<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 JUNE 30, 1999

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

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

<TABLE>
<CAPTION>

           DELAWARE                                 1-5759                               51-0255124
<S>                                         <C>                             <C>
(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>
<CAPTION>

          DELAWARE                                33-93576                              13-3593483
<S>                                         <C>                             <C>
(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 August 13, 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
                                                                                                            ----
<S>                                                                                                         <C>
PART I. FINANCIAL INFORMATION

Item 1. Brooke Group Ltd./BGLS Inc. Consolidated Financial Statements:

   Brooke Group Ltd. Consolidated Balance Sheets as of June 30, 1999 and
         December 31, 1998.............................................................................        2

   BGLS Inc. Consolidated Balance Sheets as of June 30, 1999 and December 31, 1998.....................        3

   Brooke Group Ltd. Consolidated Statements of Operations for the three and six months
         ended June 30, 1999 and June 30, 1998.........................................................        4

   BGLS Inc. Consolidated Statements of Operations for the three and six months ended
         June 30, 1999 and June 30, 1998...............................................................        5

   Brooke Group Ltd. Consolidated Statement of Stockholders' Equity (Deficit) for the six
         months ended June 30, 1999....................................................................        6

   BGLS Inc. Consolidated Statement of Stockholder's Equity (Deficit) for the six months
         ended June 30, 1999...........................................................................        7

   Brooke Group Ltd. Consolidated Statements of Cash Flows for the six months ended
         June 30, 1999 and June 30, 1998...............................................................        8

   BGLS Inc. Consolidated Statements of Cash Flows for the six months ended
         June 30, 1999 and June 30, 1998...............................................................        9

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

Item 2. Management's Discussion and Analysis
         of Financial Condition and Results of Operations..............................................       31

Item 3. Quantitative and Qualitative Disclosures About Market Risk.....................................       43

PART II.     OTHER INFORMATION

Item 1. Legal Proceedings..............................................................................       44

Item 2. Changes in Securities and Use of Proceeds......................................................       44

Item 3. Defaults Upon Senior Securities................................................................       44

Item 6. Exhibits and Reports on Form 8-K...............................................................       44

SIGNATURES.............................................................................................       46

</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>

                                                                                    June 30,        December 31,
                                                                                      1999              1998
                                                                                  -----------       -------------
<S>                                                                                <C>               <C>
ASSETS:

Current assets:
  Cash and cash equivalents.................................................        $   8,368         $   7,396
  Receivables from clearing brokers.........................................           13,427
  Investment securities available for sale..................................           48,114
  Trading securities owned..................................................           11,695
  Accounts receivable - trade...............................................           12,366            15,160
  Other receivables.........................................................            2,200               924
  Inventories...............................................................           46,421            36,316
  Restricted assets.........................................................            3,266
  Deferred income taxes.....................................................           87,983            59,613
  Other current assets......................................................            8,608             3,151
                                                                                    ---------         ---------
    Total current assets....................................................          242,448           122,560

Property, plant and equipment, net..........................................          132,603            93,504
Investment in real estate, net..............................................           92,887
Long-term investments, net..................................................            5,762
Investment in joint venture.................................................           49,466
Restricted assets...........................................................            8,310
Other assets................................................................           19,056            12,918
                                                                                    ---------         ---------
    Total assets............................................................        $ 550,532         $ 228,982
                                                                                    =========         =========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):

Current liabilities:
  Current portion of notes payable and long-term debt.......................        $  34,257         $  21,176
  Margin loan payable.......................................................            4,853
  Accounts payable..........................................................           28,680            13,880
  Cash overdraft............................................................            1,250                77
  Securities sold, not yet purchased........................................            2,979
  Accrued promotional expenses..............................................           18,750            23,760
  Accrued taxes payable.....................................................           49,181            14,854
  Accrued interest..........................................................            9,389            17,189
  Proceeds received for options.............................................                            150,000
  Other accrued liabilities.................................................           59,818            32,505
                                                                                    ---------         ---------
    Total current liabilities...............................................          209,157           273,441

Notes payable, long-term debt and other obligations, less current portion...          191,193           262,665

Noncurrent employee benefits................................................           20,874            21,701
Deferred income taxes.......................................................          132,982
Other liabilities...........................................................           68,366            65,350
Minority interests..........................................................           51,793

Commitments and contingencies...............................................

Stockholders' equity (deficit):
  Preferred stock, par value $1.00 per share, authorized 10,000,000 shares..
  Common stock, par value $0.10 per share, authorized 100,000,000
     shares, issued 26,498,043 shares, outstanding
     20,943,730 shares......................................................            2,094             2,094
  Additional paid-in capital................................................          194,788           124,120
  Deficit...................................................................         (288,621)         (512,182)
  Accumulated other comprehensive income....................................              (12)           24,774
  Other.....................................................................           (4,609)           (5,508)
  Less:  5,554,313 shares of common stock in treasury, at cost..............          (27,473)          (27,473)
                                                                                    ---------         ---------
      Total stockholders' deficit...........................................         (123,833)         (394,175)
                                                                                    ---------         ---------
      Total liabilities and stockholders' equity (deficit)..................        $ 550,532         $ 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>

                                                                                     June 30,        December 31,
                                                                                       1999              1998
                                                                                    ----------       ------------
<S>                                                                                 <C>              <C>
ASSETS:

Current assets:
  Cash and cash equivalents.................................................         $   8,368        $   7,396
  Receivables from clearing brokers.........................................            13,427
  Investment securities available for sale..................................            48,114
  Trading securities owned..................................................            11,695
  Accounts receivable - trade...............................................            12,366           15,160
  Other receivables.........................................................             2,098              755
  Inventories...............................................................            46,421           36,316
  Restricted assets.........................................................             3,266
  Deferred income taxes.....................................................            87,983           59,613
  Other current assets......................................................             8,187            2,946
                                                                                     ---------        ---------
      Total current assets..................................................           241,925          122,186

Property, plant and equipment, net..........................................           132,584           93,481
Investment in real estate, net..............................................            92,887
Long-term investments, net..................................................             5,762
Investment in joint venture.................................................            49,466
Restricted assets...........................................................             8,310
Other assets................................................................            17,929           11,729
                                                                                     ---------        ---------
      Total assets..........................................................         $ 548,863        $ 227,396
                                                                                     =========        =========

LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT):

Current liabilities:
  Current portion of notes payable and long-term debt.......................         $  33,829        $  20,955
  Margin loan payable.......................................................             4,853
  Accounts payable..........................................................            28,555           13,746
  Cash overdraft............................................................             1,243               63
  Securities sold, not yet purchased........................................             2,979
  Due to parent.............................................................            32,543           32,394
  Accrued promotional expenses..............................................            18,750           23,760
  Accrued taxes payable.....................................................            49,181           14,854
  Accrued interest..........................................................             9,389           17,188
  Proceeds received from options............................................                            150,000
  Other accrued liabilities.................................................            58,828           31,556
                                                                                     ---------        ---------
      Total current liabilities.............................................           240,150          304,516

Notes payable, long-term debt and other obligations, less current portion...           191,193          262,665

Noncurrent employee benefits................................................            20,874           21,701
Deferred income taxes.......................................................           132,982
Other liabilities...........................................................            70,744           69,216
Minority interests..........................................................            51,793

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................................................           143,207           69,297
  Deficit...................................................................          (302,068)        (524,773)
  Accumulated other comprehensive income....................................               (12)          24,774
                                                                                     ---------        ---------
      Total stockholder's deficit...........................................          (158,873)        (430,702)
                                                                                     ---------        ---------
      Total liabilities and stockholder's equity (deficit)..................         $ 548,863        $ 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                      Six Months Ended
                                                              ------------------------------        ------------------------------
                                                                June 30,          June 30,          June 30,            June 30,
                                                                  1999              1998              1999                1998
                                                              ------------       -----------        -------------     -------------

<S>                                                           <C>                <C>                <C>                <C>
Revenues:
  Tobacco* ................................................   $    109,265       $    111,262       $    217,662       $    196,065
  Broker-dealer transactions ..............................          5,876                                 5,876
  Real estate leasing .....................................            754                                   754
                                                              ------------       ------------       ------------       ------------
    Total revenues ........................................        115,895            111,262            224,292            196,065

Expenses:
  Cost of goods sold* .....................................         40,098             51,680             81,525             93,336
  Operating, selling, administrative and general expenses .         62,199             46,643            107,036             82,126
                                                              ------------       ------------       ------------       ------------
    Operating income ......................................         13,598             12,939             35,731             20,603

Other income (expenses):
  Interest and dividend income ............................            672                185                732                250
  Interest expense ........................................        (12,073)           (19,637)           (27,061)           (40,423)
  Equity in loss of affiliate .............................         (1,569)            (7,261)            (9,198)           (11,448)
  Recognition of deferred gain on sale of assets ..........                                                7,050
  Loss in joint venture ...................................           (790)                                 (790)
  Gain on sale of investments, net ........................            327                                   327
  Sale of assets ..........................................          3,984                468              4,125              1,318
  Gain on brand transaction ...............................        294,287                               294,287
  Other, net ..............................................            405             (1,079)             2,921               (998)
                                                              ------------       ------------       ------------       ------------

Income (loss) from continuing operations before provision
    for income taxes and minority interests ................       298,841            (14,385)           308,124            (30,698)
  Provision for income taxes ..............................         81,645                381             83,374              1,312
  Minority interests ......................................          1,382                                 1,382
                                                              ------------       ------------       ------------       ------------
Income (loss) from continuing operations ..................        215,814            (14,766)           223,368            (32,010)

Gain on discontinued operations in equity investee,
  net of taxes.............................................                                                1,249

Loss on extraordinary items, net of taxes .................         (1,056)                               (1,056)
                                                              ------------       ------------       ------------       ------------
Net income (loss) .........................................   $    214,758       $    (14,766)      $    223,561       $    (32,010)
                                                              ============       ============       ============       ============
Per basic common share:

  Income (loss) from continuing operations ................   $      10.30       $      (0.72)      $      10.67       $      (1.60)
                                                              ============       ============       ============       ============
  Income from discontinued operations .....................                                         $       0.06
                                                                                                    ============
  Loss from extraordinary items ...........................   $      (0.05)                         $      (0.05)
                                                              ============                          ============
  Net income (loss) applicable to common shares ...........   $      10.25       $      (0.72)      $      10.68       $      (1.60)
                                                              ============       ============       ============       ============
Basic weighted average common shares outstanding ..........     20,943,730         20,444,353         20,943,730         19,957,412
                                                              ============       ============       ============       ============

Per diluted common share:

  Income (loss) from continuing operations ................   $       8.25       $      (0.72)      $       8.56       $      (1.60)
                                                              ============       ============       ============       ============
  Income from discontinued operations .....................                                         $       0.05
                                                                                                    ============
  Loss from extraordinary items ...........................   $      (0.04)                         $      (0.04)
                                                              ============                          ============
  Net income (loss) applicable to common shares ...........   $       8.21       $      (0.72)      $       8.57       $      (1.60)
                                                              ============       ============       ============       ============

Diluted weighted average common shares outstanding ........     26,167,956         20,444,353         26,094,156         19,957,412
                                                              ============       ============       ============       ============
</TABLE>

-----------------------
*    Tobacco revenues and Cost of goods sold include excise taxes of $14,718,
     $22,427, $28,756 and $40,345, 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               Six Months Ended
                                                                  ------------------------------ -------------------------------
                                                                     June 30,       June 30,        June 30,        June 30,
                                                                       1999           1998            1999            1998
                                                                  --------------- -------------- --------------- ---------------
<S>                                                                    <C>             <C>            <C>             <C>
Revenues:
  Tobacco*..................................................           $109,265        $111,262       $217,662        $196,065
  Broker dealer transactions................................              5,876                          5,876
  Real estate leasing.......................................                754                            754
                                                                       --------        --------       --------        --------
    Total revenues..........................................            115,895         111,262        224,292         196,065

Expenses:
  Cost of goods sold*.......................................             40,098          51,680         81,525          93,336
  Operating, selling, administrative and general expenses...             62,050          45,426        106,485          80,797
                                                                       --------        --------       --------        --------
    Operating income........................................             13,747          14,156         36,282          21,932

Other income (expenses):
  Interest and dividend income..............................                670              63            730             119
  Interest expense..........................................            (13,406)        (20,738)       (29,650)        (42,562)
  Equity in loss of affiliate...............................             (1,569)         (7,261)        (9,198)        (11,448)
  Recognition of deferred gain on sale of assets............                                             8,264
  Loss in joint venture.....................................               (790)                          (790)
  Gain on sale of investments, net..........................                327                            327
  Sale of assets............................................              3,984             468          4,125           1,318
  Gain on brand transaction.................................            294,287                        294,287
  Other, net................................................                405          (1,079)         2,891          (1,001)
                                                                       --------        --------       --------        --------
Income (loss) from continuing operations before provision
    for income taxes and minority interests.................            297,655         (14,391)       307,268         (31,642)
  Provision for income taxes................................             81,645             381         83,374           1,312
  Minority interests........................................              1,382                          1,382
                                                                       --------        --------       --------        --------
Income (loss) from continuing operations....................            214,628         (14,772)       222,512         (32,954)

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

Loss on extraordinary items, net of taxes...................             (1,056)                        (1,056)
                                                                       --------        --------       --------        --------
Net income (loss)...........................................           $213,572       $ (14,772)      $222,705       $ (32,954)
                                                                       ========       =========       ========       =========

</TABLE>

----------------
*    Tobacco revenues and cost of goods sold include excise taxes of $14,718,
     $22,427, $28,756 and $40,345, 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>
<CAPTION>



                                                                                                            Accumulated
                                                                                                               Other
                                            Common Stock       Additional                                     Compre-
                                         -------------------    Paid-In               Treasury                hensive
                                           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..............................                                    223,561                                        223,561
  Unrealized loss on investment
    securities............                                                                                        (139)       (139)
  Effect of New Valley recapitalization
    on other comprehensive income.......                                                                       (24,647)    (24,647)
                                                                                                                          --------
     Total other comprehensive loss.....                                                                                   (24,786)
                                                                                                                          --------
Total comprehensive income..............                                                                                   198,775
                                                                                                                          --------

Recapitalization of New Valley..........                         72,926                                                     72,926

Distributions on common stock...........                         (3,104)                                                    (3,104)
Amortization of deferred
  compensation..........................                            846                               899                    1,745
                                         ----------  ------    --------   ---------   --------    -------     --------   ---------
Balance, June 30, 1999.................. 20,943,730  $2,094    $194,788   $(288,621)  $(27,473)   $(4,609)    $    (12)  $(123,833)
                                         ==========  ======    ========   =========   ========    =======     ========   =========

</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>
Balance, December 31, 1998...........................    100      $          $ 69,297     $(524,773)    $ 24,774      $(430,702)
Net income...........................................                                       222,705                     222,705
  Unrealized loss on investment securities...........                                                       (139)          (139)
  Effect of New Valley recapitalization on other
    comprehensive income.............................                                                    (24,647)       (24,647)
                                                                                                                       --------
    Total other comprehensive loss...................                                                                   (24,786)
                                                                                                                       --------
Total comprehensive income...........................                                                                   197,919
                                                                                                                       --------

Recapitalization of New Valley.......................                          72,926                                    72,926

Amortization of deferred compensation................                             984                                       984
                                                         ---      -----      --------     ---------     --------      ---------
Balance, June 30, 1999...............................    100      $          $143,207     $(302,068)    $    (12)     $(158,873)
                                                         ---      -----      --------     ---------     --------      ---------

</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>
                                                                                         Six Months Ended
                                                                                     --------------------------
                                                                                     June 30,          June 30,
                                                                                       1999              1998
                                                                                     ---------        ----------
<S>                                                                                  <C>              <C>
Net cash provided by (used in) operating activities.........................         $  12,116        $ (17,409)
                                                                                     ---------        ---------
Cash flows from investing activities:
  Proceeds from sale of businesses and assets, net..........................             5,214            1,686
  Proceeds from brand transaction...........................................           145,000
  Sale or maturity of investment securities.................................               491
  Purchase of investment securities.........................................            (2,529)
  Sale or liquidation of long-term investments..............................               217
  Purchase of real estate...................................................              (338)
  Payment of prepetition claims.............................................               (23)
  Capital expenditures......................................................           (37,864)          (7,138)
                                                                                     ---------        ---------
Net cash provided by (used in) investing activities.........................           110,168           (5,452)
                                                                                     ---------        ---------
Cash flows from financing activities:
  Proceeds from debt........................................................             4,976
  Repayments of debt........................................................          (142,906)          (1,068)
  Borrowings under revolver.................................................           163,978          133,671
  Repayments on revolver....................................................          (152,599)        (129,464)
  Effect of New Valley recapitalization.....................................             9,055
  Decrease in margin loan payable...........................................            (1,147)
  Decrease (increase) in cash overdraft.....................................             1,173             (824)
  Distributions on common stock.............................................            (3,210)          (3,055)
  Proceeds from participating loan..........................................                             20,000
  Issuance of common stock..................................................                             10,144
                                                                                     ---------        ---------
Net cash (used in) provided by financing activities.........................          (120,680)          29,404
                                                                                     ---------        ---------

Effect of exchange rate changes on cash and cash equivalents................              (632)              84
Net increase in cash and cash equivalents...................................               972            6,627
Cash and cash equivalents, beginning of period..............................             7,396            4,749
                                                                                     ---------        ---------
Cash and cash equivalents, end of period....................................         $   8,368        $  11,376
                                                                                     =========        =========

</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>

                                                                                         Six Months Ended
                                                                                  --------------------------
                                                                                     June 30,       June 30,
                                                                                       1999           1998
                                                                                  ----------       ----------
<S>                                                                               <C>              <C>
Net cash provided by (used in) operating activities.........................      $    9,327       $ (10,298)
                                                                                  ----------       ---------
Cash flows from investing activities:
  Proceeds from sale of businesses and assets, net..........................           5,214           1,686
  Proceeds from brand transaction...........................................         145,000
  Sale or maturity of investment securities.................................             491
  Purchase of investment securities.........................................          (2,529)
  Sale or liquidation of long-term investments..............................             217
  Purchase of real estate...................................................            (338)
  Payment of prepetition claims.............................................             (23)
  Capital expenditures......................................................         (37,864)         (7,138)
                                                                                  ----------       ---------
Net cash provided by (used in) investing activities.........................         110,168          (5,452)
                                                                                  ----------       ---------
Cash flows from financing activities:
  Proceeds from debt........................................................           4,500
  Repayments of debt........................................................        (142,858)         (1,023)
  Borrowings under revolver.................................................         163,978         133,671
  Repayments on revolver....................................................        (152,599)       (129,464)
  Effect of New Valley recapitalization.....................................           9,055
  Decrease in margin loan payable...........................................          (1,147)
  Decrease (increase) in cash overdraft.....................................           1,180            (891)
  Proceeds from participating loan..........................................                          20,000
                                                                                  ----------       ---------
Net cash (used in) provided by financing activities.........................        (117,891)         22,293
                                                                                  ----------       ---------
Effect of exchange rate changes on cash and cash equivalents................            (632)             84
Net increase in cash and cash equivalents...................................             972           6,627
Cash and cash equivalents, beginning of period..............................           7,396           4,749
                                                                                  ----------       ---------
Cash and cash equivalents, end of period....................................      $    8,368       $  11,376
                                                                                  ==========       =========

</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"), Liggett-Ducat Ltd. ("Liggett-Ducat") and other less
      significant subsidiaries. As of June 1, 1999, New Valley Corporation
      ("New Valley") became a consolidated subsidiary of the Company as a
      result of New Valley's recapitalization in which the Company's interest
      in New Valley's common shares increased to 55.1%. (See Note 3.) All
      significant intercompany balances and transactions have been eliminated.

      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. New Valley is engaged in
      the investment banking and brokerage business through its ownership of
      Ladenburg Thalmann & Co. Inc., in the real estate development business in
      Russia, in the ownership and management of commercial real estate in the
      United States and in the acquisition of operating companies.

      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.

      RISKS AND UNCERTAINTIES:

      In 1998, the Russian Federation entered a period of economic instability
      which has continued in 1999. 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 Company's Russian operations may
      be significantly affected by these factors for the foreseeable future.

      USE OF ESTIMATES:

      The preparation of financial statements in conformity with generally
      accepted accounting principles requires management to make estimates and
      assumptions that affect the reported amounts of assets and liabilities
      and disclosure of contingent assets and liabilities and the reported
      amounts of revenues and expenses. Actual results could differ from those
      estimates.





                                     -10-
<PAGE>   12
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      RECLASSIFICATIONS:

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

      PROVISION FOR INCOME TAXES:

      The effective tax rate does not bear a customary relationship to pre-tax
      accounting income principally as a consequence of the change in the
      valuation allowance relating to deferred tax assets and foreign taxes.

      EARNINGS PER SHARE:

      For the three and six months ended June 30, 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 and warrants (both vested and non-vested). For
      the three and six months ended June 30, 1998, stock options and warrants
      (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, unrealized gains
      and losses on investment securities and minimum pension liability
      adjustments. For the six months ended June 30, 1999, total comprehensive
      income was $198,775. For the six months ended June 30, 1998, the total
      comprehensive loss was $21,505.


2.    PHILIP MORRIS BRAND TRANSACTION

      On November 20, 1998, the Company and Liggett granted Philip Morris
      Incorporated options to purchase interests in Trademarks LLC which holds
      three cigarette brands, L&M, Chesterfield and Lark, formerly held by
      Liggett's subsidiary, Eve Holdings Inc.

      Under the terms of the Philip Morris agreements, Eve contributed the
      three brands to Trademarks, a newly-formed limited liability company, in
      exchange for 100% of two classes of Trademarks' interests, the Class A
      Voting Interest and the Class B Redeemable Nonvoting Interest. Philip
      Morris acquired two options to purchase the interests from Eve. On
      December 2, 1998, Philip Morris paid Eve a total of $150,000 for the
      options, $5,000 for the option for the Class A interest and $145,000 for
      the option for the Class B interest. Liggett used the payments to fund
      the redemption of Liggett's Senior Secured Notes on December 28, 1998.

      The Class A option entitled Philip Morris to purchase the Class A
      interest for $10,100. On March 19, 1999, Philip Morris exercised the
      Class A option, and the closing occurred on May 24, 1999.

      The Class B option entitles Philip Morris 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 Philip Morris 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 Trademarks for $139,900 during the same period the Class B option may
      be exercised.

      On May 24, 1999, Trademarks borrowed $134,900 from a lending institution.
      The loan is guaranteed by Eve and collateralized by a pledge by
      Trademarks of the three brands and Trademarks' interest in the trademark





                                     -11-
<PAGE>   13
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      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,
      Trademarks distributed the loan proceeds to Eve as the holder of the
      Class B interest. The cash exercise price of the Class B option and
      Trademarks' redemption price were reduced by the amount distributed to
      Eve. Upon Philip Morris' exercise of the Class B option or Trademarks'
      exercise of its redemption right, Philip Morris or Trademarks, as
      relevant, will be required to obtain 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 income or loss of
      Trademarks. The proceeds of the loan and the exercise of the Class A
      option were used to retire a portion of BGLS' 15.75% Senior Secured
      Notes. (Refer to Note 10.)

      Trademarks has granted Philip Morris an exclusive license of the three
      brands for an 11-year term expiring May 24, 2010 at an annual royalty
      based on sales of cigarettes under the brands, subject to a minimum
      annual royalty payment equal to the annual debt service obligation on the
      loan plus $1,000.

      If Philip Morris fails to exercise the Class B option, Eve will have an
      option to put its Class B interest to Philip Morris, or Philip Morris'
      designees, at a put price that is $5,000 less than the exercise price of
      the Class B option (and includes Philip Morris' obtaining 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, Trademarks' 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% interest in Trademarks.

      The $150,000 in proceeds received from the sale of the Class A and B
      options was 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 on May 24, 1999. Upon closing, Philip
      Morris obtained control of Trademarks, and the Company recognized a
      pre-tax gain of $294,287 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.    NEW VALLEY CORPORATION

      Until May 31, 1999, the Company was an equity investor in New Valley. The
      Class A Senior Preferred Shares and the Class B Preferred Shares of New
      Valley that the Company owned were 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
      were classified as available-for-sale. The Common Shares were accounted
      for pursuant to APB No. 18, "The Equity Method of Accounting for
      Investments in Common Stock".



                                     -12-
<PAGE>   14
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      Summarized financial information for New Valley for the periods ended May
      31, 1999 and June 30, 1998 follows:

<TABLE>
<CAPTION>

                                                              Five Months Ended  Six Months Ended
                                                                May 31, 1999      June 30, 1998
                                                              ----------------- ----------------
                    <S>                                           <C>               <C>
                    Revenues .................................    $ 39,452          $ 59,112
                    Costs and expenses........................      50,659            66,969
                    Loss from continuing operations...........     (10,668)           (6,719)
                    Gain from discontinued operations.........       4,100               880
                    Net loss applicable to common shares(A)...     (44,327)          (44,429)

</TABLE>

           (A) Considers all preferred accrued dividends, whether or not
               declared.

      Recapitalization. On June 4, 1999, following approval by New Valley's
      stockholders, New Valley consummated a plan of recapitalization. Pursuant
      to the plan of recapitalization:

           o  each Class A Senior Preferred Share was reclassified into 20
              Common Shares and one Warrant to purchase a Common Share at
              $12.50 per share exerciseable for five years,

           o  each Class B Preferred Share was reclassified into 1/3 of a
              Common Share and five Warrants, and

           o  each outstanding Common Share was reclassified into 1/10 of a
              Common Share and 3/10 of a Warrant.

      The recapitalization had a significant effect on the Company's financial
      position and results of operations. The recapitalization resulted in the
      elimination of the existing redeemable preferred shares of New Valley and
      the on-going dividend accruals thereon, as well as the redemption
      obligation for the Series A Senior Preferred Shares in January 2003. The
      Company increased its ownership of the outstanding Common Shares of New
      Valley from 42.3% to 55.1%, and its total voting power from 42% to 55.1%.
      As a result of the increase in ownership, New Valley became a
      consolidated subsidiary of the Company as of June 1, 1999. In addition,
      the Company's equity in New Valley increased by $59,263 which, presented
      net of tax, is $38,331.

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

      Subsequent Event. In July 1999, New Valley agreed to sell five of its
      shopping centers for an aggregate purchase price of $46,100 (before
      closing adjustments and expenses) including the assumption of $35,000 of
      mortgage financing. Closing of the sale is subject to completion of due
      diligence and other customary conditions.





                                     -13-
<PAGE>   15
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


4.    PRO FORMA EFFECTS OF BRAND TRANSACTION AND NEW VALLEY RECAPITALIZATION

      The following table presents unaudited pro forma results of operations as
      if the brand transaction and New Valley's recapitalization had occurred
      immediately prior to January 1, 1998. These pro forma results have been
      prepared for comparative purposes only and do not purport to be
      indicative of what would have occurred had these transactions been
      consummated as of such date.

<TABLE>
<CAPTION>
                                                                    Year Ended            Six Months Ended
                                                                 December 31, 1998          June 30, 1999
                                                                 -----------------        ----------------

               <S>                                                  <C>                       <C>
               Revenues.................................             $467,564                  $241,743
                                                                     ========                  ========
               Operating income.........................             $ 23,658                  $ 15,367
                                                                     ========                  ========
               Income from continuing operations........             $  6,970                  $  5,734
                                                                     ========                  ========
               Net income...............................             $ 11,235                  $  6,246
                                                                     ========                  ========
               Net income per common share:
                   Basic................................             $   0.55                  $   0.30
                                                                     ========                  ========
                   Diluted..............................             $   0.45                  $   0.24
                                                                     ========                  ========
</TABLE>


5.    INVESTMENT IN WESTERN REALTY

      WESTERN REALTY DEVELOPMENT LLC. 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. New Valley agreed to contribute the real estate
      assets of 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.

      The ownership and voting interests in Western Realty Ducat are 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 commitment of $40,000, of which $38,494 had been funded
      through June 30, 1999, together with a 15% annual rate of return. 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 is
      managed by a Board of Managers consisting of an equal number of
      representatives chosen by Apollo and New Valley. Material corporate
      transactions by Western Realty Ducat generally require the unanimous
      consent of the Board of Managers. Accordingly, New Valley accounts 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





                                     -14-
<PAGE>   16
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


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

      Summarized balance sheet information as of June 30, 1999 for Western
      Realty Ducat follows:

                                                        June 30, 1999
                                                        -------------
          Current assets.......................          $    4,873
          Participating loan receivable........              32,242
          Real estate, net.....................              85,910
          Furniture and fixtures, net..........                 169
          Noncurrent assets....................                 450
          Goodwill, net........................               6,398
          Notes payable - current..............               5,938
          Current liabilities..................               5,940
          Notes payable - long-term............              11,561
          Long-term liabilities................                 759
          Members' equity......................             105,844

      Western Realty Ducat has made a $30,000 participating loan to Western
      Tobacco Investments LLC ("Western Tobacco), which holds BOL's interest in
      Liggett-Ducat and the new factory constructed by Liggett-Ducat. (Refer to
      Note 10 for information concerning a pledge of interests in Western
      Tobacco.) The loan bears no fixed interest and is payable only out of 30%
      of distributions 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 three and
      six months ended June 30, 1999, a preference requirement equal to 30% of
      Western Tobacco's net (loss) income of $(741) and $261, respectively, has
      been charged to interest expense. The loan is classified in other
      long-term liabilities on the consolidated balance sheet at June 30, 1999.

      WESTERN REALTY REPIN LLC. In June 1998, New Valley and Apollo organized
      Western Realty Repin LLC to make a loan to BML. The proceeds of the loan
      will be used by BML for the acquisition and preliminary development of
      the Kremlin sites, two adjoining sites totaling 10.25 acres located in
      Moscow across the Moscow River from the Kremlin. BML is planning the
      development of a 1.1 million sq. ft. hotel, office, retail and
      residential complex on the Kremlin sites. In May 1999, BML acquired an
      additional 48% interest in the second Kremlin site and the related land
      lease rights. BML owned 95.9% of one site and 100% of the other site at
      June 30, 1999. Apollo will be entitled to a preference on distributions
      of cash from Western Realty Repin to the extent of its investment of
      $18,750 together with a 20% annual rate of return, and New Valley will
      then be entitled to a return of its investment of $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 is managed by a Board
      of Managers consisting of an equal number of representatives chosen by
      Apollo and New Valley. Material corporate transactions by Western Realty
      Repin will generally require the unanimous consent of the Board of
      Managers.





                                     -15-
<PAGE>   17
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      Through June 30, 1999, Western Realty Repin has advanced $25,000, of
      which $18,773 was funded by Apollo, under the Western Realty Repin loan.
      The loan is classified in other long-term obligations on the consolidated
      balance sheet at June 30, 1999. The loan bears no fixed interest and is
      payable only out of 100% of the distributions by the entities owning the
      Kremlin sites to BML. Such distributions 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 BML. BML used a portion of the proceeds of the
      loan to repay New Valley for certain expenditures on the Kremlin sites
      previously incurred. The 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 June 30, 1999, BML had invested $29,940 in the Kremlin sites and
      held $2,852, in cash, which was restricted for future investment. In
      acquiring its interest in one of the Kremlin sites, BML agreed with the
      City of Moscow to invest an additional $6,000 in 1999 (which has been
      funded) and $22,000 in 2000 in the development of the property. Failure to
      make the required investment could result in forfeiture of 34.8% interest
      in the site.

      The development of Ducat Place III and the Kremlin Sites will require
      significant amounts of debt and other financing. New Valley is considering
      potential 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.


6.    INVESTMENT SECURITIES AVAILABLE FOR SALE

      Investment securities classified as available for sale are carried at fair
      value, with net unrealized gains or losses included as a component of
      accumulated other comprehensive income. Investment securities available
      for sale totaling $48,114 at June 30, 1999 is comprised of marketable
      equity securities and warrants of $46,109 and notes receivable of $2,005.


7.    INVENTORIES

      Inventories consist of:

                                                      June 30,     December 31,
                                                       1999            1998
                                                      --------     -----------

Leaf tobacco....................................      $16,139        $13,882
Other raw materials.............................       10,871          4,629
Work-in-process.................................        3,315          2,001
Finished goods..................................       16,544         15,446
Replacement parts and supplies..................        4,556          4,130
                                                      -------        -------
Inventories at current cost.....................       51,425         40,088
LIFO adjustments................................       (5,004)        (3,772)
                                                      -------        -------
                                                      $46,421        $36,316
                                                      =======        =======

      At June 30, 1999, Liggett and Liggett-Ducat had leaf tobacco purchase
commitments of approximately $5,123 and $34,870, respectively.





                                     -16-
<PAGE>   18
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


8.    PROPERTY, PLANT AND EQUIPMENT

      Property, plant and equipment consist of:

                                                 June 30,         December 31,
                                                   1999              1998
                                                 --------         -----------

          Land and improvements................  $    416          $    412
          Buildings............................     5,852             5,823
          Machinery and equipment..............   116,994            54,144
          Construction-in-progress.............    48,526            66,981
                                                 --------          --------
                                                  171,788           127,360
          Less accumulated depreciation........   (39,185)          (33,856)
                                                 --------          --------
                                                 $132,603          $ 93,504
                                                 ========          ========


      In May 1999, Liggett-Ducat completed construction of a new cigarette
      factory on the outskirts of Moscow and began production in June 1999. At
      June 30, 1999, the remaining liability under the construction contracts
      is $4,045 and the remaining liability under equipment purchase agreements
      is $21,795.


9.    LONG-TERM INVESTMENTS

      At June 30, 1999, long-term investments consisted primarily of investments
      in limited partnerships of $3,162. The Company believes the fair value of
      the limited partnerships exceeds their carrying amount by approximately
      $3,889 based on the indicated market values of the underlying investment
      portfolio provided by the partnerships. The Company's investments in
      limited partnerships are illiquid and the ultimate realization of these
      investments are subject to the performance of the underlying partnership
      and its management by the general partners.

      Also included in long-term investments are various Internet-related
      businesses which are carried at $2,600 at June 30, 1999. These
      investments include an approximate 10% interest in Orchard/JFAX Investors
      LLC, which is the beneficial owner of 40.6% of JFAX.COM, Inc. JFAX is an
      Internet-based messaging and communications services provider to
      individuals and businesses, which completed an initial public offering in
      July 1999. New Valley also holds a 45% interest in Ant 21, LLC, which is
      engaged in the online music industry and operates the Internet site
      www.atomicpop.com.






                                     -17-
<PAGE>   19
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


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

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

<TABLE>
<CAPTION>

                                                                      June 30,        December 31,
                                                                        1999              1998
                                                                      ---------       ------------

         <S>                                                          <C>               <C>
         BGLS:
         15.75% Series B Senior Secured Notes due 2001,
             net of unamortized discount of $9,018 and $17,374.....   $  91,159         $215,490
         Deferred interest on 15.75% Series B Senior Secured
             Notes due 2001........................................      23,000           24,985

         New Valley:
         Notes payable.............................................      54,801

         Liggett:
         Revolving credit facility.................................       2,958            2,538
         Note payable..............................................       4,394

         BOL:
         Foreign credit facilities.................................      22,285           11,600
         Notes payable.............................................      23,753           28,057

         Other.....................................................       3,100            1,171
                                                                      ---------        ---------

         Total notes payable, long-term debt and other obligations.     225,450          283,841
         Less:
             Current maturities....................................      34,257           21,176
                                                                      ---------         --------
         Amount due after one year.................................   $ 191,193         $262,665
                                                                      =========         ========

</TABLE>

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

      On May 25, 1999, BGLS repurchased $132,687 principal amount of its 15.75%
      Senior Secured Notes due 2001 (the "Notes"), together with accrued
      interest thereon of $18,276, for a purchase price of $147,694. The
      purchases were made using the proceeds of the Philip Morris brand
      transaction which closed on May 24, 1999. The Company recognized an
      extraordinary loss on early extinguishment of debt primarily due to the
      unamortized imputed interest associated with the related Notes. At June
      30, 1999, the principal amount of Notes outstanding was $100,177. Of this
      amount, $60,100 principal amount of the Notes are held by the holders who
      have agreed to defer payment of interest as discussed below. On August 6,
      1999, the Company repurchased $897 principal amount of the Notes.

      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 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).




                                     -18-
<PAGE>   20
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      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.

      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.

      The Notes outstanding are collateralized by substantially all of BGLS'
      assets, including a pledge of BGLS' equity interests in Liggett, BOL and
      New Valley. The Notes Indenture contains certain covenants which, among
      other things, limit the ability of BGLS to make distributions to the
      Company to $12,000 per year (which amount increased from $6,000 per year
      in May 1999 when more than 50% of the original principal amount of the
      Notes were retired) plus any unpaid distribution amounts from prior
      years. The Notes also 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.

      Notes Payable - New Valley:

      At June 30, 1999, New Valley's investment in real estate collateralized
      seven promissory notes aggregating $54,801 due 2001 related to shopping
      centers located throughout the United States. Each shopping center note
      has a term of five years, requires no principal amortization and bears
      interest payable monthly at the rate of 8% for the first two and one-half
      years and at the rate of 9% for the remainder of the term.

      Revolving Credit Facility - Liggett:

      Liggett entered into a revolving credit facility (the "Facility") for
      $40,000 with a syndicate of commercial lenders in 1994 which is
      collateralized by all inventories and receivables of Liggett. At June 30,
      1999, $15,634 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 June 30, 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




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


      respect to Liggett's permitted maximum adjusted net worth (not to fall
      below a deficit of $195,000 as computed in accordance with the agreement,
      this computation was $40,300 at June 30, 1999) and net working capital
      (not to fall below a deficit of $17,000 as computed in accordance with
      the agreement, this computation was $34,826 at June 30, 1999). The
      Facility expires on March 8, 2000 subject to automatic renewal for an
      additional year unless notice of termination is given by the lender at
      least 60 days prior to the anniversary date.

      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 - Liggett-Ducat:

      At June 30, 1999, Liggett-Ducat had various credit facilities under which
      approximately $22,300 was outstanding. One facility for $10,000, which is
      fully utilized and bears interest at 25%, expires in May 2000. Another
      facility for $5,000, of which $2,500 is utilized and bears interest at
      20%, expires in December 1999. The remaining facilities, denominated in
      rubles (approximately $9,800 at the June 30, 1999 exchange rate), have
      terms of six - twelve months with interest rates of 52% - 63%. The
      facilities are collateralized by factory equipment and tobacco inventory.

      Notes Payable - BOL:

      In 1997, Western Tobacco entered into several contracts for the purchase
      of cigarette manufacturing equipment. Approximately 85% of the contracts
      are being financed with promissory notes generally over a period of 5
      years. The outstanding balance on these notes, which are denominated in
      various European currencies, is $20,386 at June 30, 1999. BOL also has
      issued a promissory note for $1,339 at June 30, 1999 covering deposits for
      equipment being purchased for the new factory. The note is due March 31,
      2000.

      On July 29, 1998, BOL borrowed $3,000, subsequently reduced to $2,034,
      from an unaffiliated third party with interest at 14% per annum. The
      remaining principal and interest on the loan of $1,950 was paid on August
      2, 1999.


11.   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




                                     -20-
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                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      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 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 six
      months ended June 30, 1999, Liggett incurred counsel fees and costs
      totaling approximately $3,001, compared to $2,562 for the comparable
      prior year period.

      INDIVIDUAL ACTIONS. As of June 30, 1999, there were approximately 275
      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, 80 were
      pending in Florida, 91 in New York, 31 in Massachusetts and 22 in Texas.
      The balance of the individual cases were pending in 21 states. There are
      six 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 Philip Morris. 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 Philip
      Morris. The award includes $79,500 in punitive damages. The court
      subsequently reduced the punitive damages award to $32,000. A Notice of
      Appeal has been filed by Philip Morris.

      CLASS ACTIONS. As of June 30, 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.



                                     -21-
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                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      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
      Louisiana (Liggett is not a defendant in this proceeding) and Maryland
      have certified "addiction-as-injury" class actions that covered only
      citizens in those states. Two class actions were certified in state court
      in Florida prior to the Fifth Circuit's decision, Broin and Engle. The
      Castano decision has had no measurable impact on litigation brought by or
      on behalf of single individual claimants.

      In May 1994, an action entitled Engle, et al. v. R.J. Reynolds Tobacco
      Company, et al., Circuit Court Eleventh Judicial Circuit, Dade County,
      Florida, was filed against Liggett and others. This case was brought by
      plaintiffs, on behalf of all individuals in the State of Florida, who
      allegedly have been injured as a result of smoking cigarettes. In July
      1998, Phase I of the trial in this action commenced. (See "Subsequent
      Events".)

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

      GOVERNMENTAL ACTIONS. As of June 30, 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 claims of negligence, strict
      liability, breach of express and implied warranty, violation of a
      voluntary undertaking or special duty, fraud, negligent





                                     -22-
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                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      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 June 30, 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 the Third-Party Payor Action brought by seven Blue Cross/Blue
      Shield Plans. 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. Similarly, in March 1999, a federal judge in the Northern District
      of Illinois denied the industry's motion to dismiss.

      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 Philip Morris, 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




                                     -23-
<PAGE>   25
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      plaintiffs or their 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, Philip Morris, Brown & Williamson Tobacco
      Corporation, R.J. Reynolds Tobacco Company and Lorillard Tobacco Company
      (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.





                                     -24-
<PAGE>   26
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      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.

      Pursuant to the MSA, Liggett has no payment obligations unless its market
      share exceeds 125% of its 1997 market share (the "Base Share"), or 1.67%
      of total cigarettes sold in the United States. 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):

                          Year                     Amount
                          ----                     ------
                   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

      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 nation"
      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. 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. (See "Subsequent Events".)




                                     -25-
<PAGE>   27

                               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. There are no trials involving the Company or Liggett scheduled
      for 1999, other than the Engle case. Cases currently scheduled for trial
      during the first six months of 2000 include a lawsuit brought by several
      Blue Cross/Blue Shield plans in federal court in New York (January), two
      asbestos company contribution lawsuits in Mississippi and New York
      (February), one class action in Maryland (February) and two third-party
      payor actions brought by unions in West Virginia (March) and New York
      (April). Also, three individual cases and an adequacy of warning case are
      currently scheduled for trial during the first six months of 2000. 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 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. 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. The
      Company and Liggett are unable, at this time, to predict the outcome of
      this 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





                                     -26-
<PAGE>   28
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      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 and certain of its consolidated subsidiaries 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.


      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. On
      June 6, 1999, the Fourth Circuit Court of Appeals heard oral argument in
      the appeal taken by the EPA from the district court order invalidating
      the EPA report.

      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




                                     -27-
<PAGE>   29
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      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. 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. 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.

      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.

      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.

      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 and New Valley's time to respond to
      the complaint has not yet expired. The Company and New Valley believe
      that the allegations are without merit. Although there can be no




                                     -28-
<PAGE>   30
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      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 or New Valley's consolidated
      financial position, results of operations or cash flows.

      SUBSEQUENT EVENTS: On July 2, 1999, a purported class action was
      commenced on behalf of New Valley's former Class B preferred shareholders
      against New Valley, the Company and certain directors and officers of New
      Valley in Delaware Chancery Court. The complaint alleges that the
      recapitalization, approved by a majority of each class of New Valley's
      stockholders in May 1999, was fundamentally unfair to the Class B
      preferred shareholders, the proxy statement relating to the
      recapitalization was materially deficient and the defendants breached
      their fiduciary duties to the Class B preferred shareholders in approving
      the transaction. The plaintiffs seek class certification of the action
      and an award of unspecified compensatory damages as well as all costs and
      fees. The Company and New Valley believe that the allegations are without
      merit. Although there can be no assurances, the Company and New Valley
      believe, after consultation with counsel, that the ultimate resolution of
      this matter will not have a material adverse effect on the Company's or
      New Valley's consolidated financial position, results of operations or
      cash flows.

      On July 7, 1999, the jury in the Engle matter returned a verdict in Phase
      I of the trial finding that smoking causes various diseases and is
      addictive and finding the defendants liable on various tort and warranty
      claims. Additionally, the jury found that the class may be entitled to
      punitive damages from the defendants. It is expected that the defendants
      will appeal the Phase I liability verdict. The court has decided that
      Phase II of the trial will commence September 7, 1999, with a causation
      and damages trial for two of the class representatives and a punitive
      damages trial on a class-wide basis. Phase III of the trial will be
      conducted before separate juries to address absent class members' claims,
      including issues of specific causation and other individual issues
      regarding entitlement to compensatory damages. On August 2, 1999, the
      companies filed a motion to disqualify the trial judge. On August 5,
      1999, the trial judge denied the motion.

      On July 22, 1999, the Circuit Court of Mobile County, Alabama denied
      approval of the Fletcher class action settlement.



                                     -29-
<PAGE>   31
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


12.   SEGMENT INFORMATION

      Financial information for the Company's continuing operations before
      taxes and minority interest for the three and six months ended June 30,
      1999 and 1998 follows:
<TABLE>
<CAPTION>
                                                 United
                                                 States        Russia        Broker-         Real       Corporate
                                                Tobacco       Tobacco        Dealer*       Estate*      and Other*      Total
                                                --------      --------       --------      -------      ----------     ------
<S>                                            <C>            <C>           <C>          <C>            <C>             <C>
Three Months Ended June 30, 1999:

Net revenues............................        $  93,926      $15,339      $  5,876     $     754      $               $115,895
Operating income (loss).................           16,146         (807)         (107)         (371)       (1,263)         13,598
Depreciation and amortization...........              965          429            80           168           103           1,745
Capital expenditures....................              603       17,317                                       327          18,247

Three Months Ended June 30, 1998:

Net revenues............................        $  83,398      $27,864                                  $               $111,262
Operating income (loss).................            8,895        7,018                                    (2,974)         12,939
Depreciation and amortization...........            1,708                                                     10           1,718
Capital expenditures....................              341        6,092                                       310           6,743


Six Months Ended June 30, 1999:

Net revenues............................         $179,973      $37,689      $  5,876     $     754      $               $224,292
Operating income (loss).................           36,215          568          (107)         (371)         (574)         35,731
Identifiable assets.....................          102,650      133,130        44,390       100,360       170,002         550,532
Depreciation and amortization...........            1,820        1,182            80           168           151           3,401
Capital expenditures....................            6,972       30,565                                       327          37,864

Six Months Ended June 30, 1998:

Net revenues............................         $149,024      $47,041                                  $               $196,065
Operating income (loss).................           15,146        8,728                                    (3,271)         20,603
Identifiable assets.....................           66,322       57,055                                    21,796         145,173
Depreciation and amortization...........            3,293          159                                       168           3,620
Capital expenditures....................              694        6,444                                                     7,138

</TABLE>

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

*    Broker-Dealer, Real Estate and New Valley's portion of Corporate and Other
     are included for the month ended June 30, 1999 when New Valley became a
     consolidated subsidiary of the Company.



                                     -30-
<PAGE>   32
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"), Liggett-Ducat Ltd. ("Liggett-Ducat") and other less significant
subsidiaries. As of June 1, 1999, New Valley Corporation ("New Valley") became
a consolidated subsidiary of the Company as a result of New Valley's
recapitalization in which the Company's interest in New Valley's common shares
increased to 55.1%.

         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. The Company is principally engaged in the
manufacture and sale of cigarettes in the United States through its subsidiary
Liggett; in the manufacture and sale of cigarettes in Russia through its
subsidiary Liggett-Ducat; and in the investment banking and brokerage business
in the United States and real estate operations in Russia and the United States
through its majority-owned subsidiary New Valley.


RECENT DEVELOPMENTS

         MASTER SETTLEMENT AGREEMENT. On November 23, 1998, Liggett and the
four largest U.S. cigarette manufacturers, Philip Morris Incorporated, Brown &
Williamson Tobacco Corporation, R. J. Reynolds Tobacco Company and Lorillard
Tobacco Company, entered into the Master Settlement Agreement with 46 states,
the District of Columbia, Puerto Rico and various other territories to settle
their asserted and unasserted health care cost recovery and certain other
claims caused by cigarette smoking.

         Pursuant to the Master Settlement Agreement, Liggett has no payment
obligation unless its market share exceeds 125% of its 1997 domestic market
share, or 1.67% of total cigarettes sold in the United States. In the year
following any year in which Liggett's market share exceeds 1.67%, Liggett will
pay on each excess unit an amount equal (on a per-unit basis) to that paid
during the year by the four original participating manufacturers pursuant to
the annual and strategic contribution payments provided for under the Master
Settlement Agreement. Under the Master Settlement Agreement terms, the original
participating manufacturers (and Liggett to the extent its market share exceeds
1.67%) will make annual payments based on relative unit volume of domestic
cigarette shipments.

         PHILIP MORRIS BRAND TRANSACTION. On November 20, 1998, the Company and
Liggett granted Philip Morris options to purchase interests in Trademarks LLC
which holds three cigarette brands, L&M, Chesterfield and Lark, formerly held
by Liggett's subsidiary, Eve Holdings Inc.



                                     -31-
<PAGE>   33

         Under the terms of the Philip Morris agreements, Eve contributed the
three brands to Trademarks, a newly-formed limited liability company, in
exchange for 100% of two classes of LLC interests, the Class A and the Class B
interests. Philip Morris acquired two options to purchase the interests from
Eve. On December 2, 1998, Philip Morris paid Eve a total of $150,000 for the
options. Liggett used the payments to fund the redemption of Liggett's Senior
Secured Notes on December 28, 1998.

         On May 24, 1999, Philip Morris paid Eve $10,100 upon exercise of the
option to purchase the Class A interest and Trademarks borrowed $134,900, the
proceeds of which were distributed to Eve. These proceeds were used to retire a
portion of BGLS' Senior Secured Notes. Financial information related to these
three brands, which represented approximately one-half of Liggett's premium
brand sales, are reflected in the Company's financial statements through May
21, 1999.

         CIGARETTE PRICING ACTIVITY. During 1998, the major cigarette
manufacturers, including Liggett, announced list price increases of $6.35 per
carton. This included an increase of $4.50 per carton announced by the industry
in December following the signing of the Master Settlement Agreement.

         NEW LIGGETT-DUCAT FACTORY. During the second quarter of 1999,
Liggett-Ducat completed construction of a new cigarette factory on the
outskirts of Moscow. This factory uses Western cigarette making technology and
has a capacity of approximately 35 billion cigarettes per year. Production
began at the new factory in June 1999.

         NEW VALLEY RECAPITALIZATION. On June 4, 1999, following approval by
New Valley's stockholders, New Valley consummated a plan of recapitalization.
Under the recapitalization, New Valley's outstanding preferred and common
shares were exchanged for new common shares and warrants. As a result of the
recapitalization, the Company increased its ownership from approximately 42.3%
of New Valley's outstanding common shares to 55.1%. New Valley became a
consolidated subsidiary of the Company as of June 1, 1999. In addition, the
Company's equity in New Valley increased by $59,263($38,331, net of taxes).
Prior to the recapitalization, the Company had accounted for its investment in
New Valley's common shares using the equity method and its New Valley preferred
shares were classified as available for sale and carried at fair value.

         NEW VALLEY SHOPPING CENTERS. In July 1999, New Valley agreed to sell
five of its shopping centers for an aggregate purchase price of $46,100 (before
closing adjustments and expenses) including the assumption of $35,000 of
mortgage financing. Closing of the sale is subject to completion of due
diligence and other customary conditions.


RECENT DEVELOPMENTS IN 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 June 30, 1999, there were approximately 275 individual
suits, 50 purported class actions and 90 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 and the
Food and Drug Administration. There have also been 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




                                     -32-
<PAGE>   34

these developing matters on pending litigation or the possible commencement of
additional litigation, but 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 11 to the Company's Consolidated Financial
Statements for a description of legislation, regulation and litigation.

         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. 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 Master Settlement Agreement,
$14,928 of net charges accrued for the prior settlements were reversed in 1998.
See the discussions of the tobacco litigation settlements appearing in Note 11
to the Company's Consolidated Financial Statements.


RESULTS OF OPERATIONS
<TABLE>
<CAPTION>

                                          Three Months Ended             Six Months Ended
                                               June 30,                      June 30,
                                          -------------------          -------------------
                                          1999           1998          1999           1998
                                          ----           ----          ----           ----
                                                       (Dollars in Thousands)
<S>                                     <C>            <C>            <C>            <C>
  Net revenues:
    Liggett.....................        $  93,926      $  83,398      $179,973       $149,024
    Liggett-Ducat...............           15,339         27,864        37,689         47,041
                                         --------       --------      --------       --------
      Total tobacco.............          109,265        111,262       217,662        196,065

*Broker-dealer..................            5,876                        5,876
*Real estate....................              754                          754
                                       ----------    -------------  ----------       --------
      Total revenues............          115,895        111,262       224,292        196,065

  Operating income:
    Liggett.....................           16,146          8,895        36,215         15,146
    Liggett-Ducat...............             (807)         7,018           568          8,728
                                        ---------      ---------    ----------      ---------
      Total tobacco.............           15,339         15,913        36,783         23,874

*Broker-dealer..................             (107)                        (107)
*Real estate....................             (371)                        (371)
  Corporate and other...........           (1,263)        (2,974)         (574)        (3,271)
                                        ---------       --------    ----------      ---------
      Total operating income....        $  13,598      $  12,939     $  35,731      $  20,603
                                         ========       ========      ========       ========
</TABLE>
--------------------

     * New Valley became a consolidated subsidiary on June 1, 1999. Results of
       operations are included for the month ended June 30, 1999.

Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998

         Revenues. Total revenues were $115,895 for the three months ended June
30, 1999 compared to $111,262 for the three months ended June 30, 1998. This
4.2% increase in revenues was due to a $10,528 or 12.6% increase in revenues at
Liggett and the addition of one month's revenues from New Valley of $6,630
offset by a decrease in revenues of $12,525 at Liggett-Ducat. The decline in
Liggett-Ducat's revenues was due primarily to the closing of its old factory in
March 1999 and the temporary halt in production in connection with the move to
its new factory which became operational in mid-June 1999.



                                     -33-
<PAGE>   35

         Tobacco Revenues. Total tobacco revenues were $109,265 for the three
months ended June 30, 1999 compared to $111,262 for the three months ended June
30, 1998. This 1.8% decrease in revenues was primarily due to a decline in
tobacco revenues at Liggett-Ducat of $12,525 offset by an increase at Liggett
of $10,528. Revenues at Liggett increased in both the premium and discount
segments by 12.6% ($10,528) due to price increases of $30,189 (see "Recent
Developments-Cigarette Pricing Activity"), partially offset by a 22.2% decline
in unit sales volume (approximately 332.1 million units), accounting for
$18,535 in volume variance and an unfavorable product mix of $1,126. The
decline in Liggett's unit sales volume was due primarily 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 and, to a lesser degree, the closing of the Philip Morris brand
transaction on May 24, 1999.

         Premium sales at Liggett for the second quarter of 1999 amounted to
$23,297 and represented 24.8% of Liggett's total sales, compared to $26,994 and
32.4% of total sales in the second quarter of 1998. Premium revenues declined
by 13.7% ($3,697) for the three months ended June 30, 1999, compared to the
prior year period, due, in part, to the overall industry decline and also to
the contribution of the three premium brands, Lark, Chesterfield and L & M, to
Trademarks LLC on May 24, 1999 which accounts in part for an unfavorable volume
variance of $10,688 reflecting a 39.6% decline in unit sales volume
(approximately 158.7 million units), which was partially offset by price
increases of $6,991.

         Discount sales at Liggett (comprising the brand categories of branded
discount, private label, control label, generic, international and contract
manufacturing) for the three months ended June 30, 1999 amounted to $70,629 and
represented 75.2% of Liggett's total sales, compared to $56,404 and 67.6% of
total sales for the three months ended June 30, 1998. In the discount segment,
revenues grew by 25.2% ($14,225) for the three months ended June 30, 1999
compared to the prior year period, due to price increases of $23,198, which
were partially offset by a 15.8% decline in unit sales volume (approximately
173.4 million units), accounting for $8,944 in volume variance and an
unfavorable product mix among the discount brand categories of $29.

         For the three months ended June 30, 1999, fixed manufacturing costs at
Liggett were $1,068 higher than in the same period 1998, with an increase in
costs per thousand units of $1.59 per thousand due to the impact of lower
volumes on fixed costs.

         Net tobacco revenues at Liggett-Ducat for the three months ended June
30, 1999 decreased 45.0% over the same period in 1998 due to a 26.9% decrease
in unit sales volume ($7,484) and an 18.6% decrease in prices ($5,189),
slightly offset by a small favorable product mix ($148). The decline in sales
volume was due in large part to the temporary halt in production in connection
with the move to the new factory.

         Tobacco Gross Profit. Tobacco consolidated gross profit was $69,167
for the three months ended June 30, 1999 compared to $59,582 for the three
months ended June 30, 1998, an increase of $9,585 or 16.1% when compared to the
same period last year, reflecting an increase in gross profit at Liggett of
$16,146 offset by a decrease at Liggett-Ducat of $6,561 for the three months
ended June 30, 1999 compared to the same period in the prior year. For the
three months ended June 30, 1999, Liggett's premium brands contributed 24.8%
and discount brands contributed 71.5% to the Company's gross profit.
Liggett-Ducat contributed 3.7%. Over the same period in 1998, Liggett's premium
brands contributed 29.6%, Liggett's discount brands contributed 55.0% and
Liggett-Ducat contributed 15.4% to the Company's gross profit.

         Gross profit at Liggett of $66,462 for the three months ended June 30,
1999 increased $16,146 from gross profit of $50,316 for the second quarter of
1998, due primarily to the price increases discussed above. (See "Recent
Developments-Cigarette Pricing Activity".) In the second quarter of 1999,




                                     -34-
<PAGE>   36

Liggett's premium and discount brands contributed 25.8% and 74.2%,
respectively, to Liggett's gross profit. Over the same period in 1998,
Liggett's premium and discount brands contributed 35.0% and 65.0%,
respectively, to Liggett's gross profit. As a percent of revenues (excluding
federal excise taxes), gross profit at Liggett increased to 82.7% for the three
months ended June 30, 1999 compared to 76.5% for the same period in 1998, with
gross profit for the premium segment at 84.0% in the 1999 period compared to
79.4% in the 1998 period. Gross profit for the discount segment was 82.3% for
the three months ended June 30, 1999 and 75.1% for the three months ended June
30, 1998. This increase is primarily the result of the 1998 list price
increases.

         As a percent of revenues (excluding Russian excise taxes), gross
profit at Liggett-Ducat decreased to 17.9% for the three months ended June 30,
1999 compared to 39.6% in the same period in 1998, primarily due to lower
prices and lower sales volumes coinciding with the move to the new factory.

         Broker-Dealer and Real Estate Revenues. For the month ended June 30,
1999, Ladenburg's revenues were $5,876 and real estate revenues were $754.

         Expenses. Operating, selling, general and administrative expenses were
$62,199 for the three months ended June 30, 1999 compared to $46,643 for the
same period last year, an increase of $15,556 due primarily to increased
expenses at Liggett of $8,895, an increase of $1,265 at Liggett-Ducat and an
increase of $7,392 caused by consolidation of New Valley, which was not a
consolidated subsidiary during the prior year. The increase in operating
expenses at Liggett was due primarily to higher spending for promotional and
marketing programs. The increase at Liggett-Ducat was primarily due to
increased administrative costs relating to the completion of the new factory.
These expenses were primarily offset by reduction in amortization expenses and
decreased systems development costs.

         Other Income (Expenses). For the three months ended June 30, 1999,
Liggett recognized a gain of $294,287 in connection with the closing of the
Philip Morris brand transaction. In addition, New Valley recognized a gain of
$3,801 on the sale of substantially all of Thinking Machines' assets.

         Interest expense was $12,073 for the three months ended June 30, 1999
compared to $19,637 for the same period last year. This decrease of $7,564 was
primarily due to a savings of $6,943 because of the redemption by Liggett of
its Senior Secured Notes on December 28, 1998 and lower interest expense of
approximately $1,690 at corporate due to the retirement of debt in May 1999.
This was offset by higher interest expense at BOL of $259 primarily due to
increased interest rates on credit facilities in Russia and the addition of
$784 interest expense of New Valley.

         Equity in earnings of affiliate was a loss of $1,569 for the two
months ended May 31, 1999 compared to a loss of $7,261 for the three months
ended June 30, 1998 and relates in both periods to New Valley's net loss
applicable to common shares of $20,525 and $25,754, respectively.

         Income tax expense for the second quarter of 1999 was $81,645 compared
to $381 for the second quarter of 1998. The effective tax rate for the three
months ended June 30, 1998 does not bear a customary relationship to pre-tax
accounting income principally as a consequence of the change in the valuation
allowance relating to deferred tax assets and foreign taxes.


Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998

         Revenues. Total revenues were $224,292 for the six months ended June
30, 1999 compared to $196,065 for the six months ended June 30, 1998. This
14.4% increase in revenues was due to a $30,949 or 20.8% increase in revenues




                                     -35-
<PAGE>   37

at Liggett and the addition of one month's revenues from New Valley of $6,630
offset by a decrease in revenues of $9,352 at Liggett-Ducat due primarily to
the temporary halt in production in connection with the move to the new
factory.

         Tobacco Revenues. Tobacco revenues at Liggett increased for both the
premium and discount segments due to price increases of $60,570 (see "Recent
Developments-Cigarette Pricing Activity") partially offset by an 18.6%
($27,692) decline in unit sales volume (approximately 510.0 million units) and
$1,929 in unfavorable sales mix. The decline in Liggett's unit 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. Also contributing to the decline in
the premium segment was the closing of the Philip Morris brand transaction on
May 24, 1999. The decrease in tobacco revenues at Liggett-Ducat is attributable
to decreased prices of $10,115 and a minor volume variance slightly offset by a
favorable product mix of $906 compared to the prior year period.
Liggett-Ducat's sales volume during the 1999 period was adversely affected by
the move to the new factory and price declines in Russia, following the
continued decline in the value of the ruble.

         Premium sales at Liggett for the six months ended June 30, 1999
amounted to $48,663 and represented 27.0% of total Liggett sales, compared to
$49,932 and 33.5% of total sales for the same period in 1998. In the premium
segment, revenues declined by 2.5% ($1,269) over the six months ended June 30,
1999, compared to the same period in 1998, due to an unfavorable volume
variance of $16,375, reflecting a 32.8% decline in unit sales volume
(approximately 249.6 million units), which was partially offset by price
increases of $15,106.

         Liggett's discount sales over the six month period amounted to
$131,310 and represented 73.0% of total Liggett sales, compared to $99,092 and
66.5% of total Liggett sales for the same period in 1998. In the discount
segment, revenues grew by 32.5% ($32,218) over the six months ended June 30,
1999 compared to the same period in 1998, due to price increases of $45,464,
partially offset by a 13.1% decline in unit sales volume (approximately 260.4
million units) accounting for $13,010 in volume variance and an unfavorable
product mix of $236. For the six months ended June 30, 1999, fixed
manufacturing costs on a basis comparable to the same period in 1998 were $937
higher, with an increase in costs per thousand units of $0.80 per thousand due
to the impact of lower volumes on fixed costs.

         Tobacco Gross Profit. Gross profit was $135,837 for the six months
ended June 30, 1999 compared to $102,397 for the six months ended June 30,
1998, an increase of $33,440 or 32.7% when compared to the same period last
year, due primarily to price increases at Liggett offset by the price declines
at Liggett-Ducat discussed above. Liggett's premium brands contributed 26.8% to
the Company's gross profit, the discount segment contributed 68.4% and
Liggett-Ducat contributed 4.8% for the six months ended June 30, 1999. Over the
same period in 1998, Liggett's premium brands contributed 12.4%, the discount
segment contributed 55.9% and Liggett-Ducat contributed 31.7%.

         Liggett's gross profit of $129,344 for the six months ended June 30,
1999 increased $39,590 from gross profit of $89,754 for the same period in
1998, due primarily to the price increases discussed above. In 1999, Liggett's
premium brands contributed 28.1% and Liggett's discount brands contributed
71.9% to Liggett's overall gross profit. Over the same period in 1998,
Liggett's premium brands contributed 36.2% and Liggett's discount brands
contributed 63.8% to Liggett's gross profit. As a percent of revenues
(excluding federal excise taxes), gross profit at Liggett increased to 84.1%
for the six months ended June 30, 1999 compared to 77.0% for the same period in
1998, with gross profit for the premium segment at 85.3% and 79.6% in the six
months ended June 30 of 1999 and 1998, respectively, and gross profit for the
discount segment at 83.6% and 75.6% in 1999 and 1998, respectively. This
increase is primarily the result of the 1998 list price increases.



                                     -36-
<PAGE>   38

         As a percentage of revenues (excluding Russian excise taxes), gross
profit at Liggett-Ducat decreased to 18.5% for the six months ended June 30,
1999 compared to 32.44% in the same period in 1998, due to lower prices and
reduced volume in connection with the move to the new factory.

         Broker-Dealer and Real Estate Revenues. New Valley's broker-dealer
revenues were $5,876 and real estate revenues were $754 for the month ended
June 30, 1999.

         Expenses. Operating, selling, general and administrative expenses were
$107,036 for the six months ended June 30, 1999 compared to $82,126 for the
prior year period. The increase of $24,910 is due primarily to an $18,045
increase at Liggett and additional expenses of $7,392 as a result of the
consolidation of New Valley. The increase in operating expenses at Liggett was
due primarily to higher spending for promotional and marketing programs.

        Other Income (Expenses). For the six months ended June 30, 1999,
Liggett recognized a gain of $294,287 in connection with the closing of the
Philip Morris brand transaction. In addition, New Valley recognized a gain of
$3,801 on the sale of substantially all of Thinking Machines' assets.

        Interest expense was $27,061 for the six months ended June 30, 1999
compared to $40,423 for the same period in the prior year. The decrease of
$13,662 is largely due to a saving of $13,319 because of the redemption by
Liggett of its Senior Secured Notes on December 28, 1998, and a savings of
$2,501 at BGLS due to the repurchase of a portion of BGLS' Senior Secured
Notes. This was offset by additional interest expense at Liggett-Ducat of
$1,689 and interest at New Valley of $784.

         Equity in earnings of affiliate was a loss of $9,198 for the five
months ended May 31, 1999 compared to a loss of $11,488 for the six months
ended June 30, 1998 and relates in both periods to New Valley's net loss
applicable to common shares of $44,326 and $44,429, respectively.

         Income tax expense for the six months ended June 30, 1999 was $83,374
compared to $1,312 for the six months ended June 30, 1998. The effective tax
rate does not bear a customary relationship to 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 increased $972 for the six months ended
June 30, 1999 and increased $6,627 for the six months ended June 30, 1998. Net
cash provided by operations for the six months ended June 30, 1999 was $12,116
compared to net cash used in operations of $17,409 for the comparable period of
1998. The increase of $29,525 in net cash provided by operating activities in
1999 over the prior year was primarily due to an increase in operating income
at Liggett, a reduction in debt service, resulting primarily from Liggett's
note redemption on December 28, 1998, an increase in deferred interest expense
at BGLS and an increase in accrued liabilities. In the 1998 period, cash
payments included interest payments by BGLS and Liggett of approximately
$28,800. In addition, increases in inventories and receivables were partially
offset by increases in payables and in other long-term liabilities.

         Cash provided by investing activities of $110,168 compares to cash
used of $5,452 for the periods ended June 30, 1999 and 1998, respectively. For
the six months ended June 30, 1999, the majority of the proceeds were from the
purchase of the Class A option by Philip Morris in May 1999 and loan proceeds
which Trademarks borrowed and distributed to Eve. In the 1999 period, these
proceeds were partially offset by capital expenditures for machinery and




                                     -37-
<PAGE>   39

equipment at Liggett of $6,972 and equipment and construction costs for the new
factory of $30,565 at Liggett-Ducat. Other payments made principally pertained
to broker-dealer transactions and real estate at New Valley. In 1998, capital
expenditures at Liggett of $694 and $6,444 at Liggett-Ducat were partially
offset by proceeds from the sale of equipment.

         Cash used in financing activities was $120,680 for the six months
ended June 30, 1999 as compared with cash provided of $29,404 for the six
months ended June 30, 1998. Cash was used in the 1999 period to retire the BGLS
Senior Secured Notes in the amount of $142,584. Cash was also used in 1999 to
decrease the margin loan at New Valley and for distributions on the Company's
common stock. Net borrowings under the revolving credit facilities were
$11,379, of which $420 is attributable to Liggett and $10,959 is attributable
to Liggett-Ducat. Proceeds included $4,976 of equipment financing and the
effect of the New Valley recapitalization. Proceeds in the 1998 period included
$20,000 from a participating loan made by Western Realty Ducat, $10,144 from
the issuance of stock and net borrowings under revolving credit facilities at
both Liggett and Liggett-Ducat of $4,207. These proceeds were offset primarily
by distributions on common stock of $3,055 and repayments on debt of $1,068.

         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 Philip Morris of
two options to purchase interests in the entity which acquired the three brands
of Eve were used to fund the redemption.

         The closing of the exercise by Philip Morris of the Class A option
occurred on May 24, 1999. Upon closing, Liggett received $145,000 from the
purchase of the Class A interest and the distribution of certain loan proceeds
by the entity to Eve, which guaranteed the loan.

         Liggett has a $40,000 credit facility under which $2,958 was
outstanding at June 30, 1999. Availability under the facility was approximately
$15,634 based on eligible collateral at June 30, 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, bore a rate of 9.25% at June 30,
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 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 computed in accordance with
the agreement). At June 30, 1999, Liggett was in compliance with all covenants
under the facility; Liggett's adjusted net worth was $40,300 and net working
capital was $34,826, as computed in accordance with the agreement. The facility
expires on March 8, 2000 subject to automatic renewal for an additional year
unless a notice of termination is given by the lender at least 60 days prior to
the anniversary date.

         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.

         On May 28, 1999, a newly formed entity owned by Liggett signed an
agreement to purchase an industrial facility for $8.4 million in Mebane, North
Carolina. Liggett plans to relocate its tobacco manufacturing operations to the
new facility. Liggett is currently seeking financing for the purchase, which is
subject to the completion of due diligence and other customary conditions.

         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




                                     -38-
<PAGE>   40

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 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 Note 11 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. On May 25, 1999, BGLS repurchased $132,687 principal amount of
its 15.75% Senior Secured Notes due 2001 (the "Notes"), together with accrued
interest thereon of $18,276, for a discounted purchase price of $147,694. The
purchases were made using the proceeds of the Philip Morris brand transaction
which closed on May 24, 1999.

         At June 30, 1999, BGLS had outstanding $100,177 principal amount of
the BGLS Notes which mature on January 31, 2001. Of this amount, $60,100 of the
Notes carry deferred interest. On March 2, 1998, BGLS entered into a standstill
agreement with the holders of $97,239 principal amount of its notes, who were
affiliated with Apollo, under which 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
had a total of $23,000 of deferred interest outstanding as of June 30, 1999.

      On August 6, 1999, the Company repurchased an additional $897 principal
amount of the BGLS Notes together with accrued interest thereon. BGLS and its
subsidiaries may, from time to time, based on current market conditions,
purchase additional BGLS Notes in the open market or in privately negotiated
transactions.

         BOL. Liggett-Ducat has recently completed construction of a new
cigarette factory on the outskirts of Moscow which became operational in June
1999. The new factory, which utilizes Western cigarette making technology and
has a capacity of approximately 35 billion units per 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 $21,795 at June 30, 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 $13,000 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 $220,500 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 June 30, 1999,





                                     -39-
<PAGE>   41
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 $19,982. Corporate expenditures (exclusive of
Liggett, BOL and New Valley) over the next twelve months for current operations
include cash interest expense of approximately $5,250, dividends on the
Company's shares (currently at an annual rate of approximately $6,300) and
corporate expenses. The Company anticipates funding its 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 exposed to market risks principally 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.

         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, Western Tobacco's, BrookeMil Ltd.'s and
Western Realty Ducat's operations are conducted in Russia. During 1998, the
economy of the Russian Federation entered a period of economic instability
which has continued in 1999. 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 the fiscal measures taken by government
and other actions beyond the control of companies operating in the Russian
Federation. The Company's Russian operations may be significantly affected by
these factors for the foreseeable future.

         Domestic Market Risk

         New Valley's market risk management procedures cover all market risk
sensitive financial instruments.

         Current and proposed underwriting, corporate finance, merchant banking
and other commitments at Ladenburg are subject to due diligence reviews by
Ladenburg's senior management, as well as professionals in the appropriate
business and support units involved. Credit risk related to various financing
activities is reduced by the industry practice of obtaining and maintaining
collateral. Ladenburg monitors its exposure to counterparty risk through the
use of credit exposure information, the monitoring of collateral values and the
establishment of credit limits.

         Equity Price Risk. Ladenburg maintained inventories of trading
securities at June 30, 1999 with fair values of $11,695 in long positions and
$2,979 in short positions. Ladenburg performed an entity-wide analysis of its
financial instruments and assessed the related risk and materiality. Based on
this analysis, in the opinion of management the market risk associated with the
Ladenburg's financial instruments at June 30, 1999 will not have a material
adverse effect on the consolidated financial position or results of operations
of the Company.



                                     -40-
<PAGE>   42

         New Valley held investment securities available for sale totaling
$48,114 at June 30, 1999. Approximately 43% of these securities represent an
investment in RJ Reynolds Tobacco Holdings and Nabisco Group Holdings, which
are defendants in numerous tobacco products-related litigation, claims and
proceedings. An adverse outcome in any of these proceedings against these
companies could have a significant effect on the value of New Valley's
investment.

         New Valley also holds long-term investments in limited partnerships
and limited liability companies. These investments are illiquid, and their
ultimate realization is subject to the performance of the investee entities.


NEW ACCOUNTING PRONOUNCEMENTS

         In June, 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 is effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000. SFAS 133 requires
that all derivative instruments be recorded on the balance sheet at fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction and, if it is, the type of hedge
transaction. The Company has not yet determined the impact that the adoption of
SFAS 133 will have on its earnings or statement of financial position.


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 Liggett-Ducat. The Company, New Valley and
Liggett-Ducat 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 Liggett-Ducat 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 payroll system were
completed in July 1999 with parallel upgrades to the human resources system
software scheduled for completion in August 1999. Enhancements to Liggett's



                                     -41-
<PAGE>   43

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 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.

         Ladenburg. Ladenburg has recently completed a plan to address Year 2000
compliance. Ladenburg's plan addresses external interfaces with third party
computer systems necessary in the broker-dealer industry. It also addresses
internal operations software necessary to continue operations on a daily basis.
Ladenburg believes that all phases of its Year 2000 plan have been completed and
cost approximately $650. The cost was inclusive of hardware and software
upgrades and replacements as well as consulting. All costs were incurred by July
1999. Ladenburg completed the contingency planning phase in May 1999.

         External Service Providers. The modifications for Year 2000 compliance
by the Company and its subsidiaries 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 Ladenburg's clearing agent. 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.


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 stockholders, 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



                                     -42-
<PAGE>   44

relating to the use of tobacco products and exposure to environmental tobacco
smoke, the effects of legislative actions, including tax increases,
governmental regulation and privately imposed smoking restrictions, decline in
consumption, 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, BrookeMil's and Western Realty
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 the BGLS 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, especially Ladenburg's clearing agent, 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.





                                     -43-
<PAGE>   45
                                    PART II

                               OTHER INFORMATION


Item 1.       Legal Proceedings

              Reference is made to Note 11, incorporated herein by reference,
              to the Consolidated Financial Statements of Brooke Group Ltd. and
              BGLS Inc. 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, have been issued or sold by
              the Company during the three months ended June 30, 1999.

Item 3.       Defaults Upon Senior Securities

              On June 4, 1999, New Valley consummated a recapitalization under
              which its outstanding Class A Senior Preferred Shares, Class B
              Preferred Shares and Common Shares were exchanged for new Common
              Shares and warrants. As a result of the recapitalization, all
              accrued and unpaid dividends on the preferred shares were
              eliminated.

Item 6.       Exhibits and Reports on Form 8-K

              (a)    Exhibits

              * 10.1       Amended and Restated Limited Liability Company
                           Agreement (Second Restatement) dated as of February
                           20, 1998 by and among Western Realty Development
                           LLC, New Valley, BrookeMil Ltd. ("BML") and Apollo
                           Real Estate Investment Fund III, L.P. ("Apollo")
                           (incorporated by reference to Exhibit 10.1 in New
                           Valley's Quarterly Report on Form 10-Q for the
                           quarterly period ended June 30, 1998, Commission
                           File No. 1-2493).

              * 10.2       Limited Liability Company Agreement, dated as of
                           June 18, 1998, by and among Western Realty Repin
                           LLC, Apollo and New Valley (incorporated by
                           reference to Exhibit 10.3 in New Valley's Quarterly
                           Report on Form 10-Q for the quarterly period ended
                           June 30, 1998, Commission File No. 1-2493).




                                     -44-
<PAGE>   46

              * 10.3       Participating Loan Agreement, dated as of June 18,
                           1998, by and between Western Realty Repin LLC and
                           BML (incorporated by reference to Exhibit 10.4 in
                           New Valley's Quarterly Report on Form 10-Q for the
                           quarterly period ended June 30, 1998, Commission
                           File No. 1-2493).

                10.4       Amended and Restated Formation and Limited Liability
                           Company Agreement of Trademarks LLC, dated as of May
                           24, 1999, among the Company, Liggett & Myers Inc.,
                           Eve Holdings Inc. ("Eve"), Liggett and Philip Morris
                           Incorporated, including the form of Trademark
                           License Agreement.

                10.5       Pledge Agreement dated as of May 24, 1999 from Eve,
                           as grantor, in favor of Citibank, N.A., as agent.

                10.6       Guaranty dated as of June 10, 1999 from Eve, as
                           guarantor, in favor of Citibank, N.A., as agent.

              * 10.7       Sale-Purchase Agreement, dated as of September 2,
                           1998, by and between New Valley and PW/MS OP Sub I,
                           LLC (incorporated by reference to Exhibit 2.1 in New
                           Valley's Current Report on Form 8-K dated September
                           28, 1998, Commission File No. 1-2493).

                10.8       Employment Agreement dated as of August 1, 1999,
                           between the Company and Joselynn D. Van Siclen.

                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 June 30,
                           1999 and 1998.

              * 99.3       New Valley Corporation's Interim Consolidated
                           Financial Statements for the quarterly periods ended
                           June 30, 1999 and 1998 (incorporated by reference to
                           New Valley's Quarterly Report on Form 10-Q for the
                           quarterly period ended June 30, 1999, Commission File
                           No. 1-2493).

                99.4       Brooke (Overseas) Ltd.'s Interim Consolidated
                           Financial Statements for the quarterly periods ended
                           June 30, 1999 and 1998.

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

    *Incorporated by reference

              (b) Reports on Form 8-K

              The Company filed the following Report on Form 8-K during the
              second quarter of 1999:

                                                                    FINANCIAL
                   DATE                       ITEMS                 STATEMENTS
                   ----                       -----                 ----------
               May 26, 1999                     5                      None




                                     -45-
<PAGE>   47

                                   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:  August 16, 1999






                                                 BGLS INC.
                                                 (REGISTRANT)

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

Date:  August 16, 1999






                                     -46-