDA")
informed Liggett that it did not satisfy the 75% domestic tobacco usage
requirement for 1994 and was subject to a DMA (the "USDA marketing assessment")
of approximately $5,500. Liggett has agreed to pay this assessment in
quarterly installments, with interest, over a five-year period, and $4,900 was
accrued for the assessment in 1995. Since the levels of domestic tobacco
inventories on hand at the tobacco stabilization organizations are below
reserve stock levels, the Company was not obligated to make purchases of
domestic tobacco from the tobacco stabilization cooperatives.
On September 13, 1995, the President of the United States issued
Presidential Proclamation 6821, which established a tariff rate quota ("TRQ")
on certain imported tobacco, imposing extremely high tariffs on imports of
flue-cured and burley tobacco in excess of certain levels which vary from
country to country. Oriental tobacco is exempt from the quota as well as all
tobacco originating from Canada, Mexico or Israel. Management believes that
the TRQ levels are sufficiently high to allow Liggett to operate without
material disruption to its business. In addition, the Presidential
Proclamation served to limit the application of the legislation establishing
the DMA to only those activities occurring in calendar year 1994.
On February 20, 1996, the United States Trade representative issued an
"advance notice of rule making" concerning how tobaccos imported under the TRQ
should be allocated. Currently, tobacco imported under the TRQ is allocated on
a "first-come, first-served" basis, meaning that entry is allowed on an open
basis to those first requesting entry in the quota year. Others in the
cigarette industry have suggested an "end-user licensing" system under which
the right to import tobacco under the quota would be initially assigned on the
basis of domestic market share. Such an approach, if adopted, could have a
material adverse effect on the Company.
In April 1994, the United States Occupational Safety and Health
Administration ("OSHA") issued a proposed rule that could ultimately ban
smoking in the workplace. Hearings were completed during 1995. OSHA has not
yet issued a final rule or a proposed revised rule. While the Company cannot
predict the outcome, some form of federal regulation of smoking in workplaces
may result.
In 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.
The Company has been involved in certain environmental proceedings, none
of which, either individually or in the aggregate, rise to the level of
materiality. The Company's current operations are conducted in accordance 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,
have not had a material effect on the capital expenditures, earnings or
competitive position of Liggett.
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In addition to the foregoing, there have been a number of other
restrictive regulatory actions, adverse political decisions and other
unfavorable developments concerning cigarette smoking and the tobacco industry,
the effects of which, at this time, the Company is not able to evaluate.
13. Related Party Transactions
On July 5, 1996, Liggett purchased 140,000 shares (19.97%) of
Liggett-Ducat Ltd.'s ("Liggett-Ducat") tobacco operations from Brooke
(Overseas) Ltd. ("BOL"), an indirect subsidiary of BGL, for $2,100.
Liggett-Ducat, which produces cigarettes in Russia, manufactured and marketed
11.4 billion cigarettes in 1996. Liggett also acquired on that date for $3,400
a ten-year option, exercisable by Liggett in whole or in part, 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%. The option fee is to be credited against
the purchase price. In addition, as part of the same transaction, Liggett had
the right on or before June 30, 1997 to acquire from BOL for $2,200 another
ten-year option on the same terms to purchase the remaining shares of
Liggett-Ducat (an additional 33%). On March 13, 1997, Liggett acquired this
option and paid BOL $2,000, and recorded a payable to BOL for the remaining
$0.2 million. Liggett accounts for its investment in Liggett-Ducat under the
equity method of accounting. Liggett's equity in the net loss of Liggett-Ducat
amounted to $1,116 for the year ended December 31, 1996. The excess of the
cost of the option over carrying amount of net assets to be acquired under the
option has been charged to stockholder's deficit.
Since October 1990, Liggett has provided certain administrative and
technical support to Liggett-Ducat in exchange for which Liggett-Ducat provides
assistance to Liggett in its pursuit of selling cigarettes in the Russian
Republic. The expenses associated with Liggett's activities amounted to $76,
$229 and $230 for the years ended December 31, 1996, 1995 and 1994,
respectively.
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
$3,160 in 1996, $3,010 in 1995 and $2,866 in 1994. This fee is in addition to
the management fee and overhead reimbursements described above.
In prior years, BGLS assumed specified Liggett liabilities from time to
time and Liggett repaid these amounts from time to time. During 1994, Liggett
satisfied all amounts due ($8,000) in full.
Since April 1994, the Company has leased equipment from BGLS for $50 per
month.
The Company acquired CTEC from its indirect parent during 1995 for $800.
The excess of cost over the carrying amount of the net assets acquired has
been charged to stockholder's equity (deficit). The
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26
effect of the accounting treatment presents the investment in CTEC at
carryover basis. Accounts receivable from affiliates relate principally to
advances for expenses paid by the Company on behalf of its affiliates.
14. Supplemental Disclosure of Non-Cash Financing and Investing Activities
During 1994, the Company issued $17,850 in Series C Notes in exchange for
Series B Notes and in connection with indenture consent of which $15,008 were
credited against the mandatory redemption of Series B Notes for February 1,
1994 and 1995, and $2,842 were recorded as deferred finance charges.
During 1994, the Company transferred equipment with a net book value of
$2,161 to BGLS in return for assumption of Liggett's note payable of $1,988.
15. Restructuring Charges
During 1996, the Company reduced its headcount by 38 positions and
recorded a $3,428 restructuring charge to operations ($132 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 1996, $1,416 was funded during 1996, leaving
$2,012 remaining to be funded in subsequent years. The Company expects to
continue its cost reduction programs.
During 1995, Liggett continued its efforts towards reducing costs by,
among other things, offering voluntary retirement programs to eligible
employees. The Company's 1995 cost reduction programs reduced the Company's
headcount by approximately 120 positions. In connection therewith, the Company
recorded charges totaling $2,548 to operating income including $621 relating to
manufacturing operations which has been charged to cost of sales.
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder
of Eve Holdings Inc.
We have audited the accompanying balance sheets of Eve Holdings Inc. (the
"Company") as of December 31, 1996 and 1995 and the related statements of
operations, stockholder's equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1996. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Eve Holdings Inc. at December
31, 1996 and 1995 and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 1996 in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2a to the
financial statements, the Company's revenues are comprised solely of royalties
and interest income from Liggett Group Inc. ("Liggett"). Liggett had a working
capital deficit of $40,694,000 and a net capital deficiency of $176,478,000 as
of December 31, 1996, is highly leveraged and has substantial near-term debt
service requirements. These matters raise substantial doubt about the
Company's ability to continue as a going concern. The financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
COOPERS & LYBRAND L.L.P.
Miami, Florida
March 27, 1997
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EVE HOLDINGS INC.
BALANCE SHEETS
(Dollars in thousands, except per share amounts)
December 31,
1996 1995
---- ----
ASSETS
Cash ............................................................ $ -- $ 8
Office equipment ................................................ 2 2
Trademarks, at cost, less accumulated amortization of
$17,294 and $15,593, respectively ............................ 3,119 4,820
--------- ---------
Total assets .......................................... $ 3,121 $ 4,830
========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)
Federal income taxes currently payable to parent ................ $ -- $ 164
Dividends payable ............................................... 4,623 2,536
Cash overdraft .................................................. 92 --
Other current liabilities ....................................... 19 --
Deferred income taxes ........................................... 1,092 1,687
--------- ---------
Total liabilities ..................................... 5,826 4,387
--------- ---------
Stockholder's equity (deficit):
Common stock (par value $1 00 per share; authorized,
issued and outstanding 100 shares) and contributed
capital .................................................... 46,548 47,653
Receivables from parent:
Note receivable - interest at 14%, due no sooner
than February 1, 1999 .................................... (44,520) (44,520)
Other ...................................................... (4,733) (2,690)
--------- ---------
Total stockholder's equity (deficit) ..................... (2,705) 443
--------- ---------
Total liabilities and stockholder's equity (deficit) ..... $ 3,121 $ 4,830
========= =========
The accompanying notes are an integral part
of these financial statements.
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EVE HOLDINGS INC.
STATEMENTS OF OPERATIONS
(Dollars in thousands)
Year Ended December 31,
------------------------------------
1996 1995 1994
---- ---- ----
Revenues:
Royalties - parent ............................ $ 8,608 $ 10,452 $ 10,647
Interest - parent ............................. 6,306 6,306 6,306
--------- --------- ---------
14,914 16,758 16,953
Expenses:
Amortization of trademarks .................... 1,701 1,702 1,701
Miscellaneous ................................. 129 93 70
--------- --------- ---------
Operating income .............................. 13,084 14,963 15,182
Interest expense ................................ 49 -- --
--------- --------- ---------
Income before income taxes .................... 13,035 14,963 15,182
Income tax provision ............................ 2,480 5,237 5,314
--------- --------- ---------
Net income .................................... $ 10,555 $ 9,726 $ 9,868
========= ========= =========
The accompanying notes are an integral part
of these financial statements.
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30
EVE HOLDINGS INC.
STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)
(Dollars in thousands)
Common
Stock and Receivables Total
Capital in Retained From Stockholder's
Excess of Par Earnings Parent Equity
------------- -------- ------ ------------
Balance at December 31, 1993 ............ $ 49,866 $ -- $ (45,219) $ 4,647
Net income ............................ -- 9,868 -- 9,868
Dividends/capital distributions ....... (1,107) (9,868) -- (10,975)
Net change in receivable from Parent .. -- -- (2,053) (2,053)
--------- --------- --------- ---------
Balance at December 31, 1994 ............ 48,759 -- (47,272) 1,487
Net income ............................ -- 9,726 -- 9,726
Dividends/capital distributions ....... (1,106) (9,726) -- (10,832)
Net change in receivable from Parent .. -- -- 62 62
--------- --------- --------- ---------
Balance at December 31, 1995 ............ 47,653 -- (47,210) 443
Net income ............................ -- 10,555 -- 10,555
Dividends/capital distributions ....... (1,105) (10,555) -- (11,660)
Net change in receivable from Parent .. -- -- (2 043) (2,043)
--------- --------- --------- ---------
Balance at December 31, 1996 ............ $ 46,548 $ -- $ (49,253) $ (2,705)
========= ========= ========= =========
The accompanying notes are an integral part
of these financial statements.
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EVE HOLDINGS INC.
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Cash flows from operating activities:
Net income .................................................. $ 10,555 $ 9,726 $ 9,868
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ............................. 1,701 1,703 1,701
Deferred income taxes ..................................... (595) (596) (595)
Changes in assets and liabilities:
Federal income taxes currently payable to parent ......... (164) 157 (691)
Other current liabilities ................................. 19 -- --
--------- --------- ---------
Net cash provided by operating activities ............... 11,516 10,990 10,283
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures ........................................ -- -- (3)
--------- --------- ---------
Net cash used in investing activities ................... -- -- (3)
--------- --------- ---------
Cash flows from financing activities:
Increase in cash overdraft .................................. 92 -- --
Dividends/capital distributions ............................. (9,573) (11,046) (8,225)
Increase (decrease) in due from parent ...................... (2,043) 62 (2,053)
--------- --------- ---------
Net cash used in financing activities ................... (11,524) (10,984) (10,278)
--------- --------- ---------
Net (decrease) increase in cash ............................... (8) 6 2
Cash:
Beginning of period ......................................... 8 2 --
--------- --------- ---------
End of period ............................................... $ 0 $ 8 $ 2
========= ========= =========
Supplemental cash flow information:
Payments of income taxes through receivable from parent ..... $ 5,159 $ 5,676 $ 6,600
========= ========= =========
Dividends/capital distributions declared but not paid ....... $ 4,623 $ 2,536 $ 2,750
========= ========= =========
The accompanying notes are an integral part
of these financial statements.
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EVE HOLDINGS INC.
Notes to Financial Statements
(Dollars in thousands, except per share amounts)
1. The Company
Eve Holdings Inc. ("Eve" or the "Company") is a wholly-owned subsidiary of
Liggett Group Inc. ("Liggett"). Eve's predecessor, Chesterfield Assets Inc.,
was organized in March 1987. 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 of $296, 544, $332,246 and $333,799
for the years ended December 31, 1996, 1995 and 1994, respectively. Generally,
royalties are earned based on a rate of either 2% of sales for generic product
trademarks and 5% of sales for branded product trademarks. In recent fiscal
years, Liggett has experienced greater growth in the sales of generic rather
than branded products resulting in a lower overall royalty rate. The
Trademarks are pledged as collateral for borrowings under the Liggett notes
(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 $40,694 and a net capital
deficiency of $176,478 as of December 31, 1996, is highly leveraged and has
substantial near-term debt service requirements. 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. Basis of Presentation
On February 11, 1992, Eve consummated an Agreement and Plan of Merger (the
"Merger Agreement") with LGC Corp. (a wholly-owned subsidiary of Liggett)
whereby the operations of LGC Corp., consisting primarily of holding an
unsecured $44,250 note receivable (bearing interest at 14%, due November 2,
1996) from Liggett and related interest thereon, were merged into those of
Eve. The merger was accounted for at historical cost similar to that in
pooling of interests accounting. On March 7, 1994, Liggett and Eve agreed to
extend the due date of the note to no sooner than February 1, 1999 from
November 2, 1996. All other terms of the note remained the same.
c. 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.
d. Trademarks
Trademarks are amortized using the straight-line method over 12 years.
Management periodically reviews the carrying value of trademarks to determine
whether asset values are impaired.
e. 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 and
disclosure of contingent assets and liabilities and the reported amounts of
revenues and expenses. Actual results could differ from those estimates.
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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.
4. Income Taxes
Eve's operations are included in the consolidated federal income tax
return of its indirect parent, Brooke Group Ltd. ("Brooke"). Eve's federal
income tax provisions are calculated as if it filed a separate federal income
tax return. Statement of Financial Accounting Standards No. 109 "Accounting for
Income Taxes" ("SFAS 109") requires that deferred taxes be recorded under the
liability method.
The amounts provided for income taxes are as follows:
1996 1995 1994
---- ---- ----
Current:
U.S. Federal ........................ $2,883 $5,832 $5,909
State ............................... 192 -- --
------ ------ ------
Deferred:
U.S. Federal......................... (595) (595) (595)
State................................ - - -
------ ------ ------
Total provision for continuing operations $2,480 $5,237 $5,314
====== ====== ======
Eve's deferred tax liability relates entirely to the difference in
the basis of the Trademarks for book and tax purposes. As permitted in SFAS 109,
Eve has not adjusted the basis of the Trademarks that were previously adjusted
to net of tax amounts to be consistent with the accounting treatment adopted by
Liggett.
Differences between the amounts provided for income taxes and amounts
computed at the federal statutory rate are summarized as follows:
1996 1995 1994
---- ---- ----
Income from continuing operations
before income taxes ...................... $ 13,035 $ 14,963 $ 15,182
-------- -------- --------
Federal income tax (benefit) at statutory rate 4,563 5,237 5,314
Decreases resulting from:
Exclusion of interest income
between related parties................. (2,207) -- --
State income taxes, net of federal ....... 124 -- --
-------- -------- --------
Total ........................................ $ 2,480 $ 5,237 $ 5,314
======== ======== ========
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.
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LIGGETT GROUP INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(Dollars in thousands)
Additions
---------
Balance at Charged to Charged to Balance
Beginning Costs and Net at End
of Period Expenses Sales Deductions of Period
--------- -------- ----- ---------- ---------
Year ended December 31, 1996
Allowances for:
Doubtful accounts ................. $ 200 $ 903 $ -- $ 353 (a) $ 750
Cash discounts .................... 615 13,929 -- 14,014 (b) 530
-------- -------- -------- -------- --------
Total ........................... $ 815 $ 14,832 -- $ 14,367 $ 1,280
======== ======== ======== ======== ========
Sales returns allowance ............ $ 5,000 $ -- $ -- $ -- (c) $ 5,000
======== ======== ======== ======== ========
Provision for inventory obsolescence $ 2,069 $ 1,341 $ -- $ 192 (d) $ 3,218
======== ======== ======== ======== ========
Year ended December 31, 1995
Allowances for:
Doubtful accounts ................. $ 249 $ 231 $ -- $ 280 (a) $ 200
Cash discounts .................... 720 14,579 -- 14,684 (b) 615
-------- -------- -------- -------- --------
Total ........................... $ 969 $ 14,810 -- $ 14,964 $ 815
======== ======== ======== ======== ========
Sales returns allowance ............ $ 5,800 $ 1,030 $ (800) $ 1,030 (c) $ 5,000
======== ======== ======== ======== ========
Provision for inventory obsolescence $ 1,369 $ 911 $ -- $ 211 (d) $ 2,069
======== ======== ======== ======== ========
Year ended December 31, 1994
Allowances for:
Doubtful accounts ................. $ 235 $ 21 $ -- $ 7 (a) $ 249
Cash discounts .................... 745 12,337 -- 12,362 (b) 720
-------- -------- -------- -------- --------
Total ........................... $ 980 $ 12,358 $ 12,369 $ 969
======== ======== ======== ======== ========
Sales returns allowance ............ $ 6,300 $ -- $ 2,800 $ 3,300 (c) $ 5,800
======== ======== ======== ======== ========
Provision for inventory obsolescence $ 1,418 $ 520 $ -- $ 569 (d) $ 1,369
======== ======== ======== ======== ========
(a) Represents uncollectible accounts written off.
(b) Represents cash discounts taken.
(c) Represents adjustments to lower the allowance based on revised estimates of
sales returns by management.
(d) Represents inventory written off, disposed of, or written down to
lower of cost or market value.
33
