<PAGE>   1

     THIS DOCUMENT IS A COPY OF THE JOINT QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996 FILED ON NOVEMBER 15, 1996
           PURSUANT TO A RULE 201 TEMPORARY HARDSHIP EXEMPTION.

===============================================================================

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                              ------------------

                                   FORM 10-Q


         JOINT QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
               FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996


<TABLE>
<S>                                                          <C>
               COMMISSION FILE NUMBER 1-5759                               COMMISSION FILE NUMBER 33-93576

                     BROOKE GROUP LTD.                                                BGLS INC.
  (Exact name of registrant as specified in its charter)       (Exact name of registrant as specified in its charter)

                        51-0255124                                                   13-3593483
           (I.R.S. Employer Identification No.)                         (I.R.S. Employer Identification No.)

                         DELAWARE                                                     DELAWARE
       (State or other jurisdiction of incorporation                (State or other jurisdiction of incorporation
                     or organization)                                             or organization)

                  100 S.E. SECOND STREET                                       100 S.E. SECOND STREET
                   MIAMI, FLORIDA 33131                                         MIAMI, FLORIDA 33131
(Address of principal executive offices including Zip Code)  (Address of principal executive offices including Zip Code)

                       305/579-8000                                                 305/579-8000
   (Registrant's telephone number, including area code)         (Registrant's telephone number, including area code)
</TABLE>

     Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) have been subject to such filing requirements for the past 90 days.
[ X ]  Yes   [  ]  No

     Explanatory Note:  BGLS Inc. is required to file all reports required by
Section 13 or 15(d) of the Exchange Act in connection with its 15.75% Series B
Senior Secured Notes due 2001.


     As of November 12, 1996, there were 18,497,096 shares of Brooke Group
     Ltd.'s common stock outstanding.

     As of November 12, 1996, there were 100 shares of BGLS Inc.'s common stock
     outstanding, all of which were owned by Brooke Group Ltd.

================================================================================






<PAGE>   2




                               BROOKE GROUP LTD.
                                   BGLS INC.

                                   FORM 10-Q

                               TABLE OF CONTENTS


<TABLE>

                                                                                          Page
                                                                                          ----
<S>                                                                                        <C>
PART I. FINANCIAL INFORMATION
Item 1.  Financial Statements

 Brooke Group Ltd./BGLS Inc. Consolidated Financial Statements:

 Brooke Group Ltd. Consolidated Balance Sheets as of September 30, 1996 and
   December 31, 1995....................................................................    3

 BGLS Inc. Consolidated Balance Sheets as of September 30, 1996 and
   December 31, 1995....................................................................    4

 Brooke Group Ltd. Consolidated Statements of Operations for the three and nine months
   ended September 30, 1996 and September 30, 1995......................................    5

 BGLS Inc. Consolidated Statements of Operations for the three and nine months ended
   September 30, 1996 and September 30, 1995............................................    6

 Brooke Group Ltd. Consolidated Statement of Stockholders' Equity (Deficit) for the nine
   months ended September 30, 1996......................................................    7

 BGLS Inc. Consolidated Statement of Stockholder's Equity (Deficit) for the nine 
   months ended September 30, 1996......................................................    8

 Brooke Group Ltd. Consolidated Statements of Cash Flows for the nine months ended
   September 30, 1996 and September 30, 1995............................................    9

 BGLS Inc. Consolidated Statements of Cash Flows for the nine months ended
   September 30, 1996 and September 30, 1995............................................   10

 Notes to Consolidated Financial Statements.............................................   11

 New Valley Holdings, Inc. Financial Statements:

 Balance Sheets as of September 30, 1996 and December 31, 1995..........................   27

 Statements of Operations for the three and nine months ended September 30, 1996 and
   September 30, 1995...................................................................   28

 Statement of Stockholder's Equity for the nine months ended September 30, 1996.........   29

 Statements of Cash Flows for the nine months ended September 30, 1996
   and September 30, 1995...............................................................   30

 Notes to Financial Statements..........................................................   31

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

PART II. OTHER INFORMATION

Item 1. Legal Proceedings...............................................................   42

Item 3. Defaults Upon Senior Securities.................................................   42

Item 4. Submission of Matters to a Vote of Security-Holders.............................   42

Item 6. Exhibits and Reports on Form 8-K................................................   43

SIGNATURE...............................................................................   44
</TABLE>



<PAGE>   3




Item 1.  Financial Statements

                        BROOKE GROUP LTD. AND SUBSIDIARY
                          CONSOLIDATED BALANCE SHEETS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)


<TABLE>
<CAPTION>
                                                                           September 30,  December 31,
                                                                               1996           1995
                                                                           -------------  ------------
<S>                                                                           <C>           <C>
ASSETS:

Current assets:
 Cash and cash equivalents.................................................   $   2,103     $   3,370
 Accounts receivable - trade...............................................      18,526        23,844
 Other receivables.........................................................       1,788         1,448
 Receivables from affiliates...............................................          22         1,502
 Inventories...............................................................      54,370        60,522
 Deferred tax assets.......................................................                     1,061
 Other current assets......................................................       4,624         4,868
                                                                              ---------     ---------
  Total current assets.....................................................      81,433        96,615
Property, plant and equipment, at cost, less accumulated                                    
 depreciation of $30,229 and $27,323.......................................      68,269        48,352
Intangible assets, at cost, less accumulated amortization                                   
 of $17,008 and $15,679....................................................       4,181         5,453
Investment in affiliate....................................................                    63,901
Other assets...............................................................       9,779        11,299
                                                                              ---------     ---------
  Total assets.............................................................   $ 163,662     $ 225,620
                                                                              =========     =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):                                             

Current liabilities:                                                                        
 Notes payable and current portion of long-term debt.......................   $  52,373     $   2,387
 Accounts payable..........................................................      27,969        22,762
 Cash overdraft............................................................                     4,266
 Accrued promotional expenses..............................................      28,684        25,519
 Accrued taxes payable.....................................................      19,900        25,928
 Accrued interest..........................................................      10,101        16,863
 Other accrued liabilities.................................................      27,196        21,452
                                                                              ---------     ---------
  Total current liabilities................................................     166,223       119,177
                                                                                            
Notes payable, long-term debt and other obligations, less current portion..     387,880       406,744
Noncurrent employee benefits...............................................      30,283        31,672
Other liabilities..........................................................      13,367        24,131
                                                                                            
Commitments and contingencies..............................................
                                                                                            
Stockholders' equity (deficit):                                                             
 Common stock, par value $0.10 per share, authorized 40,000,000
  shares, issued 24,998,043 shares, outstanding 18,497,096 shares..........       1,850         1,850
 Additional paid-in capital................................................      90,806        93,186
 Deficit...................................................................    (470,359)     (428,173)
 Other.....................................................................     (24,049)        9,372
 Less:  6,500,947 shares of common stock in treasury, at cost..............     (32,339)      (32,339)
                                                                              ---------     ---------
   Total stockholders' equity (deficit)....................................    (434,091)     (356,104)
                                                                              ---------     ---------
   Total liabilities and stockholders' equity (deficit)....................   $ 163,662     $ 225,620
                                                                              =========     =========
</TABLE>


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

                                     - 3 -



<PAGE>   4






                           BGLS INC. AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)



<TABLE>
<CAPTION>
                                                                                  September 30,  December 31,
                                                                                      1996           1995
                                                                                  -------------  ------------
<S>                                                                                  <C>           <C>
ASSETS:

Current assets:
 Cash and cash equivalents........................................................   $   2,008     $   3,370
 Accounts receivable - trade......................................................      18,526        23,844
 Other receivables................................................................       1,760         1,481
 Receivables from affiliates......................................................          22         1,130
 Inventories......................................................................      54,370        60,522
 Deferred tax assets..............................................................                     4,861
 Other current assets.............................................................       4,137         4,435
                                                                                     ---------     ---------
   Total current assets...........................................................      80,823        99,643
Property, plant and equipment, at cost, less accumulated depreciation of                           
$29,980 and $27,181...............................................................      67,924        47,900
Intangible assets, at cost, less accumulated amortization of $17,008 and $15,679..       4,181         5,453
Investment in affiliate...........................................................                    63,901
Other assets......................................................................      10,874        12,345
                                                                                     ---------     ---------
   Total assets...................................................................   $ 163,802     $ 229,242
                                                                                     =========     =========
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT):                                                    
                                                                                                   
Current liabilities:                                                                               
 Notes payable and current portion of long-term debt..............................   $  50,902     $   2,132
 Accounts payable.................................................................      27,844        22,637
 Cash overdraft...................................................................                     3,761
 Due to parent....................................................................      27,707        26,054
 Accrued promotional expenses.....................................................      28,684        25,519
 Accrued taxes payable............................................................      19,900        25,928
 Accrued interest.................................................................      10,101        16,863
 Other accrued liabilities........................................................      26,571        19,991
                                                                                     ---------     ---------
   Total current liabilities......................................................     191,709       142,885
                                                                                                   
Notes payable, long-term debt and other obligations, less current portion.........     387,880       420,449
Noncurrent employee benefits......................................................      30,283        31,672
Other liabilities.................................................................      16,621        24,131
                                                                                                   
Commitments and contingencies.....................................................                 
                                                                                                   
Stockholder's equity (deficit):                                                                    
 Common stock, par value $0.01 per share; authorized 100 shares,                                   
  issued 100 shares, outstanding 100 shares.......................................                 
 Additional paid-in capital.......................................................      39,081        23,594
 Deficit..........................................................................    (478,145)     (423,424)
 Other............................................................................     (23,627)        9,935
                                                                                     ---------     ---------
   Total stockholder's deficit....................................................    (462,691)     (389,895)
                                                                                     ---------     ---------
   Total liabilities and stockholder's equity (deficit)...........................   $ 163,802     $ 229,242
                                                                                     =========     =========
</TABLE>


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

                                     - 4 -



<PAGE>   5






                        BROOKE GROUP LTD. AND SUBSIDIARY
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)




<TABLE>
<CAPTION>
                                                                  Three Months Ended           Nine Months Ended     
                                                               ------------------------    -------------------------  
                                                               Sept. 30,      Sept. 30,     Sept. 30,     Sept. 30,   
                                                                  1996           1995         1996           1995     
                                                               ----------     ---------    -----------    ----------  
<S>                                                           <C>            <C>           <C>            <C>        
Revenues*................................................     $  114,635     $   124,100   $   330,364    $  341,718   
Cost of goods sold*......................................         58,361          54,626       168,931       158,766   
                                                              ----------     -----------   -----------    ----------   
    Gross profit.........................................         56,274          69,474       161,433       182,952   
Operating, selling, general and administrative expenses..         55,326          58,818       158,482       173,322   
                                                              ----------     -----------   -----------    ----------   
    Operating income.....................................            948          10,656         2,951         9,630   
Other income (expenses):                                                                                              
 Interest income.........................................             75              43           203           893   
 Interest expense........................................        (15,254)        (13,952)      (45,488)      (43,369)  
 Equity in (loss) earnings of affiliate..................         (4,618)          1,561        (7,152)        3,598   
 Sale of assets..........................................          3,047                         6,745                 
 Other, net..............................................          3,210             962         1,846         2,039   
                                                              ----------     -----------   -----------    ----------   
(Loss) from continuing operations before income taxes....        (12,592)           (730)      (40,895)      (27,209)  
Provision for income taxes...............................          1,145             394         1,291           464   
                                                              ----------     -----------   -----------    ----------   
(Loss) from continuing operations........................        (13,737)         (1,124)      (42,186)      (27,673)  
                                                              ----------     -----------   -----------    ----------   
Discontinued operations:                                                                                              
 Income from discontinued operations.....................                             98                       2,860   
 Gain on disposal........................................                                                     13,138   
                                                              -----------    -----------   -----------    ----------   
Income from discontinued operations......................                             98                      15,998   
                                                              -----------    -----------   -----------    ----------   
Net (loss)...............................................        (13,737)         (1,026)      (42,186)      (11,675)  
Proportionate share of New Valley capital transactions,                                                               
 retirement of Class A Preferred Shares..................                          2,798         1,782        16,802   
                                                              -----------    -----------   -----------    ----------   
   Net (loss) income applicable to common shares.........     $  (13,737)    $     1,772   $   (40,404)   $    5,127   
                                                              ==========     ===========   ===========    ==========   
Per common share:                                                                                                     
 (Loss) income from continuing operations................     $    (0.74)    $      0.09   $     (2.18)   $    (0.60)  
                                                              ==========     ===========   ===========    ==========   
 Income from discontinued operations.....................     $              $      0.01   $              $     0.88   
                                                              ==========     ===========   ===========    ==========   
   Net (loss) income applicable to common shares.........     $    (0.74)    $      0.10   $     (2.18)   $     0.28   
                                                              ==========     ===========   ===========    ==========   
Weighted average common shares and common                                                                             
 share equivalents outstanding...........................     18,497,096      18,247,094    18,497,096    18,248,673  
                                                              ==========     ===========   ===========    ==========    
</TABLE>
----------------------
*    Revenues and Cost of goods sold include federal excise taxes of $26,074
     and $32,643 for the three months ended September 30, 1996 and 1995,
     respectively, and $76,758 and $92,238 for the nine months ended September
     30, 1996 and 1995, respectively.

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

                                     - 5 -



<PAGE>   6






                           BGLS INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)



<TABLE>
<CAPTION>
                                                            Three Months Ended      Nine Months Ended        
                                                          ---------------------   ---------------------      
                                                          Sept. 30,   Sept. 30,   Sept. 30,   Sept. 30,      
                                                             1996        1995        1996        1995        
                                                          ----------  ---------   ----------  ---------      
<S>                                                        <C>         <C>         <C>         <C>            
Revenues*..............................................    $114,635    $124,100    $330,364    $341,718      
Cost of goods sold*....................................      58,361      54,626     168,931     158,766      
                                                           --------    --------    --------    --------      
    Gross profit.......................................      56,274      69,474     161,433     182,952      
                                                                                                             
Operating, selling, general and administrative                                                               
 expenses..............................................      54,627      59,077     157,287     173,168      
                                                           --------    --------    --------    --------      
    Operating income...................................       1,647      10,397       4,146       9,784      
                                                                                                             
Other income (expenses):                                                                                     
 Interest income.......................................          62          43         140         893      
 Interest expense......................................     (16,245)    (14,764)    (48,308)    (45,497)     
 Equity in (loss) earnings of affiliate................      (4,618)      1,561      (7,152)      3,598      
 Sale of assets........................................       3,047                   6,745                  
 Other, net............................................         502         719      (1,528)      1,621      
                                                           --------    --------    --------    --------      
(Loss) from continuing operations before income taxes..     (15,605)     (2,044)    (45,957)    (29,601)     
Provision for income taxes.............................       4,945         389       5,143          94      
                                                           --------    --------    --------    --------      
(Loss) from continuing operations......................     (20,550)     (2,433)    (51,100)    (29,695)     
                                                           --------    --------    --------    --------      
Discontinued operations:                                                                                     
 Income from discontinued operations...................                      98                   2,860      
 Gain on disposal......................................                                          13,138      
                                                           --------    --------    --------    --------      
Income from discontinued operations....................                      98                  15,998      
                                                           --------    --------    --------    --------      
    Net (loss).........................................    $(20,550)   $ (2,335)   $(51,100)   $(13,697)     
                                                           ========    ========    ========    ========      
</TABLE>

----------------------

*    Revenues and Cost of goods sold include federal excise taxes of $26,074
     and $32,643 for the three months ended September 30, 1996 and 1995,
     respectively, and $76,758 and $92,238 for the nine months ended September
     30, 1996 and 1995, respectively.

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

                                     - 6 -



<PAGE>   7






                        BROOKE GROUP LTD. AND SUBSIDIARY
            CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)



<TABLE>
<CAPTION>

                                                       Common Stock     Additional
                                                    ------------------   Paid-In                Treasury
                                                      Shares    Amount   Capital     Deficit      Stock      Other      Total
                                                    ----------  ------  ----------  ----------  ---------  ---------  ----------
<S>                                                 <C>         <C>     <C>         <C>         <C>        <C>        <C>
Balance, December 31, 1995........................  18,497,096  $1,850    $93,186   $(428,173)  $(32,339)  $  9,372   $(356,104)

Net (loss)........................................                                    (42,186)                          (42,186)

Distributions on common stock
 ($0.225 per share)...............................                         (4,162)                                       (4,162)

Amortization of deferred compensation.............                                                              141         141

Unrealized holding loss on investment
 in New Valley....................................                                                          (31,852)    (31,852)

Effect of New Valley capital transactions.........                          1,782                            (1,710)         72

                                                    ----------  ------  ---------   ---------   --------   --------   ---------
Balance, September 30, 1996.......................  18,497,096  $1,850    $90,806   $(470,359)  $(32,339)  $(24,049)  $(434,091)
                                                    ==========  ======  =========   =========   ========   ========   =========
</TABLE>



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

                                     - 7 -


<PAGE>   8







                           BGLS INC. AND SUBSIDIARIES
            CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (DEFICIT)
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)





<TABLE>
<CAPTION>
                                                          
                                Common Stock   Additional
                               --------------   Paid-In
                               Shares  Amount   Capital     Deficit        Other       Total
                               ------  ------  ----------  ----------  ------------  ----------
<S>                            <C>     <C>      <C>        <C>            <C>        <C>
Balance, December 31, 1995....  100    $        $23,594    $(423,424)     $  9,935   $(389,895)
Distributions paid to parent..                                (3,621)                   (3,621)
Net (loss)....................                               (51,100)                  (51,100)
Unrealized holding loss on 
  investment in New Valley....                                             (31,852)    (31,852)
Effect of New Valley capital                              
  transactions................                    1,782                     (1,710)         72
Forgiveness of debt by parent.                   13,705                                 13,705
                               ----    ------   -------    ---------      --------   ---------
Balance, September 30, 1996...  100    $        $39,081    $(478,145)     $(23,627)  $(462,691)
                               ====    ======   =======    =========      ========   =========
</TABLE>



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

                                     - 8 -


<PAGE>   9






                        BROOKE GROUP LTD. AND SUBSIDIARY
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)



<TABLE>
<CAPTION>
                                                                       Nine Months Ended        
                                                                  ----------------------------  
                                                                  September 30,  September 30,  
                                                                      1996           1995       
                                                                  -------------  -------------  
<S>                                                                  <C>             <C>        
 Net cash (used in) operating activities........................     $(22,000)       $(23,706)  
                                                                     --------        --------   
 Cash flows from investing activities:                                                          
  Proceeds from sale of businesses and assets...................        8,031          14,149   
  Investments...................................................         (482)         (1,965)  
  Capital expenditures..........................................      (24,047)         (5,008)  
  Dividends from New Valley.....................................       24,733          61,832   
                                                                     --------        --------   
 Net cash provided by investing activities......................        8,235          69,008   
                                                                     --------        --------   
 Cash flows from financing activities:                                                          
  Proceeds from debt............................................       29,503           3,028   
  Repayments of debt............................................       (8,559)        (28,529)  
  (Decrease) in cash overdraft..................................       (4,266)         (2,817)  
  Distributions on common stock.................................       (4,162)         (4,107)  
  Treasury stock purchases......................................                         (135)  
  Other, net....................................................          (18)            (20)  
                                                                     --------        --------   
 Net cash provided by (used in) by financing activities.........       12,498         (32,580)  
                                                                     --------        --------   
 Net (decrease) increase in cash and cash equivalents...........       (1,267)         12,722   
 Cash and cash equivalents, beginning of period.................        3,370           4,276   
                                                                     --------        --------   
 Cash and cash equivalents, end of period.......................     $  2,103        $ 16,998   
                                                                     ========        ========   
Supplemental non-cash investing and financing activities:                                       
 Exchange of Series 2 Senior Secured Notes for Series A Notes...     $ 99,154                   
 Exchange of 14.50% Subordinated Debentures for Series B Notes..      125,495                   
 Issuance of Series A Notes for options.........................          822                   
 Exchange of Series A Notes for Series B Notes..................       99,976                   
 Issuance of promissory notes for shares of LDL.................        1,643                   
 Distribution of MAI shares to stockholders.....................                     $ 27,085   
</TABLE>                                                                       
                                                                               


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

                                     - 9 -


<PAGE>   10






                           BGLS INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)




<TABLE>
<CAPTION>
                                                                         Nine Months Ended          
                                                                    September 30,  September 30,    
                                                                        1996           1995         
                                                                    -------------  -------------    
<S>                                                                    <C>            <C>           
Net cash (used in) operating activities..................              $(21,924)      $(16,513)     
                                                                       --------       --------      
Cash flows from investing activities:                                                               
  Proceeds from sale of business and assets..............                 8,031         13,849      
  Investments............................................                  (482)        (2,765)     
  Capital expenditures...................................               (24,047)        (4,781)     
  Dividends from New Valley..............................                24,733         61,832      
  Other, net.............................................                                  (88)     
                                                                       --------       --------      
Net cash provided by investing activities................                 8,235         68,047      
                                                                       --------       --------      
Cash flows from financing activities:                                                               
  Proceeds from debt.....................................                27,861          2,343      
  Repayments of debt.....................................                (8,134)       (32,934)     
  (Decrease) in cash overdraft...........................                (3,761)        (2,126)     
  Distributions paid to parent...........................                (3,621)        (5,872)     
  Other, net.............................................                   (18)          (206)     
                                                                       --------       --------      
Net cash provided by (used in) financing activities......                12,327        (38,795)     
                                                                       --------       --------      
Net (decrease) increase in cash and cash equivalents.....                (1,362)        12,739      
Cash and cash equivalents, beginning of period...........                 3,370          4,259      
                                                                       --------       --------      
Cash and cash equivalents, end of period.................              $  2,008       $ 16,998      
                                                                       ========       ========      

Supplemental non-cash investing and financing activities:
  
 Exchange of Series 2 Senior Secured Notes for Series
  A Notes ...............................................              $ 99,154
 Exchange of 14.50% Subordinated Debentures for Series 
  B Notes ...............................................               125,495
 Issuance of Series A Notes for options .................                   822
 Exchange of Series A Notes for Series B Notes ..........                99,976
 Forgiveness of debt by parent ..........................                13,705
 Issuance of promissory notes for shares of LDL .........                 1,643
 Distribution of MAI to parent ..........................                             $24,741


</TABLE>


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

                                     - 10 -


<PAGE>   11






                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)



1. PRINCIPLES OF REPORTING

   The consolidated financial statements of Brooke Group Ltd. (the "Company")
   include the consolidated statements of its wholly owned subsidiary, BGLS
   Inc. ("BGLS").  The consolidated statements of BGLS include the accounts of
   Liggett Group Inc. ("Liggett"), Brooke (Overseas) Ltd. ("BOL"), New Valley
   Holdings, Inc. ("NV Holdings") and other less significant subsidiaries.
   Based on the Company's ability to assert sufficient control, the Company
   consolidated the accounts of Liggett-Ducat Ltd. ("LDL") at December 31, 1995
   and the results of operations for the three and nine months ended September
   30, 1996.

   The interim consolidated financial statements of the Company and BGLS are
   unaudited and, in the opinion of management, reflect all adjustments
   necessary (which are normal and recurring) to present fairly the Company's
   and BGLS' consolidated financial position, results of operations and cash
   flows.  These consolidated financial statements should be read in
   conjunction with the consolidated financial statements and the notes thereto
   included in the Company's and BGLS' Annual Reports on Form 10-K, as amended,
   for the year ended December 31, 1995, as filed with the Securities and
   Exchange Commission ("SEC").  The consolidated results of operations for
   interim periods should not be regarded as necessarily indicative of the
   results that may be expected for the entire year.

   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 and the reported amounts of
   revenues and expenses.  Actual results could differ from those estimates.

   Certain amounts in the 1995 consolidated financial statements have been
   reclassified to conform to the 1996 presentation.


2. INVESTMENT IN NEW VALLEY CORPORATION

   Summarized financial information for New Valley Corporation ("New Valley")
   as of September 30, 1996 and December 31, 1995 and for the three and nine
   months ended September 30, 1996 and 1995 follows:


<TABLE>
                                          September 30,  December 31,
                                              1996           1995
                                          -------------  ------------
            <S>                              <C>            <C>
            Current assets.................  $ 234,165      $333,485
            Investment in real estate......    182,125
            Other non-current assets.......     37,099        52,337
            Current liabilities............    183,292       177,920
            Notes payable..................    159,494
            Other long-term obligations....     12,966        11,967
            Redeemable preferred shares....    201,318       226,396
            Common shareholders' deficit...   (103,681)      (30,461)
</TABLE>


                                     - 11 -


<PAGE>   12





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)






<TABLE>
<CAPTION>
                                             Three Months Ended    Nine Months Ended
                                            --------------------  --------------------
                                            Sept. 30,  Sept. 30,  Sept. 30,  Sept. 30,
                                              1996       1995       1996       1995
                                            ---------  ---------  ---------  ---------
<S>                                         <C>         <C>       <C>         <C>
Revenues................................... $ 24,263    $21,514   $ 92,794    $39,215
Cost and expenses..........................   33,000     18,436    110,647     26,189
(Loss) income from continuing operations...   (7,728)     2,784    (16,694)    11,699
(Loss) income from discontinued operations.   (4,716)       235     (5,396)     4,315
Net (loss) applicable to common shares(A)..  (27,844)    (7,860)   (64,319)      (300)
</TABLE>                                    


   (A)  Includes all preferred accrued dividends, whether or not declared, and
        the excess of carrying value of redeemable preferred shares over cost
        of shares purchased.

   The Company's and BGLS' investment in New Valley at September 30, 1996 is
   summarized as follows:




<TABLE>
<CAPTION>
                                                               
                                Number of   Fair    Carrying                
                                 Shares     Value    Amount                 
                                ---------  -------  ---------    
    <S>                         <C>        <C>      <C>                     
    Class A Preferred Shares..    618,326  $74,199  $ 74,199             
    Class B Preferred Shares..    250,885    2,509     2,509             
    Common Shares.............  3,989,710   15,959   (76,708)               
                                           -------  --------           
                                           $92,667  $                      
                                           =======  ========                
</TABLE>

   The Class A Preferred Shares and the Class B Preferred Shares are accounted
   for as debt and equity securities, respectively, pursuant to the
   requirements of Statement of Financial Accounting Standards No. 115 ("FAS"),
   "Accounting for Certain Investments in Debt and Equity Securities", and are
   classified as available-for-sale.  Prior to January 1, 1996, the Class A
   Preferred Shares' fair value had been estimated with reference to the
   securities' preference features, including dividend and liquidation
   preferences, and the composition and nature of the underlying net assets of
   New Valley.  In January 1996, however, New Valley became engaged in the
   ownership and management of commercial real estate and, in February 1996,
   acquired a controlling interest in Thinking Machines Corporation.  Because
   these businesses affect the composition and nature of the underlying net
   assets of New Valley, the Company and BGLS have determined the fair value of
   the Class A Preferred Shares based on the quoted market price commencing
   with the quarter ended March 31, 1996.  The New Valley common shares are
   accounted for under the equity method.  On July 29, 1996, New Valley
   effected a one-for-twenty reverse stock split of New Valley's common shares.
   After giving effect to this split, the Company holds 3,989,710 (41.7%)
   common shares of New Valley.

   During the quarter ended September 30, 1996, the decline in the market value
   of the Class A Preferred Shares, the dividend received on the Class A
   Preferred Shares and the Company's equity in losses incurred by New Valley
   caused the carrying value of the Company's investments in New Valley to be
   reduced to zero.  As a result, the Company did not record $8,272 of its
   proportionate interest in New Valley's FAS 115 unrealized holding losses.

                                     - 12 -



<PAGE>   13





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)





   In the first quarter of 1996, New Valley repurchased 72,104 Class A
   Preferred Shares for $10,530.  As a result of this transaction, the Company
   and BGLS now own 59.72% of the outstanding Class A Preferred Shares.  The
   Company and BGLS have recorded their proportionate interest in the excess of
   the carrying value of the shares over the cost of the shares repurchased as
   a credit to additional paid-in capital of $1,782 along with their share of
   losses in other New Valley capital transactions of $1,710 for the nine
   months ended September 30, 1996.

   NV Holdings has received $24,733 ($40.00 per share) in dividend
   distributions for the nine months ended September 30, 1996.  At September
   30, 1996, the accrued and unpaid dividends arrearage on the Class A
   Preferred Shares was $103,234 or $99.70 per share.  The Company's share of
   such arrearage was $61,647.

   At September 30, 1996, the accrued and unpaid dividends arrearage on the
   Class B Preferred Shares was $110,476 or $39.59 per share.

   As a result of asset dispositions pursuant to New Valley's First Amended
   Joint Chapter 11 Plan of Reorganization, as amended (the "Joint Plan"), New
   Valley accumulated a significant amount of cash which it was required to
   reinvest in operating companies by January 18, 1996 in order to avoid
   potentially burdensome regulation under the Investment Company Act of 1940,
   as amended (the "Investment Company Act").  The Investment Company Act and
   the rules and regulations thereunder require the registration of, and impose
   various substantive restrictions on, companies that engage primarily in the
   business of investing, reinvesting or trading in securities or engage in the
   business of investing, reinvesting, owning, holding or trading in securities
   and own or propose to acquire "investment securities" having a "value" in
   excess of 40% of a company's "total assets" (exclusive of Government
   securities and cash items) on an unconsolidated basis.  Following
   dispositions of its then operating businesses pursuant to the Joint Plan,
   New Valley was above this threshold and relied on the one-year exemption
   from registration under the Investment Company Act provided by Rule 3a-2
   thereunder, which exemption expired on January 18, 1996.  Prior to such
   date, through New Valley's acquisition of the investment banking and
   brokerage business of Ladenburg, Thalmann & Co., Inc. and its acquisition of
   a portfolio of office buildings and shopping centers, New Valley was engaged
   primarily in a business or businesses other than that of investing,
   reinvesting, owning, holding or trading in securities, and the value of its
   investment securities was below the 40% threshold.  Under the Investment
   Company Act, New Valley is required to determine the value of its total
   assets for purposes of the 40% threshold based on "market" or "fair" values,
   depending on the nature of the asset, at the end of the last preceding
   fiscal quarter and based on cost for assets acquired since that date.  If
   New Valley were required to register in the future, under the Investment
   Company Act, it would be subject to a number of severe restrictions on its
   operations, capital structure and management, including without limitation,
   entering into transactions with affiliates.  If New Valley were required to
   register under the Investment Company Act, the Company and BGLS may be in
   violation of the Investment Company Act and may be adversely affected by the
   restrictions of the Investment Company Act.  In addition, registration under
   the Investment Company Act by BGLS would constitute a violation of the
   15.75% Series B Senior Secured Notes due 2001 (the "Series B Notes")
   indenture to which BGLS is a party.



                                     - 13 -



<PAGE>   14





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)




3. RJR NABISCO HOLDINGS CORP.

   At September 30, 1996, New Valley held 4,947,250 shares of RJR Nabisco
   Holdings Corp. ("RJR Nabisco") common stock with a market value of $129,247
   (cost of $151,650) collateralizing margin loan financing of $75,863.  From
   the period October 1, 1996 to November 8, 1996, New Valley sold
   approximately 1,780,000 shares of RJR Nabisco common stock and recognized a
   loss of $3,648.  At November 8, 1996, New Valley held approximately
   3,170,000 shares of RJR Nabisco common stock with a market value of $96,815
   (cost of $97,302), collateralizing margin loan financing of $23,158.  New
   Valley's unrealized loss on its investment in RJR Nabisco common stock
   decreased from $22,403 at September 30, 1996 to $487 at November 8, 1996.

   On February 29, 1996, New Valley entered into a total return equity swap
   transaction (the "Swap") with an unaffiliated company relating to 1,000,000
   shares of RJR Nabisco common stock.  During the third quarter of 1996, the
   Swap was terminated.  New Valley recognized a loss on the Swap of $4,074 and
   $7,305 for the three and nine months ended September 30, 1996, respectively.

   For the three and nine months ended September 30, 1996, New Valley has
   expensed $791 and $11,158, respectively, for costs relating to its RJR
   Nabisco investment.  Pursuant to a December 27, 1995 agreement, New Valley
   agreed, among other things, to pay directly or reimburse the Company and its
   subsidiaries for out-of-pocket expenses in connection with the Company's
   solicitation of consents and proxies from the shareholders of RJR Nabisco.
   New Valley has reimbursed the Company and its subsidiaries $2,361 pursuant
   to this agreement of which $942 was expensed in 1996.

   On November 5, 1996, the Company submitted to RJR Nabisco, in order to
   comply with the requirements of RJR Nabisco's by-laws, a notice of intent to
   nominate a slate of directors for election at the RJR Nabisco 1997 annual
   meeting of stockholders.


4. INVENTORIES

   Inventories consist of:

<TABLE>
<CAPTION>
                                     September 30,  December 31,
                                         1996           1995
                                     ---------------------------
<S>                                     <C>           <C>
  Finished goods....................    $19,660       $19,129
  Work-in-process...................      3,564         3,570
  Raw materials.....................     26,096        29,021
  Replacement parts and supplies....      4,829         4,903
                                        -------       -------
  Inventories at current costs......     54,149        56,623
  LIFO adjustments..................        221         3,899
                                        -------       -------
                                        $54,370       $60,522
                                        =======       =======
</TABLE>

   At September 30, 1996, the Company had leaf tobacco purchase commitments of
   approximately $29,840.

                                     - 14 -



<PAGE>   15





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)





5. INCOME TAXES

   The provision for taxes for the nine months ended September 30, 1996 and
   1995 does not bear the customary relationship to the pretax loss/income for
   the Company and BGLS due principally to the effects of taxes provided for
   foreign operations and an increase in the valuation allowance related to
   deferred tax assets.


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

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


<TABLE>
                                                           September 30,  December 31,
                                                               1996           1995
                                                           ---------------------------
<S>                                                           <C>           <C>
  15.75% Series B Senior Secured Notes due 2001...........    $232,864
  13.75% Series 2 Senior Secured Notes due 1997...........                  $ 91,179
  16.125% Senior Subordinated Reset Notes due 1997........                     5,670
  14.500% Subordinated Debentures due 1998................         800       126,295
  Notes payable - Foreign.................................      22,972        11,122
  Other...................................................       1,173         2,084

  Liggett:
  11.500% Senior Secured Series B Notes due 1993 - 1999...     119,638       119,485
  Variable rate Series C Senior Secured Notes due 1999....      32,279        32,279
  Revolving credit facility...............................      30,527        21,017
                                                              --------      --------
  Total notes payable and long-term debt..................     440,253       409,131
                                                          
  Less:
   Current maturities.....................................      52,373         2,387
                                                              --------      --------
  Amount due after one year...............................    $387,880      $406,744
                                                              ========      ========
</TABLE>                                               
                                                          
   Offer to Exchange:
   15.75% Series A Senior Secured Notes Due 2001 for 13.75% Series 2
        Senior Secured Notes Due 1997, and
   15.75% Series B Senior Secured Notes Due 2001 for 16.125% Senior
        Subordinated Reset Notes Due 1997 and 14.500% Subordinated Debentures:

   As a result of the Exchange Agreement, dated November 21, 1995 (the "1995
   Exchange Agreement"), on November 27, 1995, BGLS commenced an offer to
   exchange a total of $232,864 principal amount of 15.75% Senior Secured Notes
   due January 31, 2001, for all its outstanding Series 2 Notes, Reset Notes
   and Subordinated Debentures.  The exchange ratio was $1,087.47 principal
   amount of new 15.75% Series A Senior Secured Notes ("Series A Notes") for
   each $1,000 principal amount of Series 2 Notes exchanged, $1,132.28
   principal amount of new Series B Notes for each $1,000 principal amount of
   Reset Notes exchanged and $1,000 principal amount of new Series B Notes for
   each $1,000 principal amount of Subordinated Debentures exchanged.  The new
   Series A Notes and the new Series B Notes were identical except that the
   Series B Notes were not subject to restrictions on transfer.


                                     - 15 -



<PAGE>   16





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)




   The holders of in excess of 99% of the Series 2 Notes and 88% of the
   Subordinated Debentures agreed, subject to certain conditions, to tender
   their securities in the exchange offer.  The exchange offer closed on
   January 30, 1996.  All $91,179 of the Series 2 Notes and $125,495 of the
   Subordinated Debentures were exchanged.  In addition, BGLS cancelled all of
   the Subordinated Debentures ($13,705) held by the Company.  Subordinated
   Debentures in the amount of $800 remain outstanding (see "14.500%
   Subordinated Debentures due 1998" in the table above).

   Holders of Reset Notes did not exchange and, in accordance with the 1995
   Exchange Agreement, BGLS issued an irrevocable notice of redemption for all
   of the outstanding Reset Notes.  On March 7, 1996, an additional $7,397 face
   amount of Series A Notes were sold for $6,300 including accrued interest
   with proceeds being used for the redemption of the Reset Notes, which were
   redeemed on March, 29 1996 for a total amount of $5,785, including premium,
   together with accrued interest of $452.

   Pursuant to a registered exchange offer, holders of the Series A Notes
   exchanged all of the $107,373 outstanding principal amount for an equal
   principal amount of Series B Notes.  The exchange closed March 21, 1996.
   The Company has cancelled all the Series A Notes.

   The new Series B Notes are collateralized by substantially all of BGLS'
   assets, including a pledge of BGLS' equity interests in Liggett, BOL and NV
   Holdings as well as a pledge of all of the New Valley securities held by
   BGLS and NV Holdings.  The Series B Notes Indenture contains certain
   covenants, which among other things, limit the ability of BGLS to make
   distributions to the Company, limit additional indebtedness of BGLS to
   $10,000 and restrict certain transactions with affiliates.  Interest is
   payable at the rate of 15.75% per annum on January 31 and July 31 of each
   year, except for the period ended July 31, 1996 when interest was payable at
   13.75% from October 1, 1995 to January 30, 1996 and at 15.75% from January
   31, 1996 through July 31, 1996.


7. CONTINGENCIES

   Liggett:

   Since 1954, Liggett and other United States cigarette manufacturers have
   been named as defendants in a number of direct and third-party actions
   predicated on the theory that they should be liable for damages from cancer
   and other adverse health effects alleged to have been caused by cigarette
   smoking or by exposure to secondary smoke (environmental tobacco smoke,
   "ETS") from cigarettes.  These cases are reported hereinafter as though
   having been commenced against Liggett (without regard to whether such
   actually were commenced against the Company or Liggett).  New cases continue
   to be commenced against Liggett and other cigarette manufacturers.  As new
   cases are commenced, the costs associated with defending such cases and the
   risks attendant to the inherent unpredictability of litigation continue to
   increase.  Liggett has been receiving certain financial and other assistance
   from others in the industry in defraying the costs and other burdens
   incurred in the defense of smoking and health litigation and related
   proceedings.  The future financial benefit to the Company is not
   quantifiable at this time since the arrangements for assistance can be
   terminated under certain circumstances and the amount received, if any,
   would be a function of the level of costs incurred.  Certain joint defense
   arrangements, and the financial benefits incident thereto, have ended.

                                     - 16 -



<PAGE>   17





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)



   No assurances can be made that other arrangements will continue.  To date a
   number of such actions, including several against Liggett, have been
   disposed of favorably to the defendants.

   In the action entitled Cipollone v. Liggett Group Inc., et al., the United
   States Supreme Court on June 24, 1992, issued an opinion regarding federal
   preemption of state law damage actions.  The Supreme Court in Cipollone
   concluded that The Federal Cigarette Labeling and Advertising Act (the "1965
   Act") did not preempt any state common law damage claims.  Relying on The
   Public Health Cigarette Smoking Act of 1969 (the "1969 Act"), however, the
   Supreme Court concluded that the 1969 Act preempted certain, but not all,
   common law damage claims.  Accordingly, the decision bars plaintiffs from
   asserting claims that, after the effective date of the 1969 Act, the tobacco
   companies either failed to warn adequately of the claimed health risks of
   cigarette smoking or sought to neutralize those claimed risks in their
   advertising or promotion of cigarettes.  It does permit, however, claims for
   fraudulent misrepresentation (other than a claim of fraudulently
   neutralizing the warning), concealment (other than in advertising and
   promotion of cigarettes), conspiracy and breach of express warranty after
   1969.  The Court expressed no opinion as to whether any of these claims are
   viable under state law, but assumed arguendo that they are viable.

   In addition, bills have been introduced in Congress on occasion to eliminate
   the federal preemption defense.  Enactment of any federal legislation with
   such an effect could result in a significant increase in claims, liabilities
   and litigation costs.

   On March 27, 1987, an action entitled Yvonne Rogers v. Liggett Group Inc. et
   al., Superior Court, Marion County, Indiana, was filed against Liggett and
   others.  The plaintiff seeks compensatory and punitive damages for cancer
   alleged to have been caused by cigarette smoking.  Trial commenced on
   January 31, 1995.  The trial ended on February 22, 1995 when the trial court
   declared a mistrial due to the jury's inability to reach a verdict.  The
   Court directed a verdict in favor of the defendants as to the issue of
   punitive damages during the trial of this action.  A second trial commenced
   on August 5, 1996.  On August 23, 1996, the jury returned a verdict in favor
   of the defendants.

   On October 31, 1991, an action entitled Broin et al. v. Philip Morris
   Companies, Inc., et al., Circuit Court of the 11th Judicial District in and
   for Dade County, Florida, was filed against Liggett and others.  This case
   was the first class action commenced against the industry, and has been
   brought by plaintiffs on behalf of all flight attendants that have worked or
   are presently working for airlines based in the United States and who have
   never regularly smoked cigarettes but allege that they have been damaged by
   involuntary exposure to ETS.  On December 12, 1994, plaintiffs' motion to
   certify the action as a class action was granted.  Defendants appealed this
   ruling and on January 3, 1996, the Third District Court of Appeal in Florida
   ("Third DCA") affirmed the class certification order.  On May 8, 1996, the
   Third DCA denied defendants' rehearing request.  On June 5, 1996, the Third
   DCA denied defendants' petition for a stay of its order upholding class
   certification, but granted defendants' motion for a stay of class notice
   pending consideration by the Florida Supreme Court.  On June 17, 1996, the
   Florida Supreme Court denied defendants' petition for review.  The suit is
   scheduled to go to trial on June 2, 1997.

   On May 12, 1992, an action entitled Cordova v. Liggett Group Inc., et al.,
   Superior Court of the State of California, City of San Diego, was filed
   against Liggett and others.  In her complaint, plaintiff, purportedly on
   behalf of the general public, alleges that defendants have been engaged in
   unlawful, unfair and fraudulent business practices by allegedly
   misrepresenting and concealing from the public

                                     - 17 -



<PAGE>   18





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)



   scientific studies pertaining to smoking and health funded by, and
   misrepresenting the independence of, the Council on Tobacco Research ("CTR")
   and its predecessor.  The complaint seeks equitable relief against the
   defendants, including the imposition of a corrective advertising campaign,
   restitution of funds, disgorgement of revenues and profits and the
   imposition of a constructive trust.  The case is presently in the discovery
   phase.  A similar action has been filed in the Superior Court for the State
   of California, City of San Francisco.

   On September 10, 1993, an action entitled Sackman v. Liggett Group Inc.,
   United States District Court, Eastern District of New York, was filed
   against Liggett alone alleging as injury lung cancer.  Fact discovery closed
   on August 31, 1995; expert discovery continues.  On May 25, 1996, the
   District Court granted Liggett summary judgment on plaintiffs' fraud and
   breach of warranty claims on statute of limitations grounds, but allowed
   plaintiffs' personal injury claims to survive.  In the same order, the
   District Court vacated the Magistrate's March 19, 1996 order compelling
   Liggett to produce certain CTR documents with respect to which Liggett had
   asserted various privilege claims, and allowed the other cigarette
   manufacturers and the CTR to intervene in order to assert their interests
   and privileges with respect to those same documents.  The Court also ordered
   the Magistrate to reconsider his March 19, 1996 order and the effect of the
   District Court's summary judgment order.  Oral argument concerning the
   relevancy of the CTR documents in light of the District Court's summary
   judgment order was conducted on August 8, 1996.  The Magistrate's ruling on
   this matter is pending.

   On March 25, 1994, an action entitled Castano, et al. v. The American
   Tobacco Company, et al., United States District Court, Eastern District of
   Louisiana, was filed against Liggett and others.  The class action complaint
   was brought on behalf of plaintiffs and residents of the United States who
   claim to be addicted to tobacco products and survivors who claim their
   decedents were addicted.  The complaint is based upon the claim that
   defendants manipulated the nicotine levels in their tobacco products with
   the intent to addict plaintiffs and the class members.  The complaint also
   alleges causes of action sounding in fraud, deceit, negligent
   misrepresentation, breach of express and implied warranty, strict liability
   and violation of consumer protection statutes.  Plaintiffs seek compensatory
   and punitive damages and equitable relief including disgorgement of profits
   from the sale of cigarettes and creation of a fund to monitor the health of
   class members and to pay for medical expenses allegedly caused by
   defendants, attorneys' fees and costs.  On February 17, 1995, the District
   Court issued an order that granted in part plaintiffs' motion for class
   certification.  On May 23, 1996, the Court of Appeals for the Fifth Circuit
   reversed the District Court's order certifying the nationwide class action
   and instructed the District Court to dismiss the class complaint.

   On March 12, 1996, the Company and Liggett entered into an agreement to
   settle the Castano class action tobacco litigation.  The settlement
   undertakes to release the Company and Liggett from all current and future
   addiction-based claims, including claims by a nationwide class of smokers in
   the Castano class action pending in Louisiana federal court as well as
   claims by a narrower statewide class in the Engle case (described below)
   pending in Florida state court.  The settlement is subject to and
   conditioned upon the approval of the United States District Court for the
   Eastern District of Louisiana.  The Company is unable to determine at this
   time when the Court will review the settlement, and no assurance can be
   given that the settlement will be approved by the Court.  Certain items of
   the settlement are summarized below.


                                     - 18 -



<PAGE>   19





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)




   Under the settlement, the Castano class would receive up to 5% of Liggett's
   pretax income (income before income taxes) each year (up to a maximum of
   $50,000 per year) for the next twenty-five years, subject to certain
   reductions provided for in the agreement, together with reasonable fees and
   expenses of the Castano Plaintiffs Legal Committee.  Settlement funds
   received by the class would be used to pay half the cost of
   smoking-cessation programs for eligible class members.  While neither
   consenting to Federal Drug Administration ("FDA") jurisdiction nor waiving
   their objections thereto, the Company and Liggett also have agreed to phase
   in compliance with certain of the proposed interim FDA regulations regarding
   smoking by children and adolescents, including a prohibition on the use of
   cartoon characters in tobacco advertising and limitations on the use of
   promotional materials and distribution of sample packages where minors are
   present.

   The Company and Liggett have the right to terminate the Castano settlement
   if the remaining defendants succeed on the merits or in the event of a full
   and final denial of class action certification.  The terms of the settlement
   would still apply if the Castano plaintiffs or their lawyers were to
   institute a substantially similar new class action against the tobacco
   industry.  The Company and Liggett may also terminate the settlement if they
   conclude that too many class members have chosen to opt out of the
   settlement.  In the event of any such termination by the Company and
   Liggett, the named plaintiffs would be at liberty to renew their prosecution
   of such civil action against the Company and Liggett.

   On March 14, 1996, the Company and the Castano Plaintiffs Legal Committee
   and the Castano Plaintiffs entered into a letter agreement.  According to
   the terms of the letter agreement, for the period ending nine months from
   the date of Final Approval of the Castano settlement or, if earlier, the
   completion of a combination by the Company or Liggett with certain
   defendants, or an affiliate thereof, in Castano, the Castano Plaintiffs
   agree not to enter into any settlement agreement with any Castano defendant
   which would reduce the terms of the Castano settlement agreement.  If the
   Castano Plaintiffs enter into any such settlement during this period, they
   shall pay the Company $250,000 within thirty days of the more favorable
   agreement and offer the Company and Liggett the option to enter into a
   settlement on terms at least as favorable as those included in such other
   settlement.  The letter agreement further provides that during the same time
   period, and if the Castano settlement agreement has not been earlier
   terminated by the Company in accordance with its terms, the Company and its
   affiliates will not enter into any business transaction with any third party
   which would cause the termination of the Castano settlement agreement.  If
   the Company or its affiliates enter into any such transaction, then the
   Castano Plaintiffs will be entitled to receive $250,000 within thirty days
   from the transacting party.

   On May 11, 1996, the Castano Plaintiffs Legal Committee filed a motion
   seeking preliminary approval of the Castano settlement.  That motion has not
   yet been heard by the court.

   On May 5, 1994, an action entitled Engle, et al. v. R. J. Reynolds Tobacco
   Company, et al., Circuit Court of the 11th Judicial District in and for Dade
   County, Florida, was filed against Liggett and others.  The class action
   complaint was brought on behalf of plaintiffs and all persons in the United
   States who allegedly have become addicted to cigarette products and
   allegedly have suffered personal injury as a result thereof.  Plaintiffs
   seek compensatory and punitive damages together with equitable relief
   including but not limited to a medical fund for future health care costs,
   attorneys' fees and costs.  On October 31, 1994, plaintiffs' motion to
   certify the action as a class action was granted.  Defendants have appealed
   this ruling.  On January 31, 1996, the Third DCA affirmed the ruling of the

                                     - 19 -



<PAGE>   20





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)



   trial court certifying the action as a class action, but modified the trial
   court ruling to limit the class to Florida citizens and residents.  On May
   8, 1996, the Third DCA denied defendants' rehearing request.  On June 5,
   1996, the Third DCA denied defendants' petition for a stay of its order
   upholding class certification but granted defendants' motion for a stay of
   class notice pending consideration by the Florida Supreme Court.  On October
   2, 1996, the Florida Supreme Court denied defendants' petition for review.

   In February 1995, an action entitled Grady Carter, et al. v. The American
   Tobacco Company, et al., Superior Court for the State of Florida, Duval
   County, was filed against Liggett and others.  Plaintiff sought compensatory
   damages, including, but not limited to, reimbursement for medical costs.
   Both American Tobacco and Liggett were subsequently dismissed from this
   action.  On August 9, 1996, a jury returned a verdict against the remaining
   defendant, Brown & Williamson Tobacco Corp., in the amount of $750,000.
   Brown & Williamson has announced that it intends to appeal that verdict.

   On April 11, 1996, an action entitled Harris, et al. v. The American Tobacco
   Company, et al., United States District Court for the Eastern District of
   Pennsylvania, was filed against Liggett and others.  The class action
   complaint was brought on behalf of plaintiffs and all persons in the United
   States, its territories and possessions and the Commonwealth of Puerto Rico
   who allegedly have become addicted to cigarette products and have suffered
   personal injury as a result thereof.  Plaintiffs seek compensatory and
   punitive damages together with equitable relief including, but not limited
   to, a medical fund, for future health costs, attorneys' fees and costs.

   On May 6, 1996, an action entitled Norton, et al. v. RJR Nabisco Holdings
   Corp., et al., Madison County, Indiana Superior Court, was filed against
   Liggett and others.  The class action complaint was brought on behalf of
   plaintiffs and all persons in the State of Indiana who allegedly have become
   addicted to cigarette products and allegedly have suffered personal injury
   as a result thereof.  Plaintiffs seek compensatory and punitive damages
   together with equitable relief including but not limited to a medical fund
   for future health care costs, attorneys' fees and costs.  On June 3, 1996,
   the defendant tobacco companies filed a notice of removal in the United
   States District Court for the Southern District of Indiana.

   On May 29, 1996, an action entitled Richardson, et al. v. Philip Morris
   Inc., et al., Circuit Court for Baltimore City, was filed against Liggett
   and others.  The class action complaint was brought on behalf of plaintiffs
   and all persons in the State of Maryland who allegedly have become addicted
   to cigarette products and allegedly have suffered personal injury as a
   result thereof.  Plaintiffs seek compensatory and punitive damages, together
   with equitable relief including but not limited to a medical fund for future
   health care costs, attorney's fees and costs.  On June 27, 1996, the
   defendant tobacco companies filed a notice of removal in the United States
   District Court for the District of Maryland.

   On June 21, 1996, an action entitled Reed v. Philip Morris, et al., Superior
   Court of the District of Columbia, was filed against Liggett and others.
   The class action complaint was brought on behalf of plaintiff and all
   persons in the District of Columbia who allegedly have become addicted to
   cigarette products and have suffered personal injury as a result thereof.
   Plaintiffs seek compensatory and punitive damages together with equitable
   relief including, but not limited to, a medical fund, for future health
   costs, attorneys' fees and costs.


                                     - 20 -



<PAGE>   21





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)




   On August 8, 1996, an action entitled Arch, et al. v. The American Tobacco
   Company, et al., Philadelphia County Court of Common Pleas, was filed
   against Liggett and others.  The class action complaint was brought on
   behalf of plaintiff and all persons in the State of Pennsylvania who
   allegedly have become addicted to cigarette products and have suffered
   personal injury as a result thereof.  Plaintiffs seek compensatory and
   punitive damages together with equitable relief including, but not limited
   to, a medical fund, for future health costs, attorneys' fees and costs.  On
   August 27, 1996, the defendant tobacco companies filed a notice of removal
   in the United States District Court for the Eastern District of
   Pennsylvania.  That court denied plaintiffs' Motion to Remand on October 21,
   1996.

   On August 20, 1996, an action entitled Chamberlain, et al. v. The American
   Tobacco Company, et al., Court of Common Pleas of Cuyahoga County, State of
   Ohio, was filed against Liggett and others.  The class action complaint was
   brought on behalf of plaintiffs and all persons in the State of Ohio who
   allegedly have become addicted to cigarette products and have suffered
   personal injury as a result thereof.  Plaintiffs seek compensatory and
   punitive damages together with equitable relief including, but not limited
   to, a medical fund, for future health costs, attorneys' fees and costs.  On
   September 12, 1996, the defendant tobacco companies filed a notice of
   removal in the United States District Court for the Northern District of
   Ohio.

   A number of proceedings have been filed against Liggett and others by state
   and local government entities or officials seeking restitution and indemnity
   for medical payments and expenses made or incurred for tobacco related
   illnesses.  Such actions have been filed by the States of Minnesota
   (together with Minnesota Blue Cross-Blue Shield), Mississippi, West
   Virginia, Louisiana, Texas, Washington, Maryland, Connecticut, Arizona,
   Michigan, New Jersey, Ohio and Oklahoma.  Additionally, the Commonwealth of
   Massachusetts, the City and County of San Francisco, the City and County of
   Los Angeles and the City and County of New York have commenced proceedings.
   In West Virginia, the trial court, in a ruling issued on May 3, 1995,
   dismissed eight of the ten counts of the complaint filed therein, leaving
   only two counts of an alleged conspiracy to control the market and the
   market price of tobacco products and an alleged consumer protection claim.
   In a subsequent ruling, the trial court adjudged the contingent fee
   agreement entered into by West Virginia and its counsel to be
   unconstitutional under the Constitution of the State of West Virginia.  In
   Mississippi, the Governor has recently commenced an action in the
   Mississippi Supreme Court against the Attorney General of the state, making
   application for a writ of prohibition to bar further prosecution and to seek
   dismissal of the suit brought by the Attorney General of the state seeking
   such restitution and indemnity, alleging that the commencement and
   prosecution of such a civil action by the Attorney General of the state was
   and is outside the authority of the Attorney General.

   On November 28, 1995, each of the major manufacturers in the industry,
   including Liggett, filed suit in both the Commonwealth of Massachusetts and
   the State of Texas seeking declaratory relief to the effect that the
   commencement of any such litigation seeking to recover Medicaid expenses
   against the manufacturers (as had been filed by the above referenced states)
   by either the Commonwealth of Massachusetts or the State of Texas would be
   unlawful.  On January 22, 1996, a suit seeking substantially similar
   declaratory relief was filed in the State of Maryland.

   The State of Florida enacted legislation, effective July 1, 1994, allowing
   certain state authorities or entities to commence litigation seeking
   recovery of certain Medicaid payments made on behalf of Medicaid recipients
   as a result of diseases (including, but not limited to, diseases allegedly
   caused by

                                     - 21 -



<PAGE>   22





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)



   cigarette smoking) allegedly caused by liable third parties (including, but
   not limited to, the tobacco industry).  Liggett, after initial litigation,
   entered into a settlement of this controversy with the State of Florida, the
   terms of which are described below.

   In addition, legislation authorizing a state to sue a company or individual
   to recover the costs incurred by that state to provide health care to
   persons allegedly injured by the company or individual also has been
   introduced in a number of other states.  These bills contain some or all of
   the following provisions:  eliminating certain affirmative defenses,
   permitting the use of statistical evidence to prove causation and damages,
   adopting market share liability and allowing class action suits without
   notification to class members.

   On March 15, 1996, the Company and Liggett entered into a settlement of
   tobacco-related litigation with the Attorneys General of the States of
   Florida, Louisiana, Mississippi, West Virginia and the Commonwealth of
   Massachusetts.  The settlement with the Attorneys General releases the
   Company and Liggett from all tobacco-related claims by these states
   including claims for Medicaid reimbursement and concerning sales of
   cigarettes to minors.  The settlement provides that additional states which
   commence similar Attorney General actions may agree to be bound by the
   settlement prior to six months from the date thereof (subject to extension
   of such period by the settling defendants).  Certain of the terms of the
   settlement are summarized below.

   Under the settlement, the states would share an initial $5,000 ($1,000 of
   which was paid on March 22, 1996, with the balance payable over nine years
   and indexed and adjusted for inflation), provided that any unpaid amount
   will be due sixty days after either a default by Liggett in its payment
   obligations under the settlement or a merger or other similar transaction by
   the Company or Liggett with another defendant in the lawsuits.  In addition,
   Liggett will be required to pay the states a percentage of Liggett's pretax
   income (income before income taxes) each year from the second through the
   twenty-fifth year.  This annual percentage would range from 2-1/2% to 7-1/2%
   of Liggett's pretax income depending on the number of additional states
   joining the settlement.  All of Liggett's payments are subject to certain
   reductions provided for in the agreement.  Liggett has also agreed to pay to
   the states $5,000 if the Company or Liggett fails to consummate a merger or
   other similar transaction with another defendant in the lawsuits within
   three years of the date of the settlement.  At December 31, 1995, Liggett
   accrued approximately $4,000 for the settlement with the Attorneys General.

   Settlement funds received by the Attorneys General will be used to reimburse
   the states' smoking-related healthcare costs.  While neither consenting to
   FDA jurisdiction nor waiving their objections thereto, the Company and
   Liggett also have agreed to phase in compliance with certain of the proposed
   interim FDA regulations on the same basis as provided in the Castano
   settlement.

   The Company and Liggett have the right to terminate the settlement with
   respect to any state participating in the settlement if any of the remaining
   defendants in the litigation succeed on the merits in that state's Attorney
   General action.  The Company and Liggett may also terminate the settlement
   if they conclude that too many states have filed Attorney General actions
   and have not resolved such cases as to the settling defendants by joining in
   the settlement.


                                     - 22 -



<PAGE>   23





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)




   Currently, in addition to the above, approximately 120 product liability
   lawsuits are pending and active in which Liggett is a defendant.  Of these,
   approximately 85 are pending in the State of Florida.  In most of these
   lawsuits, plaintiffs seek punitive as well as compensatory damages.  The
   next case scheduled for trial where Liggett is a defendant is George Jay v.
   R. J. Reynolds Tobacco Company, et al., which is scheduled for trial in
   March 1997.

   A grand jury investigation presently is being conducted by the office of the
   United States Attorney for the Eastern District of New York regarding
   possible violations of criminal law relating to the activities of The
   Council for Tobacco Research - USA, Inc.  The Company was a sponsor of The
   Council for Tobacco Research - USA, Inc. at one time.  The Company is unable
   at this time to predict the outcome of this investigation.

   Liggett has been responding to a civil investigative demand from the
   Antitrust Division of the United States Department of Justice which requests
   certain information from Liggett.  The request appears to focus on United
   States tobacco industry activities in connection with product development
   efforts regarding, in particular, "fire-safe" or self-extinguishing
   cigarettes.  It also requests certain general information addressing
   Liggett's involvement with and relationship to its competitors.  The Company
   is unable to predict, at this time, the outcome of this investigation.

   As to each of the cases referred to above which is pending against the
   Company, the Company believes, and has been advised by counsel handling the
   respective cases, that the Company has a number of valid defenses to the
   claim or claims asserted against the Company.  Litigation is subject to many
   uncertainties, and it is possible that some of these actions could be
   decided unfavorably.  An unfavorable outcome of a pending smoking and health
   case could encourage the commencement of additional similar litigation.
   Recently, there have been a number of restrictive regulatory actions,
   adverse political decisions and other unfavorable developments concerning
   cigarette smoking and the tobacco industry, including the commencement of
   the purported class actions referred to above.  These developments generally
   receive widespread media attention.  The Company is not able to evaluate the
   effect of these developing matters on pending litigation or the possible
   commencement of additional litigation.

   The Company is unable to make a meaningful estimate of the amount or range
   of loss that could result from an unfavorable outcome of the cases pending
   against Liggett.  It is possible that the Company's consolidated financial
   position, results of operations and cash flows could be materially adversely
   affected by an ultimate unfavorable outcome in any of such pending
   litigation.

   On August 28, 1996, the FDA filed in the Federal Register a final rule
   classifying tobacco as a drug, asserting jurisdiction by the FDA over the
   manufacture and marketing of tobacco products and imposing restrictions on
   the sale, advertising and promotion of tobacco products.  The FDA's stated
   objective and focus for its initiative is to limit access to cigarettes by
   minors by measures beyond the restrictions either mandated by existing
   federal, state and local laws or voluntarily implemented by major
   manufacturers in the industry.  Litigation has been commenced in the United
   States District Court for the Middle District of North Carolina challenging
   the legal authority of the FDA to assert such jurisdiction, as well as
   challenging the constitutionality of the rules.  Management is unable to
   predict the outcome of this litigation or the effects of regulations, if
   implemented, on Liggett's operations, but such actions could have an
   unfavorable impact thereon.


                                     - 23 -



<PAGE>   24





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)




   The Company and Liggett, while neither consenting to FDA jurisdiction nor
   waiving their objections thereto, agreed to  withdraw their objections and
   opposition to the proposed rule making and to phase in compliance with
   certain of the proposed interim FDA regulations.  See discussions of the
   Castano and Attorneys General settlements above.

   The Omnibus Budget Reconciliation Act of 1993 ("OBRA") required each United
   States cigarette manufacturer to use at least 75% domestic tobacco in the
   aggregate of the cigarettes manufactured by it in the United States,
   effective January 1, 1994, on an annualized basis or pay a "marketing
   assessment" based upon price differentials between foreign and domestic
   tobacco and, under certain circumstances, make purchases of domestic tobacco
   from the tobacco stabilization cooperatives organized by the United States
   government.  OBRA was repealed retroactively (as of December 31, 1994)
   coincident in time with the issuance of a Presidential proclamation,
   effective September 13, 1995, imposing tariffs on imported tobacco in excess
   of certain quotas.

   The USDA informed Liggett that it did not satisfy the 75% domestic tobacco
   usage requirement for 1994 and was subject to a marketing assessment of
   approximately $5,500.  At December 31, 1995, the Company accrued
   approximately $4,900 representing the present value of its obligation for
   the USDA marketing assessment.  The charge was included as a component of
   cost of sales in 1995.  Liggett has agreed to pay this assessment in
   quarterly installments with interest over a five year period.  Under certain
   circumstances, payment can be accelerated.  Since the levels of domestic
   tobacco inventories on hand at the tobacco stabilization organizations are
   below reserve stock levels, the Company was not obligated to make purchases
   of domestic tobacco from the tobacco stabilization cooperatives.

   On September 13, 1995, the President of the United States, after
   negotiations with the affected countries, declared a tariff rate quota
   ("TRQ") on certain imported tobacco, imposing extremely high tariffs on
   imports of flue-cured and burley tobacco in excess of certain levels which
   vary from country to country.  Oriental tobacco is exempt from the quota as
   well as all tobacco originating from Canada, Mexico or Israel.  Management
   believes that the TRQ levels are sufficiently high to allow Liggett to
   operate without material disruption to its business.

   On February 20, 1996, the United States Trade representative issued an
   "advance notice of rule making" concerning how tobaccos imported under the
   TRQ should be allocated.  Currently, tobacco imported under the TRQ is
   allocated on a "first-come, first-served" basis, meaning that entry is
   allowed on an open basis to those first requesting entry in the quota year.
   Others in the cigarette industry have suggested an "end-user licensing"
   system under which the right to import tobacco under the quota would be
   initially assigned on the basis of domestic market share.  Such an approach,
   if adopted, could have a material adverse effect on the Company.  The
   Company believes it is unlikely that an end-user licensing system will be
   adopted, although no assurances can be given that an end-user licensing
   system will not be adopted.

   In September 1991, the Occupational Safety and Health Administration
   ("OSHA") issued a Request for Information relating to indoor air quality,
   including ETS, in occupational settings.  OSHA announced in March 1994 that
   it would commence formal rulemaking during the year.  Hearings were
   completed during 1995 but it is not anticipated that any regulation will
   issue prior to the end of 1996.  While the Company cannot predict the
   outcome, some form of federal regulation of smoking in workplaces may
   result.

                                     - 24 -



<PAGE>   25





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)





   In January 1993, the United State Environmental Protection Agency (the
   "EPA") released a report on the respiratory effect of ETS which concludes
   that ETS is a known human lung carcinogen in adults, and in children causes
   increased respiratory tract disease and middle ear disorders and increases
   the severity and frequency of asthma.  In June 1993, the two largest of the
   major domestic cigarette manufacturers, together with other segments of the
   tobacco and distribution industries, commenced a lawsuit against the EPA
   seeking a determination that the EPA did not have the statutory authority to
   regulate ETS, and that given the current body of scientific evidence and the
   EPA's failure to follow its own guidelines in making the determination, the
   EPA's classification of ETS was arbitrary and capricious.  Whatever the
   outcome of this litigation, issuance of the report may encourage efforts to
   limit smoking in public areas.

   The Company has been involved in certain environmental proceedings, none of
   which, either individually or in the aggregate, rise to the level of
   materiality.  The Company's current operations are conducted in accordance
   with all environmental laws and regulations.   Management is unaware of any
   material environmental conditions affecting its existing facilities.
   Compliance with federal, state and local provisions regulating the discharge
   of materials into the environment, or otherwise relating to the protection
   of the environment, have not had a material effect on the capital
   expenditures, earnings or competitive position of Liggett.

   There are several other proceedings, lawsuits and claims pending against
   Liggett unrelated to product liability.  Management is of the opinion that
   the liabilities, if any, ultimately resulting from such other proceedings,
   lawsuits and claims should not materially affect Liggett's financial
   position, results of operations or cash flows.

   The Company:

   As a conclusion to the litigation commenced by a group of Contingent Value
   Right ("CVR") Holders on September 20, 1993, the Delaware Court of Chancery
   approved a settlement at a hearing conducted on June 4, 1996.  The
   settlement became final and nonappealable on or about July 8, 1996.
   Distributions to the Company and to CVR Holders, pursuant to the settlement,
   have been substantially completed.  Under the terms of the settlement, both
   the Company and the plaintiff CVR Holders may pursue claims, in certain
   circumstances, against the CVR trustee.  In connection with the settlement,
   the Company recognized a gain of $2,263 during the third quarter 1996.

   At September 30, 1996, there were several other proceedings, lawsuits and
   claims pending against subsidiaries of the Company.  The Company is of the
   opinion that the liabilities, if any, ultimately resulting from such other
   proceedings, lawsuits and claims should not materially affect its
   consolidated financial position, results of operations or cash flows.



                                     - 25 -



<PAGE>   26





                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)



8.  SALE OF ASSETS

    On July 15, 1996, the Company sold substantially all of the non-cash assets
    and certain liabilities of COM Products, Inc. ("COM"), a subsidiary engaged
    in the business of selling micrographics equipment and supplies, for
    approximately $3,700 cash and a promissory note for $500.  The Company
    recognized a gain of approximately $3,000 on this transaction.

    On April 9, 1996, Liggett executed a definitive agreement with the County of
    Durham for the sale of certain surplus realty in the amount of $4,300.  The
    closing of the transaction occurred on May 14, 1996.  Liggett recognized a
    gain of approximately $3,600.

    On April 29, 1996, Liggett executed a definitive agreement (as amended
    September 11, 1996) with Blue Devil Ventures, a North Carolina limited
    liability partnership, for the sale of additional surplus realty in the
    amount of $2,200.  While the agreement provides for the closing to occur on
    or before March 11, 1997, Blue Devil Ventures has the option to forfeit its
    deposit of $550 and not close if it determines that its development project
    is not feasible.  Such net assets ($315) have been reclassified from
    long-term to other current assets as of September 30, 1996.


9.  ACQUISITION OF MINORITY INTERESTS AND AFFILIATE TRANSACTIONS

    During the second quarter of 1996, BOL entered into stock purchase
    agreements with the chairman of LDL and the former Director of LDL's tobacco
    operations (the "Sellers").  Under the stock purchase agreements, the
    Company acquired 142,558 shares held by the Sellers for $2,143.  The
    purchase price is payable in installments during 1996 and certain shares of
    LDL collateralize BOL's obligation under both the purchase agreements and
    the consulting agreements (described below).  These transactions increased
    BOL's ownership percentage in LDL from 68% to 89%.

    Concurrently, the Company entered into consulting agreements with the
    Sellers.  Under the terms of the consulting agreements, the Company will pay
    the Sellers a total of approximately $8,357 over five years.

    On July 5, 1996, Liggett purchased from BOL 140,000 shares (approximately
    20%) of LDL's tobacco operations for $2,100.  Liggett also acquired a
    ten-year option to purchase up to 292,407 additional shares of LDL stock at
    the same per share price ($15.00) for $3,400, thereby entitling Liggett to
    increase its interest in LDL to approximately 62%.  The option fee is to be
    credited against the purchase price.  In addition, Liggett has the right on
    or before June 30, 1997 to acquire another ten-year option from BOL for
    $2,200 on the same terms to purchase the remaining 27% of the shares of LDL
    owned by BOL.  These transactions have no impact on the consolidated
    financial position or results of operations of the Company or BGLS.

10. RESTRUCTURING

    During the first nine months of 1995, Liggett, in an effort to reduce
    costs, offered voluntary retirement programs, among other things, to
    eligible employees and reduced its headcount by 117 positions. Liggett
    recorded a restructuring charge of $2,407 to operations ($621 of which was
    included in cost of sales) for severance programs, primarily salary
    continuation and related benefits for terminated employees.

    During the first nine months of 1996, Liggett continued its efforts to
    reduce costs and further reduced its headcount by 7 additional positions.
    Ligget recorded a restructuring charge of $1,180 to operations for
    severance programs, primarily salary continuation and related benefits
    for terminated employees.
    


                                     - 26 -



<PAGE>   27


                           NEW VALLEY HOLDINGS, INC.

                                 BALANCE SHEETS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)



<TABLE>
<CAPTION>
                                                                 September 30,  December 31,
                                                                     1996           1995
                                                                 -------------  ------------
<S>                                                                 <C>          <C>
ASSETS
                                                                   
Cash and cash equivalents......................................     $     1      $    738
                                                                   
                                                                   
Investment in New Valley Corporation:                              
  Redeemable preferred stock...................................      74,199       109,386
  Common stock.................................................     (74,199)      (52,045)
                                                                    -------      --------
  Total investment in New Valley Corporation...................                    57,341
                                                                    -------      --------
    Total assets...............................................     $     1      $ 58,079
                                                                    =======      ========
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)                               
                                                                   
Current income taxes payable to parent.........................     $ 6,217      $  4,472
Deferred income taxes..........................................                     4,918
                                                                    -------      --------
    Total liabilities..........................................       6,217         9,390
                                                                    -------      --------
Commitments and contingencies..................................                                      
                                                                   
Common stock, $0.01 par value,                                     
  100 shares authorized, issued and outstanding................    
Additional paid-in capital.....................................      18,732        11,020
Retained (deficit) earnings....................................      (6,908)       32,128
Unrealized holding (loss) gain, net of income tax benefit of $0    
  and income taxes of $2,983...................................     (18,040)        5,541
                                                                    -------      --------
    Total stockholder's (deficit) equity.......................      (6,216)       48,689
                                                                    -------      --------
    Total liabilities and stockholder's equity (deficit).......     $     1      $ 58,079
                                                                    =======      ========
</TABLE>




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

                                     - 27 -



<PAGE>   28


                           NEW VALLEY HOLDINGS, INC.
                            STATEMENTS OF OPERATIONS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)




<TABLE>
<CAPTION>
                                                   Three Months Ended    Nine Months Ended
                                                  --------------------  --------------------
                                                  Sept. 30,  Sept. 30,  Sept. 30,  Sept. 30,
                                                    1996       1995       1996       1995
                                                  ---------  ---------  ---------  ---------
<S>                                                <C>        <C>       <C>        <C>
Equity in (loss) earnings of affiliate..........  $ (4,836)   $ 1,538   $ (7,818)  $  3,532

Interest income.................................         7                    55        391

General and administrative expenses.............       (13)        (9)       (17)       (17)
                                                  --------    -------   --------   --------
 (Loss) income from continuing operations before
  income taxes..................................    (4,842)     1,529     (7,780)     3,906
                                                  --------    -------   --------   --------
Provision (benefit) for income taxes:
 Current........................................     1,297      1,620      1,745      4,460
 Deferred.......................................     7,212     (7,579)     4,004    (11,750)
                                                  --------    -------   --------   --------
  Income tax provision (benefit)................     8,509     (5,959)     5,749     (7,290)
                                                  --------    -------   --------   --------
(Loss) income from continuing operations........   (13,351)     7,488    (13,529)    11,196
                                                  -------- 
Income from discontinued operations of
 affiliate, net of income taxes.................                   64                 1,170
                                                  --------    -------   --------   --------
Net (loss) income...............................  $(13,351)   $ 7,552   $(13,529)  $ 12,366
                                                  ========    =======   ========   ========
</TABLE>




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

                                     - 28 -



<PAGE>   29


                           NEW VALLEY HOLDINGS, INC.
                  STATEMENT OF STOCKHOLDER'S EQUITY (DEFICIT)
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)



<TABLE>
<CAPTION>
                                 Common Stock    Additional    Retained      Unrealized
                                --------------    Paid-In      Earnings       Holding
                                Shares  Amount    Capital      (Deficit)     Gain (Loss)     Total
                                ------  ------   --------      --------     -----------     -----
<S>                              <C>    <C>       <C>          <C>           <C>           <C>
Balance, December 31, 1995....   100              $11,020      $32,128       $  5,541      $ 48,689

Increase in capital from
 New Valley's repurchase
 of Class A Shares and
 other capital transactions,
 net of tax...................                      1,152                                     1,152

Proportionate share of
 New Valley's unrealized
 depreciation in investments,
 net of tax...................                                                   (716)         (716)

Increase in unrealized holding
 loss on investment in
 New Valley, net of tax.......                                                (16,550)      (16,550)
                                               

Net (loss)....................                                 (13,529)                     (13,529)

Increase in valuation allowance
 on deferred tax assets.......                      6,560                      (6,315)          245

Dividends.....................                                 (25,507)                     (25,507)
                                ----    -----     -------      -------       --------      --------
 Balance, September 30, 1996..   100    $         $18,732      $(6,908)      $(18,040)     $ (6,216)
                                ====    =====     =======      =======       ========      ========
</TABLE>




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

                                     - 29 -



<PAGE>   30


                           NEW VALLEY HOLDINGS, INC.


                            STATEMENTS OF CASH FLOWS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)






<TABLE>
<CAPTION>                                                                                     
                                                            Nine Months Ended               
                                                       ----------------------------         
                                                       September 30,  September 30,         
                                                           1996           1995              
                                                       -------------  -------------         
<C>                                                      <C>            <C>                 
Net cash provided by operating activities.........       $     49        $   374            
                                                         --------       --------            
Cash flows from investing activities:                                                       
  Dividends received from New Valley Corporation..         24,733         61,832          
                                                         --------       --------            
  Net cash provided by investing activities.......         24,733         61,832          
                                                         --------       --------            
Cash flows from financing activities:                                                       
  Payment of dividends............................        (25,507)       (48,167)         
                                                         --------       --------            
  Net cash used for financing activities..........        (25,507)       (48,167)         
                                                         --------       --------            
Net (decrease) increase in cash...................           (725)        14,039            
                                                                                            
Cash and cash equivalents at beginning of period..            726                           
                                                         --------       --------            
Cash and cash equivalents at end of period........       $      1       $ 14,039            
                                                         ========       ========            
</TABLE>




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

                                     - 30 -



<PAGE>   31



                           NEW VALLEY HOLDINGS, INC.
                         NOTES TO FINANCIAL STATEMENTS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)


1. PRINCIPLES OF REPORTING

   Organization.  New Valley Holdings, Inc. (the "Company") was formed on
   September 9, 1994 by BGLS Inc. ("BGLS") to act as a holding company for
   certain stock investments in New Valley Corporation ("New Valley").  BGLS
   owns 100% of the authorized, issued and outstanding common stock of the
   Company.  BGLS is a wholly-owned subsidiary of Brooke Group Ltd. ("Brooke").

   The interim financial statements of the Company are unaudited and, in the
   opinion of management, reflect all adjustments necessary (which are normal
   and recurring) to present fairly the Company's financial position, results
   of operations and cash flows.  These financial statements should be read in
   conjunction with the financial statements and the notes thereto included in
   BGLS' Annual Report on Form 10-K, as amended, for the year ended December
   31, 1995, as filed with the Securities and Exchange Commission.  The results
   of operations for interim periods should not be regarded as necessarily
   indicative of the results that may be expected for the entire year.

   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
   disclosures of contingent assets and liabilities and the reported amounts of
   revenues and expenses.  Actual results could differ from those estimates.


2. INVESTMENT IN NEW VALLEY CORPORATION

   Summarized financial information for New Valley as of September 30, 1996 and
   December 31, 1995 and for the three and nine month periods ended September
   30, 1996 and 1995 follows:


<TABLE>
<CAPTION>
                                                       September 30,          December 31,
                                                           1996                   1995
                                                    -----------------       ---------------
         <S>                                            <C>                      <C>
         Current assets........................         $  234,165               $333,485
         Investment in real estate.............            182,125
         Other non-current assets..............             37,099                 52,337
         Current liabilities...................            183,292                177,920
         Notes payable ........................            159,494
         Other long-term obligations ..........             12,966                 11,967
         Redeemable preferred shares ..........            201,318                226,396
         Common shareholders' deficit .........           (103,681)               (30,461)

</TABLE>

<TABLE>
<CAPTION>
                                                         Three Months Ended            Nine Months Ended
                                                 -----------------------------  ---------------------------
                                                   Sept. 30,      Sept. 30,       Sept. 30,     Sept. 30,
                                                     1996           1995             1996         1995
                                                 -------------  --------------  ------------  -------------
   <S>                                             <C>           <C>              <C>            <C>
   Revenues....................................    $  24,263     $  21,514        $   92,794     $ 39,215
   Cost and expenses...........................       33,000        18,436           110,647       26,189
   (Loss) income from continuing operations....       (7,728)        2,784           (16,694)      11,699
   (Loss) income from discontinued operations..       (4,716)          235            (5,396)       4,315
   Net (loss) applicable to common shares(A)...      (27,844)       (7,860)          (64,319)        (300)
</TABLE>

     (A)  Includes all preferred accrued dividends, whether or not declared, and
          the excess of carrying value of redeemable preferred shares over cost
          of shares purchased.

                                     - 31 -


<PAGE>   32


                           NEW VALLEY HOLDINGS, INC.
                         NOTES TO FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)


   The Company's investment in New Valley at September 30, 1996 is summarized
   as follows:


<TABLE>
<CAPTION>
                          Number of   Fair    Carrying    
                           Shares     Value     Value                   
                          ---------  -------  ---------  
<S>                       <C>        <C>      <C>              
Class A Preferred Shares    618,326  $74,199  $ 74,199               
Common Shares...........  3,969,962   15,880   (74,199)
                                     -------  --------      
                                     $90,079  $                      
                                     =======  ========      
</TABLE>

   The Class A Preferred Shares are accounted for as debt securities pursuant
   to the requirements of Statement of Financial Accounting Standards ("FAS") 
   No. 115, "Accounting for Certain Investments in Debt and Equity Securities",
   and are classified as available-for-sale.  Prior to January 1, 1996, the 
   Class A Preferred Shares' fair value had been estimated with reference to the
   securities' preference features, including dividend and liquidation
   preferences, and the composition and nature of the underlying net assets of
   New Valley.  In January 1996, however, New Valley became engaged in the
   ownership and management of commercial real estate and, in February 1996,
   acquired a controlling interest in Thinking Machines Corporation.  Because
   these businesses affect the composition and nature of the underlying net
   assets of New Valley, the Company has determined the fair value of the Class
   A Preferred Shares based on the quoted market price commencing with the
   quarter ended March 31, 1996.  The New Valley common shares are accounted
   for under the equity method.  On July 29, 1996, New Valley effected a
   one-for-twenty reverse stock split of New Valley's common shares.  After
   giving effect to this split, the Company holds 3,969,962 shares of New
   Valley common stock.

   During the quarter ended September 30, 1996, the decline in the market value
   of the Class A Preferred Shares, the dividend received on the Class A
   Preferred Shares and the Company's equity in losses incurred by New Valley
   caused the carrying value of the Company's investments in New Valley to be
   reduced to zero.  As a result, the Company did not record $5,558 of
   unrealized holding losses on its investment in the New Valley Class A
   Preferred Shares. The Company also did not record its proportionate share of
   New Valley's FAS 115 unrealized holding losses which at September 30, 1996 
   were $8,957.

   In the first quarter of 1996, New Valley repurchased 72,104 Class A
   Preferred Shares for $10,530.  As a result of this transaction, the Company
   now owns 59.72% of the outstanding Class A Preferred Shares.  The Company
   has recorded its proportionate interest in the excess of the carrying value
   of the shares over the cost of the shares repurchased as a credit to
   additional paid-in capital of $1,773 along with its share of other New
   Valley capital transactions of $10,055 for the nine months ended September
   30, 1996.

   For the nine months ended September 30, 1996, the Company has received a
   total of $24,733 ($40.00 per share) in dividend distributions on the Class A
   Preferred Shares.  At September 30, 1996, the accrued and unpaid dividends
   arrearage on the Class A Preferred Shares was $103,234 or $99.70 per share.
   The Company's share of such arrearage was $61,647.

   At September 30, 1996, the accrued and unpaid dividends arrearage on the New
   Valley Class B Preferred Shares (none of which are held by the Company) was
   $110,076 or $39.58 per share.

   As a result of asset dispositions pursuant to New Valley's First Amended
   Joint Chapter 11 Plan of Reorganization, as amended (the "Joint Plan"), New
   Valley accumulated a significant amount of cash which it was required to
   reinvest in operating companies by January 18, 1996 in order to avoid
   potentially burdensome regulation under the Investment Company Act of 1940,
   as amended (the "Investment Company Act").  The Investment Company Act and
   the rules and regulations thereunder

                                     - 32 -





<PAGE>   33


                           NEW VALLEY HOLDINGS, INC.
                         NOTES TO FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)



   require the registration of, and impose various substantive restrictions on,
   companies that engage primarily in the business of investing, reinvesting or
   trading in securities or engage in the business of investing, reinvesting,
   owning, holding or trading in securities and own or propose to acquire
   "investment securities" having a "value" in excess of 40% of a company's
   "total assets" (exclusive of Government securities and cash items) on an
   unconsolidated basis.  Following dispositions of its then operating
   businesses pursuant to the Joint Plan, New Valley was above this threshold
   and relied on the one-year exemption from registration under the Investment
   Company Act provided by Rule 3a-2 thereunder, which exemption expired on
   January 18, 1996.  Prior to such date, through New Valley's acquisition of
   the investment banking and brokerage business of Ladenburg, Thalmann & Co.,
   Inc. and its acquisition of a portfolio of office buildings and shopping
   centers, New Valley was engaged primarily in a business or businesses other
   than that of investing, reinvesting, owning, holding or trading in
   securities, and the value of its investment securities was below the 40%
   threshold.  Under the Investment Company Act, New Valley is required to
   determine the value of its total assets for purposes of the 40% threshold
   based on "market" or "fair" values, depending on the nature of the asset, at
   the end of the last preceding fiscal quarter and based on cost for assets
   acquired since that date.  If New Valley were required to register in the
   future, under the Investment Company Act, it would be subject to a number of
   severe restrictions on its operations, capital structure and management,
   including without limitation, entering into transactions with affiliates.
   If New Valley were required to register under the Investment Company Act,
   the Company, as well as BGLS and Brooke, may be in violation of the
   Investment Company Act and may be adversely affected by the restrictions of
   the Investment Company Act.  In addition, registration under the Investment
   Company Act by BGLS would constitute a violation of the 15.75% Series B
   Senior Secured Notes due 2001 (the "Series B Notes") indenture to which BGLS
   is a party.


3. RJR NABISCO HOLDINGS CORP.

   At September 30, 1996, New Valley held 4,947,250 shares of RJR Nabisco
   Holdings Corp. ("RJR Nabisco") common stock with a market value of $129,247
   (cost of $151,650) collateralizing margin loan financing of $75,863.  From 
   the period October 1, 1996 to November 8, 1996, New Valley sold approximately
   1,780,000 shares of RJR Nabisco common stock and recognized a loss of
   $3,648.  At November 8, 1996, New Valley held approximately 3,170,000 shares
   of RJR Nabisco common stock with a market value of $96,815 (cost of $97,302),
   collateralizing margin loan financing of $23,158.  New Valley's unrealized
   loss on its investment in RJR Nabisco common stock decreased from $22,403 at
   September 30, 1996 to $487 at November 8, 1996.

   On February 29, 1996, New Valley entered into a total return equity swap
   transaction (the "Swap") with an unaffiliated company relating to 1,000,000
   shares of RJR Nabisco common stock.  During the third quarter of 1996, the
   Swap was terminated.  New Valley recognized a loss on the Swap of $4,074 and
   $7,305 for the three and nine months ended September 30, 1996, respectively.

   For the three and nine months ended September 30, 1996, New Valley has
   expensed $791 and $11,158 for costs relating to its RJR Nabisco investment.
   Pursuant to a December 27, 1995 agreement, New Valley agreed, among other
   things, to pay directly or reimburse Brooke and its subsidiaries for
   out-of-pocket expenses in connection with Brooke's solicitation of consents
   and proxies from the shareholders of RJR Nabisco.  New Valley has reimbursed
   Brooke and its subsidiaries $2,361 pursuant to this agreement of which $942
   was expensed in 1996.




                                     - 33 -





<PAGE>   34


                           NEW VALLEY HOLDINGS, INC.
                         NOTES TO FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)
                                  (UNAUDITED)




   On November 5, 1996, Brooke submitted to RJR Nabisco, in order to comply 
   with the requirements of RJR Nabisco's by-laws, a notice of intent to
   nominate a slate of directors for election at the RJR Nabisco 1997 annual
   meeting of stockholders.


4. FEDERAL INCOME TAX

   At September 30, 1996, the Company has provided a valuation allowance based
   on the determination that it is more likely than not that the deferred tax 
   asset will not be realized through the future taxable earnings or 
   alternative tax strategies. The provision for taxes for the nine month 
   periods ended September 30, 1996 and 1995 does not bear a customary 
   relationship to the pretax income for the Company due principally to the 
   effects of the 80% dividends received deduction for Federal taxes.


5. CONTINGENCIES

   BGLS has pledged its ownership interest in the Company's common stock and
   the Company's investments in the New Valley securities as collateral in
   connection with the issuance of BGLS' Series B Notes.

                                     - 34 -






<PAGE>   35
ITEM  2.             MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

                (Dollars in Thousands, Except Per Share Amounts)


INTRODUCTION

The following discussion provides an assessment of the consolidated results of
operations, capital resources and liquidity of Brooke Group Ltd. (the
"Company") and its subsidiaries and should be read in conjunction with the
Consolidated Financial Statements and notes thereto of the Company and BGLS
Inc. ("BGLS") included elsewhere in this document.  BGLS is a wholly owned
subsidiary of the Company.  The consolidated financial statements of the
Company include the accounts of BGLS, Liggett Group Inc. ("Liggett"), Brooke
(Overseas) Ltd. ("BOL"), New Valley Holdings, Inc. ("NV Holdings"), other less
significant subsidiaries, and as of December 31, 1995 and for the three and
nine months ended September 30, 1996, Liggett-Ducat Ltd. ("LDL").

For purposes of this discussion and other consolidated financial reporting, the
Company's significant business segments are tobacco and real estate.


RECENT DEVELOPMENTS

Certain Matters Relating to RJR Nabisco Holdings Corp.

As of November 8, 1996, New Valley Corporation ("New Valley") held
approximately 3,170,000 shares of RJR Nabisco Holdings Corp. ("RJR Nabisco")
common stock with a  market value of $96,815 (cost of $97,302) with an
unrealized loss of $487.  For the three and nine months ended September 30,
1996, New Valley had expensed $791 and $11,158, respectively, for costs
relating to the investment in RJR Nabisco common stock.  Pursuant to a December
27, 1995 agreement, New Valley agreed, among other things, to pay directly or
reimburse the Company and its subsidiaries for out-of-pocket expenses in
connection with the Company's solicitation of consents and proxies from the
shareholders of RJR Nabisco.  For the nine months ended September 30, 1996, New
Valley reimbursed the Company and its subsidiaries $2,321 pursuant to this
agreement, of which $942 was expensed in 1996.

On February 29, 1996, New Valley entered into a total return equity swap
transaction (the "Swap") with an unaffiliated company relating to an additional
1,000,000 shares of RJR Nabisco common.  The Swap was terminated during the
third quarter of 1996.  New Valley realized a loss of $4,074 and $7,305 on the
Swap for the three and nine months ended September 30, 1996, respectively.

On November 5, 1996, the Company submitted to RJR Nabisco, in order to comply
with the requirements of RJR Nabisco's by-laws, a notice of intent to nominate
a slate of directors for election at the RJR Nabisco 1997 annual meeting of
stockholders.

New Valley

On July 29, 1996, New Valley completed its reincorporation from the State of
New York to the State of Delaware and effected a one-for-twenty reverse stock
split of New Valley's common shares.  After giving effect to this reverse stock
split, the Company now holds 3,989,710 (41.7%) common shares of New Valley.

On January 11, 1996, a subsidiary of New Valley made a $10,600 convertible
bridge loan to finance Thinking Machines Corporation ("TMC"), a developer and
marketer of parallel software for high-end and networked computer systems.  In
February 1996, the loan was converted into a controlling interest in a
partnership which holds approximately 61% of the outstanding common stock of
Thinking Machines.  In October 1996, TMC adopted a plan to dispose of its
parallel processing computer segment.  New Valley does not anticipate a
material gain or loss in the disposal as any proceeds from the sale of the
segment would offset the expected operating losses during the phase-out period.

                                     - 35 -






<PAGE>   36






RECENT DEVELOPMENTS IN THE CIGARETTE INDUSTRY

Pricing Activity.

On April 8, 1996, Philip Morris announced a list price increase on all brands
of $.40 per carton.  The other manufacturers, including Liggett, matched the
price increase.

Legislation and Litigation.

The cigarette industry continues to be challenged on numerous fronts.  Several
federal administrative bodies, including the United States Environmental
Protection Agency and the Food and Drug Administration have issued reports or
commenced regulatory proceedings which have had or could have an adverse effect
on Liggett and the cigarette industry as a whole.  The rate of filings of
individual product liability cases has increased and Liggett's risk attendant
thereto has correspondingly increased.  Several purported class actions have
been commenced against Liggett and other companies in the industry, one of
which actions Liggett has settled.  A number of states' Attorneys General have
commenced litigation against the industry  asserting numerous different
theories of liability, five of which actions Liggett has settled.  The various
companies in the industry are actively engaged in defending against and
responding to these initiatives.  The Company is not able to evaluate the
effect of these developing matters but it is possible that the Company's
financial position, results of operations and cash flows could be materially
adversely affected by an ultimate unfavorable outcome in any of such pending
litigation and regulatory proceedings.  For a description of pending litigation
and regulatory proceedings see Note 7 to the Company's consolidated financial
statements.

On March 12, 1996, Liggett, together with the Company, entered into an
agreement to settle the Castano class action tobacco litigation, and on March
15, 1996, Liggett, together with the Company, entered into an agreement with
the Attorneys General of the State of West Virginia, State of Florida, State of
Mississippi, Commonwealth of Massachusetts and the State of Louisiana to settle
certain actions brought against Liggett by such states.

Under the Castano settlement, the Castano class would receive up to 5% of
Liggett's pretax income (income before income taxes) each year (up to a maximum
of $50,000 per year) for the next twenty-five years, subject to certain
reductions provided for in the agreement, together with reasonable fees and
expenses of the Castano Plaintiffs Legal Committee.

Under the Attorneys General Settlement, the states would share an initial
$5,000 ($1,000 of which was paid on March 22, 1996, with the balance payable
over nine years and indexed and adjusted for inflation).  In addition, Liggett
will be required to pay the states a percentage of Liggett's pretax income
(income before income taxes) each year from the second through the twenty-fifth
year.  This annual percentage would range from 2-1/2% to 7-1/2% of Liggett's
pretax income, depending on the number of additional states joining the
settlement.  All of Liggett's payments are subject to certain reductions
provided for in the agreement.  Liggett has also agreed to pay to the states
$5,000 if the Company or Liggett fails to consummate a merger or other similar
transaction with another defendant in the lawsuits within three years of the
date of the settlement.



                                     - 36 -




<PAGE>   37





RECENT DEVELOPMENTS IN THE CIGARETTE INDUSTRY (continued)


At December 31, 1995, the Company had recorded a charge of approximately $4,000
for the present value of the fixed payments under the Attorneys General
settlement.  The Company cannot quantify the future costs of the settlements at
this time as the amount Liggett must pay is based, in part, on future operating
results.  Possible future payments based on a percentage of pretax income, and
other contingent payments, will be expensed when known.


RESULTS OF OPERATIONS

Three months ended September 30, 1996 compared to three months ended September
30, 1995

Consolidated revenues were $114,635 for the three months ended September 30,
1996 compared to $124,100 for the three months ended September 30, 1995.  This
7.6% decrease in revenues primarily resulted from a decrease of $21,523 in
revenues at Liggett offset by the addition of tobacco revenues of LDL in Russia
of $12,712 (which results were not included in the consolidated group in 1995).
The 17.5% decrease in Liggett revenues was due primarily to a 20.5% decline in
domestic unit sales volume, partially offset by the effects of the recent list
price increase (see "- Recent Developments in the Cigarette Industry - Pricing
Activity").  The decline in unit sales volume was comprised of declines within
the premium segment of 15.3% and discount segment (which includes generic,
control label and branded discount products) of 22.1%.  The decline in premium
and discount unit sales volume was due to certain competitors continuing
leveraging rebate programs tied to their products and increased promotional
activity by certain other manufacturers.

Consolidated gross profit was $56,274 for the three months ended September 30,
1996 compared to $69,474 for the three months ended September 30, 1995, a
decrease of $13,200 when compared to the same period last year, due primarily
to the decline in unit sales volume at Liggett discussed above.  Overall, the
Company's gross profit as a percent of revenues decreased to 49.1% in the
current period from 56.0% in the same period in  the prior year because of
decreased margins at Liggett and the inclusion of LDL which had break-even
tobacco margins due to increased tobacco and labor costs as well as intense
price competition in the Russian market.  Gross profit at Liggett was $55,511
for the three months ended September 30, 1996, a decrease of $13,507 from
$69,018 for the same period in 1995, due primarily to the decline in unit sales
volume discussed above.  As a percent of revenues (excluding federal excise
taxes), Liggett's gross profit decreased to 74.0% for the three months ended
September 30, 1996 compared to 76.7% for the same period in 1995.  This
decrease is the result of increased tobacco costs due to reduced worldwide
supply of tobacco and a reduction in the average discount available to Liggett
from leaf tobacco dealers on tobacco purchased under prior years' purchase
commitments, partially offset by the recent list price increase.

Consolidated operating, selling, general and administrative expenses were
$55,326 for the three months ended September 30, 1996 compared to $58,818 for
the same period last year.  The decrease of $3,492 considers the effects of
lower sales volume disclosed above and the prior year's restructuring at
Liggett ($2,548 for the year ended December 31, 1995) which reduced payroll and
benefits.  Liggett, in addition, has reduced spending on promotional programs
when compared to the prior period.  The effects of this reduction were somewhat
offset by additional restructuring charges during the three months ended
September 30, 1996.  Further, the Company's operating expenses were reduced
due to lower pension expense and lower professional fees at the corporate level
in the three months ended September 30, 1996.

Consolidated interest expense was $15,254 for the three months ended September
30, 1996 compared to $13,952 for the same period last year due to a greater
amount of debt outstanding in the current period.


                                     - 37 -




<PAGE>   38





RESULTS OF OPERATIONS (continued)


Equity in earnings of affiliate was a loss of $4,618 for the three months ended
September 30, 1996 compared to income of $1,561 for the three months ended
September 30, 1995 and relates to New Valley's net loss of $12,444 in 1996
compared to net income of $3,019 in 1995, and a decrease in the market value of
the New Valley Class A Preferred Shares.

The gain on sale of assets relates to the sale of substantially all the
non-cash assets of COM Products Inc. ("COM") by the Company in July 1996.

Other, net income for the nine months ended September 30, 1996 includes a gain
upon settlement of the Contingent Value Rights ("CVR") litigation of $2,300.

Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30,1995

Consolidated revenues were $330,364 for the nine months ended September 30,
1996 compared to $341,718 for the nine months ended September 30, 1995, a
decrease of $11,354 primarily due to a decline in sales at Liggett offset by
tobacco revenues in Russia from LDL which was not part of the consolidated
group in 1995.  Net sales at Liggett were $292,899 for the nine months ended
September 30, 1996 versus $337,217 for the same period last year.  This 13.1%
decrease in revenues was primarily due to an 17.2% decline in domestic unit
sales volume, partially offset by the effects of recent list price increases.
The decline in unit sales volume was comprised of declines within the premium
segment of 11.8% and the discount segment of 18.8%.  The decline in premium and
discount unit sales volume was due to aggressive trade programs offered by
Liggett at year end 1995 and certain competitors' continuing leveraging rebate
programs tied to their products and increased promotional activity by certain
other manufacturers.

Consolidated gross profit of $161,433 for the nine months ended September 30,
1996 decreased $21,519 from gross profit of $182,952 for the same period in
1995.  The decrease in gross profit coincides with the decrease in sales
revenue at Liggett.  Liggett's gross profit as a percent of revenues (excluding
federal excise taxes) for the period decreased to 73.3% compared to 74.0% last
year.  This decrease is a result of increased tobacco costs discussed above,
partially offset by recent list price increases and restructuring changes
incurred in 1995 with no similar changes in 1996.  Tobacco margins at LDL for
the nine months ended September 30, 1996 were 0.3% for the reasons indicated
above.

Consolidated operating, selling, general and administrative expenses were
$158,482 for the nine months ended September 30, 1996 compared to $173,322 for
the same period last year, a decrease of $14,840.  The decrease resulted from
lower expenses recognized relating to LDL in 1996, reduced professional fees at
the corporate level, lower pension expense and reduced administrative expenses
at Liggett resulting from the 1995 restructuring as well as reduced spending on
promotional programs discussed above. Restructuring charges for the nine months
ended September 30, 1996 at Liggett were $1,180.

Consolidated interest expense was $45,488 for the nine months ended September
30, 1996 compared to $43,369 for the same period last year.  The increase of
$2,119 is primarily due to additional debt issued by the Company and interest
accrued on the USDA marketing assessment and Attorneys General settlement at
Liggett, partially offset by the redemption of $7,000 Liggett Series B Notes in
December 1995.  (See Note 7 to the Company's consolidated financial
statements).

Sale of assets in the amount of $6,745, reflects gains of approximately $3,000
on the sale of assets at COM discussed above and $3,700 on the sale of surplus
realty by Liggett to the County of Durham.

The gain on disposal of discontinued operations of $13,138 for the nine months
ended September 30, 1995 primarily reflects the redemption/sale of SkyBox
preferred and common stock.  No comparable transaction occurred in the nine
months ended September 30, 1996.

                                     - 38 -




<PAGE>   39





CAPITAL RESOURCES AND LIQUIDITY

Net cash and cash equivalents decreased $1,267 for the nine months ended
September 30, 1996 compared with an increase of $12,722 for the nine months
ended September 30, 1995.

Net cash used in operations for the nine months ended September 30, 1996 was
$22,000 compared to net cash used in operations of $23,706 for the comparable
period of 1995.  Cash used in operations for the period ended September 30,
1996 included interest payments of $53,000 as compared to interest payments
made in the same period in 1995 of $45,497.  Interest payments in 1996 include
interest for a ten-month period (October 1, 1995 to July 31, 1996) on the
Company's debt.  The interest payment for this ten-month period was in
accordance with the 1995 Exchange Offer and the terms of the 15.75% Series B
Senior Secured Notes due 2001 (the "Series B Notes").

Liggett believes that cash flows from operations and its revolving credit
facility ("the Facility") will continue to meet its liquidity requirements for
the twelve months ending September 30, 1997.  Management believes that the
positive effects on cash flow from operations resulting from the April 1996
price increase, estimated at approximately $7,100 on an annual basis, and the
estimated savings resulting from Liggett's restructurings, estimated at
approximately $7,350 on an annual basis, will enable Liggett to meet its
estimated interest expense of $22,700 annually, the sinking fund requirement to
redeem $7,500 principal amount of Ligget's senior secured notes on or before 
February 1, 1997, budgeted capital expenditures of $2,500 and payments of 
$1,400 on the USDA marketing assessment.  However, there can be no assurance 
that such anticipated increases in cash flow will materialize as there are a 
number of factors including increased tobacco costs, litigation expenses and 
payments based on future income to which Liggett is committed under the 
Castano and Attorneys General settlement agreements, the amounts of which are 
unknown.  Further, the Facility was reclassified to short-term debt because 
the Facility becomes due on March 8, 1997 thereby creating a working capital 
deficiency at Liggett of approximately $32,300 at September 30, 1996.  Liggett 
is currently negotiating with its lenders for an extension of the maturity and 
a modification of other terms under the Facility.  While management currently 
believes the Facility will be extended and modified on satisfactory terms and 
funds will be available to meet the requirement to redeem $7,500 principal 
amount of Ligget's senior secured notes, no assurances can be given in this 
regard.

Liggett has been receiving certain financial and other assistance from others
in the industry in defraying the costs and other burdens incurred in the
defense of smoking and health litigation and related proceedings.  The future
financial benefit to Liggett is not quantifiable at this time since the
arrangements for assistance can be terminated under certain circumstances and
the amount of assistance received, if any, would be a function of the level of
costs incurred.  Certain joint defense arrangements, and the financial benefits
incident thereto, have ended.  No assurances can be given that other
arrangements will continue.

Cash used in investing activities was $8,325 for the period ended September 30,
1996 compared to cash provided of $69,008 for the same period in 1995.  Cash
used in 1996 includes capital expenditures of approximately $21,000 for real
estate development at BOL and $3,600 for equipment modernization at Liggett.
Liggett is forecasting further capital expenditures of approximately $500 for
equipment modernization in 1996.  Capital expenditures were offset by dividends
from New Valley to NV Holdings of $24,733 or $40.00 per share on the Class A
Preferred Shares for the nine months ended September 30, 1996, cash proceeds
from the sale of surplus realty by Liggett and the sale of assets of COM by
BGLS.  In the same period in 1995, capital expenditures of $5,000 were offset
by dividends from New Valley to NV Holdings of $61,832 and proceeds from the
redemption of SkyBox International Inc. ("SkyBox") preferred stock for $4,000
plus accrued dividends and the sale of SkyBox common stock for $9,282.

On April 29, 1996, Liggett executed a definitive agreement as amended September
11, 1996 with Blue Devil Ventures, a North Carolina limited liability
partnership, for the sale by Liggett to Blue Devil Ventures of certain surplus
realty for a sale price of $2,200.  While the agreement provides for the
closing to occur on or before March 11, 1997, Blue Devil Ventures has the
option, if it determines that its development project is not feasible, to
forfeit its deposit of $550 and not close.


                                     - 39 -




<PAGE>   40





CAPITAL RESOURCES AND LIQUIDITY (continued)


On July 5, 1996, Liggett purchased from BOL 140,000 shares (approximately 20%)
of LDL's tobacco operations for $2,100.  Liggett also acquired a ten-year
option, exercisable by Liggett in whole or in part for $3,400, to purchase from
BOL at the same per-share price ($15.00) up to 292,407 additional shares of
LDL, thereby entitling Liggett to increase its interest in LDL to approximately
62%.  The option fee is to be credited against the purchase price.

Cash provided by financing activities for the nine months ended September 30,
1996 was $12,498 while cash used in financing activities for the nine months
ended September 30, 1995 was $32,580.

Proceeds from debt in the 1996 period include the private placement of the
Series A Notes (later exchanged for Series B Notes) for cash proceeds of
$6,300 including accrued interest, borrowings by BOL for real estate
development of $12,400 and net borrowings of approximately $9,500 by Liggett
and BOL under their revolving credit facilities.  These transactions were
primarily offset by the redemption for $6,237 of the 16.125% Senior
Subordinated Reset Notes, including premium and accrued interest thereon, and
distributions to the Company's shareholders of $4,162.  In the 1995 period,
proceeds from debt were $3,028, offset primarily by redemption of the Series
1 Notes of $23,594 plus accrued interest of $670 on June 12, 1995, repayments
under the Liggett facility of $3,449 and distributions of $4,107 to the
Company's shareholders.

Availability under Liggett's Facility was approximately $1,550 based on
eligible collateral at September 30, 1996.  The Facility is collateralized by
all accounts receivable and inventories of Liggett.  Borrowings under the
Facility bear interest at a rate equal to 1.5% above Philadelphia National
Bank's (the indirect parent of Congress Financial Corporation, the lead lender)
prime rate, which was 8.25% at September 30, 1996.  The Facility contains
certain financial covenants similar to those contained in the Indenture,
including restrictions on Liggett's ability to declare or pay cash dividends,
incur additional debt, grant liens and enter into any new agreements with
affiliates, among others.  In addition, the Facility imposes requirements with
respect to Liggett's adjusted net worth (not to fall below a deficit of
$175,000) and working capital (not to fall below a deficit of $35,000).  At
September 30, 1996, Liggett was in compliance with all covenants under the
Facility.  The Facility was reclassified to short-term debt because it becomes
due on March 8, 1997.  While management currently anticipates the maturity of
the Facility will be extended and other terms of the Facility will be modified
on satisfactory terms, no assurances can be given in this regard.

In December 1995, purchases by Liggett of $7,000 of 11.500% Senior Secured
Series B Notes due 1993 - 1999 using availability under the Facility
were credited against the mandatory redemption requirement for
February 1, 1996.  The remaining $500 mandatory redemption requirement for
February 1, 1996 was met by retiring the $500 of Variable Rate Series C Senior
Secured Notes due 1999 held in Liggett's treasury.  While Liggett's management
currently believes that funds will be available from cash flows from operations
and borrowings under the Facility to meet the 1997 mandatory redemption
requirement, no assurances can be given in this regard.  There are no definite
plans for funding Liggett's 1998 mandatory redemption requirement of $37,500
at this time.

At September 30, 1996, Liggett had a net capital deficiency of $167,833 and is
highly leveraged.  Due to the many risks and uncertainties associated with the
cigarette industry, impact of recent tobacco litigation settlements and
increased tobacco costs, there can be no assurance that Liggett will be able to
meet its future earnings goals.  Consequently, Liggett could be in violation of
certain debt covenants and if its lenders were to  exercise acceleration rights
under the Facility or the Liggett senior secured notes indentures or refuse to
lend under the Facility, Liggett would not be able to satisfy such demands or
its working capital requirements.

Prior to completion of the 1995 Exchange Offer on January 30, 1996, the Company
had substantial near-term debt service requirements, with aggregate required
principal payments of $318,106 due in the years 1995 through 1998.  Redemption
of the remaining Reset Notes was effectuated on March 29, 1996 through

                                     - 40 -




<PAGE>   41




CAPITAL RESOURCES AND LIQUIDITY (continued)


use of proceeds from the sale of the additional $7,397 of Series A Notes on
March 4, 1996 discussed above.  As a result of the 1995 Exchange Offer and the
redemption of the Reset Notes pursuant to the terms of the Reset Note Indenture
on March 29, 1996, BGLS decreased its scheduled debt maturities to $81,942 due
in the years 1996-1998; approximately $79,000 of this debt relates to Liggett
and LDL.  In addition, BGLS cancelled all of the subordinated debentures
($13,705) held by the Company.

The Company believes that it will continue to meet its liquidity requirements
through the twelve months ending September 30, 1997, although the BGLS Series B
Notes Indenture limits the amount of restricted payments BGLS is permitted to
make to the Company during the calendar year.  At September 30, 1996, the
remaining amount available through December 31, 1996 in the Restricted Payment
Basket related to BGLS' payment of dividends to the Company (as defined by
BGLS' Series B Notes Indenture) is $3,225.  In September 1996, the Company
provided for its quarterly dividend of $1,387 with proceeds from the CVR
distribution received in July 1996.  Company expenditures (exclusive of Liggett
and LDL) in 1996 include the $29,000 interest payment on the Series B Notes on
July 31, 1996.  In March and July 1996, New Valley declared and paid dividends
on its Class A Preferred Shares in which NV Holdings received $6,183 and
$18,550, respectively. The Company expects to finance its long-term growth,
working capital requirements, capital expenditures and debt service
requirements through a combination of cash provided from operations, proceeds
from the sale of certain assets, additional public or private debt and/or
equity financing and distributions from New Valley.  New Valley may acquire
additional operating businesses through merger, purchase of assets, stock
acquisition or other means, or seek to acquire control of operating companies
through one of such means.


SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

The Company and its representatives may from time to time make oral or written
"forward-looking statements" within the meaning of the Private Securities
Reform Act of 1995 (the "Reform Act"), including any statements that may be
contained in the foregoing discussion in "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
shareholders, which reflect management's current views 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 Reform Act, the Company is hereby identifying important
factors that could cause actual results to differ materially from those
contained in any forward-looking statement made by or on behalf of the Company.
Liggett continues to be subject to risk factors endemic to the domestic
tobacco industry including, without limitation, health concerns relating to
the use of tobacco products and exposure to ETS, legislation, including tax
increases, governmental regulation, privately imposed smoking restrictions,
governmental and grand jury investigations and litigation.  Each of the
Company's operating subsidiaries, namely Liggett and LDL, are subject to
intense competition, changes in consumer preferences, the effects of changing
prices for its raw materials and local economic  conditions.  Furthermore, the
performance of LDL's cigarette and real estate development operations in Russia
are each affected by uncertainties in Russia which include, among others,
political or diplomatic developments, regional tensions, currency repatriation
restrictions, foreign exchange fluctuations, inflation, and an undeveloped
system of commercial laws and legislative reform relating to foreign ownership
in Russia.  In addition, the Company has a high degree of leverage and
substantial near-term debt service requirements, as well as a net worth
deficiency and recent losses from continuing operations.  The Indenture for
BGLS' Series B Notes provides for, among other things, the restriction of
certain affiliated transactions  between the Company and its affiliates, as
well as for certain restrictions on the use of future distributions received
from New Valley.  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.  The Company does not
undertake to update any forward-looking statement that may be made from time to
time by or on behalf of the Company.

                                     - 41 -




<PAGE>   42


                                    PART II
                               OTHER INFORMATION


Item 1.  Legal Proceedings

         Reference is made to information entitled "Contingencies" in Note 7 to
         the Consolidated Financial Statements of Brooke Group Ltd. and BGLS
         Inc. (collectively, the "Companies") included elsewhere in this report
         on Form 10-Q.

Item 3.  Defaults Upon Senior Securities

         As of September 30, 1996, New Valley Corporation, the Companies'
         affiliate, had the following respective accrued and unpaid dividend
         arrearages on its 1,035,462 outstanding shares of $15.00 Class A
         Increasing Rate Cumulative Senior Preferred Shares ($100 Liquidation
         Value), $.01 par value per share (the "Class A Shares") and 2,790,776
         outstanding shares of $3.00 Class B Cumulative Convertible Preferred
         Shares ($25 Liquidation Value), $.10 par value per share (the "Class B
         Shares"): (1) $103.23 million or $99.70 per Class A Share; and (2)
         $110.47 million or $39.58 per Class B Share.

Item 4.  Submission of Matters to a Vote of Security-Holders

         During the third quarter of 1996, the Company submitted certain matters
         to a vote of security-holders at its Annual Meeting of Stockholders
         held on July 18, 1996 (the "Annual Meeting").  Proxies for the Annual
         Meeting were solicited pursuant to Regulation 14A under the Securities
         Exchange Act of 1934, as amended.

         The following constitutes a brief description of the matters voted upon
         at the Annual Meeting and a tabulation of the results:

         Total shares of Common Stock outstanding as of June 17, 1996 (the
         record  date) - 18,496,096

         Total shares of Common Stock voted in person or by proxy - 17,765,298

        1.   Election of Directors:

<TABLE>
<CAPTION>
                                      For        Withhold
                                   ----------    --------
             <S>                   <C>            <C>
             Bennett S. LeBow      17,727,829     37,469
             Robert J. Eide        17,727,829     37,469
             Jeffrey S. Podell     17,727,829     37,469

</TABLE>

        2.   To ratify the appointment of Coopers & Lybrand L.L.P. as
             independent auditors for the Company for the year ending December
             31, 1996:


<TABLE>
<CAPTION>
                   For          Against      Abstain
                   ---          -------      -------
                <S>             <C>          <C>
                17,740,166      15,001       10,131
</TABLE>




                                     - 42 -


<PAGE>   43






Item 6. Exhibits and Reports on Form 8-K

        (a)  Exhibits

             10    Agreement of Termination made as of June 5, 1996, by and
                   among Brooke Group Ltd., High River Limited the Schedule 13D
                   Inc. with the as amended, with Corp.) BGLS Inc., New
                   Partnership filed by, among Securities and respect to the
                   Valley Corporation, (incorporated by others, Brooke Exchange
                   Commission common stock of RJR ALKI Corp. and reference to
                   Group Ltd. and BGLS on March 11, 1996, as amended, with
                   respect to the common stock of RJR Nabisco Holdings Corp.)


             27.1  Brooke Group Ltd.'s Financial Data Schedule (for SEC use
                   only)

             27.2  BGLS Inc.'s Financial Data Schedule (for SEC use only)

             99.1  Liggett Group Inc.'s Interim Consolidated Financial
                   Statements for the quarterly period ended September 30, 1996.

             99.2  New Valley Corporation's Interim Consolidated Financial
                   Statements for the quarterly period ended September 30, 1996.

        (b)  Reports on Form 8-K

             No current reports on Form 8-K were filed by either Company during
             the third quarter of 1996.



                                                             


                                     - 43 -


<PAGE>   44




                                   SIGNATURES





     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned thereunto duly authorized.





                                      BROOKE GROUP LTD.
                                      (REGISTRANT)

                                      By: /s/ Joselynn D. Van Siclen
                                      -----------------------------------
                                      Joselynn D. Van Siclen
                                      Vice President, Treasurer and Chief
                                        Financial Officer

                                      Date: November 14, 1996
                                            -----------------------------





                                    - 44 -


<PAGE>   45
                                SIGNATURES


    Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.



                                        BGLS Inc.
                                        (Registrant)


                                        By: /s/ Joselynn D. Van Siclen
                                        -------------------------------------
                                        Joselynn D. Van Siclen
                                        Vice President, Treasurer and Chief
                                          Financial Officer


                                        Date: November 14, 1996
                                              -----------------





                                45