2014 Q3 10Q


 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended September 30, 2014
 

VECTOR GROUP LTD.
(Exact name of registrant as specified in its charter)

Delaware
1-5759
65-0949535
(State or other jurisdiction of incorporation
Commission File Number
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 

4400 Biscayne Boulevard
Miami, Florida 33137
305/579-8000
(Address, including zip code and telephone number, including area code,
of the principal executive offices)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes o No

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
x Large accelerated filer
o  Accelerated filer
o  Non-accelerated filer
o  Smaller reporting company
 
 
(Do not check if a smaller reporting company)
 

Indicate by check mark whether the Registrant is a shell company as defined in Rule 12b-2 of the Exchange Act.
o Yes x No

At October 31, 2014, Vector Group Ltd. had 109,125,587 shares of common stock outstanding.

 



VECTOR GROUP LTD.

FORM 10-Q

TABLE OF CONTENTS

 
Page
PART I. FINANCIAL INFORMATION
 
 
 
Item 1. Vector Group Ltd. Condensed Consolidated Financial Statements (Unaudited):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


1
VECTOR GROUP LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

 
September 30,
2014
 
December 31,
2013
ASSETS:
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
380,416

 
$
234,466

Investment securities available for sale
333,883

 
172,534

Accounts receivable - trade, net
13,607

 
12,159

Inventories
100,874

 
93,496

Deferred income taxes
25,540

 
50,479

Income taxes receivable, net
14,812

 
—

Restricted assets
2,780

 
1,785

Other current assets
34,226

 
23,392

Total current assets
906,138

 
588,311

Property, plant and equipment, net
86,622

 
79,258

Real estate held for sale, net
10,643

 
20,911

Long-term investments accounted for at cost
32,239

 
20,788

Long-term investments accounted for under the equity method
13,977

 
8,595

Investments in real estate ventures
154,281

 
128,202

Restricted assets
12,063

 
11,981

Deferred income taxes
70,316

 
51,474

Goodwill, trademarks and other intangible assets, net
268,141

 
271,111

Prepaid pension costs
28,165

 
26,080

Other assets
60,798

 
53,553

Total assets
$
1,643,383

 
$
1,260,264

LIABILITIES AND STOCKHOLDERS' DEFICIENCY:
 
 
 
Current liabilities:
 
 
 
   Current portion of notes payable and long-term debt
$
101,158

 
$
151,577

   Current portion of fair value of derivatives embedded within convertible debt
2,996

 
19,128

 Current payments due under the Master Settlement Agreement
91,590

 
25,348

   Current portion of employee benefits
939

 
939

Accounts payable
10,845

 
10,260

Accrued promotional expenses
20,010

 
18,655

Income taxes payable, net
3,174

 
6,423

Accrued excise and payroll taxes payable, net
861

 
11,621

Litigation accruals
3,307

 
59,310

Deferred income taxes
57,763

 
45,734

Accrued interest
17,721

 
21,968

Other current liabilities
34,256

 
34,147

Total current liabilities
344,620

 
405,110

Notes payable, long-term debt and other obligations, less current portion
857,107

 
540,766

Fair value of derivatives embedded within convertible debt
180,474

 
92,934

Non-current employee benefits
48,608

 
47,917

Deferred income taxes
165,726

 
137,650

Payments due under the Master Settlement Agreement
25,809

 
27,571

Litigation accruals
25,029

 
27,058

Other liabilities
3,877

 
2,867

Total liabilities
1,651,250

 
1,281,873

Commitments and contingencies

 

Stockholders' deficiency:
 
 
 
Preferred stock, par value $1.00 per share, 10,000,000 shares authorized
—

 
—

Common stock, par value $0.10 per share, 250,000,000 and 150,000,000 shares authorized, 113,270,834 and 101,430,853 shares issued and 109,125,587 and 97,482,998 shares outstanding
10,912

 
9,748

Additional paid-in capital
—

 
—

Accumulated deficit
(126,739
)
 
(114,787
)
Accumulated other comprehensive income
38,694

 
22,860

Less: 4,145,247 and 3,947,855 shares of common stock in treasury, at cost
(12,857
)
 
(12,857
)
Total Vector Group Ltd. stockholders' deficiency
(89,990
)
 
(95,036
)
Non-controlling interest
82,123

 
73,427

Total stockholders' deficiency
(7,867
)
 
(21,609
)
Total liabilities and stockholders' deficiency
$
1,643,383

 
$
1,260,264


The accompanying notes are an integral part of the condensed consolidated financial statements.

2


VECTOR GROUP LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
   Tobacco*
$
264,520

 
$
271,516

 
$
748,468

 
$
761,038

   Real estate
153,748

 
6,425

 
415,280

 
19,298

   E-Cigarettes
1,608

 
—

 
9,977

 
—

          Total revenues
419,876

 
277,941

 
1,173,725

 
780,336

 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
   Cost of sales:
 
 
 
 
 
 
 
     Tobacco*
189,728

 
194,991

 
537,667

 
548,377

     Real estate
96,442

 
5,844

 
261,531

 
16,080

     E-Cigarettes
1,066

 
—

 
6,357

 
—

        Total cost of sales
287,236

 
200,835

 
805,555

 
564,457

 
 
 
 
 
 
 
 
Operating, selling, administrative and general expenses
69,431

 
26,478

 
200,431

 
77,915

Litigation settlement and judgment expense
225

 
87,913

 
1,725

 
87,913

Operating income (loss)
62,984

 
(37,285
)
 
166,014

 
50,051

 
 
 
 
 
 
 
 
Other income (expenses):
 
 
 
 
 
 
 
Interest expense
(44,034
)
 
(33,583
)
 
(123,670
)
 
(99,045
)
Loss on extinguishment of debt
—

 
—

 
—

 
(21,458
)
Change in fair value of derivatives embedded within convertible debt
7,127

 
2,800

 
7,447

 
8,299

Acceleration of interest expense related to debt conversion
(994
)
 
—

 
(5,112
)
 
—

Equity income from real estate ventures
3,258

 
9,489

 
3,002

 
16,774

Equity income (loss) on long-term investments
829

 
(53
)
 
1,462

 
770

Gain (loss) on sale of investment securities available for sale
33

 
(99
)
 
(38
)
 
5,110

Other, net
2,466

 
2,871

 
8,167

 
5,151

Income (loss) before provision for income taxes
31,669

 
(55,860
)
 
57,272

 
(34,348
)
Income tax expense (benefit)
11,964

 
(18,969
)
 
21,007

 
(9,287
)
 
 
 
 
 
 
 
 
Net income (loss)
19,705

 
(36,891
)
 
36,265

 
(25,061
)
 
 
 
 
 
 
 
 
Net income attributed to non-controlling interest
(4,826
)
 
—

 
(10,881
)
 
—

 
 
 
 
 
 
 
 
Net income (loss) attributed to Vector Group Ltd.
$
14,879

 
$
(36,891
)
 
$
25,384

 
$
(25,061
)
 
 
 
 
 
 
 
 
Per basic common share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss) applicable to common shares attributed to Vector Group Ltd.
$
0.14

 
$
(0.39
)
 
$
0.24

 
$
(0.26
)
 
 
 
 
 
 
 
 
Per diluted common share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss) applicable to common shares attributed to Vector Group Ltd.
$
0.14

 
$
(0.39
)
 
$
0.24

 
$
(0.26
)
 
 
 
 
 
 
 
 
Cash distributions and dividends declared per share
$
0.38

 
$
0.36

 
$
1.14

 
$
1.09

                                      

* Revenues and cost of sales include excise taxes of $115,323, $121,787, $327,434 and $343,294, respectively.


The accompanying notes are an integral part of the condensed consolidated financial statements.

3



VECTOR GROUP LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in Thousands, Except Per Share Amounts)
Unaudited


 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
Net income (loss)
$
19,705

 
$
(36,891
)
 
$
36,265

 
$
(25,061
)
 
 
 
 
 
 
 
 
Net unrealized gains on investment securities available for sale:
 
 
 
 
 
 
 
    Change in net unrealized gains
19,184

 
11,848

 
22,292

 
28,752

    Net unrealized (losses) gains reclassified into net income
(33
)
 
99

 
38

 
(5,110
)
Net unrealized gains on investment securities available for sale
19,151

 
11,947

 
22,330

 
23,642

 
 
 
 
 


 
 
Net unrealized (losses) gains on long-term investments accounted for under the equity method:
 
 
 
 
 
 
 
Change in net unrealized (losses) gains
(4,694
)
 
1,754

 
3,920

 
1,170

Net unrealized (losses) gains reclassified into net income
—

 
—

 
—

 
—

Net unrealized (losses) gains on long-term investments accounted for under the equity method
(4,694
)
 
1,754

 
3,920

 
1,170

 
 
 
 
 
 
 
 
Net change in forward contracts
16

 
16

 
48

 
47

 
 
 
 
 
 
 
 
Net change in pension-related amounts
147

 
350

 
442

 
1,052

 
 
 
 
 
 
 
 
Other comprehensive income
14,620

 
14,067

 
26,740

 
25,911

 
 
 
 
 
 
 
 
Income tax effect on:
 
 
 
 
 
 
 
    Change in net unrealized gains on investment securities
(7,438
)
 
(4,810
)
 
(9,218
)
 
(11,673
)
    Net unrealized (losses) gains reclassified into net income on investment securities
13

 
(41
)
 
(16
)
 
2,074

Change in unrealized (losses) gains on long-term investments
1,933

 
(712
)
 
(1,621
)
 
(475
)
Net unrealized (losses) gains reclassified into net income on long-term investments accounted for under the equity method
—

 
—

 
—

 
—

Forward contracts
(8
)
 
(7
)
 
(20
)
 
(19
)
Pension-related amounts
(105
)
 
(142
)
 
(31
)
 
(427
)
Income tax provision on other comprehensive income
(5,605
)
 
(5,712
)
 
(10,906
)
 
(10,520
)
 
 
 
 
 
 
 
 
Other comprehensive income, net of tax
9,015

 
8,355

 
15,834

 
15,391

 
 
 
 
 
 
 
 
Comprehensive income (loss)
28,720

 
(28,536
)
 
52,099

 
(9,670
)
 
 
 
 
 
 
 
 
Comprehensive income attributed to non-controlling interest
(4,826
)
 
—

 
(10,881
)
 
—

Comprehensive income (loss) attributed to Vector Group Ltd.
$
23,894

 
$
(28,536
)
 
$
41,218

 
$
(9,670
)

The accompanying notes are an integral part of the condensed consolidated financial statements.

4


VECTOR GROUP LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY
(Dollars in Thousands, Except Per Share Amounts)
Unaudited


 
Vector Group Ltd. Stockholders' Deficiency
 
 
 
 
 
 
 
Additional
 
 
 
Accumulated
Other
 
 
 
 
 
 
 
Common Stock
 
Paid-In
 
Accumulated
 
Comprehensive
 
Treasury
 
Non-controlling
 
 
 
Shares
 
Amount
 
Capital
 
Deficit
 
Income
 
Stock
 
Interest
 
Total
Balance, January 1, 2014
97,482,998

 
$
9,748

 
$
—

 
$
(114,787
)
 
$
22,860

 
$
(12,857
)
 
$
73,427

 
$
(21,609
)
Net income
—

 
—

 
—

 
25,384

 
—

 
—

 
10,881

 
36,265

Change in net loss and prior service cost, net of income taxes
—

 
—

 
—

 
—

 
411

 
—

 
—

 
411

Forward contract adjustments, net of income taxes
—

 
—

 
—

 
—

 
28

 
—

 
—

 
28

Unrealized gain on long-term investment securities accounted for under the equity method, net of income taxes
—

 
—

 
—

 
—

 
2,299

 
—

 
—

 
2,299

Change in net unrealized gain on investment securities available for sale, net of income taxes
—

 
—

 
—

 
—

 
13,074

 
—

 
—

 
13,074

Net unrealized loss on investment securities available for sale reclassified into net income, net of income taxes
—

 
—

 
—

 
—

 
22

 
—

 
—

 
22

Unrealized gain on investment securities, net of income taxes
—

 
—

 
—

 
—

 
—

 
—

 
—

 
13,096

Total other comprehensive income
—

 
—

 
—

 
—

 
—

 
—

 
—

 
15,834

Total comprehensive income
—

 
—

 
—

 
—

 
—

 
—

 
—

 
52,099

Distributions and dividends on common stock
—

 
—

 
(84,524
)
 
(36,816
)
 
—

 
—

 
—

 
(121,340
)
Restricted stock grant
1,000,000

 
100

 
—

 
—

 
—

 
—

 
—

 
100

Effect of stock dividend
5,195,856

 
520

 
—

 
(520
)
 
—

 
—

 
—

 
—

Note conversions, inclusive of taxes $1,006
5,107,050

 
510

 
62,639

 
—

 
—

 
—

 
—

 
63,149

Beneficial conversion feature of notes payable, net of income taxes of $10,327
—

 
—

 
14,648

 
—

 
—

 
—

 
—

 
14,648

Exercise of stock options
339,683

 
34

 
4,273

 
—

 
—

 
—

 
—

 
4,307

Tax benefit of options exercised
—

 
—

 
937

 
—

 
—

 
—

 
—

 
937

Stock-based compensation
—

 
—

 
2,027

 
—

 
—

 
—

 
—

 
2,027

Contributions made by non-controlling interest
—

 
—

 
—

 
—

 
—

 
—

 
2,676

 
2,676

Distributions to non-controlling interest
—

 
—

 
—

 
—

 
—

 
—

 
(4,861
)
 
(4,861
)
Balance as of September 30, 2014
109,125,587

 
$
10,912

 
$
—

 
$
(126,739
)
 
$
38,694

 
$
(12,857
)
 
$
82,123

 
$
(7,867
)


The accompanying notes are an integral part of the condensed consolidated financial statements.

5


VECTOR GROUP LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands, Except Per Share Amounts)
Unaudited


 
Nine Months Ended
 
Nine Months Ended
 
September 30,
2014
 
September 30,
2013
Net cash provided by operating activities
$
100,044

 
$
55,244

Cash flows from investing activities:
 
 
 
Sale of investment securities
174,253

 
82,649

Purchase of investment securities
(312,919
)
 
(129,483
)
Proceeds from sale or liquidation of long-term investments
549

 
75

Purchase of long-term investments
(12,000
)
 
(5,000
)
Investments in real estate ventures
(29,378
)
 
(45,977
)
Investments in consolidated real estate businesses
—

 
(7,697
)
Distributions from real estate ventures
5,540

 
2,463

Increase in cash surrender value of life insurance policies
(435
)
 
(470
)
Increase in restricted assets
(1,108
)
 
(553
)
Issuance of notes receivable
(250
)
 
—

Proceeds from sale of fixed assets
4

 
11

Capital expenditures
(20,746
)
 
(8,686
)
Repayments of notes receivable
933

 
9,460

Purchase of subsidiaries
(250
)
 
—

Net cash used in investing activities
(195,807
)
 
(103,208
)
Cash flows from financing activities:
 
 
 
Proceeds from debt issuance
413,918

 
454,200

Financing costs
(12,360
)
 
(11,750
)
Repayments of debt
(10,305
)
 
(420,710
)
Borrowings under revolver
645,894

 
723,578

Repayments on revolver
(673,866
)
 
(736,007
)
Dividends and distributions on common stock
(122,051
)
 
(107,302
)
Distributions to non-controlling interest
(4,861
)
 
—

Proceeds from exercise of Vector options
4,407

 
528

Tax benefit of options exercised
937

 
33

Net cash provided by (used in) financing activities
241,713

 
(97,430
)
Net increase (decrease) in cash and cash equivalents
145,950

 
(145,394
)
Cash and cash equivalents, beginning of period
234,466

 
405,855

Cash and cash equivalents, end of period
$
380,416

 
$
260,461


The accompanying notes are an integral part of the condensed consolidated financial statements.

6
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a)
Basis of Presentation:

The condensed consolidated financial statements of Vector Group Ltd. (the “Company” or “Vector”) include the accounts of VGR Holding LLC (“VGR Holding”), Liggett Group LLC (“Liggett”), Vector Tobacco Inc. (“Vector Tobacco”), Liggett Vector Brands LLC (“Liggett Vector Brands”), Zoom E-Cigs LLC ("Zoom"), New Valley LLC (“New Valley”) and other less significant subsidiaries. New Valley includes the accounts of Douglas Elliman Realty, LLC ("Douglas Elliman") and other less significant subsidiaries. All significant intercompany balances and transactions have been eliminated.

Liggett and Vector Tobacco are engaged in the manufacture and sale of cigarettes in the United States. Zoom is engaged in the sale of electronic cigarettes in the United States. New Valley is engaged in the real estate business.

The accompanying unaudited, interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and, in management's opinion, contain all adjustments, consisting only of normal recurring items, necessary for a fair statement of the results for the periods presented. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission. The consolidated results of operations for interim periods should not be regarded as necessarily indicative of the results that may be expected for the entire year.

Certain reclassifications have been made to the 2013 financial information to conform to the 2014 presentation.

In connection with the December 13, 2013 acquisition of Douglas Elliman, the Company was required to disclose Douglas Elliman’s revenues and costs separately on the face of its condensed consolidated statements of operation. Consequently, the Company also revised the prior period in order to correctly present the gross revenues and costs of the other consolidated real estate investments as follows:

 
Three Months Ended
 
Nine Months Ended
 
September 30, 2013
 
September 30, 2013
 
As Previously Reported
 
Revision
 
As Revised
 
As Previously Reported
 
Revision
 
As Revised
Revenues
$
271,516

 
$
(271,516
)
 
$
—

 
$
761,038

 
$
(761,038
)
 
$
—

Tobacco revenues
—

 
271,516

 
271,516

 
—

 
761,038

 
761,038

Real estate revenues
—

 
6,425

 
6,425

 
—

 
19,298

 
19,298

Total revenue
271,516

 
6,425

 
277,941

 
761,038

 
19,298

 
780,336

 
 
 
 
 
 
 
 
 
 
 
 
Cost of Sales
194,991

 
(194,991
)
 
—

 
548,377

 
(548,377
)
 
—

Tobacco cost of sales
—

 
194,991

 
194,991

 
—

 
548,377

 
548,377

Real estate cost of sales
—

 
5,844

 
5,844

 
—

 
16,080

 
16,080

Total cost of sales
194,991

 
5,844

 
200,835

 
548,377

 
16,080

 
564,457

 
 
 
 
 
 
 
 
 
 
 
 
Operating, selling, administrative and general expenses
$
25,897

 
$
581

 
$
26,478

 
$
74,697

 
$
3,218

 
$
77,915




7
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


In addition, the preliminary fair values of the assets acquired, liabilities assumed and the non-controlling interest recorded for Douglas Elliman as of December 13, 2013 were adjusted during the first quarter of 2014. Goodwill and current liabilities were reduced by $454 and $105, respectively, while intangible assets related to favorable lease agreements were increased by $559. The amounts are preliminary as management is still evaluating the valuations of certain assets acquired in the acquisition. These adjustments have been reflected in the Company's condensed consolidated balance sheet as of December 31, 2013.

During the second quarter of 2014, Douglas Elliman accounts payable as of December 31, 2013, was reduced by $16,434, while current liabilities were increased by $16,434. Thus, prior period information has been recast to conform to the current presentation. This change did not have an impact to the Company's historical consolidated results.

As a result of the amount of operating losses of Zoom as of September 30, 2014 when compared to the remaining components of Corporate and Other segment, the Company has reevaluated its operating segments and has separated Zoom’s operations from the Corporate and Other segment for previously reported 2014 periods and from the Tobacco segment for the previously reported 2013 periods. Thus, prior period information has been recast to conform to the current presentation. This change did not have an impact to the Company's historical consolidated results.


(b)
Distributions and Dividends on Common Stock:

The Company records distributions on its common stock as dividends in its condensed consolidated statement of stockholders' deficiency to the extent of retained earnings and accumulated paid-in capital. Any amounts exceeding retained earnings are recorded as a reduction to additional paid-in capital. Any amounts then exceeding accumulated paid-in capital are recorded as an increase to accumulated deficit.


(c)
Revenue Recognition:

Tobacco sales:  Revenues from sales are recognized upon the shipment of finished goods when title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, the sale price is determinable and collectibility is reasonably assured. The Company provides an allowance for expected sales returns, net of any related inventory cost recoveries. Certain sales incentives, including promotional price discounts, are classified as reductions of net sales. The Company’s accounting policy is to include federal excise taxes in revenues and cost of goods sold. Since the Company’s significant line of business is tobacco, the Company’s financial position and its results of operations and cash flows have been and could continue to be materially adversely affected by significant unit sales volume declines at the Company and industry levels, regulation, litigation and defense costs, increased tobacco costs or reductions in the selling price of cigarettes in the near term.
Real estate sales: Revenue is recognized when persuasive evidence of an arrangement exists, the price is fixed or determinable, the transaction has been completed and collectibility of the resulting receivable is reasonably assured. Real estate and mortgage commissions earned by the Company’s real estate and mortgage brokerage businesses are recorded as revenue on a gross basis upon the closing of a real estate transaction as evidenced when the escrow or similar account is closed, the transaction documents have been recorded and funds are distributed to all appropriate parties. Commissions and royalties expenses are recognized concurrently with related revenues. Property management fees earned are recorded as revenue when the related services are performed.
E-Cigarettes:  Revenues from sales are recognized upon the shipment of finished goods when title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, the sale price is determinable and collectibility is reasonably assured. The Company provides an allowance for expected sales returns, net of any related inventory cost recoveries. Certain sales incentives, including promotional price discounts, are classified as reductions of net sales.

(d)
Earnings Per Share (“EPS”):

Information concerning the Company's common stock has been adjusted to give retroactive effect to the 5% stock dividend paid to Company stockholders on September 26, 2014. All per share amounts and references to share amounts have been updated to reflect the retrospective effect of the stock dividends.


8
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


Net income (loss) for purposes of determining basic and diluted EPS was as follows:

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net income (loss) attributed to Vector Group Ltd.
$
14,879

 
$
(36,891
)
 
$
25,384

 
$
(25,061
)
Expense attributed to participating securities
(423
)
 
—

 
(739
)
 
—

Net income (loss) attributed to Vector Group Ltd. available to common stockholders
$
14,456

 
$
(36,891
)
 
$
24,645

 
$
(25,061
)
 

Basic and diluted EPS were calculated using the following shares:

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Weighted-average shares for basic EPS
103,213,667

 
95,775,444

 
101,395,081

 
95,741,318

Plus incremental shares related to stock options and non-vested restricted stock
114,623

 
—

 
113,070

 
—

Weighted-average shares for basic and fully diluted EPS
103,328,290

 
95,775,444

 
101,508,151

 
95,741,318



The following stock options, non-vested restricted stock and shares issuable upon the conversion of convertible debt were outstanding during the three and nine months ended September 30, 2014 and 2013 but were not included in the computation of diluted EPS because the effect was anti-dilutive.

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
  Number of stock options
N/A

 
524,887

 
N/A

 
524,887

  Weighted-average exercise price
N/A

 
$
11.88

 
N/A

 
$
11.88

  Weighted-average shares of non-vested restricted stock
N/A

 
55,125

 
N/A

 
55,125

  Weighted-average expense per share
N/A

 
$
15.52

 
N/A

 
$
15.52

  Weighted-average number of shares issuable upon
  conversion of debt
32,599,702

 
29,726,047

 
31,257,300

 
29,726,047

  Weighted-average conversion price
$
18.36

 
$
14.50

 
$
17.30

 
$
14.50




9
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


(e)
Fair Value of Derivatives Embedded within Convertible Debt:

The Company has estimated the fair market value of the embedded derivatives based principally on the results of a valuation model. The estimated fair value of the derivatives embedded within the convertible debt is based principally on the present value of future dividend payments expected to be received by the convertible debt holders over the term of the debt. The discount rate applied to the future cash flows is estimated based on a spread in the yield of the Company's debt when compared to risk-free securities with the same duration; thus, a readily determinable fair market value of the embedded derivatives is not available. The valuation model assumes future dividend payments by the Company and utilizes interest rates and credit spreads for secured to unsecured debt, unsecured to subordinated debt and subordinated debt to preferred stock to determine the fair value of the derivatives embedded within the convertible debt. The valuation also considers other items, including current and future dividends and the volatility of the Company's stock price.  At September 30, 2014, the range of estimated fair market values of the Company's embedded derivatives was between $181,403 and $185,583.  The Company recorded the fair market value of its embedded derivatives at the midpoint of the range at $183,470 as of September 30, 2014. At December 31, 2013, the range of estimated fair market values of the Company's embedded derivatives was between $110,758 and $113,392.  The Company recorded the fair market value of its embedded derivatives at the midpoint of the range at $112,062 as of December 31, 2013.  The estimated fair market value of the Company's embedded derivatives could change significantly based on future market conditions. (See Note 6.)

(f)
Other Income, Net:

Other income, net consists of:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Gain on warrants
$
991

 
$
135

 
$
868

 
$
172

Interest income
1,476

 
2,647

 
3,665

 
4,123

Accretion of interest income from debt discount on notes receivable
11

 
81

 
87

 
704

Out-of-period adjustment
—

 
—

 
1,231

 
—

Acceleration of closing fee related to termination of Douglas Elliman joint venture
—

 
—

 
2,335

 
—

Gain on long-term investment
—

 
—

 
—

 
142

Other (expense) income
(12
)
 
8

 
(19
)
 
10

Other income, net
$
2,466

 
$
2,871

 
$
8,167

 
$
5,151


The out-of-period adjustment, recording for the period ending March 31, 2014, related to a non-accrual of a receivable from Douglas Elliman in the fourth quarter of 2013 and would have increased the Company’s gain on acquisition of Douglas Elliman in 2013. The Company assessed the materiality of this error on all previously issued financial statements and concluded that the error was immaterial to all previously issued financial statements. The impact of correcting this error in the current year is not expected to be material to the Company’s 2014 consolidated financial statements.


10
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


(g)
Goodwill, Trademarks and Other Intangible Assets:

The components of "Goodwill, trademarks and other intangible assets, net" were as follows:

 
September 30,
2014
 
December 31,
2013
Intangible assets, net
$
7,649

 
$
11,919

Goodwill
72,976

 
71,681

Trademarks
80,005

 
80,000

Intangible asset associated with benefit under the Master Settlement Agreement
107,511

 
107,511

 
$
268,141

 
$
271,111


The preliminary fair values of the assets acquired, liabilities assumed and the non-controlling interest recorded for Douglas Elliman as of December 13, 2013 were adjusted during the first quarter of 2014. Goodwill and current liabilities were reduced by $454 and $105, respectively, while intangible assets related to favorable lease agreements were increased by $559. The amounts are preliminary as management is still evaluating the valuations of certain assets acquired in the acquisition. These adjustments have been reflected in the Company's condensed consolidated balance sheet as of December 31, 2013.

(h)
Restricted Stock Grant

On July 23, 2014, the Company granted its President and Chief Executive Officer an award of 1,050,000 shares of its Common Stock subject to service and performance-based vesting. The Award Shares will be issued pursuant to the terms of an agreement that provides that both a performance requirement and a continued employment requirement must be met over a seven-year performance period to earn vested rights with respect to the Award Shares. The maximum potential amount of the Award Shares reflects recognition of the CEO's contributions as CEO since January 1, 2006 and the value of his management and real estate expertise to the Company.

(i)
New Accounting Pronouncements:
 
In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40)-Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 provides guidance to United States Generally Accepted Accounting Principles ("U.S. GAAP") about management’s responsibility to evaluate whether there is a substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Specifically, ASU 2014-15 (1) defines the term substantial doubt, (2) requires an evaluation of every reporting period including interim periods, (3) provides principles for considering the mitigating effect of management’s plan, (4) requires certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) requires an express statement and other disclosures when substantial doubt is not alleviated, and (6) requires an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The amendments in this update are effective for annual periods beginning after December 15, 2016 and interim periods within those reporting periods. Earlier adoption is permitted. This ASU is not anticipated to have a material impact on the Company's consolidated financial statements and notes to the consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” This ASU is the result of a convergence project between the FASB and the International Accounting Standards Board. The core principle behind ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for delivering those goods and services. This model involves a five-step process that includes identifying the contract with the customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction prices to the performance obligations in the contract and recognizing revenue when (or as) the entity satisfies the performance obligations. The guidance in the ASU supersedes existing revenue recognition guidance and is effective for annual reporting periods beginning after December 15, 2016 with early application not permitted. The ASU allows two methods of adoption; a full retrospective approach where three years of financial information are presented in accordance with the new standard, and a modified retrospective approach where the ASU is applied as a cumulative

11
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


effect adjustment as of the date of adoption. The Company is currently evaluating the impact of adopting the new standard but does not anticipate it will have a material impact on the Company's consolidated financial statements or notes to the consolidated financial statements.

In April 2014, the Financial Accounting Standards Board issued final guidance to change the criteria for reporting discontinued operations while enhancing disclosures in this area (ASU No. 2014-08). Under the new guidance, only disposals representing a strategic shift, such as a major line of business, a major geographical area or a major equity investment, should be presented as discontinued operations. The guidance will be applied prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date. The guidance is effective for annual financial statements with fiscal years beginning on or after December 15, 2014 with early adoption permitted for disposals or classifications as held for sale which have not been reported in financial statements previously issued or available for issuance. The Company will adopt the guidance effective January 1, 2015 and the guidance is not anticipated to have a material impact on the Company's consolidated financial statements and notes to the consolidated financial statements.

In March 2014, the Emerging Issues Task Force (the “Task Force”) reached a final consensus to amend the accounting guidance for stock compensation tied to performance targets (Issue No. 13-D). The objective of this guidance is to clarify the accounting treatment of certain types of performance conditions in stock-based compensation awards, more specifically, when performance targets can be achieved after the requisite service period. The Task Force concluded that performance criteria subsequent to a service period vesting requirement should be treated as vesting conditions, and as a result, this type of performance condition may delay expense recognition until achievement of the performance target is probable. Issue No. 13-D will be effective for all entities for reporting periods (including interim periods) beginning after December 15, 2015, and early adoption is permitted. The Company is currently evaluating the impact of adopting the new standard but does not anticipate it will have a material impact on the Company's consolidated financial statements or notes to the consolidated financial statements.

2.
INVENTORIES

Inventories consist of:
 
September 30,
2014
 
December 31,
2013
Leaf tobacco
$
55,769

 
$
49,140

Other raw materials
3,402

 
3,161

Work-in-process
606

 
353

Finished goods
63,628

 
67,201

E-Cigarettes
7,963

 
839

Inventories at current cost
131,368

 
120,694

LIFO adjustments
(30,494
)
 
(27,198
)
 
$
100,874

 
$
93,496


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 commitment date. At September 30, 2014, Liggett had tobacco purchase commitments of approximately $11,948 and E-Cigarettes purchase commitments of $389. The Company has a single source supply agreement for fire safe cigarette paper through 2015.

All of the Company's inventories at September 30, 2014 and December 31, 2013 have been reported under the LIFO method.



12
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


3. INVESTMENT SECURITIES AVAILABLE FOR SALE

The components of investment securities available for sale at September 30, 2014 were as follows:

 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Marketable equity securities
$
56,098

 
$
88,913

 
$
(1,047
)
 
$
143,964

Mutual funds invested in fixed income securities
60,637

 
—

 
(586
)
 
60,051

Marketable debt securities
129,432

 
1,616

 
(1,180
)
 
129,868

Total investment securities available for sale
$
246,167

 
$
90,529

 
$
(2,813
)
 
$
333,883


The components of investment securities available for sale at December 31, 2013 were as follows:

 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Marketable equity securities
$
53,586

 
$
65,851

 
$
(963
)
 
$
118,474

Marketable debt securities
53,063

 
1,497

 
(500
)
 
54,060

Total investment securities available for sale
$
106,649

 
$
67,348

 
$
(1,463
)
 
$
172,534



The table below summarizes the maturity dates of marketable debt securities at September 30, 2014.

Investment Type:
Market Value
 
Under 1 Year
 
1 Year up to 5 Years
 
More than 5 Years
U.S. Government securities
$
44,220

 
$
—

 
$
44,220

 
$
—

Corporate securities
50,913

 
3,480

 
40,031

 
7,402

U.S. mortgage backed securities
297

 
—

 
297

 
—

Commercial mortgage-backed securities
15,561

 
2,261

 
13,300

 
—

U.S. asset backed securities
14,671

 
3,980

 
10,691

 
—

Government agencies
2,900

 
731

 
2,169

 
—

Index-linked U.S. bonds
1,306

 
—

 
1,306

 
—

Total marketable debt securities by maturity dates
$
129,868

 
$
10,452

 
$
112,014

 
$
7,402





13
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


4.
LONG-TERM INVESTMENTS

Long-term investments accounted for at cost:
 
September 30, 2014
 
December 31, 2013
 
Carrying
 
Fair
 
Carrying
 
Fair
 
Value
 
Value
 
Value
 
Value
Investment partnerships
$
31,541

 
$
36,735

 
$
20,041

 
$
24,095

Real estate partnership
698

 
1,102

 
747

 
1,067

Investments accounted for at cost
$
32,239

 
$
37,837

 
$
20,788

 
$
25,162


The Company contributed an additional $12,000 to Investment Partnerships during the nine months ended September 30, 2014.

Long-term investment partnership accounted for under the equity method:
 
September 30,
2014
 
December 31,
2013
Investment partnership
$
13,977

 
$
8,595


The Company recorded equity income of $829 and an equity loss of $53 for the three months ended September 30, 2014 and 2013, respectively, related to the limited partnership. The Company recorded equity income of $1,462 and $770 for the nine months ended September 30, 2014 and 2013, respectively, related to the limited partnership.

The carrying value of the investment was approximately $13,977 and $8,595 as of September 30, 2014 and December 31, 2013, respectively, which approximated the investment's fair value.


5. NEW VALLEY LLC
Residential Brokerage Business Acquisition. New Valley is engaged in the real estate business and is seeking to acquire additional real estate properties and operating companies. As of January 1, 2013, the Company owned a 50% interest in Douglas Elliman, and the Company accounted for its 50% using the equity method of accounting. On December 13, 2013, an affiliate of New Valley acquired an additional 20.59% interest in Douglas Elliman from Prudential Real Estate Financial Services of America, Inc. for a purchase price of $60,000 in cash. The acquisition increased the Company's ownership position in Douglas Elliman from 50% to 70.59% and resulted in the Company having control.
The transaction was accounted for as an acquisition of a business in the fourth quarter of 2013. The preliminary fair values of the assets acquired, liabilities assumed and the non-controlling interest recorded for Douglas Elliman as of December 13, 2013 were adjusted during the first quarter of 2014. Goodwill and current liabilities were reduced by $454 and $105, respectively, while intangible assets related to favorable lease agreements were increased by $559. The amounts are preliminary as management is still evaluating the valuations of certain assets acquired in the acquisition. These adjustments have been reflected in the Company's condensed consolidated balance sheet as of December 31, 2013 and September 30, 2014.
Equity Method of Accounting. Prior to December 13, 2013, New Valley accounted for its 50% interest in Douglas Elliman under the equity method of accounting. New Valley recorded income associated with Douglas Elliman of $9,075 and $16,513 for the three and nine months ended September 30, 2013, respectively, which included management fees earned by New Valley from Douglas Elliman.
Summarized income statement information for Douglas Elliman for the three and nine months ended September 30, 2013, is presented below.

14
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


 
 
Three Months Ended
 
Nine Months Ended
 
 
 
September 30,
2013
 
September 30,
2013
 
Revenues
 
$
127,537

 
$
315,721

 
Costs and expenses
 
109,178

 
282,885

 
Depreciation expense
 
986

 
2,944

 
Amortization expense
 
56

 
167

 
Other income
 
(109
)
 
(512
)
 
Interest income, net
 
(14
)
 
(22
)
 
Income tax expense
 
442

 
684

 
Net income
 
$
16,998

 
$
29,575

 

New Valley received cash distributions from Douglas Elliman of $2,961 for the nine months ended September 30, 2013.

15
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited



Investments in real estate ventures.  New Valley also holds equity investments in various real estate projects domestically and internationally. The components of “Investments in real estate ventures” were as follows:

 
September 30,
2014
 
December 31,
2013
 
 
 
 
Milanosesto Holdings (f/k/a Sesto Holdings)
$
5,037

 
$
5,037

Land Development
5,037

 
5,037

 
 
 
 
10 Madison Square Park West (f/k/a 1107 Broadway)
6,384

 
6,579

The Whitman
526

 
1,165

The Marquand
12,000

 
7,000

11 Beach Street
12,328

 
11,160

20 Times Square (f/k/a 701 Seventh Avenue)
12,481

 
11,148

101 Murray Street
25,269

 
19,256

160 Leroy Street
1,353

 
1,150

PUBLIC Chrystie House (f/k/a Chrystie Street)
3,180

 
2,048

25-19 43rd Avenue
733

 
—

Queens Plaza (f/k/a 23-10 Queens Plaza South)
12,590

 
8,058

8701 Collins Avenue
4,634

 
3,794

125 Greenwich Street
9,308

 
—

Condominium and Mixed Use Development
100,786

 
71,358

 
 
 
 
Maryland Portfolio
3,348

 
3,498

ST Portfolio
15,508

 
15,984

Apartment Buildings
18,856

 
19,482

 
 
 
 
Park Lane Hotel
18,097

 
19,514

Hotel Taiwana
6,850

 
7,428

Coral Beach and Tennis Club
2,708

 
2,964

Hotels
27,655

 
29,906

 
 
 
 
Other
1,947

 
2,419

 
 
 
 
Investments in real estate ventures
$
154,281

 
$
128,202

 
Condominium and Mixed Use Development:
Condominium and mixed use developments investments range in ownership percentage from 5% to 49.5%. New Valley recorded equity income of $5,090 and $7,389 during the three and nine months ended September 30, 2014, respectively. The Company recorded $5,000 of income from real estate ventures for the three and nine months ended September 30, 2014 in connection with its proportionate share of the Marquand’s income from the sale of approximately 40% of its units during the quarter. In addition, during the nine months ended September 30, 2014, the Company recorded $2,254 of income in connection with its proportionate share of the sale of a commercial unit at 10 Madison Square Park West (f/k/a 1107 Broadway). New Valley recorded equity income of $526 and $656 for the three and nine months ended September 30, 2013. During the nine months ended September 30, 2014, New Valley made capital contributions totaling $27,154, primarily related to 101 Murray Street, 23-10

16
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


Queens Plaza South and a new investment, 125 Greenwich Street. New Valley contributed its proportionate share of additional capital along with contributions by the other investment partners. New Valley's investment percentage did not change. During the nine months ended September 30, 2014, New Valley and received distributions of $7,791. During the nine months ended September 30, 2013, New Valley made capital contributions totaling $23,984 primarily related to its investment in 101 Murray Street, and received distributions of $2,593. New Valley's maximum exposure to loss as a result of its investments in condominium and mixed use developments was $100,786 at September 30, 2014.

Apartment Buildings:
Apartment buildings investments range in ownership percentage from 7.5% to 16.4%. New Valley recorded net equity losses of $87 and $111 for the three months ended September 30, 2014 and 2013, respectively, related to the apartment portfolios. New Valley recorded equity losses of $251 and $394 for nine months ended September 30, 2014 and 2013, respectively, primarily related to an apartment portfolio. New Valley received distributions of $375 and $250 during the nine months ended September 30, 2014 and 2013, respectively, related to an apartment portfolio. New Valley's maximum exposure to loss as a result of its investment in apartment buildings was $18,856 at September 30, 2014.

Hotels:
Hotel investments range in ownership percentage from 5% to 49%. During the three and nine months ended September 30, 2014, New Valley recorded net equity losses of $2,053 and $4,224. New Valley made capital contributions totaling $1,973 for the nine months ended September 30, 2014, primarily related to Park Lane Hotel. New Valley made capital contributions totaling $21,992 for the nine months ended September 30, 2013, primarily related to the initial investment in Park Lane Hotel. New Valley's maximum exposure to loss as a result of its investments in hotels was $27,655 at September 30, 2014.

Other:
Other investments in real estate ventures relate to an investment in a mortgage company and an insurance company partially owned by Douglas Elliman.

Real Estate Held for Sale:
The components of “Real estate held for sale, net” were as follows:
 
September 30,
2014
 
December 31,
2013
Escena, net
$
10,643

 
$
10,625

Indian Creek
—

 
10,286

            Real estate held for sale, net
$
10,643

 
$
20,911


Escena.  In October 2013, the Company sold 200 of the 867 residential lots. The remaining project consists of 667 residential lots, consisting of both single family and multi-family lots, an 18-hole golf course, clubhouse restaurant and golf shop, and a seven-acre site approved for a 450-room hotel.

17
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


The assets of "Escena, net" are as follows:

 
September 30,
2014
 
December 31,
2013
Land and land improvements
$
8,930

 
$
8,930

Building and building improvements
1,832

 
1,530

Other
1,577

 
1,577

 
12,339

 
12,037

Less accumulated depreciation
(1,696
)
 
(1,412
)
 
$
10,643

 
$
10,625


The Company recorded an operating loss of $804 and $845 for the three months ended September 30, 2014 and 2013, respectively, from Escena. The Company recorded an operating loss of $571 and $769 for the nine months ended September 30, 2014 and 2013, respectively, from Escena.

Investment in Indian Creek. In March 2013, New Valley invested $7,616 for an 80% interest in Timbo LLC ("Indian Creek") which owns a residential real estate project located on Indian Creek, Florida. As a result of the 80% ownership interest, the consolidated financial statements of the Company included the balances of Indian Creek.
 
In May 2014, the Indian Creek property was sold for $14,400 and New Valley received a distribution of approximately $7,100. New Valley recognized income of approximately $2,400 from the sale for the nine months ended September 30, 2014.


18
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


6.
NOTES PAYABLE, LONG-TERM DEBT AND OTHER OBLIGATIONS

Notes payable, long-term debt and other obligations consist of:

 
September 30,
2014
 
December 31,
2013
Vector:
 
 
 
7.75% Senior Secured Notes due 2021, including premium of $9,577 and $0
$
609,577

 
$
450,000

6.75% Variable Interest Senior Convertible Note due 2014, net of unamortized discount of $1,733 and $19,311*
23,267

 
30,689

6.75% Variable Interest Senior Convertible Exchange Notes due 2014, net of unamortized discount of $2,713 and $25,944*
64,902

 
81,586

7.5% Variable Interest Senior Convertible Notes due 2019, net of unamortized discount of $149,342 and $155,817*
80,658

 
74,183

5.5% Variable Interest Senior Convertible Debentures due 2020, net of unamortized discount of $101,667 and $0*
157,083

 
—

Liggett:
 
 
 
Revolving credit facility
2,452

 
30,424

Term loan under credit facility
3,663

 
3,884

Equipment loans
16,128

 
17,252

Other
535

 
4,325

Total notes payable, long-term debt and other obligations
958,265

 
692,343

Less:
 
 
 
Current maturities
(101,158
)
 
(151,577
)
Amount due after one year
$
857,107

 
$
540,766

______________________
* The fair value of the derivatives embedded within the 6.75% Variable Interest Senior Convertible Note ($885 at September 30, 2014 and $6,607 at December 31, 2013, respectively), the 6.75% Variable Interest Senior Convertible Exchange Notes ($2,110 at September 30, 2014 and $12,521 at December 31, 2013, respectively), the 5.50% Variable Interest Senior Convertible Debentures ($86,228 at September 30, 2014 and $0 at December 31, 2013, respectively), and the 7.50% Variable Interest Senior Convertible Notes ($94,247 at September 30, 2014 and $92,934 at December 31, 2013, respectively), is separately classified as a derivative liability in the condensed consolidated balance sheets.

7.75% Senior Secured Notes due 2021 - Vector:

On April 15, 2014, the Company completed the sale of $150,000 principal amount of its 7.75% Senior Secured Notes due 2021 for a price of 106.750% in a private offering to qualified institutional investors in accordance with Rule 144A of the Securities Act of 1933. The Company received net proceeds of approximately $158,700 after deducting underwriting discounts, commissions, fees and offering expenses. The Company will amortize the deferred costs and debt premium related to the additional Senior Secured Notes over the estimated life of the debt.
In August 2014, the Company completed an offer to exchange the 7.75% senior secured notes issued in April 2014 for an equal amount of newly issued 7.75% senior secured notes due 2021. The new 7.75% senior secured notes have substantially the same terms as the original notes, except that the new 7.75% senior secured notes have been registered under the Securities Act.

6.75% Variable Interest Senior Convertible Note due 2014 - Vector:
On March 14, 2014, the holder of the 6.75% Variable Interest Senior Convertible Note due 2014 converted $25,000 principal balance of the $50,000 Note into 2,121,479 of the Company's common shares. The Company recorded non-cash accelerated interest expense related to the converted debt of $3,679 for the nine months ended September 30, 2014. The debt conversion resulted in a reduction of debt and an increase to equity in the amount of $25,000. The outstanding principal balance due November 15, 2014 is $25,000.

19
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


6.75% Variable Interest Senior Convertible Exchange Notes due 2014 - Vector:
On May 20, 2014, a holder of the 6.75% Variable Interest Senior Convertible Exchange Notes due 2014 converted $7,500 principal balance of the $107,530 Notes into 560,987 of the Company's common shares. The debt conversion resulted in a reduction of debt and an increase to equity in the amount of $7,500.
In August, 2014, holders of the 6.75% Variable Interest Senior Convertible Exchange Notes due 2014 converted $32,415 principal balance of the $107,530 Notes into 2,424,584 of the Company's common shares. The debt conversion resulted in a reduction of debt and an increase to equity in the amount of $32,415. The outstanding principal balance due November 15, 2014 is $67,615.
The Company recorded non-cash accelerated interest expense related to the converted debt of $994 and $1,433 for the three and nine months ended September 30, 2014.

5.5% Variable Interest Senior Convertible Notes due 2020 - Vector:
On March 24, 2014, the Company completed the sale of $258,750 of its 5.5% Variable Interest Convertible Senior Notes due 2020 (the "2020 Convertible Notes"). The 2020 Convertible Notes are the Company's senior unsecured obligations and are effectively subordinated to any of its secured indebtedness to the extent of the assets securing such indebtedness. The 2020 Convertible Notes are also structurally subordinated to all liabilities and commitments of the Company's subsidiaries.
The aggregate net proceeds from the sale of the 2020 Convertible Notes were approximately $250,300 after deducting underwriting discounts, commissions, fees and offering expenses. The net proceeds will be used for general corporate purposes, including for additional investments in real estate and in the Company's tobacco business. The Company may also consider using a portion of the net proceeds from the sale of the notes to address upcoming debt maturities.
The 2020 Convertible Notes pay interest (“Total Interest”) on a quarterly basis beginning April 15, 2014 at a rate of 1.75% per annum plus additional interest, which is based on the amount of cash dividends paid during the prior three-month period ending on the record date for such interest payment multiplied by the total number of shares of its common stock into which the debt will be convertible on such record date. Notwithstanding the foregoing, however, the interest payable on each interest payment date after April 15, 2014 shall be the higher of (i) the Total Interest and (ii) 5.5% per annum with the interest payment on April 15, 2014 being based on 5.5% per annum. The notes are convertible into the Company’s common stock at the holder’s option. The conversion price at September 30, 2014 was $25.87 per share (approximately 38.6563 shares of common stock per $1,000 principal amount of the note), and is subject to adjustment for various events, including the issuance of stock dividends. The notes will mature on April 15, 2020. If a fundamental change (as defined in the indenture) occurs, the Company will be required to offer to repurchase the notes at 100% of their principal amount, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

Revolving Credit Facility and Term Loan Under Credit Facility - Liggett:

As of September 30, 2014, a total of $6,115 was outstanding under the revolving and term loan portions of the credit facility. Availability as determined under the facility was approximately $43,885 based on eligible collateral at September 30, 2014.

Shares of Common Stock per $1,000 Principal Amount due on Convertible Notes:

The conversion rates for all convertible debt outstanding as of September 30, 2014 are summarized below:
 
September 30, 2014
 
Conversion Price
 
Shares per $1,000
 
 
 
 
6.75% Variable Interest Senior Convertible Note due 2014
$
11.22

 
89.1021

6.75% Variable Interest Senior Convertible Exchange Notes due 2014
$
12.73

 
78.5381

7.5% Variable Interest Senior Convertible Notes due 2019
$
16.78

 
59.5946

5.5% Variable Interest Senior Convertible Debentures due 2020
$
25.87

 
38.6563



20
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


Non-Cash Interest Expense - Vector:

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Amortization of debt discount
$
14,277

 
$
9,620

 
$
41,180

 
$
25,432

Amortization of deferred finance costs
1,147

 
549

 
2,910

 
1,593

Loss on extinguishment of 11% Senior Secured Notes
—

 
—

 
—

 
3,638

Accelerated interest expense on 6.75% Variable Interest Senior Convertible Note converted
—

 
—

 
3,679

 
—

Accelerated interest expense on 6.75% Variable Interest Senior Convertible Exchange Notes converted
994

 
—

 
1,433

 
—


$
16,418

 
$
10,169

 
$
49,202

 
$
30,663


Fair Value of Notes Payable and Long-Term Debt:

 
September 30, 2014
 
December 31, 2013
 
Carrying
 
Fair
 
Carrying
 
Fair
 
Value
 
Value
 
Value
 
Value
Notes payable and long-term debt
$
958,265

 
$
1,445,085

 
$
692,343

 
$
1,006,562


Notes payable and long-term debt are carried on the condensed consolidated balance sheet at amortized cost. The fair value determination disclosed above would be classified as Level 2 under the fair value hierarchy disclosed in Note 9 if such liabilities were recorded on the condensed consolidated balance sheet at fair value. The estimated fair value of the Company's notes payable and long-term debt has been determined by the Company using available market information and appropriate valuation methodologies including the evaluation of the Company's credit risk as described in the Company's Form 10-K. However, considerable judgment is required to develop the estimates of fair value and, accordingly, the estimate presented herein are not necessarily indicative of the amount that could be realized in a current market exchange.



7. CONTINGENCIES

Tobacco-Related Litigation:
 
Overview. Since 1954, Liggett and other United States cigarette manufacturers have been named as defendants in numerous direct, third-party and purported class actions predicated on the theory that cigarette manufacturers should be liable for damages alleged to have been caused by cigarette smoking or by exposure to secondary smoke from cigarettes. The cases have generally fallen into the following categories: (i) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs (“Individual Actions”); (ii) lawsuits by individuals requesting the benefit of the Engle ruling ("Engle progeny cases"); (iii) smoking and health cases primarily alleging personal injury or seeking court-supervised programs for ongoing medical monitoring, as well as cases alleging that use of the terms “lights” and/or “ultra lights” constitutes a deceptive and unfair trade practice, common law fraud or violation of federal law, purporting to be brought on behalf of a class of individual plaintiffs (“Class Actions”); and (iv) health care cost recovery actions brought by various foreign and domestic governmental plaintiffs and non-governmental plaintiffs seeking reimbursement for health care expenditures allegedly caused by cigarette smoking and/or disgorgement of profits (“Health Care Cost Recovery Actions”). With the commencement of new cases, the defense costs and the risks relating to the unpredictability of litigation increase. The future financial impact of the risks and expenses of litigation are not quantifiable. For the nine months ended September 30, 2014 and 2013, Liggett incurred tobacco product liability legal expenses and other litigation costs totaling $7,282 and $7,334, respectively. The 2013 costs exclude a charge of $86,213 associated with the Engle progeny settlement discussed below.

21
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


Litigation is subject to uncertainty and it is possible that there could be adverse developments in pending cases. Management reviews on a quarterly basis with counsel all pending litigation and evaluates whether an estimate can be  made of the possible loss or range of loss that could result from an unfavorable outcome. An unfavorable outcome or settlement of pending tobacco-related litigation could encourage the commencement of additional litigation. Damages awarded in some tobacco-related litigation can be significant.
Bonds. Although Liggett has been able to obtain required bonds or relief from bonding requirements in order to prevent plaintiffs from seeking to collect judgments while adverse verdicts are on appeal, there remains a risk that such relief may not be obtainable in all cases. This risk has been reduced given that a majority of states now limit the dollar amount of bonds or require no bond at all. To obtain stays on judgments pending current appeals, Liggett has secured approximately $5,093 in bonds as of September 30, 2014.
In June 2009, Florida amended its existing bond cap statute by adding a $200,000 bond cap that applies to all Engle progeny cases in the aggregate and establishes individual bond caps for individual Engle progeny cases in amounts that vary depending on the number of judgments in effect at a given time. In several cases, plaintiffs have challenged the constitutionality of the bond cap statute, but to date the courts that have addressed the issue have upheld the constitutionality of the statute. It is possible that the Company's consolidated financial position, results of operations, and cash flows could be materially adversely affected by an unfavorable outcome of such challenges.
Accounting Policy. The Company and its subsidiaries record provisions in their consolidated financial statements for pending litigation when they determine that an unfavorable outcome is probable and the amount of loss can be reasonably estimated. At the present time, while it is reasonably possible that an unfavorable outcome in a case may occur, except as disclosed in this Note 7: (i) management has concluded that it is not probable that a loss has been incurred in any of the pending tobacco-related cases; or (ii) management is unable to reasonably estimate the possible loss or range of loss that could result from an unfavorable outcome of any of the pending tobacco-related cases and, therefore, management has not provided any amounts in the consolidated financial statements for unfavorable outcomes, if any. Legal defense costs are expensed as incurred.
Cautionary Statement About Engle Progeny Cases. Judgments have been entered against Liggett and other industry defendants in Engle progeny cases. A number of the judgments have been affirmed on appeal and satisfied by the defendants. As of October 27, 2014, 19 Engle progeny cases where Liggett was a defendant at trial resulted in verdicts. Thirteen verdicts were returned in favor of the plaintiffs and six in favor of Liggett. Excluding the Lukacs case, which was tried in 2002, seven years before the trials of Engle progeny cases commenced, the compensatory verdicts against Liggett have ranged from $1 to $3,600. In certain cases, the judgments entered have been joint and several with other defendants. In three of the cases, punitive damages were awarded against Liggett. Except as discussed in this Note 7 regarding the cases where an adverse verdict was entered against Liggett and that remain on appeal, management is unable to estimate the possible loss or range of loss from the remaining Engle progeny cases as there are currently multiple defendants in each case and, in most cases, discovery has not occurred or is limited. As a result, the Company lacks information about whether plaintiffs are in fact Engle class members (non-class members' claims are generally time-barred), the relevant smoking history, the nature of the alleged injury and the availability of various defenses, among other things. Further, plaintiffs typically do not specify their demand for damages.
Although Liggett has generally been successful in managing litigation, litigation is subject to uncertainty and significant challenges remain, including with respect to the remaining Engle progeny cases. There can be no assurances that Liggett's past litigation experience will be representative of future results. Judgments have been entered against Liggett in the past, in Individual Actions and Engle progeny cases, and several of those judgments were affirmed on appeal and satisfied by Liggett. It is possible that the consolidated financial position, results of operations and cash flows of the Company could be materially adversely affected by an unfavorable outcome or settlement of any of the remaining smoking-related litigation. Liggett believes, and has been so advised by counsel, that it has valid defenses to the litigation pending against it, as well as valid bases for appeal of adverse verdicts. All such cases are, and will continue to be, vigorously defended. Liggett may, however, enter into settlement discussions in particular cases if it believes it is in its best interest to do so, including the remaining Engle progeny cases. As of September 30, 2014, Liggett (and in certain cases the Company) had, on an individual basis, settled 144 Engle progeny cases for approximately $1,170 in the aggregate. There were no settlements in the third quarter of 2014. In addition, in October 2013, Liggett announced a settlement of the claims of over 4,900 Engle progeny plaintiffs (see Engle Progeny Settlement below).

22
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


Individual Actions
As of September 30, 2014, there were 48 Individual Actions pending against Liggett and, in certain cases, the Company, where one or more individual plaintiffs allege injury resulting from cigarette smoking, addiction to cigarette smoking or exposure to secondary smoke and seek compensatory and, in some cases, punitive damages. These cases do not include Engle progeny cases or the approximately 100 individual cases pending in West Virginia state court as part of a consolidated action. The following table lists the number of Individual Actions, by state, that are pending against Liggett or the Company as of September 30, 2014:
State
 
Number
of Cases
Florida
 
30

New York
 
8

Maryland
 
4

Louisiana
 
2

West Virginia
 
2

Missouri
 
1

Ohio
 
1

The plaintiffs' allegations of liability in cases in which individuals seek recovery for injuries allegedly caused by cigarette smoking are based on various theories of recovery, including negligence, gross negligence, breach of special duty, strict liability, fraud, concealment, misrepresentation, design defect, failure to warn, breach of express and implied warranties, conspiracy, aiding and abetting, concert of action, unjust enrichment, common law public nuisance, property damage, invasion of privacy, mental anguish, emotional distress, disability, shock, indemnity, violations of deceptive trade practice laws, the federal Racketeer Influenced and Corrupt Organizations Act (“RICO”), state RICO statutes and antitrust statutes. In many of these cases, in addition to compensatory damages, plaintiffs also seek other forms of relief including treble/multiple damages, medical monitoring, disgorgement of profits and punitive damages. Although alleged damages often are not determinable from a complaint, and the law governing the pleading and calculation of damages varies from state to state and jurisdiction to jurisdiction, compensatory and punitive damages have been specifically pleaded in a number of cases, sometimes in amounts ranging into the hundreds of millions and even billions of dollars.
Defenses raised in Individual Actions include lack of proximate cause, assumption of the risk, comparative fault and/or contributory negligence, lack of design defect, statute of limitations, equitable defenses such as “unclean hands” and lack of benefit, failure to state a claim and federal preemption.

Engle Progeny Cases
Engle Case. In May 1994, Engle was filed against Liggett and others in Miami-Dade County, Florida. The class consisted of all Florida residents who, by November 21, 1996, “have suffered, presently suffer or have died from diseases and medical conditions caused by their addiction to cigarette smoking.” In July 1999, after the conclusion of Phase I of the trial, the jury returned a verdict against Liggett and other cigarette manufacturers on certain issues determined by the trial court to be “common” to the causes of action of the plaintiff class. The jury made several findings adverse to the defendants including that defendants' conduct “rose to a level that would permit a potential award or entitlement to punitive damages.” Phase II of the trial was a causation and damages trial for three of the class plaintiffs and a punitive damages trial on a class-wide basis before the same jury that returned the verdict in Phase I. In April 2000, the jury awarded compensatory damages of $12,704 to the three class plaintiffs, to be reduced in proportion to the respective plaintiff’s fault. In July 2000, the jury awarded approximately $145,000,000 in punitive damages, including $790,000 against Liggett.
In May 2003, Florida’s Third District Court of Appeal reversed the trial court and remanded the case with instructions to decertify the class. The judgment in favor of one of the three class plaintiffs, in the amount of $5,831, was overturned as time barred and the court found that Liggett was not liable to the other two class plaintiffs.

23
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


In July 2006, the Florida Supreme Court affirmed the decision vacating the punitive damages award and held that the class should be decertified prospectively, but determined that the following Phase I findings are entitled to res judicata effect in Engle progeny cases: (i) that smoking causes lung cancer, among other diseases; (ii) that nicotine in cigarettes is addictive; (iii) that defendants placed cigarettes on the market that were defective and unreasonably dangerous; (iv) that defendants concealed material information knowing that the information was false or misleading or failed to disclose a material fact concerning the health effects or addictive nature of smoking; (v) that defendants agreed to conceal or omit information regarding the health effects of cigarettes or their addictive nature with the intention that smokers would rely on the information to their detriment; (vi) that defendants sold or supplied cigarettes that were defective; and (vii) that defendants were negligent. The Florida Supreme Court decision also allowed former class members to proceed to trial on individual liability issues (using the above findings) and compensatory and punitive damage issues, provided they filed their individual lawsuits by January 2008. In December 2006, the Florida Supreme Court added the finding that defendants sold or supplied cigarettes that, at the time of sale or supply, did not conform to the representations made by defendants. In October 2007, the United States Supreme Court denied defendants' petition for writ of certiorari.
Pursuant to the Florida Supreme Court’s July 2006 ruling in Engle, which decertified the class on a prospective basis, and affirmed the appellate court’s reversal of the punitive damages award, former class members had until January 2008 in which to file individual lawsuits. As a result, Liggett and the Company, and other cigarette manufacturers, were named defendants in thousands of Engle progeny cases in both federal and state courts in Florida. Although the Company was not named as a defendant in the Engle case, it was named as a defendant in substantially all of the Engle progeny cases where Liggett was named as a defendant.
Engle Progeny Settlement. On October 23, 2013, the Company entered into a settlement with approximately 4,900 Engle progeny plaintiffs and their counsel. Pursuant to the terms of the settlement, Liggett agreed to pay a total of approximately $110,000, with approximately $61,600 paid in a lump sum and the balance to be paid in installments over 14 years. In exchange, the claims of over 4,900 plaintiffs were dismissed with prejudice against the Company and Liggett. In 2013 the Company recorded a charge of $86,213 in connection with the settlement. Of this amount, $25,213 is related to certain payments discounted to their present value because the timing and amounts of such payments are fixed and determinable. The present value of the installment payments was computed using an 11% annual discount rate. The installment payments total approximately $48,000 on an undiscounted basis. The Company’s future payments will be approximately $3,500 per annum through 2028, with a cost of living increase beginning in 2021.
Notwithstanding the comprehensive nature of the Engle Progeny Settlement, approximately 330 plaintiffs' claims remain outstanding. Therefore, the Company and Liggett may still be subject to periodic adverse judgments which could have a material adverse affect on the Company's consolidated financial position, results of operations and cash flows.

24
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


As of October 27, 2014, the following Engle progeny cases have resulted in judgments against Liggett:
Date
 
Case Name
 
County
 
Liggett Compensatory
Damages
 
Liggett Punitive Damages
 
Status
June 2002
 
Lukacs v. R.J. Reynolds
 
Miami-Dade
 
$12,418
 
None
 
Liggett satisfied the judgment and the case is concluded.
August 2009
 
Campbell v. R.J. Reynolds
 
Escambia
 
$156
 
None
 
Liggett satisfied the judgment and the case is concluded.
March 2010
 
Douglas v. R.J. Reynolds
 
Hillsborough
 
$1,350
 
None
 
Liggett satisfied the judgment and the case is concluded.
April 2010
 
Clay v. R.J. Reynolds
 
Escambia
 
$349
 
$1,000
 
Liggett satisfied the judgment and the case is concluded.
April 2010
 
Putney v. R.J. Reynolds
 
Broward
 
$3,008
 
None
 
On June 12, 2013, the Fourth District Court of Appeal reversed and remanded the case for further proceedings. Plaintiff filed a motion for rehearing which was denied. Both sides sought discretionary review from the Florida Supreme Court. The appeal is stayed pending the outcome of the Hess appeal.
April 2011
 
Tullo v. R.J. Reynolds
 
Palm Beach
 
$225
 
None
 
Affirmed by the Fourth District Court of Appeal. Discretionary review from the Florida Supreme Court was denied. Liggett satisfied the judgment and the case is concluded, other than an issue with respect to the calculation of interest on the judgment and the amount of costs owed by Liggett.
January 2012
 
Ward v. R.J. Reynolds
 
Escambia
 
$1
 
None
 
Liggett satisfied the merits judgment and other than an issue regarding attorneys' fees, the case is concluded.
May 2012
 
Calloway v. R.J. Reynolds
 
Broward
 
$1,947
 
$7,600
 
A joint and several judgment for $16,100 was entered against R.J. Reynolds, Philip Morris, Lorillard and Liggett. On appeal to the Fourth District Court of Appeal.
December 2012
 
Buchanan v. R.J. Reynolds
 
Leon
 
$2,035
 
None
 
A joint and several judgment for $5,500 was entered against Liggett and Philip Morris. Affirmed by the First District Court of Appeal, but, the court certified an issue of conflict with another case. The defendants sought discretionary review by the Florida Supreme Court. The appeal is stayed pending the outcome of Hess.
May 2013
 
Cohen v. R.J. Reynolds
 
Palm Beach
 
$205
 
None
 
Defendants' motion seeking a new trial was granted by the trial court. Plaintiff appealed to the Fourth District Court of Appeal.
August 2013
 
Rizzuto v. R.J. Reynolds
 
Hernando
 
$3,479
 
None
 
Liggett settled its portion of the judgment for $1,500 and the case is concluded.
August 2014
 
Irimi v. R.J. Reynolds
 
Broward
 
$31
 
None
 
The verdict has not been reduced to a judgment. Post trial motions are pending.
October 2014
 
Lambert v. R.J. Reynolds
 
Pinellas
 
$3,600
 
$9,500
 
The verdict has not been reduced to a judgment. Post trial motions are pending.
Total Damages Awarded:
$28,804
 
$18,100
 
 
Amounts paid or compromised:
$(17,978)
 
$(1,000)
 
 
Damages remaining on Appeal:
$10,826
 
$17,100
 
 

Through September 30, 2014, Liggett has paid $20,040, including interest and legal fees, to satisfy the judgments in six Engle progeny cases (Lukacs, Campbell, Douglas, Clay, Ward and Rizzuto). The Tullo judgment was satisfied on October 22, 2014. Liggett paid $272, including interest.
The Company's potential range of loss in the Putney, Calloway, Buchanan, Cohen, Irimi and Lambert cases is between $0 and $27,926 in the aggregate, plus accrued interest and legal fees. In determining the range of loss, the Company considers potential settlements as well as future appellate relief. Except as disclosed elsewhere in this Note 7, the Company is unable to determine a range of loss related to the remaining Engle progeny cases. Other than $272 accrued for Tullo, no amounts have been expensed or accrued in the accompanying condensed consolidated financial statements for the cases described above. However, as cases proceed through the appellate process, the Company will consider accruals on a case-by-case basis if an unfavorable outcome becomes probable and the amount can be reasonably estimated.
Appeals of Engle Progeny Verdicts. In December 2010, in the Martin case, a state court case against R.J. Reynolds, the First District Court of Appeal issued the first ruling by a Florida intermediate appellate court to address the B. Brown decision discussed above. The panel held that the trial court correctly construed the Florida Supreme Court's 2006 decision in Engle in instructing the jury on the preclusive effect of the Phase I Engle proceedings, expressly disagreeing with certain aspects of the B. Brown decision. In July 2011, the Florida Supreme Court declined to review the First District Court of Appeal's decision. In

25
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


March 2012, the United States Supreme Court declined to review the Martin case, along with the Campbell case and two other Engle progeny cases. This decision has led to other adverse rulings by other state appellate courts.
In Jimmie Lee Brown, a state court case against R.J. Reynolds, the trial court tried the case in two phases. In the first phase, the jury determined that the smoker was addicted to cigarettes that contained nicotine and that his addiction was a legal cause of his death, thereby establishing he was an Engle class member. In the second phase, the jury determined whether the plaintiff established legal cause and damages with regard to each of the underlying claims.  The jury found in favor of plaintiff in both phases.  In September 2011, the Fourth District Court of Appeal affirmed the judgment entered in plaintiff's favor and approved the trial court's procedure of bifurcating the trial.  The Fourth District Court of Appeal agreed with Martin that individual post-Engle plaintiffs need not prove conduct elements as part of their burden of proof, but disagreed with Martin to the extent that the First District Court of Appeal only required a finding that the smoker was a class member to establish legal causation as to addiction and the underlying claims.  The Fourth District Court of Appeal held that in addition to establishing class membership, Engle progeny plaintiffs must also establish legal causation and damages as to each claim asserted.  In so finding, the Fourth District Court of Appeal's decision in Jimmie Lee Brown is in conflict with Martin. 
In the Rey case, a state court case, the trial court entered final summary judgment on all claims in favor of the Company, Liggett and Lorillard based on what has been referred to in the Engle progeny litigation as the "Liggett Rule."  The Liggett Rule stands for the proposition that a manufacturer cannot have liability to a smoker under any asserted claim if the smoker did not use a product manufactured by that particular defendant.  The Liggett Rule is based on the entry of final judgment in favor of Liggett/Brooke Group in Engle on all of the claims asserted against them by class representatives Mary Farnan and Angie Della Vecchia, even though the Florida Supreme Court upheld, as res judicata, the generic finding that Liggett/Brooke Group engaged in a conspiracy to commit fraud by concealment. In September 2011, the Third District Court of Appeal affirmed in part and reversed in part holding that the defendants were entitled to summary judgment on all claims asserted against them other than the claim for civil conspiracy.  Defendants' further appellate efforts were unsuccessful.
In March 2012, in Douglas, the Second District Court of Appeal issued a decision affirming the judgment of the trial court in favor of the plaintiff and upholding the use of the Engle jury findings but certified to the Florida Supreme Court the question of whether granting res judicata effect to the Engle jury findings violates defendants' federal due process rights. In March 2013, the Florida Supreme Court affirmed the use of Engle jury findings and determined that there is no violation of the defendants' due process rights. This was the first time the Florida Supreme Court addressed the merits of an Engle progeny case. In October 2013, the United States Supreme Court declined to review the decision and Liggett satisfied the judgment. Recently, the United States Supreme Court declined to review the decisions in several other Engle progeny cases.

In Hess, a case pending in Broward County, the jury returned a verdict finding that decedent relied to his detriment on an omission by the defendant before May 5, 1982 (twelve years prior to the filing of the Engle Complaint).  Defendant moved for judgment as a matter of law on plaintiff’s fraudulent concealment claim on the basis that the claim was barred by Florida’s statute of repose.  The trial court denied the motion and was reversed by the Fourth District Court of Appeal, which held that any fraud committed before May 5, 1982 is barred.  This decision conflicts with decisions from other district courts of appeal and is before the Florida Supreme Court pursuant to its conflict jurisdiction.  Oral argument occurred on April 30, 2014. A decision is pending.
Liggett Only Cases.  There are currently five cases pending where Liggett is the only remaining defendant. These cases consist of three Individual Actions and two Engle progeny cases. In one of the Individual Actions, Hausrath (NY state court), plaintiff moved to restore the case to the active docket calendar after it was removed by the court. The motion was granted and Liggett appealed. There has been no recent activity in the other two Individual Actions. Trial in Lambert, an Engle progeny case, concluded on September 30, 2014 and resulted in a jury verdict against Liggett for $13,100. Post trial motions are pending. The other Engle progeny case is not currently set for trial. Cases where Liggett is the only defendant could increase as a result of the remaining Engle progeny cases.

Class Actions

As of September 30, 2014, there were four actions pending for which either a class had been certified or plaintiffs were seeking class certification where Liggett is a named defendant, including one alleged price fixing case. Other cigarette manufacturers are also named in these actions.



26
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


Plaintiffs' allegations of liability in class action cases are based on various theories of recovery, including negligence, gross negligence, strict liability, fraud, misrepresentation, design defect, failure to warn, nuisance, breach of express and implied warranties, breach of special duty, conspiracy, concert of action, violation of deceptive trade practice laws and consumer protection statutes and claims under the federal and state anti-racketeering statutes. Plaintiffs in the class actions seek various forms of relief, including compensatory and punitive damages, treble/multiple damages and other statutory damages and penalties, creation of medical monitoring and smoking cessation funds, disgorgement of profits, and injunctive and equitable relief.
Defenses raised in these cases include, among others, lack of proximate cause, individual issues predominate, assumption of the risk, comparative fault and/or contributory negligence, statute of limitations and federal preemption.
In November 1997, in Young v. American Tobacco Co., a purported personal injury class action was commenced on behalf of plaintiff and all similarly situated residents in Louisiana who, though not themselves cigarette smokers, allege they were exposed to secondhand smoke from cigarettes that were manufactured by the defendants, including Liggett, and suffered injury as a result of that exposure. The plaintiffs seek to recover an unspecified amount of compensatory and punitive damages. No class certification hearing has been held.   In June 2013, plaintiffs’ counsel moved for an indefinite stay of the case.  The defendants did not oppose the stay and it was entered by the court.
In February 1998, in Parsons v. AC & S Inc., a class was commenced on behalf of all West Virginia residents who allegedly have personal injury claims arising from exposure to cigarette smoke and asbestos fibers. The complaint seeks to recover $1,000 in compensatory and punitive damages individually and unspecified compensatory and punitive damages for the class. The case is stayed due to the December 2000 bankruptcy of three of the defendants.
In February 2000, in Smith v. Philip Morris, a case pending in Kansas, a class was commenced against cigarette manufacturers alleging they conspired to fix cigarette prices in violation of antitrust laws. Plaintiffs seek to recover an unspecified amount in actual and punitive damages. Class certification was granted in November 2001. In January 2012, the trial court heard oral argument on defendants' motions for summary judgment and in March 2012, the court granted the motions and dismissed plaintiffs' claims with prejudice. In July 2014, the court of appeals affirmed the lower court's decision. On August 18, 2014, plaintiffs submitted a petition for review to the Kansas Supreme Court. A decision is pending.
Although not technically a class action, in In Re: Tobacco Litigation (Personal Injury Cases), a West Virginia state court consolidated approximately 750 individual smoker actions that were pending prior to 2001 for trial of certain common issues. In January 2002, the court severed Liggett from the trial of the consolidated action. After two mistrials, on May 15, 2013, the jury rejected all but one of the plaintiffs' claims, finding for the plaintiffs on the claim that ventilated filter cigarettes, sold between 1964 and 1969, should have included instructions on how to use them. The issue of damages was reserved for further proceedings that have not yet been scheduled. Final judgment as to liability was issued in October 2013, after which the plaintiffs filed a notice of appeal to the West Virginia Supreme Court of Appeals. The defendants did not appeal the verdict in favor of the plaintiffs on the "failure to instruct" claim which impacted less than 30 plaintiffs. If the case were to proceed against Liggett, it is estimated that Liggett could be a defendant in approximately 100 of the individual cases.
Class action suits have been filed in a number of states against cigarette manufacturers, alleging, among other things, that use of the terms “lights” and “ultra lights” constitutes unfair and deceptive trade practices. In December 2008, the United States Supreme Court, in Altria Group v. Good, ruled that the Federal Cigarette Labeling and Advertising Act did not preempt the state law claims asserted by the plaintiffs and that they could proceed with their claims under the Maine Unfair Trade Practices Act. The Good decision has resulted in the filing of additional “lights” class action cases in other states against other cigarette manufacturers. Although Liggett was not a defendant in the Good case, and is not currently a defendant in any other “lights” class actions, an adverse ruling or commencement of additional “lights” related class actions could have a material adverse effect on the Company.
In addition to the cases described above, numerous class actions remain certified against other cigarette manufacturers. Adverse decisions in these cases could have a material adverse affect on Liggett’s sales volume, operating income and cash flows.
Health Care Cost Recovery Actions
As of September 30, 2014, there was one remaining Health Care Cost Recovery Action pending against Liggett, Crow Creek Sioux Tribe v. American Tobacco Company, a South Dakota case filed in 1997, where the plaintiff seeks to recover damages based on various theories of recovery as a result of alleged sales of tobacco products to minors. The case is inactive. Other cigarette manufacturers are also named as defendants.

27
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


The claims asserted in health care cost recovery actions vary. Although, typically, no specific damage amounts are pled, it is possible that requested damages might be in the billions of dollars. In these cases, plaintiffs typically assert equitable claims that the tobacco industry was “unjustly enriched” by their payment of health care costs allegedly attributable to smoking and seek reimbursement of those costs. Relief sought by some, but not all, plaintiffs include punitive damages, multiple damages and other statutory damages and penalties, injunctions prohibiting alleged marketing and sales to minors, disclosure of research, disgorgement of profits, funding of anti-smoking programs, additional disclosure of nicotine yields, and payment of attorney and expert witness fees.
Other claims asserted include the equitable claim of indemnity, common law claims of negligence, strict liability, breach of express and implied warranty, breach of special duty, fraud, negligent misrepresentation, conspiracy, public nuisance, claims under state and federal statutes governing consumer fraud, antitrust, deceptive trade practices and false advertising, and claims under RICO.
Department of Justice Lawsuit. In September 1999, the United States government commenced litigation against Liggett and other cigarette manufacturers in the United States District Court for the District of Columbia. The action sought to recover an unspecified amount of health care costs paid and to be paid by the federal government for lung cancer, heart disease, emphysema and other smoking-related illnesses allegedly caused by the fraudulent and tortious conduct of defendants, to restrain defendants and co-conspirators from engaging in alleged fraud and other allegedly unlawful conduct in the future, and to compel defendants to disgorge the proceeds of their unlawful conduct. Claims were asserted under RICO.
In August 2006, the trial court entered a Final Judgment against each of the cigarette manufacturing defendants, except Liggett. In May 2009, the United States Court of Appeals for the District of Columbia affirmed most of the district court's decision. The United States Supreme Court denied review. As a result, the cigarette manufacturing defendants, other than Liggett, are now subject to the trial court's Final Judgment which ordered the following relief: (i) an injunction against “committing any act of racketeering” relating to the manufacturing, marketing, promotion, health consequences or sale of cigarettes in the United States; (ii) an injunction against participating directly or indirectly in the management or control of the Council for Tobacco Research, the Tobacco Institute, or the Center for Indoor Air Research, or any successor or affiliated entities of each; (iii) an injunction against “making, or causing to be made in any way, any material false, misleading, or deceptive statement or representation or engaging in any public relations or marketing endeavor that is disseminated to the United States' public and that misrepresents or suppresses information concerning cigarettes”; (iv) an injunction against conveying any express or implied health message through use of descriptors on cigarette packaging or in cigarette advertising or promotional material, including “lights,” “ultra lights,” and “low tar,” which the court found could cause consumers to believe one cigarette brand is less hazardous than another brand; (v) the issuance of “corrective statements” in various media regarding the adverse health effects of smoking, the addictiveness of smoking and nicotine, the lack of any significant health benefit from smoking “low tar” or “lights” cigarettes, defendants' manipulation of cigarette design to ensure optimum nicotine delivery and the adverse health effects of exposure to environmental tobacco smoke; (vi) the disclosure of defendants' public document websites and the production of all documents produced to the government or produced in any future court or administrative action concerning smoking and health; (vii) the disclosure of disaggregated marketing data to the government in the same form and on the same schedules as defendants now follow in disclosing such data to the Federal Trade Commission for a period of ten years; (viii) certain restrictions on the sale or transfer by defendants of any cigarette brands, brand names, formulas or cigarette business within the United States; and (ix) payment of the government's costs in bringing the action. In June 2014, the court approved a consent agreement between the defendants and the Department of Justice regarding the "corrective statements" to be issued by the defendants. The implementation of the "corrective statements" is uncertain as the defendants are appealing the specific language of the statements.
It is unclear what impact, if any, the Final Judgment will have on the cigarette industry as a whole. To the extent that the Final Judgment leads to a decline in industry-wide shipments of cigarettes in the United States or otherwise results in restrictions that adversely affect the industry, Liggett's sales volume, operating income and cash flows could be materially adversely affected.
Upcoming Trials
As of September 30, 2014, there were 16 Engle progeny cases scheduled for trial through September 30, 2015, where Liggett (and in many cases, the Company) is a named defendant. Trial dates are, however, subject to change.

28
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


MSA and Other State Settlement Agreements
In March 1996, March 1997 and March 1998, Liggett entered into settlements of smoking-related litigation with 45 states and territories. The settlements released Liggett from all smoking-related claims made by those states and territories, including claims for health care cost reimbursement and claims concerning sales of cigarettes to minors.
In November 1998, Philip Morris, Brown & Williamson, R.J. Reynolds and Lorillard (the “Original Participating Manufacturers” or “OPMs”) and Liggett (together with any other tobacco product manufacturer that becomes a signatory, the “Subsequent Participating Manufacturers” or “SPMs”) (the OPMs and SPMs are hereinafter referred to jointly as the “Participating Manufacturers”) entered into the Master Settlement Agreement (the “MSA”) with 46 states, the District of Columbia, Puerto Rico, Guam, the United States Virgin Islands, American Samoa and the Northern Mariana Islands (collectively, the “Settling States”) to settle the asserted and unasserted health care cost recovery and certain other claims of the Settling States. The MSA received final judicial approval in each Settling State.
As a result of the MSA, the Settling States released Liggett from:
•
all claims of the Settling States and their respective political subdivisions and other recipients of state health care funds, relating to: (i) past conduct arising out of the use, sale, distribution, manufacture, development, advertising and marketing of tobacco products; (ii) the health effects of, the exposure to, or research, statements or warnings about, tobacco products; and
•
all monetary claims of the Settling States and their respective subdivisions and other recipients of state health care funds relating to future conduct arising out of the use of, or exposure to, tobacco products that have been manufactured in the ordinary course of business.
The MSA restricts tobacco product advertising and marketing within the Settling States and otherwise restricts the activities of Participating Manufacturers. Among other things, the MSA prohibits the targeting of youth in the advertising, promotion or marketing of tobacco products; bans the use of cartoon characters in all tobacco advertising and promotion; limits each Participating Manufacturer to one tobacco brand name sponsorship during any 12-month period; bans all outdoor advertising, with certain limited exceptions; prohibits payments for tobacco product placement in various media; bans gift offers based on the purchase of tobacco products without sufficient proof that the intended recipient is an adult; prohibits Participating Manufacturers from licensing third parties to advertise tobacco brand names in any manner prohibited under the MSA; and prohibits Participating Manufacturers from using as a tobacco product brand name any nationally recognized non-tobacco brand or trade name or the names of sports teams, entertainment groups or individual celebrities.
The MSA also requires Participating Manufacturers to affirm corporate principles to comply with the MSA and to reduce underage use of tobacco products and imposes restrictions on lobbying activities conducted on behalf of Participating Manufacturers. In addition, the MSA provides for the appointment of an independent auditor to calculate and determine the amounts of payments owed pursuant to the MSA.
Under the payment provisions of the MSA, the Participating Manufacturers are required to make annual payments of $9,000,000 (subject to applicable adjustments, offsets and reductions). These annual payments are allocated based on unit volume of domestic cigarette shipments. The payment obligations under the MSA are the several, and not joint, obligation of each Participating Manufacturer and are not the responsibility of any parent or affiliate of a Participating Manufacturer.
Liggett has no payment obligations under the MSA except to the extent its market share exceeds a market share exemption of approximately 1.65% of total cigarettes sold in the United States. Vector Tobacco has no payment obligations under the MSA except to the extent its market share exceeds a market share exemption of approximately 0.28% of total cigarettes sold in the United States. Liggett and Vector Tobacco's domestic shipments accounted for 3.3% of the total cigarettes sold in the United States in 2013. If Liggett’s or Vector Tobacco’s market share exceeds their respective market share exemption in a given year, then on April 15 of the following year, Liggett and/or Vector Tobacco, as the case may be, must pay on each excess unit an amount equal (on a per-unit basis) to that due from the OPMs for that year. On December 31, 2013, Liggett pre-paid $95,000 of its 2013 MSA obligation. On April 15, 2014, Liggett and Vector Tobacco paid approximately $16,300 for the balance of their 2013 MSA obligation.
Certain MSA Disputes
NPM Adjustment.  In March 2006, an economic consulting firm selected pursuant to the MSA determined that the MSA was a “significant factor contributing to” the loss of market share of Participating Manufacturers, to non-participating manufacturers, for 2003. This is known as the “NPM Adjustment.” The economic consulting firm subsequently rendered the

29
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


same decision with respect to 2004 and 2005. In March 2009, a different economic consulting firm made the same determination for 2006. As a result, the manufacturers are entitled to potential NPM Adjustments to each of their 2003 - 2006 MSA payments. The Participating Manufacturers are also entitled to potential NPM Adjustments to their 2007 - 2013 payments pursuant to agreements entered into between the OPMs and the Settling States under which the OPMs agreed to make certain payments for the benefit of the Settling States, in exchange for which the Settling States stipulated that the MSA was a “significant factor contributing to” the loss of market share of Participating Manufacturers for each of those years. A Settling State that has diligently enforced its qualifying escrow statute in the year in question may be able to avoid allocation of the NPM Adjustment to the payments made by the manufacturers for the benefit of that Settling State.
For 2003 - 2013, Liggett and Vector Tobacco, as applicable, disputed that they owed the Settling States the NPM Adjustments as calculated by the independent auditor. As permitted by the MSA, Liggett (and in many cases Vector Tobacco) paid subject to dispute, withheld payment or paid into a disputed payment account the amounts associated with these NPM Adjustments.
Notwithstanding provisions in the MSA requiring arbitration, litigation was filed in 49 Settling States involving the application of the NPM Adjustment for 2003 and whether it was to be determined through litigation or arbitration. These actions related to the potential NPM Adjustment for 2003, which the independent auditor under the MSA previously determined to be as much as $1,200,000 for all Participating Manufacturers. All but one of the 48 courts that decided the issue ruled that the 2003 NPM Adjustment dispute was arbitrable.
In response to a proposal from the OPMs and many of the SPMs, 45 of the Settling States, representing approximately 90% of the allocable share of the Settling States, entered into an agreement providing for a nationwide arbitration of the dispute with respect to the NPM Adjustment for 2003. In exchange the OPMs and SPMs agreed to a 20% reduction in amounts recovered for the NPM Adjustment for 2003. In June 2010, the three person arbitration panel was selected. In November 2011, the Participating Manufacturers advised the arbitration panel that they were not contesting diligent enforcement of 16 Settling States for 2003. Substantive hearings commenced in April 2012 and were completed in June 2013.
In December 2012, the Participating Manufacturers entered into a “term sheet” with 20 Settling States setting out terms for settlement of the NPM Adjustment for 2003 - 2012 and addressing the NPM Adjustment with respect to those states for future years. Certain of the non-settling states objected to the settlement. In March 2013, the arbitration panel entered a Stipulated Partial Settlement and Award which, among other things, overruled the objections of the non-settling states and directed the independent auditor to implement certain terms of the term sheet effective with the 2013 MSA payments. In May 2013, two additional states joined the settlement. In June 2014, two additional states joined the settlement. Several non-settling states are attempting to vacate the settlement award by filing state court actions. In Idaho, a trial court denied that state's motion to vacate, and the state noticed an appeal of that denial. In Colorado, a trial court also denied that state’s motion to vacate; Colorado has not filed an appeal, and the time period for appeal has passed. Although certain terms of the settlement were implemented by the independent auditor on April 15, 2013, no assurance can be given as to the ultimate outcome of the non-settling states' challenges.
As a result of the settlement, in the first nine months of 2013 Liggett recognized income of $6,947. Finally, Liggett received credits of $1,733 in April 2014 from these settling states related to the 2013 NPM Adjustment. The remaining NPM Adjustment accrual of $25,809 at September 30, 2014 relates to the disputed amounts Liggett withheld from the non-settling states for 2004 - 2010, which may be subject to payment, with interest, if Liggett loses the disputes for those years. Approximately $24,400 currently remains in the disputed payments accounts relating to the 2011, 2012 and 2013 NPM Adjustment dispute with the non-settling states.
In September 2013, the panel issued its decisions with respect to the 15 states that did not enter into the Stipulated Partial Settlement and Award, finding that six states did not diligently enforce their MSA escrow statutes in 2003. As a result of this ruling Liggett recognized income of $5,987 including interest, in the third quarter of 2013. All six of the states that were found to be non-diligent filed motions in state court seeking to vacate or reduce the amount of the arbitration award. A trial court in one of those states, Pennsylvania, rejected the state's motion to vacate the award but granted its motion to reduce the award. As a result, in April 2014, Liggett received a credit in the amount of $6,441 for the 2003 NPM Adjustment (as calculated by the independent auditor). It subsequently reimbursed the six states 20% of that credit, pursuant to the agreement discussed above, bringing its net recovery to $5,152, which is approximately $1,315 lower than the amount Liggett believes it’s entitled to. Subsequent to the April 15, 2014 MSA payment date, a state court in Missouri ruled similarly to the ruling in Pennsylvania. As such, Liggett's 2003 NPM credit adjustment could be reduced by an additional $521. In June 2014, Kentucky and Indiana agreed to settle the dispute. As a result, Liggett recognized income of approximately $1,400 in the second quarter of 2014. The Participating Manufacturers, including Liggett, appealed the Pennsylvania and Missouri decisions. If Liggett is unsuccessful

30
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


in its appeals or if other states are successful with respect to any such motions, the amount of the 2003 NPM Adjustment and any interest or earnings to which Liggett is entitled could be lower than the amounts described above and Liggett would be obligated to pay the difference.

Disputes over the NPM Adjustments for 2004-2013 remain to be arbitrated with the states that have not joined the settlement.
"Gross" v. "Net" Calculations.  In October 2004, the independent auditor notified Liggett and all other Participating Manufacturers that their payment obligations under the MSA, dating from the agreement’s execution in late 1998, had been re-calculated using “net” units, rather than “gross” units (which had been used since 1999). Liggett objected to this retroactive change and disputed the change in methodology.
In December 2012, the parties arbitrated the dispute before a panel of three arbitrators. In February 2013, the arbitrators ruled that the limitations provisions of the MSA precluded the independent auditor from recalculating Liggett's grandfathered market share ("GFMS") exemption or Liggett's payment obligations beyond the last four years.  The arbitrators further ruled that, for purposes of calculating Liggett's payment obligations for the applicable years, Liggett's market share, calculated on a net basis, should be increased by a factor of 1.25%.  Liggett filed a motion seeking correction of the part of the arbitrators' decision that would require the 1.25% increase in Liggett's market share. The states objected to Liggett's motion and sought additional relief from the panel declaring that any adjustment ordered by the panel is not limited by the four years limitations set forth in the MSA.
A hearing on the motions was held on September 16, 2014. On October 8, 2014 the panel issued its Corrected Final Award, which eliminated the 1.25% adjustment increase and reaffirmed that Liggett is entitled to have its GFMS calculated on a “gross” basis (1.645%). Instead of the 1.25% adjustment increase the panel determined that the independent auditor shall compute Liggett’s market share for all years after March 30, 2000 on a “net” basis but adjust that computation to approximate “gross” market share by using actual returned product data for each year. Liggett plans to work with the independent auditor to determine the amount owed for years 2001 - 2013. Liggett had previously accrued $8,500 for this matter.
Other State Settlements.  The MSA replaced Liggett’s prior settlements with all states and territories except for Florida, Mississippi, Texas and Minnesota. Each of these four states, prior to the effective date of the MSA, negotiated and executed settlement agreements with each of the other major tobacco companies, separate from those settlements reached previously with Liggett. Except as described below, Liggett's agreements with these states remain in full force and effect. These states' settlement agreements with Liggett contained most favored nation provisions which could reduce Liggett's payment obligations based on subsequent settlements or resolutions by those states with certain other tobacco companies. Beginning in 1999, Liggett determined that, based on each of these four states' settlements with United States Tobacco Company, Liggett's payment obligations to those states had been eliminated. With respect to all non-economic obligations under the previous settlements, Liggett believes it is entitled to the most favorable provisions as between the MSA and each state's respective settlement with the other major tobacco companies. Therefore, Liggett's non-economic obligations to all states and territories are now defined by the MSA.
In 2003, as a result of a dispute with Minnesota regarding its settlement agreement, Liggett agreed to pay $100 a year, in any year cigarettes manufactured by Liggett are sold in that state. In 2003 and 2004, the Attorneys General for Florida, Mississippi and Texas advised Liggett that they believed that Liggett had failed to make certain required payments under the respective settlement agreements with these states. In December 2010, Liggett settled with Florida and agreed to pay $1,200 and to make further annual payments of $250 for a period of 21 years, starting in March 2011. The payments in years 12 – 21 will be subject to an inflation adjustment. These payments are in lieu of any other payments allegedly due to Florida under the original settlement agreement. In February 2012, Mississippi provided Liggett with a 60-day notice that the state intended to pursue its remedies if Liggett did not cure the alleged defaults. Liggett responded to Mississippi's letter denying the existence of any defaults. There can be no assurance that Liggett will be able to resolve the matters with Texas and Mississippi or that Liggett will not be required to make additional payments which could adversely affect the Company's consolidated financial position, results of operations and cash flows.
Cautionary Statement.  Management is not able to reasonably predict the outcome of the litigation pending or threatened against Liggett or the Company. Litigation is subject to many uncertainties. Liggett has been found liable in several Engle progeny cases and in Individual Actions, several of which were affirmed on appeal and satisfied by Liggett. It is possible that other cases could be decided unfavorably against Liggett and that Liggett will be unsuccessful on appeal. Liggett may attempt to settle particular cases if it believes it is in its best interest to do so.
Management cannot predict the cash requirements related to any future defense costs, settlements or judgments, including cash required to bond any appeals, and there is a risk that those requirements will not be able to be met. An unfavorable outcome

31
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


of a pending smoking-related case could encourage the commencement of additional litigation. Except as discussed in this Note 7, management is unable to estimate the loss or range of loss that could result from an unfavorable outcome of the cases pending against Liggett or the costs of defending such cases and as a result has not provided any amounts in its consolidated financial statements for unfavorable outcomes.
The tobacco industry is subject to a wide range of laws and regulations regarding the marketing, sale, taxation and use of tobacco products imposed by local, state and federal governments. There have been a number of restrictive regulatory actions, adverse legislative and political decisions and other unfavorable developments concerning cigarette smoking and the tobacco industry. These developments may negatively affect the perception of potential triers of fact with respect to the tobacco industry, possibly to the detriment of certain pending litigation, and may prompt the commencement of additional litigation or legislation.
It is possible that the Company’s consolidated financial position, results of operations and cash flows could be materially adversely affected by an unfavorable outcome in any of the smoking-related litigation.
The activity in the Company's accruals for the MSA and tobacco litigation for the nine months ended September 30, 2014 were as follows:
 
Current Liabilities
 
Non-Current Liabilities
 
Payments due under Master Settlement Agreement
 
Litigation Accruals
 
Total
 
Payments due under Master Settlement Agreement
 
Litigation Accruals
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2014
$
25,348

 
$
59,310

 
$
84,658

 
$
27,571

 
$
27,058

 
$
54,629

Expenses
83,159

 
2,041

 
85,200

 
—

 
—

 
—

NPM Settlement adjustment
—

 
—

 
—

 
(1,419
)
 
—

 
(1,419
)
Change in MSA obligations capitalized as inventory
(917
)
 
—

 
(917
)
 
—

 
—

 
—

Payments
(16,343
)
 
(61,822
)
 
(78,165
)
 
—

 
—

 
—

Reclassification from non-current liabilities
343

 
3,575

 
3,918

 
(343
)
 
(3,575
)
 
(3,918
)
Interest on withholding
—

 
203

 
203

 
—

 
1,546

 
1,546

Balance as of September 30, 2014
$
91,590

 
$
3,307

 
$
94,897

 
$
25,809

 
$
25,029

 
$
50,838


32
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited




The activity in the Company's accruals for the MSA and tobacco litigation for the nine months ended September 30, 2013 were as follows:
 
Current Liabilities
 
Non-Current Liabilities
 
Payments due under Master Settlement Agreement
 
Litigation Accruals
 
Total
 
Payments due under Master Settlement Agreement
 
Litigation Accruals
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2013
$
32,970

 
$
1,470

 
$
34,440

 
$
52,639

 
$
1,862

 
$
54,501

Expenses
87,770

 
62,872

 
150,642

 
—

 
25,219

 
25,219

NPM Settlement adjustment
(5,987
)
 
—

 
(5,987
)
 
(13,489
)
 
—

 
(13,489
)
Change in MSA obligations capitalized as inventory
675

 
—

 
675

 
—

 
—

 
—

Payments
(34,077
)
 
(1,685
)
 
(35,762
)
 
—

 
—

 
—

Reclassification from non-current liabilities
3,520

 
223

 
3,743

 
(3,520
)
 
(223
)
 
(3,743
)
Interest on withholding
—

 
321

 
321

 
—

 
150

 
150

Balance as of September 30, 2013
$
84,871

 
$
63,201

 
$
148,072

 
$
35,630

 
$
27,008

 
$
62,638



Other Matters:

Liggett’s and Vector Tobacco’s management are unaware of any material environmental conditions affecting their existing facilities. Liggett’s and Vector Tobacco’s management believe that current operations are conducted in material compliance with all environmental laws and regulations and other laws and regulations governing cigarette manufacturers. Compliance with federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had a material effect on the capital expenditures, results of operations or competitive position of Liggett or Vector Tobacco.
Liggett Vector Brands entered into an agreement with a subsidiary of the American Wholesale Marketers Association to support a program to permit certain tobacco distributors to secure, on reasonable terms, tax stamp bonds required by state and local governments for the distribution of cigarettes. The agreement expires in February 2016. Under the agreement, Liggett Vector Brands has agreed to pay a portion of losses incurred by the surety under the bond program, with a maximum loss exposure of $500. To secure its potential obligations under the agreement, Liggett Vector Brands posted a $100 letter of credit and agreed to fund up to an additional $400. In the third quarter of 2013, Liggett paid $83 for obligations under this program, and therefore, is only committed to fund an additional $317 over the letter of credit. The Company believes the fair value of Liggett Vector Brands’ obligation under the agreement was immaterial at September 30, 2014.
There may be several other proceedings, lawsuits and claims pending against the Company and certain of its consolidated subsidiaries unrelated to tobacco or tobacco product liability. Management is of the opinion that the liabilities, if any, ultimately resulting from such other proceedings, lawsuits and claims should not materially affect the Company’s financial position, results of operations or cash flows.




33
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


8.
INCOME TAXES

The Company's provision for income taxes in interim periods is based on an estimated annual effective income tax rate derived, in part, from estimated annual pre-tax results from ordinary operations. The annual effective income tax rate is reviewed and, if necessary, adjusted on a quarterly basis.
The Company's income tax expense consisted of the following:

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Income (loss) before provision for income taxes
$
31,669

 
$
(55,860
)
 
$
57,272

 
$
(34,348
)
Income tax expense using estimated annual effective income tax rate
9,932

 
(22,763
)
 
17,962

 
(13,997
)
Changes in effective tax rates
(374
)
 
1,181

 
—

 
1,159

Increase in unrecognized tax benefits
—

 
251

 
—

 
373

Impact of discrete items, net
1,305

 
—

 
1,944

 
816

Impact of discrete item associated with litigation settlement
—

 
2,362

 
—

 
2,362

Inclusion of tax liabilities from unincorporated entities
1,101

 
—

 
1,101

 
—

Income tax expense (benefit)
$
11,964

 
$
(18,969
)
 
$
21,007

 
$
(9,287
)


In the first quarter of 2014, the Company properly determined an adjustment for $1,944 related to its marginal tax rate was required as a result of its acquisition of 20.59% of Douglas Elliman Realty, LLC. This amount was originally recorded as additional income tax expense of $639, a reduction of Additional Paid-In Capital of $865 and a reduction of Other Comprehensive Income of $440. During the three months ended September 30, 2014 the Company reassessed the treatment of the previously recorded reductions to Additional Paid-In-Capital and Accumulated Other Comprehensive Income and reclassified such amounts as an increase to income tax expense.  The Company assessed the materiality of the misclassifications on the financial statements in the prior quarters of 2014 and concluded that it was immaterial to all previously issued quarterly financial statements and the three and nine months ended September 30, 2014.
The discrete item for the nine months ended September 30, 2013 is related to the impact of the Company's loss on the extinguishment of the 11% Senior Secured Notes due to the differences in the Company's marginal tax rate and its anticipated effective annual income tax rate at September 30, 2013 and the accrual of an unrecognized tax benefit.






34
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


9. INVESTMENTS AND FAIR VALUE MEASUREMENTS

The Company's recurring financial assets and liabilities subject to fair value measurements are as follows:

 
 
Fair Value Measurements as of September 30, 2014
Description
 
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 

Significant Other Observable Inputs
(Level 2)
 


Significant Unobservable Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
 
Money market funds
 
$
220,197

 
$
220,197

 
$
—

 
$
—

Certificates of deposit
 
3,462

 
—

 
3,462

 
—

Bonds
 
5,093

 
5,093

 
—

 
—

Investment securities available for sale
 

 
 
 
 
 
—

Equity securities
 
143,964

 
143,403

 
561

 
—

Mutual funds invested in fixed income securities
 
60,051

 
60,051

 
—

 
—

Fixed income securities
 
 
 
 
 
 
 
 
U.S. Government securities
 
44,220

 
—

 
44,220

 
—

Corporate securities
 
50,913

 
6,525

 
44,388

 
—

U.S. mortgage backed securities
 
297

 
—

 
297

 
—

Commercial mortgage-backed securities
 
15,561

 
—

 
15,561

 
—

U.S. asset backed securities
 
14,671

 
—

 
14,671

 
—

U.S. Government agencies
 
2,900

 
—

 
2,900

 
—

Index-linked U.S. bonds
 
1,306

 
—

 
1,306

 
—

Total fixed income securities
 
129,868

 
6,525

 
123,343

 
—

 
 
 
 
 
 
 
 
 
Warrants (1)
 
2,638

 
—

 
—

 
2,638

Total
 
$
565,273

 
$
435,269

 
$
127,366

 
$
2,638

 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Fair value of derivatives embedded within convertible debt
 
$
183,470

 
$
—

 
$
—

 
$
183,470

 
 
 
 
 
 
 
 
 

(1)
Warrants include 1,000,000 of LTS Warrants received on November 4, 2011 which were carried at $2,638 as of September 30, 2014 and are included in "Other assets". The Company recognized income of $868 for the nine months ended September 30, 2014 related to the change in fair value of the Warrants.


35
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


 
 
Fair Value Measurements as of December 31, 2013
Description
 
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 

Significant Other Observable Inputs
(Level 2)
 


Significant Unobservable Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
 
Money market funds
 
$
130,733

 
$
130,733

 
$
—

 
$
—

Certificates of deposit
 
2,961

 
—

 
2,961

 
—

Bonds
 
5,337

 
5,337

 
—

 
—

Investment securities available for sale
 
 
 
 
 
 
 
—

Equity securities
 
118,474

 
117,737

 
737

 
—

Fixed income securities
 
 
 
 
 
 
 
—

U.S. Government securities
 
13,990

 
—

 
13,990

 
—

Corporate securities
 
29,923

 
6,497

 
23,426

 
—

U.S. mortgage backed securities
 
495

 
—

 
495

 
—

Commercial mortgage-backed securities
 
6,822

 
—

 
6,822

 
—

U.S. asset backed securities
 
2,081

 
—

 
2,081

 
—

Index-linked U.S. bonds
 
749

 
—

 
749

 
—

Total fixed income securities
 
54,060

 
6,497

 
47,563

 
—

 
 
 
 
 
 
 
 
 
Warrants (1)
 
1,935

 
—

 
—

 
1,935

Total
 
$
313,500

 
$
260,304

 
$
51,261

 
$
1,935

 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fair value of derivatives embedded within convertible debt
 
$
112,062

 
$
—

 
$
—

 
$
112,062

 
 
 
 
 
 
 
 
 

(1)
Warrants include 1,000,000 of LTS Warrants received on November 4, 2011 which were carried at $1,758 as of December 31, 2013 and are included in "Other assets". The Company recognized income of $172 for the nine months ended September 30, 2013 related to the change in fair value of the Warrants.


The fair value of the Level 2 certificates of deposit are based on prices posted by the financial institutions. The fair value of investment securities available for sale included in Level 1 are based on quoted market prices from various stock exchanges. The Level 2 investment securities available for sale are equity securities based on quoted market prices of securities that are thinly traded and debt securities based on evaluated prices using observable, market-based inputs.
The fair value of derivatives embedded within convertible debt was derived using a valuation model and have been classified as Level 3. The valuation model assumes future dividend payments by the Company and utilizes interest rates and credit spreads based upon the implied debt rate of the 5.50% Convertible Notes to determine the fair value of the derivatives embedded within the convertible debt. The changes in fair value of derivatives embedded within convertible debt are presented on the Condensed Consolidated Statements of Operations.
The value of the embedded derivatives is based on changes in implied interest rates of the convertible debt, the Company's stock price, stock volatility as well as projections of future cash and stock dividends over the term of the debt.  The interest rate component of the value of the embedded derivative is computed by calculating an equivalent non-convertible, unsecured and subordinated borrowing cost. This rate is determined by calculating the implied rate on the Company's 2019 Convertible Notes

36
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


when removing the embedded option value within the convertible security. This rate is based upon market observable inputs and influenced by the Company's stock price, convertible bond trading price, risk free interest rates and stock volatility. 
The Company recognized income of $7,447 and $8,299 for the nine months ended September 30, 2014 and 2013, respectively, related to the change in fair value of the embedded derivatives.
The fair value of the warrants was derived using the Black-Scholes model and has been classified as Level 3. The assumptions used under the Black-Scholes model in computing the fair value of the warrants are based on contractual term of the warrants, volatility of the underlying stock based on the historical quoted prices of the underlying stock, assumed future dividend payments and a risk-free rate of return.
The unobservable inputs related to the valuations of the Level 3 assets and liabilities are as follows at September 30, 2014:

 
 
Quantitative Information about Level 3 Fair Value Measurements
 
 
Fair Value at
 
 
 
 
 
 
 
 
September 30,
2014
 
Valuation Technique
 
Unobservable Input
 
Range (Actual)
 
 
 
 
 
 
 
 
 
Warrants
 
$
2,638

 
Option model
 
Stock price
 
$
4.24

 
 
 
 
 
 
Exercise price
 
$
1.68

 
 
 
 
 
 
Term (in years)
 
2.1

 
 
 
 
 
 
Volatility
 
44.76
%
 
 
 
 
 
 
Dividend rate
 
—

 
 
 
 
 
 
Risk-free return
 
0.70
%
 
 
 
 
 
 
 
 
 
Fair value of derivatives embedded within convertible debt
 
$
183,470

 
Discounted cash flow
 
Assumed annual stock dividend
 
5
%
 
 
 
 
 
 
Assumed annual cash dividend
 
$
1.60

 
 
 
 
 
 
Stock price
 
$
22.18

 
 
 
 
 
 
Convertible trading price
 
111.63
%
 
 
 
 
 
 
Volatility
 
16
%
 
 
 
 
 
 
Implied credit spread
 
5.0% - 6.0% (5.5%)



37
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


The unobservable inputs related to the valuations of the Level 3 assets and liabilities are as follows at December 31, 2013:

 
 
Quantitative Information about Level 3 Fair Value Measurements
 
 
Fair Value at
 
 
 
 
 
 
 
 
December 31,
2013
 
Valuation Technique
 
Unobservable Input
 
Range (Actual)
 
 
 
 
 
 
 
 
 
Warrants
 
$
1,935

 
Option model
 
Stock price
 
$
3.13

 
 
 
 
 
 
Exercise price
 
$
1.68

 
 
 
 
 
 
Term (in years)
 
2.8

 
 
 
 
 
 
Volatility
 
53.82
%
 
 
 
 
 
 
Dividend rate
 
—

 
 
 
 
 
 
Risk-free return
 
0.72
%
 
 
 
 
 
 
 
 
 
Fair value of derivatives embedded within convertible debt
 
$
112,062

 
Discounted cash flow
 
Assumed annual stock dividend
 
5
%
 
 
 
 
 
 
Assumed annual cash dividend
 
$
1.60

 
 
 
 
 
 
Stock price
 
$
16.37

 
 
 
 
 
 
Convertible trading price
 
118.70
%
 
 
 
 
 
 
Volatility
 
18
%
 
 
 
 
 
 
Implied credit spread
 
7.5% - 8.5% (8.0%)



In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company is required to record assets and liabilities at fair value on a nonrecurring basis. Generally, assets and liabilities are recorded at fair value on a nonrecurring basis as a result of impairment charges or acquisitions. The Company had no nonrecurring nonfinancial assets subject to fair value measurements as of September 30, 2014 and December 31, 2013.

10. SEGMENT INFORMATION

The Company's significant business segments for the three and nine months ended September 30, 2014 and 2013 were Tobacco, E-Cigarettes and Real Estate. The Tobacco segment consists of the manufacture and sale of conventional cigarettes. The E-Cigarettes segment includes the operations of the Company's e-cigarette business. The Real Estate segment includes the Company’s investment in New Valley LLC, which includes Douglas Elliman, Escena, Indian Creek and investments in real estate ventures. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. As a result of the amount of operating losses of Zoom as of September 30, 2014, when compared to the remaining components of the Company's Corporate and Other segment, the Company has reevaluated its operating segments and has separated Zoom’s operations from the Corporate and Other segment for previously reported 2014 periods and from the Tobacco segment for the previously reported 2013 periods. Thus, prior period information has been recast to conform to the current presentation. This change did not have an impact to the Company's historical consolidated results.
  

38
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


Financial information for the Company's operations before taxes for the three and nine months ended September 30, 2014 and 2013 follows:

 
 
 
 
 
Real
 
Corporate
 
 
 
Tobacco
 
E-Cigarettes
 
Estate
 
and Other
 
Total
Three months ended September 30, 2014
 
 
 
 
 
 
 
 
 
Revenues
$
264,520

 
$
1,608

 
$
153,748

 
$
—

 
$
419,876

Operating income (loss)
52,993

(1)
(2,910
)
 
16,222

 
(3,321
)
 
62,984

Equity income from real estate ventures
—

 
—

 
3,258

 
—

 
3,258

Depreciation and amortization
2,853

 
—

 
2,740

 
452

 
6,045

 
 
 
 
 
 
 
 
 
 
Three months ended September 30, 2013
 
 
 
 
 
 
 
 
 
Revenues
$
271,516

 
$
—

 
$
6,425

 
$
—

 
$
277,941

Operating loss
(32,414
)
(2)
(560
)
 
(806
)
 
(3,505
)
 
(37,285
)
Equity income from real estate ventures
—

 
—

 
9,489

 
—

 
9,489

Depreciation and amortization
2,361

 
—

 
160

 
251

 
2,772

 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2014
 
 
 
 
 
 
 
 
 
Revenues
$
748,468

 
$
9,977

 
$
415,280

 
$
—

 
$
1,173,725

Operating income (loss)
147,395

(3)
(7,100
)
 
36,867

 
(11,148
)
 
166,014

Equity income from real estate ventures
—

 
—

 
3,002

 
—

 
3,002

Identifiable assets
445,914

 
10,657

 
483,330

 
703,482

 
1,643,383

Depreciation and amortization
7,934

 
—

 
9,709

 
956

 
18,599

Capital expenditures
7,911

 
—

 
5,614

 
7,221

 
20,746

 


 
 
 
 
 
 
 
 
Nine months ended September 30, 2013
 
 
 
 
 
 
 
 
 
Revenues
$
761,038

 
$
—

 
$
19,298

 
$
—

 
$
780,336

Operating income (loss)
63,040

(4)
(560
)
 
(1,423
)
 
(11,006
)
 
50,051

Equity income from real estate ventures
—

 
—

 
16,774

 
—

 
16,774

Identifiable assets
425,186

 
3,834

 
208,339

 
483,596

 
1,120,955

Depreciation and amortization
7,114

 
—

 
440

 
451

 
8,005

Capital expenditures
5,813

 
—

 
553

 
2,320

 
8,686

 
 
 
 
 
 
 
 
 
 

(1) Operating income includes $225 of litigation judgment expense.
(2) Operating income includes $4,016 of income from NPM Settlement, $86,213 of Engle progeny settlement charge and $1,700 of litigation judgment expense.
(3) Operating income includes $1,419 of income from NPM Settlement and $1,725 of litigation settlement charges and judgment expense.
(4) Operating income includes $10,963 of income from NPM Settlement, $86,213 of Engle progeny settlement charge and $1,700 of litigation judgment expense.





39
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited



11. CONDENSED CONSOLIDATING FINANCIAL INFORMATION

The accompanying condensed consolidating financial information has been prepared and presented pursuant to Securities and Exchange Commission Regulation S-X, Rule 3-10, “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered”. Each of the subsidiary guarantors are 100% owned, directly or indirectly, by the Company, and all guarantees are joint and several and subject to certain automatic release provisions. Relief from the financial statement requirements under Rule 3-10 is being provided because the Company's guarantee release provisions are considered customary. Such release provisions are as follows:
•
the sale or other disposition of all or substantially all of the assets or all of the capital stock of any subsidiary guarantor; and
•
the satisfaction of the requirements for legal defeasance or the satisfaction and discharge of the indenture.
The Company's investments in its consolidated subsidiaries are presented under the equity method of accounting.
The indenture of the 7.75% Senior Secured Notes contains covenants that restrict the payment of dividends by the Company if the Company's consolidated earnings before interest, taxes, depreciation and amortization, as defined in the indenture, for the most recently ended four full quarters is less than $75,000 and the indenture also restricts the incurrence of debt if the Company's Leverage Ratio and its Secured Leverage Ratio, as defined in the indenture, exceed 3.0 and 1.5, respectively.
At September 30, 2014, management believed that the Company was in compliance with all covenants under the indentures of the 7.75% Senior Secured Notes.





40
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


CONDENSED CONSOLIDATING BALANCE SHEETS
 
 
 
September 30, 2014
 
 
 
 
 
 
 
Subsidiary
 
 
 
Consolidated
 
Parent/
 
Subsidiary
 
Non-
 
Consolidating
 
Vector Group
 
Issuer
 
Guarantors
 
Guarantors
 
Adjustments
 
Ltd.
ASSETS:
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
257,309

 
$
19,498

 
$
103,609

 
$
—

 
$
380,416

Investment securities available for sale
274,249

 
59,634

 
—

 
—

 
333,883

Accounts receivable - trade, net
—

 
11,231

 
2,376

 
—

 
13,607

Intercompany receivables
472

 
158

 
—

 
(630
)
 
—

Inventories
—

 
100,874

 
—

 
—

 
100,874

Deferred income taxes
21,497

 
4,043

 
—

 
—

 
25,540

Income taxes receivable, net
23,429

 
—

 
—

 
(8,617
)
 
14,812

Restricted assets
—

 
1,366

 
1,414

 
—

 
2,780

Other current assets
478

 
12,676

 
21,072

 
—

 
34,226

Total current assets
577,434

 
209,480

 
128,471

 
(9,247
)
 
906,138

Property, plant and equipment, net
2,896

 
62,940

 
20,786

 
—

 
86,622

Real estate held for sale, net
—

 
—

 
10,643

 
—

 
10,643

Long-term investments accounted for at cost
31,541

 
—

 
698

 
—

 
32,239

Long-term investments accounted for under the equity method
13,977

 
—

 
—

 
—

 
13,977

Investments in real estate ventures
—

 
—

 
154,281

 
—

 
154,281

Investments in consolidated subsidiaries
478,744

 
—

 
—

 
(478,744
)
 
—

Restricted assets
1,707

 
10,356

 
—

 
—

 
12,063

Deferred income taxes
56,586

 
8,174

 
5,556

 
—

 
70,316

Goodwill, trademarks and other intangible assets, net
—

 
107,511

 
160,630

 
—

 
268,141

Prepaid pension costs
—

 
28,165

 
—

 
—

 
28,165

Other assets
47,873

 
10,595

 
2,330

 
—

 
60,798

Total assets
$
1,210,758

 
$
437,221

 
$
483,395

 
$
(487,991
)
 
$
1,643,383

LIABILITIES AND STOCKHOLDERS' DEFICIENCY:
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Current portion of notes payable and long-term debt
$
88,169

 
$
12,781

 
$
208

 
$
—

 
$
101,158

Current portion of fair value of derivatives embedded within convertible debt
2,996

 
—

 
—

 
—

 
2,996

Current portion of employee benefits
—

 
939

 
—

 
—

 
939

Accounts payable
902

 
4,778

 
5,165

 
—

 
10,845

Intercompany payables
—

 
—

 
630

 
(630
)
 
—

Accrued promotional expenses
—

 
20,010

 
—

 
—

 
20,010

Income taxes payable, net
—

 
11,791

 
—

 
(8,617
)
 
3,174

Accrued excise and payroll taxes payable, net
—

 
861

 
—

 
—

 
861

Litigation accruals and current payments due under the Master Settlement Agreement
—

 
94,897

 
—

 
—

 
94,897

Deferred income taxes
44,164

 
13,599

 
—

 
—

 
57,763

Accrued interest
17,721

 
—

 
—

 
—

 
17,721

Other current liabilities
5,131

 
9,232

 
19,893

 
—

 
34,256

Total current liabilities
159,083

 
168,888

 
25,896

 
(9,247
)
 
344,620

Notes payable, long-term debt and other obligations, less current portion
847,318

 
9,517

 
272

 
—

 
857,107

Fair value of derivatives embedded within convertible debt
180,474

 
—

 
—

 
—

 
180,474

Non-current employee benefits
32,562

 
16,046

 
—

 
—

 
48,608

Deferred income taxes
80,046

 
39,867

 
45,813

 
—

 
165,726

Other liabilities, primarily litigation accruals and payments due under the Master Settlement Agreement
1,265

 
51,133

 
2,317

 
—

 
54,715

Total liabilities
1,300,748

 
285,451

 
74,298

 
(9,247
)
 
1,651,250

Commitments and contingencies


 


 


 


 


Stockholders' (deficiency) equity attributed to Vector Group Ltd.
(89,990
)
 
151,770

 
326,974

 
(478,744
)
 
(89,990
)
Non-controlling interest
—

 
—

 
82,123

 
—

 
82,123

Total stockholders' (deficiency) equity
(89,990
)
 
151,770

 
409,097

 
(478,744
)
 
(7,867
)
Total liabilities and stockholders' deficiency
$
1,210,758

 
$
437,221

 
$
483,395

 
$
(487,991
)
 
$
1,643,383




41
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


CONDENSED CONSOLIDATING BALANCE SHEETS
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Subsidiary
 
 
 
Consolidated
 
Parent/
 
Subsidiary
 
Non-
 
Consolidating
 
Vector Group
 
Issuer
 
Guarantors
 
Guarantors
 
Adjustments
 
Ltd.
ASSETS:
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
151,342

 
$
11,812

 
$
71,312

 
$
—

 
$
234,466

Investment securities available for sale
114,886

 
57,648

 
—

 
—

 
172,534

Accounts receivable - trade, net
—

 
10,154

 
2,005

 
—

 
12,159

Intercompany receivables
509

 
—

 
—

 
(509
)
 
—

Inventories
—

 
93,496

 
—

 
—

 
93,496

Deferred income taxes
45,578

 
4,901

 
—

 
—

 
50,479

Income taxes receivable, net
—

 
10,447

 
—

 
(10,447
)
 
—

Restricted assets
—

 
1,060

 
725

 
—

 
1,785

Other current assets
513

 
12,579

 
10,300

 
—

 
23,392

Total current assets
312,828

 
202,097

 
84,342

 
(10,956
)
 
588,311

Property, plant and equipment, net
3,641

 
55,093

 
20,524

 
—

 
79,258

Real estate held for sale, net
—

 
—

 
20,911

 
—

 
20,911

Long-term investments accounted for at cost
20,041

 
—

 
747

 
—

 
20,788

Long-term investments accounted for under the equity method
8,595

 
—

 
—

 
—

 
8,595

Investments in real estate ventures
—

 
—

 
128,202

 
—

 
128,202

Investments in consolidated subsidiaries
410,442

 
—

 
—

 
(410,442
)
 
—

Restricted assets
1,895

 
10,086

 
—

 
—

 
11,981

Deferred income taxes
35,000

 
12,766

 
3,708

 
—

 
51,474

Goodwill, trademarks and other intangible assets, net
—

 
107,511

 
163,600

 
—

 
271,111

Prepaid pension costs
—

 
26,080

 
—

 
—

 
26,080

Other assets
38,374

 
10,126

 
5,053

 
—

 
53,553

Total assets
$
830,816

 
$
423,759

 
$
427,087

 
$
(421,398
)
 
$
1,260,264

LIABILITIES AND STOCKHOLDERS' DEFICIENCY:
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Current portion of notes payable and long-term debt
$
112,275

 
$
39,013

 
$
289

 
$
—

 
$
151,577

Current portion of fair value of derivatives embedded within convertible debt
19,128

 
—

 
—

 
—

 
19,128

Current portion of employee benefits
—

 
939

 
—

 
—

 
939

Accounts payable
1,509

 
4,136

 
4,615

 
—

 
10,260

Intercompany payables
—

 
39

 
470

 
(509
)
 
—

Accrued promotional expenses
—

 
18,655

 
—

 
—

 
18,655

Income taxes payable, net
16,870

 
—

 
—

 
(10,447
)
 
6,423

Accrued excise and payroll taxes payable, net
—

 
11,621

 
—

 
—

 
11,621

Litigation accruals and current payments due under the Master Settlement Agreement
—

 
84,658

 
—

 
—

 
84,658

Deferred income taxes
32,309

 
13,425

 
—

 
—

 
45,734

Accrued interest
21,968

 
—

 
—

 
—

 
21,968

Other current liabilities
6,103

 
10,495

 
17,549

 
—

 
34,147

Total current liabilities
210,162

 
182,981

 
22,923

 
(10,956
)
 
405,110

Notes payable, long-term debt and other obligations, less current portion
524,182

 
12,573

 
4,011

 
—

 
540,766

Fair value of derivatives embedded within convertible debt
92,934

 
—

 
—

 
—

 
92,934

Non-current employee benefits
31,462

 
16,455

 
—

 
—

 
47,917

Deferred income taxes
65,759

 
37,602

 
34,289

 
—

 
137,650

Other liabilities, primarily litigation accruals and payments due under the Master Settlement Agreement
1,353

 
54,924

 
1,219

 
—

 
57,496

Total liabilities
925,852

 
304,535

 
62,442

 
(10,956
)
 
1,281,873

Commitments and contingencies


 


 


 


 


Stockholders' (deficiency) equity attributed to Vector Group Ltd.
(95,036
)
 
119,224

 
291,218

 
(410,442
)
 
(95,036
)
Non-controlling interest
—

 
—

 
73,427

 
—

 
73,427

Total stockholders' (deficiency) equity
(95,036
)
 
119,224

 
364,645

 
(410,442
)
 
(21,609
)
Total liabilities and stockholders' deficiency
$
830,816

 
$
423,759

 
$
427,087

 
$
(421,398
)
 
$
1,260,264



42
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS


 
 
 
Three Months Ended September 30, 2014
 
 
 
 
 
 
 
Subsidiary
 
 
 
Consolidated
 
  Parent/  
 
Subsidiary
 
Non-
 
Consolidating
 
Vector Group
 
  Issuer  
 
Guarantors
 
Guarantors
 
Adjustments
 
        Ltd.        
Revenues
$
—

 
$
266,328

 
$
153,748

 
$
(200
)
 
$
419,876

Expenses:
 
 
 
 
 
 
 
 
 
Cost of sales
—

 
190,794

 
96,442

 
—

 
287,236

Operating, selling, administrative and general expenses
6,099

 
22,395

 
41,137

 
(200
)
 
69,431

Litigation settlement and judgment expense
—

 
225

 
—

 
—

 
225

Management fee expense
—

 
2,467

 
—

 
(2,467
)
 
—

Operating (loss) income
(6,099
)
 
50,447

 
16,169

 
2,467

 
62,984

Other income (expenses):
 
 
 
 
 
 
 
 
 
Interest expense
(43,005
)
 
(1,026
)
 
(3
)
 
—

 
(44,034
)
Change in fair value of derivatives embedded within convertible debt
7,127

 
—

 
—

 
—

 
7,127

Acceleration of interest expense related to debt conversion
(994
)
 
—

 
—

 
—

 
(994
)
Equity income from real estate ventures
—

 
—

 
3,258

 
—

 
3,258

Equity income on long-term investments
829

 
—

 
—

 
—

 
829

Gain on sale of investment securities available for sale
33

 
—

 
—

 
—

 
33

Equity income in consolidated subsidiaries
36,428

 
—

 
—

 
(36,428
)
 
—

Management fee income
2,467

 
—

 
—

 
(2,467
)
 
—

Other, net
1,936

 
296

 
234

 
—

 
2,466

Income (loss) before provision for income taxes
(1,278
)
 
49,717

 
19,658

 
(36,428
)
 
31,669

Income tax benefit (expense)
16,157

 
(21,491
)
 
(6,630
)
 
—

 
(11,964
)
Net income
14,879

 
28,226

 
13,028

 
(36,428
)
 
19,705

Net income attributed to non-controlling interest
—

 
—

 
(4,826
)
 
—

 
(4,826
)
Net income attributed to Vector Group Ltd.
14,879

 
28,226

 
8,202

 
(36,428
)
 
14,879

Comprehensive income attributed to non-controlling interest
—

 
—

 
(4,826
)
 
—

 
(4,826
)
Comprehensive income attributed to Vector Group
$
23,894

 
$
28,367

 
$
8,202

 
$
(36,569
)
 
$
23,894




















43
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited



CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS


 
 
 
Three Months Ended September 30, 2013
 
 
 
 
 
 
 
Subsidiary
 
 
 
Consolidated
 
  Parent/  
 
Subsidiary
 
Non-
 
Consolidating
 
Vector Group
 
  Issuer  
 
Guarantors
 
Guarantors
 
Adjustments
 
        Ltd.        
Revenues
$
—

 
$
271,516

 
$
6,425

 
$
—

 
$
277,941

Expenses:
 
 
 
 
 
 
 
 
 
Cost of sales
—

 
194,991

 
5,844

 
—

 
200,835

Operating, selling, administrative and general expenses
4,968

 
19,990

 
1,520

 
—

 
26,478

Litigation judgment expense
—

 
87,913

 
—

 
—

 
87,913

Management fee expense
—

 
2,377

 
—

 
(2,377
)
 
—

Operating (loss) income
(4,968
)
 
(33,755
)
 
(939
)
 
2,377

 
(37,285
)
Other income (expenses):
 
 
 
 
 
 
 
 
 
Interest expense
(32,978
)
 
(602
)
 
(3
)
 
—

 
(33,583
)
Change in fair value of derivatives embedded within convertible debt
2,800

 
—

 
—

 
—

 
2,800

Equity income from real estate ventures
—

 
—

 
9,489

 
—

 
9,489

Equity loss on long-term investments
(53
)
 
—

 
—

 
—

 
(53
)
Loss on sale of investment securities available for sale
(99
)
 
—

 
—

 
—

 
(99
)
Equity loss in consolidated subsidiaries
(11,514
)
 
—

 
—

 
11,514

 
—

Management fee income
2,377

 
—

 
—

 
(2,377
)
 
—

Other, net
603

 
2,270

 
(2
)
 
—

 
2,871

(Loss) income before provision for income taxes
(43,832
)
 
(32,087
)
 
8,545

 
11,514

 
(55,860
)
Income tax benefit (expense)
6,941

 
15,521

 
(3,493
)
 
—

 
18,969

Net (loss) income
(36,891
)
 
(16,566
)
 
5,052

 
11,514

 
(36,891
)
Comprehensive (loss) income
$
(28,536
)
 
$
(11,923
)
 
$
5,052

 
$
6,871

 
$
(28,536
)

44
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited



CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS


 
 
 
Nine Months Ended September 30, 2014
 
 
 
 
 
 
 
Subsidiary
 
 
 
Consolidated
 
  Parent/  
 
Subsidiary
 
Non-
 
Consolidating
 
Vector Group
 
  Issuer  
 
Guarantors
 
Guarantors
 
Adjustments
 
        Ltd.        
Revenues
$
—

 
$
758,645

 
$
415,280

 
$
(200
)
 
$
1,173,725

Expenses:
 
 
 
 
 
 
 
 
 
Cost of sales
—

 
544,024

 
261,531

 
—

 
805,555

Operating, selling, administrative and general expenses
17,315

 
66,270

 
117,046

 
(200
)
 
200,431

Litigation settlement and judgment expense
—

 
1,725

 
—

 
—

 
1,725

Management fee expense
—

 
7,402

 
—

 
(7,402
)
 
—

Operating (loss) income
(17,315
)
 
139,224

 
36,703

 
7,402

 
166,014

Other income (expenses):
 
 
 
 
 
 
 
 
 
Interest expense
(120,977
)
 
(3,265
)
 
(40
)
 
612

 
(123,670
)
Change in fair value of derivatives embedded within convertible debt
7,447

 
—

 
—

 
—

 
7,447

Acceleration of interest expense related to debt conversion
(5,112
)
 
—

 
—

 
—

 
(5,112
)
Equity income from real estate ventures
—

 
—

 
3,002

 
—

 
3,002

Equity income on long-term investments
1,462

 
—

 
—

 
—

 
1,462

Loss on sale of investment securities available for sale
(38
)
 
—

 
—

 
—

 
(38
)
Equity income in consolidated subsidiaries
96,554

 
—

 
—

 
(96,554
)
 
—

Management fee income
7,402

 
—

 
—

 
(7,402
)
 
—

Other, net
3,702

 
780

 
4,297

 
(612
)
 
8,167

(Loss) income before provision for income taxes
(26,875
)
 
136,739

 
43,962

 
(96,554
)
 
57,272

Income tax benefit (expense)
52,259

 
(57,846
)
 
(15,420
)
 
—

 
(21,007
)
Net income
25,384

 
78,893

 
28,542

 
(96,554
)
 
36,265

Net income attributed to non-controlling interest
—

 
—

 
(10,881
)
 
—

 
(10,881
)
Net income attributed to Vector Group Ltd.
25,384

 
78,893

 
17,661

 
(96,554
)
 
25,384

Comprehensive income attributed to non-controlling interest
—

 
—

 
(10,881
)
 
—

 
(10,881
)
Comprehensive income attributed to Vector Group Ltd.
$
41,218

 
$
79,026

 
$
17,661

 
$
(96,687
)
 
$
41,218




















45
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited




CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS


 
 
 
Nine Months Ended September 30, 2013
 
 
 
  Parent/  
 
Subsidiary
 
Non-
 
Consolidating
 
Vector Group
 
  Issuer  
 
Guarantors
 
Guarantors
 
Adjustments
 
        Ltd.        
Revenues
$
—

 
$
761,038

 
$
19,298

 
$
—

 
$
780,336

Expenses:
 
 
 
 
 
 
 
 
 
Cost of sales
—

 
548,377

 
16,080

 
—

 
564,457

Operating, selling, administrative and general expenses
16,350

 
56,939

 
4,626

 
—

 
77,915

Litigation judgment expense
—

 
87,913

 
 
 
 
 
87,913

Management fee expense
—

 
7,131

 
—

 
(7,131
)
 
—

Operating (loss) income
(16,350
)
 
60,678

 
(1,408
)
 
7,131

 
50,051

Other income (expenses):
 
 
 
 
 
 
 
 
 
Interest expense
(97,661
)
 
(1,374
)
 
(10
)
 
—

 
(99,045
)
Change in fair value of derivatives embedded within convertible debt
8,299

 
—

 
—

 
—

 
8,299

Loss on extinguishment of debt
(21,458
)
 
—

 
—

 
—

 
(21,458
)
Equity income from real estate ventures
—

 
—

 
16,774

 
—

 
16,774

(Loss) gain on sale of investment securities available for sale
(296
)
 
5,406

 
—

 
—

 
5,110

Equity income on long-term investments
770

 
—

 
—

 
—

 
770

Equity income in consolidated subsidiaries
52,051

 
—

 
—

 
(52,051
)
 
—

Management fee income
7,131

 
—

 
—

 
(7,131
)
 
—

Other, net
2,550

 
2,475

 
126

 
—

 
5,151

(Loss) income before provision for income taxes
(64,964
)
 
67,185

 
15,482

 
(52,051
)
 
(34,348
)
Income tax benefit (expense)
39,903

 
(24,270
)
 
(6,346
)
 
—

 
9,287

Net (loss) income
(25,061
)
 
42,915

 
9,136

 
(52,051
)
 
(25,061
)
Comprehensive (loss) income
$
(9,670
)
 
$
49,701

 
$
9,136

 
$
(58,837
)
 
$
(9,670
)
    

46
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

 
 
 
Nine Months Ended September 30, 2014
 
 
 
 
 
 
 
Subsidiary
 
 
 
Consolidated
 
  Parent/  
 
Subsidiary
 
Non-
 
Consolidating
 
Vector Group
 
Issuer   
 
Guarantors
 
Guarantors
 
Adjustments
 
Ltd.
Net cash provided by operating activities
$
23,189

 
$
98,319

 
$
53,475

 
$
(74,939
)
 
$
100,044

Cash flows from investing activities:
 
 
 
 
 
 
 
 
 
Sale of investment securities
174,253

 
—

 
—

 
—

 
174,253

Purchase of investment securities
(310,934
)
 
(1,985
)
 
—

 
—

 
(312,919
)
Proceeds from sale or liquidation of long-term investments
500

 
—

 
49

 
—

 
549

Purchase of long-term investments
(12,000
)
 
—

 
—

 
—

 
(12,000
)
Investments in real estate ventures
—

 
—

 
(29,378
)
 
—

 
(29,378
)
Purchase of subsidiaries
—

 
—

 
(250
)
 
—

 
(250
)
Distributions from real estate ventures
—

 
—

 
5,540

 
—

 
5,540

Increase in cash surrender value of life insurance policies
—

 
(435
)
 
—

 
—

 
(435
)
Decrease (increase) in restricted assets
188

 
(607
)
 
(689
)
 
—

 
(1,108
)
Issuance of notes receivable
(35,000
)
 
—

 
(250
)
 
35,000

 
(250
)
Investments in subsidiaries
(49,834
)
 
—

 
—

 
49,834

 
—

Proceeds from sale of fixed assets
—

 
4

 
—

 
—

 
4

Capital expenditures
(11
)
 
(15,121
)
 
(5,614
)
 
—

 
(20,746
)
Repayments of notes receivable
35,933

 
—

 
—

 
(35,000
)
 
933

Net cash used in investing activities
(196,905
)
 
(18,144
)
 
(30,592
)
 
49,834

 
(195,807
)
Cash flows from financing activities:
 
 
 
 
 
 
 
 
 
Proceeds from debt issuance
408,750

 
40,168

 
—

 
(35,000
)
 
413,918

Financing costs
(12,360
)
 
—

 
—

 
—

 
(12,360
)
Repayments of debt
—

 
(41,485
)
 
(3,820
)
 
35,000

 
(10,305
)
Borrowings under revolver
—

 
645,894

 
—

 
—

 
645,894

Repayments on revolver
—

 
(673,866
)
 
—

 
—

 
(673,866
)
Capital contributions received
—

 
10,800

 
39,034

 
(49,834
)
 
—

Intercompany dividends paid
—

 
(54,000
)
 
(20,939
)
 
74,939

 
—

Dividends and distributions on common stock
(122,051
)
 
—

 
—

 
—

 
(122,051
)
Distributions to non-controlling interest
—

 
—

 
(4,861
)
 
—

 
(4,861
)
Proceeds from exercise of Vector options
4,407

 
—

 
—

 
—

 
4,407

Tax benefit of options exercised
937

 
—

 
—

 
—

 
937

Net cash provided by (used in) financing activities
279,683

 
(72,489
)
 
9,414

 
25,105

 
241,713

Net increase in cash and cash equivalents
105,967

 
7,686

 
32,297

 
—

 
145,950

Cash and cash equivalents, beginning of period
151,342

 
11,812

 
71,312

 
—

 
234,466

Cash and cash equivalents, end of period
$
257,309

 
$
19,498

 
$
103,609

 
$
—

 
$
380,416



47
VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)
Unaudited


CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

 
 
 
Nine Months Ended September 30, 2013
 
 
 
 
 
 
 
Subsidiary
 
 
 
Consolidated
 
  Parent/  
 
Subsidiary
 
Non-
 
Consolidating
 
Vector Group
 
Issuer   
 
Guarantors
 
Guarantors
 
Adjustments
 
Ltd.        
Net cash provided by operating activities
$
44,750

 
$
127,382

 
$
1,524

 
$
(118,412
)
 
$
55,244

Cash flows from investing activities:
 
 
 
 
 
 
 
 
 
Sale of investment securities
76,067

 
6,582

 
—

 
—

 
82,649

Purchase of investment securities
(117,982
)
 
(11,501
)
 
—

 
—

 
(129,483
)
Proceeds from sale of or liquidation of long-term investments
—

 
—

 
75

 
—

 
75

Purchase of long-term investments
(5,000
)
 
—

 
—

 
—

 
(5,000
)
Investments in real estate ventures
—

 
—

 
(45,977
)
 
—

 
(45,977
)
Investments in real estate held for sale
—

 
—

 
(7,697
)
 
—

 
(7,697
)
Distributions from real estate ventures
—

 
—

 
2,463

 
—

 
2,463

Increase in cash surrender value of life insurance policies
(20
)
 
(450
)
 
—

 
—

 
(470
)
Decrease (increase) in restricted assets
5

 
(558
)
 
—

 
—

 
(553
)
Repayments of notes receivable
9,460

 
—

 
—

 
—

 
9,460

Proceeds from sale of fixed assets
—

 
11

 
—

 
—

 
11

Investments in subsidiaries
(72,962
)
 
—

 
—

 
72,962

 
—

Capital expenditures
(2,320
)
 
(5,813
)
 
(553
)
 
—

 
(8,686
)
Net cash used in investing activities
(112,752
)
 
(11,729
)
 
(51,689
)
 
72,962

 
(103,208
)
Cash flows from financing activities:
 
 
 
 
 
 
 
 
 
Proceeds from debt issuance
450,000

 
1,120

 
3,080

 
—

 
454,200

Financing costs
(11,750
)
 
—

 
—

 
—

 
(11,750
)
Repayments of debt
(415,000
)
 
(5,604
)
 
(106
)
 
—

 
(420,710
)
Borrowings under revolver
—

 
723,578

 
—

 
—

 
723,578

Repayments on revolver
—

 
(736,007
)
 
—

 
—

 
(736,007
)
Capital contributions received
—

 
13,250

 
59,712

 
(72,962
)
 
—

Intercompany dividends paid
—

 
(105,882
)
 
(12,530
)
 
118,412

 
—

Dividends and distributions on common stock
(107,302
)
 
—

 
—

 
—

 
(107,302
)
Proceeds from exercise of Vector options
528

 
—

 
—

 
—

 
528

Tax benefits from exercise of Vector options
33

 
—

 
—

 
—

 
33

Net cash (used in) provided by financing activities
(83,491
)
 
(109,545
)
 
50,156

 
45,450

 
(97,430
)
Net (decrease) increase in cash and cash equivalents
(151,493
)
 
6,108

 
(9
)
 
—

 
(145,394
)
Cash and cash equivalents, beginning of period
401,344

 
3,776

 
735

 
—

 
405,855

Cash and cash equivalents, end of period
$
249,851

 
$
9,884

 
$
726

 
$
—

 
$
260,461



48


ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION    AND RESULTS OF OPERATIONS

(Dollars in Thousands, Except Per Share Amounts)


Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide a reader of Vector Group Ltd.’s  financial statements with a narrative from our management's perspective. Our MD&A is divided into the following sections:
•Overview and Recent Developments
•Results of Operations
•Summary of Real Estate Investments
•Liquidity and Capital Resources

Please read this discussion along with our MD&A and audited financial statements as of and for the year ended December 31, 2013 and Notes thereto, included in the our 2013 Annual Report on Form 10-K, and our Consolidated Condensed Financial Statements and related Notes as of and for the quarterly period ended September 30, 2014.

Overview
We are a holding company and are engaged principally in:
•
the manufacture and sale of cigarettes in the United States through our Liggett Group LLC and Vector Tobacco Inc. subsidiaries,
•
the sale of electronic cigarettes ("e-cigarettes") in the United States market through our Zoom E-Cigs LLC ("Zoom") subsidiary, and
•
the real estate business through our New Valley LLC subsidiary, which is seeking to acquire additional operating companies and real estate properties. New Valley owns 70.59% of Douglas Elliman, which operates the largest residential brokerage company in the New York metropolitan area.
On December 13, 2013, an affiliate of New Valley LLC acquired an additional 20.59% interest in Douglas Elliman from Prudential Real Estate Financial Services of America, Inc. The acquisition increased our ownership of Douglas Elliman from 50% to 70.59%. Consequently, after December 13, 2013, we consolidate the operations and financial position of Douglas Elliman.
Zoom entered the United States e-cigarette market in limited retail distribution outlets in 2014. Zoom’s operations are included in our “E-Cigarettes” reporting segment. Our exposure to Zoom, as of September 30, 2014, was approximately $10,700, which was primarily comprised of Zoom's inventory.



Recent Developments

On March 14, 2014, the holder of the 6.75% Variable Interest Senior Convertible Note due 2014 converted $25,000 principal balance of the $50,000 Note into 2,121,479 of our common shares.
On March 24, 2014, we completed the sale of $258,750 of our 5.5% Variable Interest Convertible Senior Notes due 2020 and received net proceeds from the sale of the Notes of approximately $250,300. On April 15, 2014, we completed the sale of $150,000 principal amount of our 7.75% Senior Secured Notes due 2021 for a price of 106.750% in a private offering to qualified institutional investors in accordance with Rule 144A of the Securities Act of 1933. We received net proceeds of approximately $158,700. The net proceeds of both issuances will be used for general corporate purposes, including for additional investments in real estate and in our tobacco business. In August 2014, we completed an offer to exchange the 7.75% senior secured notes issued in April 2014 for an equal amount of newly issued 7.75% senior secured notes due 2021. The new 7.75% senior secured notes have substantially the same terms as the original notes, except that the new 7.75% senior secured notes have been registered under the Securities Act.


49


In May 2014, the Indian Creek property was sold for approximately $14,400 and New Valley received a distribution of approximately $7,100.
In May 2014 and August 2014, holders of the 6.75% Variable Interest Senior Convertible Exchange Notes due 2014 converted $7,500 and $32,415 principal balance of the $107,530 Notes into 2,985,571 of our common shares.
On July 23, 2014, we granted our President and Chief Executive Officer an award of 1,050,000 shares of our Common Stock subject to performance-based vesting. The Award shares will be issued pursuant to the terms of an agreement that provides that both a performance requirement and a continued employment requirement must be met over a seven-year performance period to earn vested rights with respect to the Award Shares. The maximum potential amount of the Award Shares reflects recognition of the CEO's contributions as CEO since January 1, 2006 and the value of his management and real estate expertise to us. We anticipate expensing the value of the grant of approximately $20,780 over an estimated seven-year period.

Recent Developments in Smoking-Related Litigation

There are no material changes from the Recent Developments in Smoking-Related Litigation set forth in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K, for the year ended December 31, 2013, other than in October 2014, in an Engle progeny case, an adverse verdict was entered against Liggett in the amount of $13,100, including $9,500 in punitive damages. The verdict has not been reduced to a judgment. Post trial motions are pending. Please refer to that section and the information below for disclosures regarding the critical accounting policies related to our business.


Critical Accounting Policies

There are no material changes from the critical accounting policies set forth in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K, for the year ended December 31, 2013. Please refer to that section and the information below for disclosures regarding the critical accounting policies related to our business.


Results of Operations

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

For purposes of this discussion and other consolidated financial reporting, our significant business segments for the three and nine months ended September 30, 2014 and 2013 were Tobacco, E-Cigarettes and Real Estate. The Tobacco segment consists of the manufacture and sale of cigarettes. The E-Cigarettes segment includes the operations of Zoom. The Real Estate segment includes our investment in New Valley LLC, which includes Douglas Elliman, Escena, Indian Creek and investments in non-consolidated real estate businesses. As a result of the amount of operating losses of Zoom as of September 30, 2014 when compared to the remaining components of our Corporate and Other segment, we have reevaluated our operating segments and have separated our E-Cigarettes operations from the Corporate and Other segment for previously reported 2014 periods and from the Tobacco segment for the previously reported 2013 periods. Thus, prior period information has been recast to conform to the current presentation.

50


 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2014
 
2013
 
2014
 
2013
 
Revenues:
 
 
 
 
 
 
 
 
Tobacco
$
264,520

 
$
271,516

 
$
748,468

 
$
761,038

 
E-Cigarettes
1,608

 
—

 
9,977

 
—

 
Real Estate
153,748

 
6,425

 
415,280

 
19,298

 
Corporate and Other
—

 
—

 
—

 
—

 
  Total revenues
$
419,876

 
$
277,941

 
$
1,173,725

 
$
780,336

 
Operating income (loss):
 
 
 
 
 
 
 
 
Tobacco
$
52,993

(1) 
$
(32,414
)
(2) 
$
147,395

(3) 
$
63,040

(4) 
E-Cigarettes
(2,910
)
 
(560
)
 
(7,100
)
 
(560
)
 
Real Estate
16,222

 
(806
)
 
36,867

 
(1,423
)
 
Corporate and Other
(3,321
)
 
(3,505
)
 
(11,148
)
 
(11,006
)
 
Total operating income (loss)
$
62,984

 
$
(37,285
)
 
$
166,014

 
$
50,051

 
____________________


(1) Operating income includes $225 of litigation judgment expense.
(2) Operating income includes $4,016 of income from NPM Settlement, $86,213 of Engle progeny settlement charge and $1,700 of litigation judgment expense.
(3) Operating income includes $1,419 of income from NPM Settlement and $1,725 of litigation settlement charges and judgment expense
(4) Operating income includes $10,963 of income from NPM Settlement, $86,213 of Engle progeny settlement charge and $1,700 of litigation judgment expense.



Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013
Revenues: Total Revenues were $419,876 for the three months ended September 30, 2014 compared to $277,941 for the three months ended September 30, 2013. Total Revenues increased by $141,935 (51.1%) due to an increase in Real Estate revenues of $147,323 primarily related to the addition of the Douglas Elliman revenues in 2014 and the addition of the Zoom e-cigarette revenues of $1,608. This was offset by a decline in Tobacco revenues of $6,996 .
Cost of Sales. Total cost of sales were $287,236 for the three months ended September 30, 2014 compared to $200,835 for the three months ended September 30, 2013. The $86,401 (43.0% ) increase in cost of sales was due to an increase in real estate cost of sales of $90,598 related to the Douglas Elliman real estate commissions expense and $1,066 of cost of sales associated with the Zoom e-cigarette brand. This was offset by a $5,263 decline in Tobacco cost of sales.
Expenses. Operating, selling, general and administrative expenses were $69,431 for the three months ended September 30, 2014 compared to $26,478 for the same period last year. This was an increase of $42,953 (162.2%) of which $39,697 was primarily related to the operating, selling and administrative expenses of Real Estate, $548 of Tobacco operating, selling, general and administrative expenses, $2,894 of Zoom operating, selling, general and administrative expense offset by a decline in Corporate and Other expense of $186.
Operating income (loss). Operating income was $62,984 for the three months ended September 30, 2014 compared to an operating loss of $37,285 for the same period last year, an increase of $100,269 (268.9%). Tobacco operating income increased by $85,407, due to the absence in the 2014 period of $87,688 of litigation and judgment expense offset by the absence of $4,016 of income from the NPM Settlement. Real Estate operating income increased by $17,028 and Corporate and Other expenses declined by $186. This was offset by an increase in operating losses related to Zoom of $2,352.
Other income (expenses). Other expenses were $31,315 and $18,575 for the three months ended September 30, 2014 and 2013, respectively. For the three months ended September 30, 2014, other expenses primarily consisted of interest expense of $44,034, acceleration of interest expense related to the debt conversion of the 6.75% Variable Interest Senior Convertible Exchange Notes of $994, and an equity loss on real estate ventures of $3,258. This was offset by income of $7,127 from changes in fair value of derivatives embedded within convertible debt, other income of $2,466, equity income on long-term investments of $829 and a gain on sale of investment securities available for sale of $33. For the three months ended September 30, 2013, other expenses primarily consisted of interest expense of $33,583, loss on sale of investments available for sale of $99 and equity loss

51


on long-term investments of $53. This was offset by equity income from real estate ventures of $9,489, income of $2,800 from changes in fair value of derivatives embedded within convertible debt and other income of $2,871. The increase in interest expense in 2014 was primarily attributable to an increase in non-cash interest expenses associated with the amortization of debt discount of our convertible debt and increased debt.
Income (loss) before provision for income taxes. Income before income taxes for the three months ended September 30, 2014 was $31,669 compared to a loss of $55,860 for the three months ended September 30, 2013. The increase is attributable to the items discussed above.
Income tax expense (benefit). Income tax expense was $11,964 for the three months ended September 30, 2014 compared to a benefit of $18,969 for the three months ended September 30, 2013. Our provision for income taxes in interim periods is based on an estimated annual effective income tax rate derived, in part, from estimated annual income before provision for income taxes in accordance with guidance on accounting for income taxes on interim periods. The discrete item for the three months ended September 30, 2014 related to an adjustment to the Corporation's marginal tax rate as a result of its acquisition of 20.59% of Douglas Elliman Realty, LLC in December 2013. For the three months ended September 30, 2013, our income tax benefit was primarily decreased by $2,362 due to the impact of the Engle progeny settlement due to differences in the Company's marginal tax rate and its anticipated effective annual income tax rate at September 30, 2013 and $251 due to an increase in our unrecognized tax benefits during the three-month period.
Tobacco.
Tobacco Revenues. Liggett increased the list price of PYRAMID, LIGGETT SELECT, EVE and GRAND PRIX by $0.70 per carton in December 2013 and $0.60 per carton in June 2013 and May 2014.
All of our Tobacco sales were in the discount category in 2014 and 2013. For the three months ended September 30, 2014, tobacco revenues were $264,520 compared to $271,516 for the three months ended September 30, 2013. Revenues declined by 2.6% ($6,996) due to a decline in sales volume of $16,736 (approximately 128.4 million units) offset by a favorable price variance of $9,740.
Tobacco Cost of Sales. Our Tobacco cost of sales declined from $194,991 for the three months ended September 30, 2013 to $189,728 for the three months ended September 30, 2014. The major components of our Tobacco cost of sales are as follows:

 
 
 
 
Three Months Ended
 
 
 
 
September 30,
 
 
 
 
2014
 
2013
 
 
 
 
 
Manufacturing overhead, raw materials and labor
 
$
33,315

 
$
35,957

Federal Excise Taxes, net
 
 
115,326

 
121,787

Tobacco quota buyout expense
 
 
6,425

 
6,547

FDA expense
 
 
4,012

 
3,855

MSA expense, net of market share exemption
 
 
30,650

 
26,845

 
Total cost of sales
 
 
$
189,728

 
$
194,991

 
 
 
 
 
 
 
Tobacco gross profit was $74,792 for the three months ended September 30, 2014 compared to $72,509 (adjusting for the NPM Settlement) for the three months ended September 30, 2013. The $2,283 (3.1%) increase was due to higher margins associated with price increases. As a percentage of revenues (excluding Federal Excise Taxes), Tobacco gross profit was 50.1% in the 2014 period. Tobacco gross profit was 48.4%, adjusting for the NPM Settlement, in the 2013 period.
Tobacco expenses. Tobacco operating, selling, general and administrative expenses, excluding litigation settlement and judgment expenses, were $21,574 and $21,026 for the three months ended September 30, 2014 and 2013, respectively. The increase of $548 was due to an increase in legal expenses.

52


Tobacco operating income. Tobacco operating income was $52,993 for the three months ended September 30, 2014 compared to an operating loss of $32,414 for the same period last year. The Tobacco operating income increase of $85,407 was primarily associated with improved margins and the absence of the $86,213 Engle progeny settlement charge and a decrease in litigation settlement and judgment charges of $1,475, offset by the income from the NPM Settlement of $4,016 in 2013.

E-Cigarettes.
Zoom entered the United States e-cigarette market in limited retail distribution outlets in 2013 and expanded distribution in 2014. E-Cigarettes revenues were $1,608 and E-Cigarettes cost of sales were $1,066 for the three months ended September 30, 2014. E-Cigarettes operating, selling, general and administrative expenses were $3,454 for the three months ended September 30, 2014 compared to $560 for the three months ended September 30, 2013. The increase was due to additional selling and administrative costs in 2014 associated with marketing and promotions activity. E-Cigarettes operating losses were $2,912 and $560 for the three months ended September 30, 2014 and 2013, respectively.

Real Estate.
Real Estate Revenues. Real Estate revenues were $153,748 and $6,425 for the three months ended ended September 30, 2014 and 2013, respectively. Real Estate revenues increased by $147,323, primarily related to Douglas Elliman. Douglas Elliman became a consolidated subsidiary of ours in December 2013.
Real Estate revenues and cost of sales for the three months ended September 30, 2014 were as follows:

\
 
Three Months Ended
 
September 30,
 
2014
 
2013
Real Estate Revenues:
 
 
 
Commission and other brokerage income
$
145,407

 
$
5,850

Property management income
6,998

 
—

Title fees
800

 
—

Sales on facilities primarily from Escena
543

 
575

  Total real estate revenues
$
153,748

 
$
6,425

 
 
 
 
Real Estate Cost of Sales:
 
 
 
Commission and other brokerage income
$
95,434

 
$
4,914

Cost of sales on facilities primarily from Escena
905

 
930

Other
103

 
—

Total real estate cost of sales
$
96,442

 
$
5,844


Real Estate expenses. Real Estate operating, selling, general and administrative expenses were $41,084 and $1,387 for the three months ended September 30, 2014 and 2013, respectively. Real Estate operating, selling, general and administrative expenses increased by $39,697 primarily related to the Douglas Elliman operations.
Real Estate operating income (loss). The Real Estate segment had operating income of $16,222 for the three months ended September 30, 2014 and an operating loss of $806 for the three months ended September 30, 2013. The increase of $17,028 was primarily related to the Douglas Elliman operations.


53


Corporate and Other.
Corporate and Other operating loss. Corporate and Other operating loss was $3,319 for the three months ended September 30, 2014 compared to $3,505 for 2013. Corporate and Other operating losses declined by $186 primarily as a result of lower rent expense in 2014 offset by increased stock compensation expense in the 2014 period.

Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013

Revenues. Total Revenues were $1,173,725 for the nine months ended September 30, 2014 compared to $780,336 for the nine months ended September 30, 2013. The $393,389 (50.4%) increase in revenues was due to an increase in Real Estate revenues of $395,982 primarily related to the addition of the Douglas Elliman revenues in 2014 and an increase of $9,977 in E-Cigarettes revenues associated with Zoom. This was offset by a $12,570 decrease in Tobacco revenues.
Cost of Sales. Total cost of sales were $805,555 for the nine months ended September 30, 2014 compared to $564,457 for the nine months ended September 30, 2013. The $241,098 (42.7% ) increase in cost of sales was due to an increase in Real Estate cost of sales of $245,451 related to the Douglas Elliman real estate commissions expense and $6,357 of E-Cigarettes cost of sales associated with the Zoom e-cigarette brand. This was offset by a $10,710 decline in Tobacco cost of sales.
Expenses. Operating, selling, general and administrative expenses, net of the Engle progeny settlement charge and litigation settlement and judgment expense, were $200,431 for the nine months ended September 30, 2014 compared to $77,915 for the same period last year. This was an increase of $122,516 (157.2%) of which $112,241 was related to the operating, selling and administrative expenses of Real Estate, $10,160 was related to E-Cigarettes and $142 of Corporate and Other expenses. This was offset by a decline in Tobacco operating, selling and administrative expenses of $26.
Operating income (loss). Operating income was $166,014 for the nine months ended September 30, 2014 compared to $50,051 for the same period last year, an increase of $115,963 (231.7%). Tobacco operating income increased by $84,355 and real estate operating income increased by $38,290. This was offset by an increase in operating losses related to E-Cigarettes of $6,540 and an increase in Corporate and Other expenses of $142.
Other income (expenses). Other expenses were $108,742 and $84,399 for the nine months ended September 30, 2014 and 2013, respectively. For the nine months ended September 30, 2014, other expenses primarily consisted of interest expense of $123,670, acceleration of interest expense related to the debt conversion of the 6.75% Variable Interest Senior Convertible Exchange Notes of $5,112, equity loss on real estate ventures of $3,002 and a loss on sale of investment securities available for sale of $38. This was offset by income of $7,447 from changes in fair value of derivatives embedded within convertible debt, equity income on long-term investments of $1,462 and interest and other income of $8,167. For the nine months ended September 30, 2013, other expenses primarily consisted of interest expense of $99,045 and loss on the extinguishment of debt of $21,458. This was offset by equity income from real estate ventures of $16,774, income of $8,299 from changes in fair value of derivatives embedded within convertible debt, gain on sale of investment securities available for sale of $5,110, other income of $5,151 and equity income on long-term investments of $770. The increase in interest expense in 2014 was primarily attributable to an increase in non-cash interest expenses associated with the amortization of debt discount of our convertible debt and increased debt.
Income (loss) before provision for income taxes. Income before income taxes was $57,272 for the nine months ended September 30, 2014, compared to a loss of $34,348 for the same periods in 2013. The increase is attributable to the items discussed above.
Income tax expense (benefit). Income tax expense was $21,007 for the nine months ended September 30, 2014 compared to an income tax benefit of $9,287 for the same period in 2013. Our provision for income taxes in interim periods is based on an estimated annual effective income tax rate derived, in part, from estimated annual income before provision for income taxes in accordance with guidance on accounting for income taxes on interim periods. For the nine months ended September 30, 2014, our income tax expense was increased by $1,944 due primarily to a change in the blended state tax rate that resulted in the Company's reevaluation of its deferred taxes. For the nine months ended September 30, 2013, our income tax benefit was primarily decreased by $3,178 related to the Engle progeny settlement and our loss on the extinguishment of our 11% Senior Secured Notes due to the differences in our marginal tax rate and our anticipated effective annual income tax rate at September 30, 2013 and $373 due to an increase in our unrecognized tax benefits during the nine-month period.


54


Tobacco.
Tobacco Revenues. Liggett increased the list price of PYRAMID, LIGGETT SELECT, EVE and GRAND PRIX by $0.70 per carton in December 2013 and $0.60 per carton in June 2013 and May 2014.
All of our Tobacco sales were in the discount category in 2014 and 2013. For the nine months ended September 30, 2014, tobacco revenues were $748,468 compared to $761,038 for the nine months ended September 30, 2013. Revenues declined by 1.7% ($12,570) due to a decline in sales volume of $40,267 (approximately 315.2 million units) offset by a favorable price variance of $27,697.
Tobacco Cost of Sales. Our Tobacco cost of sales declined from $548,377 for the nine months ended September 30, 2013 to $537,667 for the nine months ended September 30, 2014. The major components of our Tobacco cost of sales are as follows:
 
 
 
 
Nine Months Ended
 
 
 
 
September 30,
 
 
 
 
2014
 
2013
 
 
 
 
 
Manufacturing overhead, raw materials and labor
 
$
94,779

 
$
93,961

Federal Excise Taxes, net
 
 
327,434

 
343,294

Tobacco quota buyout expense
 
 
20,697

 
21,553

FDA expense
 
 
13,017

 
12,765

MSA expense, net of market share exemption
 
 
81,740

 
76,804

 
Total cost of sales
 
 
$
537,667

 
$
548,377

 
 
 
 
 
 
 
Adjusting for the NPM Settlement, Tobacco gross profit was $209,382 for the nine months ended September 30, 2014 compared to $201,698 for the nine months ended September 30, 2013. The $7,684 (3.8%) increase was due to higher margins associated with price increases primarily on the PYRAMID brand. As a percentage of revenues (excluding Federal Excise Taxes and adjusting for the NPM Settlements), Tobacco gross profit was 49.7% in the 2014 period and 48.3% in the 2013 period .
Tobacco expenses. Tobacco operating, selling, general and administrative expenses excluding litigation settlement judgment expenses were $61,682 for the nine months ended September 30, 2014 compared to $61,708 for the nine months ended September 30, 2013.
Tobacco operating income. Tobacco operating income was $147,395 for the nine months ended September 30, 2014 compared to $63,040 for the same period last year. The Tobacco operating income increase of $84,355 was primarily associated with improved margins and the the absence of the $86,213 Engle progeny settlement charge offset by a decrease in income from the NPM Settlement of $9,544 in 2013.

E-Cigarettes.
Zoom entered the emerging United States electronic cigarette ("e-cigarette") market in limited retail distribution outlets in 2013 and expanded distribution in 2014. E-Cigarettes revenues were $9,977 and our E-Cigarettes cost of sales were $6,357 for the nine months ended September 30, 2014. E-Cigarettes operating, selling, general and administrative expenses were $10,720 and $560 for the nine months ended September 30, 2014 and 2013, respectively. The increase was due to additional selling and administrative costs in 2014 associated with marketing and promotions activity. E-Cigarettes operating losses were $7,100 and $560 for the nine months ended September 30, 2014 and 2013, respectively.

Real Estate.
Real Estate Revenues. Real Estate revenues were $415,280 and $19,298 for the nine months ended ended September 30, 2014 and 2013, respectively. Real Estate revenues increased by $395,982 primarily related to the Douglas Elliman operations. Douglas Elliman became a consolidated subsidiary of ours in December 2013.

55


Real Estate revenues and cost of sales for the nine months ended ended September 30, 2014 were as follows:
 
Nine Months Ended
 
September 30,
 
2014
 
2013
Real Estate Revenues:
 
 
 
Commission and other brokerage income
$
372,738

 
$
15,368

Property management income
22,111

 
—

Title fees
2,134

 
—

Indian Creek
14,400

 
—

Sales on facilities primarily from Escena
3,897

 
3,930

  Total real estate revenues
$
415,280

 
$
19,298

 
 
 
 
Real Estate Cost of Sales:
 
 
 
Commission and other brokerage income
$
248,213

 
$
12,874

Indian Creek cost of sales
9,987

 
—

Cost of sales on facilities primarily from Escena
3,052

 
3,206

Title fees
279

 
—

Total real estate cost of sales
$
261,531

 
$
16,080


Real Estate expenses. Real estate operating, selling, general and administrative expenses were $116,882 and $4,641 for the nine months ended September 30, 2014 and 2013, respectively. Real estate operating, selling, general and administrative expenses increased by $112,241 primarily related to the Douglas Elliman operations.
Real Estate operating income (loss). The real estate segment had operating income of $36,867 for the nine months ended September 30, 2014 compared to an operating loss of $1,423 for the nine months ended September 30, 2013. The increase in operating income of $38,290 was primarily related to the Douglas Elliman operations.
Corporate and other.
Corporate and other loss. The operating loss at the corporate segment was $11,148 for the nine months ended September 30, 2014 compared to $11,006 for the same period in 2013.


56


Summary of Real Estate Investments
We own, and seek to acquire investment interests in various domestic and international real estate projects through debt and equity investments. Our current real estate investments primarily include the following projects as of September 30, 2014:
 
(Dollars in Thousands. Area and Unit Information in Ones)
 
Location
Date of Initial Investment
Percentage Owned
Net Amount Invested
Earnings (Losses)
Carrying Value as of September 30, 2014
Future Capital Commit-
ments from New Valley
Projected Residential and/or Hotel Area
Projected Retail Area
Projected Number of Residential Lots, Units and/or Hotel Rooms
Projected Construction Start Date
Projected Construction End Date
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Escena, net
Master planned community, golf course, restaurant and shop in Palm Springs, CA
March 2008
100
%
N/A

N/A

$
10,643

$
—

450

Acres
 
 
667
450

R Lots
H
N/A
N/A
Real estate held for sale, net
 
 
 
—

—

10,643

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
10 Madison Square Park West (f/k/a 1107 Broadway)
Flatiron District/NoMad neighborhood, Manhattan, NY
June 2011
5.0
%
$
4,130

$
2,254

$
6,384

—

260,000

SF
17,000

SF
124

R
August 2012
August 2015
The Whitman
Flatiron District/NoMad neighborhood, Manhattan, NY
October 2011
12.0
%
—

526

526

—

24,279

SF
4,698

SF
4

R
October 2011
February 2014
The Marquand
Upper East Side, Manhattan, NY
December 2011
18.0
%
7,000

5,000

12,000

—

87,887

SF
—

 
28

R
June 2012
January 2015
11 Beach Street
TriBeCa, Manhattan, NY
June 2012
49.5
%
12,328

—

12,328

—

97,090

SF
—

 
27

R
May 2014
May 2016
20 Times Square (f/k/a 701 Seventh Avenue)
Times Square, Manhattan, NY
October 2012
11.5
%
12,481

—

12,481

—

280,000

SF
80,000

SF
452

H
September 2013
March 2017
101 Murray Street
TriBeCa, Manhattan, NY
July 2013
25.0
%
25,269

—

25,269

—

320,000

SF
TBD

 
139

R
September 2014
March 2018
160 Leroy Street
West Greenwich Village, Manhattan, NY
January 2013
5.0
%
1,353

—

1,353

—

130,137

SF
—

 
30 to 50

R
July 2015
July 2017
PUBLIC Chrystie House (f/k/a Chrystie Street)
Lower East Side, Manhattan, NY
December 2012
18.4
%
3,180

—

3,180

—

217,000

SF
43,000

SF
11
367

R
H
June 2014
December 2016
25-19 43rd Avenue
Long Island City, NY
May 2014
9.9
%
733

—

733

 
87,000

SF
—

 
86

R
September 2014
September 2016
Queens Plaza (f/k/a 23-10 Queens Plaza South)
Long Island City, NY
December 2012
45.4
%
12,590

—

12,590

—

472,574

SF
—

 
391

R
March 2014
December 2016
8701 Collins Avenue
Miami Beach, FL
December 2013
15.0
%
4,455

179

4,634

—

262,000

SF
TBD

 
TBD

 
October 2015
July 2017
125 Greenwich Street
Financial District, Manhattan, NY
August 2014
13.3
%
9,308

—

9,308

—

359,000

SF
TBD

 
TBD

R
March 2015
TBD
Condominium and Mixed Use Development
 
 
 
$
92,827

$
7,959

$
100,786

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Maryland Portfolio
Primarily Baltimore County, MD
July 2012
7.5
%
$
3,933

$
(585
)
$
3,348

—

N/A

 
N/A

 
5,517

R
N/A
N/A
ST Portfolio
Houston, TX; Phoenix, AZ; San Pedro, CA and Stamford, CT
November 2013
16.4
%
16,365

(857
)
15,508

—

1,018,404

SF
24,987

SF
761

R
N/A
N/A
Apartment Buildings
 
 
 
$
20,298

$
(1,442
)
$
18,856

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Park Lane Hotel
Central Park South, Manhattan, NY
November 2013
5.0
%
$
20,716

$
(2,619
)
$
18,097

—

445,600

SF
—

 
628

H
N/A
N/A
Hotel Taiwana
St. Barthelemy, French West Indies
October 2011
17.0
%
7,426

(576
)
6,850

—

61,300

SF
4,300

SF
30

H
N/A
N/A
Coral Beach
Coral Beach, Bermuda
December 2013
49.0
%
3,618

(910
)
2,708

—

52

Acres
—

 
87

H
N/A
N/A
Hotels
 
 
 
$
31,760

$
(4,105
)
$
27,655

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Milanosesto Holdings
Milan, Italy
October 2011
7.2
%
$
5,037

$
—

$
5,037

—

322

Acres
TBD

 
TBD

 
2014
2024
Land Development
 
 
 
$
5,037

$
—

$
5,037

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
N/A - Not applicable
SF - Square feet
H - Hotel rooms
 
 
 
 
 
 
 
 
 
 
 
TBD -To be determined
R - Residential Units
R Lots - Residential lots




 
 
 
 
 
 
 
 
 
Other investments in real estate ventures relate to an investment in a mortgage company and an insurance company by Douglas Elliman with a carrying value of $1,947 as of September 30, 2014.

57


Liquidity and Capital Resources

Cash and cash equivalents increased by $145,950 for the nine months ended September 30, 2014 and decreased by $145,394 for the nine months ended September 30, 2013.
Cash provided from operations was $100,044 and $55,244 for the nine months ended September 30, 2014 and 2013, respectively. The change primarily related to cash payments in the 2013 period associated with the extinguishment of our 11% Senior Secured Notes due 2015, increased operating income in the 2014 period and the timing of payments of accruals.  The amount was partially offset by the  Engle progeny settlement payment.
Cash used in investing activities was $195,807 and $103,208 for the nine months ended September 30, 2014 and 2013, respectively. In the first nine months of 2014, cash used in investing activities was for the purchase of investment securities of $312,919, investment in real estate ventures of $29,378, capital expenditures of $20,746, purchase of long-term investments of $12,000, an increase in non-current restricted assets of $1,108, an increase in cash surrender value of corporate-owned life insurance policies of $435, an issuance of notes receivable of $250 and purchase of subsidiaries of $250. This was offset by the sale of investment securities of $174,253, distributions from real estate ventures of $5,540, proceeds from the liquidation of long-term investments of $549, collections of notes receivable of $933 and proceeds from the sale of fixed assets of $4. In the first nine months of 2013, cash used in investing activities was for the purchase of investment securities of $129,483, investment in real estate ventures of $45,977, capital expenditures of $8,686, investments in consolidated real estate business of $7,697, purchase of long-term investments of $5,000, an increase in non-current restricted assets of $553 and an increase in cash surrender value of corporate-owned life insurance policies of $470. This was offset by the sale of investment securities of $82,649, collections of notes receivable of $9,460, distributions from real estate ventures of $2,463, the proceeds from the sale or liquidation of long-term investments of $75 and the proceeds from the sale of fixed assets of $11.
Cash provided by financing activities was $241,713 for the nine months ended September 30, 2014 compared to cash used in financing activities of $97,430 for the nine months ended September 30, 2013. In the first nine months of 2014, cash was provided by the proceeds from debt issuance of $413,918, proceeds from the exercise of Vector options of $4,407 and tax benefit of options exercised of $937. This was offset by cash used for the distributions on common stock of $122,051, payment of deferred financing costs of $12,360, repayment of debt of $10,305, net repayments of debt under the revolver of $27,972 and distributions to non-controlling interest of $4,861. In the first nine months of 2013, cash used in financing activities was used for the repayment of debt of $420,710, distributions on common stock of $107,302, net repayments of debt under the revolver of $12,429 and deferred financing costs of $11,750. This was offset by proceeds from debt issuance of $454,200, proceeds from the exercise of Vector options of $528, and tax benefit of options exercised of $33.
Liggett Credit Facility and Liggett Term Loan Under Credit Facility. As of September 30, 2014, $6,115 was outstanding under the revolving and term loan portions of the credit facility. Availability as determined under the Credit Facility was approximately $43,885 based on eligible collateral at September 30, 2014. At September 30, 2014, management believed that Liggett was in compliance with all covenants under the credit facility; Liggett's EBITDA, as defined, were approximately $125,687 for the twelve months ended September 30, 2014.
Vector.   On March 14, 2014, the holder of the 6.75% Variable Interest Senior Convertible Note due 2014 converted $25,000 principal balance of the $50,000 Note into 2,121,479 of our common shares. On May 20, 2014, a holder of the 6.75% Variable Interest Senior Convertible Exchange Notes due 2014 converted $7,500 principal balance of the $107,530 Notes into 560,987 of our common shares. In August 2014, holders of the 6.75% Variable Interest Senior Convertible Exchange Notes due 2014 converted $32,415 principal balance of the $107,530 Notes into 2,424,584 of our common shares.
On March 24, 2014, we completed the sale of $258,750 of our Variable Interest Convertible Senior Notes due 2020 and received net proceeds from the sale of the Notes of approximately $250,300. On April 15, 2014, we completed the sale of principal amount of our 7.75% Senior Secured Notes due 2021 for a price of 106.750% in a private offering to qualified institutional investors in accordance with Rule 144A of the Securities Act of 1933. We received net proceeds of approximately $158,700. In August 2014, we completed an offer to exchange the 7.75% senior secured notes issued in April 2014 for an equal amount of newly issued 7.75% senior secured notes due 2021. The new 7.75% senior secured notes have substantially the same terms as the original notes, except that the new 7.75% senior secured notes have been registered under the Securities Act.
The net proceeds of both issuances will be used for general corporate purposes, including for additional investments in real estate and in our tobacco business. We may also consider using a portion of the net proceeds from the sale of the Notes to address upcoming debt maturities.
The indenture of our 7.75% senior secured notes due 2021 contains covenants that restrict the payment of dividends if our consolidated earnings before interest, taxes, depreciation and amortization (“Consolidated EBITDA”), as defined in the indenture, for the most recently ended four full quarters is less than $75,000. The indenture also restricts the incurrence of debt if our Leverage Ratio and our Secured Leverage Ratio, as defined in the indenture, exceed 3.0 and 1.5, respectively. Our Leverage Ratio is defined in the indenture as the ratio of our guaranteeing subsidiaries’ total debt less the fair market value of our cash, investments in

58


marketable securities and long-term investments to Consolidated EBITDA, as defined in the indenture. Our Secured Leverage Ratio is defined in the indenture in the same manner as the Leverage Ratio, except that secured indebtedness is substituted for indebtedness. The following table summarizes the requirements of financial covenants and the results of the calculation, as defined by the indenture.

 
 
Indenture
 
September 30,
2014
 
December 31,
2013
Covenant
 
Requirement
 
 
Consolidated EBITDA, as defined
 
$75,000
 
$254,694
 
$264,958
Leverage ratio, as defined
 
<3.0 to 1
 
1.17 to 1
 
1.22 to 1
Secured leverage ratio, as defined
 
<1.5 to 1
 
Negative
 
0.5 to 1

We and our subsidiaries have significant indebtedness and debt service obligations. At September 30, 2014, we and our subsidiaries had total outstanding indebtedness of $1,204,143. Approximately $92,615  of our 6.75% convertible notes mature in 2014, $230,000 of our 7.5% convertible notes mature in 2019, $258,750 of our 5.5% variable interest senior convertible notes mature in 2020, and $600,000 of our 7.75% senior secured notes mature in 2021,. In addition, subject to the terms of any future agreements, we and our subsidiaries will be able to incur additional indebtedness in the future. There is a risk that we will not be able to generate sufficient funds to repay our debt. If we cannot service our fixed charges, it would have a material adverse effect on our business and results of operations.
We believe that our cigarette and real estate operations are positive cash flow generating units and will continue to be able to sustain their operations without any significant liquidity concerns.
In order to meet the above liquidity requirements as well as other anticipated liquidity needs in the normal course of business, we had cash and cash equivalents of approximately $380,400, investment securities available for sale of approximately $333,900, long-term investments with an estimated value of approximately $51,800 and availability under Liggett's credit facility of approximately $43,900 at September 30, 2014. Management currently anticipates that these amounts, as well as expected cash flows from our operations, proceeds from public and/or private debt and equity financing, management fees and other payments from subsidiaries should be sufficient to meet our liquidity needs over the next 12 months.  We 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 our liquidity otherwise available.
On a quarterly basis, we evaluate our investments to determine whether an impairment has occurred. If so, we also make a determination if such impairment is considered temporary or other-than-temporary. We believe that the assessment of temporary or other-than-temporary impairment is facts and circumstances driven. However, among the matters that are considered in making such a determination are the period of time the investment has remained below its cost or carrying value, the likelihood of recovery given the reason for the decrease in market value and our original expected holding period of the investment.

Market Risk

We are exposed to market risks principally from fluctuations in interest rates, foreign currency exchange rates and equity prices. We seek to minimize these risks through our regular operating and financing activities and our long-term investment strategy. Our market risk management procedures cover all market risk sensitive financial instruments.
As of September 30, 2014, approximately $6,100 of our outstanding debt at face value had variable interest rates determined by various interest rate indices, which increases the risk of fluctuating interest rates. Our exposure to market risk includes interest rate fluctuations in connection with our variable rate borrowings, which could adversely affect our cash flows. As of September 30, 2014, we had no interest rate caps or swaps. Based on a hypothetical 100 basis point increase or decrease in interest rates (1%), our annual interest expense could increase or decrease by approximately $61.
In addition, as of September 30, 2014, $325,910 ($581,365 principal amount) of outstanding debt had a variable interest rate determined by the amount of the dividends on our common stock. The difference between the stated value of the debt and carrying value is due principally to certain embedded derivatives, which were separately valued and recorded upon issuance. Changes to the estimated fair value of these embedded derivatives are reflected within our statements of operations as “Changes in fair value of derivatives embedded within convertible debt.” The value of the embedded derivative is contingent on changes in interest rates of debt instruments maturing over the duration of the convertible debt as well as projections of future cash and stock dividends over the term of the debt and changes in the closing stock price at the end of each quarterly period. Based on a hypothetical 100 basis point increase or decrease in interest rates (1%), our annual “Changes in fair value of derivatives embedded within convertible debt” could increase or decrease by approximately $4,098 with approximately $1 resulting from the embedded

59


derivative associated with our 6.75% note due 2014, $3 resulting from the embedded derivative associated with our 6.75% exchange notes due 2014, $1,895 resulting from the embedded derivative associated with the 7.5% variable interest senior convertible notes, and the remaining $2,199 resulting from the embedded derivative associated with our 5.5% variable interest senior convertible debentures due 2020. An increase in our quarterly dividend rate by $0.10 per share would increase interest expense by approximately $9,800 per year.
We have estimated the fair market value of the embedded derivatives based principally on the results of a valuation model. The value of the embedded derivatives is based on changes in interest rates of debt instruments maturing over the duration of the convertible debt, our stock price as well as projections of future cash and stock dividends over the term of the debt. The interest rate component of the value of the embedded derivative is computed by calculating an equivalent non-convertible, unsecured and subordinated borrowing cost. This rate is determined by calculating the implied rate on our 7.5% Convertible Notes when removing the embedded option value within the convertible security. This rate is based upon market observable inputs and influenced by our stock price, convertible bond trading price, risk free interest rates and stock volatility.The range of estimated fair market values of our embedded derivatives was between $185,583 and $181,403. We recorded the fair market value of our embedded derivatives at the midpoint of the range at $183,470 as of September 30, 2014. The estimated fair market value of our embedded derivatives could change significantly based on future market conditions.

We and New Valley also hold long-term investments in various investment partnerships. These investments are illiquid, and their ultimate realization is subject to the performance of the underlying entities.

New Accounting Pronouncements

Refer to Note 1, Summary of Significant Accounting Policies, to our financial statements for further information on New Accounting Pronouncements.

Legislation and Regulation

There are no material changes from the Legislation and Regulation section set forth in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K, for the year ended December 31, 2013. Please refer to that section and the information below for disclosures regarding the critical accounting policies related to our business.


SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
In addition to historical information, this report contains “forward-looking statements” within the meaning of the federal securities law. Forward-looking statements include information relating to our intent, belief or current expectations, primarily with respect to, but not limited to:
•
economic outlook,
•
capital expenditures,
•
cost reduction,
•
legislation and regulations,
•
cash flows,
•
operating performance,
•
litigation,
•
impairment charges and cost saving associated with restructurings of our tobacco operations, and
•
related industry developments (including trends affecting our business, financial condition and results of operations).
We identify forward-looking statements in this report by using words or phrases such as “anticipate”, “believe”, “estimate”, “expect”, “intend”, “may be”, “objective”, “plan”, “seek”, “predict”, “project” and “will be” and similar words or phrases or their negatives.
The forward-looking information involves important risks and uncertainties that could cause our actual results, performance or achievements to differ materially from our anticipated results, performance or achievements expressed or implied by the forward-looking statements. Factors that could cause actual results to differ materially from those suggested by the forward-looking statements include, without limitation, the following:

60


•
general economic and market conditions and any changes therein, due to acts of war and terrorism or otherwise,
•
governmental regulations and policies,
•
effects of industry competition,
•
impact of business combinations, including acquisitions and divestitures, both internally for us and externally in the tobacco industry,
•
impact of legislation on our competitors’ payment obligations, results of operations and product costs, i.e. the impact of federal legislation eliminating the federal tobacco quota system and providing for regulation of tobacco products by the FDA,
•
impact of substantial increases in federal, state and local excise taxes,
•
uncertainty related to product liability litigation including the Engle progeny cases pending in Florida; and,
•
potential additional payment obligations for us under the MSA and other settlement agreements with the states.
Further information on the risks and uncertainties to our business include the risk factors discussed above in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and under Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission.
Although we believe the expectations reflected in these forward-looking statements are based on reasonable assumptions, there is a risk that these expectations will not be attained and that any deviations will be material. The forward-looking statements speak only as of the date they are made.

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk” is incorporated herein by reference.

ITEM 4.    CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report, and, based on their evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are effective.

There were no changes in our internal control over financial reporting during the third quarter of 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II

OTHER INFORMATION

Item 1.     Legal Proceedings

Reference is made to Note 7, incorporated herein by reference, to our condensed consolidated financial statements included elsewhere in this report which contains a general description of certain legal proceedings to which our company, or its subsidiaries are a party and certain related matters. Reference is also made to Exhibit 99.1 for additional information regarding the pending smoking-related legal proceedings to which Liggett or us is a party. A copy of Exhibit 99.1 will be furnished without charge upon written request to us at our principal executive offices, 4400 Biscayne Boulevard, 10th Floor, Miami, Florida 33137, Attn. Investor Relations.

Item 1A. Risk Factors

Except as set forth below, there are no material changes from the risk factors set forth in Item 1A, “Risk Factors,” of our Annual Report on 10-K, as amended, for the year ended December 31, 2013.



61


Liggett faces intense competition in the domestic tobacco industry.

Liggett is considerably smaller and has fewer resources than its major competitors, and, as a result, has a more limited ability to respond to market developments. Management Science Associates’ data indicate that the three largest cigarette manufacturers controlled approximately 85.3% of the United States cigarette market during 2013. Philip Morris is the largest manufacturer in the market, and its profits are derived principally from its sale of premium cigarettes. Philip Morris had approximately 61.2% of the premium segment and 47.4% of the total domestic market during 2013. During 2013, all of Liggett’s sales were in the discount segment, and its share of the total domestic cigarette market was 3.3%. Philip Morris and RJ Reynolds, the two largest cigarette manufacturers, historically, because of their dominant market share, have been able to determine cigarette prices for the various pricing tiers within the industry.

Consolidation in the industry could adversely affect our ability to compete in the U.S. cigarette market.  For example, RJ Reynolds’ proposed merger with Lorillard Tobacco Company, which would consolidate more than 80% of the United States cigarette market within the control of two cigarette manufacturers, could make it more difficult for Liggett and Vector Tobacco to compete for shelf space in retail outlets and could impact price competition in the market, either of which could have a material adverse effect on our sales volume, operating income and cash flows.

We have significant liquidity commitments

We have certain liquidity commitments that could require the use of our existing cash resources. As of September 30, 2014, our corporate expenditures (exclusive of Liggett, Vector Tobacco and New Valley) and other potential liquidity requirements over the next 12 months could include the following:
•
cash interest expense of approximately $98.0 million,
•
retirement of our 6.75% variable interest senior convertible notes of $92.6 million;
•
dividends on our outstanding common shares (currently at an annual rate of approximately $191.6 million), 
•
Engle progeny installment payment of $3.5 million, and
•
other corporate expenses and taxes.

In order to meet the above liquidity requirements as well as other liquidity needs in the normal course of business, we will be required to use cash flows from operations and existing cash and cash equivalents. Should these resources be insufficient to meet the upcoming liquidity needs, we may also be required to liquidate investment securities available for sale and other long-term investments, or, if available, draw on Liggett's credit facility. While there are actions we can take to reduce our liquidity needs, there can be no assurance that such measures can be achieved.

We and our subsidiaries have a substantial amount of indebtedness.
We and our subsidiaries have significant indebtedness and debt service obligations. At September 30, 2014, we and our subsidiaries had total outstanding indebtedness of $1.2 billion. Approximately $92.6 million  of our 6.75% convertible notes mature in 2014, $230 million of our 7.5% convertible notes mature in 2019 and $600 million of our 7.75% senior secured notes mature in 2021. The $600 million of our 7.75% senior secured notes due 2021 includes an additional $150 million of indebtedness we incurred in connection with the April 2014 offering. We incurred an additional $258.8 million of indebtedness in connection with the March 2014 offering of our 5.5% variable interest senior convertible notes due 2020. In addition, subject to the terms of any future agreements, we and our subsidiaries will be able to incur additional indebtedness in the future. There is a risk that we will not be able to generate sufficient funds to repay our debt. If we cannot service our fixed charges, it would have a material adverse effect on our business and results of operations.

Other
Zoom’s e-cigarette business is subject to substantial risks, uncertainties and contingencies which include, without limitation, the challenges inherent in new product development initiatives, the ability to raise capital and manage the growth of its business, potential disputes concerning Zoom’s intellectual property, potential extensive government regulation or prohibition, technology

62


obsolescence, market acceptance of Zoom’s products and competition from companies with greater resources.  Our exposure to Zoom, as of September 30, 2014, was approximately $10.7 million which was comprised primarily of Zoom’s inventory.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

No securities of ours which were not registered under a private offering of the Securities Act of 1933 have been issued or sold by us during the three months ended September 30, 2014, except for approximately 5,195,856 shares of our common stock issued as a stock dividend on September 26, 2104. The issuance of the shares in connection with the stock dividend did not involve a "sale" under the Securities Act of 1933.

63


Item 6.    Exhibits


 
 
 
 
 
 
10.1
Performance-Based Restricted Share Award Agreement, pursuant to Vector Group Ltd. Management Incentive Plan, dated as of July 23, 2014 by and between Vector Group Ltd. and Howard M. Lorber.
 
 
12.1
Computation of Ratio of Earnings to Fixed Charges for each of the five years within the period ended December 31, 2013 and for each of the nine months within the periods ended September 30, 2014 and 2013.
 
 
31.1
Certification of Chief Executive Officer, Pursuant to Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2
Certification of Chief Financial Officer, Pursuant to Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32.1
Certification of Chief Executive Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
32.2
Certification of Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
99.1
Material Legal Proceedings
 
 
101.INS
XBRL Instance Document
 
 
101.SCH
XBRL Taxonomy Extension Schema
 
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase
 
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase
 
 
101.LAB
XBRL Taxonomy Extension Label Linkbase
 
 
101.PRE
XBRL Taxonomy Extension Presentation Linkbase
 
 

64


SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.


 
 
VECTOR GROUP LTD.
 
 
(Registrant)
 
 
 
 
 
By: /s/ J. Bryant Kirkland III
 
 
J. Bryant Kirkland III
 
 
Vice President, Treasurer and
 
 
Chief Financial Officer
Date:
October 31, 2014
 

65