VECTOR GROUP LTD - Quarter Report: 2010 March (Form 10-Q)

e10vq

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 March 31, 2010

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)

100 S.E. Second Street
Miami, Florida 33131
305/579-8000
(Address, including zip code and telephone number, including area code,
of the principal executive offices)

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. þ 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). o 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 the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


þ 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 þ No

At May 6, 2010, Vector Group Ltd. had 71,282,731 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):

Condensed Consolidated Balance Sheets as of March 31, 2010 and December 31, 2009		2

Condensed Consolidated Statements of Operations for the three months ended March 31, 2010 and March 31, 2009		3

Condensed Consolidated Statement of Stockholders’ Equity for the three months ended March 31, 2010		4

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2010 and March 31, 2009		5

Notes to Condensed Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		35

Item 3. Quantitative and Qualitative Disclosures About Market Risk		48

Item 4. Controls and Procedures		48

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		50

Item 1A. Risk Factors		50

Item 6. Exhibits		50

SIGNATURE		51
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-99.1

- 1 -

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


	March 31,			December 31,
	2010			2009
ASSETS:
Current assets:
Cash and cash equivalents	$	202,957		$	209,454
Investment securities available for sale		61,615			51,743
Accounts receivable — trade		7,154			8,098
Inventories		101,613			98,486
Deferred income taxes		16,409			14,154
Restricted assets		1,378			3,138
Other current assets		3,478			4,135

Total current assets		394,604			389,208

Property, plant and equipment, net		43,821			42,986
Investment in Escena, net		13,488			13,244
Long-term investments accounted for at cost		50,323			50,323
Investments in non-consolidated real estate businesses		51,809			49,566
Restricted assets		5,166			4,835
Deferred income taxes		38,580			39,838
Intangible asset		107,511			107,511
Prepaid pension costs		9,237			8,994
Other assets		28,541			29,037

Total assets	$	743,080		$	735,542


LIABILITIES AND STOCKHOLDERS’ DEFICIENCY:
Current liabilities:
Current portion of notes payable and long-term debt	$	29,787		$	21,889
Current portion of employee benefits		1,029			1,029
Accounts payable		4,819			4,355
Accrued promotional expenses		10,687			12,745
Income taxes payable, net		19,193			19,924
Accrued excise and payroll taxes payable, net		14,812			24,093
Settlement accruals		42,247			18,803
Deferred income taxes		22,283			17,254
Accrued interest		6,967			13,840
Other current liabilities		11,250			15,076

Total current liabilities		163,074			149,008

Notes payable, long-term debt and other obligations, less current portion		335,064			334,920
Fair value of derivatives embedded within convertible debt		155,729			153,016
Non-current employee benefits		34,598			34,247
Deferred income taxes		44,286			45,120
Other liabilities		23,692			23,913

Total liabilities		756,443			740,224


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, 150,000,000 shares authorized, 74,520,642 and 74,510,595 shares issued and 71,272,731 and and 71,262,684 shares outstanding		7,127			7,126
Additional paid-in capital		—			15,928
Accumulated deficit		(461	)		—
Accumulated other comprehensive loss		(7,172	)		(14,879	)
Less: 3,247,911 shares of common stock in treasury, at cost		(12,857	)		(12,857	)

Total stockholders’ deficiency		(13,363	)		(4,682	)

Total liabilities and stockholders’ deficiency	$	743,080		$	735,542

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			Three Months
	Ended			Ended
	March 31, 2010			March 31, 2009
Revenues*	$	222,087		$	121,216

Expenses:
Cost of goods sold*		169,911			72,526
Operating, selling, administrative and general expenses		21,158			21,530
Gain on brand transaction		—			(5,000	)
Restructuring charges		—			1,000

Operating income		31,018			31,160

Other income (expenses):
Interest and dividend income		65			150
Interest expense		(18,805	)		(16,074	)
Change in fair value of derivatives embedded within convertible debt		(2,714	)		(303	)
Impairment charges on investments		—			(8,500	)
Equity income (loss) from non-consolidated real estate businesses		4,571			(995	)
Gain on the sale of investment securities available for sale		4,664			—
Other, net		61			—


Income before provision for income taxes		18,860			5,438
Income tax expense		6,922			2,338


Net income	$	11,938		$	3,100


Per basic common share:

Net income applicable to common shares	$	0.17		$	0.04


Per diluted common share:

Net income applicable to common shares	$	0.15		$	0.04


Cash distributions and dividends declared per share	$	0.40		$	0.38


*		Revenues and Cost of goods sold include excise taxes of $111,193 and $33,712, respectively.

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

- 3 -

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


											Accumulated
					Additional						Other
	Common Stock				Paid-In			Accumulated			Comprehensive			Treasury
	Shares		Amount		Capital			Deficit			Loss			Stock			Total
Balance, December 31, 2009		71,262,684	$	7,126	$	15,928		$	—		$	(14,879	)	$	(12,857	)	$	(4,682	)

Net income		—		—		—			11,938			—			—			11,938
Pension-related minimum liability adjustments, net of income taxes		—		—		—			—			486			—			486
Forward contract adjustments, net of income taxes		—		—		—			—			9			—			9
Change in net unrealized gain on investment securities, net of income taxes		—		—		—			—			9,983			—			9,983
Net unrealized gains reclassified into net income, net of income taxes		—		—		—			—			(2,771	)		—			(2,771	)

Net unrealized gain on investment securities, net of income taxes		—		—		—			—			7,212			—			7,212

Total other comprehensive income		—		—		—			—			—			—			19,645

Total comprehensive income		—		—		—			—			—			—			14,963


Distributions and dividends on common stock		—		—		(16,755	)		(12,399	)		—			—			(29,154	)
Exercise of stock options		10,047		1		138			—			—			—			139
Amortization of deferred compensation		—		—		689			—			—			—			689


Balance, March 31, 2010		71,272,731	$	7,127	$	—		$	(461	)	$	(7,172	)	$	(12,857	)	$	(13,363	)

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

- 4 -

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


	Three Months			Three Months
	Ended			Ended
	March 31, 2010			March 31, 2009
Net cash provided by operating activities	$	13,163		$	21,088

Cash flows from investing activities:
Sale or maturity of investment securities		6,933			—
Proceeds from sale or liquidation of long-term investments		—			908
Investments in non-consolidated real estate businesses		(605	)		—
Distributions from non-consolidated real estate businesses		2,154			1,182
Increase in cash surrender value of life insurance policies		(536	)		(356	)
(Increase) decrease in non-current restricted assets		(331	)		452
Proceeds from sale of fixed assets		3			—
Capital expenditures		(3,795	)		(803	)

Net cash provided by investing activities		3,823			1,383


Cash flows from financing activities:
Proceeds from debt issuance		2,112			10
Repayments of debt		(1,168	)		(1,604	)
Borrowings under revolver		216,456			123,724
Repayments on revolver		(210,997	)		(123,291	)
Dividends and distributions on common stock		(30,024	)		(30,076	)
Proceeds from exercise of Vector options and warrants		138			10

Net cash used in financing activities		(23,483	)		(31,227	)


Net decrease in cash and cash equivalents		(6,497	)		(8,756	)
Cash and cash equivalents, beginning of period		209,454			211,105


Cash and cash equivalents, end of period	$	202,957		$	202,349

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

- 5 -

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(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 Inc. (“Liggett Vector Brands”), New Valley LLC (“New Valley”) and other less significant subsidiaries. All significant intercompany balances and transactions have been eliminated.

Liggett is engaged in the manufacture and sale of cigarettes in the United States. Vector Tobacco is engaged in research related to reduced risk cigarette products. New Valley is engaged in the real estate business and is seeking to acquire additional operating companies and real estate properties.

The interim condensed consolidated financial statements of the Company are unaudited and, in the opinion of management, reflect all adjustments necessary (which are normal and recurring) to state fairly the Company’s consolidated financial position, results of operations and cash flows. 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, 2009 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 2009 financial information to conform to the 2010 presentation.

(b) Distributions and Dividends on Common Stock:

The Company records distributions on its common stock as dividends in its condensed consolidated statement of stockholders’ equity 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.

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 29, 2009. All per share amounts have been presented as if the stock dividends had occurred on January 1, 2009.

Net income for purposes of determining basic EPS was as follows:


	Three Months			Three Months
	Ended			Ended
	March 31, 2010			March 31, 2009
Net income	$	11,938		$	3,100
Income attributable to participating securities		(263	)		(142	)

Net income available to common stockholders	$	11,675		$	2,958

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

Net income for purposes of determining diluted EPS was as follows:


	Three Months			Three Months
	Ended			Ended
	March 31, 2010			March 31, 2009

Net income	$	11,938		$	3,100
Income attributable to 6.75% Variable Interest Senior Convertible Exchange Notes		(257	)		—
Income attributable to participating securities		(263	)		(142	)

Net income available to common stockholders	$	11,418		$	2,958

Basic and diluted EPS were calculated using the following shares:


	Three Months		Three Months
	Ended		Ended
	March 31, 2010		March 31, 2009

Weighted-average shares for basic EPS		70,722,468		69,093,052

Plus incremental shares related to stock options		147,798		17,015

Plus incremental shares related to convertible debt		6,617,278		—


Weighted-average shares for fully diluted EPS		77,487,544		69,110,067

The following stock options, non-vested restricted stock and shares issuable upon the conversion of convertible debt were outstanding during the three months ended March 31, 2010 and 2009 but were not included in the computation of diluted EPS.


	Three Months		Three Months
	Ended		Ended
	March 31, 2010		March 31, 2009

Number of stock options		509,442		663,997


Weighted-average exercise price	$	18.14	$	17.44


Weighted-average shares of non- vested restricted stock		15,440		221,880


Weighted-average expense per share	$	17.11	$	16.30


Weighted-average number of shares issuable upon conversion of debt		9,709,561		13,579,184


Weighted-average conversion price	$	16.48	$	16.34

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

(d) Comprehensive Income:

Other comprehensive income is a component of stockholders’ equity and includes such items as the unrealized gains and losses on investment securities available for sale, forward foreign contracts and minimum pension liability adjustments. The Company’s comprehensive income (loss) was income of $19,645 for the three months ended March 31, 2010 and a loss of $1,213 for the three months ended March 31, 2009.

(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 Vector’s stock price. The range of estimated fair market values of the Company’s embedded derivatives was between $159,252 and $152,346. The Company recorded the fair market value of its embedded derivatives at the midpoint of the inputs at $155,729 as of March 31, 2010. The estimated fair market value of the Company’s embedded derivatives could change significantly based on future market conditions. (See Note 4.)

(f) New Accounting Pronouncements:

In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for transfers of financial assets. The guidance requires additional disclosures for transfers of financial assets and changes the requirements for derecognizing financial assets. The Company adopted this guidance for interim and annual reporting periods beginning on January 1, 2010. The adoption of this guidance did not impact the Company’s condensed consolidated financial statements.

In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for the consolidation of variable interest entities. The amended guidance eliminates exceptions to consolidating qualifying special purpose entities, contains new criteria for determining the primary beneficiary, and increases the frequency of required reassessments to determine whether a company is the primary beneficiary of a variable interest entity. This guidance also contains a new requirement that any term, transaction, or arrangement that does not have a substantive effect on an entity’s status as a variable interest entity, a company’s power over a variable interest entity, or a company’s obligation to absorb losses or its right to receive benefits of an entity must be disregarded. The elimination of the qualifying special-purpose entity concept and its consolidation exception means more entities will be subject to consolidation assessments and reassessments. The Company adopted this guidance for interim and annual reporting periods beginning on January 1, 2010. The adoption of this guidance did not impact the Company’s condensed consolidated financial statements.

In January 2010, the FASB issued authoritative guidance intended to improve disclosure about fair value measurements. The guidance requires entities to disclose significant transfers in and out of fair value hierarchy levels and the reasons for the transfers and to present information about purchases, sales, issuances, and

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

settlements separately in the reconciliation of fair value measurements using significant unobservable inputs (Level 3). Additionally, the guidance clarifies that a reporting entity should provide fair value measurements for each class of assets and liabilities and disclose the inputs and valuation techniques used for fair value measurements using significant other observable inputs (Level 2) and significant unobservable inputs (Level 3). This guidance is effective for interim and annual periods beginning after December 15, 2009 except for the disclosure about purchases, sales, issuances and settlements in the Level 3 reconciliation, which will be effective for interim and annual periods beginning after December 15, 2010. As this guidance provides only disclosure requirements, the adoption of this guidance did not impact the Company’s condensed consolidated financial statements.

2. INVENTORIES

Inventories consist of:


	March 31,			December 31,
	2010			2009

Leaf tobacco	$	47,023		$	48,942
Other raw materials		3,916			3,497
Work-in-process		398			2,388
Finished goods		67,126			59,293

Inventories at current cost		118,463			114,120
LIFO adjustments		(16,850	)		(15,635	)

	$	101,613		$	98,485

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 March 31, 2010, Liggett had leaf tobacco purchase commitments of approximately $30,300. During 2007, the Company entered into a single source supply agreement for fire safe cigarette paper through 2012.

All of the Company’s inventories at March 31, 2010 and December 31, 2009 have been reported under the LIFO method.

3. LONG-TERM INVESTMENTS

Long-term investments consist of investments in the following:


	March 31, 2010				December 31, 2009
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Investment partnerships	$	49,486	$	69,699	$	49,486	$	68,679
Real estate partnership		837		1,259		837		1,261

	$	50,323	$	70,958	$	50,323	$	69,940

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

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

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited


	March 31,			December 31,
	2010			2009

Vector:
11% Senior Secured Notes due 2015, net of unamortized discount of $4,655 and $4,849	$	245,345		$	245,151
6.75% Variable Interest Senior Convertible Note due 2014, net of unamortized discount of $39,491 and $39,755*		10,509			10,245
6.75% Variable Interest Senior Convertible Exchange Notes due 2014, net of unamortized discount of $68,702 and $69,749*		38,828			37,781
3.875% Variable Interest Senior Convertible Debentures due 2026, net of unamortized discount of $83,455 and $83,589*		26,545			26,411

Liggett:
Revolving credit facility		22,841			17,382
Term loan under credit facility		6,622			6,755
Equipment loans		6,073			4,852

V.T. Aviation:
Note payable		3,520			3,882

VGR Aviation:
Note payable		3,595			3,687

Other		973			663


Total notes payable, long-term debt and other obligations		364,851			356,809
Less:
Current maturities		(29,787	)		(21,889	)

Amount due after one year	$	335,064		$	334,920


*		The fair value of the derivatives embedded within the 6.75% Variable Interest Convertible Note ($22,352 at March 31, 2010 and $23,890 at December 31, 2009, respectively), the 6.75% Variable Interest Senior Convertible Exchange Notes ($42,373 at March 31, 2010 and $47,552 at December 31, 2009, respectively), and the 3.875% Variable Interest Senior Convertible Debentures ($91,004 at March 31, 2010 and $81,574 at December 31, 2009, respectively) is separately classified as a derivative liability in the condensed consolidated balance sheets.

Revolving Credit Facility – Liggett:

Liggett has a $50,000 credit facility with Wachovia Bank, N.A. (“Wachovia”) under which $22,841 was outstanding at March 31, 2010. Availability as determined under the facility was approximately $13,200 based on eligible collateral at March 31, 2010.

11% Senior Secured Notes due 2015 – Vector:

In September 2009, the Company sold an additional $85,000 principal amount of its 11% Senior Secured Notes due 2015 (the “Senior Secured Notes”) at 94% of face value in a private offering to qualified institutional investors in accordance with Rule 144A of the Securities Act of 1933.

In April 2010, the Company sold an additional $75,000 principal amount of the Senior Secured Notes at 101% of face value in a private offering to qualified institutional investors in accordance with Rule 144A of the Securities Act of 1933. The Company received net proceeds from the 2010 offering of approximately $73,500.

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

On May 6, 2010, the Company commenced an offer to exchange the Senior Secured Notes issued in September 2009 and April 2010 for an equal amount of newly issued 11% Senior Secured Notes due 2015. The new Secured Notes have substantially the same terms as the original notes, except that the new Secured Notes have been registered under the Securities Act.

Non-cash Interest Expense — Vector:

Components of non-cash interest expense is as follows:


	Three Months		Three Months
	Ended		Ended
	March 31, 2010		March 31, 2009

Amortization of debt discount	$	1,638	$	2,681
Amortization of deferred finance costs		1,002		954

	$	2,640	$	3,635

Fair Value of Notes Payable and Long-term Debt:


	March 31, 2010				December 31, 2009
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Notes payable and
long-term debt	$	364,851	$	604,437	$	356,809	$	573,439

5. 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. New cases continue to be commenced against Liggett and other cigarette manufacturers. The cases generally fall into the following categories: (i) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs (“Individual Actions”); (ii) smoking and health cases primarily alleging personal injury or seeking court-supervised programs for ongoing medical monitoring, as well as cases alleging the 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 (iii) 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”). As new cases are commenced, the costs associated with defending these cases and the risks relating to the inherent unpredictability of litigation continue to increase. The future financial impact of the risks and expenses of litigation and the effects of the tobacco litigation settlements discussed below are not quantifiable at this time. For the three months ended March 31, 2010 and 2009, Liggett incurred legal expenses and other litigation costs totaling approximately $1,648 and $1,387, respectively.

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 or future cases. An unfavorable outcome or settlement of pending tobacco-related or other litigation could encourage the commencement of additional litigation. Damages claimed in some tobacco-related or other litigation are or can be significant.

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 43 states now limit the dollar amount of bonds or require no bond at all. Liggett has secured approximately $1,127 in bonds as of March 31, 2010.

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: (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 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. 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. However, Liggett may enter into settlement discussions in particular cases if it believes it is in the best interest of the Company to do so.

Individual Actions

As of March 31, 2010, there were 35 individual cases pending against Liggett and/or 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. In addition, there were approximately 7,160 Engle progeny cases (defined below) pending against Liggett and the Company, in state and federal courts in Florida, and approximately 100 individual cases pending in West Virginia state court as part of a consolidated action. The following table lists the number of individual cases by state that are pending against Liggett or its affiliates as of March 31, 2010 (excluding Engle progeny cases and the consolidated cases in West Virginia):


	Number
State	of Cases
Florida		15
New York		9
Louisiana		5
West Virginia		2
Maryland		2
Missouri		1
Ohio		1

Liggett Only Cases. There are currently five cases pending where Liggett is the only tobacco company defendant. Cases where Liggett is the only defendant could increase substantially as a result of the Engle progeny cases. In February 2009, in Ferlanti v. Liggett Group, a Florida state court jury awarded compensatory damages of $1,200 against Liggett, but found that the plaintiff was 40% at fault. Therefore, plaintiff was awarded $720 in compensatory damages and $96 in expenses. Punitive damages were not awarded. Liggett appealed the award. In May 2009, the court granted plaintiff’s motion for an award of attorneys’ fees but the amount has not yet been determined. In Hausrath v. Philip Morris, a case pending in New York state court, plaintiffs recently dismissed all defendants other than Liggett. The other three individual actions, in which Liggett is the only tobacco company defendant, are dormant.

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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 and 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 cases include lack of proximate cause, assumption of the risk, comparative fault and/or contributory negligence, lack of design defect, statute of limitations, equitable defenses such as “unclean hands” and lack of benefit, failure to state a claim and federal preemption.

In addition to awards against Liggett, including Ferlanti (and the Engle progeny cases described below), jury awards in individual cases have also been returned against other cigarette manufacturers in recent years. The awards in these individual actions, often in excess of millions of dollars, may be for both compensatory and punitive damages. There are several significant jury awards against other cigarette manufacturers which are currently on appeal and several awards which are final and have been paid.

As of April 30, 2010, in addition to the Lukacs case described below, the following Engle progeny cases have resulted in verdicts against Liggett:


Date of Verdict	Case Name	County	Verdict Against Liggett
August 2009	Campbell, et al. v. R.J. Reynolds	Escambia	$	156

March 2010	Douglas v. R.J. Reynolds	Hillsborough	$	1,350

April 2010	Clay v. R.J. Reynolds	Escambia	$349 plus $1,000 in punitive damages

April 2010	Putney v. R.J. Reynolds	Broward	$	3,017

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These verdicts are all currently on appeal or will be appealed. As of April 30, 2010, there were 38 Engle progeny cases scheduled for trial in 2010 and 2011, where Liggett and the Company are named defendants. For further information on the Engle case and on Engle progeny cases, including a description of the Lukacs case, see “Class Actions — Engle Case,” below.

Class Actions

As of March 31, 2010, there were seven 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. Many of these actions purport to constitute statewide class actions and were filed after May 1996 when the United States Court of Appeals for the Fifth Circuit, in Castano v. American Tobacco Co., reversed a federal district court’s certification of a purported nationwide class action on behalf of persons who were allegedly “addicted” to tobacco products.

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.

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.

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

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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. As a result of the Engle decision, approximately 8,500 former Engle class members have claims pending against the Company and Liggett and other cigarette manufacturers.

Three federal district courts (in the Merlob, Brown and Burr cases) have ruled that the findings in Phase I of the Engle proceedings cannot be used to satisfy elements of plaintiffs’ claims, and two of those rulings (Brown and Burr) were certified by the trial court for interlocutory review. The certification was granted by the United States Court of Appeals for the Eleventh Circuit and the appeals were consolidated (in February 2009, the appeal in Burr was dismissed for lack of prosecution). Oral argument was held in January 2010. A decision is pending. Engle progeny cases pending in the federal district courts in the Middle District of Florida have been stayed pending interlocutory review by the Eleventh Circuit. Several state trial court judges have issued contrary rulings that allowed plaintiffs to use the Engle findings to establish elements of their claims and required certain defenses to be stricken.

Lukacs Case. In June 2002, the jury in a Florida state court action entitled Lukacs v. R.J. Reynolds Tobacco Co., awarded $37,500 in compensatory damages, jointly and severally, in a case involving Liggett and two other cigarette manufacturers, which amount was subsequently reduced by the court. The jury found Liggett 50% responsible for the damages incurred by the plaintiff. The Lukacs case was the first case to be tried as an individual Engle progeny case, but was tried almost five years prior to the Florida Supreme Court’s final decision in Engle. In November 2008, the court entered final judgment in the amount of $24,835 (for which Liggett is 50% responsible), plus interest from June 2002 which, as of March 31, 2010, was in excess of $15,000 (for which

Liggett is 50% responsible). Plaintiff filed a motion seeking an award of attorneys’ fees from Liggett based on plaintiff’s prior proposal for settlement. All proceedings relating to the motion for attorneys’ fees are stayed pending a final resolution of appellate proceedings. Defendants filed a notice of appeal in December 2008. On March 17, 2010, the Third District Court of Appeal affirmed the decision, per curiam, which will not likely be reviewed by the Florida Supreme Court. The defendants have filed a petition for rehearing with the court of appeal.

In June 2009, Florida amended its existing bond cap statute by adding a $200,000 bond cap that applies to all Engle progeny lawsuits 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. The legislation, which became effective in June 2009, applies to judgments entered after the effective date and remains in effect until December 31, 2012.

Other Class Actions. In Smith v. Philip Morris, a Kansas state court case filed in February 2000, plaintiffs allege that cigarette manufacturers 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. Discovery is ongoing.

Class action suits have been filed in a number of states against cigarette manufacturers, alleging, among other things, that use of the terms “light” and “ultra light” constitutes unfair and deceptive trade practices, among other things. One such suit, Schwab [McLaughlin] v. Philip Morris, pending in federal court in New York since 2004, sought to create a nationwide class of “light” cigarette smokers. In September 2006, the United States District Court for the Eastern District of New York certified the class. In April 2008, the United States Court of Appeals for the Second Circuit decertified the class. The case was returned to the trial court for further proceedings. 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. This ruling has resulted in the filing of additional “lights” class action cases in other states against other cigarette manufacturers. Although Liggett was

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not a defendant in the Good case, an adverse ruling or commencement of additional “lights” related class actions could have a material adverse effect on the Company.

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, are alleged to have been exposed to secondhand smoke from cigarettes which were manufactured by the defendants, and who suffered injury as a result of that exposure. The plaintiffs seek to recover an unspecified amount of compensatory and punitive damages. In October 2004, the trial court stayed this case pending the outcome of the appeal in Scott v. American Tobacco Co. (see discussion below).

In June 1998, in Cleary v. Philip Morris, a putative class action was brought in Illinois state court on behalf of persons who were allegedly injured by: (i) defendants’ purported conspiracy to conceal material facts regarding the addictive nature of nicotine; (ii) defendants’ alleged acts of targeting their advertising and marketing to minors; and (iii) defendants’ claimed breach of the public’s right to defendants’ compliance with laws prohibiting the distribution of cigarettes to minors. Plaintiffs sought disgorgement of all profits unjustly received through defendants’ sale of cigarettes to plaintiffs and the class. In March 2009, plaintiffs filed a third amended complaint adding, among other things, allegations regarding defendants’ sale of “light” cigarettes. The case was then removed to federal court on the basis of this new claim. In September 2009, the court granted summary judgment to all defendants other than Philip Morris as to the “lights” claims. In November 2009, plaintiffs filed a revised motion for class certification as to the three proposed classes, which motion was denied by the court on February 22, 2010. On February 1, 2010, the court granted summary judgment in favor of defendants as to all claims, other than a “lights” claim involving another cigarette manufacturer. The court granted leave to the plaintiffs to reinstate the motion as to the addiction claims, if the plaintiffs identified another class representative, which they did on April 13, 2010. Defendants intend to move to dismiss the remaining addiction claim. The court plans to rule on that motion on or before June 9, 2010.

In April 2001, in Brown v. Philip Morris USA, a California state court granted in part plaintiffs’ motion for class certification and certified a class comprised of adult residents of California who smoked at least one of defendants’ cigarettes “during the applicable time period” and who were exposed to defendants’ marketing and advertising activities in California. In March 2005, the court granted defendants’ motion to decertify the class based on a recent change in California law. In June 2009, the California Supreme Court reversed and remanded the case to the trial court for further proceedings regarding whether the class representatives have, or can, demonstrate standing. In August 2009, the California Supreme Court denied defendants’ rehearing petition and issued its mandate. In September 2009, plaintiffs sought reconsideration of the court’s September 2004 order finding that plaintiffs’ allegations regarding “lights” cigarettes were preempted by federal law, in light of the recent United States Supreme Court decision in Altria Group v. Good. The court is reviewing the question. A hearing was held on March 11, 2010. 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, which is scheduled for June 2010. 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 certification motions are pending in a number of other cases and a number of orders denying class certification are on appeal. In addition to the cases described above, numerous class actions remain certified against other cigarette manufacturers, including Scott. In that case, a Louisiana jury returned a $591,000 verdict (subsequently reduced by the court to $263,500 plus interest from June 2004) against other cigarette manufacturers to fund medical monitoring or smoking cessation programs for members of the class. Oral argument on the appeal occurred in September 2009. In April 2010, the Louisiana Fourth Circuit Court of Appeal affirmed in part prior decisions ordering the defendants to fund a statewide 10-year smoking cessation program. The court of appeal lowered the amount of the judgment to approximately $241,000, plus interest from July 2008.

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Health Care Cost Recovery Actions

As of March 31, 2010, there were three active Health Care Cost Recovery Actions pending against Liggett. Other cigarette manufacturers are also named in these cases. 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.

DOJ Case. 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 and Remedial Order 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. In February 2010, the government and all defendants, other than Liggett, filed petitions for writs of certiorari to the United States Supreme Court. In the government’s petition, it is seeking reinstatement of its claims for remedies, including disgorgement of industry profits. Although this case has been concluded as to Liggett, 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.

In City of St. Louis v. American Tobacco Company, a case pending in Missouri state court since December 1998, the City of St. Louis and approximately 40 hospitals seek recovery of costs expended by the hospitals on behalf of patients who suffer, or have suffered, from illnesses allegedly resulting from the use of cigarettes. In June 2005, the court granted defendants’ motion for summary judgment as to claims for damages which accrued prior to November 16, 1993. The claims for damages which allegedly accrued after November 16, 1993 are pending. Discovery is ongoing. In September 2009, the defendants filed a motion for partial summary judgment on the plaintiffs’ claims for future damages and for fraud. In December 2009, the defendants filed motions for summary judgment based upon, among other things, plaintiffs’ failure to prove unreimbursed costs and plaintiffs’ failure to show fact of injury or damage. These motions are pending before the court. Trial is scheduled to commence January 10, 2011.

In June 2005, the Jerusalem District Court in Israel added Liggett as a defendant in an action commenced in 1998 by the largest private insurer in that country, General Health Services, against the major United States cigarette manufacturers. The plaintiff seeks to recover the past and future value of the total expenditures for health care services provided to residents of Israel resulting from tobacco related diseases, court ordered interest for past expenditures from the date of filing the statement of claim, increased and/or punitive and/or exemplary damages

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and costs. The court ruled that, although Liggett had not sold product in Israel since at least 1978, it might still have liability for cigarettes sold prior to that time. Motions filed by defendants are pending before the Israel Supreme Court seeking appeal from a lower court’s decision granting leave to plaintiff for foreign service of process.

In May 2008, in National Committee to Preserve Social Security and Medicare v. Philip Morris USA, a case pending in the United States District Court for the Eastern District of New York, plaintiffs commenced an action to recover damages equal to twice the amount paid by Medicare for the smoking-related health care services provided from May 21, 2002 to the present, for which treatment defendants’ allegedly were required to make payment under the Medicare Secondary Payer provisions of the Social Security Act. In July 2008, defendants’ filed a motion to dismiss plaintiffs’ claims and plaintiffs filed a motion for partial summary judgment. In March 2009, the court granted the defendants’ motion and dismissed the case. In May 2009, plaintiffs noticed an appeal. In September 2009, defendants filed a motion for summary disposition of the appeal and for a stay of the briefing schedule. The stay was granted. In January 2010, the Second Circuit Court of Appeals referred the motion for summary affirmance to the Merits Panel and ordered briefing on the motion.

Upcoming Trials

In addition to the January 2011 trial in the City of St. Louis case discussed above, as of April 30, 2010, there were 38 Engle progeny cases that are scheduled for trial in 2010 and 2011. The Company and/or Liggett and other cigarette manufacturers are currently named as defendants in each of these cases. Cases against other cigarette manufacturers are also currently scheduled for trial in 2010 and 2011. Trial dates are subject to change.

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

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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. According to data from Management Science Associates, Inc., domestic shipments by Liggett and Vector Tobacco accounted for approximately 2.7% of the total cigarettes shipped in the United States in 2009. 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. Liggett and Vector Tobacco paid $54,435 for their 2009 MSA obligations.

Certain MSA Disputes

NPM Adjustment. In March 2006, an economic consulting firm selected pursuant to the MSA rendered its final and non-appealable decision 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 same decision with respect to 2004, 2005 and 2006. As a result, the manufacturers are entitled to potential NPM Adjustments to their 2003, 2004, 2005 and 2006 MSA payments. The Participating Manufacturers are also entitled to potential NPM Adjustments to their 2007, 2008 and 2009 payments pursuant to an agreement entered into in June 2009 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 in 2007, 2008 and 2009. A Settling State that has diligently enforced its qualifying escrow statute in the year in question may be able to avoid application of the NPM Adjustment to the payments made by the manufacturers for the benefit of that Settling State.

For 2003 through 2009, Liggett and Vector Tobacco disputed that they owe the Settling States the NPM Adjustments as calculated by the Independent Auditor. As permitted by the MSA, Liggett and Vector Tobacco have withheld payment associated with these NPM Adjustment amounts. The total amount withheld or paid into a disputed payment account by Liggett and Vector Tobacco for 2003 through 2009 is $29,236. In 2003, Liggett and Vector Tobacco paid the NPM adjustment amount of $9,345 to the Settling States although both companies continue to dispute this amount. At March 31, 2010, included in “Other assets” on the Company’s condensed consolidated balance sheet was a noncurrent receivable of $6,542 relating to such payment.

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The following amounts have not been expensed by the Company as they relate to Liggett and Vector Tobacco’s NPM Adjustment claims for 2003 through 2009: $6,542 for 2003, $3,789 for 2004 and $800 for 2005.

Since April 2006, notwithstanding provisions in the MSA requiring arbitration, litigation was filed in 49 Settling States over the issue of whether the application of the NPM Adjustment for 2003 is to be determined through litigation or arbitration. These actions relate to the potential NPM Adjustment for 2003, which the independent auditor under the MSA previously determined to be as much as $1,200,000 for all Participating Manufacturers. All but one of the 48 courts that have decided the issue have ruled that the 2003 NPM Adjustment dispute is arbitrable. All 47 of those decisions are final and non-appealable. One court, the Montana Supreme Court, ruled that Montana’s claim of diligent enforcement must be litigated. This decision has been appealed. 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. The agreement provides for selection of the arbitration panel beginning November 1, 2009 and that the parties and the arbitrators will thereafter establish the schedule and procedures for the arbitration. Because states representing more than 80% of the allocable share signed the agreement, signing states will receive a 20% reduction of any potential 2003 NPM adjustment. It is anticipated that the arbitration will commence in 2010. There can be no assurance that Liggett or Vector Tobacco will receive any adjustment as a result of these proceedings.

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 recalculated using “net” unit amounts, rather than “gross” unit amounts (which had been used since 1999).

Liggett objected to this retroactive change and disputed the change in methodology. Liggett contends that the retroactive change from “gross” to “net” unit amounts is impermissible for several reasons, including:

	•		use of “net” unit amounts is not required by the MSA (as reflected by, among other things, the use of “gross” unit amounts through 2005);

	•		such a change is not authorized without the consent of affected parties to the MSA;

	•		the MSA provides for four-year time limitation periods for revisiting calculations and determinations, which precludes recalculating Liggett’s 1997 Market Share (and thus, Liggett’s market share exemption); and

	•		Liggett and others have relied upon the calculations based on “gross” unit amounts since 1998.

The change in the method of calculation could result in Liggett owing, at a minimum, approximately $9,500, plus interest, of additional MSA payments for prior years, because the proposed change from “gross” to “net” units would serve to lower Liggett’s market share exemption under the MSA. The Company estimates that future MSA payments would be at least approximately $2,250 higher if the method of calculation is changed. No amounts have been expensed or accrued in the accompanying condensed consolidated financial statements for any potential liability relating to the “gross” versus “net” dispute. There can be no assurance that Liggett will not be required to make additional material payments, which payments could adversely affect the Company’s consolidated financial position, results of operations or cash flows.

Litigation Challenging the MSA. In Freedom Holdings Inc. v. Cuomo, litigation pending in federal court in New York, certain importers of cigarettes allege that the MSA and certain related New York statutes violate federal antitrust and constitutional law. The district court granted New York’s motion to dismiss the complaint for failure to state a claim. On appeal, the United States Court of Appeals for the Second Circuit held that if all of the allegations of the complaint were assumed to be true, plaintiffs had stated a claim for relief on antitrust grounds.

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In January 2009, the district court granted New York’s motion for summary judgment, dismissing all claims brought by the plaintiffs, and dissolving the preliminary injunction. Plaintiffs appealed the decision. Oral argument on the appeal occurred in December 2009. A decision is pending.

In Grand River Enterprises Six Nations, Ltd. v. King, another proceeding pending in federal court in New York, plaintiffs seek to enjoin the statutes enacted by New York and other states in connection with the MSA on the grounds that the statutes violate the Commerce Clause of the United States Constitution and federal antitrust laws. In September 2005, the United States Court of Appeals for the Second Circuit held that if all of the allegations of the complaint were assumed to be true, plaintiffs had stated a claim for relief and that the New York federal court had jurisdiction over the other defendant states. On remand, the trial court held that plaintiffs are unlikely to succeed on the merits. Discovery is pending.

Similar challenges to the MSA and MSA-related state statutes are pending in Kentucky, Arkansas, Kansas, Louisiana, Tennessee and Oklahoma. Liggett and the other cigarette manufacturers are not defendants in these cases. Litigation challenging the validity of the MSA, including claims that the MSA violates antitrust laws, has not been successful to date.

In October 2008, Vibo Corporation, Inc., d/b/a General Tobacco (“Vibo”) commenced litigation in the United States District Court for the Western District of Kentucky against each of the Settling States and certain Participating Manufacturers, including Liggett and Vector Tobacco. Vibo alleged, among other things, that the market share exemptions (i.e., grandfathered shares) provided to certain SPMs under the MSA, including Liggett and Vector Tobacco, violate federal antitrust and constitutional law. In January 2009, the district court dismissed the complaint. In January 2010, the court entered final judgment in favor of the defendants. Vibo appealed to the United States Court of Appeals for the Sixth Circuit.

Other State Settlements. The MSA replaces 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. Liggett’s agreements with these states remain in full force and effect, and Liggett made various payments to these states under the agreements. 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, in order to resolve any potential issues with Minnesota as to Liggett’s ongoing economic settlement obligations, Liggett negotiated a $100 a year payment to Minnesota, to be paid any year cigarettes manufactured by Liggett are sold in that state. In 2004, the Attorneys General for Florida, Mississippi and Texas advised Liggett that they believed that Liggett had failed to make required payments under the respective settlement agreements with these states from 1998 through 2003 and that additional payments may be due for subsequent years. Liggett believes the states’ allegations are without merit, based, among other things, on the language of the most favored nation provisions of the settlement agreements. There can be no assurance that Liggett will resolve these matters or that Liggett will not be required to make additional material payments, which payments could adversely affect the Company’s consolidated financial position, results of operations or cash flows. During 2009, Liggett reversed a previously recorded accrual of $2,500 with respect to this matter.

Cautionary Statement. Management is not able to predict the outcome of the litigation pending or threatened against Liggett. Litigation is subject to many uncertainties. For example, the jury in the Lukacs case, an Engle progeny case tried in 2002, awarded compensatory damages against Liggett and two other defendants and found

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

Liggett 50% responsible for the damages. In November 2008, the court entered final judgment in favor of the plaintiff for $24,835, plus interest from 2002 which, as of March 31, 2010, exceeded $15,000. The Lukacs verdict was recently affirmed by the appellate court. Liggett has been found liable in four other Engle progeny cases, which are currently on appeal or will be appealed. As a result of the Engle decision, approximately 8,500 former Engle class members have claims pending against the Company and Liggett and other cigarette manufacturers. It is possible that other cases could be decided unfavorably against Liggett and that Liggett will be unsuccessful on appeal. Liggett may enter into discussions in an 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 of a pending smoking and health case could encourage the commencement of additional similar litigation, or could lead to multiple adverse decisions in the Engle progeny cases. Management is unable to make a reasonable estimate with respect to the amount 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 condensed consolidated financial statements for unfavorable outcomes. The complaints filed in these cases rarely detail alleged damages. Typically, the claims set forth in an individual’s complaint against the tobacco industry seek money damages in an amount to be determined by a jury, plus punitive damages and costs.

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 similar litigation or legislation.

It is possible that the Company’s consolidated financial position, results of operations or cash flows could be materially adversely affected by an unfavorable outcome in any of the smoking-related litigation.

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.

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

Other Matters:

In February 2004, Liggett Vector Brands and another cigarette manufacturer entered into a five year 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. This agreement has been extended through February 2014. Under the agreement, Liggett Vector Brands has agreed to pay a portion of losses, if any, incurred by the surety under the bond program, with a maximum loss exposure of $500 for Liggett Vector Brands. To secure its potential obligations under the agreement, Liggett Vector Brands has delivered to the subsidiary of the association a $100 letter of credit and agreed to fund up to an additional $400. Liggett Vector Brands has incurred no losses to date under this agreement, and the Company believes the fair value of Liggett Vector Brands’ obligation under the agreement was immaterial at March 31, 2010.

In December 2009, a complaint was filed against Liggett in Alabama state court by the estate of a woman who died, in 2007, in a house fire allegedly caused by the ignition of contents of the house by a Liggett cigarette. Plaintiff is suing under the Alabama Extended Manufacturers Liability Doctrine and for breach of warranty and negligence. The plaintiff seeks both punitive and compensatory damages. In February 2010, Liggett filed a notice of removal to federal court. Plaintiff filed a motion for remand. A hearing occurred in March 2010. A decision is pending.

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.

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:

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited


	Three Months			Three Months
	Ended			Ended
	March 31, 2010			March 31, 2009
Income before provision for income taxes	$	18,860		$	5,438


Income tax expense using estimated annual effective income tax rate		7,422			2,338
Reduction of valuation allowance		(500	)		—


Income tax expense	$	6,922		$	2,338

The Company recorded a benefit of $500 for the three months ended March 31, 2010 resulting from the reduction of a previously established valuation allowance of a deferred tax asset. The valuation allowance was reduced for the recognition of state tax net operating losses at Vector Tobacco Inc. after evaluating the impact of the negative and positive evidence that such asset would be realized.

NEW VALLEY LLC

The components of “Investments in non-consolidated real estate businesses” were as follows:


	March 31, 2010		December 31, 2009
Douglas Elliman Realty, LLC	$	38,696	$	36,086
Aberdeen Townhomes LLC		277		1,248
New Valley Oaktree Chelsea Eleven LLC		12,836		12,232


Investments in non-consolidated real estate businesses	$	51,809	$	49,566

Residential Brokerage Business. New Valley recorded income of $4,571 and a loss of $1,195 for the three months ended March 31, 2010 and 2009, respectively, associated with Douglas Elliman Realty, LLC. New Valley received cash distributions from Douglas Elliman Realty, LLC of $1,962 and $1,428 for the three months ended March 31, 2010 and 2009, respectively. The summarized financial information of Douglas Elliman Realty, LLC is as follows:


	March 31, 2010		December 31, 2009
Cash	$	30,836	$	26,920
Other current assets		7,243		6,664
Property, plant and equipment, net		13,525		13,498
Trademarks		21,663		21,663
Goodwill		38,349		38,601
Other intangible assets, net		1,550		742
Other non-current assets		2,638		2,871
Notes payable — current		519		776
Current portion of notes payable to member - Prudential Real Estate Financial Services of America, Inc.		1,360		2,487
Current portion of notes payable to member — New Valley		1,360		2,487
Other current liabilities		18,509		20,724
Notes payable — long term		1,132		2,136
Other long-term liabilities		9,965		7,747
Members’ equity		82,959		74,602

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited


	Three Months Ended March 31,
	2010		2009
Revenues	$	76,661	$	48,956
Costs and expenses		67,175		50,560
Depreciation expense		900		1,199
Amortization expense		77		64
Other income		397		—
Interest expense, net		278		691
Income tax expense (benefit)		271		(310	)

Net income (loss)	$	8,357	$	(3,248	)

Aberdeen Townhomes LLC. In January 2010, Aberdeen sold one of its four townhomes and the mortgage of approximately $4,550 was retired. The Company received a preferred return distribution of approximately $971 in connection with the sale. In addition, $375 from the sale is being held in escrow until July 2010. Mortgages on the three remaining Aberdeen townhomes had a balance of approximately $27,400 as of March 31, 2010. These mortgages matured during 2009 and are in default. Aberdeen is in discussions with the lender related to the three remaining mortgages which are in default. There can be no assurance that an agreement will be reached.

The Company’s maximum exposure to loss on its investment in Aberdeen is $277 at March 31, 2010.

New Valley Oaktree Chelsea Eleven, LLC. A subsidiary of New Valley (“New Valley Chelsea”) is operating as an investment vehicle for the Chelsea Eleven LLC (the “Chelsea”) real estate development project. Chelsea sold three units during the quarter ended March 31, 2010. As of the financial statement issue date, sales of 15 of the 54 luxury residential units have closed.

As of March 31, 2010, Chelsea had approximately $198,802 of total assets and $117,952 of total liabilities, excluding amounts owed to New Valley Chelsea (approximately $67,438 at March 31, 2010).

The outstanding balance on the $96,000 construction loan was approximately $40,300 at March 31, 2010. The outstanding balance of the $24,000 mezzanine loan plus accrued interest was approximately $54,600 at March 31, 2010.

As of March 31, 2010, the Company had lent an additional amount of $822 to New Valley Oaktree. The Company’s maximum exposure to loss on its investment in New Valley Chelsea is $12,836 at March 31, 2010.

Investment in Escena:

The components of the Company’s investment in Escena are as follows:


	March 31,			December 31,
	2010			2009
Land and land improvements	$	11,112		$	11,126
Building and building improvements		1,426			1,154
Other		1,092			1,038

		13,630			13,318
Less accumulated depreciation		(142	)		(74	)

	$	13,488		$	13,244

The Company recorded operating income of approximately $282 for three months ended March 31, 2010 from Escena.

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

8.		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 March 31, 2010
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
Description	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Money market funds	$	194,865	$	194,865	$	—	$	—
Certificates of deposit		2,766		—		2,766		—
Bonds		1,128		1,128		—		—
Investment securities available for sale		61,615		49,722		11,893		—

Total	$	260,374	$	245,715	$	14,659	$	—


Liabilities:
Fair value of derivatives embedded within convertible debt	$	155,729	$	—	$	—	$	155,729


	Fair Value Measurements as of December 31, 2009
			Quoted Prices
			in Active		Significant		Significant
			Markets for		Other		Unobservable
			Identical		Observable		Inputs
			Assets		Inputs		(Level 3)
Description	Total		(Level 1)		(Level 2)
Assets:
Money market funds	$	199,423	$	199,423	$	—	$	—
Certificates of deposit		2,785		—		2,785		—
Bonds		3,128		3,128		—		—
Investment securities available for sale		51,742		38,706		13,036		—


Total	$	257,078	$	241,257	$	15,821	$	—


Liabilities:
Fair value of derivatives embedded within convertible debt	$	153,016	$	—	$	—	$	153,016

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 were not registered and do not have direct market quotes.

The fair value of derivatives embedded within convertible debt were 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 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

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

debt. The changes in fair value of derivatives embedded within convertible debt are presented on the Condensed Consolidated Statements of Operations.

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.

The Company’s nonrecurring nonfinancial assets subject to fair value measurements are as follows:


			Fair Value Measurements as of March 31, 2009 Using:
					Quoted
					Prices in
	Three				Active
	Months Ended				Markets		Significant
	March 31,				for		Other		Significant
	2009				Identical		Observable		Unobservable
	Impairment				Assets		Inputs		Inputs
Description	Charge		Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Investment in real estate	$	5,000	$	12,704	$	—	$	—	$	12,704
Investment in non- consolidated real estate businesses		3,500		3,000		—		—		3,000

Total	$	8,500	$	15,704	$	—	$	—	$	15,704

The Company estimated the fair value of its investment in Escena and non-consolidated real estate using observable inputs such as market pricing based on recent events, however, significant judgment was required to select certain inputs from observed market data. The decrease in the mortgage receivable and the non-consolidated real estate were attributed to the decline in the New York and California real estate markets due to various factors including downward pressure on housing prices, the impact of the recent contraction in the subprime and mortgage markets generally and a large inventory of unsold homes at the same time that sales volumes were decreasing.

SEGMENT INFORMATION

As a result of the suspension of the marketing of low nicotine and nicotine-free cigarette products by Vector Tobacco and significant reductions in Vector Tobacco’s related research activities, the Company has reevaluated its operating segments and combined the Liggett and Vector Tobacco businesses into a single Tobacco segment. The Company’s significant business segments for the three months ended March 31, 2010 and 2009 were Tobacco and Real Estate. The Tobacco segment consists of the manufacture and sale of cigarettes and the research related to reduced risk products. The Real Estate segment includes the Company’s investment in Escena and investments in non-consolidated real estate businesses. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Prior period information has been recast to conform to the current presentation.

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 months ended March 31, 2010 and 2009 follows:


				Real			Corporate
	Tobacco			Estate			and Other			Total
Three months ended March 31, 2010
Revenues	$	222,087			—			—		$	222,087
Operating income (loss)		34,932			282			(4,196	)		31,018
Equity income on non-consolidated real estate businesses		—			4,571			—			4,571
Identifiable assets		406,691			65,297	⁽²⁾		271,092			743,080
Depreciation and amortization		2,073			68			579			2,720
Capital expenditures		3,445			321			29			3,795

Three months ended March 31, 2009
Revenues	$	121,216			—			—		$	121,216
Operating income (loss)		35,625	⁽¹⁾		—			(4,465	)		31,160
Equity loss on non-consolidated real estate businesses		—			(995	)		—			(995	)
Identifiable assets		289,951			56,762	⁽²⁾		336,513			683,226
Depreciation and amortization		2,013			—			580			2,593
Capital expenditures		803			—			—			803


(1)		Operating income includes a gain of $5,000 on the Philip Morris brand transaction completed February 2009 and restructuring expenses of $1,000.

(2)		Includes investments accounted for under the equity method of accounting of $51,809 and $44,058 as of March 31, 2010 and 2009, respectively.

10.		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 full and unconditional and joint and several. The Company’s investments in its consolidated subsidiaries are presented under the equity method of accounting.

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

CONDENSED CONSOLIDATING BALANCE SHEETS


	March 31, 2010
						Subsidiary					Consolidated
	Parent/			Subsidiary		Non-		Consolidating			Vector Group
	Issuer			Guarantors		Guarantors		Adjustments			Ltd.
ASSETS:
Current assets:
Cash and cash equivalents	$	197,382		$	4,918	$	657	$	—		$	202,957
Investment securities available for sale		61,615			—		—		—			61,615
Accounts receivable — trade		—			7,154		—		—			7,154
Intercompany receivables		32			—		—		(32	)		—
Inventories		—			101,613		—		—			101,613
Deferred income taxes		13,102			3,307		—		—			16,409
Income taxes receivable		—			17,060		—		(17,060	)		—
Restricted assets		—			1,378		—		—			1,378
Other current assets		906			2,470		102		—			3,478

Total current assets		273,037			137,900		759		(17,092	)		394,604

Property, plant and equipment, net		626			43,195		—		—			43,821
Investment in Escena, net		—			—		13,488		—			13,488
Long-term investments accounted for at cost		49,486			—		837		—			50,323
Investments in non- consolidated real estate businesses		—			—		51,809		—			51,809
Investments in consolidated subsidiaries		270,282			—		—		(270,282	)		—
Restricted assets		2,666			2,500		—		—			5,166
Deferred income taxes		27,801			109,520		9,342		(108,083	)		38,580
Intangible asset		—			107,511		—		—			107,511
Prepaid pension costs		—			9,237		—		—			9,237
Other assets		14,297			14,244		—		—			28,541

Total assets	$	638,195		$	424,107	$	76,235	$	(395,457	)	$	743,080

LIABILITIES AND STOCKHOLDERS’ DEFICIENCY:
Current liabilities:
Current portion of notes payable and long-term debt	$	—		$	29,787	$	—	$	—		$	29,787
Current portion of employee benefits		—			1,029		—		—			1,029
Accounts payable		443			4,314		62		—			4,819
Intercompany payables		—			32		—		(32	)		—
Accrued promotional expenses		—			10,687		—		—			10,687
Income taxes payable, net		1,662			1,970		32,621		(17,060	)		19,193
Accrued excise and payroll taxes payable, net		—			14,812		—		—			14,812
Settlement accruals		—			42,247		—		—			42,247
Deferred income taxes		20,520			1,763		—		—			22,283
Accrued interest		6,967			—		—		—			6,967
Other current liabilities		3,385			7,130		735		—			11,250

Total current liabilities		32,977			113,771		33,418		(17,092	)		163,074
Notes payable, long-term debt and other obligations, less current portion		321,227			13,270		567		—			335,064
Fair value of derivatives embedded within convertible debt		155,729			—		—		—			155,729
Non-current employee benefits		13,663			20,935		—		—			34,598
Deferred income taxes		127,676			24,634		59		(108,083	)		44,286
Other liabilities		286			22,709		697		—			23,692

Total liabilities		651,558			195,319		34,741		(125,175	)		756,443

Commitments and contingencies		—			—		—		—			—

Stockholders’ deficiency		(13,363	)		228,788		41,494		(270,282	)		(13,363	)

Total liabilities and stockholders’ deficiency	$	638,195		$	424,107	$	76,235	$	(395,457	)	$	743,080

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

CONDENSED CONSOLIDATING BALANCE SHEETS


	December 31, 2009
						Subsidiary					Consolidated
	Parent/			Subsidiary		Non-		Consolidating			Vector Group
	Issuer			Guarantors		Guarantors		Adjustments			Ltd.
ASSETS:
Current assets:
Cash and cash equivalents	$	204,133		$	5,004	$	317	$	—		$	209,454
Investment securities available for sale		51,743			—		—		—			51,743
Accounts receivable — trade		—			8,089		9		—			8,098
Intercompany receivables		—			43		—		(43	)		—
Inventories		—			98,485		1		—			98,486
Deferred income taxes		11,240			2,914		—		—			14,154
Income taxes receivable		—			26,086		—		(26,086	)		—
Restricted assets		—			3,138		—		—			3,138
Other current assets		497			3,512		126		—			4,135

Total current assets		267,613			147,271		453		(26,129	)		389,208
Property, plant and equipment, net		623			42,363		—		—			42,986
Investment in Escena, net		—			—		13,244		—			13,244
Long-term investments accounted for at cost		49,486			—		837		—			50,323
Investments in non- consolidated real estate businesses		—			—		49,566		—			49,566
Investments in consolidated subsidiaries		282,010			—		—		(282,010	)		—
Restricted assets		2,685			2,150		—		—			4,835
Deferred income taxes		28,729			94,088		9,667		(92,646	)		39,838
Intangible asset		—			107,511		—		—			107,511
Prepaid pension costs		—			8,994		—		—			8,994
Other assets		14,942			14,095		—		—			29,037

Total assets	$	646,088		$	416,472	$	73,767	$	(400,785	)	$	735,542

LIABILITIES AND STOCKHOLDERS’ DEFICIENCY:
Current liabilities:
Current portion of notes payable and long-term debt	$	—		$	21,773	$	116	$	—		$	21,889
Current portion of employee benefits		—			1,029		—		—			1,029
Accounts payable		1,490			2,763		102		—			4,355
Intercompany payables		43			—		—		(43	)		—
Accrued promotional expenses		—			12,745		—		—			12,745
Income taxes payable, net		14,472			547		30,991		(26,086	)		19,924
Accrued excise and payroll taxes payable, net		—			24,088		5		—			24,093
Settlement accruals		—			18,803		—		—			18,803
Deferred income taxes		14,992			2,262		—		—			17,254
Accrued interest		13,840			—		—		—			13,840
Other current liabilities		6,039			8,427		610		—			15,076

Total current liabilities		50,876			92,437		31,824		(26,129	)		149,008
Notes payable, long-term debt and other obligations, less current portion		319,588			14,853		479		—			334,920
Fair value of derivatives embedded within convertible debt		153,016			—		—		—			153,016
Non-current employee benefits		13,301			20,946		—		—			34,247
Deferred income taxes		113,667			24,040		59		(92,646	)		45,120
Other liabilities		322			22,763		828		—			23,913

Total liabilities		650,770			175,039		33,190		(118,775	)		740,224

Commitments and contingencies		—			—		—		—			—

Stockholders’ deficiency		(4,682	)		241,433		40,577		(282,010	)		(4,682	)

Total liabilities and stockholders’ deficiency	$	646,088		$	416,472	$	73,767	$	(400,785	)	$	735,542

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 March 31, 2010
							Subsidiary						Consolidated
	Parent/			Subsidiary			Non-			Consolidating			Vector Group
	Issuer			Guarantors			Guarantors			Adjustments			Ltd.
Revenues	$	—		$	222,087		$	—		$	—		$	222,087
Expenses:
Cost of goods sold		—			169,911			—			—			169,911
Operating, selling, administrative and general expenses		5,218			16,195			(255	)		—			21,158
Management fee expense		—			2,130			—			(2,130	)		—

Operating (loss) income		(5,218	)		33,851			255			2,130			31,018
Other income (expenses):
Interest and dividend income		57			8			—			—			65
Interest expense		(18,575	)		(219	)		(11	)		—			(18,805	)
Changes in fair value of derivatives embedded within convertible debt		(2,714	)		—			—			—			(2,714	)
Equity income on non-consolidated real estate businesses		—			—			4,571			—			4,571
Gain on the sale of investment securities available for sale		4,664			—			—			—			4,664
Equity income in consolidated subsidiaries		27,368			—			—			(27,368	)		—
Management fee income		2,130			—			—			(2,130	)		—
Other, net		61			—			—			—			61

Income before provision for income taxes		7,773			33,640			4,815			(27,368	)		18,860
Income tax (expense) benefit		(9,928	)		(9,132	)		(1,955	)		14,093			(6,922	)

Net income	$	(2,155	)	$	24,508		$	2,860		$	(13,275	)	$	11,938

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 March 31, 2009
							Subsidiary						Consolidated
	Parent/			Subsidiary			Non-			Consolidating			Vector Group
	Issuer			Guarantors			Guarantors			Adjustments			Ltd.
Revenues	$	—		$	121,216		$	—		$	—		$	121,216
Expenses:
Cost of goods sold		—			72,526			—			—			72,526
Operating, selling, administrative and general expenses		5,150			15,990			390			—			21,530
Gain on brand transaction		—			(5,000	)		—			—			(5,000	)
Restructuring charges		—			1,000			—			—			1,000
Management fee expense		—			2,056			—			(2,056	)		—

Operating(loss) income		(5,150	)		34,644			(390	)		2,056			31,160
Other income (expenses):
Interest and dividend income		75			75			—			—			150
Interest expense		(15,794	)		(280	)		—			—			(16,074	)
Changes in fair value of derivatives embedded within convertible debt		(303	)		—			—			—			(303	)
Impairment charges on investments		—			—			(8,500	)		—			(8,500	)
Equity loss on non-consolidated real estate businesses		—			—			(995	)		—			(995	)
Equity income in consolidated subsidiaries		15,499			—			—			(15,499	)		—
Management fee income		2,056			—			—			(2,056	)		—

Other, net		—			—			—			—			—
Income before provision for income taxes		(3,617	)		34,439			(9,885	)		(15,499	)		5,438
Income tax benefit (expense)		6,717			(13,119	)		4,064			—			(2,338	)

Net income (loss)	$	3,100		$	21,320		$	(5,821	)	$	(15,499	)	$	3,100

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS


	Three Months Ended March 31, 2010
							Subsidiary						Consolidated
	Parent/			Subsidiary			Non-			Consolidating			Vector Group
	Issuer			Guarantors			Guarantors			Adjustments			Ltd.
Net cash provided by (used in) operating activities	$	18,368		$	48,836		$	1,074		$	(55,115	)	$	13,163


Cash flows from investing activities:
Sale or maturity of investment securities		6,933			—			—			—			6,933
Investment in non- consolidated real estate businesses		—			—			(605	)		—			(605	)
Distributions from non-consolidated real estate businesses		—			—			2,154			—			2,154
Increase in cash surrender value of life insurance policies		(425	)		(111	)		—			—			(536	)
(Increase) decrease in non-current restricted assets		19			(350	)		—			—			(331	)
Proceeds from sale of fixed assets		—			3			—			—			3
Investments in subsidiaries		(1,731	)		—			—			1,731			—
Capital expenditures		(29	)		(3,445	)		(321	)		—			(3,795	)


Net cash (used in) provided by investing activities		4,767			(3,903	)		1,228			1,731			3,823


Cash flows from financing activities:
Proceeds from debt issuance		—			2,112			—			—			2,112
Repayments of debt		—			(1,140	)		(28	)		—			(1,168	)
Borrowings under revolver		—			216,456			—			—			216,456
Repayments on revolver		—			(210,997	)		—			—			(210,997	)
Capital contributions received		—			1,450			281			(1,731	)		—
Intercompany dividends paid		—			(52,900	)		(2,215	)		55,115			—
Dividends and distributions on common stock		(30,024	)		—			—			—			(30,024	)
Proceeds from exercise of Vector options and warrants		138			—			—			—			138

Net cash provided by (used in) financing activities		(29,886	)		(45,019	)		(1,962	)		53,384			(23,483	)

Net decrease in cash and cash equivalents		(6,751	)		(86	)		340			—			(6,497	)
Cash and cash equivalents, beginning of period		204,133			5,004			317			—			209,454

Cash and cash equivalents, end of period	$	197,382		$	4,918		$	657		$	—		$	202,957

VECTOR GROUP LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in Thousands, Except Per Share Amounts)
Unaudited

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS


	Three Months Ended March 31, 2009
							Subsidiary						Consolidated
	Parent/			Subsidiary			Non-			Consolidating			Vector Group
	Issuer			Guarantors			Guarantors			Adjustments			Ltd.
Net cash provided by (used in) operating activities	$	23,102		$	7,037		$	333		$	(9,384	)	$	21,088


Cash flows from investing activities:
Proceeds from sale or liquidation of long-term investments		908			—			—			—			908
Distributions from non-consolidated real estate businesses		—			—			1,182			—			1,182
Increase in cash surrender value of life insurance policies		(244	)		(112	)		—			—			(356	)
(Increase) decrease in non-current restricted assets		(116	)		568			—			—			452
Investments in subsidiaries		(1,350	)					—			- 1,35			0 -
Capital expenditures		—			(803	)		—			—			(803	)


Net cash (used in) provided by investing activities		(802	)		(347	)		1,182			1,350			1,383


Cash flows from financing activities:
Proceeds from debt issuance		—			10			—			—			10
Repayments of debt		—			(1,604	)		—			—			(1,604	)
Borrowings under revolver		—			123,724			—			—			123,724
Repayments on revolver		—			(123,291	)		—			—			(123,291	)
Capital contributions received		—			1,350			—			(1,350	)		—
Intercompany dividends paid		—			(7,875	)		(1,509	)		9,384			—
Dividends and distributions on common stock		(30,076	)		—			—			—			(30,076	)
Proceeds from exercise of Vector options and warrants		10			—			—			—			10

Net cash provided by (used in) financing activities		(30,066	)		(7,686	)		(1,509	)		8,034			(31,227	)

Net decrease in cash and cash equivalents		(7,766	)		(996	)		6			—			(8,756	)
Cash and cash equivalents, beginning of period		200,066			11,039			—			—			211,105

Cash and cash equivalents, end of period	$	192,300		$	10,043		$	6		$	—		$	202,349


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

(Dollars in Thousands, Except Per Share Amounts)

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,

	•		research relating to reduced risk cigarette products through our Vector Tobacco Inc. 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 50% of Douglas Elliman Realty, LLC, which operates the largest residential brokerage company in the New York metropolitan area.

All of Liggett’s unit sales volume in 2009 and for the first three months of 2010 was in the discount segment, which Liggett’s management believes has been the primary growth segment in the industry for over a decade. The significant discounting of premium cigarettes in recent years has led to brands, such as EVE, that were traditionally considered premium brands to become more appropriately categorized as discount, following list price reductions.

Liggett’s cigarettes are produced in approximately 160 combinations of length, style and packaging. Liggett’s current brand portfolio includes:

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

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

	•		EVE — a leading brand of 120 millimeter cigarettes in the branded discount category,

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

	•		USA and various Partner Brands and private label brands.

In 1999, Liggett introduced LIGGETT SELECT, one of the leading brands in the deep discount category. LIGGETT SELECT’s unit volume was 15.5% of Liggett’s unit volume for the three months ended March 31, 2010 and 21.5% for the year ended December 31, 2009. In September 2005, Liggett repositioned GRAND PRIX to distributors and retailers nationwide. GRAND PRIX’s unit volume was 22.4% of Liggett’s unit volume for the three months ended March 31, 2010 and 27.9% for the year ended December 31, 2009. In April 2009, Liggett repositioned PYRAMID as a box-only brand in specific markets with a new low price to specifically compete with brands which are priced at the lowest level of the deep discount segment. PYRAMID is now the largest seller in Liggett’s family of brands with 30.2% of Liggett’s unit volume for the three months ended March 31, 2010 and 14.6% for the year ended December 31, 2009.

Under the Master Settlement Agreement reached in November 1998 with 46 states and various territories, the three largest cigarette manufacturers must make settlement payments to the states and territories based on how many cigarettes they sell annually. Liggett, however, is not required to make any payments unless its market share exceeds approximately 1.65% of the

- 35 -

U.S. cigarette market. Additionally, Vector Tobacco has no payment obligation unless its market share exceeds approximately 0.28% of the U.S. market. Liggett’s and Vector Tobacco’s payments under the Master Settlement Agreement are based on each company’s incremental market share above the minimum threshold applicable to such company. We believe that Liggett has gained a sustainable cost advantage over its competitors as a result of the settlement.

The discount segment is a challenging marketplace, with consumers having less brand loyalty and placing greater emphasis on price. Liggett’s competition is now divided into two segments. The first segment is made up of the three largest manufacturers of cigarettes in the United States, Philip Morris USA Inc., Reynolds America Inc., and Lorillard Tobacco Company as well as the fourth largest, Commonwealth Brands, Inc. (acquired by Imperial Tobacco PLC in 2007). The three largest manufacturers, while primarily premium cigarette based companies, also produce and sell discount cigarettes. The second segment of competition is comprised of a group of smaller manufacturers and importers, most of which sell lower quality, deep discount cigarettes.

Recent Developments

Senior Secured Notes. In September 2009, we sold an additional $85,000 principal amount of our 11% Senior Secured Notes due 2015 (the “Senior Secured Notes”) at 94% of face value in a private offering to qualified institutional investors in accordance with Rule 144A of the Securities Act of 1933. In April 2010, we sold an additional $75,000 principal amount of the Senior Secured Notes at 101% of face value in a private offering to qualified institutional investors in accordance with Rule 144A of the Securities Act of 1933. On May 6, 2010, we commenced an offer to exchange the Secured Notes issued in September 2009 and April 2010 for an equal amount of newly issued 11% Senior Secured Notes due 2015. The new Secured Notes have substantially the same terms as the original notes, except that the new Secured Notes have been registered under the Securities Act.

Enacted and proposed excise tax increases. Effective April 1, 2009, the federal cigarette excise tax was increased from $3.90 per carton ($0.39 per pack) to $10.07 per carton ($1.01 per pack). Wholesale shipment volume in the first quarter of 2009 for Liggett and for the total industry was negatively impacted by tax-driven trade purchasing patterns in anticipation of the increase in the federal excise taxes on cigarettes. In 2009, 14 states and the District of Columbia enacted increases to state excise taxes and further increases in states’ excise taxes are expected. As of the financial statement issuance date, three states had enacted increases to state excise taxes in 2010 and further increases in states’ excise taxes are expected.

New Valley Oaktree Chelsea Eleven, LLC. Chelsea sold three units during the quarter ended March 31, 2010. As of the financial statement issue date, sales of 15 of 54 units in the Chelsea Eleven LLC real estate development project have closed. As of March 31, 2010, Chelsea had approximately $198,802 of total assets and $117,952 of total liabilities, excluding amounts owed to New Valley Chelsea (approximately $67,438 at March 31, 2010). The outstanding balance on Chelsea’s construction loan was approximately $40,300 at March 31, 2010. The outstanding balance of the mezzanine loan, plus accrued interest, was approximately $54,600 at March 31, 2010.

Aberdeen Townhomes LLC. In January 2010, Aberdeen sold one of its four townhomes and the mortgage of approximately $4,550 was retired. In addition, $375 from the sale is being held in escrow until July 2010. We received a preferred return distribution of approximately $971 in connection with the sale and did not record a gain or loss associate with the sale.

Recent Developments in Tobacco-Related Litigation

The cigarette industry continues to be challenged on numerous fronts. New cases continue to be commenced against Liggett and other cigarette manufacturers. As of March 31, 2010, there were approximately 7,200 individual suits (excluding approximately 100 individual cases pending

- 36 -

in West Virginia state court as part of a consolidated action; Liggett has been severed from the trial of the consolidated action), seven purported class actions and four healthcare cost recovery actions pending in the United States in which Liggett or us, or both, were named as a defendant.

Liggett Only Cases. There are currently five cases pending where Liggett is the only tobacco company defendant. Cases where Liggett is the only defendant could increase substantially as a result of the Engle progeny cases. In February 2009, in Ferlanti v. Liggett Group, a Florida state court jury awarded compensatory damages of $1,200 against Liggett, but found that the plaintiff was 40% at fault. Therefore, plaintiff was awarded $720 in compensatory damages plus $96 in expenses. Punitive damages were not awarded. Liggett appealed the award. In May 2009, the court granted plaintiff’s motion for an award of attorneys’ fees but the amount has not yet been determined. In Hausrath v. Philip Morris, a case pending in New York state court, plaintiffs recently dismissed all defendants other than Liggett. The other three individual actions, in which Liggett is the only tobacco company defendant, are dormant.

Engle Progeny Cases. In 2000, a jury in Engle v. R.J. Reynolds Tobacco Co. rendered a $145,000,000 punitive damages verdict in favor of a “Florida Class” against certain cigarette manufacturers, including Liggett. Pursuant to the Florida Supreme Court’s July 2006 ruling in Engle, which decertified the class on a prospective basis, and affirmed the appellate court’s reversal of the punitive damages award, former class members had one year from January 11, 2007 in which to file individual lawsuits. In addition, some individuals who filed suit prior to January 11, 2007, and who claim they meet the conditions in Engle, are attempting to avail themselves of the Engle ruling. Lawsuits by individuals requesting the benefit of the Engle ruling, whether filed before or after the January 11, 2007 deadline, are referred to as the “Engle progeny cases.” Liggett and/or the Company have been named in approximately 7,160 Engle progeny cases in both state and federal courts in Florida. Other cigarette manufacturers have also been named as defendants in these cases. These cases include approximately 8,500 plaintiffs, approximately 3,860 of whom have claims pending in federal court and 5,295 in state court. Duplicate cases were filed in federal and state court on behalf of approximately 660 plaintiffs. The federal court cases are stayed pending the outcome of an appeal to the United States Court of Appeals for the Eleventh Circuit of several district court orders in which it was found that the Florida Supreme Court’s decision in Engle was unconstitutional. The number of progeny cases will likely increase as the courts may require multi-plaintiff cases to be severed into individual cases. The total number of plaintiffs may also increase as a result of attempts by existing plaintiffs to add additional parties. As of April 30, 2010, 38 alleged Engle progeny cases, where Liggett is currently named as a defendant, were scheduled for trial in 2010 and 2011. As of April 30, 2010, four adverse verdicts in Engle progeny cases have been entered against Liggett. In June 2002, the jury in Lukacs v. R. J. Reynolds Tobacco Company, an individual case brought under the third phase of the Engle case, awarded $37,500, (subsequently reduced by the court to $24,835) of compensatory damages, plus interest, jointly and severally, against Liggett and two other cigarette manufacturers and found Liggett 50% responsible for the damages. In November 2008, the court entered final judgment. On March 17, 2010, the Third District Court of Appeal affirmed the decision, per curiam, which will likely not be reviewed by the Florida Supreme Court. The defendants have filed a petition for rehearing with the court of appeal. The plaintiffs are seeking an award of attorneys’ fees from Liggett. It is possible that additional cases could be decided unfavorably and that there could be further adverse developments in the Engle case. Liggett may enter into discussions in an attempt to settle particular cases if it believes it is appropriate to do so. We cannot predict the cash requirements related to any future settlements and judgments, including cash required to bond any appeals, and there is a risk that those requirements will not be able to be met.

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

- 37 -

Annual Report on Form 10-K, for the year ended December 31, 2009. Please refer to that section and the information below for disclosures regarding the critical accounting policies related to our business.

Results of Operations

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

As a result of the suspension of the marketing of low nicotine and nicotine-free cigarette products by Vector Tobacco and the significant reductions in Vector Tobacco’s related research activities, we have reevaluated our operating segments and combined the Liggett and Vector Tobacco businesses into a single Tobacco segment. For purposes of this discussion and other consolidated financial reporting, our significant business segments for the three months ended March 31, 2010 and 2009 were Tobacco and Real Estate. The Tobacco segment consists of the manufacture and sale of cigarettes and the research related to reduced risk products. The Real Estate segment includes our investment in Escena and investments in non-consolidated real estate businesses. Prior period information has been recast to conform to the current presentation.


	Three Months Ended
	March 31,			March 31,
	2010			2009
Revenues:

Tobacco	$	222,087		$	121,216


Operating income (loss):
Tobacco	$	34,932		$	35,625	⁽¹⁾
Real estate		282			—
Corporate and other		(4,196	)		(4,465	)

Total operating income	$	31,018		$	31,160


(1)		Includes a gain of $5,000 on the Philip Morris brand transaction completed in February 2009 and restructuring expenses of $1,000.

Three Months Ended March 31, 2010 Compared to Three Months ended March 31, 2009

Revenues. All of our revenues were from the Tobacco segment for the first quarter of 2010 and 2009. We increased the list price of LIGGETT SELECT and EVE by $0.90 per carton in February 2009 and an additional $7.10 per carton in March 2009. Liggett increased the list price of GRAND PRIX by $7.20 per carton in March 2009. We increased the list price of LIGGETT SELECT, EVE, and GRAND PRIX by $0.60 per carton in January 2010 and an additional $0.65 per carton in May 2010.

All of our sales for the first quarter of 2010 and 2009 were in the discount category. For the three months ended March 31, 2010, revenues were $222,087 compared to $121,216 for the three months ended March 31, 2009. Revenues increased by 83.2% ($100,871) due to a favorable price variance of $57,478 primarily related to increases in price of LIGGETT SELECT and GRAND PRIX (primarily associated with the increase in federal excise taxes on cigarettes), a favorable sales mix

- 38 -

of $10,040, and a favorable sales volume of $33,721 (approximately 482.0 million units). Wholesale shipment volume for the three months ended March 31, 2010 returned to its normal pattern in comparison to the same period in 2009. Wholesale shipment volume for the three months ended March 31, 2009 for Liggett and for the total industry was negatively impacted by tax-driven trade purchasing patterns in anticipation of the increase ($6.17 per carton) in the federal excise tax on cigarettes from $3.90 to $10.07 per carton on April 1, 2009. This legislation included provisions that imposed this increase in excise taxes on inventory held as of March 31, 2009. As a result, many wholesalers and retailers significantly reduced their inventory levels as of March 31, 2009 to minimize any such taxes owed on such inventory.

Tobacco Gross Profit. Tobacco gross profit was $52,176 for the three months ended March 31, 2010 compared to $48,689 for the three months ended March 31, 2009. This represented an increase of $3,487 (7.2%) when compared to the same period in 2009. This increase was due primarily to higher volumes. As a percent of revenues (excluding federal excise taxes), however, Tobacco gross profit at decreased to 47.1% for the three months ended March 31, 2010 compared to gross profit of 55.6% for the three months ended March 31, 2009 due to sales mix.

Expenses. Operating, selling, general and administrative expenses were $21,158 for the three months ended March 31, 2010 compared to $21,530 for the same period last year, a decrease of $372 (1.7%). Tobacco expenses were $17,244 for the three months ended March 31, 2010 compared to $17,065 for the same period in the prior year, an increase of $179, which was primarily the result of increased legal and product liability expenses of $261 in 2010. Tobacco product liability legal expenses and other litigation costs were $1,648 and $1,387 for the three months ended March 31, 2010 and 2009, respectively. Expenses at the corporate level decreased from $4,465 to $4,196.

Operating Income. For the three months ended March 31, 2010, Tobacco segment operating income decreased from $35,625 in 2009 to $34,932 in 2010 primarily due to the absence of a gain of $5,000 from the Philip Morris brands transaction offset by $1,000 of restructuring expenses in 2009 and increased margins based on higher volume in 2010. The real estate segment operating income of $282 in the 2010 period related primarily to Escena’s operations.

Other expenses. Other expenses were $12,158 for the three months ended March 31, 2010 compared to $25,722 for the same period last year, a decrease of $13,564. For the three months ended March 31, 2010, other expenses primarily consisted of interest expense of $18,805 and charges of $2,714 for changes in fair value of derivatives embedded within convertible debt. These expenses were offset by a realized gain on investments held for sale of $4,664 and equity income on non-consolidated real estate businesses of $4,571. For the three months ended March 31, 2009, other expenses primarily consisted of interest expense of $16,074, a loss of $8,500 associated with a decline in value in the Escena mortgage receivable ($5,000) and the Aberdeen real estate investment ($3,500), equity losses of $995 on non-consolidated real estate businesses, and charges of $303 for changes in fair value of derivatives embedded within convertible debt.

The value of the embedded derivatives is contingent on changes in interest rates of debt instruments maturing over the duration of the convertible debt, our stock price as well as projections of future cash and stock dividends over the term of the debt. The loss of $2,714 and $303 from the embedded derivatives in the three month months ended March 31, 2010 and 2009, respectively, was primarily the result of declining spreads between corporate convertible debt and risk free investments offset by interest payments during the period.

- 39 -

Income before income taxes. Income before income taxes for the three months ended March 31, 2010 was $18,860 compared to income before income taxes of $5,438 for the three months ended March 31, 2009.

Income tax provision. The income tax provision was $6,922 and $2,338 for the three months ended March 31, 2010 and 2009, respectively. Our provision for income taxes in interim periods is based on an estimated annual effective income tax rate derived, in part, from estimated annual pre-tax results from ordinary operations in accordance with guidance on accounting for income taxes on interim periods. We recorded a benefit of approximately $500 for the three months ended March 31, 2010 resulting from the reduction of a previously established valuation allowance of a deferred tax asset. The net deferred tax asset has been recognized for state tax net operating losses at Vector Tobacco Inc. after evaluating the impact of the negative and positive evidence that such asset would be realized.

Liquidity and Capital Resources

Net cash and cash equivalents decreased $6,497 and $8,756 for the three months ended March 31, 2010 and 2009, respectively.

Net cash provided from operations was $13,163 and $21,088 for the three months ended March 31, 2010 and 2009, respectively. The difference between the two periods related primarily to the absence of the $5,000 payment received on the Philip Morris brands transaction in 2010 compared to 2009, increased income tax payments in 2010 and increased inventory balances in the 2010 period at Liggett due to higher federal excise tax rates.

Cash provided by investing activities was $3,823 for the three months ended March 31, 2010 compared to $1,383 for the same period in 2009. In the first three months of 2010, cash provided by investing activities was from the proceeds from the sale or maturity of investment securities of $6,933, distributions from non-consolidated real estate businesses of $2,154 offset by an increase in non-current restricted assets of $331, cash used for a purchase of real estate businesses of $605, cash used for capital expenditures of $3,795 and an increase in cash surrender value of corporate- owned life insurance policies of $536. In the first three months of 2009, cash provided by investing activities was from the proceeds from the liquidation of long-term investments of $908, distributions from non-consolidated real estate businesses of $1,182, and the decrease in non-current restricted assets of $452 offset by cash used for capital expenditures of $803 and an increase in cash surrender value of corporate- owned life insurance policies of $356.

Cash used in financing activities was $23,483 and $31,227 for the three months ended March 31, 2010 and 2009, respectively. In the first three months of 2010, cash was primarily used for distributions on common stock of $30,024, and repayments of debt of $1,168 offset by proceeds from debt issuance of $2,112, net borrowings of debt under the revolver of $5,459 and proceeds from exercise of options of $138. In the first three months of 2009, cash was primarily used for distributions on common stock of $30,076, and repayments of debt of $1,604 offset by net borrowings of debt under the revolver of $433.

Liggett. Liggett has a $50,000 credit facility with Wachovia Bank, N.A. under which $22,841 was outstanding at March 31, 2010. Availability as determined under the facility was approximately $13,200 based on eligible collateral at March 31, 2010. The facility contains covenants that provide that Liggett’s earnings before interest, taxes, depreciation and amortization, as defined under the facility, on a trailing twelve-month basis, shall not be less than

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$100,000 if Liggett’s excess availability, as defined, under the facility is less than $20,000. The covenants also require that annual capital expenditures, as defined under the facility, (before a maximum carryover amount of $2,500) shall not exceed $10,000 during any fiscal year. At March 31, 2010, management believed that Liggett was in compliance with all covenants under the credit facility; Liggett’s EBITDA, as defined, were approximately $149,000 for the twelve months ended March 31, 2010.

In June 2002, the jury in an individual case brought under the third phase of the Engle case awarded $24,835 of compensatory damages against Liggett and two other defendants and found Liggett 50% responsible for the damages. As of March 31, 2010, interest on the award was more than $15,000. To date, four other adverse verdicts have been entered in Engle progeny cases against Liggett in the total amount of approximately $5,872. It is possible that additional cases could be decided unfavorably. There are approximately 7,160 Engle progeny cases, in state and federal courts in Florida, where Liggett (and other cigarette manufacturers) and us, were named as defendants. Approximately 38 cases are currently scheduled for trial in 2010 and 2011. Liggett may enter into discussions in an attempt to settle particular cases if it believes it is appropriate to do so. Management cannot predict the cash requirements related to any future 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 of a pending smoking and health case could encourage the commencement of additional similar litigation. In recent years, there have been a number of adverse regulatory, political and other developments concerning cigarette smoking and the tobacco industry. These developments generally receive widespread media attention. Neither we nor Liggett are able to evaluate the effect of these developing matters on pending litigation or the possible commencement of additional litigation or regulation. See Note 5 to our consolidated financial statements and “Legislation and Regulation” below for a description of legislation, regulation and litigation.

Management is unable to make a reasonable estimate of the amount or range of loss that could result from an unfavorable outcome of the cases pending against Liggett or the costs of defending such cases. It is possible that our consolidated financial position, results of operations or cash flows could be materially adversely affected by an unfavorable outcome in any such tobacco-related litigation.

In April 2010, we sold an additional $75,000 principal amount of the Senior Secured Notes at 101% of face value in a private offering to qualified institutional investors in accordance with Rule 144A of the Securities Act of 1933. We received net proceeds from the 2010 offering of $73,500. Following the offering, a total of $325,000 of principal amount of Senior Secured Notes were outstanding.

The Senior Secured Notes are fully and unconditionally guaranteed on a joint and several basis by all of our wholly-owned domestic subsidiaries that are engaged in the conduct of our cigarette businesses. In addition, some of the guarantees are collateralized by second priority or first priority security interests in certain collateral of some of the subsidiary guarantors pursuant to security and pledge agreements.

The indenture contains covenants that restrict the payment of dividends by us if our consolidated earnings before interest, taxes, depreciation and amortization, which is defined in the indenture as Consolidated EBITDA, for the most recently ended four full quarters is less than $50,000. 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 and our guaranteeing subsidiaries’ total debt less the fair market value of our cash, investments in 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

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indebtedness is substituted for indebtedness. The following table summarizes the requirements of these financial covenants and the results of the calculation, as defined by the indenture.

Indenture

March 31,

December 31,

Covenant

Requirement

2010

2009

Consolidated EBITDA, as defined

50,000

177,594

174,158

Leverage ratio, as defined

<3.0 to 1

0.2 to 1

0.3 to 1

Secured leverage ratio, as defined

<1.5 to 1

Negative

We and our subsidiaries have significant indebtedness and debt service obligations. At March 31, 2010, we and our subsidiaries had total outstanding indebtedness (including the embedded derivative liabilities related to our convertible notes) of approximately $518,000. We must redeem $11,000 of our 3.875% Variable Interest Senior Convertible Debentures by June 15, 2011, and we may be required to purchase $99,000 of the debentures on June 15, 2012. Approximately $157,500 of our 6.75% convertible debt matures in 2014 and $250,000 of our 11% senior secured notes matures in 2015. 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 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 $203,000, investment securities available for sale of approximately $62,000, long-term investments with an estimated value of approximately $71,000 and availability under Liggett’s credit facility of approximately $13,200 at March 31, 2010. 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 March 31, 2010, approximately $36,600 of our outstanding debt at face value had variable interest rates determined by various interest rate indices, which increases the risk of

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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 March 31, 2010, 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 $367.

In addition, as of March 31, 2010, approximately $75,882 ($267,530 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 $6,650 with approximately $500 resulting from the embedded derivative associated with our 6.75% Note due 2014, $900 resulting from the embedded derivative associated with our 6.75% exchange notes due 2014, and the remaining $5,250 resulting from the embedded derivative associated with our 3.875% variable interest senior convertible debentures due 2026. An increase in our quarterly dividend rate by $0.10 per share would increase interest expense by approximately $6,600 per year.

We have 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 yield of our 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 our future dividend payments 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 items, including current and future dividends and the volatility of Vector’s stock price. The range of estimated fair market values of our embedded derivatives was between $159,252 and $152,346. We recorded the fair market value of our embedded derivatives at the midpoint of the inputs at $155,729 as of March 31, 2010. The estimated fair market value of our embedded derivatives could change significantly based on future market conditions.

We held investment securities available for sale totaling $61,615 at March 31, 2010, which includes 13,891,205 shares of Ladenburg Thalmann Financial Services Inc. carried at $13,058.

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

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Reports with respect to the alleged harmful physical effects of cigarette smoking have been publicized for many years and, in the opinion of Liggett’s management, have had and may continue to have an adverse effect on cigarette sales. Since 1964, the Surgeon General of the United States and the Secretary of Health and Human Services have released a number of reports which state that cigarette smoking is a causative factor with respect to a variety of health hazards, including cancer, heart disease and lung disease, and have recommended various government actions to reduce the incidence of smoking. In 1997, Liggett publicly acknowledged that, as the Surgeon General and respected medical researchers have found, smoking causes health problems, including lung cancer, heart and vascular disease, and emphysema.

On June 22, 2009, the President signed into law the “Family Smoking Prevention and Tobacco Control Act” (Public Law 111-31). The law grants the Food and Drug Administration (“FDA”) broad authority over the manufacture, sale, marketing and packaging of tobacco products, although the FDA is prohibited from issuing regulations banning all cigarettes or all smokeless tobacco products, or requiring the reduction of nicotine yields of a tobacco product to zero. Among other measures, the law (under various deadlines):

	•		increases the number of health warnings required on cigarette and smokeless tobacco products, increases the size of warnings on packaging and in advertising, requires the FDA to develop graphic warnings for cigarette packages, and grants the FDA authority to require new warnings;

	•		requires practically all tobacco product advertising to eliminate color and imagery and instead consist solely of black text on white background;

	•		imposes new restrictions on the sale and distribution of tobacco products, including significant new restrictions on tobacco product advertising and promotion, as well as the use of brand and trade names;

	•		bans the use of “light,” “mild,” “low” or similar descriptors on tobacco products;

	•		bans the use of “characterizing flavors” in cigarettes other than tobacco or menthol;

	•		gives the FDA the authority to impose tobacco product standards that are appropriate for the protection of the public health (by, for example, requiring reduction or elimination of the use of particular constituents or components, requiring product testing, or addressing other aspects of tobacco product construction, constituents, properties or labeling);

	•		requires manufacturers to obtain FDA review and authorization for the marketing of certain new or modified tobacco products;

	•		requires pre-market approval by the FDA for tobacco products represented (through labels, labeling, advertising, or other means) as presenting a lower risk of harm or tobacco-related disease;

	•		requires manufacturers to report ingredients and harmful constituents and requires the FDA to disclose certain constituent information to the public;

	•		mandates that manufacturers test and report on ingredients and constituents identified by the FDA as requiring such testing to protect the public health, and allows the FDA to require the disclosure of testing results to the public;

	•		requires manufacturers to submit to the FDA certain information regarding the health, toxicological, behavioral or physiologic effects of tobacco products;

	•		prohibits use of tobacco containing a pesticide chemical residue at a level greater than allowed under federal law;

	•		requires the FDA to establish “good manufacturing practices” to be followed at tobacco manufacturing facilities;

	•		requires tobacco product manufacturers (and certain other entities) to register with the FDA;

	•		authorizes the FDA to require the reduction of nicotine (although it may not require the reduction of nicotine yields of a tobacco product to zero) and the potential reduction or elimination of other constituents, including menthol;

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	•		imposes (and allows the FDA to impose) various recordkeeping and reporting requirements on tobacco product manufacturers; and

	•		grants the FDA the regulatory authority to impose broad additional restrictions.

The law also requires establishment, within the FDA’s new Center for Tobacco Products, of a Tobacco Products Scientific Advisory Committee to provide advice, information and recommendations with respect to the safety, dependence or health issues related to tobacco products, including:

	•		a recommendation on modified risk applications;

	•		a recommendation on the effects of tobacco product nicotine yield alteration and whether there is a threshold level below which nicotine yields do not produce dependence;

	•		a report on the public health impact of the use of menthol in cigarettes; and

	•		a report on the public health impact of dissolvable tobacco products.

The law imposes user fees on certain tobacco product manufacturers in order to fund tobacco-related FDA activities. User fees will be allocated among tobacco product classes according to a formula set out in the legislation, and then among manufacturers and importers within each class based on market share. The FDA user fees for Liggett and Vector Tobacco for 2009 were $2,300 and we estimate that they will be significantly higher in the future.

The law also imposes significant new restrictions on the advertising and promotion of tobacco products. For example, the law requires the FDA to finalize certain portions of regulations previously adopted by the FDA in 1996 (which were struck down by the Supreme Court in 2000 as beyond the FDA’s authority). As written, these regulations would significantly limit the ability of manufacturers, distributors and retailers to advertise and promote tobacco products, by, for example, restricting the use of color and graphics in advertising, limiting the use of outdoor advertising, restricting the sale and distribution of non-tobacco items and services, gifts, and sponsorship of events, and imposing restrictions on the use for cigarette or smokeless tobacco products of trade or brand names that are used for nontobacco products.

In August 2009, several cigarette manufacturers filed a federal lawsuit against FDA challenging the constitutionality of a number of the restrictions imposed by these regulations, including the ban on color and graphics, limits on the right to make truthful statements regarding modified risk tobacco products, restrictions on the placement of outdoor advertising, and a ban on the distribution of product samples. On January 4, 2010, a federal judge ruled that the regulations’ ban on the use of color and graphics in certain tobacco product advertising was unconstitutional and prohibited FDA from enforcing that ban. The judge, however, let stand numerous other advertising and promotion restrictions. While we would expect this decision to be appealed, we cannot predict the future course or outcome of this lawsuit.

Separately, the law also requires the FDA to issue future regulations regarding the promotion and marketing of tobacco products sold through non-face-to-face transactions.

It is likely that the new tobacco law could result in a decrease in cigarette sales in the United States, including sales of Liggett’s and Vector Tobacco’s brands. Total compliance and related costs are not possible to predict and depend substantially on the future requirements imposed by the FDA under the new tobacco law. Costs, however, could be substantial and could have a material adverse effect on the companies’ financial condition, results of operations, and cash flows. In addition, failure to comply with the new tobacco law and with FDA regulatory requirements could result in significant financial penalties and could have a material adverse effect on the business, financial condition and results of operation of both Liggett and Vector Tobacco. At present, we are not able to predict whether the new tobacco law will impact Liggett and Vector Tobacco to a greater degree than other companies in the industry, thus affecting its competitive position.

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Liggett and Vector Tobacco provide ingredient information annually, as required by law, to the states of Massachusetts, Texas and Minnesota. Several other states are considering ingredient disclosure legislation.

In October 2004, the Fair and Equitable Tobacco Reform Act of 2004 (“FETRA”) was signed into law. FETRA provides for the elimination of the federal tobacco quota and price support program through an industry funded buyout of tobacco growers and quota holders. Pursuant to the legislation, manufacturers of tobacco products have been assessed $10,140,000 over a ten year period, commencing in 2005, to compensate tobacco growers and quota holders for the elimination of their quota rights. Cigarette manufacturers are currently responsible for 95% of the assessment (subject to adjustment in the future), which is allocated based on relative unit volume of domestic cigarette shipments. Liggett’s and Vector Tobacco’s assessment was approximately $22,900 for 2009. Management anticipates that the assessment will be higher for 2010. The relative cost of the legislation to the three largest cigarette manufacturers will likely be less than the cost to smaller manufacturers, including Liggett and Vector Tobacco, because one effect of the legislation is that the three largest manufacturers are no longer obligated to make certain contractual payments, commonly known as Phase II payments, that they agreed in 1999 to make to tobacco-producing states. The ultimate impact of this legislation cannot be determined, but there is a risk that smaller manufacturers, such as Liggett and Vector Tobacco, will be disproportionately affected by the legislation, which could have a material adverse effect on us.

Cigarettes are subject to substantial and increasing federal, state and local excise taxes. Effective April 1, 2009, the federal cigarette excise tax increased from $0.39 to $1.01 per pack. State excise taxes vary considerably and, when combined with sales taxes, local taxes and the federal excise tax, may exceed $4.00 per pack. In 2009, 14 states and the District of Columbia enacted increases in excise taxes and several other states are considering, or have pending, legislation proposing further state excise tax increases. Management believes increases in excise and similar taxes have had, and will continue to have, an adverse effect on sales of cigarettes.

Over the last several years a majority of states have enacted virtually identical legislation requiring cigarettes to meet a laboratory test standard for reduced ignition propensity. Cigarettes that meet this standard are referred to as “fire standards compliant” or “FSC,” and are sometimes commonly called “self-extinguishing.” Effective January 1, 2009, substantially all of the cigarettes that Liggett and Vector Tobacco manufacture are fire standards compliant. Compliance with such legislation could be burdensome and costly and could harm the business of Liggett and Vector Tobacco, particularly if there were to be varying standards from state to state.

In November 2008, the Federal Trade Commission (“FTC”) rescinded guidance it issued in 1966 that generally permitted statements concerning cigarette “tar” and nicotine yields if they were based on the Cambridge Filter Method, sometimes called the FTC method. In its rescission notice, the FTC also indicated that advertisers should no longer use terms suggesting the FTC’s endorsement or approval of any specific test method, including terms such as “per FTC Method” or other phrases that state or imply FTC endorsement or approval of the Cambridge Filter Method or other machine-based methods for measuring cigarette “tar” or nicotine yields. Also in its rescission notice, the FTC indicated that cigarette descriptors such as “light” and “ultra light” have not been defined by the FTC, nor has the FTC provided any guidance or authorization for their use. The FTC indicated that to the extent descriptors are used in a manner that convey an overall impression that is false, misleading, or unsubstantiated, such use could be actionable. The FTC further indicated that companies must ensure that any continued use of descriptors does not convey an erroneous or unsubstantiated message that a particular cigarette presents a reduced risk of harm or is otherwise likely to mislead consumers. In response to the FTC’s action, we have removed all reference to “tar” and nicotine testing from our point-of-sale advertising. In addition, the new tobacco law imposes a ban — scheduled to take effect in June 2010 — on the use of “light”, “mild”, “low” or similar descriptors on tobacco product labels and in

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labeling or advertising. To the extent descriptors are no longer used to market or promote our cigarettes, this may have a material adverse effect on us.

A wide variety of federal, state and local laws limit the advertising, sale and use of cigarettes, and these laws have proliferated in recent years. For example, many local laws prohibit smoking in restaurants and other public places, and many employers have initiated programs restricting or eliminating smoking in the workplace. There are various other legislative efforts pending at the federal, state or local level which seek to, among other things, eliminate smoking in public places, curtail affirmative defenses of tobacco companies in product liability litigation, and further restrict the sale, marketing and advertising of cigarettes and other tobacco products. This trend has had, and is likely to continue to have, an adverse effect on us. It is not possible to predict what, if any, additional legislation, regulation or other governmental action will be enacted or implemented, or to predict what the impact of the new FDA tobacco law will be on these pending legislative efforts.

In addition to the foregoing, there have been a number of other 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 similar litigation or legislation.

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,

	•		new legislation,

	•		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:

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	•		general economic and market conditions and any changes therein, due to acts of war and terrorism or otherwise,

	•		impact of current crises in capital and credit markets, including any continued worsening,

	•		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 restructurings on our tobacco business and our ability to achieve any increases in profitability estimated to occur as a result of these restructurings,

	•		impact of new legislation on our competitors’ payment obligations, results of operations and product costs, i.e. the impact of recent 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 litigation and potential additional payment obligations for us under the Master Settlement Agreement and other settlement agreements with the states, and

	•		risks inherent in our new product development initiatives.

Further information on risks and uncertainties specific to our business include the risk factors discussed above in “Management’s Discussion and Analysis of Financial Condition and Results Operations” and under Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009 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.

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There were no changes in our internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings

Reference is made to Note 5, 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, VGR Holding, Liggett, Vector Tobacco, New Valley or their subsidiaries are a party and certain related matters. Reference is also made to Exhibit 99.1 for additional information regarding the pending smoking-related material 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, 100 S.E. Second St., 32nd Floor, Miami, Florida 33131, 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 for the year ended December 31, 2009. Please refer to that section for disclosures regarding the risks and uncertainties related to our business. The risk factors in the Annual Report on Form 10-K entitled “Litigation will continue to harm the tobacco industry”, “Individual tobacco-related cases have increased as a result of the Florida Supreme Court’s ruling in Engle” and “Liggett may have additional payment obligations under the Master Settlement Agreement and its other settlement agreements with the states” are revised to reflect the updated information concerning the number and status of cases and other matters discussed under Note 5 to our condensed consolidated financial statements and in “Management’s Discussion and Analysis of Financial Condition — Recent Developments — Tobacco Settlement Agreements”, “— Recent Developments in Legislation, Regulation and Tobacco-Related Litigation”, and “— Legislation and Regulation.”

Item 6. Exhibits

	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

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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: May 6, 2010

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