Exhibit 99.3
 Vector Tobacco Inc. and Subsidiaries
 Consolidated Financial Statements
as of December 31, 2009 and 2008
and for each of the three years
ended December 31, 2009, 2008 and 2007




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##### 



Vector Tobacco Inc. and Subsidiaries
Index
December 31, 2009 and 2008
 Page(s)Report of Independent Registered Public Accounting Firm
    
    
    1Consolidated Financial StatementsConsolidated Balance Sheets as of December 31, 2009 and 2008
    
    
    23Consolidated Statements of Operations for the years ended December 31, 2009, 2008 and 2007
    
    
    4Consolidated
Statements of Stockholders Equity (Deficiency)
    
    
    5Consolidated Statements of Cash Flows
    
    
    67Notes to Consolidated Financial Statements
    
    
    826Consolidated Financial Statement ScheduleSchedule II  Valuation and Qualifying Accounts
    
    
    27




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##### 



Report of Independent Registered Public Accounting Firm
 
    
 1




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##### 



Vector Tobacco Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2009 and 2008
 (in thousands of dollars)
 2009
    
    
    2008AssetsCurrent assetsCash and cash equivalents
    
    $
    472
    
    
    $
    178Accounts receivable  trade, less allowances of $18 and $15, respectively
    
    
    609
    
    
    
    436Inventories, net
    
    
    5,782
    
    
    
    4,810Deferred taxes
    
    
    2,341
    
    
    
    Other current assets
    
    
    192
    
    
    
    209Total current assets
    
    
    9,396
    
    
    
    5,633Property, plant and equipment, net
    
    
    25
    
    
    
    72Intangible asset
    
    
    107,511
    
    
    
    107,511Deferred taxes
    
    
    93,113
    
    
    
    Other assets
    
    
    999
    
    
    
    817Total assets
    
    $
    211,044
    
    
    $
    114,033
  2




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##### 



Vector Tobacco Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2009 and 2008
 (in thousands of dollars, except share amounts)
 2009
    
    
    2008Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable  trade
    
    $
    
    
    
    $
    8Due to related parties
    
    
    9,629
    
    
    
    5,652Accrued promotional expenses
    
    
    646
    
    
    
    590Estimated allowance for sales returns
    
    
    1,007
    
    
    
    1,000Settlement accruals
    
    
    2,723
    
    
    
    2,091Deferred taxes
    
    
    1,433
    
    
    
    Income taxes payable
    
    
    538
    
    
    
    Other
    
    
    311
    
    
    
    942Total current liabilities
    
    
    16,287
    
    
    
    10,283Non-current employee benefits
    
    
    1,142
    
    
    
    870Due to related parties
    
    
    
    
    
    
    454Deferred income taxes
    
    
    22,550
    
    
    
    19,122Other long-term liabilities
    
    
    2,982
    
    
    
    1,878Total liabilities
    
    
    42,961
    
    
    
    32,607Commitments and contingencies (Note 13)Stockholders equityCommon stock ($1 par value per share; 1,000 sharesauthorized; 100 shares issued and outstanding)
    
    
    
    
    
    
    Additional paid-in capital
    
    
    372,292
    
    
    
    393,667Accumulated other comprehensive income
    
    
    295
    
    
    
    321Accumulated deficit
    
    
    (204,504
    )
    
    
    (312,562
    )Total stockholders equity
    
    
    168,083
    
    
    
    81,426Total liabilities and stockholders equity
    
    $
    211,044
    
    
    $
    114,033
  3




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##### 



Vector Tobacco Inc. and Subsidiaries
Consolidated Statements of Operations
Years Ended December 31, 2009, 2008, and 2007
 (in thousands of dollars)
 2009
    
    
    2008
    
    
    2007Revenues *
    
    $
    106,446
    
    
    $
    70,652
    
    
    $
    72,017ExpensesCost of goods sold
    
    
    80,772
    
    
    
    43,455
    
    
    
    44,757Operating, selling, administrative and
general expenses
    
    
    4,564
    
    
    
    6,499
    
    
    
    6,884Management fees paid to Vector Group Ltd.
    
    
    500
    
    
    
    500
    
    
    
    500Restructuring and impairment charges,
changes in estimate
    
    
    900
    
    
    
    (18
    )
    
    
    (83
    )Research and development
    
    
    1,552
    
    
    
    2,960
    
    
    
    4,240Operating income
    
    
    18,158
    
    
    
    17,256
    
    
    
    15,998Other income (expense)Interest income
    
    
    3
    
    
    
    105
    
    
    
    72Interest expense
    
    
    (6
    )
    
    
    (39
    )
    
    
    (5,704
    )Income before income taxes
    
    
    18,155
    
    
    
    17,322
    
    
    
    10,366Income tax benefit (expense)
    
    
    89,903
    
    
    
    (1,983
    )
    
    
    (2,855
    )Net income
    
    $
    108,058
    
    
    $
    15,339
    
    
    $
    7,511
 
 *
    
    Revenues and cost of goods sold include excise taxes of $52,365,
$22,212, and $23,681 for the years
ended December 31, 2009, 2008, and 2007, respectively.  4




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##### 



Vector Tobacco Inc. and Subsidiaries
Consolidated Statements of Stockholders Equity (Deficiency)
Years Ended December 31, 2009, 2008, and 2007
 (in thousands of dollars)
 AccumulatedAdditional
    
    
    Other
    
    
    
    
    
    
    TotalCommon Stock
    
    
    Paid-In
    
    
    Comprehensive
    
    
    Accumulated
    
    
    StockholdersShares
    
    
    Amount
    
    
    Capital
    
    
    Income
    
    
    Deficit
    
    

Equity
(Deficiency)Balance at January 1, 2007
    
    
    100
    
    
    $
    
    
    
    $
    280,671
    
    
    $
    303
    
    
    $
    (335,359
    )
    
    $
    (54,385
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,511
    
    
    
    7,511Accumulated other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    
    
    
    
    9Total
comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,520Capital contributions
    
    
    
    
    
    
    
    
    
    
    144,396
    
    
    
    
    
    
    
    
    
    
    
    144,396Distributions
    
    
    
    
    
    
    
    
    
    
    (10,000
    )
    
    
    
    
    
    
    
    
    
    
    (10,000
    )Balance as of December 31, 2007
    
    
    100
    *
    
    
    
    
    
    
    415,067
    
    
    
    312
    
    
    
    (327,848
    )
    
    
    87,531Net Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,339
    
    
    
    15,339SFAS No. 158 Pension Adjustments,
measurement date
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (53
    )
    
    
    (53
    )Accumulated other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    
    
    
    
    9(44
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,295Distributions
    
    
    
    
    
    
    
    
    
    
    (21,400
    )
    
    
    
    
    
    
    
    
    
    
    (21,400
    )Balance as of December 31, 2008
    
    
    100
    *
    
    
    
    
    
    
    393,667
    
    
    
    321
    
    
    
    (312,562
    )
    
    
    81,426Net Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    108,058
    
    
    
    108,058Accumulated other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26
    )
    
    
    
    
    
    
    (26
    )Total
comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    108,032Distributions
    
    
    
    
    
    
    
    
    
    
    (21,375
    )
    
    
    
    
    
    
    
    
    
    
    (21,375
    )Balance as of December 31, 2009
    
    
    100
    *
    
    $
    
    
    
    $
    372,292
    
    
    $
    295
    
    
    $
    (204,504
    )
    
    $
    168,083
 
 *
    
    Stock pledged as collateral for Vector Tobaccos guarantee of the Parents debt. See Note 1.  5




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##### 



Vector Tobacco Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2009, 2008, and 2007
 (in thousands of dollars)
 2009
    
    
    2008
    
    
    2007Cash flows from operating activitiesNet income
    
    $
    108,058
    
    
    $
    15,339
    
    
    $
    7,511Adjustments
to reconcile net income to net cash
provided by operating activitiesDepreciation and amortization
    
    
    28
    
    
    
    39
    
    
    
    55Deferred taxes
    
    
    (90,593
    )
    
    
    2,856
    
    
    
    2,855Net gain on disposal of equipment
    
    
    
    
    
    
    (50
    )
    
    
    Non-cash interest expense
    
    
    
    
    
    
    
    
    
    
    1,627Restructuring and impairment charges, changes in
estimates
    
    
    938
    
    
    
    (18
    )
    
    
    (83
    )Cash payments on restructuring liabilities
    
    
    (753
    )
    
    
    (66
    )
    
    
    (694
    )Changes in assets and liabilitiesAccounts receivable
    
    
    (173
    )
    
    
    (49
    )
    
    
    352Inventories
    
    
    (972
    )
    
    
    20
    
    
    
    4,271Other assets
    
    
    2
    
    
    
    (84
    )
    
    
    (22
    )Accounts payable
    
    
    (8
    )
    
    
    2
    
    
    
    (9
    )Due to/from related parties
    
    
    3,523
    
    
    
    (214
    )
    
    
    1,080Accrued expenses
    
    
    (56
    )
    
    
    992
    
    
    
    (6,103
    )Income tax payable
    
    
    538
    
    
    
    
    
    
    
    Change in book overdraft
    
    
    
    
    
    
    
    
    
    
    (5
    )Employee benefits
    
    
    246
    
    
    
    212
    
    
    
    182Other long-term liabilities
    
    
    1,104
    
    
    
    107
    
    
    
    1,311Net cash provided by operating activities
    
    
    21,882
    
    
    
    19,086
    
    
    
    12,328Cash flows from investing activitiesCapital expenditures
    
    
    
    
    
    
    (4
    )
    
    
    (58
    )Proceeds from sales of equipment
    
    
    
    
    
    
    50
    
    
    
    Increase in cash surrender value of life insurance
policies
    
    
    (213
    )
    
    
    (208
    )
    
    
    (195
    )Net cash used in investing activities
    
    
    (213
    )
    
    
    (162
    )
    
    
    (253
    )Cash flows from financing activitiesRepayments of notes payable
    
    
    
    
    
    
    
    
    
    
    (4,000
    )Distributions to Parent
    
    
    (21,375
    )
    
    
    (21,400
    )
    
    
    (10,000
    )Net cash used in financing activities
    
    
    (21,375
    )
    
    
    (21,400
    )
    
    
    (14,000
    )Net (decrease) increase in cash and cash equivalents
    
    
    294
    
    
    
    (2,476
    )
    
    
    (1,925
    )Cash and cash equivalentsBeginning of period
    
    
    178
    
    
    
    2,654
    
    
    
    4,579End of period
    
    $
    472
    
    
    $
    178
    
    
    $
    2,654
  6




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##### 



Vector Tobacco Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2009, 2008, and 2007
 (in thousands of dollars)
 Supplemental schedule of non-cash investing and financing activities
    
    Vector Tobacco recorded $26 in other comprehensive loss in 2009 and $9 and $9 in
other accumulated comprehensive income during 2008 and 2007, respectively, in relation
to certain pension plans.
    
    Vector Tobacco recorded non-cash capital contributions from VGR Holdings in the
amount of $109,396 during the year ended December 31, 2007 to retire the revolving
credit facility balance.
    
    Vector Tobacco recorded a non-cash capital contribution from VGR Holdings in the
amount of $35,000 during the year ended December 31, 2007 for the payment of the
Medallion note on behalf of Vector Tobacco.
  7




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 1.
    
    Basis of Presentation Vector Tobacco Inc. (Vector Tobacco or the Company), is a wholly-owned subsidiary of VGR
Holding LLC (VGR), which in turn is wholly owned by Vector Group Ltd. (Vector or
Parent). The Company is engaged in the development of low nicotine and nicotine-free
cigarette products, the development of reduced risk cigarette products, and the manufacturing
and sale of other discount cigarettes principally in the United States. Certain management and
administrative functions are performed by affiliates (See Note 15 and 16).Management believes the assumptions underlying the consolidated financial statements are
reasonable. However, the consolidated financial statements included herein may not necessarily
reflect the Companys results of operations, financial position and cash flows in the future
or what its results of operations, financial position and cash flows would have been had the
Company been a stand-alone company during the periods presented. Amounts due to and receivable
from Vector, including related party debt, are shown separately on the balance sheets. All
significant intercompany accounts and transactions have been eliminated in consolidation.Liggett Vector Brands Inc. (Liggett Vector Brands), a company affiliated through common
ownership, coordinates and executes the sales, marketing, administration and manufacturing
efforts along with certain support functions for all of Vectors tobacco operations. In
conjunction with the duties performed at Liggett Vector Brands, a portion of sales, marketing,
manufacturing, distribution, and administrative expenses have been allocated to Vector
Tobacco.Liggett Group LLC (Liggett), an affiliate of Vector Tobacco, manufactures all of Vector
Tobaccos cigarette brands under contract at Liggetts Mebane, North Carolina manufacturing
facility.Vector and VGR are holding companies and as a result do not have any operating activities that
generate revenues or cash flows. Accordingly, Vector relies on distributions from VGR and its
other subsidiaries and investments and VGR relies on distributions from its other
subsidiaries, including Vector Tobacco, in order to fund its operations and meet its
obligations. Vector has certain debt outstanding which will require interest and principal
payments over the terms of such debt. Interest and principal to service the debt is expected
to be funded by Vectors cash and cash equivalents, investments, the operations of Vectors
subsidiaries, including Vector Tobacco, and proceeds, if any, from Vectors future financings.
During 2009, 2008 and 2007 Vector Tobacco made distributions of $21,375, $21,400 and $10,000
respectively, to VGR.11% Senior Secured Notes due 2015In August 2007, Vector sold $165,000 of its 11% Senior Secured Notes due 2015 (the Senior
Secured Notes) in a private offering to qualified institutional investors in accordance with
Rule 144A of the Securities Act of 1933. Vector intends to use the net proceeds of the
issuance for general corporate
purposes which may include working capital requirements, the financing of capital
expenditures, future acquisitions, the repayment or refinancing of outstanding indebtedness,
payment of dividends and distributions and the repurchase of all or any part of its
outstanding debt obligations.In September 2009, the Company sold an additional $85,000 principal amount of the Senior
Secured Notes at 94% of face value in a private offering to qualified institutional investors
in accordance with Rule 144A of the Securities Act of 1933.
 8




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 The Senior Secured Notes are fully and unconditionally guaranteed on a joint and several basis
by all of the wholly-owned domestic subsidiaries of Vector that are engaged in the conduct of
the Vectors cigarette businesses, including Vector Tobacco. Vector Tobaccos stock has been
pledged as collateral for the guarantee of the Senior Secured Notes. Vector Tobaccos
consolidated balance sheet, statement of operations and statement of stockholders equity
(deficiency) as of December 31, 2009 and 2008 for each of
the three years in the period ended December 31, 2009 do not reflect any accounts related to these notes as the
debt is not acquisition related.The Senior Secured Notes are due with a lump sum payment of $250,000 in 2015. Vector
Tobaccos cash flows from operations may be utilized to fund the interest and debt obligation
of the Senior Secured Notes.Additional Parent Company NotesAs of December 31, 2009, Vector has debt with a net amount of approximately $74,437 (face amount $267,530) in
addition to the principal amount of Senior Secured Notes previously discussed. These notes are not
reflected in Vector Tobaccos consolidated financial statements because they are not
collateralized by Vector Tobaccos assets and Vector Tobacco has not guaranteed these obligations.General Corporate ExpensesGeneral corporate expense allocations represent costs related to corporate functions such as
executive oversight, risk management, accounting, legal, investor relations, tax, other
services and employee benefits and incentives Vector provides to the Company. The allocations
are based on a reasonable estimation of Vectors overhead expenses based on the relative
specific identification and the relative percentage of the Companys revenues and headcount to
Vectors total cost. All of these allocations are reflected in management fees paid to Vector
Group Ltd. of $500, $500 and $500 in the Companys consolidated statements of operations for
each of the years ended December 31, 2008, 2008, and 2007, respectively.The Company and Vector considered these general corporate expense allocations to be a
reasonable reflection of the utilization of services provided. The allocations may not,
however, reflect the expense the Company would have incurred as a stand-alone company. Actual
costs which may have been incurred if the Company had been a stand-alone company in 2007, 2008
and 2009 would depend on a number of factors, including how the Company chose to organize
itself, what if any functions were outsourced or performed by Company employees and strategic
decisions made in areas such as infrastructure. However, the Company currently does not
believe the difference between the cost allocations from Vector and the costs the Company
would have incurred on a stand-alone basis would have a material impact on the Companys
statements of operations, balance sheets or statements of cash flows for 2007, 2008, and 2009.BackgroundIn January 2003, Vector Tobacco introduced QUEST, the Companys brand of low nicotine and
nicotine-free cigarette products. QUEST brand cigarettes were
marketed from 2003 until 2009 as premium cigarettes
to permit adult smokers, who wish to continue smoking, to gradually reduce their intake of
nicotine. The products are not labeled or advertised for smoking cessation and
Vector Tobacco makes no claims that QUEST is safer than other cigarette products. Vector
Tobacco ceased manufacturing Quest cigarettes during the third quarter of 2009.Vector Tobacco is also engaged in the sale of conventional cigarettes through their USA,
Silver Eagle, Eagle and Meridian brands.
 9




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 Recent DevelopmentsIn February 2009 Vector Tobacco settled an outstanding patent interference suit with North
Carolina State University (NCSU). Under the terms of the settlement, Vector Tobacco received
$325 during 2009. The $325 was recorded as a reduction of expense in 2009. The patents have a
book value of $0 at December 31, 2008 and 2009. 2.
    
    Summary of Significant Accounting Policies Basis of PresentationThese consolidated financial statements include the accounts of Vector Tobacco and its
wholly-owned subsidiaries; Vector Tobacco Limited (Bermuda), and VT Real Estate Limited. The
consolidated financial statements exclude VT Aviation LLC as Vector consolidates this entity
as its primary beneficiary. In 2007, VT Real Estate Limited was dissolved. In 2008, Vector
Tobacco Limited (Bermuda) was dissolved. All significant intercompany balances and
transactions have been eliminated.Estimates and AssumptionsThe preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities as of
December 31, 2009, and 2008, and the reported amounts of revenues and expenses for the years
ended December 31, 2009, 2008, and 2007. Significant estimates subject to material changes in
the near term include restructuring and impairment charges, promotional accruals, inventory
reserves, allowances for doubtful accounts and allowances for sales returns, Master Settlement
Agreement (MSA) liabilities and litigation and defense costs. Actual results could differ
from those estimates.Cash and Cash EquivalentsFor purposes of the statements of cash flows, cash includes cash on hand, cash on deposit in
banks and cash equivalents, comprised of short-term investments which have an original
maturity of 90 days or less. The carrying value of cash and cash equivalents, restricted
assets and short-term loans approximate their fair value. The Company places its cash and
cash equivalents with large commercial banks. The Federal Deposit Insurance Corporation
(FDIC) and Securities Investor Protection Corporation (SIPC) insure these balances, up to
$250 and $500, respectively. The carrying amount of bank deposits, including amounts
classified as cash and cash equivalents, were approximately $472 and $178 at December 31,
2009, and 2008 respectively. Bank deposits of approximately $100 and $178 at December 31, 2009
and 2008, respectively, are insured by the FDIC.Accounts ReceivableAccounts receivable-trade is recorded at their net realizable value. The allowance for
doubtful accounts and cash discounts was $18 and $15 at December 31, 2009 and 2008,
respectively.InventoriesInventories are stated at the lower of cost or market with cost determined using the last-in,
first-out method. Although portions of leaf tobacco inventories may not be used or sold
within one year because of the time required for aging, they are included in current assets,
which is common practice in
the cigarette industry. It is not practicable to determine the amount that will not be used
or sold within one year.The Company estimates an inventory reserve for excess quantities and obsolete items based on
specific identification and historical write-offs, taking into account future demand and
market conditions.
 10




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 Property, Plant and EquipmentProperty, plant and equipment are stated at cost and are depreciated using the straight-line
method over the estimated useful lives of the respective assets which are three to fifteen
years for machinery and equipment. Leasehold improvements are amortized over the term of the
respective lease or the estimated useful life of improvements whichever is shorter.Expenditures for repairs and maintenance are charged to expense as incurred. The costs of
major renewals and betterments are capitalized. The cost and related accumulated depreciation
of property, plant and equipment are removed from the accounts upon retirement or other
disposition and any resulting gain or loss is reflected in operations.The Company reviews long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable.
Accordingly, when indicators of impairment are present, the Company evaluates the carrying
value of property, plant and equipment against their related future undiscounted cash flows.
If the carrying value exceeds such cash flows, then impairment is deemed to exist. The amount
of any impairment is determined by comparing the long-lived assets carrying value against its
fair value, which is determined using discounted future cash flows.Intangible AssetThe Company is required to conduct an annual review of intangible assets for potential
impairment including the intangible asset of $107,511, which is not subject to amortization
due to its indefinite useful life. This intangible asset relates to the exemption of
Medallion, acquired in April 2002, under the MSA agreement, which states payments under the
MSA continue in perpetuity. (See Note 6) As a result, the Company believes it will realize the
benefit of the exemption for the foreseeable future.Other intangible assets, included in other assets, consisting of trademarks are amortized
using the straight-line method over 10 years and had a net book value of $0 and $46 at
December 31, 2009 and 2008, respectively. The amortization expense related to the intangible
assets was $8, $7, and $7 in 2009, 2008, and 2007, respectively. In connection with the
restructuring of Vector Tobacco, the Company recorded an impairment charge of approximately
$38 related to Quest trademark agreements, which is included as a component of Operating,
selling, general and administrative charges in the Companys consolidated statement of
operations for the year ended December 31, 2009.Other AssetsOther current assets of $192 and $209 as of December 31, 2009 and 2008, respectively, are
primarily pre-paid items including insurance.Other non-current assets of $999 and $817 as of December 31, 2009 and 2008, respectively, are
primarily related to the cash surrender value of certain life insurance policies.Revenue RecognitionRevenues from sales are recognized upon shipment of finished goods when title and risk of loss
have passed to the customer, there is pervasive evidence of an arrangement, the sales price is
determinable and collectibility is reasonably assured. The Company provides for expected sales
returns. Certain sales incentives, including buydowns, are classified as reductions of net
sales. The Companys accounting policy is to include federal excise taxes in revenues and cost
of goods sold. Such revenues and cost of goods sold totaled $52,365, $22,212, and $23,681 for
the years ended December 31, 2009, 2008, and 2007, respectively. The large increase in 2009
was due to the imposition of a $6.17 per carton increase in the federal excise tax on tobacco
products effective April 1, 2009. Since the
 11




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 Companys primary line of business is tobacco,
the Companys financial position and its results of operations and cash flows have been and
could continue to be materially adversely affected by significant unit sales volume declines,
litigation and defense costs, increased tobacco costs or reductions in the selling price of
cigarettes in the near term.Shipping and Handling Fees and CostsShipping and handling fees related to sales transactions are not billed to customers nor
recorded as sales revenue. Shipping and handling costs, which were $572, $595, and $634 in
2009, 2008, and 2007, respectively, are recorded as selling, general and administrative
expenses.Advertising CostsAdvertising costs are expensed as incurred and were $14, $27, and $38 for the years ended
December 31, 2009, 2008 and 2007, respectively and are recorded as selling, general and
administrative expenses.Research and Development CostsResearch and development costs are expensed as incurred and were $1,552, $2,960, and $4,240 in
2009, 2008, and 2007, respectively. The ongoing decline in expense from 2007 to 2009 relates
primarily to the decision not to pursue FDA approval of Quest as a smoking cessation device.
(Note 16) In connection with this decision, the Company closed its Durham, NC research
operations in the second quarter of 2009.Stock-Based CompensationEffective January 1, 2006, Vector Tobacco through an affiliate accounted for employee stock
compensation plans by measuring compensation cost for share-based payments at fair value.Employee BenefitsAs of December 31, 2009, Vector Tobacco has no employees. Employees of Liggett Vector Brands,
an affiliate, perform services for Vector Tobacco and associated expenses, including benefits,
of such employees are allocated to Vector Tobacco. A senior executive of Liggett Vector Brands
who provides services to Vector Tobacco participates in the Supplemental Executive Retirement
Plan (SERP) sponsored by Vector and such expenses are allocated from Vector to Vector
Tobacco.The cost of providing retiree pension benefits, health care and life insurance benefits is
actuarially determined and accrued over the service period of the active employee group. The
funded status of each defined benefit pension plan, retiree health care and other
postretirement benefit plans and postemployment benefit plans as of December 31, 2009 and 2008
are recognized on the balance sheet.Income TaxesAccounting guidance requires that an entity recognize the financial statement impact of a tax
position when it is more likely than not that the position will be sustained upon examination.
If the tax position meets the more-likely-than-not recognition threshold, the tax effect is
recognized at the largest amount of the benefit that is greater than 50% likely of being
realized upon ultimate settlement. Any liability
created for unrecognized deferred tax benefits is presented as a liability and cannot be
combined with deferred tax liabilities or assets.Deferred taxes reflect the impact of temporary differences between the amounts of assets and
liabilities recognized for financial reporting purposes and the amounts recognized for tax
purposes as well as tax credit carryforwards and loss carryforwards. These deferred taxes are
measured by applying currently enacted tax rates. A valuation allowance reduces deferred tax
assets when it is deemed more likely
 12




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 than not that future taxable income will be insufficient
to realize some portion or all of the deferred tax assets. A current tax provision is
recorded for any income taxes payable.Vector Tobaccos U.S. income tax provision and related deferred income tax amounts are
determined as if the Company filed tax returns on a stand-alone basis. The Companys entities
currently join in the filing of a consolidated U.S. tax return with Vector and its other U.S.
subsidiaries.Although indefinite-lived intangible assets and goodwill are not amortized, the Company
recognizes deferred tax liabilities and assets for temporary differences related to its
indefinite-lived intangible asset and the tax-deductible portion of such assets. Because
indefinite-lived intangible assets are not amortized for financial reporting purposes, the
related deferred tax liability will not reverse until some indeterminate future period should
the assets become impaired or are disposed of. Therefore, the reversal of deferred tax
liability related to the Medallion intangible asset is no longer considered a source of future
taxable income in assessing the realization of deferred tax assets. As a result, the Company
is required to record a deferred tax asset valuation allowance totaling approximately $46,900
and $135,000 as of December 31, 2009 and 2008, respectively.Legal CostsThe Company records product liability legal expenses and other litigation costs as selling,
general and administrative expenses as those costs are incurred.The Company records provisions in its consolidated financial statements for pending litigation
when it is determined that an unfavorable outcome is probable and the amount of loss can be
reasonably estimated. Management is unable to make a reasonable estimate with respect to the
amount or range of loss that could result from an unfavorable outcome in any of the pending
tobacco-related cases or the costs of defending such cases, and no amounts have been provided
in the Companys consolidated financial statements for unfavorable outcomes. Litigation is
subject to many uncertainties, and 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 such tobacco-related litigation.Distributions and Dividends on Common StockThe Company records distributions on its common stock as dividends in its consolidated
statement of stockholders equity (deficiency) to the extent of retained earnings. Any amounts
exceeding retained earnings are recorded as a reduction to additional paid-in-capital.Comprehensive IncomeOther comprehensive income is a component of
stockholders equity and relates to
pension related adjustments. The Companys comprehensive income was $108,032, $15,348 and
$7,520 for the years ended December 31, 2009, 2008 and 2007, respectively.The components of accumulated other comprehensive income, were as follows at December 31:
 2009
    

    2008
    

2007Pension related amounts
    
    $
    295
    
    
    $
    321
    
    
    $
    312
 Fair Value of Financial InstrumentsThe estimates presented herein are not necessarily indicative of the amounts the Company could
realize in a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair values.
 13




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 
 December 31, 2009
    
    December 31, 2008Carrying
    
    Fair
    
    Carrying
    
    FairAmount
    
    Value
    
    Amount
    
    ValueFinancial assets:Cash and cash equivalents
    
    $
    472
    
    
    $
    472
    
    
    $
    178
    
    
    $
    178
 New Accounting PronouncementsIn June 2009, the Financial Accounting Standards Board (FASB) issued the FASB Accounting
Standards Codification (the Codification). The Codification is the single source of
authoritative nongovernmental U.S. GAAP, superseding existing FASB, American Institute of
Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related
literature. The Codification eliminates the GAAP hierarchy contained in Statement of Financial
Accounting Standard and establishes one level of authoritative GAAP. All other literature is
considered non-authoritative. The Codification is effective for financial statements issued
for interim and annual periods ending after September 15, 2009. In response, the Company has
used plain English or included the references to the Codification, as appropriate, in these consolidated financial statements.On January 1, 2008, the FASB issued new accounting guidance on fair value measurement. The
guidance does not require any new fair value measurements but provides a definition of fair
value, establishes a framework for measuring fair value, and expands disclosure about fair
value measurements. On January 1, 2009, the Company adopted the guidance as it relates to
nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at fair
value in the financial statements on at least an annual basis. The guidance defines fair
value, establishes a framework for measuring fair value in accounting principles generally
accepted in the United States of America (GAAP), and expands disclosures about fair value
measurements. The provisions of this standard apply to other accounting pronouncements that
require or permit fair value measurements and are to be applied prospectively with limited
exceptions. The adoption of the guidance did not have a material impact on the Companys consolidated financial statements.In April 2009, the FASB issued a staff position providing additional guidance that clarifies
the methodology used to determine fair value when there is no active market or where the price
inputs being used represent distressed sales. The staff position guidance reaffirms the
objective of fair value measurement, as stated in the original guidance which is to reflect
how much an asset would be sold for in an orderly transaction. It also reaffirms the need to
use judgment to determine if a formerly active market has become inactive, as well as to
determine fair values when markets have become inactive. The adoption of the staff position
guidance had no impact on the Companys consolidated financial statements.On January 1, 2009, the FASBs revised guidance on business combinations became effective.
The revision is intended to simplify existing guidance and converge rulemaking under U.S. GAAP
with international accounting rules. The adoption of this standard did not have a material
impact on the Companys consolidated financial statements.On January 1, 2009, the FASBs amended guidance on determining whether instruments granted in
share-based payment transactions are participating securities became effective for the
Company. The amended guidance states that unvested share-based payment awards that contain
nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are
participating securities and shall be included in the computation of earnings per share
pursuant to the two-class method. The adoption of the amended guidance had no impact on the
Companys consolidated financial statements.
 14




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 In April 2009, the FASB issued authoritative guidance on the methodology for determining
whether an other-than-temporary impairment exists for debt securities and the amount of the
impairment to be recorded in earnings through increased consistency in the timing of
impairment recognition and enhanced disclosures related to the credit and noncredit components
of impaired debt securities that are not expected to be sold. In addition, increased
disclosures are required for both debt and equity securities regarding expected cash flows,
credit losses, and an aging of securities with unrealized losses. The adoption of the
guidance did not have an impact on the consolidated financial statements.In December 2008, the FASB issued authoritative guidance on employers disclosures about plan
assets of a defined benefit pension or other postretirement plan. The objective of the
guidance is to provide users of financial statements with an understanding of how investment
allocation decisions are made, the major categories of plan assets held by the plans, the
inputs and valuation techniques used to measure the fair value of plan assets, significant
concentration of risk within the companys plan assets, and for fair value measurements
determined using significant unobservable inputs, a reconciliation of changes between the
beginning and ending balances. The Company adopted the new disclosure requirements in the 2009
annual reporting period.In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for
transfers of financial assets. The guidance requires additional disclosures for transfers of
financial assets and changes the requirements for derecognizing financial assets. The Company
will adopt these Statements for annual reporting periods beginning on January 1,
2010. The Company is currently assessing the impact, if any, of the amended guidance on its consolidated financial statements.In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for
the consolidation of variable interest entities. The amended guidance eliminates exceptions
to consolidating qualifying special purpose entities, contains new criteria for determining
the primary beneficiary, and increases the frequency of required reassessments to determine
whether a company is the primary beneficiary of a variable interest entity. This guidance
also contains a new requirement that any term, transaction, or arrangement that does not have
a substantive effect on an entitys status as a variable interest entity, a companys power
over a variable interest entity, or a companys obligation to absorb losses or its right to
receive benefits of an entity must be disregarded. The elimination of the qualifying
special-purpose entity concept and its consolidation exception means more entities will be
subject to consolidation assessments and reassessments. The Company will adopt these
statements for annual reporting periods beginning on January 1, 2010. The Company
is currently assessing the impact, if any, the amended guidance on its consolidated
financial statements.In May 2009, the FASB issued guidance which establishes general standards of: 1) the period
after the balance sheet date during which management of a reporting entity should evaluate
events or
 15




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 transactions that may occur for potential recognition or disclosure in the financial
statements; 2) the circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements; and 3) the disclosures
that an entity should make about events or transactions that occurred after the balance sheet
date. The adoption of this guidance did not impact the Companys consolidated
financial statements.In January 2010, the FASB issued authoritative guidance intended to improve disclosure about
fair value measurements. The guidance requires entities to disclose significant transfers in
and out of fair value hierarchy levels and the reasons for the transfers and to present
information about purchases, sales, issuances, and 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 annual periods beginning after December 15, 2010. As this guidance provides only disclosure requirements, the adoption of
this standard will not impact the Companys consolidated financial statements. 3.
    
    Medallion On April 1, 2002, an indirect wholly owned subsidiary of Vector acquired the stock of
Medallion and certain related assets from Medallions principal stockholder. The total
purchase price consisted of $50,000 in cash and $60,000 in promissory notes, which were
guaranteed by Vector and Liggett. Subsequently, and on the same day, the acquiring Vector
subsidiary and Vector Tobacco were merged into Medallion, and Medallion was renamed Vector
Tobacco Inc. As a result of the aforementioned transactions, Vector Tobacco became the
obligor for $60,000 of promissory notes (See Note 8). Vector made the final acquisition
payment of $35,000 on April 2, 2007 on behalf of Vector Tobacco. The Company has accounted
for the Vector payment of $35,000 as a capital contribution during 2007.Medallion, formerly a discount cigarette manufacturer headquartered in Richmond, Virginia, is
a participant in the MSA agreement between the state Attorneys General and the tobacco
industry. Medallion has no payment obligations under the MSA agreement except to the extent
its market share exceeds approximately 0.28% of total cigarettes sold in the United States
(approximately 900 million cigarettes in 2009).
 16




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 4.
    
    Inventories Inventories consist of the following at December 31:
 2009
    
    
    2008Leaf tobacco
    
    $
    329
    
    
    $
    628Work-in-process
    
    
    
    
    
    
    3Finished goods
    
    
    5,467
    
    
    
    4,179Inventories at current cost
    
    
    5,796
    
    
    
    4,810LIFO adjustment
    
    
    (14
    )
    
    
    Total inventories, net
    
    $
    5,782
    
    
    $
    4,810
 Leaf tobacco at December 31, 2009 includes costs related to tobacco purchased by the Company
from third party tobacco dealers and tobacco grown under contract with independent farmers.
There were no leaf tobacco purchase commitments at Vector Tobacco as of December 31, 2009.The Company classifies the prepaid cost of the MSA in ending inventory. The prepaid cost of
MSA was $1,654 and $1,874 at December 31, 2009 and 2008, respectively.Since January 1, 2004 all of Vector Tobaccos products have been manufactured under a contract
manufacturing agreement by Liggett at Liggetts manufacturing facility in Mebane, North
Carolina. (See Note 15) 5.
    
    Property, Plant and Equipment Property, plant and equipment consist of the following at December 31:
 2009
    
    
    2008Buildings and improvements
    
    $
    
    
    
    $
    47Machinery and equipment
    
    
    858
    
    
    
    1,712Property, plant and equipment
    
    
    858
    
    
    
    1,759Less accumulated depreciation
    
    
    (833
    )
    
    
    (1,687
    )Property, plant and equipment, net
    
    $
    25
    
    
    $
    72
 Depreciation expense was $20, $32, and $48 for the years ended December 31, 2009, 2008, and
2007, respectively. There were no commitments to purchase machinery and equipment at
December 31, 2009. 6.
    
    Intangible Assets Intangible assets consist of the following at December 31:
 17




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 
 2009
    
    
    2008Indefinite useful live intangible asset
    
    $
    107,511
    
    
    $
    107,511
 In connection with the acquisition of Medallion, the Company allocated a portion of the total
purchase price of $110,000 to Medallions exemption under the
MSA agreement. See Note 3.
This intangible asset was deemed to have an indefinite useful life and is tested for
impairment annually or more frequently when indicators of impairment are present. The annual
test was performed in the fourth quarter of 2009, 2008, and 2007, resulting in no impairment.Other intangible assets, included in other assets, consists of trademarks which were amortized
using the straight-line method over 10 years and had a net book value of $0 and $46 at
December 31, 2009, and 2008, respectively. Amortization expense associated with trademarks
and patents totaled $8 in 2009 and $7 in both 2008 and 2007. An impairment charge of $38 was
taken in the fourth quarter of 2009 to write off the remaining value of the trademarks. 7.
    
    Revolving Demand Promissory Note  Parent Vector Tobacco had a revolving demand promissory note with VGR and Vector. This credit
facility, as amended, provided for borrowings up to $350,000. The principal amount was
payable in full upon thirty days notice of demand. Interest accrued on the unpaid principal
balance at the prime rate plus 1% and was added to the principal balance on the first day of
each month. Accrued interest was payable upon any prepayment of the principal or upon demand.
The loan was revolving and Vector Tobacco had the right to repay a portion of the loan from
time to time and thereafter seek to borrow additional funds.The Company incurred interest expense of $5,127 in 2007. During 2007, the Company made a
$3,500 interest payment, and in 2007 the Company incurred non-cash interest expense of $1,627,
which increased the balance of the revolving demand promissory note due to parent.In June 2007, Vector contributed its revolving demand promissory note (with an outstanding
balance of $109,396) to Vector Tobacco by cancelling the note. The transaction was recorded as
a capital contribution to the Company. 8.
    
    Long-Term Debt Notes Payable for Medallion AcquisitionOn April 1, 2002 as a result of the Medallion transaction described in Note 3, the Company
became obligor on two promissory notes totaling $60,000. The first note for $25,000 bore
interest at 9% and was paid off at a rate of $3,125 per quarter commencing June 30, 2002 and
continuing through March 31, 2004. The second note for $35,000 bore interest at 6.5% payable
semi-annually. The entire principal was retired on April 2, 2007. 9.
    
    Employee Benefit Plans The Companys portion of the 401(k) plan expenses sponsored by Liggett Vector Brands, for
entities in the affiliates controlled group, were $43, $71, and $29 for the years ended
December 31, 2009, 2008, and 2007, respectively.
 18




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 Defined Benefit Retirement PlansDuring 2009, 2008, and 2007, a certain senior executive of the Company also participated in
the Supplemental Executive Retirement Plan (SERP) sponsored by Vector. The Company will
reimburse Vector for payment of supplemental retirement benefits to the senior executive. The
Company expensed $245, $212, and $191 in relation to the SERP plan during 2009, 2008, and
2007. The executives retirement date is January 1, 2012 and the Company projects the
payment under the SERP will be approximately $1,703. 10.
    
    Income Taxes Vector Tobaccos income tax provision and related deferred income tax amounts are determined
as if the Company filed tax returns on a stand alone basis. The Companys entities currently
join in the filing of a consolidated tax return with Vector and its other subsidiaries.The amounts provided for income taxes are as follows: Year Ended December 31,2009
    
    
    2008
    
    
    2007Current:U.S. Federal
    
    $
    4,746
    
    
    $
    
    
    
    $
    State
    
    
    1,487
    
    
    
    
    
    
    
    $
    6,233
    
    
    $
    
    
    
    $
    Deferred:U.S. Federal
    
    $
    (91,041
    )
    
    $
    1,468
    
    
    $
    2,340State
    
    
    (5,095
    )
    
    
    515
    
    
    
    515(96,136
    )
    
    $
    1,983
    
    
    $
    2,855Total
    
    $
    89,903
    
    
    $
    1,983
    
    
    $
    2,855
 Vector Tobaccos operations are included in consolidated federal and state income tax returns
of its indirect parent, Vector Group Ltd. At December 31, 2009 and 2008, the Company had
$46,899 and $134,849 of unrecognized net deferred tax assets, comprised principally of net
operating loss carryforwards, available to offset future taxable income for federal and state
income tax purposes, respectively. A valuation allowance had been provided against these net
deferred tax assets as of December 31, 2008 because it was deemed more likely than not that the benefit of such
net tax assets would not be utilized. The valuation allowance was
reduced in 2009 for the recognition
of federal and state tax net operating losses after evaluating the impact of the negative and
positive evidence that such asset would be realized. The Company based its conclusion on the
fact that Vector Tobacco reported federal and state taxable income on a separate company basis
for the second consecutive year in 2009. The Company continues to evaluate the realizability
of its net deferred tax assets and its estimate is subject to change. The reversal of deferred
tax liabilities related to Medallion intangible asset are not considered a source of future
taxable income in assessing the realization of deferred tax assets. As a result, the Company
was required to record a deferred tax asset valuation allowance totaling approximately $46,899
and $134,849 during the year ended December 31, 2009 and 2008, respectively.The Companys parent, VGR, participates in a tax sharing agreement with Vector in which VGR
remits tax payments to Vector based on the consolidated taxable income of VGR and its
subsidiaries (the VGR Group). Under the tax sharing agreement, each member of the VGR Group
whose tax liability is reduced by a net operating loss or credit of another member is treated
as paying such member for the use of such benefit. However, the member providing such benefit
does not receive credit until it is able to use the benefit on a separate company basis,
rather than when the benefit is actually used by the VGR Group. Because Vector Tobacco could
not use the benefit of its net operating losses on a separate company basis, VGR did not
allocate tax benefits to Vector Tobacco as of December 31, 2008, and 2007. Consequently, no
income tax benefit was recorded for the years ended December 31, 2008, and 2007.Temporary differences which give rise to a significant portion of deferred tax assets and
liabilities are as follows:
 2009
    
    
    2008Deferred Tax
    
    
    Deferred TaxAsset
    
    
    Liability
    
    
    Asset
    
    
    LiabilitySales and product allowances
    
    $
    419
    
    
    $
    
    
    
    $
    330
    
    
    $
    Inventories
    
    
    15
    
    
    
    1,433
    
    
    
    21
    
    
    
    Property, plant and equipment
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    11
 19




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 2009
    
    
    2008Deferred Tax
    
    
    Deferred TaxAsset
    
    
    Liability
    
    
    Asset
    
    
    LiabilityCompensation, benefits and related items
    
    
    467
    
    
    
    
    
    
    
    561
    
    
    
    Amortization of intangibles
    
    
    
    
    
    
    22,542
    
    
    
    
    
    
    
    19,122Restructuring
    
    
    6
    
    
    
    
    
    
    
    6
    
    
    
    Settlement payments
    
    
    1,901
    
    
    
    
    
    
    
    
    
    
    
    1,535Net operating losses
    
    
    139,545
    
    
    
    
    
    
    
    144,814
    
    
    
    Valuation allowance
    
    
    (46,899
    )
    
    
    
    
    
    
    (143,835
    )
    
    
    Reclassifications
    
    
    
    
    
    
    
    
    
    
    (1,546
    )
    
    
    (1,546
    )Total deferred taxes
    
    $
    95,454
    
    
    $
    23,983
    
    
    $
    
    
    
    $
    19,122
 Differences between the amounts provided for income taxes and amounts computed at the federal
statutory tax rates for the years ended December 31, 2009, 2008, and 2007 are summarized as
follows:
 2009
    
    
    2008
    
    
    2007Income before income tax provision
    
    $
    18,155
    
    
    $
    17,322
    
    
    $
    10,366Federal income tax expense at statutory rate
    
    $
    6,354
    
    
    $
    6,063
    
    
    $
    3,628State income tax provision at statutory rate,
net of federal income taxes
    
    
    1,654
    
    
    
    338
    
    
    
    488Other changes due to changes in deferred
state income tax rates
    
    
    (493
    )
    
    
    (385
    )
    
    
    (330
    )Change in valuation allowance, net
    
    
    (97,418
    )
    
    
    (4,033
    )
    
    
    (931
    )Total income tax (benefit) provision
    
    $
    (89,903
    )
    
    $
    1,983
    
    
    $
    2,855
 There were no unrecognized tax benefits for the years ended December 31, 2009, 2008 and 2007,
respectively. The Company classifies all tax-related interest and penalties as income tax
expense. 11.
    
    Operating Leases As of December 31, 2009, the Company has no operating leases.Rental expense for the years ended December 31, 2009, 2008, and 2007 was $378, $340, and $349,
respectively. This includes $141 expensed as part of the Companys restructuring in 2009. 12.
    
    Concentrations of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk
consist principally of trade receivables and cash and cash equivalents.Vector Tobaccos customers are primarily candy and tobacco distributors, and large grocery,
drug and convenience store chains. Three customers accounted for approximately 42%, 14% and
13%, respectively of gross sales in 2009. Three customers accounted for approximately 35%, 17%
and 15%, respectively of gross sales in 2008. Three customers accounted for approximately 32%,
17% and 15%, respectively of gross sales in 2007. Concentrations of credit risk with respect
to trade receivables are limited due to the number of customers comprising the Companys
customer base and the frequency of orders by these customers. Vector Tobaccos largest single
customer represented approximately 39%
 20




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 of net accounts receivable at December 31, 2009 and 28%
at December 31, 2008. Ongoing credit evaluations of customers financial condition are
performed and, generally, no collateral is required. The Company maintains reserves for
potential credit losses and such losses, in the aggregate, have generally not exceeded
managements estimates.The Company maintains cash deposits and money market accounts with major banks which from time
to time may exceed federally insured limits. The Company periodically assesses the financial
condition of the institutions and believes that the risk of loss is minimal. 13.
    
    Contingencies Tobacco-Related LitigationOverviewSince 1954, 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. Although, new cases continue to be commenced
against certain cigarette manufacturers, including Vector Tobaccos affiliate, Liggett Group
LLC, Vector Tobacco has not been named as a defendant in any such actions.Master Settlement AgreementIn November 1998, Philip Morris Incorporated, Brown & Williamson Tobacco Corporation, R.J.
Reynolds Tobacco Company and Lorillard Tobacco Company (collectively, the Original
Participating Manufacturers or OPMs) (together with the OPMs and 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 Marianas (collectively, the Settling States) to settle the asserted and
unasserted health care cost recovery and certain other claims of those Settling States. The
MSA received final judicial approval in each of the settling jurisdictions. In February 1999,
Medallion (n/k/a Vector Tobacco) became a subsequent participating manufacturer under the MSA.In the Settling States, the MSA released Vector Tobacco 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
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
 21




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Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 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; prohibits Participating Manufacturers from using as a
tobacco product brand name any nationally recognized non-tobacco brand or trade name or the
name or 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 usage 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 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, obligations of each
Participating Manufacturer and are not the responsibility of any parent or affiliate of a
Participating Manufacturer.Vector Tobacco has no payment obligations under the MSA except to the extent its market share
exceeds a base amount of approximately 0.28% of total cigarettes sold in the United States
(approximately 900 million cigarettes in 2009). If Vector Tobaccos market share exceeds its respective market share exemption in a given year, then on April 15 of the following
year, Vector Tobacco must pay on each excess unit an amount equal (on a per-unit basis) to
that due by the OPMs for that year. Vector Tobacco paid $2,500 for its 2007 MSA
obligations and paid $3,040 for its 2008 MSA obligations. Vector Tobacco expensed $8,496
for its estimated MSA obligation for 2009 as part of cost of goods sold. Vector Tobacco
prepaid $5,500 of its 2009 estimated MSA obligation in December 2009. Additional amounts may
be due for 2009 but will not be determined by the Independent Auditor until April 2010.Certain MSA DisputesNPM Adjustment.In March 2006, an economic consulting firm selected pursuant to the MSA
rendered its final and non-appealable decision that the MSA was a significant factor
contributing to the loss of market share of Participating Manufacturers to non-participating
manufacturers for 2003. This is known as the NPM Adjustment. The economic consulting firm
rendered the same decision with respect to 2004, 2005 and 2006. As a result, the
manufacturers are entitled to a potential NPM Adjustment to their 2003, 2004, 2005 and 2006
MSA payments. The Participating Manufacturers are also entitled to potential NPM Adjustments
to their 2007, 2008 and 2009 payments pursuant to an agreement entered into in June 2009
between the OPMs and the Settling States under which the OPMs agreed to make certain payments
for the benefit of the Settling States, in exchange for which the Settling States stipulated
that the MSA was a significant factor contributing to the loss of market share of
Participating Manufacturers in 2007, 2008 and 2009. A Settling State that has diligently
enforced its qualifying escrow statute in the year in question may be able to avoid
application of the NPM Adjustment to the payments made by the manufacturers for the benefit
of that Settling State.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
 22




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 have ruled that the 2003 NPM Adjustment dispute is
arbitrable. All 47 of those decisions are final and non-appealable. One court, the Montana
Supreme Court, ruled that Montanas claim of diligent enforcement must be litigated. This
decision has been appealed. In response to a proposal from each of the OPMs and many of the
SPMs, 45 of the Settling States have entered into an agreement providing for a nationwide
arbitration of the dispute with respect to the NPM Adjustment for 2003. The agreement
provides for selection of the arbitration panel beginning November 1, 2009 and that the
parties and the arbitrators will thereafter establish the schedule and procedures for the
arbitration. Because states representing more than 80% of the allocable share signed the
agreement, signing states will receive a 20% reduction of any potential 2003 NPM adjustment.
It is anticipated that the arbitration will commence in 2010. There can be no assurance that
Vector Tobacco will receive any adjustment as a result of these proceedings.Gross v. Net Calculations. In October 2004, the independent auditor notified Vector Tobacco
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).Vector Tobacco has objected to this retroactive change and has disputed the change in
methodology. Vector Tobacco contends that the retroactive change from using 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 Vector
Tobaccos 1997 Market Share (and thus, Vector Tobaccos market share exemption);
and
    
    Vector Tobacco and others have relied upon the calculations based
on gross unit amounts since 1998.
 No amounts have been expensed or accrued in the accompanying financial statements for any potential liability relating to the gross versus net dispute.QUEST 3. Vector Tobacco does not make MSA payments on sales of its QUEST 3 product as Vector
Tobacco believes that QUEST 3 does not fall within the definition of a cigarette under the
MSA. Quest is no longer being sold by Vector Tobacco. There can be no assurance that Vector
Tobaccos assessment is correct and that additional payments under the MSA for QUEST 3 will
not be owed.Other MattersVector Tobaccos management is unaware of any material environmental conditions affecting its
existing facilities. Vector Tobaccos management believes 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, earnings or competitive position of Vector
 23




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 Tobacco. Vector Tobaccos management
is also unaware of any other claims that would materially affect the Companys financial
position, results of operations or cash flows.In February 2008 an arbitration panel ruled on certain matters related to outstanding royalty
payments, legal fees and licensing agreements between Vector Tobacco and a third party. The
awards were fully accrued at December 31, 2007 and paid in 2008. 14.
    
    Legislation and Regulation Vector Tobaccos management believes that it is in compliance in all material respects with
the laws regulating cigarette manufacturers. 15.
    
    Related Party Transactions In October 2002, the sales and marketing functions of Liggett and Vector Tobacco were combined
into Liggett Vector Brands. Liggett Vector Brands coordinates and executes the sales,
marketing and manufacturing efforts along with certain support functions for all of the
Companys tobacco operations. In conjunction with the duties performed at Liggett Vector
Brands, a portion of sales, marketing, manufacturing, distribution, and administrative
expenses have been allocated to the Company. During 2009, 2008 and 2007, Vector Tobacco
expensed $3,507, $3,512 and $3,418, respectively, for services provided by Liggett Vector
Brands. These expenses have been classified as selling, general and administrative costs.In 2006, Vector Tobacco entered into an agreement with VGR to provide various management and
administrative services to Vector Tobacco in consideration for an annual management fee. The
charges for services under this agreement amounted to $500 for each year ending December 31
2009, 2008 and 2007.On January 1, 2004 Vector Tobacco entered into a manufacturing agreement (the Agreement)
with Liggett whereby Liggett agreed to provide handling, storage, manufacturing, preparation,
record-keeping, remittance of federal excise tax payments, processing of returns and other
services relating to the manufacture of Vector Tobacco brands. The Agreement expired
December 31, 2005, but is automatically renewed for a successive one year term unless
otherwise terminated by either party. Pricing is set forth in the Agreement based on
previously determined standard costs and invoices are sent to Vector Tobacco monthly. In
2009, 2008 and 2007, Vector Tobacco purchased approximately 1.2 billion, 1.1 billion and 1.2
billion units, respectively, from Liggett and paid $67,161, $34,557 and $32,845, respectively,
which included profit of $1,349, $1,158 and $1,028, respectively, to Liggett.Vector Tobacco incurred additional expenses of approximately $2, $1, and $3,570 in 2009, 2008
and 2007, respectively, for transactions with VGR and Vector, which primarily reflects
interest payments on the revolving demand promissory note and reimbursement of amounts paid on
behalf of Vector Tobacco.Vector Tobacco has a related party payable to Liggett of $868, and $300 at December 31, 2009
and 2008, respectively, relating to the contract manufacturing agreement.Related party payables for each year ended consisted of the following:
 24




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 
 2009
    
    
    2008Liggett
    
    $
    6,304
    
    
    $
    4,362Vector
    
    
    
    
    
    
    (873
    )Liggett Vector Brands
    
    
    3,325
    
    
    
    2,617$
    9,629
    
    
    $
    6,106
 16.
    
    Restructuring
 Asset ImpairmentEmployee
    
    
    ContractSeverance
    
    
    Termination,and Benefits
    
    
    and Exit Cost
    
    
    TotalsBalance as of December 31, 2006
    
    $
    484
    
    
    $
    423
    
    
    $
    907Change in estimate
    
    
    (71
    )
    
    
    (12
    )
    
    
    (83
    )Utilized in 2007
    
    
    (343
    )
    
    
    (351
    )
    
    
    (694
    )Balance as of December 31, 2007
    
    
    70
    
    
    
    60
    
    
    
    130Change in estimate
    
    
    (14
    )
    
    
    (4
    )
    
    
    (18
    )Utilized in 2008
    
    
    (56
    )
    
    
    (10
    )
    
    
    (66
    )Balance as of December 31, 2008
    
    
    
    
    
    
    46
    
    
    
    46Restructuring charges
    
    
    691
    
    
    
    209
    
    
    
    900Utilized in 2009
    
    
    (586
    )
    
    
    (206
    )
    
    
    (792
    )Balance as of December 31, 2009
    
    $
    105
    
    
    $
    49
    
    
    $
    154
 In November 2006, Vectors Board of Directors determined to discontinue the genetics operation
of Vector Tobacco and not to pursue, at this time, FDA approval of QUEST as a smoking
cessation aid, due to the projected significant additional time and expense involved in
seeking such approval. In connection with this decision, we eliminated 12 full-time positions
effective December 31, 2006. In addition, we terminated certain license agreements associated
with the genetics operation. In March 2009, Vector Tobacco eliminated an additional nine
full-time positions in connection with this decision. Notwithstanding the foregoing, Vector
Tobacco is continuing its dialogue with the FDA with respect to the prospects for phase III
trials. Vector Tobacco will continue to evaluate whether to proceed with phase III trials.The Company recognized pre-tax restructuring charges of $900, during 2009 in connection with
the closure of its Durham research operations. The restructuring charges primarily related to
employee severance and benefit costs. The remaining balance of the severance and benefit costs
restructuring charges was $120 as of December 31, 2009. Approximately $780 was utilized during
2009. 17.
    
    Stock Compensation The Companys parent, Vector, offers stock option plans. As of December 31, 2009, there were
approximately 3,783,653 shares available for issuance under Vectors Amended and Restated 1999
Long-Term Incentive Plan (the 1999 Plan). All employees of Vectors subsidiaries are
eligible to
 25




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 receive grants under such plans. Although Vector Tobacco has no employees it
received a stock compensation expense allocation from Liggett Vector Brands of $39, $43, and
$15 for the years ended December 31, 2009, 2008, and 2007, respectively. These amounts have
been recorded in selling, general and administrative cost in the Companys consolidated
statement of operations. As of December 31, 2009 Liggett Vector Brands has employees with
639,688 options outstanding.The fair value of option grants is estimated at the date of grant using the Black-Scholes
option pricing model. The Black-Scholes option pricing model was developed for use in
estimating the fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly subjective
assumptions including expected stock price characteristics which are significantly different
from those of traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, the existing models do not necessarily provide a
reliable single measure of the fair value of stock-based compensation awards.The assumptions used under the Black-Scholes option pricing model in computing fair value of
options are based on the expected option life considering both the contractual term of the
option and expected employee exercise behavior, the interest rate associated with U.S.
Treasury issues with a remaining term equal to the expected option life and the expected
volatility of Vectors common stock over the expected term of the option. There were no
option grants during 2009, 2008 or 2007 Awards of options to employees under the VGRs stock compensation plans generally vest over
periods ranging from four to five years and have a term of ten years from the date of grant.In November 2005, the President of Liggett and Liggett Vector Brands was awarded a restricted
stock grant of 60,775 shares of Vectors common stock pursuant to the 1999 Plan. Pursuant to
his restricted share agreement, one-fourth of the shares vested on November 1, 2006, with an
additional one-fourth vesting on each of the three succeeding one-year anniversaries of the
first vesting date through November 1, 2009. Vector recorded deferred compensation of $1,018
representing the fair market value of the restricted shares on the date of grant. Vector
Tobacco recorded an expense of $22 in 2009 and $25 associated with the grant for each of the
years ended December 31, 2008, and 2007. These amounts have been recorded in selling, general
and administrative cost in the Companys consolidated statement of operations. 18.
    
    Subsequent Events The Company has evaluated events that occurred subsequent to December 31, 2009, through the
financial statement issue date of March 1, 2010  and determined that there were no recordable or reportable
subsequent events.
 26




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##### 



Vector Tobacco Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009, 2008 and 2007
 (in thousands of dollars)
 
 Schedule II  Valuation and Qualifying Accounts
 AdditionsBalance at
    
    
    Charged to
    
    
    
    
    
    
    Balance atBeginning
    
    
    Costs and
    
    
    
    
    
    
    End ofof Period
    
    
    Expenses
    
    
    Deductions
    
    
    PeriodDescriptionYear ended December 31, 2009Allowance for:Doubtful accounts
    
    $
    5
    
    
    $
    
    
    
    $
    1
    
    
    $
    4Cash discounts
    
    
    10
    
    
    
    2,553
    
    
    
    2,549
    
    
    
    14Deferred tax valuation allowance
    
    
    143,835
    
    
    
    
    
    
    
    96,936
    
    
    
    46,899Sales returns
    
    
    1,000
    
    
    
    622
    
    
    
    615
    
    
    
    1,007Total
    
    $
    144,850
    
    
    $
    3,175
    
    
    $
    100,101
    
    
    $
    47,924Year ended December 31, 2008Allowance for:Doubtful accounts
    
    $
    5
    
    
    $
    
    
    
    $
    
    
    
    $
    5Cash discounts
    
    
    8
    
    
    
    1,817
    
    
    
    1,815
    
    
    
    10Deferred tax valuation allowance
    
    
    138,882
    
    
    
    4,953
    
    
    
    
    
    
    
    143,835Sales returns
    
    
    1,100
    
    
    
    542
    
    
    
    642
    
    
    
    1,000Total
    
    $
    139,995
    
    
    $
    7,312
    
    
    $
    2,457
    
    
    $
    144,850Year ended December 31, 2007Allowance for:Doubtful accounts
    
    $
    5
    
    
    $
    
    
    
    $
    
    
    
    $
    5Cash discounts
    
    
    28
    
    
    
    2,455
    
    
    
    2,475
    
    
    
    8Deferred tax valuation allowance
    
    
    139,813
    
    
    
    (931
    )
    
    
    
    
    
    
    138,882Sales returns
    
    
    1,094
    
    
    
    426
    
    
    
    420
    
    
    
    1,100Total
    
    $
    140,940
    
    
    $
    1,950
    
    
    $
    2,895
    
    
    $
    139,995
 27