Edgar Filing: VECTOR GROUP LTD

VGR-2011.6.30-10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended June 30, 2011

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. x Yes o No

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



x Large accelerated filer	o Accelerated filer	o Non-accelerated filer	o Smaller reporting company
		(Do not check if a smaller reporting company)

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

At August 4, 2011, Vector Group Ltd. had 75,719,733 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 June 30, 2011 and December 31, 2010	2

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2011 and June 30, 2010	3

Condensed Consolidated Statement of Stockholders' Deficiency for the six months ended June 30, 2011	4

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and June 30, 2010	5

Notes to Condensed Consolidated Financial Statements	6

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	36

Item 3. Quantitative and Qualitative Disclosures About Market Risk	49

Item 4. Controls and Procedures	49

PART II. OTHER INFORMATION

Item 1. Legal Proceedings	50

Item 1A. Risk Factors	50

Item 6. Exhibits	50

SIGNATURE	51

VECTOR GROUP LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, Except Per Share Amounts)

Unaudited



	June 30, 2011			December 31, 2010
ASSETS:
Current assets:
Cash and cash equivalents	$	319,989		$	299,825
Investment securities available for sale	64,340			78,754
Accounts receivable - trade	20,722			1,849
Inventories	117,895			107,079
Deferred income taxes	36,734			31,786
Restricted assets	1,483			2,661
Other current assets	3,653			4,809
Total current assets	564,816			526,763
Property, plant and equipment, net	55,068			55,412
Investment in Escena, net	13,233			13,354
Long-term investments accounted for at cost	7,425			46,033
Long-term investments accounted for under the equity method	20,114			10,954
Investments in non-consolidated real estate businesses	91,703			80,416
Investments in townhomes	—			16,275
Restricted assets	7,747			8,694
Deferred income taxes	28,620			37,828
Intangible asset	107,511			107,511
Prepaid pension costs	14,710			13,935
Other assets	30,212			32,420
Total assets	$	941,159		$	949,595
LIABILITIES AND STOCKHOLDERS' DEFICIENCY:
Current liabilities:
Current portion of notes payable and long-term debt	$	26,578		$	51,345
Current portion of fair value of derivatives embedded within convertible debt	79,493			480
Current portion of employee benefits	1,014			1,014
Accounts payable	11,087			9,027
Accrued promotional expenses	15,064			14,327
Income taxes payable, net	3,306			11,617
Accrued excise and payroll taxes payable, net	23,050			18,523
Settlement accruals	77,742			48,071
Deferred income taxes	32,515			36,963
Accrued interest	20,758			20,824
Other current liabilities	16,596			14,681
Total current liabilities	307,203			226,872
Notes payable, long-term debt and other obligations, less current portion	486,989			506,052
Fair value of derivatives embedded within convertible debt	53,129			141,012
Non-current employee benefits	39,356			38,742
Deferred income taxes	55,029			51,815
Other liabilities	49,522			31,336
Total liabilities	991,228			995,829
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, 79,130,039 and 78,349,590 shares issued and 75,719,733 and 74,939,284 shares outstanding	7,572			7,494
Additional paid-in capital	—			—
Accumulated deficit	(42,530		)	(45,327		)
Accumulated other comprehensive (loss) income	(2,254		)	4,456
Less: 3,410,306 and 3,410,306 shares of common stock in treasury, at cost	(12,857		)	(12,857		)
Total stockholders' deficiency	(50,069		)	(46,234		)
Total liabilities and stockholders' deficiency	$	941,159		$	949,595

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

VECTOR GROUP LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except Per Share Amounts)

Unaudited



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010

Revenues*	$	291,180		$	268,460		$	551,558		$	490,547

Expenses:
Cost of goods sold*	231,073			210,994			436,250			380,905
Operating, selling, administrative and general expenses	22,140			22,028			45,865			43,186
Litigation judgment expense	—			14,361			—			14,361
Operating income	37,967			21,077			69,443			52,095

Other income (expenses):
Interest expense	(25,082		)	(20,770		)	(50,010		)	(39,575		)
Change in fair value of derivatives embedded within convertible debt	9,437			13,789			8,862			11,075
Loss on extinguishment of debt	(1,217		)	—			(1,217		)	—
Equity income from non-consolidated real estate businesses	6,197			7,207			11,101			11,778
Gain on sale of investment securities available for sale	1,506			6,447			14,541			11,111
Gain on liquidation of long-term investments	19,475			—			23,611			—
Gain on sales of townhomes	577			—			3,712			—
Other, net	(14		)	2,852			825			2,978

Income before provision for income taxes	48,846			30,602			80,868			49,462
Income tax expense	18,545			11,379			31,194			18,301

Net income	$	30,301		$	19,223		$	49,674		$	31,161

Per basic common share:

Net income applicable to common shares	$	0.40		$	0.25		$	0.65		$	0.41

Per diluted common share:

Net income applicable to common shares	$	0.36		$	0.19		$	0.64		$	0.39

Cash distributions and dividends declared per share	$	0.40		$	0.38		$	0.80		$	0.76

* Revenues and Cost of goods sold include excise taxes of $142,934, $135,217, $270,568 and $246,410, respectively.

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

VECTOR GROUP LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY

(Dollars in Thousands, Except Share Amounts)

Unaudited



						Additional						Accumulated Other
	Common Stock					Paid-In			Accumulated			Comprehensive			Treasury
	Shares		Amount			Capital			Deficit			(Loss) Income			Stock			Total
Balance, December 31, 2010	74,939,284		$	7,494		$	—		$	(45,327	)	$	4,456		$	(12,857	)	$	(46,234	)
Net income	—		—			—			49,674			—			—			49,674
Pension-related minimum liability adjustments, net of income taxes	—		—			—			—			816			—			816
Forward contract adjustments, net of income taxes	—		—			—			—			17			—			17
Unrealized gain on long-term investment securities, accounted for under the equity method, net of income taxes	—		—			—			—			(870		)	—			(870		)
Change in net unrealized gain on investment securities, net of income taxes	—		—			—			—			2,052			—			2,052
Net unrealized gains reclassified into net income, net of income taxes	—		—			—			—			(8,725		)	—			(8,725		)
Unrealized gain on investment securities, net of income taxes	—		—			—			—			—			—			(6,673		)
Total other comprehensive income	—		—			—			—			—			—			(6,710		)
Total comprehensive income	—		—			—			—			—			—			42,964
Distributions and dividends on common stock	—		—			(14,723		)	(46,877		)	—			—			(61,600		)
Note conversion	652,386		65			12,150			—			—			—			12,215
Exercise of employee stock options, net of 300,799 shares to pay exercise price	176,420		18			955			—			—			—			973
Surrender of shares in connection with employee stock option exercise	(48,357	)	(5		)	(763		)	—			—			—			(768		)
Tax benefit of employee stock options exercised	—		—			808			—			—			—			808
Amortization of deferred compensation	—		—			1,573			—			—			—			1,573
Balance, as of June 30, 2011	75,719,733		$	7,572		$	—		$	(42,530	)	$	(2,254	)	$	(12,857	)	$	(50,069	)

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

VECTOR GROUP LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands, Except Per Share Amounts)

Unaudited



	Six Months Ended			Six Months Ended
	June 30, 2011			June 30, 2010
Net cash provided by operating activities	$	36,587		$	55,852
Cash flows from investing activities:
Sale of investment securities	19,703			15,433
Purchase of investment securities	(1,788		)	(7,414		)
Proceeds from sale or liquidation of long-term investments	62,219			1,001
Purchase of long-term investments	(10,000		)	(5,000		)
Investments in non-consolidated real estate businesses	(6,712		)	(924		)
Distributions from non-consolidated real estate businesses	2,425			3,539
Proceeds from sale of townhomes, net	19,629			—
Increase in cash surrender value of life insurance policies	(677		)	(529		)
Decrease (increase) in restricted assets	1,775			(878		)
Issuance of notes receivable	(161		)	(535		)
Proceeds from sale of fixed assets	9			3
Capital expenditures	(4,872		)	(9,244		)
Net cash provided by (used in) investing activities	81,550			(4,548		)
Cash flows from financing activities:
Proceeds from debt issuance	77			79,585
Deferred financing costs	—			(2,582		)
Repayments of debt	(2,281		)	(2,429		)
Borrowings under revolver	486,298			472,865
Repayments on revolver	(521,995		)	(465,330		)
Dividends and distributions on common stock	(61,846		)	(57,919		)
Proceeds from exercise of employee stock options	966			507
Tax benefit of employee stock options exercised	808			75
Net cash (used in) provided by financing activities	(97,973		)	24,772
Net increase in cash and cash equivalents	20,164			76,076
Cash and cash equivalents, beginning of period	299,825			209,454
Cash and cash equivalents, end of period	$	319,989		$	285,530

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

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

Liggett and Vector Tobacco are engaged in the manufacture and sale of cigarettes in the United States. 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, 2010 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.


(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.


(c)	Earnings Per Share (“EPS”):

Information concerning the Company's common stock has been adjusted to give retroactive effect to the 5% stock dividend paid to Company stockholders on September 29, 2010. All per share amounts have been presented as if the stock dividends had occurred on January 1, 2010.

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



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010
Net income	$	30,301		$	19,223		$	49,674		$	31,161
Income attributable to participating securities	(639		)	(405		)	(1,033		)	(671		)
Net income available to common stockholders	$	29,662		$	18,818		$	48,641		$	30,490

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

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)

Unaudited



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010
Net income	$	30,301		$	19,223		$	49,674		$	31,161
Income attributable to 3.875% Variable Interest Senior Convertible Debentures	(95		)	(3,509		)	—			—
Expense attributable to 6.75% Variable Interest Senior Convertible Note	—			—			1,856			—
Expense attributable to 6.75% Variable Interest Senior Convertible Exchange Notes	—			—			—			1,046
Income attributable to participating securities	(637		)	(331		)	(1,072		)	(694		)
Net income available to common stockholders	$	29,569		$	15,383		$	50,458		$	31,513

Basic and diluted EPS were calculated using the following shares:



	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2011	2010	2011	2010
Weighted-average shares for basic EPS	74,661,628	74,292,853	74,577,078	74,275,816
Plus incremental shares related to stock options and non-vested restricted stock	627,993	261,784	448,288	212,374
Plus incremental shares related to convertible debt	6,407,890	6,529,810	3,665,228	6,948,142
Weighted-average shares for fully diluted EPS	81,697,511	81,084,447	78,690,594	81,436,332

The following stock options, non-vested restricted stock and shares issuable upon the conversion of convertible debt were outstanding during the three and six months ended June 30, 2011 and 2010 but were not included in the computation of diluted EPS.



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2011		2010		2011		2010
Number of stock options	149,789		639,914		155,973		639,914
Weighted-average exercise price	$	24.87	$	17.01	$	24.59	$	17.01
Weighted-average shares of non-vested restricted stock	N/A		10,842		N/A		5,481
Weighted-average expense per share	N/A		$	16.02	N/A		$	16.02
Weighted-average number of shares issuable upon conversion of debt	10,613,370		10,613,371		13,416,690		10,195,039
Weighted-average conversion price	$	14.84	$	14.85	$	16.20	$	15.70


(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 was $28,114 and $42,964 for the three and six months ended June 30, 2011, respectively. The Company's comprehensive income was $21,818 and $41,463 for the three and six months ended June 30, 2010, respectively.

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)

Unaudited


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

The Company has estimated the fair market value of the embedded derivatives based principally on the results of a valuation model. The estimated fair value of the derivatives embedded within the convertible debt is based principally on the present value of future dividend payments expected to be received by the convertible debt holders over the term of the debt. The discount rate applied to the future cash flows is estimated based on a spread in the yield of the Company's debt when compared to risk-free securities with the same duration; thus, a readily determinable fair market value of the embedded derivatives is not available. The valuation model assumes future dividend payments by the Company and utilizes interest rates and credit spreads for secured to unsecured debt, unsecured to subordinated debt and subordinated debt to preferred stock to determine the fair value of the derivatives embedded within the convertible debt. The valuation also considers other items, including current and future dividends and the volatility of Vector's stock price. The range of estimated fair market values of the Company's embedded derivatives was between $130,061 and $135,280. The Company recorded the fair market value of its embedded derivatives at the midpoint of the inputs at $132,622 as of June 30, 2011. At December 31, 2010, the range of estimated fair market values of the Company's embedded derivatives was between $138,701 and $144,391. The Company recorded the fair market value of its embedded derivatives at the midpoint of the inputs at $141,492 as of December 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 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 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.

In May 2011, the FASB issued amendments to disclosure requirements for common fair value measurement. These amendments, effective for the interim and annual periods beginning on or after December 15, 2011 (early adoption is prohibited), result in common definition of fair value and common requirements for measurement of and disclosure requirements between U.S. GAAP and IFRS. Consequently, the amendments change some fair value measurement principles and disclosure requirements. The implementation of this amended accounting guidance is not expected to have a material impact on the Company's consolidated financial position and results of operations.

In April 2011, the FASB issued authoritative guidance to clarify when a restructuring constitutes a troubled debt restructuring. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that two conditions exist: (1) the restructuring constitutes a concession and (2) the debtor is experiencing financial difficulties. The guidance became effective for interim and annual reporting periods beginning after June 15, 2011 and will be applied retrospectively to the beginning of the annual period of adoption. The adoption of this guidance did not impact the Company's condensed consolidated financial statements.

In June 2011, the FASB issued authoritative guidance that will be included in ASC Topic 220, “Comprehensive Income”. This guidance eliminates the option to report other comprehensive income and its components in the statement of changes in equity. Companies can elect to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. The Company is currently evaluating which method it will utilize to present items of net income and other comprehensive income. This

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)

Unaudited

presentation guidance is effective for the Company on January 1, 2012.

2. INVENTORIES

Inventories consist of:



	June 30, 2011			December 31, 2010
Leaf tobacco	$	63,707		$	54,479
Other raw materials	4,484			4,073
Work-in-process	403			2,067
Finished goods	74,009			67,773
Inventories at current cost	142,603			128,392
LIFO adjustments	(24,708		)	(21,313		)
	$	117,895		$	107,079

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 June 30, 2011, Liggett had leaf tobacco purchase commitments of approximately $38,567.

All of the Company's inventories at June 30, 2011 and December 31, 2010 have been reported under the LIFO method.

3. LONG-TERM INVESTMENTS

Long-term investments accounted for at cost:



	June 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Investment partnerships	$	6,526	$	14,136	$	45,134	$	70,966
Real estate partnership	899		1,268		899		1,136
Investments accounted for at cost	$	7,425	$	15,404	$	46,033	$	72,102

The Company received distributions of $53,333 and $62,219 for the three and six months ended June 30, 2011, primarily from the liquidation of two long-term investments. The Company recognized a gain of $19,475 and $23,611 for the three months and six months ended June 30, 2011. The Company received an additional distribution of $2,775 in July 2011.

Long-term investment partnerships accounted for under the equity method:

In April 2011, the Company invested $10,000 in an investment partnership with an underlying investment in a hedge fund. The Company accounts for the investment under the equity method.

The Company had an equity loss of $154 for the three months ended June 30, 2011 and equity income of $609 for the six months ended June 30, 2011, related to the limited partnerships accounted for under the equity method. The Company owned only one limited partnership accounted for under the equity method in 2010. The Company recorded equity income of $2,770 and $2,770 related to the limited partnership for the three and six months ended June 30, 2010.

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)

Unaudited

The carrying value of the investments was approximately $20,114 as of June 30, 2011 which approximated the investments' fair value.

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

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



	June 30, 2011			December 31, 2010
Vector:
11% Senior Secured Notes due 2015, net of unamortized discount of $667 and $730	$	414,333		$	414,270
6.75% Variable Interest Senior Convertible Note due 2014, net of unamortized discount of $37,265 and $38,353*	12,735			11,647
6.75% Variable Interest Senior Convertible Exchange Notes 2014, net of unamortized discount of $61,323 and $64,713*	46,207			42,817
3.875% Variable Interest Senior Convertible Debentures due 2026, net of unamortized discount of $82,759 and $83,060*	16,241			26,940
Liggett:
Revolving credit facility	13			35,710
Term loan under credit facility	5,956			6,222
Equipment loans	17,406			19,030
Other	676			761
Total notes payable, long-term debt and other obligations	513,567			557,397
Less:
Current maturities	(26,578		)	(51,345		)
Amount due after one year	$	486,989		$	506,052

______________________

* The fair value of the derivatives embedded within the 6.75% Variable Interest Convertible Note ($18,349 at June 30, 2011 and $20,219 at December 31, 2010, respectively), the 6.75% Variable Interest Senior Convertible Exchange Notes ($34,780 at June 30, 2011 and $38,324 at December 31, 2010, respectively), and the 3.875% Variable Interest Senior Convertible Debentures ($79,493 at June 30, 2011 and $82,949 at December 31, 2010, 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 $13 was outstanding at June 30, 2011. Availability as determined under the facility was approximately $36,987 based on eligible collateral at June 30, 2011.

11% Senior Secured Notes due 2015 - Vector:

The Company has outstanding $415,000 principal amount of its 11% Senior Secured Notes due 2015 (the “Senior Secured Notes”). The Senior Secured Notes were sold in August 2007 ($165,000), September 2009 ($85,000), April 2010 ($75,000) and December 2010 ($90,000) in private offerings to qualified institutional investors in accordance with Rule 144A of the Securities Act of 1933.

In May 2011, the Company completed an exchange offer to exchange the Senior Secured Notes issued in December 2010 for an equal amount of newly issued 11% Senior Secured Notes due 2015. The new Secured Notes have substantially the same terms as the original notes, except that the new Secured Notes have been registered under the Securities Act.

3.875% Variable Interest Senior Convertible Notes due 2026 - Vector:

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)

Unaudited

The Company was required to mandatorily redeem 10% of the total aggregate principal amount outstanding, or $11,000, of the Company's 3.875% Variable Interest Senior Convertible Debentures due 2026 on June 15, 2011. Other than the holders of $7 principal amount of the Notes, who had 10% of their aggregate principal amount of Notes mandatorily redeemed, each holder of the notes chose to convert its pro-rata portion of the $11,000 of principal into Vector's common stock. The Company recorded a loss of $1,217 for the three and six months ended June 30, 2011, on the conversion of the $11,000 of notes into 652,386 shares of common stock. The debt conversion resulted in a non-cash financing transaction of $10,993. The holders have the option to put all of the remaining senior convertible notes on June 15, 2012. Accordingly, the Company reclassified the remaining Notes and related fair value of derivatives embedded within convertible debt to current liabilities.

Non-cash Interest Expense - Vector:

Components of non-cash interest expense are as follows:



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2011		2010		2011		2010
Amortization of debt discount	$	2,560	$	1,810	$	4,842	$	3,448
Amortization of deferred finance costs	1,464		1,140		2,881		2,142
Loss on 3.875% Variable Interest Senior Convertible Debentures mandatorily redeemed	1,217		—		1,217		—
	$	5,241	$	2,950	$	8,940	$	5,590

Fair Value of Notes Payable and Long-term Debt:



	June 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
Notes payable and long-term debt	$	513,567	$	777,226	$	557,397	$	827,247

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 are not quantifiable at this time. For the six months ended June 30, 2011 and 2010, Liggett incurred legal expenses and other litigation costs totaling approximately $3,718 and $17,626 (which included $14,361 for the Lukacs case

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discussed below) , respectively.

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 litigation could encourage the commencement of additional litigation. Damages claimed in some tobacco-related 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 a majority of states now limit the dollar amount of bonds or require no bond at all. Liggett has secured approximately $4,083 in bonds as of June 30, 2011.

In June 2009, Florida amended its existing bond cap statute by adding a $200,000 bond cap that applies to all Engle progeny cases (defined below) 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 applies to judgments entered after the effective date of the legislation. The legislation was set to expire on December 31, 2012, but the sunset provision was recently repealed. Plaintiffs have challenged the constitutionality of the bond cap statute, but to date, the courts that have addressed the issue have upheld the constitutionality of the statute. Although the Company cannot predict the outcome of such challenges, it is possible that the Company's financial position, results of operations, or cash flows could be materially affected by an unfavorable outcome of such challenges.

The Company and its subsidiaries record provisions in their consolidated financial statements for pending litigation when they determine that an unfavorable outcome is probable and the amount of loss can be reasonably estimated. At the present time, while it is reasonably possible that an unfavorable outcome in a case may occur, except as disclosed in this Note 5: (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 legal defense costs are expensed or incurred.

Although the Company and Liggett have generally been successful in managing litigation, litigation is subject to uncertainty and significant challenges remain. Adverse verdicts have been rendered against Liggett in the past, in individual cases and Engle progeny cases, which have been affirmed on appeal. It is possible that the consolidated results of operations, cash flows or financial position of the Company could be materially adversely affected by an unfavorable outcome or settlement of certain pending litigation. Liggett believes, and has been so advised by counsel, that it has valid defenses to the litigation pending against it, as well as valid bases for appeal of adverse verdicts. All such cases are, and will continue to be vigorously defended. However, Liggett may enter into settlement discussions in particular cases if it believes it is in its best interest to do so.

Individual Actions

As of June 30, 2011, there were 42 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. These cases do not include Engle progeny cases (described below) or the approximately 100 individual cases pending in West Virginia state court as part of a consolidated action. The following table lists the number of individual cases by state that are pending against Liggett or its affiliates as of June 30, 2011 (excluding Engle progeny cases in Florida and the consolidated cases in West Virginia):

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State		Number of Cases
Florida		16
Maryland		9
New York		9
Louisiana		3
Missouri		2
West Virginia		2
Ohio		1

The plaintiffs' allegations of liability in cases in which individuals seek recovery for injuries allegedly caused by cigarette smoking are based on various theories of recovery, including negligence, gross negligence, breach of special duty, strict liability, fraud, concealment, misrepresentation, design defect, failure to warn, breach of express and implied warranties, conspiracy, aiding and abetting, concert of action, unjust enrichment, common law public nuisance, property damage, invasion of privacy, mental anguish, emotional distress, disability, shock, indemnity 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.

Liggett Only Cases. There are currently six 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, discussed below.

In February 2009, in Ferlanti v. Liggett Group, a Florida state court jury awarded compensatory damages to plaintiff and an $816 judgment was entered by the court. That judgment was affirmed on appeal and was satisfied by Liggett in March 2011. In September 2010, the court awarded plaintiff legal fees of $996. Plaintiff is appealing the amount of the attorneys' fee award. Liggett previously accrued $2,000 for the Ferlanti case. In Katz v. R.J. Reynolds, an Engle progeny case, no trial date has been set. There has been no recent activity in Hausrath v. Philip Morris, a case pending in New York state court, where two individuals are suing. 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.” As of June 30, 2011, Liggett and the Company are defendants in 5,785 Engle progeny cases in both federal (2,764 cases) and state (3,021 cases) courts in Florida. Other cigarette manufacturers are also named as defendants in these cases, although as a case proceeds, one or more defendants may ultimately be dismissed from the action. These cases include approximately 8,000 plaintiffs. The number of state court Engle progeny cases may increase as multi-plaintiff cases continue to be severed into individual cases. The total number of plaintiffs may also increase as a result of attempts by existing plaintiffs to add additional parties.

As of June 30, 2011, the following Engle progeny cases have resulted in judgments against Liggett:

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Date	Case Name	County	Net Compensatory Damages	Punitive Damages	Status
June 2002	Lukacs v. R.J. Reynolds	Miami-Dade	$12,418	None	Affirmed on appeal. See “Lukacs Case” description below.
August 2009	Campbell v. R.J. Reynolds	Escambia	$156	None	Affirmed on appeal. Defendants filed a Motion with DCA for certification to FL Sup. Ct., which was denied by the court on May 13, 2011. Defendants appealed to the FL Sup. Ct.
March 2010	Douglas v. R.J. Reynolds	Hillsborough	$1,350	None	On appeal
April 2010	Clay v. R.J. Reynolds	Escambia	$349	$1,000	On appeal
April 2010	Putney v. R.J. Reynolds	Broward	$3,008	None	On appeal
April 2011	Tullo v. R.J. Reynolds	Palm Beach	$225	None	On appeal

Through June 30, 2011, there were 32 plaintiffs' verdicts in Engle progeny cases, including the six referenced above, and 15 defense verdicts, excluding several cases which were either dismissed by the court on summary judgment or where a mistrial was declared. For further information on the Engle case and on Engle progeny cases, see “Class Actions -- Engle Case,” below.

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, plus interest from June 2002. In March 2010, the Third District Court of Appeal affirmed the decision, per curiam. In June 2010, Liggett satisfied its share of the judgment, including attorneys' fees and accrued interest, for $14,361.

Class Actions

As of June 30, 2011, there were six 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.

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

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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 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 8,000 plaintiffs have claims pending against the Company and Liggett and other cigarette manufacturers.

Three federal district courts (in the Merlob, Brown and Burr cases) ruled that the findings in Phase I of the Engle proceedings could not 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). In July 2010, the Eleventh Circuit ruled that plaintiffs do not have an unlimited right to use the findings from the original Engle trial to meet their burden of establishing the elements of their claims at trial. Rather, plaintiffs may only use the findings to establish specific facts that they demonstrate with a reasonable degree of certainty were actually decided by the original Engle jury. The Eleventh Circuit remanded the case to the district court to determine what specific factual findings the Engle jury actually made. All federal cases were stayed pending review by the Eleventh Circuit. On December 22, 2010, stays were lifted in 12 cases selected by plaintiffs, two of which were subsequently re-stayed. Liggett is a defendant in two of the ten cases.

In December 2010, in the Martin case, a case against R.J. Reynolds, the Florida District Court of Appeals issued the first ruling by a Florida intermediate appellate court to address the Brown decision discussed above. The panel held that the trial court correctly construed the Florida Supreme Court's 2006 decision in Engle in instructing the jury on the preclusive effect of the Phase I Engle proceedings, expressly disagreeing with certain aspects of the Brown decision. In July 2011, the Florida Supreme Court declined to review the District Court of Appeals' decision. This matter may be subject to review by the United States Supreme Court. This decision could lead to other adverse rulings by state appellate courts.

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. In November 2010, defendants filed a motion for summary judgment. In addition to joining that summary judgment motion, Liggett filed its own summary judgment motion on June 1, 2011. Briefing is underway.

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

In November 1997, in Young v. American Tobacco Co., a purported personal injury class action was commenced

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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 an appeal in another matter.

In February 1998, in Parsons v. AC & S Inc., a case pending in West Virginia, the personal injury class was commenced on behalf of all West Virginia residents who allegedly have personal injury claims arising from exposure to cigarette smoke and asbestos fibers. The complaint seeks to recover unspecified damages. The case has been stayed as a result of the December 2000 bankruptcy of three of the defendants.

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 “lights” cigarettes. The case was then removed to federal court on the basis of this new claim. In November 2009, plaintiffs filed a revised motion for class certification as to the three proposed classes, which motion was denied by the court. In February 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. Plaintiffs filed a Fourth Amended Complaint in an attempt to resurrect their addiction claims. In June 2010, the court granted defendants' motion to dismiss the Fourth Amended Complaint and in July 2010, the court denied plaintiffs' motion for reconsideration. In August 2010, plaintiffs appealed to the United States Court of Appeals for the Seventh Circuit. Oral argument occurred on April 7, 2011. A decision is pending.

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 are preempted by federal law, in light of the United States Supreme Court decision in Good. In March 2010, the trial court granted reconsideration of its September 2004 order granting partial summary judgment to defendants with respect to plaintiffs' “lights” claims on the basis of judicial decisions issued since its order was issued, including Good, thereby reinstating plaintiffs' “lights” claims. Since the trial court's prior ruling decertifying the class was reversed on appeal by the California Supreme Court, the parties and the court are treating all claims currently being asserted by the plaintiffs as certified, subject, however, to defendants' challenge to the class representatives standing to assert their claims. In December 2010, defendants filed a motion for a determination that the class representatives, as set forth in plaintiffs' tenth amended complaint, lack standing to pursue the claims, which was granted by the court. Plaintiffs moved to file an amended complaint adding new class representatives. On June 21, 2011, the motion was granted by the court and on July 1, 2011, plaintiffs filed their eleventh amended complaint.

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 commenced in June 2010 and ended in a mistrial. A new trial is scheduled for October 17, 2011. If the case were to proceed against Liggett, it is estimated that Liggett could be a defendant in approximately 100 of the individual cases.

In addition to the cases described above, numerous class actions remain certified against other cigarette manufacturers. Adverse decisions in these cases could have a material adverse affect on Liggett's sales volume, operating income and cash flows.

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Health Care Cost Recovery Actions

As of June 30, 2011, there were two Health Care Cost Recovery Actions pending against Liggett, both of which are inactive. 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.

Department of Justice Lawsuit. In September 1999, the United States government commenced litigation against Liggett and other cigarette manufacturers in the United States District Court for the District of Columbia. The action sought to recover an unspecified amount of health care costs paid and to be paid by the federal government for lung cancer, heart disease, emphysema and other smoking-related illnesses allegedly caused by the fraudulent and tortious conduct of defendants, to restrain defendants and co-conspirators from engaging in alleged fraud and other allegedly unlawful conduct in the future, and to compel defendants to disgorge the proceeds of their unlawful conduct. Claims were asserted under RICO.

In August 2006, the trial court entered a Final Judgment against each of the cigarette manufacturing defendants, except Liggett. In May 2009, the United States Court of Appeals for the District of Columbia affirmed most of the district court's decision. In February 2010, the government and all defendants, other than Liggett, filed petitions for writ of certiorari to the United States Supreme Court. In June 2010, the United States Supreme Court, without comment, denied review. As a result, the cigarette manufacturing defendants, other than Liggett, are now subject to the trial court's Final Judgment which ordered the following relief: (i) an injunction against “committing any act of racketeering” relating to the manufacturing, marketing, promotion, health consequences or sale of cigarettes in the United States; (ii) an injunction against participating directly or indirectly in the management or control of the Council for Tobacco Research, the Tobacco Institute, or the Center for Indoor Air Research, or any successor or affiliated entities of each (iii) an injunction against “making, or causing to be made in any way, any material false, misleading, or deceptive statement or representation or engaging in any public relations or marketing endeavor that is disseminated to the United States public and that misrepresents or suppresses information concerning cigarettes”; (iv) an injunction against conveying any express or implied health message through use of descriptors on cigarette packaging or in cigarette advertising or promotional material, including “lights,” “ultra lights,” and “low tar,” which the court found could cause consumers to believe one cigarette brand is less hazardous than another brand; (v) the issuance of “corrective statements” in various media regarding the adverse health effects of smoking, the addictiveness of smoking and nicotine, the lack of any significant health benefit from smoking “low tar” or “light” cigarettes, defendants' manipulation of cigarette design to ensure optimum nicotine delivery and the adverse health effects of exposure to environmental tobacco smoke; (vi) the disclosure of defendants' public document websites and the production of all documents produced to the government or produced in any future court or administrative action concerning smoking and health; (vii) the disclosure of disaggregated marketing data to the government in the same form and on the same schedules as defendants now follow in disclosing such data to the Federal Trade Commission for a period of ten years; (viii) certain restrictions on the sale or transfer by defendants of any cigarette brands, brand names, formulas or cigarette business within the United States; and (ix) payment of the government's costs in bringing the action.

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 38 hospitals and former 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

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of cigarettes. Trial commenced in January 2011 and on April 29, 2011, the jury returned a defense verdict on all claims. No appeal was taken and therefore, the matter is concluded.

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 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. On July 13, 2011, the Israeli Supreme Court rejected the plaintiff's claims.

In Crow Creek Sioux Tribe v. American Tobacco Company, a South Dakota case filed in 1997, the plaintiff seeks to recover damages based on various theories of recovery as a result of alleged sales of tobacco products to minors. There has been no activity in this case.

Upcoming Trials

As of June 30, 2011, there were 52 Engle progeny cases scheduled for trial through June 30, 2012. The Company and/or Liggett and other cigarette manufacturers are currently named as defendants in each of these cases, although as a case proceeds, one or more defendants may ultimately be dismissed from the action. 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 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

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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., Liggett and Vector Tobacco's domestic shipments accounted for approximately 3.5%, of the total cigarettes sold in the United States in 2010. If Liggett's or Vector Tobacco's market share exceeds their respective market share exemption in a given year, then on April 15 of the following year, Liggett and/or Vector Tobacco, as the case may be, must pay on each excess unit an amount equal (on a per-unit basis) to that due from the OPMs for that year. On December 31, 2010, Liggett and Vector Tobacco paid $96,500 of the approximately $144,200 of 2010 MSA payment obligations determined by the independent auditor. On April 15, 2011, Liggett and Vector Tobacco paid an additional approximately $26,700. Liggett and Vector Tobacco disputed the balance of approximately $21,000.

Certain MSA Disputes

NPM Adjustment. In March 2006, an economic consulting firm selected pursuant to the MSA determined that the MSA was a “significant factor contributing to” the loss of market share of Participating Manufacturers, to non-participating manufacturers, for 2003. This is known as the “NPM Adjustment.” The economic consulting firm subsequently rendered the same decision with respect to 2004 and 2005. In March 2009, a different economic consulting firm made the same determination for 2006. As a result, the manufacturers are entitled to potential NPM Adjustments to their 2003, 2004, 2005 and 2006 MSA payments. The Participating Manufacturers may also be 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 - 2010, Liggett and Vector Tobacco, as applicable, disputed that they owed the Settling States the NPM Adjustments as calculated by the Independent Auditor. As permitted by the MSA, Liggett and Vector Tobacco withheld payment associated with these NPM Adjustment amounts. For 2003, Liggett and Vector Tobacco paid the NPM adjustment amount of $9,345 to the Settling States although both companies continue to dispute that this amount is owed. The total amount withheld (or paid into a disputed payment account) by Liggett and Vector Tobacco for 2004 - 2010 was $46,938. At June 30, 2011, included in “Other assets” on the Company's condensed consolidated balance sheet was a noncurrent receivable of $6,542 relating to the $9,345 payment.

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

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)

Unaudited

arbitrable. All 47 of those decisions are final. One court, the Montana Supreme Court, ruled that Montana's claim of diligent enforcement must be litigated. The United States Supreme Court denied certiorari with respect to that opinion. In response to a proposal from the OPMs and many of the SPMs, 45 of the Settling States, representing approximately 90% of the allocable share of the Settling States, entered into an agreement providing for a nationwide arbitration of the dispute with respect to the NPM Adjustment for 2003. In June 2010, the three person arbitration panel was selected and procedural hearings, discovery and briefing on legal issues of general application commenced. 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. 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 $10,500, 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 Liggett's future MSA payments would be at least approximately $2,300 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 payments, which payments could adversely affect the Company's consolidated financial position, results of operations or cash flows.

Litigation Challenging the MSA. In Grand River Enterprises Six Nations, Ltd. v. King, litigation pending in federal court in New York, plaintiffs sought 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. After discovery, in November 2009, the parties cross-moved for summary judgment. In March 2011, the United States District Court for the Southern District of New York granted defendants' motion for summary judgment. Plaintiff appealed the decision.

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 sought damages from Participating Manufacturers under antitrust laws. 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. A decision is pending.

VECTOR GROUP LTD.

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Unaudited

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. Except as described below, Liggett's agreements with these states remain in full force and effect. These states' settlement agreements with Liggett contained most favored nation provisions which could reduce Liggett's payment obligations based on subsequent settlements or resolutions by those states with certain other tobacco companies. Beginning in 1999, Liggett determined that, based on each of these four states' settlements with United States Tobacco Company, Liggett's payment obligations to those states had been eliminated. With respect to all non-economic obligations under the previous settlements, Liggett believes it is entitled to the most favorable provisions as between the MSA and each state's respective settlement with the other major tobacco companies. Therefore, Liggett's non-economic obligations to all states and territories are now defined by the MSA.

In 2003, as a result of a dispute with Minnesota regarding the settlement agreement described above, Liggett agreed to pay $100 a year, in any year cigarettes manufactured by Liggett are sold in that state. In 2003 and 2004, the Attorneys General for Florida, Mississippi and Texas advised Liggett that they believed that Liggett had failed to make certain required payments under the respective settlement agreements with these states. In December 2010, Liggett settled with Florida and agreed to pay $1,200 and to make further annual payments of $250 for a period of 21 years, starting in March 2011. The payments in years 12 - 21 will be subject to an inflation adjustment. These payments are in lieu of any other payments allegedly due to Florida under the original settlement agreement. The Company accrued approximately $3,200 for this matter in 2010. There can be no assurance that Liggett will be able to resolve the matters with Texas and Mississippi or that Liggett will not be required to make additional payments which could adversely affect the Company's consolidated financial position, results of operations or cash flows.

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 $24,835 in compensatory damages plus interest against Liggett and two other defendants and found Liggett 50% responsible for the damages. The verdict was affirmed on appeal and Liggett paid $14,361 in June 2010. Through June 30, 2011, Liggett has been found liable in five other Engle progeny cases. These adverse verdicts have been appealed. As a result of the Engle decision, over 5,785 lawsuits are pending against the Company and Liggett. Other cigarette manufacturers are also currently named as defendants in these cases. Liggett has also had verdicts entered against it in other individual cases, which verdicts were affirmed on appeal and, thereafter, satisfied by Liggett. It is possible that other cases could be decided unfavorably against Liggett and that Liggett will be unsuccessful on appeal. Liggett may attempt to settle particular cases if it believes it is in its best interest to do so.

Management cannot predict the cash requirements related to any future defense costs, settlements or judgments, including cash required to bond any appeals, and there is a risk that those requirements will not be able to be met. An unfavorable outcome 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, costs and legal fees.

The tobacco industry is subject to a wide range of laws and regulations regarding the marketing, sale, taxation and use of tobacco products imposed by local, state and federal governments. There have been a number of restrictive regulatory actions, adverse legislative and political decisions and other unfavorable developments concerning cigarette smoking and the tobacco industry. These developments may negatively affect the perception of potential triers of fact with respect to the tobacco industry, possibly to the detriment of certain pending litigation, and may prompt the commencement of additional litigation or legislation.

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

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)

Unaudited

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.

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 June 30, 2011.

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.

6. INCOME TAXES

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

The Company's income tax expense consisted of the following:



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2011			2010			2011		2010
Income before provision for income taxes	$	48,846		$	30,602		$	80,868	$	49,462
Income tax expense using estimated annual effective income tax rate	18,561			11,751			30,730		18,959
Impact of discrete item, net	464			—			464		—
Changes in effective tax rates	(480		)	(214		)	—		—
Reduction of valuation allowance	—			—			—		(500		)
Reversal of unrecognized tax benefits	—			(158		)	—		(158		)
Income tax expense	$	18,545		$	11,379		$	31,194	$	18,301

The discrete item for the three and six months ended June 30, 2011 related to the Company's nondeductible loss on extinguishment of debt. The Company recorded a benefit of $0 and $500 for the three and six months ended June 30, 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.

7. NEW VALLEY LLC

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

VECTOR GROUP LTD.

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Unaudited



	June 30, 2011		December 31, 2010
Douglas Elliman Realty LLC	$	51,422	$	46,421
New Valley Oaktree Chelsea Eleven LLC	11,344		10,958
Fifty Third-Five Building LLC	18,000		18,000
Sesto Holdings S.r.l.	5,037		5,037
Toy Center	5,000		—
Lofts 21 LLC	900		—
Investments in non-consolidated real estate businesses	$	91,703	$	80,416

Residential Brokerage Business. New Valley recorded income of $5,397 and $7,207 for the three months ended June 30, 2011 and 2010, respectively, and income of $8,801 and $11,778 for the six months ended June 30, 2011 and 2010, respectively, associated with Douglas Elliman Realty, LLC. New Valley received cash distributions from Douglas Elliman Realty, LLC of $2,725 and $3,224 for the three months ended June 30, 2011 and 2010, respectively and $3,800 and $5,185 for the six months ended June 30, 2011 and 2010, respectively. The summarized financial information of Douglas Elliman Realty, LLC is as follows:



	June 30, 2011		December 31, 2010
Cash	$	53,423	$	45,032
Other current assets	6,804		5,989
Property, plant and equipment, net	14,884		15,556
Trademarks	21,663		21,663
Goodwill	38,463		38,424
Other intangible assets, net	1,209		1,337
Other non-current assets	3,132		3,416
Notes payable - current	611		1,067
Other current liabilities	19,865		21,765
Notes payable - long term	800		1,129
Other long-term liabilities	10,501		10,500
Members' equity	107,801		96,956



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2011		2010		2011		2010
Revenues	$	96,353	$	98,518	$	174,397	$	175,179
Costs and expenses	85,613		83,653		157,114		150,828
Depreciation expense	878		865		1,814		1,765
Amortization expense	63		88		126		165
Other income	410		441		1,387		838
Interest expense, net	42		167		83		445
Income tax expense	305		435		504		706
Net income	$	9,862	$	13,751	$	16,143	$	22,108

Aberdeen Townhomes LLC. In February 2011 and June 2011, Aberdeen sold its two remaining townhomes for $11,635 and $7,994, respectively, and recorded gain on sale of townhomes of $577 and $3,712 for the three and six months ended June 30, 2011.

New Valley Oaktree Chelsea Eleven, LLC. Chelsea sold four and ten units during the three and six months

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)

Unaudited

ended June 30, 2011. As of the financial statement issue date, sales of 47 of the 54 luxury residential units have closed.

As of June 30, 2011, Chelsea Eleven LLC had approximately $36,576 of total assets and $7,785 of total liabilities, excluding amounts owed to New Valley Oaktree Chelsea Eleven LLC.

The Company received net distributions of $220 and $1,613 from New Valley Oaktree Chelsea Eleven LLC for the three and six months ended June 30, 2011. The Company contributed $317 and $923 to New Valley Oaktree Chelsea Eleven LLC for the three and six months ended June 30, 2010. New Valley recorded equity income of $500 and $2,000 for the three and six months ended June 30, 2011, related to New Valley Chelsea. New Valley recorded no equity income for the three and six months ended June 30, 2010, related to New Valley Chelsea. The Company's maximum exposure to loss on our investment in New Valley Chelsea Eleven LLC is $11,344 at June 30, 2011.

Fifty Third-Five Building LLC. In 2010, New Valley, through its NV 955 LLC subsidiary, contributed $18,000 to a joint venture, Fifty Third-Five Building LLC (“JV”), of which it owns 50%. In 2010, the JV acquired a defaulted real estate loan, collateralized by real estate located in New York City for approximately $35,500. The previous lender had commenced proceedings seeking to foreclose its mortgage. Upon acquisition of the loan, the JV succeeded to the rights of the previous lender in the litigation. On April 27, 2011, the court granted the JV's motion for summary judgment, dismissing certain substantive defenses raised by the borrower and the other named parties. The borrower has challenged the validity of the assignment from the previous lender to the JV and the litigation is ongoing.

Lofts 21 LLC. In February 2011, New Valley LLC invested $900 for an approximate 12% interest in Lofts 21 LLC. Lofts 21 LLC acquired an existing property in Manhattan, NY, which is scheduled to be developed into condominiums. New Valley LLC will account for Lofts 21 LLC under the equity method of accounting. Lofts 21 LLC is a variable interest entity; however, New Valley LLC is not the primary beneficiary. New Valley LLC's maximum exposure to loss as a result of this investment is $900.

Toy Center LLC. In June 2011, New Valley LLC invested $5,000 in the form of a non-refundable deposit for an approximate 50% interest in Toy Center LLC. Toy Center LLC is in process of acquiring an existing property in Manhattan, NY, which is scheduled to be developed into luxury residential condominiums with new retail space on the ground floor. The purchase agreement calls for a closing by September 27, 2011. Once the agreements are finalized, the Company will evaluate the accounting treatment for Toy Center LLC.

St. Regis Hotel, Washington, D.C. In June 2011, the Company received $300 in distributions related to its former interest in the St. Regis Hotel. The Company recorded income of $300 for the three and six months ended June 30, 2011, respectively, related to its interest in the St. Regis Hotel. The Company does not anticipate receiving any additional payments related to the sale of the tax credits related to its former interest in St. Regis Hotel.

Investment in Escena:

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



	June 30, 2011			December 31, 2010
Land and land improvements	$	11,112		$	11,112
Building and building improvements	1,462			1,471
Other	1,192			1,144
	13,766			13,727
Less accumulated depreciation	(533		)	(373		)
	$	13,233		$	13,354

The Company recorded an operating loss of approximately $184 and $164 for the three months ended June 30,

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)

Unaudited

2011 and 2010, respectively. The Company recorded operating income of $283 and for the six months ended June 30, 2011 and an operating loss of approximately $118 for the six months ended June 30, 2010, from Escena.

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 June 30, 2011
Description	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Money market funds	$	278,626	$	278,626	$	—	$	—
Certificates of deposit	1,992		—		1,992		—
Bonds	4,324		4,324		—		—
Investment securities available for sale	64,340		60,683		3,657		—
Total	$	349,282	$	343,633	$	5,649	$	—

Liabilities:
Fair value of derivatives embedded within convertible debt	$	132,622	$	—	$	—	$	132,622



	Fair Value Measurements as of December 31, 2010
Description	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Money market funds	$	267,333	$	267,333	$	—	$	—
Certificates of deposit	2,773		—		2,773		—
Bonds	5,300		5,300		—		—
Investment securities available for sale	78,754		74,640		4,114		—
Total	354,160		347,273		6,887		—

Liabilities:
Fair value of derivatives embedded within convertible debt	$	141,492	$	—	$	—	$	141,492

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

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in Thousands, Except Per Share Amounts)

Unaudited

Consolidated Statements of Operations. The fair value of derivatives embedded within convertible debt was $132,622 and $141,941 as of June 30, 2011 and 2010, respectively. The income of $8,862 and $11,075 from the embedded derivatives in the six months ended June 30, 2011 and 2010, respectively, were primarily the result of declining spreads between corporate convertible debt and risk free investments offset by interest payments during the period.

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 had no nonrecurring nonfinancial assets subject to fair value measurements as of June 30, 2011 and 2010, respectively.

9. SEGMENT INFORMATION

The Company's significant business segments for the three and six months ended June 30, 2011 and 2010 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 investments in consolidated and non-consolidated real estate businesses. The accounting policies of the segments are the same as those described in the summary of significant accounting policies.

Financial information for the Company's operations before taxes for the three and six months ended June 30, 2011 and 2010 follows:



				Real			Corporate
	Tobacco			Estate			and Other			Total
Three months ended June 30, 2011
Revenues	$	291,180		$	—		$	—		$	291,180
Operating income (loss)	42,214			(487		)	(3,760		)	37,967
Equity income from non-consolidated real estate businesses	—			6,197			—			6,197
Depreciation and amortization	2,386			80			191			2,657

Three months ended June 30, 2010
Revenues	$	268,460		$	—		$	—		$	268,460
Operating income (loss)	26,027		⁽¹⁾	(164		)	(4,786		)	21,077
Equity income from non-consolidated real estate businesses	—			7,207			—			7,207
Depreciation and amortization	2,119			76			580			2,775

Six months ended June 30, 2011
Revenues	$	551,558		$	—		$	—		$	551,558
Operating income (loss)	78,639			(330		)	(8,866		)	69,443
Equity income from non-consolidated real estate businesses	—			11,101			—			11,101
Depreciation and amortization	4,384			160			774			5,318
Capital expenditures	4,813			48			11			4,872

Six months ended June 30, 2010
Revenues	$	490,547		$	—		$	—		$	490,547
Operating income (loss)	60,959		⁽¹⁾	118			(8,982		)	52,095
Equity income from non-consolidated real estate businesses	—			11,778			—			11,778
Depreciation and amortization	4,192			144			1,159			5,495
Capital expenditures	8,639			560			45			9,244

^{______________________________}

(1)Operating income includes litigation judgment expense of $14,361.

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

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Unaudited

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.

Certain revisions have been made to the Company's Condensed Consolidating financial information as of December 31, 2010 to conform to the 2011 presentation. The revisions increased parent "Investment in consolidated subsidiaries" by $24,371 and decreased parent "Investment securities available for sale" by $29,753, "Other current assets" by $923 and the current liability, "Deferred Income taxes," by $6,305. The revisions increased subsidiary guarantors' "Stockholders equity (deficiency)" by $24,371, "Investment securities available for sale" by $29,753, "Other current assets" by $923 and the current liability, "Deferred Income taxes," by $6,305. The Company's consolidated financial information as of December 31, 2010 has not changed. The Company does not believe these revisions are material to the consolidating financial information as of December 31, 2010 or any prior periods' consolidating financial statements.

VECTOR GROUP LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

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CONDENSED CONSOLIDATING BALANCE SHEETS



			June 30, 2011
					Subsidiary					Consolidated
	Parent/		Subsidiary		Non-		Consolidating			Vector Group
	Issuer		Guarantors		Guarantors		Adjustments			Ltd.
ASSETS:
Current assets:
Cash and cash equivalents	$	301,645	$	17,525	$	819	$	—		$	319,989
Investment securities available for sale	52,097		12,243		—		—			64,340
Accounts receivable - trade	—		20,717		5		—			20,722
Intercompany receivables	441		—		—		(441		)	—
Inventories	—		117,894		1		—			117,895
Deferred income taxes	33,494		3,240		—		—			36,734
Income taxes receivable	49,808		—		—		(49,808		)	—
Restricted assets	—		1,482		1		—			1,483
Other current assets	191		3,323		139		—			3,653
Total current assets	437,676		176,424		965		(50,249		)	564,816
Property, plant and equipment, net	563		54,505		—		—			55,068
Investment in Escena, net	—		—		13,233		—			13,233
Long-term investments accounted for at cost	6,527		—		898		—			7,425
Long-term investments accounted for under the equity method	20,114		—		—		—			20,114
Investments in non- consolidated real estate businesses	—		—		91,703		—			91,703
Investment in townhomes	—		—		—		—			—
Investments in consolidated subsidiaries	278,972		—		—		(278,972		)	—
Restricted assets	1,892		5,855		—		—			7,747
Deferred income taxes	17,397		102,330		9,563		(100,670		)	28,620
Intangible asset	—		107,511		—		—			107,511
Prepaid pension costs	—		14,710		—		—			14,710
Other assets	15,261		14,951		—		—			30,212
Total assets	$	778,402	$	476,286	$	116,362	$	(429,891	)	$	941,159
LIABILITIES AND STOCKHOLDERS' DEFICIENCY:
Current liabilities:
Current portion of notes payable and long-term debt	$	16,241	$	10,205	$	132	$	—