<PAGE>   1





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



                       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 MARCH 31, 1999

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

                                BROOKE GROUP LTD.
             (Exact name of registrant as specified in its charter)
<TABLE>
    <S>                                         <C>                             <C>
               DELAWARE                                 1-5759                              51-0255124
    (State or other jurisdiction of             Commission File Number          (I.R.S. Employer Identification No.)
     incorporation or organization)
</TABLE>

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

<TABLE>
    <S>                                         <C>                             <C> 
               DELAWARE                                33-93576                              13-3593483
    (State or other jurisdiction of             Commission File Number          (I.R.S. Employer Identification No.)
     incorporation or organization)
</TABLE>

                             100 S.E. SECOND STREET
                              MIAMI, FLORIDA 33131
                                  305/579-8000
     (Address, including zip code and telephone number, including area code,
                       of the principal executive offices)

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


         Indicate by check mark whether the 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 Registrants were required to file such
reports), and (2) have been subject to such filing requirements for the past 90
days. [ X ] Yes [ ] No

         At May 14, 1999 Brooke Group Ltd. had 20,943,730 shares of common stock
outstanding, and BGLS Inc. had 100 shares of common stock outstanding, all of
which are held by Brooke Group Ltd.

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

<PAGE>   2



                                BROOKE GROUP LTD.
                                    BGLS INC.

                                    FORM 10-Q

                                TABLE OF CONTENTS
<TABLE>
<CAPTION>

                                                                                                         Page
PART I. FINANCIAL INFORMATION

Item 1. Brooke Group Ltd./BGLS Inc. Consolidated Financial Statements:
<S>                                                                                                       <C>    
   Brooke Group Ltd. Consolidated Balance Sheets as of March 31, 1999 and
         December 31, 1998.............................................................................     2

   BGLS Inc. Consolidated Balance Sheets as of March 31, 1999 and December 31, 1998....................     3

   Brooke Group Ltd. Consolidated Statements of Operations for the three months ended
         March 31, 1999 and March 31, 1998.............................................................     4

   BGLS Inc. Consolidated Statements of Operations for the three months ended
         March 31, 1999 and March 31, 1998.............................................................     5

   Brooke Group Ltd. Consolidated Statement of Stockholders' Equity (Deficit) for the three
         months ended March 31, 1999...................................................................     6

   BGLS Inc. Consolidated Statement of Stockholder's Equity (Deficit) for the three months
         ended March 31, 1999..........................................................................     7

   Brooke Group Ltd. Consolidated Statements of Cash Flows for the three months ended
         March 31, 1999 and March 31, 1998.............................................................     8

   BGLS Inc. Consolidated Statements of Cash Flows for the three months ended
         March 31, 1999 and March 31, 1998.............................................................     9

   Notes to Consolidated Financial Statements..........................................................    10

Item 2. Management's Discussion and Analysis
        of Financial Condition and Results of Operations...............................................    32

Item 3. Quantitative and Qualitative Disclosures About Market Risk.....................................    42


PART II.     OTHER INFORMATION

Item 1. Legal Proceedings..............................................................................    43

Item 2. Changes in Securities and Use of Proceeds......................................................    43

Item 3. Defaults Upon Senior Securities................................................................    43

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

SIGNATURES.............................................................................................    45
</TABLE>



                                      -1-


<PAGE>   3

Item 1.  Consolidated Financial Statements

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

<TABLE>
<CAPTION>

                                                                                   March 31,           December 31,
                                                                                     1999                  1998
                                                                                   --------------------------------
ASSETS:
Current assets:
<S>                                                                                <C>                 <C> 
  Cash and cash equivalents .............................................          $   5,519           $   7,396
  Accounts receivable - trade ...........................................             17,920              15,160
  Other receivables .....................................................                979                 924
  Inventories ...........................................................             42,740              36,316
  Deferred income taxes .................................................             54,328              59,613
  Other current assets ..................................................              4,756               3,151
                                                                                   ---------           ---------
        Total current assets ............................................            126,242             122,560

Property, plant and equipment, at cost, less accumulated
    depreciation of $35,427 and $33,856 .................................            108,919              93,504
Intangible assets, at cost, less accumulated amortization
    of $21,555 and $21,551 ..............................................                167                 171
Other assets ............................................................             13,017              12,747
                                                                                   ---------           ---------
        Total assets ....................................................          $ 248,345           $ 228,982
                                                                                   =========           =========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):

Current liabilities:
  Notes payable and current portion of long-term debt ...................          $  29,077           $  21,176
  Accounts payable ......................................................             13,552              13,880
  Cash overdraft ........................................................                 43                  77
  Accrued promotional expenses ..........................................             22,117              23,760
  Accrued taxes payable .................................................             12,420              14,854
  Accrued interest ......................................................              7,737              17,189
  Proceeds received for options .........................................            150,000             150,000
  Other accrued liabilities .............................................             32,296              32,505
                                                                                   ---------           ---------
    Total current liabilities ...........................................            267,242             273,441

Notes payable, long-term debt and other obligations, less current 
  portion ...............................................................            280,410             262,665
Noncurrent employee benefits ............................................             20,383              21,701
Other liabilities .......................................................             60,361              65,350

Commitments and contingencies

Stockholders' equity (deficit):
  Preferred Stock, par value $1.00 per share, authorized
    10,000,000 shares ...................................................
  Series G Preferred Stock, 2,184,834 shares, convertible,
    participating, cumulative, each share convertible to 1,000
    shares of common stock and cash or stock distribution,
    liquidation preference of $1.00 per share ...........................
  Common stock, par value $0.10 per share, authorized 100,000,000
    and 40,000,000 shares, issued 26,498,043 shares, outstanding
    20,943,730 shares ...................................................              2,094               2,094
  Additional paid-in capital ............................................            123,041             124,120
  Deficit ...............................................................           (503,379)           (512,182)
  Accumulated other comprehensive income ................................             30,694              24,774
  Other .................................................................             (5,028)             (5,508)
  Less:  5,554,313 shares of common stock in treasury, at cost ..........            (27,473)            (27,473)
                                                                                   ---------           ---------
      Total stockholders' equity (deficit) ..............................           (380,051)           (394,175)
                                                                                   ---------           ---------

      Total liabilities and stockholders' equity (deficit) ..............          $ 248,345           $ 228,982
                                                                                   =========           =========
</TABLE>



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



                                      -2-

<PAGE>   4


Item 1.  Consolidated Financial Statements - (Continued)

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

<TABLE>
<CAPTION>

                                                                                           March 31           December 31,
                                                                                             1999                 1998
                                                                                          --------------------------------
ASSETS:

Current assets:
<S>                                                                                       <C>                 <C>    
  Cash and cash equivalents ....................................................          $   5,519           $   7,396
  Accounts receivable - trade ..................................................             17,920              15,160
  Other receivables ............................................................                824                 755
  Inventories ..................................................................             42,740              36,316
  Deferred income taxes ........................................................             54,328              59,613
  Other current assets .........................................................              4,681               2,946
                                                                                          ---------           ---------
      Total current assets .....................................................          $ 126,012             122,186

Property, plant and equipment, at cost, less accumulated depreciation of
  $35,421 and $33,852 ..........................................................            108,899              93,481
Intangible assets, at cost, less accumulated amortization of $21,555 and 
  $21,551 ......................................................................                167                 171
Other assets ...................................................................             11,878              11,558
                                                                                          ---------           ---------
      Total assets .............................................................          $ 246,956           $ 227,396
                                                                                          =========           =========

LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT):

Current liabilities:
  Notes payable and current portion of long-term debt ..........................          $  29,037           $  20,955
  Accounts payable .............................................................             13,427              13,746
  Cash overdraft ...............................................................                 43                  63
  Due to parent ................................................................             32,560              32,394
  Accrued promotional expenses .................................................             22,117              23,760
  Accrued taxes payable ........................................................             12,420              14,854
  Accrued interest .............................................................              7,737              17,188
  Proceeds received from options ...............................................            150,000             150,000
  Other accrued liabilities ....................................................             31,211              31,556
                                                                                          ---------           ---------
      Total current liabilities ................................................            298,552             304,516

Notes payable, long-term debt and other obligations, less current portion ......            280,410             262,665
Noncurrent employee benefits ...................................................             20,383              21,701
Other liabilities ..............................................................             62,768              69,216

Commitments and contingencies

Stockholder's equity (deficit):
  Common stock, par value $0.01 per share; 100 shares authorized,
    issued and outstanding
  Additional paid-in capital ...................................................             69,789              69,297
  Deficit ......................................................................           (515,640)           (524,773)
  Accumulated other comprehensive income .......................................             30,694              24,774
                                                                                          ---------           ---------
      Total stockholder's equity (deficit) .....................................           (415,157)           (430,702)
                                                                                          ---------           ---------

      Total liabilities and stockholder's equity (deficit) .....................          $ 246,956           $ 227,396
                                                                                          =========           =========
</TABLE>

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


                                      -3-
<PAGE>   5


Item 1.  Consolidated Financial Statements - (Continued)


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

<TABLE>
<CAPTION>

                                                                               Three Months Ended
                                                                      --------------------------------
                                                                        March 31,           March 31,
                                                                          1999                1998
                                                                      --------------------------------
<S>                                                                   <C>                 <C>
Revenues* ..................................................          $    108,409        $     84,803
Cost of goods sold* ........................................                41,427              41,656
                                                                      ------------        ------------

Gross profit ...............................................                66,982              43,147
Operating, selling, administrative and general expenses ....                44,837              35,604
                                                                      ------------        ------------

Operating income ...........................................                22,145               7,543

Other income (expenses):
    Interest income ........................................                    60                  65
    Interest expense .......................................               (14,988)            (20,786)
    Equity in loss of affiliate ............................                (7,629)             (4,187)
    Recognition of deferred gain on sale of assets .........                 7,050
    Foreign currency gain ..................................                 2,270                  79
    Other, net .............................................                   375                 852
                                                                      ------------        ------------

Income (loss) from continuing operations before income 
  taxes.....................................................                 9,283             (16,434)
Provision for income taxes .................................                 1,729                 931
                                                                      ------------        ------------

Income (loss) from continuing operations ...................                 7,554             (17,365)
                                                                      ------------        ------------

Gain on discontinued operations in equity investee .........                 1,249
                                                                      ------------        ------------

Net income (loss) ..........................................          $      8,803        $    (17,365)
                                                                      ============        ============

Net income (loss) applicable to common shares ..............          $      8,803        $    (17,365)
                                                                      ============        ============

Per basic common share:

    Income (loss) from continuing operations ...............          $       0.36        $      (0.89)
                                                                      ============        ============
    Income from discontinued operations ....................          $       0.06
                                                                      ============        ============
    Net income (loss) applicable to common shares ..........          $       0.42        $      (0.89)
                                                                      ============        ============

Basic weighted average common shares outstanding ...........            20,943,730          19,465,056
                                                                      ============        ============
Per diluted common share:

    Income (loss) from continuing operations ...............          $       0.29        $      (0.89)
                                                                      ============        ============
    Income from discontinued operations ....................          $       0.05
                                                                      ============        ============
    Net income (loss) applicable to common shares ..........          $       0.34        $      (0.89)
                                                                      ============        ============

Diluted weighted average common shares outstanding .........            26,020,356          19,465,056
                                                                      ============        ============
</TABLE>



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

*   Revenues and Cost of goods sold include federal excise taxes of $14,038
    and $17,918 for the three months ended March 31, 1999 and 1998,
    respectively.



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



                                       -4-
<PAGE>   6


Item 1.  Consolidated Financial Statements - (Continued)




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

<TABLE>
<CAPTION>

                                                                        Three Months Ended
                                                                    --------------------------
                                                                      March 31,      March 31,
                                                                        1999           1998
                                                                    --------------------------

<S>                                                                   <C>            <C>
Revenues* ..................................................          $ 108,409      $  84,803
Cost of goods sold* ........................................             41,427         41,656
                                                                      ---------      ---------

Gross profit ...............................................             66,982         43,147
Operating, selling, administrative and general expenses ....             44,435         35,371
                                                                      ---------      ---------

Operating income ...........................................             22,547          7,776

Other income (expenses):
   Interest income .........................................                 60             56
   Interest expense ........................................            (16,244)       (21,824)
   Equity in loss of affiliate .............................             (7,629)        (4,187)
   Recognition of deferred gain on sale of assets ..........              8,264
   Foreign currency gain ...................................              2,270             79
   Other, net ..............................................                345            849
                                                                      ---------      ---------

Income (loss) from continuing operations before income taxes              9,613        (17,251)
Provision for income taxes .................................              1,729            931
                                                                      ---------      ---------

Income (loss) from continuing operations ...................              7,884        (18,182)
                                                                      ---------      ---------

Gain on discontinued operations of equity investee .........              1,249
                                                                      ---------      ---------

Net income (loss) ..........................................          $   9,133      $ (18,182)
                                                                      =========      =========
</TABLE>


----------

*Revenues and Cost of goods sold include federal excise taxes of $14,038 and
$17,918 for the three months ended March 31, 1999 and 1998, respectively.


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



                                      -5-
<PAGE>   7

Item 1.  Consolidated Financial Statements - (Continued)

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


<TABLE>
                                               -----------------------------------------------------------------------------------
                                                                                                                       
                                                                                                            Accumulated
                                                   Common Stock    Additional                                 Other
                                               -------------------  Paid-In              Treasury         Comprehensive
                                                 Shares     Amount  Capital    Deficit    Stock     Other     Income        Total
                                               ---------- ------------------------------------------------------------------------
<S>                                            <C>         <C>     <C>       <C>        <C>        <C>       <C>         <C> 
Balance, December 31, 1998..................   20,943,730  $2,094  $124,120  $(512,182) $(27,473)  $(5,508)  $24,774     $(394,175)

Net income..................................                                     8,803                                       8,803
  Unrealized holding gain on 
   investment in New Valley.................                                                                   8,159         8,159
  Effect of New Valley capital 
   transactions.............................                                                                  (2,239)       (2,239)
                                                                                                                         ---------
      Total other comprehensive income......                                                                                 5,920
                                                                                                                         ---------
Total comprehensive income..................                                                                                14,723
                                                                                                                         ---------

Distributions on common stock...............                         (1,534)                                                (1,534)
Amortization of deferred compensation.......                            455                            480                     935
                                               ----------  ------  --------  ---------  --------   -------   -------     ----------
Balance, March 31, 1999.....................   20,943,730  $2,094  $123,041  $(503,379) $(27,473)  $(5,028)  $30,694    $ (380,051)
                                               ==========  ======  ========  =========  ========   =======   =======     =========
</TABLE>






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



                                      -6-
<PAGE>   8

Item 1.  Consolidated Financial Statements - (Continued)

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

<TABLE>
<CAPTION>


                                                     --------------------------------------------------------------------
                                                                                                              
                                                                                                 Accumulated
                                                       Common Stock     Additional                  Other
                                                     -----------------    Paid-In               Comprehensive
                                                       Shares   Amount    Capital     Deficit       Income       Total
                                                     -------------------------------------------------------------------
<S>                                                  <C>        <C>     <C>         <C>            <C>         <C>
Balance, December 31, 1998........................       100    $       $69,297     $(524,773)     $24,774     $(430,702)

Net income........................................                                      9,133                      9,133
  Unrealized holding gain on 
    investment in New Valley......................                                                   8,159         8,159
  Effect of New Valley capital transactions.......                                                  (2,239)       (2,239)
                                                                                                               ---------
    Total other comprehensive income..............                                                                 5,920
                                                                                                               ---------
Total comprehensive income........................                                                                15,053
                                                                                                               ---------

Amortization of deferred compensation.............                          492                                      492
                                                      ------    ------  -------     ---------      -------     ---------

Balance, March 31, 1999...........................       100    $       $69,789     $(515,640)     $30,694     $(415,157)
                                                      ======    ======  =======     =========      =======     =========
</TABLE>



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


                                      -7-
<PAGE>   9


Item 1.  Consolidated Financial Statements - (Continued)

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

<TABLE>
<CAPTION>

                                                                        Three Months Ended
                                                                ------------------------------
                                                                   March 31,         March 31,
                                                                     1999               1998
                                                                ------------------------------
<S>                                                                 <C>              <C>  
Net cash provided by (used in) operating activities ........        $  2,571         $(25,984)
                                                                    --------         --------

Cash flows from investing activities:
  Proceeds from sale of business and assets ................              36            1,217
  Capital expenditures .....................................         (19,617)            (395)
                                                                    --------         --------

Net cash (used in) provided by investing activities ........         (19,581)             822
                                                                    --------         --------

Cash flows from financing activities:
  Proceeds from debt .......................................           4,500
  Repayments of debt .......................................            (323)            (102)
  Borrowings under revolver ................................          83,986           63,961
  Repayments on revolver ...................................         (71,319)         (58,799)
  Decrease in cash overdraft ...............................             (34)             (45)
  Distributions on common stock ............................          (1,358)            (900)
  Proceeds from participating loan .........................                           11,000
  Issuance of common stock .................................                            9,796
                                                                    --------         --------

Net cash provided by financing activities ..................          15,452           24,911
                                                                    --------         --------

Effect of exchange rate changes on cash and cash equivalents            (319)              79
Net decrease in cash and cash equivalents ..................          (1,877)            (172)
Cash and cash equivalents, beginning of period .............           7,396            4,749
                                                                    --------         --------

Cash and cash equivalents, end of period ...................        $  5,519         $  4,577
                                                                    ========         ========
</TABLE>




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


                                      -8-
<PAGE>   10


Item 1.  Consolidated Financial Statements - (Continued)

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



<TABLE>
<CAPTION>
                                                                         Three Months Ended
                                                                --------------------------------
                                                                    March 31,          March 31,
                                                                      1999               1998
                                                                --------------------------------

<S>                                                                 <C>              <C> 
Net cash provided by (used in) operating activities ........        $  1,019         $(17,218)
                                                                    --------         --------

Cash flows from investing activities:
  Proceeds from sale of business and assets ................              36            1,217
  Capital expenditures .....................................         (19,617)            (395)
                                                                    --------         --------

Net cash (used in) provided by investing activities ........         (19,581)             822
                                                                    --------         --------

Cash flows from financing activities:
  Proceeds from debt .......................................           4,500
  Repayments of debt .......................................            (143)            (102)
  Borrowings under revolver ................................          83,986           63,961
  Repayments on revolver ...................................         (71,319)         (58,799)
  Decrease (increase) in cash overdraft ....................             (20)              47
  Proceeds from participating loan .........................                           11,000
                                                                    --------         --------

Net cash provided by financing activities ..................          17,004           16,107
                                                                    --------         --------

Effect of exchange rate changes on cash and cash equivalents            (319)              79
Net decrease in cash and cash equivalents ..................          (1,877)            (210)
Cash and cash equivalents, beginning of period .............           7,396            4,749
                                                                    --------         --------

Cash and cash equivalents, end of period ...................        $  5,519         $  4,539
                                                                    ========         ========
</TABLE>


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



                                      -9-
<PAGE>   11

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


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"),
         Liggett-Ducat Ltd. ("Liggett-Ducat") and other less significant
         subsidiaries. Liggett is engaged primarily in the manufacture and sale
         of cigarettes, principally in the United States. Liggett-Ducat is
         engaged in the manufacture and sale of cigarettes in Russia. All
         significant intercompany balances and transactions have been
         eliminated.

         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 Report on Form 10-K, as amended, for the year ended
         December 31, 1998, as filed with the Securities and Exchange
         Commission. The consolidated results of operations for interim periods
         should not be regarded as necessarily indicative of the results that
         may be expected for the entire year.

         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 1998 consolidated financial statements have
         been reclassified to conform to the 1999 presentation.

         LIQUIDITY:

         The Company's anticipated sources of liquidity for 1999 include, among
         other things, proceeds from the exercise of an option in an entity to
         which a subsidiary of Liggett will contribute certain trademarks (the
         "Marks") and the distribution of loan proceeds from the entity (refer
         to Note 2), additional debt and/or equity financing, management fees
         and tax sharing and other payments from Liggett and certain funds
         available from New Valley Corporation ("New Valley") subject to
         limitations imposed by BGLS' indenture agreements. Liggett's and New
         Valley's ability to make such payments is subject to risks and
         uncertainties attendant to their businesses. (Refer to Notes 3 and 8.)
         New Valley may also acquire or seek to acquire additional operating
         businesses through merger, purchase of assets, stock acquisition or
         other means, or to make other investments, which may limit its ability
         to make such distributions.

         Liggett has a $40,000 revolving credit facility expiring March 8, 2000
         (the "Facility"), under which $6,793 was outstanding and $12,990 was
         available at March 31, 1999.

         Liggett-Ducat is in the process of constructing a new tobacco factory
         in Moscow, Russia, currently scheduled to be operational in June 1999.
         The remaining construction costs and equipment required


                                     -10-
<PAGE>   12

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


         for the new factory will be financed primarily by equipment lease
         financing currently in place and loans from banks. (Refer to Note 4.)

         EARNINGS PER SHARE:

         For the three months ended March 31, 1999, basic net income per share
         is computed by dividing net income by the weighted-average number of
         shares outstanding. Diluted net income per share includes the dilutive
         effect of stock options, vested restricted stock grants and warrants.
         For the three months ended March 31, 1998, stock options, warrants and
         contingent shares (both vested and non-vested) were excluded from the
         calculation of diluted per share results because their effect was
         accretive.

         COMPREHENSIVE INCOME:

         Comprehensive income is a component of stockholders' equity and
         includes the Company's net income and other comprehensive income such
         as the proportionate interest in New Valley's capital transactions,
         unrealized gains and losses on investment securities and minimum
         pension liability adjustments. For the three months ended March 31,
         1999, total comprehensive income was $14,723. For the three months
         ended March 31, 1998, the total comprehensive loss was $13,179.


2.       PHILIP MORRIS BRAND TRANSACTION

         On November 20, 1998, the Company and Liggett entered into a
         definitive agreement with Philip Morris Incorporated ("PM") which
         provided for PM to purchase options in an entity which will hold three
         cigarette brands, L&M, Chesterfield and Lark (the "Marks"), held by
         Liggett's subsidiary, Eve Holdings Inc. ("Eve"). As contemplated by
         the agreement, Liggett and PM entered into additional agreements
         (collectively, the "PM Agreements") on January 12, 1999 to effectuate
         the transactions.

         Under the terms of the PM Agreements, Eve will contribute the Marks to
         Brands LLC ("LLC"), a newly-formed limited liability company, in
         exchange for 100% of two classes of LLC interests, the Class A Voting
         Interest (the "Class A Interest") and the Class B Redeemable Nonvoting
         Interest (the "Class B Interest"). PM acquired two options to purchase
         such interests (the "Class A Option" and the "Class B Option"). On
         December 2, 1998, PM paid Eve a total of $150,000 for such options,
         $5,000 for the Class A Option and $145,000 for the Class B Option. The
         payments were used to fund the redemption of the Liggett Notes on
         December 28, 1998.

         The Class A Option entitles PM to purchase the Class A Interest for
         $10,100. The statutory waiting period under the Hart-Scott-Rodino Act
         regarding the exercise by PM of the Class A Option expired on February
         12, 1999. On March 19, 1999, PM exercised the Class A Option with the
         closing scheduled for no later than June 10, 1999 (currently scheduled
         to close May 24, 1999), subject to customary closing conditions.

         The Class B Option will entitle PM to purchase the Class B Interest
         for $139,900. The Class B Option will be exercisable during the 90-day
         period beginning on December 2, 2008, with PM being entitled to extend
         the 90-day period for up to an additional six months under certain
         circumstances. The Class B Interest will also be redeemable by the LLC
         for $139,900 during the same period the Class B Option may be
         exercised.


                                     -11-
<PAGE>   13

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


         The LLC will seek to borrow $134,900 (the "Loan") from a lending
         institution. The Loan will be guaranteed by Eve and collateralized by
         a pledge by the LLC of the Marks and of the LLC's interest in the
         trademark license agreement (discussed below) and by a pledge by Eve
         of its Class B Interest. In connection with the closing of the Class A
         Option, the LLC will distribute the Loan proceeds to Eve with respect
         to its Class B Interest. The cash exercise price of the Class B Option
         and the LLC's redemption price will be reduced by the amount
         distributed to Eve. Upon PM's exercise of the Class B Option or the
         LLC's exercise of its redemption right, PM or the LLC, as relevant,
         will be required to procure Eve's release from its guaranty. The Class
         B Interest will be entitled to a guaranteed payment of $500 each year,
         with the Class A Interest allocated all remaining LLC income or loss.

         The LLC will grant PM an exclusive license of the Marks for an 11-year
         term at an annual royalty based on sales of cigarettes under the
         Marks, subject to a minimum annual royalty payment equal to the annual
         debt service obligation on the Loan plus $1,000.

         If PM fails to exercise the Class B Option, Eve will have an option to
         put its Class B Interest to PM, or PM's designees (the "Eve Put
         Option"), at a put price that is $5,000 less than the exercise price
         of the Class B Option (and includes PM's procuring Eve's release from
         its Loan guarantee). The Eve Put Option is exercisable at any time
         during the 90-day period beginning March 2, 2010.

         If the Class B Option, the LLC's redemption right and the Eve Put
         Option expire unexercised, the holder of the Class B Interest will be
         entitled to convert the Class B Interest, at its election, into a
         Class A Interest with the same rights to share in future profits and
         losses, the same voting power and the same claim to capital as the
         entire existing outstanding Class A Interest, i.e., a 50% LLC
         interest.

         The $150,000 in proceeds received from the sale of the Class A and B
         Options is presented as a liability on the consolidated balance sheet
         until the closing of the exercise of the Class A Option and the
         distribution of the Loan proceeds which is scheduled to occur during
         the second quarter of 1999. Upon such closing, PM will obtain control
         of the LLC, and the Company anticipates, based on the expected
         structure of the transactions, to recognize a gain in its consolidated
         financial statements to the extent of the total cash proceeds received
         from the payment of the option fees, the exercise of the Class A
         Option and the distribution of the Loan proceeds.


3.       INVESTMENT IN NEW VALLEY CORPORATION

         At March 31, 1999 and December 31, 1998, the Company's investment in
         New Valley consisted of an approximate 42% voting interest. At March
         31, 1999 and December 31, 1998, the Company owned 57.7% of the
         outstanding $15.00 Class A Increasing Rate Cumulative Senior Preferred
         Shares ($100 Liquidation Value), $.01 par value (the "Class A
         Preferred Shares"), 9.0% of the outstanding $3.00 Class B Cumulative
         Convertible Preferred Shares ($25 Liquidation Value), $.10 par value
         (the "Class B Preferred Shares"), and 41.7% of New Valley's common
         shares, $.01 par value (the "Common Shares").

         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 SFAS No. 115, "Accounting for Certain Investments
         in Debt and Equity Securities", and are classified as
         available-for-sale. The


                                     -12-
<PAGE>   14

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


         Common Shares are accounted for pursuant to APB No. 18, "The Equity
         Method of Accounting for Investments in Common Stock".

         The Company determines the fair value of the Class A Preferred Shares
         and Class B Preferred Shares based on the quoted market price. Through
         September 1996, earnings on the Class A Preferred Shares were
         comprised of dividends accrued during the period and the accretion of
         the difference between the Company's basis and their mandatory
         redemption price. 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 investment in New Valley to be reduced to zero.
         Beginning in the fourth quarter of 1996, the Company suspended the
         recording of its earnings on the dividends accrued and the accretion
         of the difference between the Company's basis in the Class A Preferred
         Shares and their mandatory redemption price.

         The Company's and BGLS' investment in New Valley at March 31, 1999 is
         summarized below:

<TABLE>
<CAPTION>
                                                Number of    Fair     Carrying
                                                  Shares    Value      Amount
                                                ---------  -------    --------

               <S>                              <C>        <C>        <C>
               Class A Preferred Shares.......    618,326  $51,939    $ 51,939
               Class B Preferred Shares.......    250,885      847         847
               Common Shares..................  3,989,710    1,621     (52,786)
                                                           -------    --------
                                                           $54,407    $      0
                                                           =======    ========
</TABLE>

         In November 1994, New Valley's First Amended Joint Chapter 11 Plan of
         Reorganization, as amended ("Joint Plan"), was confirmed by order of
         the United States Bankruptcy Court for the District of New Jersey and
         on January 18, 1995, New Valley emerged from bankruptcy reorganization
         proceedings and completed substantially all distributions to creditors
         under the Joint Plan. Pursuant to the Joint Plan, among other things,
         the Class A Preferred Shares, the Class B Preferred Shares, the Common
         Shares and other equity interests were reinstated and retained all of
         their legal, equitable and contractual rights.

         The Class A Preferred Shares of New Valley are required to be redeemed
         on January 1, 2003 for $100.00 per share plus dividends accrued to the
         redemption date. The shares are redeemable, at any time, at the option
         of New Valley, at $100.00 per share plus accrued dividends. The
         holders of Class A Preferred Shares are entitled to receive a
         quarterly dividend, as declared by the Board of Directors, payable at
         the rate of $19.00 per annum. At March 31, 1999, the accrued and
         unpaid dividends arrearage was $234,581 ($218.94 per share).

         Holders of the Class B Preferred Shares are entitled to receive a
         quarterly dividend, as declared by the Board, at a rate of $3.00 per
         annum. At March 31, 1999, the accrued and unpaid dividends arrearage
         was $172,905 ($61.96 per share).


                                     -13-
<PAGE>   15

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


         Summarized financial information for New Valley as of March 31, 1999
         and December 31, 1998 and for the three ended March 31, 1998 and 1998
         follows:

<TABLE>
<CAPTION>
                                                                  March 31,     December 31,
                                                                    1999           1998
                                                                  ---------     ------------

           <S>                                                    <C>            <C>
           Current assets, primarily cash and marketable
              securities ....................................     $  70,851      $  91,451
           Non-current assets ...............................       183,787        181,271
           Current liabilities ..............................        66,975         83,581
           Non-current liabilities ..........................        83,001         78,251
           Redeemable preferred shares ......................       332,198        316,202
           Shareholders' deficit ............................      (227,536)      (205,312)
</TABLE>

<TABLE>
<CAPTION>
                                                                        Three Months Ended
                                                                      -----------------------
                                                                      March 31,    March 31,
                                                                         1999         1998
                                                                      ---------    ----------
         
          <S>                                                         <C>          <C>
          Revenues .............................................      $ 22,770      $ 33,840
          Costs and expenses ...................................        28,917        34,260
          (Loss) income from continuing operations .............        (5,682)          157
          Gain from discontinued operations ....................         4,100
          Net loss applicable to common shares(A) ..............       (23,801)      (18,675)
</TABLE> 
         
         (A) Considers all preferred accrued dividends, whether or not
         declared.

         In February 1998, New Valley and Apollo Real Estate Investment Fund
         III, L.P. ("Apollo") organized Western Realty Development LLC
         ("Western Realty Ducat") to make real estate and other investments in
         Russia. In connection with the formation of Western Realty Ducat, New
         Valley agreed, among other things, to contribute the real estate
         assets of BrookeMil Ltd. ("BML"), including Ducat Place II and the
         site for Ducat Place III, to Western Realty Ducat and Apollo agreed to
         contribute up to $58,750, including the investment in Western Realty
         Repin discussed below. Through March 31, 1999, Apollo had funded
         $36,529 of its investment in Western Realty Ducat.

         The ownership and voting interests in Western Realty Ducat will be
         held equally by Apollo and New Valley. Apollo will be entitled to a
         preference on distributions of cash from Western Realty Ducat to the
         extent of its investment ($40,000), together with a 15% annual rate of
         return, and New Valley will then be entitled to a return of $20,000 of
         BML-related expenses incurred and cash invested by New Valley since
         March 1, 1997, together with a 15% annual rate of return; subsequent
         distributions will be made 70% to New Valley and 30% to Apollo.
         Western Realty Ducat will be managed by a Board of Managers consisting
         of an equal number of representatives chosen by Apollo and New Valley.
         All material corporate transactions by Western Realty Ducat generally
         require the unanimous consent of the Board of Managers. Accordingly,
         New Valley has accounted for its non-controlling interest in Western
         Realty Ducat using the equity method of accounting.

         New Valley recorded its basis in the investment in Western Realty
         Ducat in the amount of $60,169 based on the carrying value of assets
         less liabilities transferred. There was no difference between the
         carrying value of the investment and New Valley's proportionate
         interest in the underlying value of net assets of Western Realty
         Ducat. New Valley recognizes losses incurred by Western Realty

                                     -14-
<PAGE>   16

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


         Ducat to the extent that cumulative earnings of Western Realty Ducat
         are not sufficient to satisfy Apollo's preferred return.

         Western Realty Ducat will seek to make additional real estate and
         other investments in Russia. Western Realty Ducat has made a $30,000
         participating loan to, and payable out of a 30% profits interest in, a
         company organized by BOL which, among other things, acquired an
         interest in a new factory being constructed on the outskirts of Moscow
         by a subsidiary of BOL. (Refer to Note 4.)

         In June 1998, New Valley and Apollo organized Western Realty Repin LLC
         ("Western Realty Repin") to make a $25,000 participating loan (the
         "Repin Loan") to BML. The proceeds of the loan will be used by BML for
         the acquisition and preliminary development of two adjoining sites
         totaling 10.25 acres (the "Kremlin Sites") located in Moscow across
         the Moscow River from the Kremlin. BML, which is planning the
         development of a 1.1 million sq. ft. hotel, office, retail and
         residential complex on the Kremlin Sites, owned 95.29% of one site and
         52% of the other site at March 31, 1999. Apollo will be entitled to a
         preference on distributions of cash from Western Realty Repin to the
         extent of its investment ($18,750) together with a 20% annual rate of
         return, and New Valley will then be entitled to a return of its
         investment ($6,250), together with a 20% annual rate of return;
         subsequent distributions will be made 50% to New Valley and 50% to
         Apollo. Western Realty Repin will be managed by a Board of Managers
         consisting of an equal number of representatives chosen by Apollo and
         New Valley. All material corporate transactions by Western Realty
         Repin will generally require the unanimous consent of the Board of
         Managers.

         Through March 31, 1999, Western Realty Repin has advanced $25,000 (of
         which $18,773 was funded by Apollo) under the Repin Loan to BML. The
         Repin Loan, which bears no fixed interest, is payable only out of 100%
         of the distributions, if made, by the entities owning the Kremlin
         Sites to BML. Such distributions shall be applied first to pay the
         principal of the Repin Loan and then as contingent participating
         interest on the Repin Loan. Any rights of payment on the Repin Loan
         are subordinate to the rights of all other creditors of BML. BML used
         a portion of the proceeds to repay New Valley for certain expenditures
         on the Kremlin Sites previously incurred. The Repin Loan is due and
         payable upon the dissolution of BML and is collateralized by a pledge
         of New Valley's shares of BML.

         As of March 31, 1999, BML had invested $19,621 in the Kremlin sites
         and held $3,525, in cash, which was restricted for future investment.
         In connection with the acquisition of its interest in one of the
         Kremlin Sites, BML has agreed with the City of Moscow to invest an
         additional $6,000 (which has been funded) in 1999 and $22,000 in 2000
         in the development of the property.

         The development of Ducat Place III and the Kremlin Sites will require
         significant amounts of debt and other financing. New Valley is
         actively pursuing various financing alternatives on behalf of Western
         Realty Ducat and BML. However, in light of the recent economic turmoil
         in Russia, no assurance can be given that such financing will be
         available on acceptable terms. Failure to obtain sufficient capital
         for the projects would force Western Realty Ducat and BML to curtail
         or delay the planned development of Ducat Place III and the Kremlin
         Sites.

         Proposed Recapitalization Plan:

         New Valley has submitted for approval of its shareholders at its 1999
         annual meeting, which will be held on May 21, 1999, a proposed
         recapitalization of its capital stock (the "Recapitalization Plan").

                                     -15-
<PAGE>   17

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


         Under the Recapitalization Plan, each of New Valley's outstanding
         Class A Preferred Shares would be reclassified and changed into 20
         Common Shares and one Warrant to purchase Common Shares (the
         "Warrants"). Each of the Class B Preferred Shares would be
         reclassified and changed into one-third of a Common Share and five
         Warrants. The existing Common Shares would be reclassified and changed
         into one-tenth of a Common Share and three-tenths of a Warrant. The
         number of authorized Common Shares would be reduced from 850,000,000
         to 100,000,000. The Warrants to be issued as part of the
         Recapitalization Plan would have an exercise price of $12.50 per share
         subject to adjustment in certain circumstances and be exercisable for
         five years following the effective date of New Valley's Registration
         Statement covering the underlying Common Shares. The Warrants would
         not be callable by New Valley for a three-year period. Upon completion
         of the Recapitalization Plan, New Valley will apply for listing of the
         Common Shares and Warrants on NASDAQ. Completion of the
         Recapitalization Plan is subject to, among other things, approval by
         the required holders of the various classes of New Valley's shares.

         The Company has agreed to vote all of its shares in New Valley in
         favor of the Recapitalization Plan. As a result of the
         Recapitalization Plan and assuming no warrant holder exercises its
         warrants, the Company will increase its ownership of the outstanding
         Common Shares of New Valley from 42.3% to 55.1% and its total voting
         power from 42.3% to 55.1%. New Valley would become part of the
         Company's consolidated group for financial statement purposes.


4.       INVESTMENT IN BROOKE (OVERSEAS) LTD.

         At March 31, 1999, BOL owned approximately 99.9% of the stock of
         Liggett-Ducat through its subsidiary, Western Tobacco Investments LLC
         ("Western Tobacco"). (Refer to Note 7 for information concerning
         pledges of interests in Western Tobacco.)

         Liggett-Ducat is currently completing construction of a new cigarette
         factory on the outskirts of Moscow. Production at Liggett-Ducat's
         existing factory ceased in March 1999, with production scheduled to
         start in the new factory in mid-1999. The remaining liability under
         the factory construction contract, as amended, at March 31, 1999 is
         approximately $2,500. Equipment purchase agreements in place at March
         31, 1999 total $35,846, of which $29,438 is being financed by the
         manufacturers.

         Western Realty Ducat has made a $30,000 participating loan to Western
         Tobacco which holds BOL's interest in Liggett-Ducat and the new
         factory. The loan, which bears no fixed interest, is payable only out
         of 30% of distributions, if any, made by Western Tobacco to BOL. After
         the prior payment of debt service on loans to finance the construction
         of the new factory, 30% of distributions from Western Tobacco to BOL
         will be applied first to pay the principal of the loan and then as
         contingent participating interest on the loan. Any rights of payment
         on the loan are subordinate to the rights of all other creditors of
         Western Tobacco. For the period ended March 31, 1999, a preference
         requirement equal to 30% of Western Tobacco's net income, $1,002, has
         been charged to interest expense. The loan is classified in other
         long-term liabilities on the consolidated balance sheet at March 31,
         1999. (Refer to Note 3.)

         In connection with the sale by BOL of the common shares of BML to New
         Valley in 1997, a portion of the gain was deferred in recognition of
         the fact that the Company retains an interest in BML through its 42%
         equity ownership of New Valley and that a portion of the property sold
         (the site of the third


                                     -16-
<PAGE>   18

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


         phase of the Ducat Place real estate project being developed by BML,
         which was used by Liggett-Ducat for its cigarette factory operation)
         was subject to a put option held by New Valley. The option expired
         when Liggett-Ducat ceased factory operations at the site in March
         1999. The Company recognized that portion of the deferred gain,
         $7,050, in March 1999.

         In 1998, the Russian Federation entered a period of economic
         instability. The impact includes, but is not limited to, a steep
         decline in prices of domestic debt and equity securities, a severe
         devaluation of the currency, a moratorium on foreign debt repayments,
         an increasing rate of inflation and increasing rates on government and
         corporate borrowings. The return to economic stability is dependent to
         a large extent on the effectiveness of the fiscal measures taken by
         government and other actions beyond the control of companies operating
         in the Russian Federation. The operations of Liggett-Ducat may be
         significantly affected by these factors for the foreseeable future.


5.       INVENTORIES

         Inventories consist of:

<TABLE>
<CAPTION>
                                                                    March 31,  December 31,
                                                                      1999         1998
                                                                    ---------  ------------

              <S>                                                   <C>        <C>
              Leaf tobacco .....................................    $ 10,884     $ 13,882
              Other raw materials ..............................       5,445        4,629
              Work-in-process ..................................       2,481        2,001
              Finished goods ...................................      23,209       15,446
              Replacement parts and supplies ...................       4,195        4,130
                                                                    --------     --------
              Inventories at current cost ......................      46,214       40,088
              LIFO adjustments .................................      (3,474)      (3,772)
                                                                    --------     --------
                                                                    $ 42,740     $ 36,316
                                                                    ========     ========
</TABLE>

         At March 31, 1999, Liggett and Liggett-Ducat had leaf tobacco purchase
         commitments of approximately $4,754 and $11,560, respectively.


6.       PROPERTY, PLANT AND EQUIPMENT

         Property, plant and equipment consist of:

<TABLE>
<CAPTION>
                                                                    March 31,  December 31,
                                                                      1999         1998
                                                                    ---------  ------------

              <S>                                                   <C>        <C>
              Land and improvements ............................    $     412    $    412
              Buildings ........................................        5,823       5,823
              Machinery and equipment ..........................       60,732      54,144
              Construction-in-progress .........................       77,379      66,981
                                                                    ---------    --------
                                                                      144,346     127,360
              Less accumulated depreciation ....................      (35,427)    (33,856)
                                                                    ---------    --------
                                                                    $ 108,919    $ 93,504
                                                                    =========    ========
</TABLE>

         Equipment purchase commitments for $3,011 were outstanding at BOL at
         March 31, 1999.


                                     -17-
<PAGE>   19

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


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

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

<TABLE>
<CAPTION>
                                                                                March 31,     December 31,
                                                                                  1999            1998
                                                                                ---------     ------------
              <S>                                                               <C>           <C>
              15.75% Series B Senior Secured Notes due 2001,
                  net of unamortized discount of $15,449 and $17,374 ......     $ 217,415       $215,490
              Deferred interest on 15.75% Series B Senior Secured
                  Notes due 2001 ..........................................        34,602         24,985

              Liggett:
              Revolving credit facility ...................................         6,793          2,538
              Note payable ................................................         4,475

              BOL:
              Foreign credit facilities ...................................        19,737         11,600
              Notes payable ...............................................        25,475         28,057

              Other .......................................................           990          1,171
                                                                                ---------       --------

              Total notes payable, long-term debt and other obligations ...       309,487        283,841
              Less:
                  Current maturities ......................................        29,077         21,176
                                                                                ---------       --------
              Amount due after one year ...................................     $ 280,410       $262,665
                                                                                =========       ========
</TABLE>


         15.75% Series B Senior Secured Notes Due 2001 - BGLS: 

         On March 2, 1998, the Company entered into an agreement with AIF II,
         L.P. and an affiliated investment manager on behalf of a managed
         account (together the "Apollo Holders"), who held approximately 41.8%
         of the $232,864 principal amount of the 15.75% Series B Senior Secured
         Notes (the "Notes") then outstanding. The Apollo Holders (and any
         transferees) agreed to defer the payment of interest on the Notes held
         by them, commencing with the interest payment that was due July 31,
         1997, which they had previously agreed to defer, through the interest
         payment due July 31, 2000. The deferred interest payments will be
         payable at final maturity of the Notes on January 31, 2001 or upon an
         event of default under the Indenture for the Notes. In connection with
         the agreement, the Company pledged 50.1% of Western Tobacco to
         collateralize the Notes held by the Apollo Holders (and any
         transferees).

         In connection with the March 2, 1998 agreement with the Apollo
         Holders, the Company issued to the Apollo Holders a five-year warrant
         to purchase 2,000,000 shares of the Company's common stock at a price
         of $5.00 per share. The Apollo Holders were also issued a second
         warrant expiring October 31, 2004 to purchase an additional 2,150,000
         shares of the Company's common stock at a price of $0.10 per share.
         The second warrant will become exercisable on October 31, 1999, and
         the Company will have the right under certain conditions prior to that
         date to substitute for that warrant a new warrant for 9.9% of the
         common stock of Liggett.


                                     -18-
<PAGE>   20

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


         Based on the fair value of the equity instruments given to the holders
         of the debt, and the difference between the fair value of the modified
         debt and the carrying value of the debt held by the Apollo Holders
         prior to the transaction, no gain or loss was recorded on the
         transaction. The fair value of the equity instruments was estimated
         based on the Black-Scholes option pricing model and the following
         assumptions: volatility of 77%, risk-free interest rate of 6%,
         expected life of five to seven years and a dividend rate of 0%.
         Imputed interest of approximately $23,000 is being accreted over the
         term of the modified debt based on its recorded fair value.

         On February 17, 1999, BGLS entered into an agreement with a third
         party to purchase, during the second quarter of 1999, approximately
         $31,139 principal amount of the Notes, originally held by the Apollo
         Holders and subject to the standstill agreement. The purchase price is
         95% of the principal amount of the notes and the accrued interest
         thereon. Such purchase is contingent upon receipt by the Company of
         approximately $145,000 (in addition to the $150,000 option fee paid in
         December 1998) on terms substantially consistent with the transactions
         contemplated by the PM Agreements. (Refer to Note 2.)

         In April 1999, the Company agreed with a third party to purchase
         during the second quarter 1999, approximately $3,697 of the BGLS
         Notes. The purchase price is 98% of the principal amount of the notes
         and the accrued interest thereon. BGLS will fund both purchases with
         tax sharing payments from Liggett.

         The 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 Notes Indenture contains certain
         covenants, which among other things, limit the ability of BGLS to make
         distributions to the Company to $6,000 per year ($12,000 if less than
         50% of the Notes remain outstanding), limit additional indebtedness of
         BGLS to $10,000, limit guaranties of subsidiary indebtedness by BGLS
         to $50,000, and restrict certain transactions with affiliates that
         exceed $2,000 in any year subject to certain exceptions which include
         payments to the Company not to exceed $6,500 per year for permitted
         operating expenses, payment of the Chairman's salary and bonus and
         certain other expenses, fees and payments. In addition, the Indenture
         contains certain restrictions on the ability of the Chairman and
         certain of his affiliates to enter into certain transactions with, and
         receive payments above specified levels from, New Valley. The Notes
         may be redeemed, in whole or in part, through December 31, 1999, at a
         price of 101% of the principal amount and thereafter at 100%. Interest
         is payable at the rate of 15.75% per annum on January 31 and July 31
         of each year.

         Revolving Credit Facility - Liggett:

         Liggett entered into the Facility for $40,000 with a syndicate of
         commercial lenders in 1994 which is collateralized by all inventories
         and receivables of Liggett. At March 31, 1999, $12,990 was available
         under the Facility based on eligible collateral. Borrowings under the
         Facility, whose interest is calculated at a rate equal to 1.5% above
         the Philadelphia National Bank's prime rate, bore a rate of 9.25% at
         March 31, 1999. The Facility requires Liggett's compliance with
         certain financial and other covenants including restrictions on the
         payment of cash dividends and distributions by Liggett. In addition,
         the Facility, as amended, imposes requirements with respect to
         Liggett's permitted maximum adjusted net worth (not to fall 


                                     -19-
<PAGE>   21

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


         below a deficit of $195,000 as computed in accordance with the
         agreement, this computation was $146,239 at March 31, 1999) and net
         working capital (not to fall below a deficit of $17,000 as computed in
         accordance with the agreement, this computation was $4,466 at March
         31, 1999).

         Equipment Loan - Liggett:

         In January 1999, Liggett purchased equipment for $5,750 and borrowed
         $4,500 to fund the purchase from a third party. The loan, which is
         collateralized by the equipment and guaranteed by BGLS and the Company,
         is payable in 60 monthly installments of $56 including annual interest
         of 7.67% with a final payment of $2,550.

         Foreign Loans:

         At March 31, 1999, Liggett-Ducat had various credit facilities under
         which approximately $19,700 was outstanding. One, for $10,000, expired
         in May 1999 but was extended for one year at an interest rate of 25%.
         The second, for $5,000, expires in December 1999. The interest rate is
         20%. The remaining facilities, denominated in rubles (approximately
         $7,200 at the March 31, 1999 exchange rate), have terms of six -
         twelve months with interest rates of 52% - 55%. The facilities are
         collateralized by factory equipment and tobacco inventory.

         Notes Payable - BOL:

         In 1997, Western Tobacco entered into two contracts for the purchase
         of cigarette manufacturing equipment. A portion (85%) of both
         contracts is being financed with promissory notes. One contract is
         financed by ten half-year promissory notes payable at the rate of
         6.71% per annum interest, with the first note due in May 1999. The
         outstanding balance on the contract is $13,677 at March 31, 1999. The
         second contract is financed by 60 monthly promissory notes payable at
         the rate of 7.5% interest. The first note was paid in December 1998.
         The outstanding balance at March 31, 1999 is $8,250. The Company also
         has a promissory note for $1,514 at March 31, 1999 covering deposits
         for equipment being purchased for the factory. The note is due March
         31, 2000.

         On July 29, 1998, the Company borrowed $3,000, subsequently reduced to
         $2,034, from an unaffiliated third party with interest at 14% per
         annum. The note, which is due on August 1, 1999, is collateralized by
         factory equipment. Payments of $50 toward principal and interest are
         made monthly, with the remaining principal balance due at maturity.


8.       CONTINGENCIES

         TOBACCO-RELATED LITIGATION:

         Overview. Since 1954, Liggett and other United States cigarette
         manufacturers have been named as defendants in numerous direct and
         third-party actions predicated on the theory that cigarette
         manufacturers 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 cases were actually commenced against the Company or
         Liggett). There has been a noteworthy increase in the number of cases
         commenced against Liggett and the other cigarette manufacturers in
         recent years. The cases generally fall into four categories: (i)
         smoking and health cases alleging personal injury brought on behalf of
         individual


                                     -20-
<PAGE>   22

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


         smokers ("Individual Actions"); (ii) smoking and health cases alleging
         personal injury and purporting to be brought on behalf of a class of
         individual plaintiffs ("Class Actions"); (iii) health care cost
         recovery actions brought by various governmental entities
         ("Governmental Actions"); and (iv) health care cost recovery actions
         brought by third-party payors including insurance companies, union
         health and welfare trust funds, asbestos manufacturers and others
         ("Third-Party Payor Actions"). As new cases are commenced, defense
         costs and the risks attendant to the inherent unpredictability of
         litigation continue to increase. The future financial impact of the
         risks and expenses of litigation and the effects of the tobacco
         litigation settlements discussed below is not quantifiable at this
         time. For the three months ended March 31, 1999, Liggett incurred
         counsel fees and costs totaling approximately $1,568, compared to
         $1,342 for the comparable prior year period.

         Individual Actions. As of March 31, 1999, there were approximately 265
         cases pending against Liggett, and in most cases the other tobacco
         companies, where individual plaintiffs allege injury resulting from
         cigarette smoking, addiction to cigarette smoking or exposure to ETS
         and seek compensatory and, in some cases, punitive damages. Of these,
         89 were pending in Florida, 91 in New York, 29 in Massachusetts and 19
         in Texas. The balance of the individual cases were pending in 21
         states. There are four individual cases pending where Liggett is the
         only named defendant.

         The plaintiffs' allegations of liability in those cases in which
         individuals seek recovery for personal injuries allegedly caused by
         cigarette smoking are based on various theories of recovery, including
         negligence, gross negligence, special duty, voluntary undertaking,
         strict liability, fraud, misrepresentation, design defect, failure to
         warn, breach of express and implied warranties, conspiracy, aiding and
         abetting, concert of action, unjust enrichment, common law public
         nuisance, indemnity, market share liability and violations of
         deceptive trade practices laws, the Federal Racketeer Influenced and
         Corrupt Organization Act ("RICO") and antitrust statutes. In many of
         these cases, in addition to compensatory damages, plaintiffs also seek
         other forms of relief including disgorgement of profits and punitive
         damages. Defenses raised by defendants in these cases include lack of
         proximate cause, assumption of the risk, comparative fault and/or
         contributory negligence, lack of design defect, statute of
         limitations, equitable defenses such as "unclean hands" and lack of
         benefit, failure to state a claim and federal preemption.

         In February 1999, a state court jury in San Francisco awarded $51,500
         in damages to a woman who claimed lung cancer from smoking Marlboro
         cigarettes made by PM. The award includes $1,500 in compensatory
         damages and $50,000 in punitive damages. The court subsequently
         reduced the punitive damages award to $25,000.

         In March 1999, a state court jury in Portland awarded $80,311 in
         damages to the family of a deceased smoker who smoked Marlboro made by
         PM. The award includes $79,500 in punitive damages.

         Class Actions. As of March 31, 1999, there were approximately 50
         actions pending, for which either a class has been certified or
         plaintiffs are seeking class certification, where Liggett, among
         others, was a named defendant. Two of these cases, Fletcher, et al. v.
         Brooke Group Ltd., et al. and Walker, et al. v. Liggett Group Inc., et
         al., have been settled by the Company, subject to court approval.
         These two settlements are more fully discussed below under the
         "Settlements" section.

         In October 1991, an action entitled Broin, et al. v. Philip Morris
         Incorporated, et al., Circuit Court of the Eleventh Judicial District
         in and for Dade County, Florida, was filed against Liggett and others.


                                     -21-
<PAGE>   23

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


      This case was brought by plaintiffs on behalf of all flight attendants
      that worked or are presently working for airlines based in the United
      States and who never regularly smoked cigarettes but allege that they have
      been damaged by involuntary exposure to ETS. In October 1997, the other
      major tobacco companies settled this matter, which settlement provides for
      a release of the Company and Liggett. In February 1998, the Circuit Court
      approved the settlement, which settlement was affirmed by the Third
      District Court of Appeals in March 1999.

      In March 1994, an action entitled Castano, et al. v. The American Tobacco
      Company Inc., et al., United States District Court, Eastern District of
      Louisiana, was filed against Liggett and others. The class action
      complaint sought relief for a nationwide class of smokers based on their
      alleged addiction to nicotine. In February 1995, the District Court
      granted plaintiffs' motion for class certification (the "Class
      Certification Order").

      In May 1996, the Court of Appeals for the Fifth Circuit reversed the Class
      Certification Order and instructed the District Court to dismiss the class
      complaint. The Fifth Circuit ruled that the District Court erred in its
      analysis of the class certification issues by failing to consider how
      variations in state law affect predominance of common questions and the
      superiority of the class action mechanism. The appeals panel also held
      that the District Court's predominance inquiry did not include
      consideration of how a trial on the merits in Castano would be conducted.
      The Fifth Circuit further ruled that the "addiction-as-injury" tort is
      immature and, accordingly, the District Court could not know whether
      common issues would be a "significant" portion of the individual trials.
      According to the Fifth Circuit's decision, any savings in judicial
      resources that class certification may bring about were speculative and
      would likely be overwhelmed by the procedural problems certification
      brings. Finally, the Fifth Circuit held that in order to make the class
      action manageable, the District Court would be forced to bifurcate issues
      in violation of the Seventh Amendment.

      The extent of the impact of the Castano decision on tobacco-related class
      action litigation is still uncertain, although the decertification of the
      Castano class by the Fifth Circuit may preclude other federal courts from
      certifying a nationwide class action for trial purposes with respect to
      tobacco-related claims. The Castano decision has had to date, however,
      only limited effect with respect to courts' decisions regarding narrower
      tobacco-related classes or class actions brought in state rather than
      federal court. For example, since the Fifth Circuit's ruling, courts in
      New York, Louisiana and Maryland have certified "addiction-as-injury"
      class actions that covered only citizens in those states. Two class
      actions pending in state court in Florida have also been certified, one of
      which, the Broin case, was settled in 1997. The Castano decision has had
      no measurable impact on litigation brought by or on behalf of single
      individual claimants.

      Class certification motions are pending in a number of putative class
      actions. Class certification has been denied or reversed in 13 actions
      while classes remain certified in two cases in Florida and Maryland. A
      number of class certification decisions are on appeal.

      Governmental Actions. As of March 31, 1999, there were approximately 20
      Governmental Actions pending against Liggett. In these proceedings, the
      governmental entities seek reimbursement for Medicaid and other health
      care expenditures allegedly caused by use of tobacco products. The claims
      asserted in these health care cost recovery actions vary. In most of
      these cases, plaintiffs assert the equitable claim that the tobacco
      industry was "unjustly enriched" by plaintiffs' payment of health care
      costs allegedly attributable to smoking and seek reimbursement of those
      costs. Other claims made by some but not all plaintiffs include the
      equitable claim of indemnity, common law


                                     -22-
<PAGE>   24

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


         claims of negligence, strict liability, breach of express and implied
         warranty, violation of a voluntary undertaking or special duty, fraud,
         negligent misrepresentation, conspiracy, public nuisance, claims under
         state and federal statutes governing consumer fraud, antitrust,
         deceptive trade practices and false advertising, and claims under
         RICO.

         On January 19, 1999, at the State of the Union Address, President
         Clinton announced that the Department of Justice ("DOJ") was preparing
         a litigation plan to take the tobacco industry to court to recover
         monies that Medicare and other programs allegedly expended to treat
         smoking-related illnesses. The effects of this lawsuit cannot be
         predicted at this time; however, an adverse verdict could have a
         material adverse effect on the Company and Liggett.

         Third-Party Payor Actions. As of March 31, 1999, there were
         approximately 70 Third-Party Payor Actions pending against Liggett.
         The claims in these cases are similar to those in the Governmental
         Actions but have been commenced by insurance companies, union health
         and welfare trust funds, asbestos manufacturers and others. In April
         1998, a group known as the "Coalition for Tobacco Responsibility",
         which represents Blue Cross and Blue Shield Plans in more than 35
         states, filed federal lawsuits against the industry seeking payment of
         health-care costs allegedly incurred as a result of cigarette smoking
         and ETS. The lawsuits were filed in Federal District Courts in New
         York, Chicago, and Seattle and seek billions of dollars in damages.
         The lawsuits allege conspiracy, fraud, misrepresentation and violation
         of federal racketeering and antitrust laws as well as other claims. In
         January 1999, a federal judge in Seattle dismissed a Third-Party Payor
         Action brought by seven Blue Cross/Blue Shield Plans against the
         tobacco industry. The court ruled that the insurance providers did not
         have standing to bring the lawsuit. However, in February 1999, a
         federal judge in the Eastern District of New York denied pleas by the
         industry to dismiss the Third-Party Payor Action brought by 24 Blue
         Cross/Blue Shield Plans.

         In other Third-Party Payor Actions claimants have set forth several
         additional theories of relief sought: funding of corrective public
         education campaigns relating to issues of smoking and health; funding
         for clinical smoking cessation programs; disgorgement of profits from
         sales of cigarettes; restitution; treble damages; and attorneys' fees.
         Nevertheless, no specific amounts are provided. It is understood that
         requested damages against the tobacco company defendants in these
         cases might be in the billions of dollars.

         Settlements. In March 1996, the Company and Liggett entered into an
         agreement, subject to court approval, to settle the Castano class
         action tobacco litigation. Under the Castano settlement agreement,
         upon final court approval of the settlement, the Castano class would
         be entitled to receive up to five percent of Liggett's pretax income
         (income before income taxes) each year (up to a maximum of $50,000 per
         year) for the next 25 years, subject to certain reductions provided
         for in the agreement and a $5,000 payment from Liggett if the Company
         or Liggett fail to consummate a merger or similar transaction with
         another non-settling tobacco company defendant within three years of
         the date of settlement. The Company and Liggett have the right to
         terminate the Castano settlement under certain circumstances. In March
         1996, the Company, 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 (as defined in the letter), if granted, of
         the Castano settlement or, if earlier, the completion by the Company
         or Liggett of a combination with any defendant in Castano, except PM,
         the Castano plaintiffs and their counsel agree not to enter into any
         more favorable settlement agreement with any Castano defendant which
         would reduce the terms of the Castano settlement agreement. If the
         Castano plaintiffs or their 


                                     -23-
<PAGE>   25


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


         counsel enter into any such settlement during this period, they shall
         pay the Company $250,000 within 30 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 30 days from the transacting
         party. In May 1996, the Castano Plaintiffs Legal Committee filed a
         motion with the United States District Court for the Eastern District
         of Louisiana seeking preliminary approval of the Castano settlement.
         In September 1996, shortly after the class was decertified, the
         Castano plaintiffs withdrew the motion for approval of the Castano
         settlement.

         In March 1996, March 1997 and March 1998, the Company and Liggett
         entered into settlements of tobacco-related litigation with the
         Attorneys General of a total of 45 states and territories. The
         settlements released the Company and Liggett from all tobacco-related
         claims including claims for health care cost reimbursement and claims
         concerning sales of cigarettes to minors.

         On November 23, 1998, PM, B&W, R.J. Reynolds Tobacco Company ("RJR")
         and Lorillard Tobacco Company ("Lorillard") (collectively, the
         "Original Participating Manufacturers" or "OPMs") and Liggett
         (together with the OPMs and any other tobacco product manufacturer
         that becomes a signatory, the "Participating Manufacturers") entered
         into the Master Settlement Agreement (the "MSA") with 46 states, the
         District of Columbia, Puerto Rico, Guam, the United States Virgin
         Islands, American Samoa and the Northern Marianas (collectively, the
         "Settling States") to settle the asserted and unasserted health care
         cost recovery and certain other claims of those Settling States. As
         described below, the Company and Liggett had previous settlements with
         a number of these Settling States and also had previously settled
         similar claims brought by Florida, Mississippi, Texas and Minnesota.

         The MSA is subject to final judicial approval in each of the Settling
         States, which approval has been obtained, to date, in 42 states and
         territories.

         The MSA restricts tobacco product advertising and marketing within the
         Settling States and otherwise restricts the activities of
         Participating Manufacturers. Among other things, the MSA: prohibits
         the targeting of youth in the advertising, promotion or marketing of
         tobacco products; bans the use of cartoon characters in all tobacco
         advertising and promotion; limits each Participating Manufacturer to
         one tobacco brand name sponsorship during any 12-month period; bans
         all outdoor advertising, with the exception of signs 14 square feet or
         less in dimension at retail establishments that sell tobacco products;
         prohibits payments for tobacco product placement in various media;
         bans gift offers based on the purchase of tobacco products without
         sufficient proof that the intended recipient is an adult; prohibits
         Participating Manufacturers from licensing third parties to advertise
         tobacco brand names in any manner prohibited under the MSA; prohibits
         Participating Manufacturers from using as a tobacco product brand name
         any nationally recognized non-tobacco brand or trade name or the names
         of sports teams, entertainment groups or individual celebrities; and
         prohibits Participating Manufacturers from selling packs containing
         fewer than twenty cigarettes.

         The MSA also requires Participating Manufacturers to affirm corporate
         principles to comply with the MSA and to reduce underage usage of
         tobacco products and imposes requirements applicable to lobbying
         activities conducted on behalf of Participating Manufacturers.


                                     -24-
<PAGE>   26

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


         Pursuant to the MSA, Liggett has no payment obligations unless its
         market share exceeds 125% of its 1997 market share (the "Base Share").
         In the year following any year in which Liggett's market share does
         exceed the Base Share, Liggett will pay on each excess unit an amount
         equal (on a per-unit basis) to that paid during such following year by
         the OPMs pursuant to the annual and strategic contribution payment
         provisions of the MSA, subject to applicable adjustments, offsets and
         reductions. Pursuant to the annual and strategic contribution payment
         provisions of the MSA, the OPMs (and Liggett to the extent its market
         share exceeds the Base Share) will pay the following annual amounts
         (subject to certain adjustments):

<TABLE>
<CAPTION>
                              Year                   Amount
                              ----                   ------

                         <S>                       <C>  
                         2000                      $4,500,000
                         2001                      $5,000,000
                         2002 - 2003               $6,500,000
                         2004 - 2007               $8,000,000
                         2008 - 2017               $8,139,000
                         2018 and each             $9,000,000
                          year thereafter
</TABLE>

         These annual payments will be allocated based on relative unit volume
         of domestic cigarette shipments. The payment obligations under the MSA
         are the several, and not joint, obligations of each Participating
         Manufacturer and are not the responsibility of any parent or affiliate
         of a Participating Manufacturer.

         The MSA replaces Liggett's prior settlements with all states and
         territories except for Florida, Mississippi, Texas and Minnesota. In
         the event the MSA does not receive final judicial approval in any
         state or territory, Liggett's prior settlement with that state or
         territory, if any, will be revived.

         The states of Florida, Mississippi, Texas and Minnesota, prior to the
         effective date of the MSA, negotiated and executed settlement
         agreements with each of the other major tobacco companies separate
         from those settlements reached previously with Liggett. Because these
         states' settlement agreements with Liggett provided for "most favored
         nations" protection for both the Company and Liggett, the payments due
         these states by Liggett (with certain possible exceptions) have been
         eliminated. With respect to all non-economic obligations under the
         previous settlements, both the Company and Liggett are entitled to the
         most favorable provisions as between the MSA and each state's
         respective settlement with the other major tobacco companies.
         Therefore, Liggett's non-economic obligations to all states and
         territories are now defined by the MSA.

         In March 1997, Liggett, the Company and a nationwide class of
         individuals that allege smoking-related claims filed a mandatory class
         settlement agreement in an action entitled Fletcher, et al. v. Brooke
         Group Ltd., et al., Circuit Court of Mobile County, Alabama, where the
         court granted preliminary approval and preliminary certification of
         the class, and in May 1997, a similar mandatory class settlement
         agreement was filed in an action entitled Walker, et al. v. Liggett
         Group Inc., et al., United States District Court, Southern District of
         West Virginia. In July 1998, Liggett, the Company and plaintiffs filed
         an amended class action settlement agreement in Fletcher which
         agreement was preliminarily approved by the court in December 1998. A
         hearing on final approval of the settlement is scheduled for June 3,
         1999; however, hearing dates are subject to change. Effectiveness of
         the


                                     -25-
<PAGE>   27

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


         mandatory settlement is conditioned on final court approval of the
         settlement. There can be no assurance as to whether, or when, such
         court approval will be obtained. Pursuant to the amended agreement,
         Liggett is required to pay to the class 7.5% of Liggett's pre-tax
         income each year for 25 years, with a minimum annual payment guarantee
         of $1,000 over the term of the agreement. The amended agreement does
         not set forth a formula with respect to the distribution of settlement
         proceeds to the class. If the court issues a final order and judgment
         approving the settlement, such an order, the Company anticipates,
         would preclude further prosecution by class members of tobacco-related
         claims against both Liggett and the Company. Under the Full Faith and
         Credit Act, a final judgment entered in a nationwide class action
         pending in a state court has a preclusive effect against any class
         member with respect to the claims settled and released. As the class
         definition in Fletcher encompasses all persons in the United States
         who could claim injury as a result of cigarette smoking or ETS and any
         third-party payor claimants, it is anticipated that, upon final order
         and judgment, all such persons and third-party payor claimants would
         be barred from further prosecution of tobacco-related claims against
         Liggett and the Company.

         The Walker court also granted preliminary approval and preliminary
         certification of the nationwide class; however, in August 1997, the
         court vacated its preliminary certification of the settlement class,
         which decision is currently on appeal. The Walker court relied on the
         Supreme Court's decision in Amchem Products Inc. v. Windsor in
         reaching its decision to vacate preliminary certification of the
         class. In Amchem, the Supreme Court affirmed a decision of the Third
         Circuit vacating the certification of a settlement class that involved
         asbestos-exposure claims. The Supreme Court held that the proposed
         settlement class did not meet the requirements of Rule 23 of the
         Federal Rules of Civil Procedure for predominance of common issues and
         adequacy of representation. The Third Circuit had held that, although
         classes could be certified for settlement purposes, Rule 23's
         requirements had to be satisfied as if the case were going to be
         litigated. The Supreme Court agreed that the fairness and adequacy of
         the settlement are not pertinent to the predominance inquiry under
         Rule 23(b)(3), and thus, the proposed class must have sufficient unity
         so that absent class members can fairly be bound by decisions of class
         representatives.

         After the Amchem opinion was issued by the Supreme Court in June 1997,
         objectors to Liggett's settlement in Walker moved for decertification.
         Although Liggett's settlement in the Walker action is a "limited fund"
         class action settlement proceeding under Rule 23(b)(1) and Amchem was
         a Rule 23 (b)(3) case, the court in the Walker action, nonetheless,
         decertified the Walker class. Applying Amchem to the Walker case, the
         District Court, in a decision issued in August 1997, determined that
         while plaintiffs in Walker have a common interest in "maximizing the
         limited fund available from the defendants," there remained
         "substantial conflicts among class members relating to distribution of
         the fund and other key concerns" that made class certification
         inappropriate.

         The Amchem decision's ultimate affect on the viability of both the
         Walker and Fletcher settlements remains uncertain given the Fifth
         Circuit's recent ruling reaffirming a limited fund class action
         settlement in In re Asbestos Litigation ("Ahearn"). In June 1997, the
         Supreme Court remanded Ahearn to the Fifth Circuit for consideration
         in light of Amchem. On remand, the Fifth Circuit made two decisive
         distinctions between Amchem and Ahearn. First, the Ahearn class action
         proceeded under Rule 23(b)(1) while Amchem was a Rule 23(b)(3) case,
         and second, in Ahearn, there was no allocation or difference in award,
         according to nature or severity of injury, as there was in Amchem. The
         Fifth Circuit concluded that all members of the class and all class
         representatives share common interests and none of the uncommon
         questions abounding in Amchem exist. In June 1998, the Supreme Court
         granted certiorari to review the Fifth Circuit decision.


                                     -26-
<PAGE>   28

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


         The Company previously accrued approximately $4,000 for the present
         value of the fixed payments under the March 1996 Attorneys General
         settlements and $16,902 for the present value of the fixed payments
         under the March 1998 Attorneys General settlements. As a result of the
         Company's treatment under the MSA, $14,928 of net charges accrued for
         the prior settlements were reversed in 1998.

         Copies of the various settlement agreements are filed as exhibits to
         the Company's Form 10-K and the discussion herein is qualified in its
         entirety by reference thereto.

         Trials. In July 1998, trial commenced in the Engle, et al. v. Philip
         Morris Incorporated, et al., case, a class action pending in Miami
         Dade County, Florida, brought on behalf of all Florida residents
         allegedly injured by smoking. Plaintiffs seek compensatory and
         punitive damages ranging into the billions of dollars, as well as
         equitable relief including, but not limited to, a medical fund for
         future health care costs, attorneys' fees and court costs. The class
         consists of all Florida residents and citizens, and their survivors,
         who claim to have suffered, presently suffer or have died from
         diseases and medical conditions caused by their addiction to
         cigarettes that contain nicotine.

         The current trial plan calls for the case to be tried in three
         "Phases". Phase One, which is currently underway, involves evidence
         concerning certain "common" class issues relating to the plaintiff
         class' causes of action. Entitlement to punitive damages will be
         decided at the end of Phase One, but no amount will be set at that
         time.

         If plaintiffs prevail in Phase One, the first two stages of Phase Two
         will involve individual determinations of specific causation and other
         individual issues regarding entitlement to compensatory damages for
         the class representatives. Stage three of Phase Two will involve an
         assessment of the amount of punitive damages, if any, that individual
         class representatives will be awarded. Stage four of Phase Two will
         involve the setting of a percentage or ratio of punitive damages for
         absent class members, assuming entitlement was found at the end of
         Phase One.

         Phase Three of the trial will be held before separate juries to
         address absent class members' claims, including issues of specific
         causation and other individual issues regarding entitlement to
         compensatory damages.

         Additional cases are currently scheduled for trial during 1999,
         including two Third-Party Payor Actions brought by unions in
         Washington (September) and New York (September), and three Class
         Actions in Alabama (August), Wisconsin (September) and New York
         (November). Also, six Individual Actions are currently scheduled for
         trial during 1999. Trial dates, however, are subject to change.

         Other Related Matters. A grand jury investigation is being conducted
         by the office of the United States Attorney for the Eastern District
         of New York (the "Eastern District Investigation") regarding possible
         violations of criminal law relating to the activities of The Council
         for Tobacco Research - USA, Inc. (the "CTR"). Liggett was a sponsor of
         the CTR at one time. In May 1996, Liggett received a subpoena from a
         Federal grand jury sitting in the Eastern District of New York, to
         which Liggett has responded.

         In March 1996, and in each of March, July, October and December 1997,
         the Company and/or Liggett received subpoenas from a Federal grand
         jury in connection with an investigation by the


                                     -27-
<PAGE>   29

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


         United States Department of Justice (the "DOJ Investigation")
         involving the industry's knowledge of: the health consequences of
         smoking cigarettes; the targeting of children by the industry; and the
         addictive nature of nicotine and the manipulation of nicotine by the
         industry. Liggett has responded to the March 1996, March 1997 and July
         1997 subpoenas and is in the process of responding to the October and
         December 1997 subpoenas. The Company understands that the Eastern
         District Investigation and the DOJ Investigation essentially have been
         consolidated into one investigation conducted by the DOJ. The Company
         and Liggett are unable, at this time, to predict the outcome of this
         investigation.

         In April 1998, the Company announced that Liggett had reached an
         agreement with the DOJ to cooperate in both the Eastern District
         Investigation and the DOJ Investigation. The agreement does not
         constitute an admission of any wrongful behavior by Liggett. The DOJ
         has not provided immunity to Liggett and has full discretion to act or
         refrain from acting with respect to Liggett in the investigation.

         In September 1998, Liggett received a subpoena from a federal grand
         jury in the Eastern District of Philadelphia investigating possible
         antitrust violations in connection with the purchase of tobacco by and
         for tobacco companies. Liggett has responded to this subpoena. Liggett
         and the Company are unable, at this time, to predict the outcome of
         this investigation.

         Litigation is subject to many uncertainties, and it is possible that
         some of the aforementioned actions could be decided unfavorably
         against the Company or Liggett. An unfavorable outcome of a pending
         smoking and health case could encourage the commencement of additional
         similar litigation. The Company is unable to make a meaningful
         estimate with respect to the amount of loss that could result from an
         unfavorable outcome of many of the cases pending against the Company,
         because the complaints filed in these cases rarely detail alleged
         damages. Typically, the claims set forth in an individual's complaint
         against the tobacco industry pray for money damages in an amount to be
         determined by a jury, plus punitive damages and costs. These damage
         claims are typically stated as being for the minimum necessary to
         invoke the jurisdiction of the court.

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

         Liggett has been involved in certain environmental proceedings, none
         of which, either individually or in the aggregate, rises to the level
         of materiality. Liggett's management believes that current operations
         are conducted in material compliance 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, has 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 the Company unrelated to smoking or tobacco product liability.
         Management is of the opinion that the liabilities, if any, ultimately
         resulting from such other proceedings, lawsuits and claims should not
         materially affect the Company's financial position, results of
         operations or cash flows.


                                     -28-
<PAGE>   30

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


         LEGISLATION AND REGULATION:

         In 1993, the United States Environmental Protection Agency ("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. In July 1998, the court
         ruled that the EPA made procedural and scientific mistakes when it
         declared in its 1993 report that secondhand smoke caused as many as
         3,000 cancer deaths a year among nonsmokers.

         In February 1996, the United States Trade representative issued an
         "advance notice of rule making" concerning how tobaccos imported under
         a previously established tobacco rate quota ("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 based on domestic market share. Such an
         approach, if adopted, could have a material adverse effect on the
         Company and Liggett.

         In August 1996, the FDA filed in the Federal Register a Final Rule
         (the "FDA 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. Litigation was 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. The court, after
         argument, granted plaintiffs' motion for summary judgment prohibiting
         the FDA from regulating or restricting the promotion and advertising
         of tobacco products and denied plaintiffs' motion for summary judgment
         on the issue of whether the FDA has the authority to regulate access
         to, and labeling of, tobacco products. The Fourth Circuit reversed the
         district court on appeal and in August 1998 held that the FDA cannot
         regulate tobacco products because Congress had not given them the
         authority to do so. The Company and Liggett support the FDA Rule and
         have begun to phase in compliance with certain of the proposed interim
         FDA regulations. See discussions of the Castano and Governmental
         Actions settlements above. See also "Subsequent Events" below.

         In August 1996, Massachusetts enacted legislation requiring tobacco
         companies to publish information regarding the ingredients in
         cigarettes and other tobacco products sold in that state. In December
         1997, the United States District Court for the District of
         Massachusetts enjoined this legislation from going into effect;
         however, in December 1997, Liggett began complying with this
         legislation by providing ingredient information to the Massachusetts
         Department of Public Health. Several other states have enacted, or are
         considering, legislation similar to that enacted in Massachusetts.


                                     -29-
<PAGE>   31

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


         As part of the 1997 budget agreement approved by Congress, federal
         excise taxes on a pack of cigarettes, which are currently 24 cents,
         would rise 10 cents in the year 2000 and 5 cents more in the year
         2002. Additionally, in November 1998, the citizens of California voted
         in favor of a 50 cents per pack tax on cigarettes sold in that state.

         In addition to the foregoing, there have been a number of other
         restrictive regulatory actions, adverse political decisions and other
         unfavorable developments concerning cigarette smoking and the tobacco
         industry, the effects of which, at this time, the Company is not able
         to evaluate.

         Subsequent Events: In April 1999, the Supreme Court granted certiorari
         to review the Fourth Circuit's decision that the FDA does not have the
         authority to regulate access to, and labeling of, tobacco products.

         OTHER MATTERS:

         In March 1997, a shareholder derivative suit was filed against New
         Valley, as a nominal defendant, its directors and the Company in the
         Delaware Chancery Court, by a shareholder of New Valley. The suit
         alleges that New Valley's purchase in January 1997 of the BML shares
         from BOL constituted a self-dealing transaction which involved the
         payment of excessive consideration by New Valley. The plaintiff seeks
         (i) a declaration that New Valley's directors breached their fiduciary
         duties, the Company aided and abetted such breaches and such parties
         are therefore liable to New Valley, and (ii) unspecified damages to be
         awarded to New Valley. The Company's time to respond to the complaint
         has not yet expired. The Company believes that the allegations are
         without merit. Although there can be no assurances, management is of
         the opinion, after consultation with counsel, that the ultimate
         resolution of this matter will not have a material adverse effect on
         the Company's consolidated financial position, results of operations
         or cash flows.

         In September 1998, a lawsuit was commenced against the Company, New
         Valley, certain officers, directors and shareholders and others in the
         United States District Court, Southern District of Texas, Houston
         Division. The defendants have moved to dismiss the case. The court, in
         the interim, has stayed all discovery.


                                     -30-
<PAGE>   32

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


9.       SEGMENT INFORMATION

         The Company's business segment is tobacco with reportable segments
         being geographic, i.e., the United States and Russia. Information for
         the three months ended March 31, 1999 and 1998 follows:


<TABLE>
<CAPTION>
                                                   United
                                                   States         Russia       Corporate
                                                  Tobacco        Tobacco       and Other        Total
                                                  --------       --------      ---------      ---------
          <S>                                     <C>            <C>           <C>            <C>
          1999
          Net sales .......................       $ 86,047       $ 22,350       $     12      $ 108,409
          Operating income ................         20,069          1,302            774         22,145
          Identifiable assets .............         77,000        121,812         49,533        248,345
          Depreciation and amortization ...            855            798              3          1,656
          Capital expenditures ............          6,369         13,248                        19,617

          1998
          Net sales .......................       $ 65,626       $ 19,154       $     23      $  84,803
          Operating income (loss) .........          6,251          1,397           (105)         7,543
          Identifiable assets .............         69,241         50,048         15,144        134,433
          Depreciation and amortization ...          1,585            235             82          1,902
          Capital expenditures ............            353             42                           395
</TABLE>



                                     -31-
<PAGE>   33

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 include the
accounts of BGLS, Liggett Group Inc. ("Liggett"), Brooke (Overseas) Ltd.
("BOL"), New Valley Holdings, Inc. ("NV Holdings"), Liggett-Ducat Ltd.
("Liggett-Ducat") and other less significant subsidiaries. The Company holds an
equity interest in New Valley Corporation ("New Valley") through NV Holdings.
(See "Recent Developments - New Valley", below.)

         The Company is a holding company for a number of businesses which it
holds through its wholly-owned subsidiary BGLS. Accordingly, a separate
Management's Discussion and Analysis of Financial Condition and Results of
Operations for BGLS is not presented herein as it would not differ materially
from the discussion of the Company's consolidated results of operations,
capital resources and liquidity.

         For purposes of this discussion and other consolidated financial
reporting, the Company's significant business segment is tobacco sold in the
United States and Russia for the three months ended March 31, 1999 and March
31, 1998.


RECENT DEVELOPMENTS

         THE COMPANY AND LIGGETT

         Philip Morris Brand Transaction. On November 20, 1998, the Company and
Liggett entered into a definitive agreement with PM which provided for PM to
purchase options in an entity which will hold three cigarette brands, L&M,
Chesterfield and Lark, held by Liggett's subsidiary, Eve. As contemplated by
the agreement, Liggett and PM entered into the PM Agreements on January 12,
1999 to effectuate the transactions. (See Note 2 to the Company's Consolidated
Financial Statements.)

         Under the terms of the PM Agreements, Eve will contribute the Marks to
Brands LLC, a newly-formed limited liability company, in exchange for 100% of
two classes of LLC interests, the Class A Interest and the Class B Interest. PM
acquired two options to purchase such interests, the Class A Option and the
Class B Option. On December 2, 1998, PM paid Eve a total of $150,000 for such
options, $5,000 for the Class A Option and $145,000 for the Class B Option. The
payments were used to fund the redemption of Liggett's 11.50% Series B Senior
Secured Notes and Series C Variable Rate Notes (the "Liggett Notes"), together
with accrued interest, on December 28, 1998.


                                     -32-
<PAGE>   34

         BOL

         Liggett-Ducat. Liggett-Ducat is currently completing construction of a
new cigarette factory on the outskirts of Moscow. Production at Liggett-Ducat's
existing factory ceased in March 1999, with production scheduled to start at
the new factory in mid-1999.

         NEW VALLEY

         Western Realty Ducat. In February 1998, New Valley and Apollo
organized Western Realty Ducat to make real estate and other investments in
Russia. In connection with the formation of Western Realty Ducat, New Valley
agreed, among other things, to contribute the real estate assets of BML to
Western Realty Ducat and Apollo agreed to contribute up to $58,750, including
the investment in Western Realty Repin. Western Realty Ducat has made a $30,000
participating loan to, and payable out of a 30% profits interest in Western
Tobacco which was organized by BOL to hold BOL's interests in Liggett-Ducat.

         Proposed Recapitalization Plan. New Valley intends to submit a
proposed recapitalization plan to its stockholders at its 1999 annual meeting
of stockholders. The recapitalization plan, if implemented, will have a
significant effect on New Valley's and the Company's financial position and
results of operations. (See Note 3 to the Company's Consolidated Financial
Statements.)

         YEAR 2000 COSTS

         The "Year 2000 issue" is the result of computer programs that were
written using two digits rather than four digits to define the applicable year.
If the Company's or its subsidiaries' computer programs with date-sensitive
functions are not Year 2000 compliant, they may recognize a date using "00" as
the Year 1900 rather than the Year 2000. This could result in system failure or
miscalculations causing disruption to operations, including, among other
things, an inability to process transactions or engage in similar normal
business activities.

         The Company, New Valley and BOL. The Company, New Valley and BOL use
personal computers for all transactions. All such computers and related systems
and software are less than three years old and are Year 2000 compliant. As a
result, the Company, New Valley and BOL believe they are Year 2000 compliant.

         Liggett. Liggett utilizes management information systems and software
technology that may be affected by Year 2000 issues throughout its operations.
Liggett has evaluated the costs to implement century date change compliant
systems conversions and is in the process of executing a planned conversion of
its systems prior to the Year 2000. To date, the focus of Year 2000 compliance
and verification efforts has been directed at the implementation of new
customer service, inventory control and financial reporting systems at each of
the three regional Strategic Business Units formed as part of Liggett's
reorganization which began in January 1997. Liggett estimates that
approximately $138 of the expenditures for this reengineering effort related to
Year 2000 compliance, validation and testing. In January of 1998, Liggett
initiated a major conversion of factory accounting, materials management and
information systems at its Durham production facility with upgrades that have
been successfully tested for Year 2000 compliance. This conversion was
completed in November 1998. Program upgrades to Liggett's human resources and
payroll systems are scheduled for completion in July 1999. Enhancements to
Liggett's finished goods inventory system are expected to be completed in
September 1999. It is anticipated that all factory, corporate, field sales and
physical distribution systems will be completed in sufficient time to support
Year 2000 compliance and verification.

         Although such costs may be a factor in describing changes in operating
profit in any given reporting period, Liggett currently does not believe that
the anticipated costs of Year 2000


                                     -33-
<PAGE>   35

systems conversions will have a material impact on its future consolidated
results of operations. Based on the progress Liggett has made in addressing
Year 2000 issues and its strategy and timetable to complete its compliance
program, Liggett does not foresee significant risks associated with its Year
2000 initiatives at this time.

         External Service Providers. While modifications for Year 2000
compliance by the Company, its subsidiaries and New Valley are proceeding
according to plan and are expected to be completed by 1999, the failure of the
Company's service providers or vendors to resolve their own processing issues
in a timely manner could result in a material financial risk. The most
significant outside service provider is the clearing agent for Ladenburg, a
broker-dealer subsidiary of New Valley. Ladenburg has been informed by its
clearing agent that it has initiated an extensive effort to ensure that it is
Year 2000 compliant and that the clearing agent will conduct system-wide
testing of its Year 2000 software throughout 1999.

         It is unclear whether the Russian government and other organizations
who provide significant infrastructure services in Russia have addressed the
Year 2000 problem sufficiently to mitigate potential substantial disruption to
these infrastructure services. The substantial disruption to these services
would have an adverse affect on the operations of Liggett-Ducat. Furthermore,
the current financial crises in Russia could affect the ability of the
government and other organizations to fund Year 2000 compliance programs.

         Although the Company and its subsidiaries are in the process of
confirming that their service providers are adequately addressing Year 2000
issues, there can be no complete assurance of success, or that interaction with
other service providers will not impair the Company's or its subsidiaries'
services.


RECENT DEVELOPMENTS IN THE CIGARETTE INDUSTRY

         Pricing Activity. List price increases initiated by the industry
during 1998 amounted to $6.35 per carton. In 1998, Liggett announced list price
increases of $.25 per carton in January, $.50 per carton in April, $.50 per
carton in May, $.60 per carton in August and $4.50 per carton in December.

         Legislation, Regulation and Litigation. The cigarette industry
continues to be challenged on numerous fronts. New cases continue to be
commenced against Liggett and other cigarette manufacturers. As of March 31,
1999, there were approximately 270 individual suits, 50 purported class actions
and 85 governmental and other third-party payor health care reimbursement
actions pending in the United States in which Liggett was a named defendant. 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. Recently, there have been a number of restrictive regulatory actions
from various Federal administrative bodies, including the United States
Environmental Protection Agency ("EPA") and the Food and Drug Administration
("FDA"), adverse political decisions and other unfavorable developments
concerning cigarette smoking and the tobacco industry, including the
commencement and certification of class actions and the commencement of
third-party payor actions. 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, but it is possible that the Company's consolidated
financial position, results of operations or cash flows could be materially
adversely affected by an unfavorable outcome in any of such tobacco-related
litigation. (See Part II, Item 1, "Legal Proceedings" and Note 8 to the
Company's Consolidated Financial Statements for a description of legislation,
regulation and litigation.)


                                     -34-
<PAGE>   36

         The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for personal injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence, gross
negligence, special duty, voluntary undertaking, strict liability, fraud,
misrepresentation, design defect, failure to warn, breach of express and
implied warranties, conspiracy, aiding and abetting concert of action, unjust
enrichment, common law public nuisance, indemnity, market share liability, and
violations of deceptive trade practices laws, RICO and antitrust statutes. In
many of these cases, in addition to compensatory damages, plaintiffs also seek
other forms of relief including disgorgement of profits and punitive damages.
Defenses raised by defendants in these cases include lack of proximate cause,
assumption of the risk, comparative fault and/or contributory negligence, lack
of design defect, statutes of limitations or repose, equitable defenses such as
"unclean hands" and lack of benefit, failure to state a claim and federal
preemption.

         The claims asserted in the third-party payor actions vary. In most of
these cases, plaintiffs assert the equitable claim that the tobacco industry
was "unjustly enriched" by plaintiffs' payment of health care costs allegedly
attributable to smoking and seek reimbursement of those costs. Other claims
made by some but not all plaintiffs include the equitable claim of indemnity,
common law claims of negligence, strict liability, breach of express and
implied warranty, violation of a voluntary undertaking or special duty, fraud,
negligent misrepresentation, conspiracy, public nuisance, claims under state
and federal statutes governing consumer fraud, antitrust, deceptive trade
practices and false advertising, and claims under the RICO.

         In March 1996, March 1997 and March 1998, the Company and Liggett
entered into settlements of tobacco-related litigation with the Attorneys
General of 45 states and territories. The settlements released the Company and
Liggett from all tobacco claims including claims for health care cost
reimbursement and claims concerning sales of cigarettes to minors.

         On November 23, 1998, PM, B&W, RJR and Lorillard (collectively, the
"Original Participating Manufacturers" or "OPMs") and Liggett (together with
the OPMs and any other tobacco product manufacturer that becomes a signatory,
the "Participating Manufacturers") entered into the Master Settlement Agreement
(the "MSA") with 46 states, the District of Columbia, Puerto Rico, Guam, the
United States Virgin Islands, American Samoa and the Northern Marianas
(collectively, the "Settling States") to settle the asserted and unasserted
health care cost recovery and certain other claims of those Settling States. As
described below, the Company and Liggett had previous settlements with a number
of these Settling States and also had previously settled similar claims brought
by Florida, Mississippi, Texas and Minnesota.

         The MSA is subject to final judicial approval in each of the Settling
States, which approval has been obtained, to date, in 42 states and
territories.

         Pursuant to the MSA, Liggett has no payment obligations unless its
market share exceeds 125% of its 1997 market share (the "Base Share"). In the
year following any year in which Liggett's market share does exceed the Base
Share, Liggett will pay on each excess unit an amount equal (on a per-unit
basis) to that paid during such following year by the OPMs pursuant to the
annual and strategic contribution payment provisions of the MSA, subject to
applicable adjustments, offsets and reductions. Pursuant to the annual and
strategic contribution payment provisions of the MSA, the OPMs (and Liggett to
the extent its market share exceeds the Base Share) will pay the following
annual amounts (subject to certain adjustments):


                                     -35-
<PAGE>   37

<TABLE>
<CAPTION>
                              Year                   Amount
                              ----                   ------

                         <S>                       <C>  
                         2000                      $4,500,000
                         2001                      $5,000,000
                         2002 - 2003               $6,500,000
                         2004 - 2007               $8,000,000
                         2008 - 2017               $8,139,000
                         2018 and each             $9,000,000
                          year thereafter
</TABLE>

         These annual payments will be allocated based on relative unit volume
of domestic cigarette shipments. The payment obligations under the MSA are the
several, and not joint, obligations of each Participating Manufacturer and are
not the responsibility of any parent or affiliate of a Participating
Manufacturer.

         The MSA replaces Liggett's prior agreements with all states and
territories except for Florida, Mississippi, Texas and Minnesota. In the event
the MSA does not receive final judicial approval in any state or territory,
Liggett's prior settlement with that state or territory, if any, will be
revived.

         The states of Florida, Mississippi, Texas and Minnesota, prior to the
effective date of the MSA, negotiated and executed settlement agreements with
each of the other major tobacco companies separate from those settlements
reached previously with Liggett. Because these states' settlement agreements
with Liggett provided for "most favored nations" protection for both the
Company and Liggett, the payments due these states by Liggett (with certain
possible exceptions) have been eliminated.

         In March 1997, Liggett, the Company and a nationwide class of
individuals that allege smoking-related claims filed a mandatory class
settlement agreement in an action entitled Fletcher, et al. v. Brooke Group
Ltd., et al., Circuit Court of Mobile County, Alabama, where the court granted
preliminary approval and preliminary certification of the class. On July 2,
1998, Liggett, the Company and plaintiffs filed an amended class action
settlement agreement which was preliminarily approved by the court on December
8, 1998. A hearing on final approval of the settlement is scheduled for June 3,
1999; however, hearing dates are subject to change. Effectiveness of the
mandatory settlement is conditioned on final court approval of the settlement.
There can be no assurance as to whether, or when, such court approval will be
obtained. Pursuant to the amended agreement, Liggett is required to pay to the
class 7.5% of Liggett's pre-tax income each year for 25 years, with a minimum
annual payment guarantee of $1,000 over the term of the agreement. The amended
agreement does not set forth a formula with respect to the distribution of
settlement proceeds to the class. If the court issues a final order and
judgment approving the settlement, such an order, the Company anticipates,
would preclude further prosecution by class members of tobacco-related claims
against both Liggett and the Company. Under the Full Faith and Credit Act, a
final judgment entered in a nationwide class action pending in a state court
has a preclusive effect against any class member with respect to the claims
settled and released. As the class definition in Fletcher encompasses all
persons in the United States who could claim injury as a result of cigarette
smoking or ETS and any third-party payor claimants, it is anticipated that,
upon final order and judgment, all such persons and third-party payor claimants
would be barred from further prosecution tobacco-related claims against Liggett
and the Company.

         The Company accrued approximately $4,000 for the present value of the
fixed payments under the March 1996 Attorneys General settlements and $16,902
for the present value of the fixed payments under the March 1998 Attorneys
General settlements. As a result of the Company's treatment under the MSA,
$14,928 of net charges accrued for the prior settlements were reversed


                                     -36-
<PAGE>   38

in 1998. (See the discussions of the tobacco litigation settlements appearing
in Note 8 to the Company's Consolidated Financial Statements.)


RESULTS OF OPERATIONS

<TABLE>
<CAPTION>
                                          Revenues                 Operating Income
                                  -----------------------      ----------------------
                                    Three Months Ended           Three Months Ended
                                         March 31,                    March 31,
                                  -----------------------      ----------------------
                                    1999           1998          1999          1998
                                  ---------      --------      --------       -------

                  <S>             <C>           <C>           <C>             <C>

                  Liggett         $  86,047      $ 65,626      $ 20,069       $ 6,251

                  Liggett-Ducat      22,350        19,154         1,302         1,710

                  Other                  12            23           774          (418)
                                  ---------      --------      --------       -------

                  Total           $ 108,409      $ 84,803      $ 22,145       $ 7,543
                                  =========      ========      ========       =======
</TABLE>


Three months ended March 31, 1999 compared to three months ended March 31,
1998.

         Revenues. Total revenues were $108,409 for the three months ended
March 31, 1999 compared to $84,803 for the three months ended March 31, 1998.
This 27.8% increase in revenues was primarily due to an increase in tobacco
revenues at Liggett of $20,421 and at Liggett-Ducat of $3,196. Revenues at
Liggett increased in both the premium and discount segments by 31.1% ($20,421)
due to price increases of $30,497 (see "Recent Developments in the Cigarette
Industry - Pricing Activity"), partially offset by an 14.2% decline in unit
sales volume (approximately 178 million units), accounting for $9,337 in volume
variance and an unfavorable product mix of $739. The decline in Liggett's sales
volume was due to an overall decline in industry volume, certain competitors'
continuing leveraged rebate programs tied to their products and increased
promotional activity by certain other manufacturers.

         Premium sales at Liggett for the first quarter of 1999 amounted to
$25,366 and represented 29.5% of total revenues, compared to $22,958 and 35.0%
of total sales in the prior year period. In the premium segment, revenues grew
by 10.5% ($2,408) for the three months ended March 31, 1999, compared to the
prior year period, due to price increases of $8,202, which were partially
offset by a 25.2% decline in unit sales volume (approximately 91 million
units), accounting for $5,794 in volume variance.

         Discount sales at Liggett (comprising the brand categories of branded
discount, private label, control label, generic, international and contract
manufacturing) for the first three months of 1999 amounted to $60,681 and
represented 70.5% of total revenues, compared to $42,668 and 65.0% of total
sales for the year-ago first quarter. In the discount segment, revenues grew by
42.2% ($18,013) for the three months ended March 31, 1999 compared to the prior
year period, due to price increases of $22,295, which were partially offset by
a 9.8% decline in unit sales volume (approximately 87 million units),
accounting for $4,169 in volume variance and an unfavorable product mix among
the discount brand categories of $113.

         For the three months ended March 31, 1999, fixed manufacturing costs
on a basis comparable to 1998 was $1,149 lower, although costs per thousand
units increased by $0.09 per thousand.

         Net sales at Liggett-Ducat for the three months ended March 31, 1999
increased 14.9% ($3,196) to $22,350 over the same period in 1998 due primarily
to an increase in unit sales


                                     -37-
<PAGE>   39

volume of 38.8% (1,400 million units) accounting for a $7,425 volume variance
and favorable product mix of $745 offset by unfavorable price effect of $4,974.

         Gross Profit. Consolidated gross profit was $66,982 for the three
months ended March 31, 1999 compared to $43,147 for the three months ended
March 31, 1998, an increase of $23,835 or 55.2% when compared to the same
period last year, reflecting an increase in gross profit at Liggett of $23,477
and an increase at Liggett-Ducat of $348 for the three months ended March 31,
1999 compared to the same period in the prior year.

         Gross profit at Liggett of $62,882 for the three months ended March
31, 1999 increased $23,477 from gross profit of $39,405 for the first quarter
of 1998, due primarily to the price increases discussed above. (See "Recent
Developments in the Cigarette Industry - Pricing Activity".) In 1999, Liggett's
premium and discount brands contributed 28.62% and 65.26%, respectively, to the
Company's overall gross profit. Over the same period in 1998, Liggett's premium
and discount brands contributed 36.1% and 63.9%, respectively, to total gross
profit. As a percent of revenues (excluding federal excise taxes), gross profit
at Liggett increased to 85.6% for the three months ended March 31, 1999
compared to 77.5% for the same period in 1998, with gross profit for the
premium segment at 86.6% and 79.2%, respectively, in the first quarter of 1999
and 1998, respectively, and gross profit for the discount segment at 85.1% and
76.6% in 1999 and 1998, respectively. This increase is the result of the 1998
list price increases, a total of 63.5 cents per pack, and improved production
variances. These increases were partially offset by increased tobacco costs at
Liggett due to a reduction in the average discount available to the Company
from leaf tobacco dealers on tobacco purchased under prior years' purchase
commitments.

         As a percent of revenues (excluding Russian excise taxes), gross
profit at Liggett-Ducat decreased to 20.5% for the three months ended March 31,
1999 compared to 22.0% in the same period in 1998, primarily due to the
devaluation of the ruble.

         Expenses. Selling, general and administrative expenses were $44,837
for the three months ended March 31, 1999 compared to $35,604 for the same
period last year due to an increase in expenses at Liggett of $9,659 and an
increase of $507 at Liggett-Ducat offset by lower corporate expense primarily
due to lower pension expense. Operating, selling, general and administrative
expenses at Liggett increased to $42,813 for the three months ended March 31,
1999 compared to $33,154 for the same period for the prior year. This increase
in operating expenses was due primarily to higher spending for promotional and
marketing programs of approximately $11,011, partially offset by a reduction in
amortization of approximately $867 and the absence of system development costs
in the current year quarter of $485. The increase at Liggett-Ducat of $507 was
primarily due to increased marketing and depreciation expense.

         Other Income (Expense). Interest expense was $14,988 for the three
months ended March 31, 1999 compared to $20,786 for the same period last year,
a decrease of $5,798 primarily due to the redemption by Liggett of the Liggett
Senior Secured Notes on December 28, 1998 and lower interest expense of
approximately $800 at corporate. Net interest expense at Liggett decreased by
$6,376 for the three months ended March 31, 1999 compared to the three months
ended March 31, 1998. This was offset by higher interest expense at BOL of
$1,390 primarily due to increased interest rates on credit facilities in
Russia.

         Equity in earnings of affiliate was a loss of $7,629 for the three
months ended March 31, 1999 compared to a loss of $4,187 for the three months
ended March 31, 1998 and relates in both periods to New Valley's net loss
applicable to common shares of $23,801 and $18,675, respectively.

         For the three months ended March 31, 1999, interest expense and loss
in equity of affiliate were offset by foreign currency gain of $2,270 and the
recognition of deferred gain of


                                     -38-
<PAGE>   40

$7,050 relating to the expiration of the put obligation on Ducat III (the site
of the old cigarette factory in Russia) in connection with the sale of the
BrookeMil Ltd. common shares in 1997. The factory ceased operations in March
1999.

         Provision for Income Taxes.  Income tax for the first quarter of 1999
was $1,729 compared to $931 for the first quarter of 1998. The effective tax
rate does not bear a customary relationship with pre-tax accounting income
principally as a consequence of the change in the valuation allowance relating
to deferred tax assets and foreign taxes.


CAPITAL RESOURCES AND LIQUIDITY

         Net cash and cash equivalents decreased $1,877 and $172 for the three
months ended March 31, 1999 and March 31, 1998, respectively. Net cash provided
by operations for the three months ended March 31, 1999 was $2,571 compared to
net cash used in operations of $25,984 for the comparable period of 1998. The
increase of $28,555 in net cash provided by operating activities in 1999 over
the prior year was primarily due to an increase in operating income at Liggett
and a reduction in debt service, resulting from Liggett's bond redemption on
December 28, 1998. In the 1998 period, cash was used in operations at BGLS and
Liggett to make interest payments of approximately $29,600. In addition, there
were also reductions in promotional expenses, taxes payable and other accrued
liabilities, in total amount of $6,366, and an increase in inventories of
$8,385. These items were partially offset by an increase in accounts payable of
$4,842.

         Cash used in investing activities of $19,581 compares to cash provided
of $822 for the periods ended March 31, 1999 and 1998, respectively. In 1999,
capital expenditures for machinery and equipment at Liggett amounted to $6,369
while equipment and construction costs for the new factory amounted to $13,248
at Liggett-Ducat. In 1998, proceeds from sales of equipment and an investment
of $1,295 were partially offset by capital expenditures of $395 at Liggett and
BOL.

         Cash provided by financing activities was $15,452 and $24,911 for the
three months ended March 31, 1999 and 1998, respectively. Proceeds in the 1999
period included net borrowings under revolving credit facilities at both Liggett
and Liggett-Ducat of $12,667 and proceeds from equipment financing of $4,500.
These proceeds were offset primarily by distributions on common stock of
$1,358. Proceeds in the 1998 period included cash received from the sale of
common stock and exercise of stock options, in total $9,796, proceeds from the
participating loan made by Western Realty Ducat, and net borrowings under
Liggett's revolving credit facility (the "Facility") of $5,162 partially offset
by distributions on common stock of $900.

         Liggett. On December 28, 1998, Liggett redeemed the $144,891 principal
amount of the Liggett Notes at 100% of the principal amount together with
accrued interest. Proceeds of $150,000 from the purchase by PM of two options
to purchase the Class A Interest and the Class B Interest in the LLC were used
to fund the redemption.

         The closing of the exercise by PM of the Class A Option is scheduled
for no later than June 10, 1999 (currently scheduled for May 24, 1999). Upon
closing, Liggett will receive approximately $145,000 from the purchase of the
Class A Interest and the distribution of the Loan proceeds by the LLC.

         Liggett has a $40,000 Facility expiring March 8, 2000, under which
$6,793 was outstanding at March 31, 1999. Availability under the Facility was
approximately $12,990 based on eligible collateral at March 31, 1999. The
Facility is collateralized by all inventories and receivables of Liggett.
Borrowings under the Facility, whose interest is calculated at a rate equal to
1.5% above Philadelphia National Bank's (the indirect parent of Congress
Financial Corporation, the lead lender) prime rate, bear a rate of 9.25% at
March 31, 1999. The Facility required Liggett's compliance with certain
financial and other covenants including restrictions on the payment of cash
dividends and distributions by Liggett. In addition, the Facility, as amended,
imposes requirements with respect to Liggett's adjusted net worth (not to fall
below a deficit of $195,000 as computed in accordance with the agreement) and
working capital (not to fall below a deficit of $17,000 as 


                                     -39-
<PAGE>   41

computed in accordance with the agreement). At March 31, 1999, Liggett was in
compliance with all covenants under the Facility; Liggett's adjusted net worth
deficiency and net working capital, as computed in accordance with the
agreement, were $146,239 and $4,466, respectively.

         In January 1999, Liggett purchased equipment for $5,750 and borrowed
$4,500 to fund the purchase from a third party. The loan, which is
collateralized by the equipment, is payable in 60 monthly installments of $56
including annual interest of 7.6% with a final payment of $2,550.

         Liggett (and, in certain cases, the Company) and other United States
cigarette manufacturers have been named as defendants in a number of direct and
third-party actions (and purported class 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 so-called
secondary smoke (environmental tobacco smoke) from cigarettes.

         The Company believes, and has been so advised by counsel handling the
respective cases, that the Company and Liggett have a number of valid defenses
to the claim or claims asserted against them. 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 adverse regulatory, political and other developments
concerning cigarette smoking and the tobacco industry. These developments
generally receive widespread media attention. Neither the Company nor Liggett
is able to evaluate the effect of these developing matters on pending
litigation or the possible commencement of additional litigation or regulation.
(See "Recent Developments in the Cigarette Industry - Legislation, Regulation
and Litigation" above and Note 8 to the Company's Consolidated Financial
Statements.)

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

         BGLS. At March 31, 1999, BGLS had outstanding $232,864 principal
amount of the BGLS Notes which mature on January 31, 2001. On March 5, 1998,
BGLS entered into the Standstill Agreement whereby the Apollo Holders (and any
transferees) agreed to the deferral of interest payments, commencing with the
interest payment due July 31, 1997 through the interest payment due July 31,
2000. BGLS has deferred a total of $34,602 of interest as of March 31, 1999.

         On February 17, 1999, BGLS entered into an agreement with a third
party to purchase, during the second quarter of 1999, approximately $31,139
principal amount of the BGLS Notes, originally held by the Apollo Holders and
subject to the Standstill Agreement. The purchase price is 95% of the principal
amount of the notes and the accrued interest thereon. The purchase is
contingent upon receipt by the Company of approximately an additional $145,000
(in addition to the $150,000 option fee paid in December 1998) on terms
substantially consistent with the transactions contemplated by the PM
Agreements.

         In April 1999, the Company agreed with a third party to purchase during
the second quarter 1999, approximately $3,697 of the BGLS Notes. The purchase
price is 98% of the principal amount of the notes and the accrued interest
thereon. BGLS will fund both purchases with tax sharing payments from Liggett.

         BOL. Liggett-Ducat is currently completing construction of a new
cigarette factory on the outskirts of Moscow which is currently scheduled to be
operational in June 1999. The new factory, which will utilize Western cigarette
making technology and have a capacity of in excess of 30 billion units per


                                     -40-
<PAGE>   42

year, will produce American and international blend cigarettes, as well as
traditional Russian cigarettes. Western Realty Ducat has made a $30,000
participating loan to, and payable out of a 30% profits interest in, a company
organized by BOL which, among other things, holds BOL's interest in
Liggett-Ducat and the new factory. In addition, BOL has entered into promissory
notes for equipment purchases which have a liability of approximately $23,500
at March 31, 1999. The Company is a guarantor on purchases for which the
remaining obligation is approximately $8,500. The remaining costs for
construction and equipment for the new factory are being financed by loans from
Russian banks and approximately $12,000 of loans from BOL made during the first
half of 1999.

         The Company. The Company has substantial near-term consolidated debt
service requirements, with aggregate required principal payments of
approximately $297,000 due in the years 1999 through 2001. The Company believes
that it will continue to meet its liquidity requirements through 1999, although
the BGLS Notes Indenture limits the amount of restricted payments BGLS is
permitted to make to the Company during the calendar year. At March 31, 1999,
the remaining amount available through December 31, 1999 in the Restricted
Payment Basket related to BGLS' payment of dividends to the Company (as defined
by the BGLS Notes Indenture) is $15,472. Company expenditures (exclusive of
Liggett and Liggett-Ducat) in 1999 for current operations include cash interest
expense of approximately $21,350 (excluding accrued interest due on the BGLS
Notes discussed above that BGLS has contingently agreed to repurchase),
dividends on the Company's shares (currently at an annual rate of approximately
$6,300) and corporate expenses. The Company anticipates funding its 1999
expenditures for current operations with public and/or private debt and equity
financing, management fees from subsidiaries and tax sharing and other payments
from Liggett or New Valley. New Valley may acquire or seek to acquire additional
operating businesses through merger, purchase of assets, stock acquisition or
other means, or to make other investments, which may limit its ability to make
such distributions.


MARKET RISK

         The Company is principally exposed to market risks from fluctuations
in interest rates, foreign currency exchange rates and equity prices. The
Company seeks to minimize these risks through its regular operating and
financing activities and its long-term investment strategy.

         Equity Price Risk. The Company holds investment securities available
for sale with a fair market value of $54,407 at March 31, 1999. These
securities represent an investment in New Valley Class A Preferred Shares,
Class B Preferred Shares and Common Shares which the Company carries on its
balance sheet at zero.

         Foreign Market Risk

         Europe. The Company has foreign currency exchange risk relating to its
outstanding obligations under foreign currency denominated construction and
equipment contracts with various European companies where costs are affected by
fluctuations in the United States dollar as compared to certain European
currencies. Management believes that currencies in which it presently has such
exposure are relatively stable.

         Russia. Liggett-Ducat's and Western Tobacco's operations are conducted
in Russia. During 1998 and continuing into 1999, the economy of the Russian
Federation entered a period of economic instability. The impact includes, but
is not limited to, a steep decline in prices of domestic debt and equity
securities, a severe devaluation of the currency, a moratorium on foreign debt
repayments, an increasing rate of inflation and increasing rates on government
and corporate borrowings. The Company seeks to minimize such risks by reducing
its cash exposure when appropriate. The return to economic stability is
dependent to a large extent on the effectiveness of


                                     -41-
<PAGE>   43

the fiscal measures taken by government and other actions beyond the control of
companies operating in the Russian Federation. The operations of Liggett-Ducat
and Western Tobacco may be significantly affected by these factors for the
foreseeable future.

         Russian taxation is subject to varying interpretations and constant
changes. Furthermore, the interpretation of tax legislation by tax authorities
as applied to the transactions and activity of Liggett-Ducat and Western
Tobacco may not coincide with that of management. As a result, transactions may
be challenged by tax authorities and Liggett-Ducat and Western Tobacco may be
assessed additional taxes, penalties and interest, which can be significant.
Management regularly reviews the Company's taxation compliance with applicable
legislation, laws and decrees and current interpretations and from time to time
potential exposures are identified. At any point in time, a number of open
matters may exist; however, management believes that adequate provision has
been made for all material liabilities. Tax years remain open to review by the
authorities for six years.


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 Liggett-Ducat, 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 Liggett-Ducat's operations in Russia are
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. 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. The failure of the Company or its
significant suppliers and customers to adequately address the "Year 2000" issue
could result in misstatement of reported financial information or could
adversely affect its business. 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.


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         The information under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Market Risk" is
incorporated herein by reference.


                                     -42-
<PAGE>   44

                                    PART II

                               OTHER INFORMATION




Item 1.  Legal Proceedings

         Reference is made to Note 8, incorporated herein by reference, to
         the Consolidated Financial Statements of Brooke Group Ltd. and
         BGLS Inc. (collectively, the "Companies") included elsewhere in
         this report on Form 10-Q which contains a general description of
         certain legal proceedings to which the Company and/or BGLS or
         their subsidiaries are a party and certain related matters.
         Reference is also made to Exhibit 99.1 for additional information
         regarding the pending material legal proceedings to which the
         Company, BGLS and/or Liggett are party. A copy of Exhibit 99.1
         will be furnished to security holders of the Company and its
         subsidiaries without charge upon written request to the Company
         at its principal executive offices, 100 S.E. Second St., Miami,
         Florida 33131, Attn. Investor Relations.

Item 2.  Changes in Securities and Use of Proceeds

         No securities of the Company which were not registered under the
         Securities Act of 1933, as amended (the "Securities Act"), have
         been issued or sold by the Company during the three months ended
         March 31, 1999.

Item 3.  Defaults Upon Senior Securities

         As of March 31, 1999, New Valley Corporation, the Companies'
         affiliate, had the following respective accrued and unpaid
         dividend arrearages on its 1,071,462 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) $234.6
         million or $218.94 per Class A Share; and (2) $172.9 million or
         $61.96 per Class B Share.

Item 6.  Exhibits and Reports on Form 8-K

<TABLE>
<CAPTION>
         (a)      Exhibits
                  --------

         <S>      <C>
         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         Material Legal Proceedings.

         99.2         Liggett Group Inc.'s Interim Consolidated Financial
                      Statements for the quarterly periods ended March 31,
                      1999 and 1998.

         99.3         New Valley Corporation's Interim Consolidated
                      Financial Statements for the quarterly periods ended
                      March 31, 1999 and 1998.
</TABLE>


                                     -43-
<PAGE>   45

<TABLE>
         <S>          <C>
         99.4         Brooke (Overseas) Ltd.'s Interim Consolidated
                      Financial Statements for the quarterly periods ended
                      March 31, 1999 and 1998.

         99.5         New Valley Holdings, Inc.'s Interim Consolidated
                      Financial Statements for the quarterly periods ended
                      March 31, 1999 and 1998.

         (b)          Reports on Form 8-K

                      None.
</TABLE>


                                     -44-
<PAGE>   46

                                   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 and Chief
                                                        Financial Officer

Date: May 14, 1999






                                                 BGLS INC.
                                                 (REGISTRANT)

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

Date: May 14, 1999


                                     -45-