<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 SEPTEMBER 30, 1999

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


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


<TABLE>
<CAPTION>

<S>                                                     <C>                                  <C>
               DELAWARE                                 1-5759                               65-0949535
    (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>
<S>                                                    <C>                                   <C>
               DELAWARE                                33-93576                              65-0949536
    (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 November 12, 1999 Brooke Group Ltd. had 21,989,782 shares of common
stock outstanding, and BGLS Inc. had 100 shares of common stock outstanding,
all of which are held by Brooke Group Ltd.

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



<PAGE>   2



                               BROOKE GROUP LTD.
                                   BGLS INC.

                                   FORM 10-Q

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>

                                                                                                          Page
                                                                                                          ----
PART I. FINANCIAL INFORMATION

<S>                                                                                                       <C>
Item 1. Brooke Group Ltd./BGLS Inc. Consolidated Financial Statements:

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

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

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

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

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

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

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

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

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

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk.....................................       44


PART II. OTHER INFORMATION

Item 1. Legal Proceedings..............................................................................       45

Item 2. Changes in Securities and Use of Proceeds......................................................       45

Item 3. Defaults Upon Senior Securities................................................................       45

Item 5. Other Information..............................................................................       45

Item 6. Exhibits and Reports on Form 8-K...............................................................       46

SIGNATURES.............................................................................................       48

</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>

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

Current assets:
  Cash and cash equivalents ................................................         $   6,314          $   7,396
  Receivables from clearing brokers ........................................            10,705
  Investment securities available for sale .................................            41,378
  Trading securities owned .................................................             9,779
  Accounts receivable - trade ..............................................            11,138             15,160
  Other receivables ........................................................             2,172                924
  Inventories ..............................................................            49,054             36,316
  Restricted assets ........................................................             1,113
  Deferred income taxes ....................................................            98,470             59,613
  Other current assets .....................................................             3,108              3,151
                                                                                     ---------          ---------
    Total current assets ...................................................           233,231            122,560

Property, plant and equipment, net .........................................           137,195             93,504
Investment in real estate, net .............................................            52,842
Long-term investments, net .................................................             7,431
Investment in joint venture ................................................            51,206
Restricted assets ..........................................................             8,919
Other assets ...............................................................            18,490             12,918
                                                                                     ---------          ---------
    Total assets ...........................................................         $ 509,314          $ 228,982
                                                                                     =========          =========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):

Current liabilities:
  Current portion of notes payable and long-term debt ......................         $  36,071          $  21,176
  Margin loan payable ......................................................               955
  Accounts payable .........................................................            26,880             13,880
  Cash overdraft ...........................................................               173                 77
  Securities sold, not yet purchased .......................................             2,696
  Accrued promotional expenses .............................................            20,368             23,760
  Accrued taxes payable ....................................................            49,584             14,854
  Accrued interest .........................................................             3,776             17,189
  Proceeds received for options ............................................                              150,000
  Other accrued liabilities ................................................            57,680             32,505
                                                                                     ---------          ---------
    Total current liabilities ..............................................           198,183            273,441

Notes payable, long-term debt and other obligations, less current portion ..           156,691            262,665

Noncurrent employee benefits ...............................................            19,696             21,701
Deferred income taxes ......................................................           140,122
Other liabilities ..........................................................            73,739             65,350
Minority interests .........................................................            45,622

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 27,822,779 shares, outstanding 21,989,782 shares ........             2,199              2,094
  Additional paid-in capital ...............................................           216,382            124,120
  Deficit ..................................................................          (308,391)          (512,182)
  Accumulated other comprehensive income (loss) ............................            (3,279)            24,774
  Other ....................................................................            (4,177)            (5,508)
  Less:  5,832,997 shares of common stock in treasury, at cost .............           (27,473)           (27,473)
                                                                                     ---------          ---------
      Total stockholders' deficit ..........................................          (124,739)          (394,175)
                                                                                     ---------          ---------

      Total liabilities and stockholders' equity (deficit) .................         $ 509,314          $ 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>
                                                                                   September 30,     December 31,
                                                                                        1999              1998
                                                                                  ---------------- ------------------
<S>                                                                               <C>                <C>
ASSETS:

Current assets:
  Cash and cash equivalents .............................................         $   6,314          $   7,396
  Receivables from clearing brokers .....................................            10,705
  Investment securities available for sale ..............................            41,378
  Trading securities owned ..............................................             9,779
  Accounts receivable - trade ...........................................            11,138             15,160
  Other receivables .....................................................             2,109                755
  Inventories ...........................................................            49,054             36,316
  Restricted assets .....................................................             1,113
  Deferred income taxes .................................................            98,470             59,613
  Other current assets ..................................................             2,776              2,946
                                                                                  ---------          ---------
      Total current assets ..............................................           232,836            122,186

Property, plant and equipment, net ......................................           137,180             93,481
Investment in real estate, net ..........................................            52,842
Long-term investments, net ..............................................             7,431
Investment in joint venture .............................................            51,206
Restricted assets .......................................................             8,919
Other assets ............................................................            17,329             11,729
                                                                                  ---------          ---------
      Total assets ......................................................         $ 507,743          $ 227,396
                                                                                  =========          =========

LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT):

Current liabilities:
  Current portion of notes payable and long-term debt ...................         $  35,729          $  20,955
  Margin loan payable ...................................................               955
  Accounts payable ......................................................            26,755             13,746
  Cash overdraft ........................................................                69                 63
  Securities sold, not yet purchased ....................................             2,696
  Due to parent .........................................................                               32,394
  Accrued promotional expenses ..........................................            20,368             23,760
  Accrued taxes payable .................................................            49,584             14,854
  Accrued interest ......................................................             3,776             17,188
  Proceeds received from options ........................................                              150,000
  Other accrued liabilities .............................................            53,221             31,556
                                                                                  ---------          ---------
      Total current liabilities .........................................           193,153            304,516

Notes payable, long-term debt and other obligations, less current portion           156,691            262,665

Noncurrent employee benefits ............................................            19,696             21,701
Deferred income taxes ...................................................           140,122
Other liabilities .......................................................            76,474             69,216
Minority interests ......................................................            45,622

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 ............................................           175,988             69,297
  Deficit ...............................................................          (296,724)          (524,773)
  Accumulated other comprehensive income ................................            (3,279)            24,774
                                                                                  ---------          ---------
      Total stockholder's deficit .......................................          (124,015)          (430,702)
                                                                                  ---------          ---------

      Total liabilities and stockholder's equity (deficit) ..............         $ 507,743          $ 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               Nine Months Ended
                                                                  ------------- -------------     ------------- -------------
                                                                   Sept. 30,     Sept. 30,          Sept. 30,     Sept. 30,
                                                                      1999          1998               1999          1998
                                                                  ------------- -------------     ------------- -------------

<S>                                                              <C>             <C>             <C>             <C>
Revenues:
  Tobacco* .................................................     $  135,932      $  108,179      $  353,594      $    304,207
  Broker-dealer transactions  ..............................         12,711                          18,587
  Real estate leasing ......................................          1,576                           2,330
                                                                 ----------      ----------      ----------      ------------
    Total revenues .........................................     $  150,219      $  108,179      $  374,511      $    304,207

Expenses:
  Cost of goods sold* ......................................         47,473          47,086         128,998           140,422
  Operating, selling, administrative and general expenses ..         83,384          48,115         190,395           130,241
                                                                 ----------      ----------      ----------      ------------
  Operating income .........................................         19,362          12,978          55,118            33,544

Other income (expenses):
  Interest and dividend income .............................            507              75           1,239               325
  Interest expense .........................................        (16,114)        (20,138)        (43,200)          (60,561)
  Equity in loss of affiliate ..............................           (908)         (8,935)        (10,106)          (20,383)
  Recognition of deferred gain on sale of assets ...........                                          7,050
  Gain in joint venture ....................................          1,740                             950
  Gain on sale of investments, net .........................            151                             478
  Sale of assets ...........................................          3,844             707           7,969             2,025
  Gain on brand transaction ................................           (189)                        294,098
  Other, net ...............................................          (427)            256           2,494              (705)
                                                                 ----------      ----------      ----------      ------------

Income (loss) from continuing operations before provision
    (benefit) for income taxes and minority interests ......          7,966         (15,057)        316,090           (45,755)
  Provision (benefit) for income taxes .....................          2,782          (2,447)         86,156            (1,135)
  Minority interests .......................................          1,046                            (336)
                                                                 ----------      ----------      ----------      ------------

Income (loss) from continuing operations ...................          6,230         (12,610)        229,598           (44,620)

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

Gain on disposal of discontinued operations ................                          3,208                             3,208

Loss on extraordinary items, net of taxes ..................           (354)                         (1,410)
                                                                 ----------      ----------      ----------      ------------

Net income (loss) ..........................................     $    5,876      $   (9,402)     $  229,437      $    (41,412)
                                                                 ==========      ==========      ==========      ============

Per basic common share:

  Income (loss) from continuing operations .................     $     0.28      $    (0.58)     $    10.44      $      (2.10)
                                                                 ==========      ==========      ==========      ============
  Income from discontinued operations ......................                     $     0.15      $     0.06      $       0.15
                                                                                 ==========      ==========      ============
  Loss from extraordinary items ............................     $    (0.02)                     $    (0.06)
                                                                 ==========                      ==========
  Net income (loss) applicable to common shares ............     $     0.26      $    (0.43)     $    10.44      $      (1.95)
                                                                 ==========      ==========      ==========      ============

Basic weighted average common shares outstanding ...........     21,990,917      21,867,543      21,990,917        21,262,709
                                                                 ==========      ==========      ==========      ============

Per diluted common share:

  Income (loss) from continuing operations .................     $     0.21      $    (0.58)     $     7.68      $      (2.10)
                                                                 ==========      ==========      ==========      ============
  Income from discontinued operations ......................                     $     0.15      $     0.04      $       0.15
                                                                                 ==========      ==========      ============
  Loss from extraordinary items ............................     $    (0.01)                     $    (0.05)
                                                                 ==========                      ==========
  Net income (loss) applicable to common shares ............     $     0.20      $    (0.43)     $     7.67      $      (1.95)
                                                                 ==========      ==========      ==========      ============

Diluted weighted average common shares outstanding .........     29,864,048      21,867,543      29,902,071        21,262,709
                                                                 ==========      ==========      ==========      ============
</TABLE>


--------------------
*    Tobacco revenues and Cost of goods sold include excise taxes of $17,374,
     $20,244, $46,129 and $60,589, 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                Nine Months Ended
                                                                ------------------------------- ---------------------------------
                                                                  Sept. 30,        Sept. 30,       Sept. 30,        Sept. 30,
                                                                     1999            1998             1999             1998
                                                                ---------------  --------------  ---------------  ---------------

<S>                                                             <C>              <C>              <C>              <C>
Revenues:
  Tobacco* ..............................................       $ 135,932        $ 108,179        $ 353,594        $ 304,207
  Broker dealer transactions ............................          12,711                            18,587
  Real estate leasing ...................................           1,576                             2,330
                                                                ---------        ---------        ---------        ---------
    Total revenues ......................................       $ 150,219        $ 108,179        $ 374,511        $ 304,207

Expenses:
  Cost of goods sold* ...................................          47,473           47,086          128,998          140,422
  Operating, selling, administrative and general expenses          82,961           46,838          189,421          127,635
                                                                ---------        ---------        ---------        ---------
    Operating income ....................................          19,785           14,255           56,092           36,150

Other income (expenses):
  Interest and dividend income ..........................             506               65            1,236              184
  Interest expense ......................................         (17,060)         (21,270)         (46,735)         (63,832)
  Equity in loss of affiliate ...........................            (908)          (8,935)         (10,106)         (20,383)
  Recognition of deferred gain on sale of assets ........                                             8,264
  Gain in joint venture .................................           1,740                               950
  Gain on sale of investments, net ......................             151                               478
  Sale of assets ........................................           3,844                             7,969            1,318
  Gain on brand transaction .............................            (189)                          294,098
  Other, net ............................................            (435)              94            2,456             (870)
                                                                ---------        ---------        ---------        ---------

Income (loss) from continuing operations before provision
    (benefit) for income taxes and minority interests ...           7,434          (15,791)         314,702          (47,433)
  Provision (benefit) for income taxes ..................           2,782           (2,447)          86,156           (1,135)
  Minority interests ....................................           1,046                              (336)
                                                                ---------        ---------        ---------        ---------

Income (loss) from continuing operations ................           5,698          (13,344)         228,210          (46,298)

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

Gain on disposal of discontinued operations .............                            3,208                             3,208

Loss on extraordinary items, net of taxes ...............            (354)                           (1,410)
                                                                ---------        ---------        ---------        ---------

Net income (loss) .......................................       $   5,344        $ (10,136)       $ 228,049        $ (43,090)
                                                                =========        =========        =========        =========

</TABLE>


-------------------
* Tobacco revenues and cost of goods sold include excise taxes of $17,374,
  $20,244, $46,129 and $60,589, 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
                                              Common Stock     Additional                                    Other
                                           ------------------   Paid-In               Treasury            Comprehensive
                                            Shares     Amount   Capital    Deficit     Stock      Other   Income (Loss)   Total
                                           ---------   ------  ---------  ---------   --------   -------  ------------- ---------

<S>                                        <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 .............................                                    229,437                                       229,437
  Unrealized loss on investment
   securities ..........................                                                                       (3,501)     (3,501)
  Effect of New Valley recapitalization
   on other comprehensive loss .........                                                                      (24,647)    (24,647)
  Other New Valley capital
   transactions ........................                                                                           95          95
                                                                                                                        ---------
     Total other comprehensive loss ....                                                                                  (28,053)
                                                                                                                        ---------
Total comprehensive income .............                                                                                  201,384
                                                                                                                        ---------

Effect of stock dividend ...............   1,046,052      105     25,541    (25,646)

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

New Valley purchase of preferred
  stock in subsidiary ..................                             850                                                      850
Distributions on common stock ..........                          (8,340)                                                  (8,340)
Amortization of deferred
  compensation .........................                           1,285                           1,331                    2,616
                                          ----------   ------  ---------  ---------   --------   -------    ---------   ---------

Balance, September 30, 1999 ............  21,989,782   $2,199  $ 216,382  $(308,391)  $(27,473)  $(4,177)   $  (3,279)  $(124,739)
                                          ==========   ======  =========  =========   ========   =======    =========   =========

</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 (Loss)      Total
                                                        ------- ------     ----------     -------     -------------       ------

<S>                                                       <C>      <C>     <C>           <C>             <C>             <C>
Balance, December 31, 1998 .........................      100    $         $ 69,297      $(524,773)      $  24,774       $(430,702)

Net income .........................................                                       228,049                         228,049
  Unrealized loss on investment securities .........                                                        (3,501)         (3,501)
  Other New Valley capital transactions ............                                                            95              95
  Effect of New Valley recapitalization on other
    comprehensive loss .............................                                                       (24,647)        (24,647)
                                                                                                                         ---------
      Total other comprehensive loss ...............                                                                       (28,053)
                                                                                                                         ---------
Total comprehensive income .........................                                                                       199,996
                                                                                                                         ---------

Capital contribution ...............................                         31,260                                         31,260

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

New Valley purchase of preferred stock in subsidiary                            850                                            850

Amortization of deferred compensation ..............                          1,655                                          1,655
                                                          ---     ---      --------      ---------       ---------       ---------

Balance, September 30, 1999 ........................      100    $         $175,988      $(296,724)      $  (3,279)      $(124,015)
                                                          ===     ===      ========      =========       =========       =========
</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>
                                                                                          Nine Months Ended
                                                                                  ----------------------------------
                                                                                     Sept. 30,        Sept. 30,
                                                                                       1999              1998
                                                                                  ---------------- -----------------

<S>                                                                                  <C>              <C>
Net cash provided by (used in) operating activities.........................         $  30,750        $ (17,847)
                                                                                      --------         --------

Cash flows from investing activities:
  Proceeds from sale of businesses and assets, net..........................               932            2,377
  Proceeds from brand transaction...........................................           145,000
  Sale or maturity of investment securities.................................             3,234
  Purchase of investment securities.........................................            (6,737)
  Purchase of long-term investments.........................................            (2,902)
  Proceeds from sale or purchase of real estate, net........................            47,550
  Payment of prepetition claims.............................................               (67)
  Capital expenditures......................................................           (44,372)         (17,289)
                                                                                      --------         --------

Net cash provided by (used in) investing activities.........................           142,638          (14,912)
                                                                                      --------         --------

Cash flows from financing activities:
  Proceeds from debt........................................................             4,976            4,425
  Repayments of debt........................................................          (187,582)          (1,520)
  Borrowings under revolver.................................................           262,084          208,434
  Repayments on revolver....................................................          (247,196)        (210,050)
  Purchase of preferred stock in subsidiary.................................            (1,509)
  Effect of New Valley recapitalization.....................................             9,055
  Decrease in margin loan payable...........................................            (5,046)
  Increase in cash overdraft................................................                95              460
  Distributions on common stock.............................................            (8,446)          (3,055)
  Proceeds from participating loan..........................................                             25,000
  Issuance of common stock..................................................                             10,144
                                                                                      --------         --------

Net cash (used in) provided by financing activities.........................          (173,569)          33,838
                                                                                      --------         --------

Effect of exchange rate changes on cash and cash equivalents................              (901)             557
Net (decrease) increase in cash and cash equivalents........................            (1,082)           1,636
Cash and cash equivalents, beginning of period..............................             7,396            4,754
                                                                                      --------         --------

Cash and cash equivalents, end of period....................................        $    6,314       $    6,390
                                                                                      ========         ========

Supplemental non-cash investing and financing activities:

Issuance of stock to Liggett bondholders....................................                              4,105
Issuance of stock to consultants............................................                              3,705
Issuance of warrants........................................................                             22,421
Issuance of stock dividends.................................................            25,646



</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>

                                                                       Nine Months Ended
                                                               ---------------- -----------------
                                                                  Sept. 30,        Sept. 30,
                                                                    1999              1998
                                                               ---------------- -----------------

<S>                                                               <C>             <C>
Net cash provided by (used in) operating activities ........      $  22,513       $  (9,783)
                                                                  ---------       ---------

Cash flows from investing activities:
  Proceeds from sale of businesses and assets, net .........            932           1,670
  Proceeds from brand transaction ..........................        145,000
  Sale or maturity of investment securities ................          3,234
  Purchase of investment securities ........................         (6,737)
  Purchase of long-term investments ........................         (2,902)
  Proceeds from sale or purchase of real estate, net .......         47,550
  Payment of prepetition claims ............................            (67)
  Capital expenditures .....................................        (44,372)        (17,289)
                                                                  ---------       ---------

Net cash provided by (used in) investing activities ........        142,638         (15,619)
                                                                  ---------       ---------

Cash flows from financing activities:
  Proceeds from debt .......................................          4,500           3,950
  Repayments of debt .......................................       (187,226)         (1,433)
  Borrowings under revolver ................................        262,084         208,434
  Repayments on revolver ...................................       (247,196)       (210,050)
  Purchase of preferred stock in subsidiary ................         (1,509)
  Effect of New Valley recapitalization ....................          9,055
  Increase in margin loan payable ..........................         (5,046)
  Increase in cash overdraft ...............................              6             514
  Proceeds from participating loan .........................                         25,000
                                                                  ---------       ---------

Net cash (used in) provided by financing activities ........       (165,332)         26,415
                                                                  ---------       ---------

Effect of exchange rate changes on cash and cash equivalents           (901)            557
Net (decrease) increase in cash and cash equivalents .......         (1,082)          1,570
Cash and cash equivalents, beginning of period .............          7,396           4,754
                                                                  ---------       ---------

Cash and cash equivalents, end of period ...................      $   6,314       $   6,324
                                                                  =========       =========

Supplemental non-cash investing and financing activities:

Issuance of stock to Liggett bondholders ...................                         4,105
Issuance of stock to consultants ...........................                         3,705
Issuance of warrants .......................................                        22,421


</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
      primarily in the investment banking and brokerage business through its
      ownership of Ladenburg Thalmann & Co. Inc., in the real estate
      development business in Russia and in investment in Internet-related
      businesses.

      Effective October 1, 1999, the Company was reorganized into a holding
      company form of organizational structure. The new corporate structure was
      implemented by the merger of a wholly-owned indirect subsidiary of the
      former Brooke Group Ltd. (the "Predecessor") with the Predecessor, which
      was the surviving corporation. As a result of this merger, each share of
      the common stock of the Predecessor issued and outstanding or held in its
      treasury was converted into one share of common stock of the Company
      (formerly known as BGL Successor Inc.). The Company became the holding
      company for the business and operations previously conducted by the
      Predecessor and its subsidiaries, and the Predecessor became an indirect
      wholly-owned subsidiary of the Company. On the effective date of the
      merger, the name of the Company was changed to Brooke Group Ltd. and the
      name of the Predecessor was changed to Brooke Group Holding Inc. ("Brooke
      Group Holding"). The holding company reorganization had no impact on these
      consolidated financial statements.

      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.




                                     -10-
<PAGE>   12

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

      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.

      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:

      Information concerning the Company's common stock has been adjusted to
      give effect to the 5% stock dividend paid to Company stockholders on
      September 30, 1999. The dividend was charged to retained earnings in the
      net amount of $25,646, which was based on the fair value of the Company's
      common stock. In connection with the 5% dividend, the Company increased
      the number of warrants and stock options by 5% and reduced the exercise
      prices accordingly. All share amounts have been presented as if the stock
      dividend had occurred on January 1, 1998.

      For the three and nine months ended September 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 nine months ended September 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 nine months ended September 30, 1999, total
      comprehensive income was $201,384. For the nine months ended September
      30, 1998, the total comprehensive loss was $22,225.




                                     -11-
<PAGE>   13

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


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
      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 11.)

      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.



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

      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".

      Summarized financial information for New Valley for the periods ended May
      31, 1999 and September 30, 1998 when the Company was an equity investor
      follows:

<TABLE>
<CAPTION>
                                                          Five Months Ended          Nine Months Ended
                                                            May 31, 1999               Sept. 30, 1998
                                                      -------------------------- ---------------------------

       <S>                                                    <C>                         <C>
       Revenues   ....................................        $ 39,452                    $ 78,552
       Costs and expenses..............................         50,659                      95,633
       Loss from continuing operations.................        (10,668)                    (15,458)
       Gain from discontinued operations...............          4,100                       7,740
       Net loss applicable to common shares(A).........        (44,327)                    (67,051)
</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 exercisable 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



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

      Company's ownership of the outstanding Common Shares of New Valley
      increased from 42.3% to 55.1%, and its total voting power increased 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.

      On August 30, 1999, New Valley completed the sale of five of its shopping
      centers for an aggregate purchase price of $46,125 (before closing
      adjustments and expenses) including the assumption of $35,023 of mortgage
      financing. In connection with the transaction, New Valley recorded a gain
      of $3,849 for the three and nine months ended September 30, 1999.


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, New Valley's recapitalization and the sale of
      New Valley's office buildings, shopping centers and the Thinking Machines
      assets 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             Nine Months Ended
                                                         December 31, 1998           Sept. 30, 1999
                                                     -------------------------- -------------------------

       <S>                                                   <C>                    <C>
       Revenues.................................               $462,235               $389,187
                                                                =======                =======

       Operating income.........................              $  24,135               $ 39,358
                                                                =======                =======

       Income from continuing operations........             $    7,447               $ 13,853
                                                                =======                =======

       Net income...............................              $  11,712               $ 14,516
                                                                =======                =======

       Net income per common share:
           Basic................................                  $0.55                  $0.66
                                                                =======                =======
           Diluted..............................                  $0.45                  $0.49
                                                                =======                =======
</TABLE>



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

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 $65,875,
      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 $39,581 had been funded
      through September 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
      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 September 30, 1999 for Western
      Realty Ducat follows:

                                             September 30, 1999
                                             ------------------

            Current assets ..............      $  5,174
            Participating loan receivable        36,470
            Real estate, net ............        85,519
            Furniture and fixtures, net .           335
            Other noncurrent assets .....           371
            Goodwill, net ...............         5,778
            Notes payable-current .......         6,192
            Other current liabilities ...         6,939
            Notes payable - long-term ...         9,915
            Other long-term liabilities .           753
            Members' equity .............       109,848

      Western Realty Ducat has made a $30,000 participating loan to, and
      payable out of a 30% profits interest in, 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 11 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



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

      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. In addition, Western Realty Ducat is entitled to receive a
      15% annual rate of return on amounts advanced as the loan under certain
      circumstances in the event of a sale or refinancing of Western Tobacco or
      the new factory. Any rights of repayment on the loan are subordinate to
      the rights of all other creditors of BML. Western Tobacco has recognized
      net interest expense of $4,218 and $4,479 for the three and nine months
      ended September 30, 1999, which represents a 15% cumulative adjustment to
      realizable value on the loan plus 30% of any net expense applicable to
      common interests in Western Tobacco. The loan is classified in other
      long-term liabilities on the consolidated balance sheet at September 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 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 September 30, 1999.
      Apollo will be entitled to a preference on distributions of cash from
      Western Realty Repin to the extent of its investment of $25,875 together
      with a 20% annual rate of return, and New Valley will then be entitled to
      a return of its investment of $10,525, 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.

      Through September 30, 1999, Western Realty Repin has advanced $29,298, of
      which $18,773 was funded by Apollo under the Western Realty Repin loan.
      Apollo funded an additional advance of $7,125 under the Repin loan on
      October 1, 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,
      including the $7,125 advance in October 1999, 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 September 30, 1999, BML had invested $31,651 in the Kremlin sites
      and held $1,999 in cash and $1,392 in receivables from Western Realty
      Ducat, both of which were 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 $22,000 by May 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.




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


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 $41,378 at September 30, 1999 is comprised of
      marketable equity securities and warrants of $39,298 and notes receivable
      of $2,080.


7.    INVENTORIES

      Inventories consist of:
<TABLE>
<CAPTION>

                                                               September 30,       December 31,
                                                                   1999                1998
                                                             ------------------ -------------------

      <S>                                                           <C>              <C>
      Leaf tobacco.....................................             $14,714          $13,882
      Other raw materials..............................               9,074            4,629
      Work-in-process..................................               2,758            2,001
      Finished goods...................................              21,615           15,446
      Replacement parts and supplies...................               4,786            4,130
                                                                    -------          -------
      Inventories at current cost......................              52,947           40,088
      LIFO adjustments.................................              (3,893)          (3,772)
                                                                    -------          -------
                                                                    $49,054          $36,316
                                                                     ======           ======
</TABLE>

      At September 30, 1999, Liggett and Liggett-Ducat had leaf tobacco
purchase commitments of approximately $4,019 and $30,770, respectively.


8.    PROPERTY, PLANT AND EQUIPMENT

      Property, plant and equipment consist of:

<TABLE>
<CAPTION>
                                                         September 30,       December 31,
                                                             1999                1998
                                                       ------------------ -------------------

<S>                                                        <C>             <C>
            Land and improvements ...................      $     415       $     412
            Buildings ...............................         51,167           5,823
            Machinery and equipment .................        122,567          54,144
            Construction-in-progress ................          5,049          66,981
                                                           ---------       ---------
                                                             179,198         127,360
            Less accumulated depreciation ...........        (42,003)        (33,856)
                                                           ---------       ---------
                                                           $ 137,195       $  93,504
                                                           =========       =========
</TABLE>



                                                 -17-
<PAGE>   19


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

      In May 1999, Liggett-Ducat completed construction of a new cigarette
      factory on the outskirts of Moscow and began production in June 1999. At
      September 30, 1999, the remaining liability under the construction
      contracts is $1,980 and the remaining liability under equipment purchase
      agreements is $23,428.


9.   LADENBURG, THALMANN & CO. INC.

     On September 14, 1999, New Valley agreed to sell for $10,200 a 19.9%
     interest in its subsidiary Ladenburg, Thalmann & Co., Inc. ("Ladenburg")
     to Berliner Effektengesellschaft AG ("BEAG"). Pursuant to the agreement,
     BEAG will also acquire a three-year option to purchase additional
     interests in Ladenburg subject to certain conditions. Consummation of the
     transaction is subject to the approval of the New York Stock Exchange and
     other closing conditions.


10.  LONG-TERM INVESTMENTS

      At September 30, 1999, long-term investments consisted primarily of
      investments in limited partnerships of $7,649. The Company believes the
      fair value of the limited partnerships exceeds their carrying amount by
      approximately $4,413 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 $4,516 at September 30, 1999. New Valley
      owns a 33.33% interest in AtomicPop, an online music company, and smaller
      interests in other Internet companies.



                                     -18-
<PAGE>   20

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


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

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

<TABLE>
<CAPTION>
                                                                          September 30,     December 31,
                                                                              1999              1998
                                                                         ---------------- -----------------
<S>                                                                            <C>           <C>
            BGLS:
            15.75% Series B Senior Secured Notes due 2001,
                net of unamortized discount of $7,027 and $17,374 ....      $ 86,043      $215,490
            Deferred interest on 15.75% Series B Senior Secured
                Notes due 2001 .......................................        27,863        24,985

            New Valley:
            Notes payable ............................................        19,881

            Liggett:
            Revolving credit facility ................................         3,818         2,538
            Note payable .............................................         4,288

            BOL:
            Foreign credit facilities ................................        24,464        11,600
            Notes payable ............................................        23,428        28,057

            Other ....................................................         2,977         1,171
                                                                            --------      --------

            Total notes payable, long-term debt and other obligations        192,762       283,841
            Less:
                Current maturities ...................................        36,071        21,176
                                                                            --------      --------
            Amount due after one year ................................      $156,691      $262,665
                                                                            ========      ========
</TABLE>


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

      Through September 30, 1999, BGLS had repurchased $139,794 principal
      amount of its 15.75% Senior Secured Notes due 2001 (the "Notes"),
      together with accrued interest thereon. The purchases were funded
      primarily with proceeds from 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 September 30, 1999, the
      principal amount of Notes outstanding was $93,070. Of this amount,
      $60,600 principal amount of the Notes are held by the holders who have
      agreed to defer payment of interest as discussed below.

      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).




                                     -19-
<PAGE>   21

                               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
      2,100,000 shares of the Company's common stock at a price of $4.76 per
      share. The Apollo Holders were also issued a second warrant expiring
      October 31, 2004 to purchase an additional 2,257,500 shares of the
      Company's common stock at a price of $0.095 per share. The second warrant
      became exercisable on October 31, 1999.

      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:

      On August 30, 1999, New Valley completed the sale of five of its shopping
      centers for an aggregate purchase price of $46,125 before closing
      adjustments and expenses. The shopping centers were subject to
      approximately $35,023 of mortgage financing, which was assumed by the
      purchasers at closing.

      During the third quarter 1999, New Valley refinanced the notes payable
      for $19,898, in the aggregate, on its two remaining shopping centers in
      Florida and West Virginia. Interest rates range from 7.5% to 9.03% per
      annum. The four notes are due between 2002 and 2024. Two, for $8,510, are
      subject to call in 2001 under certain conditions.

      Revolving Credit Facility - Liggett:

      Liggett has a revolving credit facility (the "Facility") for $40,000 with
      a syndicate of commercial lenders which is collateralized by all
      inventories and receivables of Liggett. At September 30, 1999, $14,755
      was available under the Facility based on eligible collateral. Borrowings



                                     -20-
<PAGE>   22
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)

      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 9.75%
      at September 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
      permitted maximum adjusted net worth (not to fall below a deficit of
      $195,000 as computed in accordance with the agreement, this computation
      was $30,707 at September 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 $24,670 at September 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 Credit Facilities - Liggett-Ducat:

      At September 30, 1999, Liggett-Ducat had various credit facilities under
      which approximately $24,464 was outstanding. Facilities denominated in
      dollars amount to $17,000, of which $14,500 has been utilized, bear
      interest at rates of 20% to 25% and expire within the next twelve months.
      The remaining facilities, denominated in rubles (approximately $9,964 at
      the September 30, 1999 exchange rate), have terms of six to twelve months
      with interest rates of 50% to 63%. The facilities are collateralized by
      factory equipment and tobacco inventory.

      On November 1, 1999, Liggett-Ducat entered into an agreement with a
      Russian bank for a revolving credit facility for $14,500 denominated in
      dollars and collateralized by the new factory building bearing interest of
      13% and $3,000 denominated in rubles and collateralized by certain
      equipment bearing interest of 40%. The credit facility will be used to
      repay existing credit lines.

      Notes Payable - BOL:

      Western Tobacco has 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 $22,046 at September 30, 1999. BOL also has issued
      a promissory note for approximately $1,382 covering deposits for equipment
      being purchased for the new factory. The note is due March 31, 2000.


12.   EQUITY

      On November 4, 1999, the Company adopted its 1999 Long-Term Incentive
      Plan (the "Plan") subject to approval by the stockholders of the Company
      at next year's annual meeting. The Plan authorizes the granting of up to
      5,000,000 shares of the Company's common stock through awards of stock




                                     -21-
<PAGE>   23
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)

      options (which may include incentive stock options and/or nonqualified
      stock options), stock appreciation rights and shares of restricted
      Company common stock. All officers, employees and consultants of the
      Company and its subsidiaries are eligible to receive awards under the
      Plan.

      On November 4, 1999, the Company granted non-qualified stock options to
      six executive officers of the Company or its subsidiaries (the "Option
      Holders") pursuant to the Plan. The grant of the options to the Option
      Holders is conditioned upon the approval of the Plan by the Company's
      stockholders. Under the options, the Option Holders have the right to
      purchase an aggregate of 2,100,000 shares of the Company's common stock
      at an exercise price of $15 7/16 per share (the fair market value of a
      share of common stock on the date of grant), subject to increase under
      certain circumstances. Common stock dividend equivalents will be paid on
      each option share. The options have a ten-year term and become
      exercisable on the fourth anniversary of the date of grant. However, the
      options will earlier vest and become immediately exercisable upon (i) the
      occurrence of a "Change in Control" or (ii) the termination of the Option
      Holder's employment with the Company due to death or disability.


13.   CONTINGENCIES

      TOBACCO-RELATED LITIGATION:

      Overview. Since 1954, Liggett and other United States cigarette
      manufacturers have been named as defendants in numerous direct and
      third-party actions predicated on the theory that cigarette manufacturers
      should be liable for damages from cancer and other adverse health effects
      alleged to have been caused by cigarette smoking or by exposure to
      secondary smoke (environmental tobacco smoke, "ETS") from cigarettes.
      These cases are reported hereinafter as though having been commenced
      against Liggett (without regard to whether such cases were actually
      commenced against Brooke Group Holding, the Company's predecessor and a
      wholly-owned subsidiary of BGLS, 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
      the following categories: (i) smoking and health cases alleging personal
      injury brought on behalf of individual plaintiffs ("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
      nine months ended September 30, 1999, Liggett incurred counsel fees and
      costs totaling approximately $4,210, compared to $3,713 for the
      comparable prior year period.

      Individual Actions. As of September 30, 1999, there were approximately
      280 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, 82 were
      pending in Florida, 91 in New York, 30 in Massachusetts and 17 in Texas.
      The balance of the individual cases were pending in 22 states. There are
      six individual cases pending where Liggett is the only named defendant.



                                     -22-
<PAGE>   24
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)

      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, breach of special duty, 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 and
      violations of deceptive trade practice laws, the Federal Racketeer
      Influenced and Corrupt Organization Act ("RICO"), state RICO statutes and
      antitrust statutes. In many of these cases, in addition to compensatory
      damages, plaintiffs also seek other forms of relief including,
      treble/multiple damages, 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 September 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. Many of these actions purport to constitute
      statewide class actions and were filed after May 1996 when the Fifth
      Circuit Court of Appeals, in the Castano case (discussed below), reversed
      a Federal district court's certification of a purported nationwide class
      action on behalf of persons who were allegedly "addicted" to tobacco
      products.

      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.




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

      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, Broin and Engle, were
      certified in state court in Florida prior to the Fifth Circuit's
      decision. 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. The class consists of all
      Florida residents and citizens, and their survivors, who have suffered,
      presently suffer or have died from diseases and medical conditions caused
      by their addiction to cigarettes that contain nicotine. In July 1998,
      Phase I of the trial in this action commenced. On July 7, 1999, the jury
      returned the Phase I verdict. The Phase I verdict concerned certain issues
      determined by the trial court to be "common" to the causes of action of
      the plaintiff class. Among other things, the jury found that smoking
      cigarettes causes 20 diseases or medical conditions, that cigarettes are
      addictive or dependence producing, defective and unreasonably dangerous,
      that defendants made materially false statements with the intention of
      misleading smokers, that defendants concealed or omitted material
      information concerning the health effects and/or the addictive nature of
      smoking cigarettes and agreed to misrepresent and conceal the health
      effects and/or the addictive nature of smoking cigarettes, and that
      defendants were negligent and engaged in extreme and outrageous conduct or
      acted with reckless disregard with the intent to inflict emotional
      distress. The jury also found that defendants' conduct "rose to a level
      that would permit a potential award or entitlement to punitive damages."
      The court has decided that Phase II of the trial, which commenced November
      1, 1999, will be a causation and damages trial for three 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.
      (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 one case against Liggett in
      Florida and one in Maryland. A number of class certification decisions
      are on appeal.

      Governmental Actions. As of September 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, breach of special
      duty, fraud, negligent misrepresentation, conspiracy, public nuisance,
      claims under state and federal statutes governing consumer fraud,
      antitrust, deceptive trade practices and false advertising, and claims
      under RICO.



                                     -24-
<PAGE>   26


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

      On or about September 22, 1999, the United States of America commenced
      litigation against Liggett and the other tobacco companies in the United
      States District Court for the District of Columbia. The action seeks to
      recover healthcare costs paid for and furnished, and to be paid for and
      furnished, by the Federal Government for lung cancer, heart disease,
      emphysema and other tobacco-related illnesses caused by the fraudulent
      and tortious conduct of defendants, and to restrain defendants and
      co-conspirators from engaging in fraud and other unlawful conduct in the
      future, and to compel defendants to disgorge the proceeds of their
      unlawful conduct. The action is allegedly brought under the Medical Care
      Recovery Act and the Medicare secondary payer provisions of the Social
      Security Act and RICO.

      Third-Party Payor Actions. As of September 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, Brooke Group Holding and Liggett entered into
      an agreement, subject to court approval, to settle the Castano class
      action tobacco litigation. The Castano class was subsequently decertified
      by the court.

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

      In November 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,


                                     -25-
<PAGE>   27
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)

      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, Brooke Group Holding 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 45 states and
      territories.

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

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

      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




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


      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 Brooke Group Holding 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 Brooke Group Holding 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, Brooke Group Holding 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, Brooke Group Holding and plaintiffs filed
      an amended class action settlement agreement in Fletcher which agreement
      was preliminarily approved by the court in December 1998. On July 22,
      1999, the court denied approval of the Fletcher class action settlement.
      The parties' motion for reconsideration is still pending.

      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 Brooke Group Holding or Liggett
      scheduled for the remainder of 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 (April), two asbestos company contribution lawsuits in
      Mississippi and New York (February), one Class Action in Maryland
      (February) and a Third-Party Payor Action brought by unions in New York
      (June). Also, two Individual Actions 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. 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.



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

      The Company is not able to predict the outcome of the litigation pending
      against Brooke Group Holding or Liggett. Litigation is subject to many
      uncertainties. An unfavorable verdict has been returned in the first
      phase of the Engle smoking and health class action trial pending in
      Florida. It is possible that additional cases could be decided
      unfavorably and that there could be further adverse developments in the
      Engle case. An unfavorable outcome of a pending smoking and health case
      could encourage the commencement of additional similar litigation. The
      Company is unable to make a meaningful estimate with respect to the
      amount of loss that could result from an unfavorable outcome of many of
      the cases pending against Brooke Group Holding or Liggett, 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.

      SUBSEQUENT EVENTS:

      In connection with the Engle case, on October 20, 1999, the Third
      District Court of Appeal denied the defendants' motion to order the trial
      court to assess punitive damages on an individual basis. On October 29,
      1999, the defendants petitioned the Florida Supreme Court for relief. On
      November 3, 1999, the Florida Supreme Court requested briefing from the
      plaintiffs.


      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



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

      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
      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. Oral argument has been
      scheduled for December 1999. 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



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

      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 legislative and 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. These developments may negatively affect the
      perception of potential triers of fact with respect to the tobacco
      industry, possibly to the detriment of certain pending litigation, and
      may prompt the commencement of additional similar litigation.


      OTHER MATTERS:

      In March 1997, a shareholder derivative suit was filed against New
      Valley, as a nominal defendant, its directors and Brooke Group Holding 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. Brooke Group Holding's and New Valley's time to
      respond to the complaint has not yet expired. Brooke Group Holding and
      New Valley believe that the allegations are without merit. Although there
      can be no assurances, the Company is of the opinion, after consultation
      with counsel, that the ultimate resolution of this matter will not have a
      material adverse effect on the Company's consolidated financial position,
      results of operations or cash flows.

      On July 2, 1999, a purported class action was commenced on behalf of New
      Valley's former Class B preferred shareholders against New Valley, Brooke
      Group Holding 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. Brooke Group Holding
      and New Valley believe that the allegations are without merit. Although
      there can be no assurances, Brooke Group Holding 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
      consolidated financial position, results of operations or cash flows.

      On October 18, 1999, an action was commenced against a subsidiary of
      Brooke Group Holding. in the Supreme Court of the State of New York,
      County of New York. The Complaint alleges that under the terms of a 1993
      Put Agreement, Brooke Group Holding's subsidiary was obligated to
      purchase certain shares of plaintiff's stock for $7.5 million. In
      addition, the Complaint seeks prejudgment interest in the amount of
      approximately $3 million. The Company believes, and has been so advised
      by counsel, that it has a number of valid defenses to this matter.



                                     -30-
<PAGE>   32
                               BROOKE GROUP LTD.
                                   BGLS INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)

14.   SEGMENT INFORMATION

      Financial information for the Company's continuing operations before
      taxes and minority interest for the three and nine months ended September
      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>
Three Months Ended Sept. 30, 1999:

Net revenues............................         $108,676    $  27,256      $12,711       $  1,576     $                $150,219
Operating income (loss).................           19,689        4,262       (2,424)         1,683        (3,848)         19,362
Depreciation and amortization...........              747        1,649          244            450            12           3,102
Capital expenditures....................            1,112        5,350                                        46           6,508

Three Months Ended Sept. 30, 1998:

Net revenues............................           85,630       22,549                                                   108,179
Operating income (loss).................            8,685        2,177                                     2,116          12,978
Depreciation and amortization...........            1,738          253                                        60           2,051
Capital expenditures....................              488        9,663                                                    10,151


Nine Months Ended Sept. 30, 1999:

Net revenues............................          288,649       64,945       18,587          2,330                       374,511
Operating income (loss).................           55,904        4,830       (2,531)         1,312        (4,397)         55,118
Identifiable assets.....................          107,785      135,268       39,841         59,872       166,548         509,314
Depreciation and amortization...........            2,567        2,921          144            863             8           6,503
Capital expenditures....................            8,084       35,915                                       373          44,372

Nine Months Ended Sept. 30, 1998:

Net revenues............................          234,654       69,553                                                   304,207
Operating income (loss).................           23,830        9,651                                        63          33,544
Identifiable assets.....................           61,678       69,031                                    10,621         141,330
Depreciation and amortization...........            5,031          412                                       228           5,671
Capital expenditures....................            1,182       16,107                                                    17,289

</TABLE>

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




                                     -31-
<PAGE>   33




ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        RESULTS OF OPERATIONS

                (Dollars in Thousands, Except Per Share Amounts)


INTRODUCTION

         The following discussion provides an assessment of the consolidated
results of operations, capital resources and liquidity of Brooke Group Ltd.
(the "Company") and its subsidiaries and should be read in conjunction with the
Consolidated Financial Statements and notes thereto of the Company and BGLS
Inc. ("BGLS") included elsewhere in this document. BGLS is a wholly owned
subsidiary of the Company. The consolidated financial statements include the
accounts of BGLS, Liggett Group Inc. ("Liggett"), Brooke (Overseas) Ltd.
("BOL"), 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, real estate operations in Russia and investment in
Internet-related businesses 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.

         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.



                                     -32-
<PAGE>   34

         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. In August
1999, Philip Morris increased list prices by $1.80 per carton. Other major
manufacturers, including Liggett, followed suit.

         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. On August 30, 1999, New Valley completed
the sale of five of its shopping centers for an aggregate purchase price of
$46,125 (before closing adjustments and expenses) including the assumption of
$35,023 of mortgage financing. In connection with the transaction, New Valley
recorded a gain of $3,849 on the sale.


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 September 30, 1999, there were approximately 280
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. An unfavorable
verdict has been returned in the first phase of the Engle smoking and health
class action trial pending in Florida. It is possible that additional cases
could be decided unfavorably and that there could be further adverse
developments in the Engle case. 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



                                     -33-
<PAGE>   35


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
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 13 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 13
to the Company's Consolidated Financial Statements.


RESULTS OF OPERATIONS

<TABLE>
<CAPTION>
                                          Three Months Ended            Nine Months Ended
                                             September 30,                September 30,
                                          -------------------          -------------------
                                          1999           1998          1999           1998
                                          ----           ----          ----           ----
                                                       (Dollars in Thousands)

<S>                                      <C>           <C>            <C>            <C>
  Net revenues:
  Liggett.......................         $108,676      $  85,630      $288,649       $234,654
  Liggett-Ducat.................           27,256         22,549        64,945         69,553
                                         --------       --------      --------       --------
      Total tobacco.............          135,932        108,179       353,594        304,207

*Broker-dealer..................           12,711                       18,587
*Real estate....................            1,576                        2,330
                                         --------       --------      --------       --------
      Total revenues............          150,219        108,179       374,511        304,207

  Operating income:
  Liggett.......................           19,689          8,685        55,904         23,830
  Liggett-Ducat.................            4,262          2,177         4,830          9,651
                                         --------       --------      --------       --------
      Total tobacco.............           23,951         10,862        60,734         33,481

*Broker-dealer..................           (2,424)                      (2,531)
*Real estate....................            1,683                        1,312
  Corporate and other...........           (3,848)         2,116        (4,397)            63
                                         --------       --------      --------       --------
      Total operating income....        $  19,362      $  12,978     $  55,118      $  33,544
                                         ========       ========      ========       ========
</TABLE>


*New Valley became a consolidated subsidiary on June 1, 1999. Results of
 operations for New Valley are included for the three and four months ended
 September 30, 1999.

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

         Revenues. Total revenues were $150,219 for the three months ended
September 30, 1999 compared to $108,179 for the three months ended September
30, 1998. This 38.9% increase in revenues was due to a $23,046 or 26.9%
increase in revenues at Liggett, an increase of $4,707 or 20.9% in revenues at
Liggett-Ducat and the addition of three months' revenues from New Valley of
$14,287.



                                     -34-
<PAGE>   36

         Tobacco Revenues. Total tobacco revenues were $135,932 for the three
months ended September 30, 1999 compared to $108,179 for the three months ended
September 30, 1998. This 25.7% increase in revenues was primarily due to an
increase in tobacco revenues at Liggett and at Liggett-Ducat discussed above.
Revenues at Liggett increased in both the premium and discount segments
combined by 26.9% ($23,046) due to price increases of $33,224 (see "Recent
Developments-Cigarette Pricing Activity"), partially offset by a 7.0% decline
in unit sales volume (approximately 99.5 million units), accounting for $5,971
in volume variance and an unfavorable product mix of $4,207. The decline in
Liggett's unit sales volume was due primarily to the closing of the Philip
Morris brand transaction on May 24, 1999 as well as an overall decline in
industry volume, certain competitors continuing leveraged rebate programs tied
to their products and increased promotional activity by certain other
manufacturers.

         Premium sales at Liggett for the third quarter of 1999 amounted to
$15,114 and represented 13.9% of Liggett's total sales, compared to $26,986 and
31.5% of total sales in the third quarter of 1998. Premium revenues declined by
44.0% ($11,872) for the three months ended September 30, 1999, compared to the
prior year period, due primarily 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 $15,693 reflecting a
58.2% decline in unit sales volume (approximately 221.8 million units), which
was partially offset by price increases of $3,821. As adjusted for the
contribution of the three brands, the decline in Liggett's premium segment
compared to the prior year period was 13.5% (approximately 25.2 million units).
This compares to an overall industry decline in the premium segment of
approximately 10.4% in the third quarter of 1999 compared to prior year period.

         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 September 30, 1999 amounted to
$93,562 and represented 86.1% of Liggett's total sales, compared to $58,644 and
68.5% of total sales for the three months ended September 30, 1998. In the
discount segment, revenues grew by 59.5% ($34,918) for the three months ended
September 30, 1999 compared to the prior year period, due to price increases of
$29,403, along with an 11.7% increase in unit sales volume (approximately 122.3
million units), accounting for $6,860 in volume variance partially offset by an
unfavorable product mix among the discount brand categories of $1,345.

         For the three months ended September 30, 1999, fixed manufacturing
costs at Liggett were $1,541 lower than in the same period in 1998, with a
decrease in costs per thousand units of $1.25 per thousand due primarily to a
reduction in the fixed portion of indirect labor costs.

         Net tobacco revenues at Liggett-Ducat for the three months ended
September 30, 1999 increased 20.8% over the same period in 1998 due to a 36.5%
increase in unit sales volume ($8,236) (approximately 1,809 million units) and
a small favorable product mix of $317 offset by a 17.1% decrease in prices
($3,846).

         Tobacco Gross Profit. Tobacco consolidated gross profit was $88,459
for the three months ended September 30, 1999 compared to $61,093 for the three
months ended September 30, 1998, an increase of $27,366 or 44.8% when compared
to the same period last year, reflecting an increase in gross profit at Liggett
of $25,916 and at Liggett-Ducat of $1,450 for the three months ended September
30, 1999 compared to the same period in the prior year. For the three months
ended September 30, 1999, Liggett's premium brands contributed 13.0% and
discount brands contributed 77.8% to the Company's gross tobacco profit.
Liggett-Ducat contributed 9.2%. Over the same period in 1998, Liggett's premium
brands contributed 30.0%, Liggett's discount brands contributed 59.0% and
Liggett-Ducat contributed 11% to the Company's gross profit.


                                     -35-
<PAGE>   37


         Gross profit at Liggett of $80,163 for the three months ended
September 30, 1999 increased $25,916 from gross profit of $54,247 for the third
quarter of 1998, due primarily to the price increases discussed above. (See
"Recent Developments-Cigarette Pricing Activity".) As a percent of revenues
(excluding federal excise taxes), gross profit at Liggett increased to 85.6%
for the three months ended September 30, 1999 compared to 78.9% for the same
period in 1998, with gross profit for the premium segment at 86.7% in the 1999
period compared to 80.8% in the 1998 period. Gross profit for the discount
segment was 85.8% for the three months ended September 30, 1999 and 78.0% for
the three months ended September 30, 1998. This increase is primarily the
result of the 1998 list price increases, followed by the August 1999 increase.

         As a percent of revenues (excluding Russian excise taxes), gross
profit at Liggett-Ducat decreased 2.6% to 32.4% for the three months ended
September 30, 1999 compared to 35.0% in the same period in 1998, primarily due
to lower prices offset by higher sales volumes.

         Broker-Dealer and Real Estate Revenues. For the three months ended
September 30, 1999, Ladenburg's revenues were $12,711 and real estate revenues
were $1,576.

         Expenses. Operating, selling, general and administrative expenses were
$83,384 for the three months ended September 30, 1999 compared to $48,115 for
the same period last year, an increase of $35,269 due to increased expenses at
Liggett of $14,912 and an increase of $19,482 caused by consolidation of New
Valley, which was not a consolidated subsidiary during the prior year slightly
offset by a decrease of $464 at Liggett-Ducat. The increase in operating
expenses at Liggett was due primarily to higher spending for promotional and
marketing programs and increased administrative costs partially offset by a
reduction in legal expense and in amortization charges. At Liggett-Ducat, other
selling, general and administrative expenses were reduced over the prior year
period offset by increased depreciation due to the opening of the new factory
in June 1999 and increased marketing and advertising expense due primarily to
the introduction of western style cigarettes.

         Other Income (Expenses). For the three months ended September 30,
1999, other expense was $11,396 compared to expense of $28,035 for the prior
year period.

         Interest expense was $16,114 for the three months ended September 30,
1999 compared to $20,138 for the same period last year. This decrease of $4,024
was primarily due to a savings of $6,979 at Liggett because of the redemption
by Liggett of its Senior Secured Notes on December 28, 1998 and lower interest
expense of approximately $5,706 at corporate due to the repurchase of a portion
of BGLS' 15.75% Senior Secured Notes beginning in May 1999. This was offset by
the addition of $2,209 in interest expense of New Valley and higher interest
expense at Western Tobacco Investment LLC ("Western Tobacco") of $6,211
primarily due to increased interest rates on credit facilities in Russia and
non-cash interest expense under the participating loan agreement.

         New Valley contributed gains of $1,740 from its joint venture, $151
from sale of investments, and $3,849 from the sale of five of its U. S.
shopping centers.

         Equity in earnings of affiliate was a loss of $908 for the three
months ended September 30, 1999 compared to a loss of $8,935 for the three
months ended September 30, 1998. The 1999 loss relates to New Valley's minority
interests in its equity investees while the 1998 loss for the period relates to
New Valley's net loss applicable to common shares of $22,622 when the Company
accounted for its interest in New Valley on the equity method.




                                     -36-
<PAGE>   38

         Income tax expense for the third quarter of 1999 was $2,782 compared
to a tax benefit of $2,447 for the third quarter of 1998. The effective tax
rates for the three months ended September 30, 1999 and 1998 do 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.


Nine Months Ended September 30, 1999 Compared to Nine Months Ended
September 30, 1998

         Revenues. Total revenues were $374,511 for the nine months ended
September 30, 1999 compared to $304,207 for the nine months ended September 30,
1998. This 23.1% increase in revenues was due to a $53,995 or 23.0% increase in
revenues at Liggett and the addition of revenues from New Valley of $20,917
offset by a decrease in revenues of $4,608 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 $94,328 (see "Recent
Developments-Cigarette Pricing Activity") partially offset by a 14.6% ($34,290)
decline in unit sales volume (approximately 609.6 million units) and $6,043 in
unfavorable sales mix. The decline in Liggett's unit sales volume was due to an
overall decline in industry volume, the closing of the Philip Morris brand
transaction, certain competitors continuing leveraged rebate programs tied to
their products and increased promotional activity by certain other
manufacturers. The decrease in tobacco revenues at Liggett-Ducat is
attributable to decreased prices of $15,366 offset by a positive volume
variance of $9,011 and a favorable product mix of $1,747 compared to the prior
year period. Although volume increased by approximately 1,791 million units in
the nine months ended September 30, 1999, Liggett-Ducat's sales volume was
adversely affected by the move to the new factory and price declines in Russia.

         Premium sales at Liggett for the nine months ended September 30, 1999
amounted to $63,777 and represented 22.1% of total Liggett sales, compared to
$76,898 and 32.8% of total sales for the same period in 1998. In the premium
segment, revenues declined by 17.1% over the nine months ended September 30,
1999, compared to the same period in 1998, due to an unfavorable volume
variance of $31,728, reflecting a 41.3% decline in unit sales volume
(approximately 471.4 million units), primarily due to the closing of the Philip
Morris brand transaction on May 24, 1999, which was partially offset by price
increases of $18,607. As adjusted for the contribution of the three brands in
the Philip Morris brand transaction, the decline in Liggett's premium segment
from the prior year period was 21.5% (approximately 184.4 million units).
Although this decline compares unfavorably to an overall industry decline in
the premium segment of approximately 9.7% during the nine months of 1999,
Liggett's management believes that the percentage decline is consistent with
other, smaller premium brands.

         Liggett's discount sales over the nine month period amounted to
$224,872 and represented 77.9% of total Liggett sales, compared to $157,756 and
67.2% of total Liggett sales for the same period in 1998. In the discount
segment, revenues grew by 42.5% ($67,116) over the nine months ended September
30, 1999 compared to the same period in 1998, due to price increases of
$75,721, partially offset by a 4.6% decline in unit sales volume
(approximately 138.2 million units) accounting for $7,197 in volume variance
and an unfavorable product mix of $1,408.

         For the nine months ended September 30, 1999, fixed manufacturing
costs on a basis comparable to the same period in 1998 were $604 lower, with an
increase in costs per thousand units of $0.04 per thousand against a 6.0%
decline in production volume from the previous year.

         Tobacco Gross Profit. Tobacco consolidated gross profit was $224,596
for the nine months ended September 30, 1999 compared to $163,785 for the nine
months ended September 30, 1998, an increase of $60,811 or 37.1% 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



                                     -37-
<PAGE>   39

premium brands contributed 21.2% to the Company's gross profit, the discount
segment contributed 72.2% and Liggett-Ducat contributed 6.6% for the nine
months ended September 30, 1999. Over the same period in 1998, Liggett's
premium brands contributed 31%, the discount segment contributed 57% and
Liggett-Ducat contributed 12%.

         Liggett's gross profit of $209,507 for the nine months ended September
30, 1999 increased $66,139 from gross profit of $143,368 for the same period in
1998, due primarily to the price increases discussed above. As a percent of
revenues (excluding federal excise taxes), gross profit at Liggett increased to
84.5% for the nine months ended September 30, 1999 compared to 77.4% for the
same period in 1998, with gross profit for the premium segment at 85.5% and
79.8% in the nine months ended September 30 of 1999 and 1998, respectively, and
gross profit for the discount segment at 84.7% and 76.1% in 1999 and 1998,
respectively. This increase is primarily the result of the 1998 list price
increases and, to a lesser degree, list price increases in August 1999.

         As a percentage of revenues (excluding Russian excise taxes), gross
profit at Liggett-Ducat increased to 49.5% for the nine months ended September
30, 1999 compared to 33.3% in the same period in 1998, due to larger volume and
better product mix.

         Broker-Dealer and Real Estate Revenues. New Valley's broker-dealer
revenues were $18,587 and real estate revenues were $2,330 for the four months
ended September 30, 1999.

         Expenses. Operating, selling, general and administrative expenses were
$190,395 for the nine months ended September 30, 1999 compared to $130,241 for
the prior year period. The increase of $60,154 is due primarily to a $33,277
increase at Liggett and additional expenses of $26,849 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
partially offset by a reduction in amortization charges and legal expenses.

        Other Income (Expenses). For the nine months ended September 30, 1999,
Liggett recognized a gain of $294,098 in connection with the closing of the
Philip Morris brand transaction. In addition, New Valley recognized a gain of
$7,877 primarily on the sale of substantially all of Thinking Machines' assets
and the sale of five U. S. shopping centers. The Company also recognized in
March 1999 a deferred gain of $7,050 relating to the expiration of the put
obligation on Ducat Place III (the site of the old cigarette factory in Russia)
in connection with the 1997 sale of the BrookeMil Ltd. common shares.

        Interest expense was $43,200 for the nine months ended September 30,
1999 compared to $60,561 for the same period in the prior year. The decrease of
$17,361 is largely due to a savings of $20,297 because of the redemption by
Liggett of its Senior Secured Notes on December 28, 1998, and a savings of
$8,207 at BGLS due to the repurchase of a portion of BGLS' Senior Secured
Notes. This was offset by additional interest expense at Western Tobacco of
$8,174 and interest at New Valley of $3,018.

         Equity in earnings of affiliate was a loss of $10,106 and includes the
Company's loss in New Valley which was accounted for on the equity method for
the five months ended May 31, 1999 as well as losses at New Valley on its
equity method investees compared to a loss of $20,383 for the nine months ended
September 30, 1998 which relates to New Valley's net loss applicable to common
shares of $67,051 also accounted for on the equity method.

         Income tax expense for the nine months ended September 30, 1999 was
$86,156 compared to a benefit of $1,135 for the nine months ended September 30,
1998. The effective tax rates do 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.




                                     -38-
<PAGE>   40

CAPITAL RESOURCES AND LIQUIDITY

         Net cash and cash equivalents decreased $1,082 for the nine months
ended September 30, 1999 and increased $1,636 for the nine months ended
September 30, 1998. Net cash provided by operations for the nine months ended
September 30, 1999 was $30,750 compared to net cash used in operations of
$17,847 for the comparable period of 1998. The increase of $48,597 in net cash
provided by operating activities in the 1999 period 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 at BGLS and an increase in accrued
liabilities. In the 1998 period, cash payments included interest payments by
BGLS and Liggett of approximately $50,000. In addition, increases in
inventories were partially offset by decreases in receivables and in payables
and in other long-term liabilities.

         Cash provided by investing activities of $142,638 compares to cash
used of $14,912 for the periods ended September 30, 1999 and 1998,
respectively. For the nine months ended September 30, 1999, the majority of the
proceeds were from the purchase of the Class A option by Philip Morris in May
1999, loan proceeds which Trademarks borrowed and distributed to Eve and the
sale of real estate. In the 1999 period, these proceeds were partially offset
by capital expenditures primarily for machinery and equipment at Liggett of
$8,084 and equipment and construction costs for the new factory of $35,915 at
Liggett-Ducat. Other payments made principally pertained to broker-dealer
transactions and the sale of assets at New Valley. In the 1998 period, capital
expenditures at Liggett of $1,182 and $16,107 at Liggett-Ducat were partially
offset by proceeds from the sale of equipment.

         Cash used in financing activities was $173,569 for the nine months
ended September 30, 1999 as compared with cash provided of $33,838 for the nine
months ended September 30, 1998. Cash was used in the 1999 period to retire the
BGLS Senior Secured Notes in the amount of $149,735 and retire $35,023 of New
Valley mortgage financing relating to the five shopping centers sold in August
1999. Cash was also used in the 1999 period to decrease the margin loan at New
Valley, to purchase preferred stock in a New Valley subsidiary and for
distributions on the Company's common stock. Net borrowings under the revolving
credit facilities were $14,888, of which $1,380 is attributable to Liggett and
$13,508 is attributable to Liggett-Ducat. Proceeds included $4,976 of equipment
financing and the effect of the New Valley recapitalization ($9,055). Proceeds
in the 1998 period included $25,000 from a participating loan made by Western
Realty Ducat, $10,144 from the issuance of stock and net proceeds from debt of
$2,905. These proceeds were offset primarily by distributions on common stock
of $3,055 and repayments under revolving credit facilities of $1,616.

         Liggett. On December 28, 1998, Liggett redeemed the entire outstanding
$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 $3,818 was
outstanding at September 30, 1999. Availability under the facility was
approximately $14,755 based on eligible collateral at September 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%
through June 30, 1999, 9.50% for the months of July and August 1999 and 9.75%
at September 30, 1999. The facility requires Liggett's compliance with certain



                                     -39-
<PAGE>   41

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 September 30, 1999, Liggett was in
compliance with all covenants under the facility; Liggett's adjusted net worth
was $30,707 and adjusted net working capital was $24,670, 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. The loan, which is collateralized by the
equipment, is payable in 60 monthly installments of $56 including annual
interest of 7.67% 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's predecessor, Brooke
Group Holding) and other United States cigarette manufacturers have been named
as defendants in a number of direct and third-party actions (and purported
class actions) predicated on the theory that they should be liable for damages
from cancer and other adverse health effects alleged to have been caused by
cigarette smoking or by exposure to so-called secondary smoke (environmental
tobacco smoke) from cigarettes. The Company believes, and has been so advised
by counsel handling the respective cases, that Brooke Group Holding and Liggett
have a number of valid defenses to claims asserted against them. Litigation is
subject to many uncertainties. An unfavorable verdict has been returned in the
first phase of the Engle smoking and health class action trial pending in
Florida. It is possible that additional cases could be decided unfavorably and
that there could be further adverse developments in the Engle case. 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 13 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 Brooke Group Holding or 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. Through September 30, 1999, BGLS repurchased $139,794 principal
amount of its 15.75% Senior Secured Notes due 2001 (the "Notes"), together with
accrued interest thereon for a discounted purchase price of $157,288. The
purchases were made using primarily the proceeds of the Philip Morris brand
transaction which closed on May 24, 1999.

         At September 30, 1999, BGLS had outstanding $93,070 principal amount
of the BGLS Notes which mature on January 31, 2001. Of this amount, $60,600 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 $27,863 of deferred interest outstanding as of
September 30, 1999.



                                     -40-
<PAGE>   42

         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, produces American
and international blend cigarettes, as well as traditional Russian cigarettes.
Western Realty Ducat has made a $30,000 participating loan to Western Tobacco
which holds BOL's interest in Liggett-Ducat and the new factory. In addition,
BOL has entered into promissory notes for equipment purchases which have a
liability of approximately $23,428 at September 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 $14,500 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 $150,000 due in the years 1999 through 2001. The Company believes
that it will continue to meet its liquidity requirements through 1999, although
the BGLS Notes Indenture limits the amount of restricted payments BGLS is
permitted to make to the Company during the calendar year. At September 30,
1999, the remaining amount available through December 31, 1999 in the
Restricted Payment Basket related to BGLS' payment of dividends to the Company
(as defined by the BGLS Notes Indenture) is $14,864. Corporate expenditures
(exclusive of Liggett, BOL and New Valley) over the next twelve months for
current operations include cash interest expense of approximately $5,114,
dividends on the Company's shares (currently at an annual rate of approximately
$21,990) 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.



                                     -41-
<PAGE>   43

         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 September 30, 1999 with fair values of $9,779 in long positions
and $2,697 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 September 30, 1999 will not have a
material adverse effect on the consolidated financial position or results of
operations of the Company.

         New Valley held investment securities available for sale totaling
$41,378 at September 30, 1999. Approximately 38% 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.



                                     -42-
<PAGE>   44

         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 completed in August 1999. Enhancements to Liggett's warehouse
management finished goods inventory tracking systems were completed in October
1999. Y2K testing is currently underway on manufacturing's
database/applications software (in addition to all other related software and
hardware used in production operations). This project timetable calls for the
completion of all tests, along with resolution of any issues encountered, by
December 11, 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.



                                     -43-
<PAGE>   45

         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
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 investigations and litigation. An unfavorable verdict
has been returned in the first phase of the Engle smoking and health class
action trial pending in Florida, and there could be further adverse
developments in the Engle case or in other cases. 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.



                                     -44-
<PAGE>   46

                                    PART II

                               OTHER INFORMATION


Item 1.       Legal Proceedings

              Reference is made to Note 13, 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 Brooke Group Holding, 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 September 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 5.       Other Information

              On October 1, 1999, pursuant to Section 251(g) of the Delaware
              General Corporation Law and the Agreement and Plan of Merger,
              dated as of September 30, 1999, by and among Brooke Group
              Holding, the predecessor of the Company (the "Predecessor"), the
              Company and BGL Merger Inc., an indirect wholly-owned Delaware
              subsidiary of the Company ("BGL Merger"), BGL Merger merged (the
              "Merger") with and into the Predecessor, which was the surviving
              corporation in the Merger, and BGL Merger ceased to exist.
              Pursuant to the Merger, (i) each share of common stock, par value
              $.01 per share, of BGL Merger issued and outstanding immediately
              prior to the effective time of the Merger (the "Effective Time"),
              was converted into one share of common stock, par value $.10 per
              share, of the Predecessor, (ii) each share of common stock, par
              value $.10 per share, of the Predecessor issued and outstanding
              or held in its treasury immediately prior to the Effective Time
              was converted into one share of common stock, par value $.10 per
              share, of the Company (the "Company Common Stock"), and (iii)
              each share of the Company Common Stock issued and outstanding
              immediately prior to the Effective Time was canceled.



                                     -45-
<PAGE>   47

              In connection with the Merger, BGLS Inc. ("BGLS"), a subsidiary
              of the Predecessor, sold the stock of all of its direct
              wholly-owned subsidiaries, other than Liggett Group Inc., to BGLS
              Holding Inc. ("BGLS Holding"), a Delaware corporation which is a
              direct wholly-owned subsidiary of the Company. In consideration
              for such shares, BGLS transferred and assigned to BGLS Holding,
              and BGLS Holding assumed and agreed to perform and discharge,
              pursuant to a supplemental indenture, all of BGLS' obligations
              under the Indenture dated as of January 1, 1996 between BGLS and
              State Street Bank and Trust Company, as Trustee, pursuant to
              which BGLS had issued its 15.75% Series B Senior Secured Notes
              due 2001. In addition, BGLS Holding assumed all of BGLS'
              liability as plan sponsor of three pension plans. Following these
              transactions, BGLS merged into the Predecessor and the name of
              BGLS Holding was changed to "BGLS Inc."

              As a result of the Merger, all the business and operations
              previously conducted by the Predecessor and its direct and
              indirect subsidiaries are now conducted by the Company and its
              direct and indirect subsidiaries. The assets and liabilities of
              the Company and its direct and indirect subsidiaries on a
              consolidated basis are the same as the assets and liabilities of
              the Predecessor and its direct and indirect subsidiaries
              immediately before the Merger. The Certificate of Incorporation
              and the Bylaws of the Company immediately after the Merger were
              identical to the Restated Certificate of Incorporation, as
              amended, and the Amended and Restated Bylaws of the Predecessor
              as in effect immediately prior to the Merger. The capital stock
              of the Company has the same designations, rights and preferences
              as the capital stock of the Predecessor immediately prior to the
              Merger. In addition, the persons who held offices as directors
              and officers of the Predecessor prior to the Merger hold the same
              offices in the Company after the Merger. The Company Common Stock
              is listed for trading on the NYSE under the symbol "BGL", as was
              the common stock of the Predecessor. Stockholders of the
              Predecessor do not recognize gain or loss for U.S. Federal income
              tax purposes as a result of the Merger.

              The conversion of shares in the Merger occurred without an
              exchange of certificates. Accordingly, certificates formerly
              representing shares of common stock of the Predecessor are deemed
              to represent shares of Company Common Stock.

Item 6.       Exhibits and Reports on Form 8-K

              (a)    Exhibits

              *2.1    Agreement and Plan of Merger, dated as of September
                      30, 1999, by and among Brooke Group Ltd., BGL Successor
                      Inc. and BGL Merger Inc. (incorporated by reference to
                      Exhibit 2.1 in the Company's Report on Form 8-K dated
                      October 1, 1999, Commission File No. 1-5759).

               3.1    Amended and Restated Certificate of Incorporation of
                      Brooke Group Ltd.

               3.2    By-Laws of Brooke Group Ltd.

               3.3     Certificate of Incorporation of BGLS Inc.

               3.4     By-Laws of BGLS Inc.

              *4.1    First Supplemental Indenture, dated as of September
                      30, 1999, to the Indenture, dated as of January 1, 1996,
                      between BGLS Inc., BGLS Holding Inc. and State Street
                      Bank and Trust Company, as Trustee (incorporated by
                      reference to Exhibit 4.1 in the Company's Report on Form
                      8-K dated October 1, 1999, Commission File No. 1-5759).



                                     -46-
<PAGE>   48


              *4.2    Amendment No. 1, dated as of September 30, 1999, to
                      the Pledge and Security Agreement, dated as of January 1,
                      1996, between BGLS Holding Inc., Brooke Group Holding
                      Inc., BGLS Inc. and State Street Bank and Trust Company,
                      as Trustee (incorporated by reference to Exhibit 4.2 in
                      the Company's Report on Form 8-K dated October 1, 1999,
                      Commission File No. 1-5759).

              *10.1   Purchase Agreement, dated as of September 30, 1999,
                      between BGLS Inc. and BGLS Holding Inc. (incorporated by
                      reference to Exhibit 10.1 in the Company's Report on Form
                      8-K dated October 1, 1999, Commission File No. 1-5759).

               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 September 30,
                      1999 and 1998.

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

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


----------------
*Incorporated by reference

              (b)     Reports on Form 8-K

                      None.




                                     -47-
<PAGE>   49




                                   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:  November 15, 1999






                                                BGLS INC.
                                                (REGISTRANT)

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

Date:  November 15, 1999






                                       48