10-Q 1 g96793e10vq.txt NEW VALLEY CORPORATION ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2005 Commission File Number 1-2493 New Valley Corporation (Exact name of registrant as specified in its charter) DELAWARE 13-5482050 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 100 S.E. SECOND STREET, 32ND FLOOR MIAMI, FLORIDA 33131 (Address of principal executive offices) (Zip Code) (305) 579-8000 (Registrant's telephone number, including area code) 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. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of August 8, 2005, there were outstanding 23,332,036 of the registrant's Common Shares, $.01 par value. ================================================================================ NEW VALLEY CORPORATION AND SUBSIDIARIES QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005 TABLE OF CONTENTS

- 1 - NEW VALLEY CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in Thousands, Except Per Share Amounts) (Unaudited)

See accompanying notes to condensed consolidated financial statements - 2 - NEW VALLEY CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands, Except Per Share Amounts) (Unaudited)

See accompanying notes to condensed consolidated financial statements - 3 - NEW VALLEY CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands, except per share amounts) (Unaudited)

See accompanying notes to condensed consolidated financial statements - 4 - NEW VALLEY CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands, except per share amounts) (Unaudited)

See accompanying notes to condensed consolidated financial statements - 5 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) (Unaudited) 1. BASIS OF PRESENTATION The condensed consolidated financial statements include the accounts of New Valley Corporation and its majority-owned subsidiaries ("New Valley" or the "Company"). The condensed consolidated financial statements as of June 30, 2005 presented herein have been prepared by the Company and are unaudited. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the financial position as of June 30, 2005 and the results of operations and cash flows for all periods presented have been made. Results for the interim periods are not necessarily indicative of the results for the entire year. These financial statements should be read in conjunction with the consolidated financial statements in New Valley's Annual Report on Form 10-K for the year ended December 31, 2004 as filed with the Securities and Exchange Commission (Commission File Number 1-2493). NATURE OF OPERATIONS The Company is engaged in the real estate business and is seeking to acquire additional operating companies and real estate properties. New Valley holds a 50% interest in Douglas Elliman Realty, LLC ("Douglas Elliman Realty"), which operates a residential real estate brokerage company in the New York metropolitan area. The Company also owns, through its New Valley Realty Division, a 50% interest in Koa Investors LLC ("Koa Investors"), which owns the Sheraton Keauhou Bay Resort & Spa in Kailua-Kona, Hawaii. At June 30, 2005, Vector Group Ltd. ("Vector"), New Valley's principal stockholder, owned 55.1% of New Valley's Common Shares. USE OF ESTIMATES The 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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CONCENTRATION OF CREDIT RISK Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and investments. The Company maintains its cash, cash equivalents and investments with what management believes are high quality and creditworthy financial institutions. The Company's account balances with various of these financial institutions exceed the insured limits of the Federal Deposit Insurance Corporation and Securities Investor Protection Corporation. NET (LOSS) INCOME PER COMMON SHARE Basic net (loss) income per common share is based on the weighted average number of Common Shares outstanding. Diluted net (loss) income per common share assuming full dilution is based on the weighted average number of Common Shares outstanding plus the additional Common Shares resulting from the exercise of stock options and warrants if such exercise was dilutive. The following table reconciles weighted average shares outstanding for basic and diluted purposes. - 6 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited)

The following stock options and warrants were outstanding during the three and six months ended June 30, 2005 and 2004, but were not included in the computation of diluted net (loss) income per common share because either the options' exercise prices were greater than the average market price of the Common Shares or, in the case of net loss per common share, the effect would have been anti-dilutive during the respective periods:

RECLASSIFICATIONS Certain reclassifications have been made to prior interim period financial information to conform to the current interim period presentation. NEW ACCOUNTING PRONOUNCEMENTS In 2004, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"). SFAS No. 123R requires companies to measure compensation cost for share-based payments at fair value. The Company will adopt this new standard prospectively, on January 1, 2006, and has not yet determined the impact that SFAS No. 123 (revised 2004) will have on the Company's financial position or results of operations. - 7 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS No. 154"). SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle. The provisions of SFAS No. 154 require, unless impracticable, retrospective application to prior periods' financial statements of (1) all voluntary changes in accounting principles and (2) changes required by a new accounting pronouncement, if a specific transition is not provided. SFAS No. 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate, which requires prospective application of the new method. SFAS No. 154 is effective for all accounting changes made in fiscal years beginning after December 15, 2005. The application of SFAS No. 154 is not expected to have a material impact on the Company's consolidated financial position or results of operations. In March 2005, the FASB issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations - an Interpretation of SFAS Statement No. 143" ("FIN 47"). FIN 47 clarifies the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and/or method of settlement are conditional on a future event. FIN 47 is effective for fiscal years ending after December 15, 2005. The application of FIN 47 is not expected to have a material impact on the Company's consolidated financial position or results of operations. 2. INVESTMENT IN REAL ESTATE HELD FOR SALE AND MORTGAGE NOTE PAYABLE In February 2005, New Valley completed the sale of its two commercial office buildings in Princeton, N.J. for an aggregate purchase price of $71,500 and recorded a gain of $8,290, net of income taxes of $6,395, in the six months ended June 30, 2005 which has been classified as "Gain on disposal of discontinued operations" in the accompanying condensed consolidated financial statements. The properties were subject to a nonrecourse mortgage loan due in December 2006, of which $39,213 was outstanding at December 31, 2004. New Valley retired the mortgage at closing with the proceeds of the sale. As a result of the sale, New Valley's real estate leasing operations, which were the primary source of New Valley's revenues for 2003, 2004 and the first quarter of 2005, have been treated as discontinued operations in the accompanying condensed consolidated financial statements (see Note 15). 3. INVESTMENTS IN NON-CONSOLIDATED REAL ESTATE BUSINESSES RESIDENTIAL BROKERAGE BUSINESS During 2000 and 2001, New Valley acquired for $1,744 a 37.2% ownership interest in B&H Associates of NY, doing business as Prudential Douglas Elliman Real Estate ("Realty"), formerly known as Prudential Long Island Realty, a residential real estate brokerage company on Long Island, and a minority interest in an affiliated mortgage company. On December 19, 2002, New Valley and the other owners of Realty contributed their interests in Realty to Douglas Elliman Realty, formerly known as Montauk Battery Realty, LLC, a newly formed entity. New Valley acquired a 50% interest in Douglas Elliman Realty as a result of an additional investment of $1,413 by New Valley and the redemption by Realty of various ownership interests. As part of the transaction, Realty renewed for a ten-year term its franchise agreement with The Prudential Real Estate Affiliates, Inc. The owners of Realty also agreed, upon receipt of the required regulatory approvals, to contribute to Douglas Elliman Realty their interests in the related mortgage company. In October 2004, upon receipt of the required regulatory approvals, the former owners of Realty contributed to Douglas Elliman Realty their interests in the related mortgage company. In March 2003, Douglas Elliman Realty purchased the New York City-based residential brokerage firm, Douglas Elliman, LLC ("Douglas Elliman"), formerly known as Insignia Douglas Elliman, and an affiliated property management company, for $71,250. New Valley invested an additional $9,500 in subordinated debt and equity of Douglas Elliman Realty to help fund the acquisition. The subordinated debt, which had an initial principal amount of $9,500, bears interest at 12% per annum and is due in March 2013. Interest income earned by New Valley on the subordinated debt is recognized in the Company's condensed consolidated statements of operations as part of equity income from non-consolidated real estate businesses. New Valley accounts for its interest in Douglas Elliman Realty on the equity method and recorded income of $4,126 and $5,460 for the three and six months ended June 30, 2005, respectively, and $4,704 and $5,413 for the three and six months ended June 30, 2004, respectively, associated with Douglas Elliman Realty. New Valley's equity income from Douglas Elliman Realty for the three and six months ended June 30, 2005 includes $313 and $628, respectively, of interest income earned by New Valley on the subordinated debt. New Valley's equity income from Douglas Elliman Realty for the three and six months ended June 30, 2004 includes $307 and $619, - 8 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) respectively, of interest income earned by New Valley on the subordinated debt and income of $28 and a loss of $30, respectively, which represented 44% of the mortgage company's loss from operations. Summarized financial information as of June 30, 2005 and December 31, 2004 and for the three and six months ended June 30, 2005 and 2004, for Douglas Elliman Realty is presented below. The summarized financial information for 2005 includes the results from operations from the related mortgage company.

The Company received cash distributions from Douglas Elliman Realty of $806 and $1,040 for the three and six months ended June 30, 2005 and $1,079 and $1,238 for the three and six months ended June 30, 2004, respectively. The cash distributions consisted of tax distributions and interest payments received on the subordinated note. - 9 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) HAWAIIAN HOTEL In 2001, together with developer Brickman Associates and other investors, New Valley acquired control of the former Kona Surf Hotel in Kailua-Kona, Hawaii. The Company, which holds a 50% interest in Koa Investors LLC, the owner of the hotel, had invested $11,900 in the project and had committed to make additional investments of up to $600 at June 30, 2005. Following a major renovation, the property reopened in the fourth quarter 2004 as the Sheraton Keauhou Bay Resort & Spa, a four star resort with 521 rooms. In April 2004, a subsidiary of Koa Investors closed on a $57,000 construction loan to finance the renovation. In the event that Koa Investors makes distributions of cash, the Company is entitled to 50% of the cash distributions until it has recovered its invested capital and achieved an annual 12% internal rate of return ("IRR"), compounded on a quarterly basis. The Company is then entitled to 35% of subsequent cash distributions until it has achieved an annual 25% IRR. The Company is then entitled to 30% of subsequent cash distributions until it has achieved an annual 35% IRR. After the Company has achieved an annual 35% IRR, the Company is then entitled to 25% of subsequent cash distributions. The Company accounts for its interest in Koa Investors under the equity method and recorded losses of $1,802 and $3,442 for the three and six months ended June 30, 2005 and losses of $62 and $125 for the three and six months ended June 30, 2004, respectively, associated with the property. Koa Investors capitalized all costs related to the acquisition and development of the property during the construction phase, which ceased in connection with the opening of the hotel in the fourth quarter of 2004. Koa Investors anticipates that the hotel will continue to experience operating losses during its opening phase. Summarized financial information as of June 30, 2005 and December 31, 2004 and for the three and six months ended June 30, 2005 and 2004, respectively, for Koa Investors is presented below.

- 10 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) In August 2005, a wholly-owned subsidiary of Koa Investors borrowed $82,000 at an interest rate of LIBOR plus 2.45%. Koa Investors used the proceeds of the loan to repay its $57,000 construction loan and distributed a portion of the proceeds to its members, including $5,500 to New Valley. As a result of the refinancing, New Valley will record a gain in the third quarter of 2005 equaling the amount by which the distribution exceeds its basis plus any commitment to make additional investments. At June 30, 2005, New Valley's basis in Koa Investors was $4,958 and it had committed to make additional investments of up to $600. The Company did not receive cash distributions from Koa Investors for the three and six months ended June 30, 2005 and 2004. ST. REGIS HOTEL, WASHINGTON, D.C. In June 2005, affiliates of New Valley and Brickman Associates formed 16th & K Holdings LLC ("Hotel LLC"), which acquired the St. Regis Hotel in Washington, DC for $47,000 in August 2005. The Company, which holds a 50% interest in Hotel LLC, had invested $1,377 in the project and had committed to make additional investments of up to $8,623 at June 30, 2005, of which $4,873 has been funded in the third quarter of 2005. The members of Hotel LLC currently plan to renovate the hotel commencing in 2006. In connection with the closing of the purchase of the hotel, a subsidiary of Hotel LLC entered into agreements to borrow up to $50,000 of senior and subordinated debt. The Company accounts for its interest in Hotel LLC under the equity method. Hotel LLC will capitalize all costs related to the renovation of the property during the renovation phase. In the event that Hotel LLC makes distributions of cash, the Company is entitled to 50% of the cash distributions until it has recovered its invested capital and achieved an annual 11% IRR, compounded quarterly. The Company is then entitled to 35% of subsequent cash distributions until it has achieved an annual 22% IRR. The Company is then entitled to 30% of subsequent cash distributions until it has achieved an annual 32% IRR. After the Company has achieved an annual 35% IRR, the Company is then entitled to 25% of subsequent cash distributions. 4. INVESTMENT SECURITIES AVAILABLE FOR SALE Investment securities classified as available for sale are carried at fair value, with net unrealized gains included as a component of stockholders' equity. The Company had realized gains on sales of investment securities available for sale of $0 and $1,441 for the three and six months ended June 30, 2005, respectively, and $5,179 and $5,179 for the three and six months ended June 30, 2004, respectively. The components of investment securities available for sale, which were all equity securities, at June 30, 2005, are as follows:

Investment securities available for sale as of June 30, 2005 include the Company's 11,111,111 shares of Ladenburg Thalmann Financial Services Inc. ("LTS"), which were carried at $6,333 (see Note 5). 5. LADENBURG THALMANN FINANCIAL SERVICES In 2002, LTS, the Company's majority-owned subsidiary until December 2001, borrowed a total of $5,000 from New Valley. The loans, which bear interest - 11 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) at 1% above the prime rate, were due on the earlier of December 31, 2003 or the completion of one or more equity financings where LTS received at least $5,000 in total proceeds. In November 2002, New Valley agreed, in connection with a $3,500 loan to LTS by an affiliate of its clearing broker, to extend the maturity of its notes to December 31, 2006 and to subordinate its notes to the repayment of the loan from the clearing broker. New Valley evaluated its ability to collect $13,198 of notes receivable and related interest from LTS at September 30, 2002. These notes receivable included the $5,000 of notes issued in 2002 and an $8,010 convertible note issued to New Valley in May 2001. New Valley determined, based on the then current trends in the broker-dealer industry and LTS's operating results and liquidity needs, that a reserve for uncollectibility should be established against these notes and interest receivable. As a result, New Valley recorded a charge of $13,198 in the third quarter of 2002. In November 2004, New Valley and the other holder of the convertible notes of LTS entered into a debt conversion agreement with LTS. New Valley and the other holder agreed to convert their notes, with an aggregate principal amount of $18,010, together with the accrued interest, into common stock of LTS. Pursuant to the debt conversion agreement, the conversion price of the notes held by New Valley was reduced from the previous conversion price of approximately $2.08 to $0.50 per share, and New Valley and the other holder each agreed to purchase $5,000 of LTS common stock at $0.45 per share. The note conversion transaction was approved by the LTS shareholders in January 2005 and closed on March 11, 2005. At the closing, New Valley's note, representing approximately $9,938 of principal and accrued interest, was converted into 19,876,358 shares of LTS common stock and New Valley purchased 11,111,111 LTS shares. In the first quarter 2005, New Valley recorded a gain from the conversion of $9,461, which represented the fair value of the converted shares as determined by an independent appraisal firm. LTS borrowed $1,750 from New Valley in 2004 and an additional $1,750 in the first quarter 2005. At the closing of the note conversion agreement, New Valley delivered these notes for cancellation as partial payment for its purchase of LTS common stock. On March 30, 2005, New Valley distributed the 19,876,358 shares of LTS common stock it acquired from the conversion of the notes to the holders of New Valley's Common Shares through a special distribution. New Valley stockholders of record as of March 18, 2005 received 0.852 of a LTS share for each share of New Valley. New Valley accounted for its interest in LTS from March 11, 2005 to March 30, 2005 (date of distribution) using the equity method of accounting because its ownership in LTS exceeded 20% and recorded a loss of $299 associated with LTS's operations during the period. New Valley recorded a reduction in equity of $9,162, which represented its carrying value of the LTS stock distributed at March 30, 2005. Following the distribution, New Valley continued to hold the 11,111,111 shares of LTS common stock (approximately 9% of the outstanding shares), the $5,000 of notes due December 31, 2006 and a warrant to purchase 100,000 shares of its common stock at $1.00 per share. The 11,111,111 common shares have been accounted for as investment securities available for sale and are carried at $6,333 in the Company's condensed consolidated balance sheet at June 30, 2005. 6. LONG-TERM INVESTMENTS At June 30, 2005, long-term investments consisted of investments in limited partnerships of $2,552 which are accounted for at historical cost. The Company believes the fair value of the limited partnerships exceeds their carrying amount by approximately $12,828 based on the indicated market values of the underlying investment portfolio provided by the partnerships - 12 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) based on the indicated market values of the underlying assets or investment portfolio. The Company's estimates of the fair value of its long-term investments are subject to judgment and are not necessarily indicative of the amounts that could be realized in the current market. The Company is required to make additional investments in one of its limited partnerships of up to an aggregate of $591 at June 30, 2005. In addition, the investments in limited partnerships are illiquid, and the ultimate realization of these investments is subject to the performance of the underlying partnership and its management by the general partners. The Company recognized gains of $113 for the three and six months ended June 30, 2004 related to the liquidation of one of its limited partnership investments. 7. OTHER LONG-TERM LIABILITIES The components of other long-term liabilities at June 30, 2005 are as follows:

The retiree and disability obligations represent amounts recorded in connection with employee benefit accruals originating from the Company's former Western Union business. The liabilities have been computed based on estimates of future benefits payable and may be subject to future adjustments based on actual payments. The Company recorded expenses of $94 and $94 for the three and six months ended June 30, 2005 and $80 and $83 for the three and six months ended June 30, 2004, respectively, in connection with the retiree and disability obligations. The Company evaluates its accruals on a quarterly basis and makes adjustments when appropriate. 8. CONTINGENCIES LAWSUITS In March 1997, a stockholder derivative suit was filed against the Company, as a nominal defendant, its directors and Brooke Group Holding Inc. ("Brooke Group Holding"), an indirect wholly-owned subsidiary of Vector, in the Delaware Chancery Court by a stockholder of the Company. The suit alleged that the Company's purchase in January 1997 of the shares of BrookeMil Ltd., which was engaged in the real estate business in Russia, from Brooke (Overseas) Ltd., an indirect subsidiary of Brooke Group Holding, constituted a self-dealing transaction which involved the payment of excessive consideration by the Company. The plaintiff sought a declaration that the Company's directors breached their fiduciary duties and Brooke Group Holding aided and abetted such breaches and that damages be awarded to the Company. In December 1999, another stockholder of the Company commenced an action in Delaware Chancery Court substantially similar to the March 1997 action. This stockholder alleged, among other things, that the consideration paid by the Company for the BrookeMil shares was excessive, unfair and wasteful, that the special committee of the Company's board lacked independence, and that the appraisal and fairness opinion were flawed. By order of the court, both actions were consolidated. In March 2005, New Valley, its directors and Brooke Group Holding settled the consolidated action. The defendants did not admit any wrongdoing as part of the settlement. At a hearing held on June 14, 2005, the court approved the settlement. No appeal was taken and, therefore, the settlement is final. Under the settlement, New Valley paid $2,150 of legal fees in June 2005 and Vector paid $7,000 to New Valley on July 21, 2005. New Valley will record the receipt of $7,000 as additional paid-in-capital in the third quarter of 2005. New Valley accrued the legal fees and expenses of $2,150 during the year ended December 31, 2004 and charged the amount to general and administrative expenses. In July 1999, a purported class action was commenced on behalf of the Company's former Class B preferred shareholders against the Company, Brooke Group Holding and certain directors and officers of the Company in Delaware - 13 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) Chancery Court. The complaint alleges that the recapitalization, approved by a majority of each class of the Company's stockholders in May 1999, was fundamentally unfair to the Class B preferred shareholders, the proxy statement relating to the recapitalization was materially deficient and the defendants breached their fiduciary duties to the Class B preferred shareholders in approving the transaction. The Court dismissed six of plaintiff's nine claims alleging inadequate disclosure in the proxy statement. Brooke Group Holding and the Company filed a motion for summary judgment on the remaining three claims, which was granted by the court in May 2005. The plaintiffs did not appeal the decision. In 1994, the Company commenced an action against the United States government seeking damages for breach of a launch services agreement covering the launch of one of the Westar satellites owned by New Valley's former Western Union satellite business. The Company had a contract with NASA to launch two Westar satellites. The first satellite was launched in 1984, and the second was scheduled to be launched in 1986. Following the explosion of the space shuttle Challenger in January 1986, the President of the United States announced a change in the government's policy regarding commercial satellite launches, and the Company's satellite was not launched. As a result, the Company sued the government for breach of contract seeking damages of approximately $34,000. In 1995, the United States Court of Federal Claims granted the government's motion to dismiss and, in 1997, the United States Court of Appeals for the Federal Circuit reversed and remanded the case. Trial of the case was completed in New York federal court in August 2004 and the parties are awaiting the ruling of the court. OTHER As of June 30, 2005, New Valley had $300 of prepetition bankruptcy-related claims and restructuring accruals. The remaining claims may be subject to future adjustments based on potential settlements or decisions of the court. In December 2001, New Valley's subsidiary, Western Realty Development LLC, sold all the membership interests in Western Realty Investments LLC to Andante Limited. In August 2003, Andante submitted an indemnification claim to Western Realty Development alleging losses of $1,225 from breaches of various representations made in the purchase agreement. Under the terms of the purchase agreement, Western Realty Development has no obligation to indemnify Andante unless the aggregate amount of all claims for indemnification made by Andante exceeds $750, and Andante is required to bear the first $200 of any proven loss. New Valley would be responsible for 70% of any damages payable by Western Realty Development. New Valley is contesting the indemnification claim. 9. RESTRICTED STOCK GRANT On January 10, 2005, New Valley's President and Chief Operating Officer was awarded a restricted stock grant of 1,250,000 Common Shares pursuant to the Company's 2000 Long-Term Incentive Plan. Under the terms of the award, one-seventh of the shares vested on July 15, 2005, with an additional one-seventh vesting on each of the five succeeding one-year anniversaries of the first vesting date through July 15, 2010 and an additional one-seventh vesting on January 15, 2011. In the event the President and Chief Operating Officer's employment with New Valley is terminated for any reason other than his death, his disability or a change of control of New Valley or Vector, any remaining balance of the shares not previously vested will be forfeited by the President and Chief Operating Officer. New Valley recorded deferred compensation of $8,875 representing the fair market value of the restricted shares on the date of the grant. The deferred compensation will be amortized over the vesting period as a charge to compensation expense. New Valley anticipates recording $1,855 in compensation expense in 2005, $1,268 as compensation expense in each of the years from 2006 to 2009, $1,896 in 2010 and $52 in 2011. The Company recorded expense associated with the grant of $545 and $1,165 for the three and six months ended June 30, 2005, respectively. - 14 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) 10. INCOME TAX EXPENSE Income tax expense for the three and six months ended June 30, 2005 was $100 and $9,600, respectively, which consisted of the utilization of deferred tax assets of $9,000, alternative minimum tax expense and state income taxes. An intraperiod allocation of income tax expense was performed and $3,027 of the expense was allocated to income from continuing operations and $6,573 was allocated to income from discontinued operations. The income tax provision from continuing operations for the three and six months ended June 30, 2005 did not bear a customary relationship with pre-tax accounting income from continuing operations principally as a consequence of utilization of net operating loss carryfowards, alternative minimum and state income tax expense and the impact of expenses not deductible for income tax purposes. For the three and six months ended June 30, 2004, the Company performed an intraperiod allocation of income tax expense between income from continuing operations and income from discontinued operations, which resulted in an income tax benefit from continuing operations of $212 and $456, respectively, and an income tax expense from discontinued operations of $262 and $506, respectively. The income tax provision from continuing operations for the three and six months ended June 30, 2004 did not bear a customary relationship with pre-tax accounting income from continuing operations principally as a consequence of utilization of net operating loss carryfowards and the impact of expenses not deductible for income tax purposes. As of June 30, 2005, the Company had approximately $78,250 of unrecognized deferred tax assets, which primarily consisted of the tax effects of U.S. net operating loss carryforwards of approximately $143,750 and net cumulative temporary differences where the tax basis of its assets exceeds the book basis of approximately $24,500. New Valley also has approximately $13,900 of alternative minimum tax credit carryforwards as of June 30, 2005. The Company establishes a valuation allowance against deferred tax assets when it is deemed more likely than not that the benefit from such items will be realized. Approximately $24,950 of the Company's consolidated net operating carryforwards expire at December 31, 2006, approximately $24,800 expire at December 31, 2007 and approximately $37,600 expire at December 31, 2011. The remaining $56,400 expire at various dates between December 31, 2017 and December 31, 2023. The Company's alternative minimum tax credit carryfoward may be carried forward indefinitely under current U.S. tax law. 11. WARRANTS On June 14, 2004, warrants to purchase 17,859,354 Common Shares expired. The warrants were issued in connection with the Company's 1999 recapitalization. A total of 8,084 warrants were exercised during the three and six months ended June 30, 2004. - 15 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) 12. BUSINESS SEGMENT INFORMATION The following table presents certain financial information of the Company's operations as of and for the three and six months ended June 30, 2005 and 2004. For the three and six months ended June 30, 2005 and 2004, New Valley's results of operations include the accounts of its 50% interests in Douglas Elliman Realty and Koa Investors, which are included in other income (loss) from real estate activities. As a result of the sale of the office buildings, New Valley's real estate leasing operations, which were the primary source of New Valley's revenues for 2003, 2004 and the three months ended March 31, 2005, have been treated as discontinued operations and are not reflected in the table.

-------------- (a) Identifiable assets in the real estate segment include $54,945 at June 30, 2004 of assets attributable to discontinued real estate operations. - 16 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) 13. COMPREHENSIVE (LOSS) INCOME Comprehensive (loss) income of the Company includes net (loss) income and net changes in the value of investment securities available for sale that have not been included in net (loss) income. Comprehensive (loss) income applicable to Common Shares for the three and six months ended June 30, 2005 and 2004 is as follows:

The components of accumulated other comprehensive income were as follows as of June 30, 2005 and December 31, 2004:

- 17 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) 14. STOCK OPTION PLANS The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related Interpretations. No stock-based employee compensation cost is reflected in net income to the extent options granted under these plans had an exercise price equal to the market value of the underlying Common Shares on the date of the grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123, "Accounting for Stock-Based Compensation", to stock-based employee compensation for the three and six months ended June 30, 2005 and 2004, respectively.

15. DISCONTINUED OPERATIONS Real Estate Leasing. In February 2005, New Valley completed the sale for $71,500 of its two office buildings in Princeton, N.J. As a result of the sale, the condensed consolidated financial statements of New Valley reflect its real estate operations as discontinued operations for the three and six months ended June 30, 2005 and 2004. Accordingly, revenues, costs and expenses, and cash flows of the discontinued operations have been excluded from the respective captions in the condensed consolidated statements of operations and condensed consolidated statements of cash flows. The net operating results of the discontinued operations have been reported, net of applicable income taxes and minority interests, as "Income from discontinued operations," and the net cash flows of the discontinued operations have been reported as "Net cash provided from discontinued operations." The assets of the discontinued operations were recorded at December 31, 2004 as "Investment in real estate held for sale" in the condensed consolidated balance sheet. - 18 - NEW VALLEY CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) - (Continued) (Unaudited) Summarized operating results of the discontinued real estate leasing operations for the three and six months ended June 30, 2005 and 2004, respectively, are as follows:

The Company recorded a gain in connection with the sale of $8,290, net of income taxes of $6,395, in the first quarter of 2005, which has been classified as "Gain on disposal of discontinued operations" in the accompanying condensed consolidated financial statements. Other. In February 2005, a state tax hearing officer reduced an assessment for the amount due for taxes associated with the 1994 sale of the Company's money transfer business to $1,589, which included interest of $885. In March 2005, the Company paid the $1,589 under protest and is challenging the assessment in an additional administrative hearing. No assurances can be given that the Company will prevail in this matter. The payment has been classified, along with the $30,023 provided from the sale and operations of the office buildings, as "Net cash provided from discontinued operations" in the condensed consolidated statements of cash flows. - 19 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in Thousands, Except Per Share Amounts) New Valley is engaged in the real estate business and is seeking to acquire additional operating companies and real estate properties. New Valley holds a 50% interest in Douglas Elliman Realty, LLC, which operates a residential real estate brokerage company in the New York metropolitan area. New Valley also owns, through its New Valley Realty Division, a 50% interest in Koa Investors LLC, which owns the Sheraton Keauhou Bay Resort & Spa in Kailua-Kona, Hawaii. RECENT DEVELOPMENTS SALE OF OFFICE BUILDINGS. In February 2005, New Valley completed the sale of the two commercial office buildings in Princeton, N.J. for an aggregate purchase price of $71,500 and recorded a gain of $8,290, net of income taxes of $6,395, in the first quarter of 2005, which has been classified as "Gain on disposal of discontinued operations" in the accompanying condensed consolidated financial statements. The properties were subject to a nonrecourse mortgage loan due in December 2006, of which $39,213 was outstanding at December 31, 2004. New Valley retired the mortgage at closing with the proceeds of the sale. As a result of the sale, New Valley's real estate leasing operations, which were the primary source of New Valley's revenues for 2003, 2004 and the three and six months ended June 30, 2005, have been treated as discontinued operations in the accompanying condensed consolidated financial statements. RESTRICTED SHARE AWARD. In January 2005, Howard M. Lorber, the President and Chief Operating Officer of New Valley, was awarded a restricted stock grant of 1,250,000 Common Shares pursuant to New Valley's 2000 Long-Term Incentive Plan. Under the terms of the award, one-seventh of the shares vested on July 15, 2005, with an additional one-seventh vesting on each of the five succeeding one-year anniversaries of the first vesting date through July 15, 2010 and an additional one-seventh vesting on January 15, 2011. In the event Mr. Lorber's employment with New Valley is terminated for any reason other than his death, his disability or a change of control of New Valley or Vector, any remaining balance of the shares not previously vested will be forfeited by Mr. Lorber. LAWSUIT SETTLEMENT. In March 2005, New Valley, its directors and Vector Group settled a stockholder derivative suit that alleged, among other things, that New Valley paid excessive consideration to acquire Vector's BrookeMil Ltd. subsidiary in 1997. The defendants did not admit any wrongdoing as part of the settlement, which was approved by the Delaware Chancery Court in June 2005. Under the settlement, Vector Group paid New Valley $7,000 on July 21, 2005, and New Valley paid legal fees and expenses of $2,150 in June 2005. New Valley charged the legal fees and expenses to general and administrative expenses in its consolidated statement of operations for the year ended December 31, 2004. New Valley will record the receipt of $7,000 as additional paid-in-capital in the third quarter of 2005. LADENBURG CONVERTIBLE NOTES. In November 2004, New Valley and the other holder of the convertible notes of Ladenburg Thalmann Financial Services Inc. ("LTS") entered into a debt conversion agreement with LTS. New Valley and the other holder agreed to convert their notes, with an aggregate principal amount of $18,010, together with the accrued interest, into common stock of LTS. Pursuant to the debt conversion agreement, the conversion price of the note held by New Valley was reduced from the previous conversion price of approximately $2.08 to $0.50 per share, and New Valley and the other holder each agreed to purchase $5,000 of LTS common stock at $0.45 per share. The note conversion transaction was approved by the LTS shareholders in January 2005 and closed on March 11, 2005. At the closing, New Valley's note, representing approximately $9,938 of principal and accrued interest, was converted into 19,876,358 shares of LTS common stock and New Valley purchased 11,111,111 LTS shares. In the first quarter of 2005, New Valley recorded a gain from the conversion of $9,461, which represented the fair value of the converted shares as determined by an independent appraisal firm. - 20 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) LTS borrowed $1,750 from New Valley in 2004 and an additional $1,750 in the first quarter 2005. At the closing of the debt conversion agreement, New Valley delivered these notes for cancellation as partial payment for its purchase of LTS common stock. On March 30, 2005, New Valley distributed the 19,876,358 shares of LTS common stock it acquired from the conversion of the note to the holders of New Valley's Common Shares through a special distribution. New Valley stockholders of record as of March 18, 2005 received 0.852 of a LTS share for each share of New Valley. New Valley accounted for its interest in LTS from March 11, 2005 to March 30, 2005 (date of distribution) using the equity method of accounting because its ownership in LTS exceeded 20% and recorded a loss of $299 associated with LTS's operations during the period. New Valley recorded a reduction in equity of $9,162, which represented its carrying value of the LTS stock distributed at March 30, 2005. Following the distribution, New Valley continued to hold the 11,111,111 shares of LTS common stock (approximately 9% of the outstanding shares), which have been classified as "Investment securities available for sale" in New Valley's condensed consolidated balance sheet at June 30, 2005, $5,000 of LTS's notes due December 31, 2006, which are carried at $0 in New Valley's condensed consolidated balance sheet as of June 30, 2005, and a warrant to purchase 100,000 shares of its common stock at $1.00 per share. HAWAIIAN HOTEL. New Valley holds a 50% interest in Koa Investors which owns the Sheraton Keauhou Bay Resort & Spa in Kailua-Kona, Hawaii. Following a major renovation, the property reopened in the fourth quarter of 2004 as a four star resort with 521 rooms. Koa Investors anticipates that the hotel will continue to experience operating losses during its opening phase. In August 2005, a wholly-owned subsidiary of Koa Investors borrowed $82,000 at an interest rate of LIBOR plus 2.45%. Koa Investors used the proceeds of the loan to repay its $57,000 construction loan and distributed a portion of the proceeds to its members, including $5,500 to New Valley. ST. REGIS HOTEL, WASHINGTON, D.C. In June 2005, affiliates of New Valley and Brickman Associates formed 16th & K Holdings LLC ("Hotel LLC") which acquired the St. Regis Hotel in Washington, DC for $47,000 in August 2005. New Valley, which holds a 50% interest in Hotel LLC, had invested $1,377 in the project and had committed to make additional investments of up to $8,623 at June 30, 2005, of which $4,873 has been funded in the third quarter of 2005. The members of Hotel LLC currently plan to renovate the hotel commencing in 2006. In connection with the closing of the purchase of the hotel, a subsidiary of Hotel LLC entered into agreements to borrow up to $50,000 of senior and subordinated debt. DOUGLAS ELLIMAN REALTY, LLC. During 2000 and 2001, New Valley acquired for $1,744 a 37.2% ownership interest in Prudential Douglas Elliman Real Estate, formerly known as Prudential Long Island Realty, the largest independently owned and operated residential real estate brokerage company on Long Island, and a minority interest in an affiliated mortgage company, Preferred Empire Mortgage Company. In December 2002, New Valley and the other owners of Prudential Douglas Elliman Real Estate contributed their interests in Prudential Douglas Elliman Real Estate to Douglas Elliman Realty, LLC, formerly known as Montauk Battery Realty, LLC, a newly formed entity. New Valley acquired a 50% interest in Douglas Elliman Realty as a result of an additional investment of $1,413 by New Valley and the redemption by Prudential Douglas Elliman Real Estate of various ownership interests. As part of the transaction, Prudential Douglas Elliman Real Estate renewed its franchise agreement with The Prudential Real Estate Affiliates, Inc. for an additional ten-year term. In October 2004, upon receipt of required regulatory approvals, the former owners of Douglas Elliman Realty contributed to Douglas Elliman Realty their interests in the related mortgage company. In March 2003, Douglas Elliman Realty purchased the leading New York City-based residential brokerage firm, Douglas Elliman, LLC, formerly Insignia Douglas Elliman, and an affiliated property management company, for $71,250. With that acquisition, the combination of Prudential Douglas Elliman Real Estate with Douglas Elliman has created the largest residential brokerage company in the New York metropolitan area. Upon closing of the acquisition, Douglas Elliman entered into a ten-year franchise agreement with The Prudential Real Estate Affiliates, Inc. New Valley invested an additional $9,500 in subordinated debt and equity of Douglas Elliman Realty to help fund the acquisition. The subordinated debt, which had an initial principal amount of $9,500, bears interest at 12% per annum and is due in March 2013. New Valley accounts for its interest in Douglas Elliman Realty on the equity method. New Valley's equity income from Douglas Elliman Realty includes interest earned by New Valley on the subordinated debt and, prior to October 1, 2004, 44% of the mortgage company's results from operations. - 21 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) CRITICAL ACCOUNTING POLICIES GENERAL. The 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, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates. INVESTMENT SECURITIES AVAILABLE FOR SALE. At June 30, 2005, New Valley had investment securities available for sale of $12,519, which included 11,111,111 shares of LTS common stock, which were carried at $6,333. New Valley classifies investments in debt and marketable equity securities as either available for sale or held to maturity. Investments classified as available for sale are carried at fair value, with net unrealized gains and losses included as a separate component of stockholders' equity. Realized gains and losses are included in other results from continuing operations. The cost of securities sold is determined based on average cost. Gains are recognized when realized in New Valley's condensed consolidated statement of operations. Losses are recognized as realized or upon the determination of the occurrence of an other-than-temporary decline in fair value. New Valley's policy is to review its securities on a regular basis to evaluate whether any security has experienced an other-than-temporary decline in fair value. If it is determined that an other-than-temporary decline exists in one of New Valley's marketable securities, it is New Valley's policy to record an impairment charge with respect to such investment in the Company's condensed consolidated statements of operations. During the six months ended June 30, 2005, New Valley experienced net increases to unrealized gains on investment securities of $73, which have been included in accumulated other comprehensive income in the Company's condensed consolidated statement of changes in stockholders' equity. INVESTMENTS IN NON-CONSOLIDATED REAL ESTATE BUSINESSES. New Valley accounts for its 50% interest in Douglas Elliman Realty and in Koa Investors on the equity method because it has a significant, but less than controlling, interest in these entities. New Valley records its investments in these entities in its condensed consolidated balance sheets as "Investments in non-consolidated real estate businesses" and its share of the entities' income or loss as "Equity income (loss) from non-consolidated real estate businesses". Judgment is required in determining controlling interest. Factors considered by New Valley in determining whether it has significant influence or has control include risk and reward sharing, experience and financial condition of the other investors, voting rights, involvement in day-to-day capital and operating decisions and continuing involvement. The difference between consolidation and the equity method impacts certain financial ratios because of the presentation of the detailed line items reported in the financial statements. However, New Valley's consolidated net income or loss for the period and its stockholders' equity at the end of the period are the same whether its investments in these entities are accounted for under the equity method or these entities are consolidated. Because New Valley does not control the decision-making process or business management practices of these entities, it relies on management of these entities and their independent accountants to provide it with accurate financial information prepared in accordance with generally accepted accounting principles that New Valley uses in the application of the equity method. New Valley is not aware, however, of any errors in or possible misstatements of the financial information provided by these entities that would have a material effect on New Valley's condensed consolidated financial statements. LONG-TERM INVESTMENTS. At June 30, 2005, New Valley had long-term investments of $2,552, which principally represented investments in various limited partnerships. The principal business of the limited partnerships is investing in real estate and investment securities. These long-term investments are illiquid, and the value of the investments is dependant on the performance of the underlying partnership and its management by the general partners. In assessing potential impairment for these investments, New Valley considers the external markets for these types of investments as well as the forecasted financial performance of its investees. If these forecasts are not met, New Valley may have to recognize an impairment charge in its condensed consolidated statements of operations. INCOME TAXES. The years 2000 and 2004 were the only years out of the last five in which New Valley has reported net income. New Valley's losses during these and prior years have generated federal tax net operating loss, or - 22 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) NOL, carry forwards of approximately $143,750 as of June 30, 2005, which expire at various dates from 2006 through 2023, and approximately $24,500 of net cumulative temporary differences where the tax basis of its assets exceeds the book basis. New Valley also has approximately $13,900 of alternative minimum tax credit carry forwards as of June 30, 2005, which may be carried forward indefinitely under current U.S. tax law. Generally accepted accounting principles require that New Valley record a valuation allowance against the deferred tax assets associated with these loss carry forwards, temporary differences and credit carry forwards if it is "more likely than not" that New Valley will not be able to utilize its deferred tax assets to offset future taxes. Prior to December 31, 2004, due to the size of the loss carry forwards in relation to New Valley's history of unprofitable operations and to the continuing uncertainties surrounding its operations as it seeks to acquire additional operating companies and real estate properties, New Valley had not recognized any of these net deferred tax assets. In 2004, New Valley recognized $9,000 of deferred tax assets based on management's belief that it is more likely than not such deferred tax assets will be realized based upon a projection of taxable income for 2005. The amount was expensed in the first quarter of 2005 in connection with New Valley's income for the three months ended March 31, 2005. Management will continue to monitor the Company's unrealized deferred tax assets in the future and determine whether any additional adjustments to the valuation allowance are warranted. For example, it is possible that New Valley could report additional profits in the future at levels which cause management to conclude that it is more likely than not that it will realize additional amounts of the carry forwards. Upon reaching such a conclusion, New Valley would immediately record the estimated net realizable value of the deferred tax asset at that time and would then provide for income taxes at a rate equal to its combined federal and state effective rates, which would approximate 41% under current tax rates. It is also possible that New Valley may not realize in the future deferred tax assets that may be recorded on its balance sheet. Upon reaching such a conclusion, New Valley will immediately reduce the value of the deferred tax assets at that time and then record an income tax provision equaling the amount of the impaired deferred tax assets. Thus, subsequent revisions to the estimated net realizable value of the deferred tax assets could cause New Valley's provision for income taxes to vary significantly from period to period, although its cash tax payments would remain unaffected until the benefit of the loss carry forwards is utilized. New Valley's current tax provision consists of amounts due for current taxable income, which is primarily associated with state income taxes and the federal alternative minimum tax. - 23 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) RESULTS OF OPERATIONS For the three and six months ended June 30, 2005 and 2004, New Valley's results of operations include the accounts of its 50% interests in Douglas Elliman Realty and Koa Investors, which are included in other income from real estate activities. As a result of the sale of the office buildings, New Valley's real estate leasing operations, which were the primary source of New Valley's revenues for 2003, 2004 and the three months ended March 31, 2005, have been treated as discontinued operations and are not reflected in the table.

THREE MONTHS ENDED JUNE 30, 2005 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2004 REAL ESTATE Other income from real estate activities for the three months ended June 30, 2005 consisted of equity income from non-consolidated real estate businesses of $2,324. The equity income resulted from income of $4,126 from Douglas Elliman Realty offset by losses of $1,802 related to New Valley's investment in Koa Investors, which owns the Sheraton Keauhou Bay Resort & Spa in Kailua-Kona, Hawaii. Other income from real estate activities in the 2004 period consisted of equity income from non-consolidated real estate businesses of $4,642. The equity income resulted from income of $4,704 from Douglas Elliman Realty offset by a loss of $62 related to New Valley's investment in Koa Investors. The principal source of Douglas Elliman Realty's revenues and profitability is commissions earned on residential property sales in the New York metropolitan area, which experienced high levels of residential sales activity and real estate prices during the 2004 and 2005 periods. A downturn in the residential real estate market or economic conditions in the New York metropolitan region could have a material adverse effect on Douglas Elliman Realty and New Valley's investment in that company. Koa Investors' loss in the 2005 first quarter primarily consisted of losses from operations of the Sheraton Keauhou Bay Resort & Spa. Koa Investors' loss in the 2004 period primarily consisted of management fees and losses from operations of the hotel. Koa Investors capitalized substantially all costs related to the acquisition and development of the property during the construction phase, which ceased in connection with the opening of the hotel in the fourth quarter of 2004. Koa Investors anticipates that the hotel will continue to experience operating losses during its opening phase. - 24 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) CORPORATE AND OTHER Corporate and other expenses of $3,802 for the three months ended June 30, 2005 consisted primarily of employee compensation and benefits of $1,876, non-cash compensation expense of $620 associated with the amortization of a restricted stock grant and legal expense of $180. Corporate and other expenses of $3,224 for the three months ended June 30, 2004 consisted primarily of employee compensation and benefits of $1,761 and legal expense of $444. The increase in corporate expenses in the 2005 period was primarily due to the non-cash charges associated with the restricted stock grant. For the three months ended June 30, 2005, New Valley's income of $705 from corporate and other activities consisted primarily of interest and dividend income of $653. For the three months ended June 30, 2004, New Valley's income of $5,492 from corporate and other activities consisted primarily of gain on sale of investments of $5,292 and interest and dividend income of $206. The income tax provision of $100 for the three months ended June 30, 2005 related to state income taxes. This provision did not bear a customary relationship with pre-tax accounting income from continuing operations principally as a consequence of utilization of net operating loss carryfowards, alternative minimum and state income tax expense and the impact of expenses not deductible for income tax purposes. The benefit for income taxes of $212 for the three months ended June 30, 2004 resulted from an intraperiod allocation between income from discontinued operations and income from continuing operations offset by the impact of alternative minimum tax. SIX MONTHS ENDED JUNE 30, 2005 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2004 REAL ESTATE Other income from real estate activities for the six months ended June 30, 2005 consisted of equity income from non-consolidated real estate businesses of $2,018. The equity income resulted from income of $5,460 from Douglas Elliman Realty, offset by losses of $3,442 related to New Valley's investment in Koa Investors. Other income from real estate activities in the 2004 period consisted of equity income from non-consolidated real estate businesses of $5,288. The equity income resulted from income of $5,413 from Douglas Elliman Realty offset by a loss of $125 related to New Valley's investment in Koa Investors. The principal source of Douglas Elliman Realty's revenues and profitability is commissions earned on residential property sales in the New York metropolitan area, which experienced high levels of residential sales activity and real estate prices during the 2004 and 2005 periods. A downturn in the residential real estate market or economic conditions in the New York metropolitan region could have a material adverse effect on Douglas Elliman Realty and New Valley's investment in that company. Koa Investors' loss in the 2005 first quarter primarily consisted of losses from operations of the Sheraton Keauhou Bay Resort & Spa. Koa Investors' loss in the 2004 period primarily consisted of management fees and losses from operations of the hotel. Koa Investors capitalized substantially all costs related to the acquisition and development of the property during the construction phase, which ceased in connection with the opening of the hotel in the fourth quarter of 2004. Koa Investors anticipates that the hotel will continue to experience operating losses during its opening phase. CORPORATE AND OTHER Corporate and other expenses of $7,168 for the six months ended June 30, 2005 consisted primarily of employee compensation and benefits of $3,839, non-cash compensation expense of $1,165 associated with the amortization of a - 25 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) restricted stock grant and legal expense of $361. Corporate and other expenses of $5,638 for the six months ended June 30, 2004 consisted primarily of employee compensation and benefits of $3,329 and legal expense of $587. The increase in corporate expenses in the 2005 period was primarily due to increased compensation expenses and the non-cash charges associated with the restricted stock grant offset by reduced legal expenses. The decrease in legal expenses in the first half of 2005 was primarily due to incremental legal expenses in the 2004 period associated with the Company's action against the United States government seeking damages for breach of a launch services agreement covering the launch of one of the Westar satellites owned by New Valley's former Western Union satellite business. Trial of the case was completed in New York federal court in August 2004 and the parties are awaiting the ruling of the court. For the six months ended June 30, 2005, New Valley's income of $11,791 from corporate and other activities consisted primarily of the gain from the conversion of the LTS notes of $9,461, gain on sale of investments of $1,441, and interest and dividends income of $1,139 offset by equity losses from the operations of LTS of $299. For the six months ended June 30, 2004, New Valley's income of $5,736 from corporate and other activities consisted primarily of gain on sale of investments of $5,292 and interest and dividend income of $455. The income tax expense from continuing operations for the six months ended June 30, 2005 was $3,027. This amount consisted of the utilization of deferred tax assets of $2,875, alternative minimum tax expense and state income taxes. This provision did not bear a customary relationship with pre-tax accounting income from continuing operations principally as a consequence of utilization of net operating loss carryfowards, alternative minimum and state income tax expense and the impact of expenses not deductible for income tax purposes. The benefit for income taxes of $456 for the six months ended June 30, 2004 resulted from an intraperiod allocation between income from discontinued operations and income from continuing operations offset by the impact of alternative minimum tax. DISCONTINUED OPERATIONS Real Estate Leasing. In February 2005, New Valley completed the sale for $71,500 of its two office buildings in Princeton, N.J. As a result of the sale, the condensed consolidated financial statements of New Valley reflect its real estate operations as discontinued operations for the three and six months ended June 30, 2005 and 2004. Accordingly, revenues, costs and expenses, and cash flows of the discontinued operations have been excluded from the respective captions in the condensed consolidated statements of operations and condensed consolidated statements of cash flows. The net operating results of the discontinued operations have been reported, net of applicable income taxes and minority interests, as "Income from discontinued operations," and the net cash flows of the discontinued operations have been reported as "Net cash provided from discontinued operations." The assets of the discontinued operations were recorded at December 31, 2004 as "Investment in real estate held for sale" in the condensed consolidated balance sheet. Summarized operating results of the discontinued real estate leasing operations for the three and six months ended June 30, 2005 and 2004, respectively, are as follows:

- 26 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) New Valley recorded a gain in connection with the sale of $8,290, net of income taxes of $6,395, in the first quarter of 2005, which has been classified as "Gain on disposal of discontinued operations" in the accompanying condensed consolidated financial statements. OTHER. In February 2005, a state tax hearing officer reduced an assessment for the amount due for taxes associated with the 1994 sale of the Company's money transfer business to $1,589, which included interest of $885. In March 2005, the Company paid the $1,589 under protest. The Company is challenging the assessment in an additional administrative hearing. No assurances can be given that the Company will prevail in this matter. The payment has been classified, along with the $30,023 provided from the sale and operations of the office buildings, in "Net cash provided from discontinued operations" in the condensed consolidated statements of cash flows. LIQUIDITY AND CAPITAL RESOURCES During the six months ended June 30, 2005, New Valley's cash and cash equivalents increased from $70,688 to $89,755 due primarily to cash provided from the sale of the office buildings. Cash used for operating activities for the six months ended June 30, 2005 was $7,117 compared to $3,724 in the prior year. The difference is primarily due to the payment of legal fees and expenses of $2,150 associated with the settlement of the stockholder suit in the 2005 period as compared to the 2004 period. Cash used for investing activities for the six months ended June 30, 2005 was $2,263 compared to cash provided from investing activities of $5,641 for the six months ended June 30, 2004. The decrease is primarily attributable to the investment in LTS notes receivable and common stock of $3,250 in the 2005 period and the net sales of investsment securities of $2,661 in the 2005 period versus $7,863 in the 2004 period offset by investments in non-consolidated real estate businesses of $2,500 in the 2004 period and $1,377 in the 2005 period. During 2000 and 2001, New Valley acquired for approximately $1,744 a 37.2% ownership interest in Prudential Douglas Elliman Real Estate, the largest independently owned and operated real estate brokerage company on Long Island, New York and a minority interest in an affiliated mortgage company. On December 19, 2002, New Valley and the other owners of Prudential Douglas Elliman Real Estate contributed their interests in Prudential Douglas Elliman Real Estate to Douglas Elliman Realty, a newly formed entity. New Valley acquired a 50% interest in Douglas Elliman Realty as a result of an additional investment of $1,413 by New Valley and the redemption by Prudential Douglas Elliman Real Estate of various ownership interests. In March 2003, Douglas Elliman Realty purchased the leading New York City-based residential brokerage firm, Douglas Elliman, and an affiliated property management company, for $71,250. New Valley invested an additional $9,500 in subordinated debt and equity of Douglas Elliman Realty to help fund the acquisition. The subordinated debt, which had an initial principal amount of $9,500, bears interest at 12% per annum and is due in March 2013. New Valley holds a 50% interest in Koa Investors which owns the Sheraton Keauhou Bay Resort & Spa in Kailua-Kona, Hawaii. Following a major renovation, the property reopened in the fourth quarter of 2004 as a four star resort with 521 rooms. In April 2004, a subsidiary of Koa Investors closed on a $57,000 construction loan to finance the renovation. New Valley had invested $11,900 in the project and had committed to make additional investments of up to $600 at June 30, 2005. In the event that Koa Investors makes distributions of cash, the Company is entitled to 50% of the cash distributions until it has - 27 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) recovered its invested capital and achieved an annual 12% internal rate of return ("IRR"), compounded on a quarterly basis. The Company is then entitled to 35% of subsequent cash distributions until it has achieved an annual 25% IRR. The Company is then entitled to 30% of subsequent cash distributions until it has achieved an annual 35% IRR. After the Company has achieved an annual 35% IRR, the Company is then entitled to 25% of subsequent cash distributions. In August 2005, a wholly-owned subsidiary of Koa Investors borrowed $82,000 at an interest rate of LIBOR plus 2.45%. Koa Investors used the proceeds of the loan to repay its $57,000 construction loan and distributed a portion of the proceeds to its members, including $5,500 to New Valley. As a result of the refinancing, New Valley will record a gain in the third quarter of 2005 equaling the amount by which the distribution exceeds its basis plus any commitment to make additional investments. At June 30, 2005, New Valley's basis in Koa Investors was $4,958 and it had committed to make additional investments of up to $600. In June 2005, affiliates of New Valley and Brickman Associates formed 16th & K Holdings LLC ("Hotel LLC"), which acquired the St. Regis Hotel in Washington, DC for $47,000 in August 2005. New Valley, which holds a 50% interest in Hotel LLC, had invested $1,377 in the project and had committed to make additional investments of up to $8,623 at June 30, 2005, of which $4,873 has been funded in the third quarter of 2005. The members of Hotel LLC currently plan to renovate the hotel commencing in 2006. In connection with the closing of the purchase of the hotel, a subsidiary of Hotel LLC entered into agreements to borrow up to $50,000 of senior and subordinated debt. New Valley accounts for its interest in Hotel LLC under the equity method. Hotel LLC will capitalize all costs related to the renovation of the property during the renovation phase. In the event that Hotel LLC makes distributions of cash, New Valley is entitled to 50% of the cash distributions until it has recovered its invested capital and achieved an annual 11% IRR, compounded quarterly. The Company is then entitled to 35% of subsequent cash distributions until it has achieved an annual 22% IRR. The Company is then entitled to 30% of subsequent cash distributions until it has achieved an annual 32% IRR. After the Company has achieved an annual 35% IRR, the Company is then entitled to 25% of subsequent cash distributions. New Valley has also committed to make additional investments in another limited partnership of up to $591 at June 30, 2005. In November 2004, New Valley entered into a debt conversion agreement with LTS where it agreed to convert its convertible note into common stock and to purchase an additional $5,000 of LTS shares. The closing of these transactions occurred on March 11, 2005. See Note 5 to the condensed consolidated financial statements. LTS borrowed a total of $1,750 from New Valley in 2004 and an additional $1,750 in 2005. At the closing of the note conversion agreement, New Valley delivered these notes for cancellation as partial payment for its purchase of LTS shares. In the first quarter 2005, New Valley recorded a gain from the conversion of $9,461, which represented the fair value of the converted shares as determined by an independent appraisal firm. On March 30, 2005, New Valley distributed to its stockholders of record as of March 18, 2005 the LTS shares received on conversion. In the first quarter of 2005, New Valley recorded a reduction in equity of $9,162, which represented its carrying value of the LTS stock distributed on that date. Cash flows provided from financing activities were $13 for the three months ended June 30, 2005 in connection with the par value received for the issuance of 1,250,000 shares of restricted stock. Cash flows provided from discontinued operations were $28,434 for the six months ended June 30, 2005, which consisted of $30,023 provided from the sale and operations of the office buildings and $1,589 in connection with the payment of a state income tax assessment discussed below. As of June 30, 2005, New Valley had $300 of prepetition bankruptcy-related claims. These remaining claims may be subject to future adjustments based on potential settlements or decisions of the court. - 28 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) As of June 30, 2005, New Valley had recorded $2,861 of liabilities ($500 of which are classified as current accrued liabilities and $2,361 of which are classified as long-term liabilities) related to retiree and disability obligations in connection with employee benefit accruals originating from the Company's former Western Union business. The liabilities have been computed based on estimates of future benefits payable and may be subject to future adjustments based on actual payments. In February 2005, a state tax hearing officer reduced an assessment for the amount due for taxes associated with the 1994 sale of the Company's money transfer business to $1,589, which included interest of $885. In March 2005, the Company paid $1,589 under protest and is challenging the assessment in an additional administrative hearing. No assurances can be given that the Company will prevail in this matter. The payment has been classified in "Net cash provided from discontinued operations" in the condensed consolidated statements of cash flows. On October 5, 1999, New Valley's Board of Directors authorized the repurchase of up to 2,000,000 Common Shares from time to time on the open market or in privately negotiated transactions depending on market conditions. As of August 9, 2005, New Valley had repurchased 1,229,515 shares for approximately $4,897. New Valley expects that its available capital resources will be sufficient to fund its currently anticipated cash requirements for 2005, including the currently anticipated cash requirements of its operating businesses, investments and commitments. NEW ACCOUNTING PRONOUNCEMENTS In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS No. 154"). SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle. The provisions of SFAS No. 154 require, unless impracticable, retrospective application to prior periods' financial statements of (1) all voluntary changes in accounting principles and (2) changes required by a new accounting pronouncement, if a specific transition is not provided. SFAS No. 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate, which requires prospective application of the new method. SFAS No. 154 is effective for all accounting changes made in fiscal years beginning after December 15, 2005. The application of SFAS No. 154 is not expected to have a material impact on the Company's consolidated financial position or results of operations. In March 2005, the FASB issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations - an Interpretation of SFAS Statement No. 143" ("FIN 47"). FIN 47 clarifies the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and/or method of settlement are conditional on a future event. FIN 47 is effective for fiscal years ending after December 15, 2005. The application of FIN 47 is not expected to have a material impact on the Company's consolidated financial position or results of operations. In 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"). SFAS No. 123R requires companies to measure compensation cost for share-based payments at fair value. The Company will adopt this new standard prospectively, on January 1, 2006, and has not yet determined the impact that SFAS No. 123 (revised 2004) will have on the Company's financial position or results of operations. OFF-BALANCE SHEET ARRANGEMENTS New Valley has various agreements in which it may be obligated to indemnify the other party with respect to certain matters. Generally, these indemnification clauses are included in contracts arising in the normal course of business under which New Valley customarily agrees to hold the other party harmless against losses arising from a breach of representations related to such matters as title to assets sold and licensed or certain intellectual property rights. Payment by New Valley under such indemnification clauses is generally - 29 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) conditioned on the other party making a claim that is subject to challenge by New Valley and dispute resolution procedures specified in the particular contract. Further, New Valley's obligations under these arrangements may be limited in terms of time and/or amount, and in some instances, New Valley may have recourse against third parties for certain payments made by it. It is not possible to predict the maximum potential amount of future payments under these indemnification agreements due to the conditional nature of New Valley's obligations and the unique facts of each particular agreement. Historically, payments made by New Valley under these agreements have not been material. As of June 30, 2005, New Valley was not aware of any indemnification agreements that would or are reasonably likely to have a current or future material adverse effect on its financial position, results of operations or cash flows. In December 2001, New Valley's subsidiary, Western Realty Development LLC, sold all the membership interests in its subsidiary, Western Realty Investments LLC, which was the entity through which Western Realty Development owned the Ducat Place II office building and the adjoining Ducat Place III site in Moscow, Russia, to Andante Limited, a Bermuda company. In August 2003, Andante submitted an indemnification claim to Western Realty Development alleging losses of $1,225 from breaches of various representations made in the purchase agreement. Under the terms of the purchase agreement, Western Realty Development has no obligation to indemnify Andante unless the aggregate amount of all claims for indemnification made by Andante exceeds $750, and Andante is required to bear the first $200 of any proven loss. New Valley would be responsible for 70% of any damages payable by Western Realty Development. New Valley is contesting the indemnification claim. New Valley is not aware of any material variable interest entities. MARKET RISK Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest and currency exchange rates, equity and commodity prices, changes in the implied volatility of interest rate, foreign exchange rate, equity and commodity prices and also changes in the credit ratings of either the issuer or its related country of origin. Market risk is inherent to both derivative and non-derivative financial instruments, and accordingly, the scope of New Valley's market risk management procedures extends beyond derivatives to include all market risk sensitive financial instruments. EQUITY PRICE RISK New Valley held investment securities available for sale totaling $12,519 at June 30, 2005, which included New Valley's 11,111,111 shares of LTS, which were carried at $6,333. Adverse market conditions could have a significant effect on the value of New Valley's investments. New Valley also holds long-term investments in limited partnerships and limited liability companies. These investments are illiquid, and their ultimate realization is subject to the performance of the investee entities. - 30 - Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued (Dollars in Thousands, Except Per Share Amounts) SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS New Valley and its representatives may from time to time make oral or written "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, including any statements that may be contained in the foregoing "Management's Discussion and Analysis of Financial Condition and Results of Operations", in this report and in other filings with the Securities and Exchange Commission and in its reports to stockholders, which represent New Valley's expectations or beliefs with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties and, in connection with the "safe-harbor" provisions of the Private Securities Litigation Reform Act, New Valley has identified under "Risk Factors" in Item 1 of New Valley's Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission important factors that could cause actual results to differ materially from those contained in any forward-looking statements made by or on behalf of New Valley. Results actually achieved may differ materially from expected results included in these forward-looking statements as a result of these or other factors. Due to such uncertainties and risks, readers are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date on which such statements are made. New Valley does not undertake to update any forward-looking statement that may be made from time to time on behalf of New Valley. - 31 - Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk" is incorporated herein by reference. Item 4. CONTROLS AND PROCEDURES Under the supervision and with the participation of New Valley's management, including its principal executive officer and principal financial officer, New Valley has evaluated the effectiveness of its disclosure controls and procedures as of the end of the period covered by this report, and, based on that evaluation, its principal executive officer and principal financial officer have concluded that these controls and procedures are effective. There were no changes in New Valley's internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, New Valley's internal control over financial reporting. Disclosure controls and procedures are New Valley's controls and other procedures that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act is accumulated and communicated to its management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding disclosure. - 32 - PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS See Note 8 to the Condensed Consolidated Financial Statements in Part I, Item 1 of this Report. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS New Valley held its 2005 annual meeting of stockholders on May 23, 2005. There were 23,332,036 New Valley common shares entitled to be voted on the April 19, 2005 record date for the meeting. New Valley's stockholders were asked to elect the following eight director nominees to serve for the ensuing year and until their successors are elected. The votes cast and withheld for such nominees were as follows:

New Valley's stockholders were also asked to approve an amendment to the Company's Certificate of Incorporation to decrease the authorized number of Common Shares from 100,000,000 to 50,000,000. The votes cast were as follows:

Based on these voting results, each of the directors nominated was elected, and the amendment to the Company's Certificate of Incorporation was approved. - 33 - Item 6. EXHIBITS 31.1 Certification of Chief Executive Officer, Pursuant to Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer, Pursuant to Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. - 34 - SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NEW VALLEY CORPORATION (Registrant) Date: August 9, 2005 By: /s/ J. Bryant Kirkland III -------------------------------- J. Bryant Kirkland III Vice President, Treasurer and Chief Financial Officer - 35 -

NEW VALLEY CORP 10-Q