Tobacco Documents Online

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International Place 100 S.E. Second Street 32nd Floor Miami, Florida 33131 305/579-8000 BROOKE GROUP Bennett S. LeBow Chairman LTD. Dear Fellow Stockholder: I am pleased to report that the hard work at Brooke Group over the last several years began paying off in 1994 and in early 1995. Brooke Group has never shied away from complex transactions in out-of-favor industries in our quest for value. As we look to 1995 and beyond, we will continue to focus on maximizing the value of our existing operations while exploring a wide range of additional opportunities in various industries in the United States and overseas in order to generate long-term value for our stockholders. For the year, Brooke Group reported consolidated revenues of $479 million, with net income of $110 million, or $6.25 per share, which includes gains from discontinued operations. Most significantly since our last report, New Valley Corporation, of which we are approximately 42 percent stockholders, successfully emerged from Chapter 11 bankruptcy proceedings in January 1995. We were particularly pleased with this outcome. With the sale of New Valley's money transfer business in November, to First Financial Management Corporation, New Valley was able to pay all of its creditor claims in full and retain over $300 million in unrestricted cash. In February 1995, New Valley acquired, for $12.6 million, a stake in Empresa Brasileira de Aeronautica, S.A., a recently privatized Brazilian commuter and military airplane manufacturer. In April, New Valley announced a definitive agreement to acquire Ladenburg Thalmann & Co., a privately held investment banking firm, for approximately $26.8 million in cash. This transaction is expected to close in June 1995. As 1995 unfolds, New Valley will continue to pursue an opportunis- tic acquisition program in various industries. We were also pleased that during 1994, Liggett Group Inc., the fifth largest manufacturer of cigarettes in the United States, continued to improve its operations in what proved to be an unfavorable operating environment. Liggett continued to focus on maximizing profitability in both the price/value and full-price branded tobacco segments. Reduced operating expenses, including a 16 percent reduction in selling, general and administrative expenses, and an increase in unit cigarette sales to approximately 11.3 billion cigarettes in 1994 from 11.2 billion in 1993, led to net income of $15.4 million for 1994, compared to a loss of $31.4 million for 1993. Liggett was the first major domestic cigarette manufacturer to successfully introduce price/value cigarettes as an alternative to full-price branded cigarettes. While the overall market for price/value cigarettes, which represented 67 percent of Liggett's 1994 net sales, declined in 1994, Liggett improved its market share in this segment to 5.4 percent from 4.7 percent in 1993, according to industry surveys. We intend to maintain or increase our market share and increase profitability in this category by providing consistently high quality products and services at competitive prices. Liggett also produces four full-price cigarette brands, including L&M, Chesterfield, Lark and Eve, which represent the remaining percentage of Liggett's cigarette sales. As we entered 1995, we simplified our operating structure through the spin off, in the form of a special dividend to our stockholders, of our 65 percent interest in MAI Systems Corporation and the

BROOKE GROUP LTD. sale of our remaining interest in SkyBox International Inc. SkyBox, the majority of which was distributed to Brooke Group stockholders in October 1993 as a special dividend, has entered into a definitive agreement to be acquired by Marvel Entertainment Group Inc. for $150 million, or $16 per share of common stock. That price represents a positive return to Brooke Group stockholders who received the stock in 1993, validating the accuracy of the independent appraisal of SkyBox done earlier that year. We also announced that we are resuming payment of a regular quarterly cash dividend on Brooke Group common stock for the first time since 1992, at $0.075 per share, beginning February 1995. The positive developments of the past year will not go unnoticed to Brooke Group's long-term stockholders. An investor who originally purchased Liggett common stock, Brooke Group's prede- cessor, at the initial public offering price of $12 per share in 1987, has to date received cash and stock dividends in excess of $20 per share. Looking ahead, we are optimistic about the future and are continuing to work hard to create long-term value for all Brooke Group stockholders. Sincerely, Bennett S. LeBow Chairman, President and Chief Executive Officer

III IIII II II I i i iiil ill ill ,, UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1994 Commission File Number : 1-5759 BROOKE GROUP LTD. (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 100 S.E. Second Street, Miami, Florida (Address of principal executive offices) 51-0255124 (I.R.S. Employer Identification Number) 33131 (Zip Code) Registrant's telephone number, including area code: (305) 579-8000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which re~_istered Common Stock, Par Value $.10 New York Stock Exchange Securities registered pursuant to Section 12(g)of the Act: None 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 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 [ ] No Indicate by check mark if disclosure of delinquent fliers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant~s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ ]. l~e aggregate market value of the voting stock held by non-affiliates of the registrant as of Apdl 11, 1995 was approximately $21,916,569. Dlrectore and officare and ten percent or greater stockholders are considered affiliates for purposes of this calculation but should not necessarily be deemed affiliates for any other purpose. As of April tl, 1995, 18,247,096 shares of the registmnt's Common Stock were outstanding. Documents Incorporated by Reference: Part III (Items 10, 11, 12 and 13) from the definitive Proxy Statement for the 1995 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days after the end of the registrant~s fiscal year covered by this Report.

Item 1. Item 2. Item 3. Item 4. Item 5. Item 6. Item 7. Item 8. Item 9. ~tem 10. Item 1 1. Item 1 2. Item 1 3. Item 14. INDEX PART I Page Business .................................................................................................... .............. 2 Properties .................................................................................................... ............ 8 Legal Proceedings .................................................................................................... . 9 Submission of Matters to a Vote of Security Holders .................................................... 9 Executive Officers of the Registrant ............................................................................. 9 PART II Market for the Registrant's Common Equity and Related Stockholder Matters .................................................................................................. 1 1 Selected Financial Data ............................................................................................. 1 1 Management's Discussion and Analysis of Financial Condition and Results of Operations ........................................................................... 12 Financial Statements and Supplementary Data ............................................................. 12 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ............................................................................................ 12 PART ill Directors and Executive Officers of the Registrant ........................................................ 13 Executive Compensation ........................................................................................... 13 Security Ownership of Certain Beneficial Owners and Management ................................ 13 Certain Relationships and Related Transactions ............................................................ 13 PART IV Exhibits, Financial Statement Schedules, and Reports on Form 8-K ................................. 14 Signatures .................................................................................................... ........... 16 3.

PART I Item 1. Business Brooke Group Ltd. (the "Company" or "BGL"), a Delaware corporation founded in 1980, is principally engaged in the manufacture and sale of cigarettes, the acquisition of operating companies through a controlled subsidiary, and, through December 31, 1994, the sale of information processing systems. See "Business-Recent Developments". The Company also has investments in a number of additional companies engaged in a diverse group of businesses. Described below are the operations of the Company's core businesses. Tobacco General. The Company's tobacco business is conducted principally through its wholly- owned subsidiary, Liggett Group Inc. ("Liggett"), a Delaware corporation, which is the ultimate operating successor to the Liggett & Myers Tobacco Company formed in 1873. Liggett is engaged primarily in the manufacture and sale of cigarettes. Liggett is the fifth largest manufacturer of cigaret"tes in the United States in terms of unit sales with approximately 2.3% of the total domestic cigarette market for the year ended December 31, 1994. Liggett is headquartered in Durham, North Carolina. Liggett produces both full-price branded cigarettes as well as price/value cigarettes. Full- price branded cigarettes are generally marketed under well-recognized brand names at full retail prices to adult smokers with strong preference for branded products, whereas price/value cigarettes (which include, among others, branded discount and generic cigarettes), are marketed at lower retail prices to adult smokers who are more cost conscious. Liggett's full-price branded and price/value cigarettes are produced in over approximately 300 combinations of lengths, styles and packaging. Liggett produces four (4) full-price cigarette brands: L&M, Chesterfield, Lark and Eve. Liggett's full-price branded cigarettes represented approximately 33%, 42% and 50% of net sales (excluding federal excise taxes) in the years ended December 31, 1994, 1993 and 1992, respectively, and contributed substantially to Liggett's operating profits. Liggett's share of the full-price branded market was approximately 0.9% for the 12 months ended December 31, 1994, compared to 1.1% for the comparable period in 1993 and 1.4% for the comparable period in 1992, according to The Maxwell Consumer Report, a recognized industry publication (the "Maxwell Report"). In 1980, Liggett was the first major domestic cigarette manufacturer to successfully introduce price/value cigarettes as an alternative to full-price branded cigarettes. In 1989, Liggett established a new price point within the price/value segment by introducing Pyramid, a branded product which at that time sold for less than most other price/value cigarettes. Liggett's share of the price/value market was approximately 5.4% for the twelve months ended December 31, 1994 according to the Maxwell Report. This represents an increase from 4.7% for the comparable period in 1993, and a decrease from 6.9% for the comparable period in 1992. Liggett has attempted to regain market share in this segment by launching new price/value cigarette brands. As discussed herein, shifts in consumer preferences among different product tiers (for example, switches to premium brands resulting from the narrowing of the price differential between such brands and discount brands) have affected and could further affect Liggett's sales in the future, which .are predominantly in the price/value segment. At the present time, Liggett sells its full-price branded and price/value cigarettes principally in the United States. Liggett does not own the international rights to its L&M, Chesterfield, Lark and Eve brands. However, Liggett has introduced an international brand and sold more than 750 million cigarettes (in excess of 6% of Liggett's unit volume) in Eastern Europe and the Middle East in 1994. Liggett anticipates increased emphasis in its international segment in the future. 2

Business Strategy. Liggett's near-term business strategy is to further reduce certain of its operating and selling costs so as to maintain or increase the profitability of both its full-price and price/value products at their current unit sales volume and, further, to reduce its investment in working capital. As part of this strategy, Liggett restructured its headquarters and manufacturing operations in early 1993 and reorganized its sales force in early 1994, reducing its field sales force by 150 permanent positions and adding approximately 300 part-time positions. These changes have significantly reduced operating costs and enabled Liggett to nearly double its retail base coverage. Liggett has further reduced costs in both the administrative and manufacturing functions by making additional modifications to its manufacturing operations and significantly curtailing employee benefit programs. In March 1995, Liggett continued its efforts towards reducing costs by, among other things, offering voluntary retirement programs to eligible employees. Thus far, Liggett's cost reduction programs have reduced its headcount by approximately 14% of its total hourly employees. Liggett anticipates further cost reduction programs during 1995. Liggett's long-term business strategy in the full-price branded segment of the market is to maintain its share of that segment of the market by consistently offering promotional programs with the objective of maximizing the profitability of its full-price brands. Liggett's long-term business strategy in the price/value segment of the market is to maintain its market share and increase its profitability by providing consistently high quality products and services at prices and terms comparable to those available elsewhere in the market. Sales, Marketing and Distribution. The majority of Liggett's products are distributed from a central distribution center in Durham, North Carolina to approximately 28 public warehouses located throughout the United States. These warehouses serve as local distribution centers for Liggett's customers. Liggett's products are transported from the central distribution center to the warehouses via third party trucking companies to meet pre-existing contractual obligations to its customers. Liggett s customers are primarily candy and tobacco distributors, the military, and large grocery, drug and convenience store chains. Liggett manufactures and markets the third largest selling brand family of price/value cigarettes to the U.S. military. Liggett offers its customers discount payment terms, traditional rebates and promotional incentives. Customers typically pay for purchased goods within two weeks following delivery from Liggett. None of Liggett's customers accounted for more than 10% of revenues in 1994. Liggett's marketing and sales functions are now performed by approximately 110 direct sales representatives calling on national and regional customer accounts, together with approximately 385 part-time retail sales consultants who service retail outlets. In addition, Liggett employs food broker groups in certain geographic locations to perform these marketing and sales functions. Manufacturing. Liggett purchases and maintains leaf tobacco inventory to support cigarette manufacturing requirements. Tobacco is an agricultural commodity subject to United States government production controls and price supports which can substantially affect its market price. Liggett normally purchases all of its tobacco requirements from domestic and foreign leaf tobacco dealers, much of it under long-term purchase commitments, and believes that there is a sufficient supply of tobacco within the worldwide tobacco market to satisfy its current production requirements. Liggett stores its leaf tobacco inventory in warehouses in North Carolina and Virginia. Recent federal legislation imposes domestic tobacco content requirements on domestic manufacturers. See "Business- Tobacco-Government Regulation". Liggett's cigarette manufacturing facilities are designed for the execution of short production runs in a cost-effective manner, which enables Liggett to manufacture and market a wide variety of cigarette brand styles. Liggett's full-price branded and price/value cigarettes are produced in approximately 300 different brand styles of cigarettes under its own trademarks and brand names as well as private labels for other companies, typically retail or wholesale distributors, who supply supermarkets and convenience stores. Liggett believes that its existing facilities are sufficient to accommodate a substantial increase in production.

While Liggett pursues product development, its total expenditures for research and development on new products have not been financially material during the past three years. Trademarks. All of the major trademarks used by Liggett are federally registered or are in the process of being registered in the United States. In view of the significance of cigarette brand awareness among consumers, management of Liggett believes that the protection afforded by its trademarks is material to the conduct of Liggett's business. Competition. Liggett is the fifth largest manufacturer of cigarettes in the United States. The four largest manufacturers of cigarettes are Philip Morris Incorporated ("Philip Morris"), R JR Nabisco Inc. ("R JR Nabisco"), Brown & Williamson Tobacco Corporation (which recently acquired American Tobacco Company; See "Management's Discussion and Analysis of Financial Condition and Results of Operation-Recent Developments in the Cigarette Industry-Competitive Activity") and Lorillard Inc. According to the Maxwell Report, Liggett's domestic shipments of approximately 11.3 billion cigarettes in 1994 accounted for 2.3% of the approximately 489.6 billion cigarettes shipped in the United States during such year, and Liggett's domestic shipments of approximately 11.2 billion cigarettes in 1993 accounted for 2.4% of the approximately 461.2 billion cigarettes shipped in the United States during such year. Although Liggett experienced an increase in its unit cigarette sales in 1994, its market share decreased. The Company believes that this was primarily ascribable to decreases in volume and market share for the price/value segment of the market. Recent pricing changes described below have caused Liggett to become more reliant upon sales in the price/value segment of the market, relative to the full-price branded segment, than certain of its competitors. The United States cigarette industry had three (3) price tiers from 1989 to 1993: full price, branded discount and generic. The cigarette industry has not historically competed on the basis of list price within a given price tier. In recent years, there have been substantial regular price increases by all manufacturers culminating in full-price branded list prices in excess of $14.00 per carton. These increases widened the gap between prices of this segment and prices in the generic segment of the market, culminating in a price gap of approximately $7.00 (50%) per carton in July 1993. In July 1993, the two (2) largest cigarette manufacturers reduced the price of their full-price branded cigarettes to 1989-1990 levels, forcing other manufacturers, including Liggett, to do likewise. This price decrease also narrowed the gap between prices of full-price brands and prices in the price/value segment (reducing the price gap from 43% to approximately 25%), which has resulted in a substantial reduction in volumes in the latter segment. Since that price decrease, list prices at all tiers have again increased and the relative volume and market share of full-price cigarettes have been increasing. According to the Maxwell Report, the price/value segment accounted for 32.5% of the 489.6 billion cigarettes shipped in the United States during 1994, compared to 36.8% of the 461.2 billion ciqarettes shipped in the United States during 1993. Consequently, Liggett's market share, which is predominantly in the price/value segment, declined in 1994. Prior to 1994, industry-wide consumer purchases of cigarettes in the United States have steadily declined at an average annual rate of 2% to 3%. The Maxwell Report, however, estimates that domestic industry-wide consumer purchases increased by approximately 6.2% in 1994, Liggett's management does not believe that this increase in 1994 is indicative of a trend. Liggett's management believes that future shipments in the United States will return to historical decline rates as a result of numerous factors, including health considerations, diminishing social acceptance of smoking, legislative limitations on smoking in public places, and federal and state excise tax increases which have augmented cigarette price increases. Historically, because of their dominant market share, Philip Morris and R JR Nabisco have been able to determine cigarette prices for the various pricing tiers within the industry, and the other manufacturers have been compelled, in order to remain competitive, to bring their prices into line with the levels established by the two major manufacturers. There are substantial barriers to entry into the cigarette business, including extensive distribution organizations, large capital outlays for sophisticated production equipment, substantial inventory investment, costly promotional spending, regulated advertising and strong brand loyalty..In

II I this industry, the major cigarette manufacturers compete among themselves for market share on the basis of brand loyalty, advertising and promotional activities and trade rebates and incentives. Liggett's four major competitors all have substantially greater financial resources than Liggett, and most of these competitors' brands have greater saies and consumer recognition than Liggett's brands. Government Regulation. Reports with respect to the alleged harmful physical effects associated with cigarette smoking have been publicized for many years and, in the opinion of Liggett's management, have had and may continue to have an adverse effect on cigarette sales. Since 1964, the Surgeon General of the United States and the Secretary of Health and Human Services have released a number of reports which claim that cigarette smoking is a causative factor with respect to a variety of health hazards, including cancer, heart disease and lung disease, and have recommended various government actions to reduce the incidence of smoking. Since 1966, federal law has required that cigarettes manufactured, packaged or imported for sale or distribution in the United States include specific health warnings on their packaging. Since 1972, Liggett and the other cigarette manufacturers have included the federally-required warning statements in print advertising, on billboards and on certain categories of point-of-sale display materials relating to cigarettes. The Comprehensive Smoking Education Act, which became effective October 12, 1985, requires that packages of cigarettes distributed in the United States and cigarette advertisements (other than billboard advertisements) in the United States bear one of the following four warning statements, in lieu of the prier warning notice, on a quarterly rotating basis: "SURGEON GENERAL'S WARNING: Smoking Causes Lung Cancer, Heart Disease, Emphysema, And May Complicate Pregnancy"; "SURGEON GENERAL'S WARNING: Quitting Smoking Now Greatly Reduces Serious Risks to Your Health"; "SURGEON GENERAL'S WARNING: Smoking By Pregnant Women May Result in Fetal Injury, Premature Birth, and Low Birth Weight"; and "SURGEON GENERAL'S WARNING: Cigarette Smoke Contains Carbon Monoxide." Shortened versions of these statements are also required, on a rotating basis, on billboard advertisements. By a limited eligibility amendment to the Comprehensive Smoking Education Act for which Liggett qualifies, Liggett is allowed to display all four required package warnings for the majority of its brand packages on a simultaneous basis (such that the packages at any time may carry any one of the four required warnings), although it rotates the required warnings for advertising on a quarterly basis in the same manner as do the other major manufacturers. The law also requires that each person who manufactures, packages or imports cigarettes annually provide to the Secretary of Health and Human Services a list of the ingredients added to tobacco in the manufacture of cigarettes. Annual reports to the United States Congress also are required from the Secretary of Health and Human Services as to current information on the health consequences of smoking and from the Federal Trade Commission on the effectiveness of cigarette labeling and current practices and methods of cigarette advertising and promotion. Both federal agencies are also required annually to make such recommendations as they deem appropriate with regard to further legislation. The Omnibus Budget Reconciliation Act of 1993 ("OBRA") requires that domestic tobacco comprise at least 75% of the tobacco content of cigarettes manufactured in the United States effective January 1, 1994. Liggett uses both foreign and domestic tobacco in its cigarettes. The foreign tobacco used in Liggett's cigarettes is less expensive than comparable domestic tobacco. However, the Company took certain steps, including modifying its agreements with tobacco vendors, in an effort to reduce the potentially unfavorable effects of this legislation on its business. A General Agreement on Tariffs and Trade ("GATT"} tribunal ruled that this legislation violates GATT. Legislation has been enacted which will repeal retroactively the domestic content legislation as of December 31, 1994 upon the declaration of tariffs on imported tobacco in excess of certain quotas pursuant to a Presidential proclamation. Management believes that such a proclamation will be issued during 1995. The Company is exploring avenues which might be available to it to realize relief from the imposition of these sanctions under OBRA. While Liggett is of the opinion that there is a realistic potential for the Company realizing relief, no assurance can be given at this time that Liggett will be successful in realizing such relief, either in whole or in part.

In March 1994, the Food and Drug Administration ("FDA") began an investigation of whether cigarettes should be regulated by that agency in response to certain accusations made on a tabloid television program. These accusations have been denied by the Company and others in the industry. All radio and television advertising of cigarettes has been prohibited by federal statute since 1971 and federal law prohibits smoking aboard aircraft for domestic flights of six hours or less. Both the State of Florida and the Commonwealth of Massachusetts have enacted legislation allowing recovery of certain payments made on behalf of Medicaid recipients as a result of diseases allegedly caused by third parties. The United States Interstate Commerce Commission has banned smoking on buses transporting passengers inter-state. In addition, the United States Congress and a number of states and local government units have enacted or are considering legislation which is intended to discourage smoking through education efforts or which imposes various restrictions or requirements relating to smoking including restrictions on public smoking. Certain employers have initiated programs restricting or eliminating smoking in the workplace. Other proposals previously presented to or currently before Congress and certain states and local government units include, but are not limited to, legislative efforts to further restrict or ban the advertising and promotion of cigarettes, to eliminate the income tax deductibility of expenses incurred for such advertising and promotion, to restrict or prohibit smoking in public buildings and other areas, to increase excise taxes, to require additional warnings on cigarette packaging and advertising, to ban vending machine sales, to eliminate the federal preemption defense in product liability actions, to place cigarettes under the regulatory jurisdiction of the FDA and to require that cigarettes meet certain fire safety hazards. If adopted, at least certain of the foregoing legislative proposals might have a materially adverse impact on Liggett's business. While attitudes toward cigarette smoking vary around the world, a number of foreign countries have also taken steps to discourage cigarette smoking, to restrict or prohibit cigarette advertising and promotion and to increase taxes on cigarettes. The price of cigarettes includes federal excise taxes at the rate of $12.00 per 1,000 cigarettes. This tax, which was levied as of January 1, 1993, increased the previous federal excise tax of $10.00 per 1,000 cigarettes. In the prior session of Congress, health care legislation was introduced which would have substantially increased excise taxes on cigarettes. While that legislation was not enacted, and no proposals to increase federal excise taxes are pending before Congress currently, there remains a possibility that proposals to increase excise taxes may be put forward. A substantial excise tax increase could accelerate the trend away from smoking. Excise and similar taxes on cigarettes, which are levied upon and typically paid by the distributors, are also in effect in the 50 states, the District of Columbia and many municipalities. These state and local taxes range from approximately $1.25 to $37.50 per 1,000 cigarettes. Management believes that, with the exception of certain provisions of the federal domestic content requirements described above, Liggett is in compliance in all material respects with the laws regulating 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, have no material effect on the capital expenditures, earnings or competitive position of Liggett. Acquisition of Operating Companies The Company holds an approximately 42% voting interest in New Valley Corporation ("New Valley"), a company predominantly engaged in the acquisition of operating companies. On or about November 15, 1991, an involuntary petition seeking an order for relief under Chapter 11 of Title 11 of the United States Code was commenced against New Valley by certain of its bondholders. On or about November 1, 1994, the United States Bankruptcy Court for the District of New Jersey entered an order confirming the First Amended Joint Chapter 11 Plan of Reorganization, as amended (the "Joint Plan"). Pursuant to the Joint Plan, on November 15, 1994, New Valley sold the assets and operations with which it provided domestic and international money transfer services, bill payment services, telephone cards, money orders and bank card services (collectively the "Money Transfer 6