<PAGE>   1

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

      FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998

                         Commission File Number 33-75224

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


           DELAWARE                                      56-1702115
(State or other jurisdiction of                      (I.R.S. Employer
incorporation or organization)                       Identification No.)


100 SOUTHEAST SECOND STREET, MIAMI, FLORIDA                 33131 
(Address of principal executive offices)                  (Zip Code)


       Registrant's telephone number, including area code: (305) 374-7714


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


          DELAWARE                                       56-1703877
(State or other jurisdiction of                      (I.R.S. Employer 
incorporation or organization)                       Identification No.)


100 SOUTHEAST SECOND STREET, MIAMI, FLORIDA                 33131
(Address of principal executive offices)                  (Zip Code)


       Registrant's telephone number, including area code: (305) 539-9460


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 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. Yes X   No
                                                  ----   ----


As of August 14, 1998 there were outstanding 1,000 shares of common stock, par
value $0.10 per share, of Liggett Group Inc. and 100 shares of common stock, par
value $1.00 per share, of Eve Holdings Inc.


<PAGE>   2


                                      INDEX
<TABLE>
<CAPTION>

                                                                                                    PAGE

<S>                                                                                                  <C>
PART I    FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

          Liggett Group Inc.:
          -------------------

                  Consolidated Balance Sheets as of June 30, 1998 and
                      December 31, 1997..............................................                3
                  Consolidated Statements of Operations for the three and six
                      months ended June 30, 1998 and 1997............................                5
                  Consolidated Statement of Stockholder's Equity (Deficit) for
                      the six months ended June 30, 1998.............................                6
                  Consolidated Statements of Cash Flows for the six months
                      ended June 30, 1998 and 1997...................................                7
                  Notes to Consolidated Financial Statements.........................                8


           Eve Holdings Inc.:
           ------------------

                  Balance Sheets as of June 30, 1998 and December 31, 1997...........               24
                  Statements of Operations for the three and six months ended
                      June 30, 1998 and 1997.........................................               25
                  Statements of Cash Flows for the six months ended June 30,
                      1998 and 1997..................................................               26
                  Notes to Financial Statements......................................               27


ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
            RESULTS OF OPERATIONS....................................................               29



PART II    OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS.........................................................               39



ITEM 6.    EXHIBITS..................................................................               39



SIGNATURES...........................................................................               40
</TABLE>






<PAGE>   3


                         PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                               LIGGETT GROUP INC.

                           CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)
                (Dollars in thousands, except per share amounts)

<TABLE>
<CAPTION>

                                                                      June 30,    December 31,
                                                                        1998         1997
                                                                       -------      -------
                             ASSETS

<S>                                                                    <C>          <C>    
Current assets:
     Cash .......................................................      $   582      $    --
     Accounts receivable:
         Trade, less allowances of $529 and $1,062, respectively        11,384        9,572
         Other ..................................................          991          743

     Inventories ................................................       31,549       35,057

     Other current assets .......................................          719          738
                                                                       -------      -------

             Total current assets ...............................       45,225       46,110

Property, plant and equipment, at cost, less accumulated
     depreciation of $29,702 and $29,452, respectively ..........       16,673       17,756

Intangible assets, at cost, less accumulated amortization
     of $19,845 and $19,111, respectively .......................          750        1,609

Other assets and deferred charges, at cost, less accumulated
     amortization of $11,671 and $9,000, respectively ...........        3,674        3,000
                                                                       -------      -------

             Total assets .......................................      $66,322      $68,475
                                                                       =======      =======

</TABLE>







                                   (continued)













                                       3





<PAGE>   4


                               LIGGETT GROUP INC.

                     CONSOLIDATED BALANCE SHEETS (Continued)
                                   (Unaudited)
                (Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>

                                                                                    June 30,      December 31,
                                                                                     1998            1997
                                                                                   ---------       ---------
<S>                                                                                <C>             <C>      
                                  LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)

Current liabilities:
     Current maturities of long-term debt ...................................      $ 167,458       $      28
     Cash overdraft .........................................................             --             891
     Accounts payable, principally trade ....................................          5,974           6,413
     Accrued expenses:
         Promotional ........................................................         22,891          26,993
         Taxes, principally excise taxes ....................................          3,347           3,643
         Estimated allowance for sales returns ..............................          4,750           4,750
         Interest ...........................................................          8,067           8,070
         Settlement accruals ................................................          2,936           4,030
         Other ..............................................................          6,586           8,834
                                                                                   ---------       ---------

             Total current liabilities ......................................        222,009          63,652

Long-term debt, less current maturities .....................................             --         168,112

Non-current employee benefits and other liabilities .........................         11,357          11,168

Other long-term liabilities .................................................         21,328          18,400

Commitments and contingencies (Notes 5 and 8)

Stockholder's equity (deficit):
     Redeemable preferred stock (par value $1.00 per share; authorized 1,000
       shares; no shares issued and outstanding)
     Common stock (par value $0.10 per share; authorized 2,000 shares; issued
       and outstanding 1,000 shares)
       and contributed capital ..............................................         53,156          50,218
     Accumulated deficit ....................................................       (241,528)       (243,075)
                                                                                   ---------       ---------

             Total stockholder's deficit ....................................       (188,372)       (192,857)
                                                                                   ---------       ---------

             Total liabilities and stockholder's equity (deficit) ...........      $  66,322       $  68,475
                                                                                   =========       =========
</TABLE>



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





                                       4
<PAGE>   5


                               LIGGETT GROUP INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                              Three Months Ended              Six Months Ended
                                                                   June 30,                       June 30,
                                                           ---------------------------     ---------------------------
                                                               1998            1997            1998            1997
                                                           ------------    -----------     -----------     -----------

<S>                                                          <C>             <C>             <C>             <C>      
Net sales*  ...........................................      $  83,398       $  78,142       $ 149,024       $ 144,443

Cost of sales* ........................................         33,082          36,214          59,270          66,473
                                                             ---------       ---------       ---------       ---------

          Gross profit ................................         50,316          41,928          89,754          77,970

Selling, general and administrative expenses ..........         40,022          37,430          72,728          71,353

Settlement charges ....................................          1,399              --           1,881              --

Restructuring .........................................             --              70              --           1,831
                                                             ---------       ---------       ---------       ---------

          Operating income ............................          8,895           4,428          15,145           4,786

Other income (expense):

     Interest income ..................................             --               3              --              60
     Interest expense .................................         (7,352)         (5,930)        (14,434)        (11,970)
     Equity in income of affiliate ....................             --             218              --             185
     Sale of assets ...................................            468           2,402             836           3,994
     Retirement of debt ...............................             --              --              --           2,963
     Miscellaneous, net ...............................             --               1              --              --
                                                             ---------       ---------       ---------       ---------

          Net income ..................................      $   2,011       $   1,122       $   1,547       $      18
                                                             =========       =========       =========       =========
</TABLE>





*Net sales and cost of sales include federal excise taxes of $17,666, $19,153,
$32,476, and $36,013, respectively.








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





                                       5
<PAGE>   6


                               LIGGETT GROUP INC.

            CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (DEFICIT)
                                   (Unaudited)
                             (Dollars in thousands)
<TABLE>
<CAPTION>

                                                          Common
                                                         Stock and                         Total
                                                        Contributed     Accumulated    Stockholder's
                                                          Capital          Deficit        Deficit
                                                       -------------    ------------   -------------

<S>                                                      <C>             <C>             <C>       
Balance at December 31, 1997  .....................      $  50,218       $(243,075)      $(192,857)

   Net income .....................................             --           1,547           1,547
   Effectiveness fee on debt ......................          4,105              --           4,105
   Transfer of ownership interest in an affiliate .         (1,167)             --          (1,167)
                                                         ---------       ---------       ---------

Balance at June 30, 1998 ..........................      $  53,156       $(241,528)      $(188,372)
                                                         =========       =========       =========
</TABLE>






























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






                                       6
<PAGE>   7


                               LIGGETT GROUP INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                             (Dollars in thousands)
<TABLE>
<CAPTION>

                                                                                 Six Months Ended
                                                                                     June 30,
                                                                              -------------------------
                                                                                1998           1997
                                                                              ---------       ---------
<S>                                                                           <C>             <C>      
Cash flows from operating activities:
    Net income .........................................................      $   1,547       $      18
    Adjustments to reconcile net income to net cash used in operating
        activities:
       Depreciation and amortization ...................................          3,400           3,482
       Gain on sale of property, plant and equipment ...................           (836)         (3,994)
       Gain on retirement of notes .....................................             --          (2,963)
       Effectiveness fee on debt .......................................          1,710              --
       Deferred finance charges and debt discount written off ..........             --             130
       Equity in income of affiliate ...................................             --            (185)
    Changes in assets and liabilities:
       Accounts receivable .............................................         (2,050)          7,430
       Inventories .....................................................          3,508           7,197
       Accounts payable ................................................         (1,764)         (2,364)
       Accrued expenses ................................................         (5,166)         (8,607)
       Non-current employee benefits ...................................            (52)           (205)
       Other, net ......................................................          1,916            (974)
                                                                              ---------       ---------
             Net cash provided by (used in) operating activities .......          2,213          (1,035)

Cash flows from investing activities:
    Proceeds from sale of property, plant and equipment ................          1,171           4,743
    Capital expenditures ...............................................           (694)         (1,086)
    Purchase of an option in affiliate .................................             --          (2,200)
                                                                              ---------       ---------
            Net cash provided by investing activities ..................            477           1,457

Cash flows from financing activities:
    Repayments of long-term debt .......................................            (28)         (4,664)
    Borrowings under revolving credit facility .........................        124,042         137,062
    Repayments under revolving credit facility .........................       (124,792)       (132,308)
    Deferred finance charges ...........................................           (439)             --
    Decrease in cash overdraft .........................................           (891)             (6)
                                                                              ---------       ---------
            Net cash (used in) provided by financing activities ........         (2,108)             84

Net increase in cash and cash equivalents ..............................            582             506
Cash and cash equivalents:
    Beginning of period ................................................             --              --
                                                                              ---------       ---------
    End of period ......................................................      $     582       $     506


Supplemental cash flow information: Cash payments during the period for:
        Interest .......................................................      $  11,064       $  11,984
        Income taxes ...................................................      $     126       $     108
</TABLE>



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








                                       7

<PAGE>   8


                               LIGGETT GROUP INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)
                (Dollars in thousands, except per share amounts)






1.       THE COMPANY

         Liggett Group Inc. ("Liggett" or the "Company") is a wholly-owned
subsidiary of BGLS Inc. ("BGLS"), a wholly-owned subsidiary of Brooke Group Ltd.
("BGL"). Liggett is engaged primarily in the manufacture and sale of cigarettes,
principally in the United States. Certain management and administrative
functions are performed by affiliates. (See Note 9.)

         The consolidated financial statements included herein are unaudited
and, in the opinion of management, reflect all adjustments necessary (which are
normal and recurring) to present fairly the Company's consolidated financial
position, results of operations and cash flows. The December 31, 1997 balance
sheet has been derived from audited financial statements. These consolidated
financial statements should be read in conjunction with the consolidated
financial statements included in the Company's Annual Report on Form 10-K, as
amended, for the year ended December 31, 1997, as filed with the Securities and
Exchange Commission. The results of operations for interim periods should not be
regarded as necessarily indicative of the results that may be expected for the
entire year.

         The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. Liggett had a net
capital deficiency of $188,372 as of June 30, 1998, is highly leveraged and has
substantial near-term debt service requirements. (See Note 7.) Due to the many
risks and uncertainties associated with the cigarette industry and the impact of
tobacco litigation (see Note 8), there can be no assurance that the Company will
be able to meet its future earnings or cash flow goals. Consequently, the
Company could be in violation of its debt covenants, including covenants
limiting the maximum permitted net worth and working capital deficiencies, and
if its lenders were to exercise acceleration rights under its revolving credit
facility (the "Facility") or the indenture for its Senior Secured Notes (the
"Liggett Notes") or refuse to lend under the Facility, the Company would not be
able to satisfy such demands or its working capital requirements.

         The Liggett Notes mature on February 1, 1999 and the Facility expires
on March 9, 1999. Accordingly, as of June 30, 1998, the current maturities of
the Liggett Notes of $144,780 (net of unamortized discount) and of the Facility
of $22,678 contribute substantially to the working capital deficit of $176,784.

         On January 30, 1998, the Company obtained the consents of the required
majority of the holders of the Liggett Notes to various amendments to the
Indenture governing the Liggett Notes. The amendments provided, among other
things, for a deferral of the February 1, 1998 mandatory redemption of $37,500
principal amount of the Liggett Notes to the date of final maturity, February 1,
1999. (Refer to Note 7.) At maturity, the Liggett Notes will require a principal
payment of $144,891. The Company does not anticipate it will be able to generate
sufficient cash from operations to make such payments. In addition, the Company
has a $40,000 Facility expiring March 8, 1999 under which $22,678 was
outstanding at June 30, 1998. While management currently intends to seek to
refinance and/or restructure with the Company's note holders the maturity
requirements on the Liggett Notes and to extend the Facility, there are no
refinancing or restructuring arrangements for the notes or commitments to extend
the Facility at this time, and no assurances can be given in this regard. If the
Company is unable to refinance or restructure the terms of the Liggett Notes or
otherwise make all payments thereon, the Liggett Notes and the Facility would be
in default and holders of such debt could accelerate the maturity of such debt.
In such event, Liggett may be forced to seek protection from creditors under
applicable laws. These matters 







                                       8









<PAGE>   9

raise substantial doubt about the Company meeting its liquidity needs and its
ability to continue as a going concern. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.

         The Company adopted Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" ("SFAS No. 130"), for the year ending
December 31, 1998. SFAS No. 130 requires the Company to display an amount
representing the total comprehensive income for the period in a financial
statement which is displayed with the same prominence as other financial
statements. The Company has no items of other comprehensive income in any period
presented and therefore is not required to report comprehensive income.

         The Company will adopt Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS No. 131"), for the year ending December 31, 1998. SFAS No. 131 requires
the Company to report certain information about operating segments in complete
sets of financial statements and in condensed financial statements of interim
period issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Company does not expect this new pronouncement to have a significant impact
on the financial statements.

         The Company will adopt Statement of Financial Accounting Standards No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits"
("SFAS No. 132"), for the year ending December 31, 1998. SFAS No. 132
standardizes the disclosure requirements for pensions and other postretirement
benefits to the extent practicable, requires additional information and changes
in the benefit obligations and fair values of plan assets that will facilitate
financial analysis, and eliminates certain disclosures that are no longer
useful. The Company has not yet determined the impact of this pronouncement.

2.       ESTIMATES AND ASSUMPTIONS

         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, the
disclosure of contingent assets and liabilities and the reported amounts of
revenues and expenses. Significant estimates subject to material changes in the
near term include allowance for doubtful accounts, sales returns and allowances,
actuarial assumptions of pension plans and litigation and defense costs. Actual
results could differ from those estimates.

3.       PER SHARE DATA

         All of the Company's common shares (1,000 shares, issued and
outstanding for all periods presented herein) are owned by BGLS. Accordingly,
earnings and dividends per share data are not presented in these consolidated
financial statements.

4.       SALE OF ASSETS

         On March 11, 1997, Liggett sold to Blue Devil Ventures, a North
Carolina limited liability partnership, certain surplus realty in Durham, North
Carolina, for a sale price of $2,200. A gain of $1,147 was recognized, net of
costs required to prepare the properties for sale and selling costs. (See Note 9
for sales to affiliates.)







                                       9
<PAGE>   10

5.       INVENTORIES

         Inventories consist of the following:

                                             June 30,     December 31,
                                               1998          1997
                                             --------     ------------

         Finished goods ...............      $ 12,456       $ 13,273
         Work-in-process ..............         2,256          1,926
         Raw materials ................        16,693         21,211
         Replacement parts and supplies         3,465          3,545
                                             --------       --------

         Inventories at current cost ..        34,870         39,955

         LIFO adjustment ..............        (3,321)        (4,898)
                                             --------       --------

         Inventories at LIFO cost .....      $ 31,549       $ 35,057
                                             ========       ========


         The Company has a leaf inventory management program whereby, among
other things, it is committed to purchase certain quantities of leaf tobacco.
The purchase commitments are for quantities not in excess of anticipated
requirements and are at prices, including carrying costs, established at the
date of the commitment. Liggett had leaf tobacco purchase commitments of
approximately $7,311 at June 30, 1998.

6.       PROPERTY, PLANT AND EQUIPMENT

         Property, plant and equipment consists of the following:

<TABLE>
<CAPTION>
                                                                    June 30,     December 31,
                                                                      1998           1997
                                                                    --------       --------
<S>                                                                 <C>            <C>     
         Land and improvements ...............................      $    411       $    411
         Buildings ...........................................         6,015          6,228
         Machinery and equipment .............................        39,949         40,569
                                                                    --------       --------

         Property, plant and equipment .......................        46,375         47,208

         Less accumulated depreciation .......................       (29,702)       (29,452)
                                                                    --------       --------

         Property, plant and equipment, net ..................      $ 16,673       $ 17,756
                                                                    ========       ========
</TABLE>








                                       10
<PAGE>   11



7.       LONG-TERM DEBT

         Long-term debt consists of the following:
<TABLE>
<CAPTION>

                                                                    June 30,      December 31,
                                                                      1998            1997
                                                                    ---------      ----------
<S>                                                                 <C>             <C>      
         11.5% Senior Secured Notes due February 1, 1999,
            net of unamortized discount of $111 and $206,
            respectively .....................................      $ 112,501       $ 112,406
         Variable Rate Series C Senior Secured Notes due
            February 1, 1999 .................................         32,279          32,279
         Borrowings outstanding under revolving credit
            facility .........................................         22,678          23,427
         Other ...............................................             --              28
                                                                    ---------       ---------
                                                                      167,458         168,140

         Current portion .....................................       (167,569)            (28)
         Unamortized discount, current portion ...............            111              --
                                                                    ---------       ---------

         Amount due after one year ...........................      $      --       $ 168,112
                                                                    =========       =========
</TABLE>

         SENIOR SECURED NOTES

         On February 14, 1992, Liggett issued $150,000 in Senior Secured Notes
(the "Series B Notes"). Interest on the Series B Notes is payable semiannually
on February 1 and August 1 at an annual rate of 11.5%. The Series B Notes and
Series C Notes referred to below (collectively, the "Liggett Notes") required
mandatory principal redemptions of $7,500 on February 1 in each of the years
1993 through 1997 and $37,500 on February 1, 1998 with the balance of the
Liggett Notes due on February 1, 1999. In February 1997, $7,500 of the Series B
Notes were purchased using revolver availability and credited against the
mandatory redemption requirements. The transaction resulted in a net gain of
$2,963. The Liggett Notes are collateralized by substantially all of the assets
of the Company, excluding inventories and receivables. Eve is a guarantor for
the Notes. The Liggett Notes may be redeemed, in whole or in part, at a price
equal to 100% of the principal amount at the option of the Company. The Liggett
Notes contain restrictions on Liggett's ability to declare or pay cash
dividends, incur additional debt, grant liens and enter into any new agreements
with affiliates, among others.

         The Series C Notes, issued in 1994, have the same terms (other than
interest rate) and stated maturity as the Series B Notes. The Series C Notes
bore a 16.5% interest rate, which was reset on February 1, 1995 to 19.75%.

         On January 30, 1998, with the consent of the required majority of the
holders of the Liggett Notes, Liggett entered into various amendments to the
Indenture governing the Liggett Notes, which provided, among other things, for a
deferral of the February 1, 1998 mandatory redemption payment of $37,500 to the
date of final maturity of the Liggett Notes on February 1, 1999. In connection
with the deferral, BGL agreed to issue 483,002 shares of BGL's common stock to
the holders of record on January 15, 1998 of the Liggett Notes. As a result of
this transaction, the Company recorded a deferred charge of approximately $4,100
during the first quarter of 1998 reflecting the fair value of the instruments
issued. This deferred charge is being amortized as an adjustment to interest
expense over a period of one year. The Indenture under which the Liggett Notes
are outstanding was also amended to prohibit, with limited exceptions, payments
of dividends and incurrence of new debt by Liggett and to tighten restrictions
on the disposition of proceeds of asset sales. BGL and BGLS also agreed to
guarantee the payment by Liggett of the August 1, 1998 interest payment on the
Liggett Notes and to subordinate, until repayment in full of all amounts







                                       11


<PAGE>   12

outstanding in respect of the Liggett Notes, their reimbursement rights with
respect to the guarantee of borrowings under the Facility made in connection
with the Company's August 1, 1997 interest installment and any future advances
in connection with the guarantee of the August 1, 1998 interest payment. In
consideration of the contribution of the BGL common stock, the waiver of certain
management and other fees, the guarantee of the interest payments and
subordination of certain reimbursement rights, the Company transferred its
ownership interest in, and options to acquire additional shares of stock of,
Liggett-Ducat Ltd. ("Liggett-Ducat") to Brooke (Overseas) Ltd. ("BOL"), a
subsidiary of BGLS. The Company accounted for the transfer of its ownership
interest in, and options to acquire additional shares of stock of, Liggett-Ducat
to BOL as a capital distribution to BGLS. Based on the carrying value of the
investment at January 30, 1998, the capital distribution is approximately
$1,167. In addition, the Liggett Noteholders were granted additional collateral
in the form of a security interest in 16% of the stock of Liggett-Ducat or a
successor entity held by BOL.

         On February 1, 1999, all of the Liggett Notes, totaling $144,891, will
reach maturity. There are no refinancing or restructuring arrangements in place
at this time for the notes and no assurances can be given in this regard. (Refer
to Note 1.)

         REVOLVING CREDIT FACILITY

         On March 8, 1994, Liggett entered into the Facility under which it can
borrow up to $40,000 (depending on the amount of eligible inventory and
receivables as determined by the lenders) from a syndicate of commercial
lenders. Availability under the Facility was approximately $5,946 based upon
eligible collateral at June 30, 1998. The Facility is collateralized by all
inventories and receivables of the Company. Borrowings under the Facility are
charged interest 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. Liggett's interest rate is currently 10.0%. The Facility contains
certain financial covenants similar to those contained in the Liggett Notes
Indenture, including restrictions on Liggett's ability to declare or pay cash
dividends, incur additional debt, grant liens and enter into any new agreements
with affiliates, among others. In addition, the Facility, as amended April 8,
1998, imposes requirements with respect to the Company's adjusted net worth (not
to fall below a deficit of $195,000 as computed in accordance with the
agreement, this computation was $185,051 at June 30, 1998) and working capital
(not to fall below a deficit of $17,000 as computed in accordance with the
agreement, this computation was $6,005 at June 30, 1998). The Facility, as
amended, also provides that a default by Liggett or its subsidiaries under the
March 1996 Settlements, March 1997 Settlements and March 1998 Settlements (all
as defined below in Note 8) shall constitute an event of default under the
Facility.

         In November 1997, the Facility was extended until March 8, 1999. For
information concerning Liggett's substantial near-term debt service requirements
and other related matters, see Note 1.

8.       COMMITMENTS AND 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 Liggett or BGL). There has been a
noteworthy increase in the number of cases commenced against Liggett and the
other cigarette manufacturers. The cases generally fall into four categories:
(i) smoking and health cases alleging personal injury brought on behalf of
individual smokers ("Individual Actions"), (ii) smoking and health cases










                                       12






<PAGE>   13

alleging personal injury and purporting to be brought on behalf of a class
of plaintiffs ("Class Actions"), (iii) health care cost recovery actions brought
by state and local governments ("Attorneys General Actions") and (iv) health
care cost recovery actions brought by third-party payors including asbestos
manufacturers, unions and taxpayers ("Third-Party Payor Actions"). As new cases
are commenced, defense costs and the risks attendant to the inherent
unpredictability of litigation continue to increase. Liggett had been receiving
assistance from others in the industry in defraying the costs and other burdens
incurred in the defense of smoking and health litigation and related
proceedings, which, for the most part, consisted of the payment of counsel fees
and costs, but this assistance terminated in 1997. The future financial impact
on Liggett of the termination of this assistance and the effects of the tobacco
litigation settlements discussed below is not quantifiable at this time. For the
six months ended June 30, 1998, Liggett incurred counsel fees and costs totaling
approximately $2,562, compared to $2,152 for the comparable prior year period.

         In June 1992, in an action entitled CIPOLLONE V. LIGGETT GROUP INC., ET
AL., the United States Supreme Court issued an opinion concluding that The
Federal Cigarette Labeling and Advertising Act did not preempt state common law
damage claims but that The Public Health Cigarette Smoking Act of 1969 (the
"1969 Act") did preempt certain, but not all, state common law damage claims.
The decision bars plaintiffs from asserting claims that, after the effective
date of the 1969 Act, the tobacco companies either failed to warn adequately of
the claimed health risks of cigarette smoking or sought to neutralize those
claimed risks in their advertising or promotion of cigarettes. Bills have been
introduced in Congress on occasion to eliminate the federal preemption defense.
Enactment of any federal legislation with such an effect could result in a
significant increase in claims, liabilities and litigation costs.

         INDIVIDUAL ACTIONS. As of June 30, 1998, there were approximately 245
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, 95 were pending in the State of Florida,
84 in the State of New York and 20 in the State of Texas. The balance of
individual cases were pending in 16 states. There are three individual cases
pending where Liggett is the only named defendant.

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

         On May 12, 1998, Liggett settled an individual tobacco-related action
entitled WIDDICK V. BROWN & WILLIAMSON, Duval County Circuit Court, Florida. The
settlement will not have a material affect on Liggett's or BGL's financial
condition, results of operations or cash flows.

         CLASS ACTIONS. As of June 30, 1998, there were approximately 40 actions
pending, for which either a class has been certified or plaintiffs are seeking
class certification, where Liggett, among others, was a named defendant. Two of
these cases, FLETCHER, ET AL. V. BROOKE GROUP LTD., ET AL. and WALKER, ET AL. V.
LIGGETT GROUP INC., ET AL. have been settled by Liggett, subject to court
approval. These two settlements are more fully discussed below under the
"Settlements" section.








                                       13



<PAGE>   14

         In October 1991, an action entitled BROIN, ET AL. V. PHILIP MORRIS
INCORPORATED, ET AL., Circuit Court of the Eleventh Judicial District in and for
Dade County, Florida, was filed against Liggett and others. This case was
brought by plaintiffs on behalf of all flight attendants that worked or are
presently working for airlines based in the United States and who never
regularly smoked cigarettes but allege that they have been damaged by
involuntary exposure to ETS. In October 1997, the other major tobacco companies
settled this matter which settlement provides for a release of Liggett and BGL.
In February 1998, the Circuit Court approved the settlement; however, an
objector filed a Notice of Appeal of the settlement in the Third District Court
of Appeal.

         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, any savings in judicial
resources that class certification may bring about is speculative and would
likely be overwhelmed by the procedural problems certification brings. Finally,
the Fifth Circuit held that in order to make the class action manageable, the
District Court would be forced to bifurcate issues in violation of the Seventh
Amendment.

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

         ATTORNEY GENERAL ACTIONS. As of June 30, 1998, 40 Attorney General
Actions were filed against Liggett and BGL. As more fully discussed below,
Liggett and BGL have settled 36 of these actions. In addition, Liggett has
reached settlements with nine Attorneys General representing states,
commonwealths or territories that have not yet commenced litigation against
Liggett or BGL. In these proceedings, state and local government entities seek
reimbursement for Medicaid and other health care expenditures allegedly caused
by use of tobacco products. The claims asserted in these health care cost
recovery actions vary. In most of these cases, plaintiffs assert the equitable
claim that the tobacco industry was "unjustly enriched" by plaintiffs' payment
of health care costs allegedly attributable to smoking and seek reimbursement of
those costs. Other claims made by some but not all plaintiffs include the
equitable claim of indemnity, common law claims of negligence, strict liability,
breach of express and implied warranty, violation of a voluntary undertaking or
special duty, fraud, negligent misrepresentation, conspiracy, public nuisance,
claims under state and federal statutes governing consumer fraud, antitrust,
deceptive trade practices and false advertising, and claims under RICO.








                                       14

<PAGE>   15

         THIRD-PARTY PAYOR ACTIONS. As of June 30, 1998, there were
approximately 55 Third-Party Payor Actions pending. The claims in these cases
are similar to those in the Attorney General Actions. 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 anti-trust laws as well as other claims.

         SETTLEMENTS. In March, 1996, Liggett and BGL entered into an agreement,
subject to court approval, to settle the CASTANO class action tobacco
litigation. Under the CASTANO settlement agreement, upon final court approval of
the settlement, the CASTANO class would be entitled to receive up to five
percent of Liggett's pretax income (income before income taxes) each year (up to
a maximum of $50,000 per year) for the next 25 years, subject to certain
reductions provided for in the agreement and a $5,000 payment from Liggett if
Liggett or BGL fail to consummate a merger or similar transaction with another
non-settling tobacco company defendant within three years of the date of
settlement. Liggett and BGL have the right to terminate the CASTANO settlement
under certain circumstances. On March 14, 1996, Liggett, the CASTANO Plaintiffs
Legal Committee and the CASTANO plaintiffs entered into a letter agreement.
According to the terms of the letter agreement, for the period ending nine
months from the date of Final Approval (as defined in the letter), if granted,
of the CASTANO settlement or, if earlier, the completion by Liggett or BGL of a
combination with any defendant in CASTANO, except Philip Morris, the CASTANO
plaintiffs and their counsel agree not to enter into any more favorable
settlement agreement with any CASTANO defendant which would reduce the terms of
the CASTANO settlement agreement. If the CASTANO plaintiffs or their counsel
enter into any such settlement during this period, they shall pay Liggett
$250,000 within 30 days of the more favorable agreement and offer Liggett and
BGL the option to enter into a settlement on terms at least as favorable as
those included in such other settlement. The letter agreement further provides
that during the same time period, and if the CASTANO settlement agreement has
not been earlier terminated by Liggett in accordance with its terms, Liggett and
its affiliates will not enter into any business transaction with any third party
which would cause the termination of the CASTANO settlement agreement. If
Liggett or its affiliates enter into any such transaction, then the CASTANO
plaintiffs will be entitled to receive $250,000 within 30 days from the
transacting party. In May 1996, the CASTANO Plaintiffs Legal Committee filed a
motion with the United States District Court for the Eastern District of
Louisiana seeking preliminary approval of the CASTANO settlement. In September
1996, shortly after the class was decertified, the CASTANO plaintiffs withdrew
the motion for approval of the CASTANO settlement.

         In March 1996, Liggett and BGL entered into a settlement of
tobacco-related litigation with the Attorneys General of Florida, Louisiana,
Massachusetts, Mississippi and West Virginia (the "March 1996 Settlements"). The
March 1996 Settlements release Liggett and BGL from all tobacco-related claims
including claims for health case cost reimbursement and claims concerning sales
of cigarettes to minors. Certain of the terms of the March 1996 Settlements are
summarized below.

         Under the March 1996 Settlements, the five settling states would share
an initial payment by Liggett of $5,000, payable over nine years and indexed and
adjusted for inflation, provided that any unpaid amount will be due 60 days
after either a default by Liggett in its payment obligations under the
settlement or a merger or other similar transaction by Liggett or BGL with
another defendant in the lawsuits. In addition, Liggett will be required to pay
the settling states a percentage of Liggett's pretax income (income before
income taxes) each year from the second through the twenty-fifth year. This
annual percentage is 2.5% of Liggett's pretax income, subject to increase to
7.5% depending on the number of additional states joining the settlement. No
additional states have joined this settlement to date. All of Liggett's payments
are subject to certain reductions provided for in the agreement. Liggett has
also agreed to pay to the settling states $5,000 if Liggett or BGL fails to
consummate a merger or other similar transaction with another defendant in the
lawsuits within three years from the date of the March 1996 Settlements.

  




                                       15

<PAGE>   16

         Settlement funds received by the Attorneys General will be used to
reimburse the states for smoking-related health care costs. Liggett and BGL also
have agreed to phase in compliance with certain of the proposed interim FDA
regulations on the same basis as provided in the CASTANO settlement. Liggett and
BGL have the right to terminate the March 1996 Settlements with respect to any
settling state if any of the remaining defendants in the litigation succeed on
the merits in that state's respective Attorney General action. Liggett and BGL
may also terminate the March 1996 Settlements if they conclude that too many
states have filed Attorney General actions and have not settled such cases with
Liggett and BGL.

         In March 1997, Liggett, BGL and the five settling states executed an
addendum pursuant to which Liggett and BGL agreed to provide to the five
settling states, among other things, the additional cooperation and compliance
with advertising restrictions that is provided for in the March 1997 Settlements
(discussed below). Also, pursuant to the addendum, the initial settling states
agreed to use best efforts to ensure that in the event of a global tobacco
settlement enacted through federal legislation or otherwise, Liggett's and BGL's
financial obligations under such a global settlement would be no more onerous
than under this settlement.

         During 1997, Liggett and BGL entered into a comprehensive settlement of
tobacco litigation through parallel agreements with the Attorneys General of 21
states and with a nationwide class of individuals and entities that allege
smoking-related claims (settlements with these 21 Attorneys General and with the
nationwide class are hereinafter referred to as the "March 1997 Settlements").
In March 1998, Liggett and BGL announced settlements with the Attorneys General
of 15 states, the District of Columbia, Guam, Northern Mariana Islands and the
U.S. Virgin Islands (the "March 1998 Settlements"). The foregoing settlements
cover all smoking-related claims, including both addiction-based and tobacco
injury claims against Liggett and BGL, brought by the Attorneys General and,
upon court approval, the nationwide class.

         The states, commonwealths and territories where settlements have been
reached with Attorneys General are: Alaska, Arizona, Arkansas, California,
Colorado, Connecticut, District of Columbia, Florida, Georgia, Guam, Hawaii,
Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Maryland,
Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska,
Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Northern
Mariana Islands, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Texas,
Utah, U.S. Virgin Islands, Washington, West Virginia, Wisconsin and Wyoming.
Other states have either recently filed health care cost recovery actions or
indicated intentions to do so. Both Liggett and BGL will endeavor to resolve
those actions on substantially the same terms and conditions as the March 1998
Settlements, however, there can be no assurance that any such settlements will
be completed.

         As mentioned above, in March 1997, Liggett, BGL and plaintiffs filed
the mandatory class settlement agreement in an action entitled FLETCHER, ET AL.
V. BROOKE GROUP LTD., ET AL., Circuit Court of Mobile County, Alabama, where the
court granted preliminary approval and preliminary certification of the class,
and in May 1997, a similar mandatory class settlement agreement was filed in an
action entitled WALKER, ET AL. V. LIGGETT GROUP INC., ET AL., United States
District Court, Southern District of West Virginia. On July 2, 1998, Liggett,
BGL and plaintiffs filed an amended class action settlement agreement in
FLETCHER. Pursuant to the amended agreement, Liggett is required to pay to the
class 7.5% of Liggett's pre-tax income each year for 25 years, with a minimum
annual payment guarantee of $1,000 over the term of the agreement. The amended
agreement does not set forth a formula with respect to the distribution of
settlement proceeds to the class. The Company anticipates that should the court
in FLETCHER, after dissemination of notice to the class of the pending limited
fund class action settlement and a full fairness hearing with respect thereto,
issue a final order and judgment approving the settlement, such an order would
preclude further prosecution by class members of tobacco-related claims against
Liggett and BGL. Under the Full Faith and Credit Act, a final judgment entered
in a nationwide class action pending in a state court has a preclusive effect
against any class member with respect to the claims settled and released in the
nationwide class action. As the class definition in FLETCHER encompasses all
persons in the United States who could claim injury as a result of cigarette
smoking or ETS and any third-party payor claimants, it is 









                                       16

<PAGE>   17

anticipated that, upon final order and judgment, all such persons and
third-party payor claimants would be barred from further prosecution of
tobacco-related claims against Liggett and BGL.

         In the FLETCHER action, it is anticipated that class members will be
notified of the settlement and will have an opportunity to appear at a later
court hearing. Effectiveness of the mandatory settlement is conditioned on final
court approval of the settlement after a fairness hearing. There can be no
assurance as to whether, or when, such court approval will be obtained.

         The WALKER court also granted preliminary approval and preliminary
certification of the nationwide class; however, on August 5, 1997, the court
vacated its preliminary certification of the settlement class, which decision is
currently on appeal. The WALKER court relied on the Supreme Court's decision in
AMCHEM PRODUCTS INC. V. WINDSOR in reaching its decision. In AMCHEM, the Supreme
Court affirmed a decision of the Third Circuit vacating the certification of a
settlement class that involved asbestos-exposure claims. The Supreme Court held
that the proposed settlement class did not meet the requirements for Rule 23 of
the Federal Rules of Civil Procedure for predominance of common issues and
adequacy of representation. The Third Circuit had held that, although classes
could be certified for settlement purposes only, Rule 23's requirements had to
be satisfied as if the case were going to be litigated. The Supreme Court agreed
that the fairness and adequacy of the settlement are not pertinent to the
predominance inquiry under Rule 23(b)(3), and thus, the proposed class must have
sufficient unity so that absent class members can fairly be bound by decisions
of class representatives.

         After the AMCHEM opinion was issued by the Supreme Court on June 25,
1997, objectors to Liggett's settlement in WALKER moved for decertification.
Although Liggett's settlements, particularly in the WALKER action, are "limited
fund" class action settlements proceeding under Rule 23(b)(1), and AMCHEM was a
Rule 23(b)(3) case, the court in the WALKER action, nonetheless, decertified the
WALKER class. Applying AMCHEM to the WALKER case, the District Court, in a
decision issued on August 5, 1997, determined that while plaintiffs in WALKER
have a common interest in "maximizing the limited fund available from the
defendants," there remained "substantial conflicts among class members relating
to distribution of the fund and other key concerns" that made class
certification inappropriate.

         The AMCHEM decision's ultimate effect on the viability of the WALKER
and FLETCHER settlements remains uncertain given the Fifth Circuit's recent
ruling reaffirming the limited fund class action settlement in IN RE ASBESTOS
LITIGATION ("AHEARN"). In June 1997, the Supreme Court remanded AHEARN to the
Fifth Circuit for consideration in light of AMCHEM. On remand, the Fifth Circuit
made two decisive distinctions between AMCHEM and AHEARN. First, the AHEARN
class action proceeded under Rule 23(b)(1) while AMCHEM was a Rule 23(b)(3) case
and second, in AHEARN, there was no allocation or difference in award, according
to nature or severity of injury, as there was in AMCHEM. The Fifth Circuit
concluded that all members of the class and all class representatives share
common interests and none of the uncommon questions abounding in AMCHEM exist.
On June 22, 1998, the Supreme Court granted certiorari to review the Fifth
Circuit decision.

         The remaining material terms of the March 1996 Settlements, the March
1997 Settlements and the March 1998 Settlements are described below.

         Pursuant to each of the settlements, both Liggett and BGL agreed to
cooperate fully with the Attorneys General and the nationwide class in their
respective lawsuits against the tobacco industry. Liggett and BGL agreed to
provide to these parties all relevant tobacco documents in their possession,
other than those subject to claims of joint defense privilege, and to waive,
subject to court order, certain attorney-client privileges and work product
protections regarding Liggett's smoking-related documents to the extent Liggett
and BGL can so waive these privileges and protections. The Attorneys General and
the nationwide class agreed to keep Liggett's documents under protective order
and, subject to final court approval, to limit their use to those actions
brought by parties to the settlement agreements. Those documents that may be
subject to a joint defense privilege with other tobacco companies will not be
produced to the Attorneys General or the nationwide class, but will be, pursuant
to court order, submitted 








                                       17



<PAGE>   18

to the appropriate court and placed under seal for possible IN CAMERA review.
Additionally, under similar protective conditions, Liggett and BGL agreed to
offer their employees for witness interviews and testimony at deposition and
trial. Pursuant to both settlement agreements, Liggett also agreed to place an
additional warning on its cigarette packaging stating that "Smoking is
Addictive" and to issue a public statement, as requested by the Attorneys
General. Liggett has commenced distribution of cigarette packaging which
displays the new warning label.

         Pursuant to the March 1996 Settlements, any other tobacco company
defendant, except Philip Morris, merging or combining with Liggett or BGL, prior
to the third anniversary of the settlement, would receive certain settlement
benefits, including limitations on potential liability. Pursuant to the
agreement, any such combining tobacco company would be released from the
lawsuits brought by the five initial settling states. Such combining tobacco
company would be obligated to pay into the settlement fund within sixty days of
becoming bound to the agreement $135,000, and make annual payments of 2.5% of
the combining company's pre-tax income (but not less than $30,000 per year).
Such combining tobacco company would also have to comply with the advertising
and access restrictions provided for in the agreement, and would have to
withdraw their objections to the FDA rule.

         Pursuant to the March 1997 Settlements, any other tobacco company
defendant, except Philip Morris, merging or combining with Liggett or BGL, prior
to the fourth anniversary of the settlements, would receive certain settlement
benefits, including limitations on potential liability for affiliates not
engaged in domestic tobacco operations and a waiver of any obligation to post a
bond to appeal any future adverse judgment. In addition, within 120 days
following any such combination, Liggett would be required to pay the settlement
fund $25,000. Under all settlements, the plaintiffs have agreed not to seek an
injunction preventing a defendant tobacco company combining with Liggett or BGL
from spinning off any affiliate which is not engaged in the domestic tobacco
business.

         Pursuant to the March 1998 Settlements, Liggett is required to pay each
of settling states and territories their relative share (based on the Medicaid
population of each state over the total Medicaid population of the United
States) of between 27.5% and 30% of Liggett's pre-tax income each year for 25
years, with a minimum payment guarantee of $1,000 per state over the first nine
years of the agreement. The liability was computed using a discount rate of 18%.
The aggregate payments required under the March 1996, March 1997 and March 1998
Settlements are $45,000. Of this amount, $3,389 has been paid as of June 30,
1998. The annual percentage is subject to increase, pro rata from 27.5% - 30%,
depending on the number of additional states joining the settlement. Pursuant to
the "most favored nation" provisions under the March 1996 and March 1997
Settlements, each of the states settling under those settlements could benefit
from the economic terms of the March 1998 Settlements. In all settlements,
Liggett agreed to phase-in compliance with certain proposed FDA regulations
regarding smoking by children and adolescents, including a prohibition on the
use of cartoon characters in tobacco advertising and limitations on the use of
promotional materials and distribution of sample packages where minors are
present. The March 1998 Settlements provide for additional restrictions and
regulations on Liggett's advertising, including a prohibition on outdoor
advertising and product advertising on the Internet and on payments for product
placement in movies and television.

         Under all settlements, Liggett and BGL are also entitled to "most
favored nation" treatment in the event any settling Attorney General reaches a
settlement with any other defendant tobacco company. Pursuant to the March 1996
and March 1997 Settlements, in the event of a global settlement involving
federal legislation with any other defendant tobacco company, the settling
Attorneys General agreed to use their "best efforts" to ensure that Liggett's
and BGL's liability under such legislation should be no more onerous than under
those settlements. Under the March 1998 Settlements, the settling Attorneys
General agreed to write letters to Congress and the President of the United
States to ensure that Liggett's and BGL's liability under any such legislation
should be more onerous than under this settlement.




                                       18

<PAGE>   19

         Liggett accrued approximately $4,000 for the present value of the fixed
payments under the March 1996 Settlements and $16,902 for the present value of
the fixed payments under the March 1998 Settlements. No additional amounts have
been accrued because Liggett cannot quantify the future costs of the settlements
as the amounts Liggett must pay are based, in part, on future operating results.
Possible future payments based on a percentage of pretax income, and other
contingent payments based on the occurrence of a business combination, will be
expensed when considered probable.

         Separately, the other tobacco companies negotiated settlements of the
Attorney General Actions in Mississippi, Florida, Texas, and Minnesota, and it
has been widely publicized that the other companies have engaged in negotiations
to settle with the Attorneys General of the remaining states.

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

         TRIALS. On May 8, 1998, the other tobacco companies settled the
litigation in Minnesota known as the STATE OF MINNESOTA BY HUBERT H. HUMPHREY,
III, ITS ATTORNEY GENERAL AND BLUE CROSS AND BLUE SHIELD OF MINNESOTA V. PHILIP
MORRIS INCORPORATED, ET AL. Liggett settled the claims of the State of Minnesota
on March 20, 1997 and on June 2, 1998 settled the claims of Blue Cross and Blue
Shield of Minnesota. There are several other trial dates scheduled during 1998
for individual cases; however, trial dates are subject to change.

         OTHER RELATED MATTERS. In March 1997, RJR, Philip Morris, B&W and
Lorillard obtained a temporary restraining order from a North Carolina state
court preventing Liggett and BGL and their agents, employees, directors,
officers and lawyers from turning over documents allegedly subject to the joint
defense privilege in connection with the settlements, which restraining order
was converted to a preliminary injunction by the court in April 1997. In March
1997, the United States District Court for the Eastern District of Texas and
state courts in Mississippi and Illinois each issued orders enjoining the other
tobacco companies from interfering with Liggett's filing with the courts, under
seal, those documents.

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

         In March 1996, and in each of March, July, October and December 1997,
Liggett and/or BGL received subpoenas from a Federal grand jury in connection
with an investigation by the United States Department of Justice (the "DOJ
Investigation") involving the industry's knowledge of the health consequences of
smoking cigarettes; the targeting of children by the industry and the addictive
nature of nicotine and the manipulation of nicotine by the industry. Liggett has
responded to the March 1996, March 1997 and July 1997 subpoenas and is in the
process of responding to the October and December 1997 subpoenas. Liggett
understands that the Eastern District Investigation and the DOJ Investigation
essentially have been consolidated into one investigation conducted by the
Department of Justice (the "DOJ"). Liggett and BGL are unable, at this time, to
predict the outcome of this investigation.

         On April 28, 1998, BGL announced that Liggett had reached an agreement
with the United States Department of Justice to cooperate in both the Eastern
District Investigation and the DOJ Investigation. The agreement does not
constitute an admission of any wrongful behavior by Liggett. The DOJ has not
provided immunity to Liggett and has full discretion to act or refrain from
acting with respect to Liggett in the investigation.

         Litigation is subject to many uncertainties, and it is possible that
some of the aforementioned actions could be decided unfavorably against Liggett
or BGL. An unfavorable outcome of a pending smoking and health case could
encourage the commencement of additional similar litigation. Liggett is 





                                       19

<PAGE>   20

unable to evaluate the effect of these developing matters on pending litigation
or the possible commencement of additional litigation. Liggett is also unable to
make a meaningful estimate with respect to the amount of loss that could result
from an unfavorable outcome of many of the cases pending against the Company,
because the complaints filed in these cases rarely detail alleged damages.
Typically, the claims set forth in an individual's complaint against the tobacco
industry pray for money damages in an amount to be determined by a jury, plus
punitive damages and costs. These damage claims are typically stated as being
for the minimum necessary to invoke the jurisdiction of the court.

         Third-party payor claimants and others have set forth several
additional variations on 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.

         It is possible that Liggett's consolidated financial position, results
of operation and 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 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 Liggett 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 Liggett's
financial position, results of operations or cash flows.

LEGISLATION AND REGULATION:

         In January 1993, the United States Environmental Protection Agency
("EPA") released a report on the respiratory effect of ETS which concludes that
ETS is a known human lung carcinogen in adults and in children, causes increased
respiratory tract disease and middle ear disorders and increases the severity
and frequency of asthma. In June 1993, the two largest of the major domestic
cigarette manufacturers, together with other segments of the tobacco and
distribution industries, commenced a lawsuit against the EPA seeking a
determination that the EPA did not have the statutory authority to regulate ETS,
and that given the current body of scientific evidence and the EPA's failure to
follow its own guidelines in making the determination, the EPA's classification
of ETS was arbitrary and capricious. Whatever the outcome of this litigation,
issuance of the report may encourage efforts to limit smoking in public areas.
On July 17, 1998, the court ruled that the EPA made procedural and scientific
mistakes when it declared in its 1993 report that secondhand smoke caused as
many as 3,000 cancer deaths a year among nonsmokers.

         In April 1994, the United States Occupational Safety and Health
Administration ("OSHA") issued a proposed rule that could ultimately ban smoking
in the workplace. Hearings were completed during 1995. OSHA has not yet issued a
final rule or a proposed revised rule. While Liggett cannot predict the outcome,
some form of federal regulation of smoking in workplaces may result.

         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. 




                                       20





<PAGE>   21

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 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 four major cigarette manufacturers and the FDA have filed notices of appeal.
Liggett and BGL 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 Attorney General Actions above.

         In August 1996, the Commonwealth of 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.

         As part of the budget agreement recently approved by Congress, federal
excise taxes on a pack of cigarettes, which are currently 24 cents, would rise
10 cents in the year 2000 and 5 cents more in the year 2002. 

         PROPOSED RESOLUTION. In June 1997, Philip Morris Incorporated ("Philip
Morris"), R. J. Reynolds Tobacco Company ("RJR"), B&W, Lorillard Tobacco Company
("Lorillard") and the United States Tobacco Company, along with the Attorneys
General for the States of Arizona, Connecticut, Florida, Mississippi, New York
and Washington and the CASTANO Plaintiffs' Litigation Committee executed a
Memorandum of Understanding to support the adoption of federal legislation and
necessary ancillary undertakings, incorporating the features described in a
proposed resolution (the "Resolution"). The proposed Resolution mandates a total
reformation and restructuring of how tobacco products are manufactured, marketed
and distributed in the United States. (The proposed Resolution is discussed in
Liggett's 1997 Form 10-K/A No. 1.)

         In a speech in September 1997, President Clinton called for federal
legislation that, among other things, would raise cigarette prices by up to
$1.50 per pack. Since then, several bills have been introduced in Congress,
including bills modeled after the proposed Resolution, that purport to propose
legislation along these lines. The White House, Congress and various public
interest groups are currently reviewing the proposed Resolution along with other
proposed federal tobacco legislation. Management is unable to predict whether
the proposed Resolution or other federal legislation will be enacted or the form
any such enactment might take. The present legislative and litigation
environment is substantially uncertain and could have a material adverse effect
on the business of Liggett.

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







                                       21


<PAGE>   22

9.       RELATED PARTY TRANSACTIONS

         On July 5, 1996, Liggett purchased 140,000 shares (19.97%) of
Liggett-Ducat's tobacco operations from BOL, for $2,100. Liggett-Ducat produces
and markets cigarettes in Russia. Liggett also acquired on that date for $3,400
a ten-year option to purchase from BOL at the same per share price up to 292,407
additional shares of Liggett-Ducat, thereby entitling Liggett to increase its
interest in Liggett-Ducat to approximately 62%. On March 13, 1997, Liggett
acquired a second ten-year option to purchase BOL's remaining shares in
Liggett-Ducat (an additional 33%) for $2,200 of which $2,049 was paid in cash,
with the balance settled through intercompany accounts. Such amounts were
accounted for as an element of cash flows from investing activities in the
Company's consolidated statements of cash flows. Liggett accounted for its
investment in Liggett-Ducat under the equity method of accounting. Liggett's
equity in the net income of Liggett-Ducat amounted to $498 for the year ended
December 31, 1997. The excess of the cost of the option over the carrying amount
of net assets to be acquired under the option has been charged to stockholder's
deficit. On January 30, 1998, in connection with the restructuring of the
Liggett Notes, BOL acquired the Liggett-Ducat shares and options held by
Liggett. (Refer to Note 7 to the Company's consolidated financial statements.)

         On April 28, 1997, BOL purchased excess production equipment from
Liggett for $3,000. The difference of $2,578 between the sale price and the
carrying value is accounted for as a credit to contributed capital.

         Liggett is party to a Tax-Sharing Agreement dated June 29, 1990 with
BGL and certain other entities pursuant to which Liggett has paid taxes to BGL
as if it were filing a separate company tax return, except that the agreement
effectively limits the ability of Liggett to carry back losses for refunds.
Liggett is entitled to recoup overpayments in a given year out of future
payments due under the agreement.

         Liggett is a party to an agreement dated February 26, 1991, as amended
October 1, 1995, with BGL to provide various management and administrative
services to the Company in consideration for an annual management fee of $900
paid in monthly installments and annual overhead reimbursements of $864 paid in
quarterly installments.

         Liggett has entered into an annually renewable Corporate Services
Agreement with BGLS wherein BGLS agreed to provide corporate services to the
Company at an annual fee paid in monthly installments. Corporate services
provided by BGLS under this agreement include the provision of administrative
services related to Liggett's participation in its parent company's
multi-employer benefit plan, external publication of financial results,
preparation of consolidated financial statements and tax returns and such other
administrative and managerial services as may be reasonably requested by
Liggett. The charges for services rendered under the agreement amounted to $918
in the first six months of 1998 and $1,659 in the first six months of 1997. This
fee is in addition to the management fee and overhead reimbursements described
above. In connection with the January 30, 1998 amendment to the Liggett Notes
Indenture, BGL and BGLS agreed to waive corporate services and management fees
above $3,600 per year, effective January 1, 1998.

         Since April 1994, the Company has leased equipment from BGLS for $50
per month.

10.      RESTRUCTURING CHARGES

         During 1997, the Company reduced its headcount by 108 full-time
positions and recorded a $1,964 restructuring charge to operations ($407 of
which was included in cost of sales) for severance programs, primarily salary
continuation and related benefits for terminated employees. Of the total
restructuring recorded during 1997, $1,671 was funded during 1997, leaving $293
remaining to be funded in 1998.








                                       22



<PAGE>   23

         For the six months ending June 30, 1998, restructuring charges of
approximately $241 were funded, leaving $52 to be funded in the remainder of
1998.







































                                       23

<PAGE>   24



                                EVE HOLDINGS INC.

                                 BALANCE SHEETS
                                   (Unaudited)
                (Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>

                                                                                      June 30,     December 31,
                                                                                        1998           1997
                                                                                      --------     ------------
<S>                                                                                   <C>            <C>     
                                          ASSETS

Cash ...........................................................................      $      4       $      1

Office equipment ...............................................................             2              2

Trademarks, at cost, less accumulated amortization of
    $19,845 and $18,995, respectively ..........................................           568          1,418
                                                                                      --------       --------

               Total assets ....................................................      $    574       $  1,421
                                                                                      ========       ========

                        LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)

Federal income taxes currently payable to parent ...............................      $     73       $     91

Dividends payable ..............................................................         1,318          1,273

Other current liabilities ......................................................            --              3

Deferred income taxes ..........................................................           199            496
                                                                                      --------       --------

              Total liabilities ................................................         1,590          1,863
                                                                                      --------       --------

Stockholder's equity (deficit):
   Common stock (par value $1.00 per share; authorized,
        issued and outstanding 100 shares) and contributed
        capital ................................................................        48,041         45,442

   Receivables from parent:
       Note receivable - interest at 14%, due no sooner
         than February 1, 1999 .................................................       (44,520)       (44,520)
       Other ...................................................................        (4,537)        (1,364)
                                                                                      --------       --------

              Total stockholder's equity (deficit) .............................        (1,016)          (442)
                                                                                      --------       --------

              Total liabilities and stockholder's equity (deficit)..............      $    574       $  1,421
                                                                                      ========       ========
               
                                                                                      
</TABLE>



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






                                       24
<PAGE>   25


                                EVE HOLDINGS INC.

                            STATEMENTS OF OPERATIONS
                                   (Unaudited)
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                          Three Months Ended       Six Months Ended
                                               June 30,                June 30,
                                          ------------------      ------------------
                                           1998        1997        1998       1997
                                          ------      ------      ------      ------

<S>                                       <C>         <C>         <C>         <C>   
Revenues:
     Royalties - parent ............      $2,052      $1,761      $3,571      $3,306
     Interest - parent .............       1,577       1,576       3,153       3,153
                                          ------      ------      ------      ------
                                           3,629       3,337       6,724       6,459

Expenses:
     Amortization of trademarks ....         426         425         851         851
     Miscellaneous, net ............          24          27          39          64
                                          ------      ------      ------      ------

          Income before income taxes       3,179       2,885       5,834       5,544

Income tax provision ...............         562         458         939         837
                                          ------      ------      ------      ------

          Net income ...............      $2,617      $2,427      $4,895      $4,707
                                          ======      ======      ======      ======
</TABLE>
























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



                                       25

<PAGE>   26


                                EVE HOLDINGS INC.
                            STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                             (Dollars in thousands)
<TABLE>
<CAPTION>

                                                                                   Six Months Ended
                                                                                        June 30,
                                                                                  ---------------------
                                                                                   1998          1997
                                                                                  -------       -------
<S>                                                                               <C>           <C>    
Cash flows from operating activities:
    Net income .............................................................      $ 4,895       $ 4,707
    Adjustments to reconcile net income to net cash provided by 
        operating activities:
        Depreciation and amortization ......................................          851           851
        Deferred income taxes ..............................................         (297)         (298)
    Changes in assets and liabilities:
        Federal income taxes currently payable to parent ...................          (18)           74
        Other current liabilities ..........................................           (3)          (16)
                                                                                  -------       -------

            Net cash provided by operating activities ......................        5,428         5,318
                                                                                  -------       -------

Cash flows from financing activities:
    Dividends/capital distributions ........................................       (2,252)       (5,603)
    Decrease (increase) in due from parent .................................       (3,173)          387
    Decrease in cash overdraft .............................................           --           (92)
                                                                                  -------       -------

           Net cash used in financing activities ...........................       (5,425)       (5,308)

Net increase in cash .......................................................            3            10

Cash:
    Beginning of period ....................................................            1            --
                                                                                  -------       -------

    End of period ..........................................................      $     4       $    10
                                                                                  =======       =======
Supplemental cash flow information:
    Payments of income taxes through receivable from parent ................      $    --       $ 1,060
    Income taxes ...........................................................           74            32
    Dividends/capital distributions declared but not paid ..................        2,295         1,127
</TABLE>












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




                                       26

<PAGE>   27



                                EVE HOLDINGS INC.

                          NOTES TO FINANCIAL STATEMENTS
                                   (Unaudited)
                (Dollars in thousands, except per share amounts)



1.       THE COMPANY

         Eve Holdings Inc. ("Eve") is a wholly-owned subsidiary of Liggett Group
Inc. ("Liggett"). Eve, formed in June 1990, is the proprietor of, and has all
right, title and interest in, certain federal trademark registrations (the
"Trademarks"). Eve has entered into an exclusive licensing agreement with
Liggett (effective until 2010) whereby Eve grants the use of the Trademarks to
Liggett in exchange for royalties, computed based upon Liggett's annual net
sales, excluding excise taxes. The Trademarks are pledged as collateral for
Liggett's borrowings under the notes indentures (see Note 3).

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a.       Going Concern

         The accompanying financial statements have been prepared assuming that
Eve will continue as a going concern. Eve's revenues are comprised solely of
royalties and interest income from Liggett. In addition, Eve holds a note
receivable from Liggett for $44,520 due no sooner than February 1, 1999. Liggett
had a working capital deficiency of $176,784 and a net capital deficiency of
$188,372 as of June 30, 1998, is highly leveraged and has substantial near-term
debt service requirements. Both the Liggett Series B and Series C Notes (as
defined below) and the revolving credit facility, amounting in total to
approximately $167,500, mature during the first quarter of 1999. These matters
raise substantial doubt about Eve and Liggett meeting their liquidity needs and
their ability to continue as going concerns.

         The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

b.       Per Share Data

         All of Eve's common shares (100 shares authorized, issued and
outstanding for all periods presented herein) are owned by Liggett. Accordingly,
earnings and dividends per share data are not presented in these financial
statements.

3.       GUARANTEE OF LIGGETT NOTES

         On February 14, 1992, Liggett issued $150,000 of Senior Secured Notes
(the "Series B Notes"). In connection with the issuance of the Series B Notes,
the Trademarks were pledged as collateral. In addition, Eve is a guarantor for
the Series B Notes. At June 30, 1998, a total of $112,612 Series B Notes remains
outstanding.

         During 1994, Liggett issued $32,850 of Series C Senior Secured Notes
(the "Series C Notes"). Eve is a guarantor for the Series C Notes. At June 30,
1998, a total of $32,279 Series C Notes remains outstanding.











                                       27

<PAGE>   28

4.       INCOME TAXES

             Eve qualifies as a company conducting operations exempt from income
taxation under Delaware General Statute Section 1903(b). In recent years, some
states have been aggressively pursuing companies exempt under this statute.
Eve's management believes that certain state income tax rulings supporting these
states' arguments will be ultimately reversed and that Eve's status as a company
not conducting business in these states will be respected. Consequently,
management has not provided a reserve for additional state income taxes. No
assurance can be given with regard to future state income tax rulings and audit
activity with respect to Eve.









































                                       28
<PAGE>   29


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

                  (DOLLARS IN THOUSANDS, EXCEPT SELLING PRICES)


INTRODUCTION

         Liggett Group Inc. ("Liggett" or the "Company") is the operating
successor to the Liggett & Myers Tobacco Company formed in 1873. Liggett is the
fifth largest manufacturer of cigarettes in the United States in terms of unit
sales. Liggett is a wholly-owned subsidiary of BGLS Inc. ("BGLS"), a
wholly-owned subsidiary of Brooke Group Ltd. ("BGL").

         The following discussion provides an assessment of Liggett's
consolidated results of operations and capital resources and liquidity and
should be read in conjunction with the consolidated financial statements of
Liggett and notes thereto included elsewhere in this Report on Form 10-Q. The
operating results of the periods presented were not significantly affected by
inflation.

         Eve Holdings Inc. ("Eve") is a wholly-owned subsidiary of Liggett.
Eve's sole business is to hold certain federal trademark registrations used by,
and to license them on an exclusive basis to, Liggett and to hold a certain note
receivable from Liggett. Accordingly, Management's Discussion and Analysis of
Financial Condition and Results of Operations of Eve are not presented herein
because they are not material to Liggett's operations.

        The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. Liggett had a net
capital deficiency of $188,372 and a working capital deficiency of $176,784 as
of June 30, 1998, is highly leveraged and has substantial near-term debt service
requirements. Due to the many risks and uncertainties associated with the
cigarette industry and the impact of tobacco litigation, there can be no
assurance that the Company will be able to meet its future earnings or cash flow
goals. Consequently, the Company could be in violation of its debt covenants,
including covenants limiting the maximum permitted net worth and working capital
deficiencies, and if the lenders were to exercise acceleration rights under its
revolving credit facility (the "Facility") or the indenture for its Senior
Secured Notes (the "Liggett Notes") or refuse to lend under the Facility, the
Company would not be able to satisfy such demands or its working capital
requirements.

         On January 30, 1998, the Company obtained the consents of the required
majority of the holders of the Liggett Notes to various amendments to the
Indenture governing the Liggett Notes. The amendments provided, among other
things, for a deferral of the February 1, 1998 mandatory redemption of $37,500
principal amount of the Liggett Notes to the date of final maturity, February 1,
1999. (Refer to Note 7.) At maturity, the Liggett Notes will require a principal
payment of $144,891. The Company does not anticipate it will be able to generate
sufficient cash from operations to make such payments. In addition, the Company
has the $40,000 Facility expiring March 8, 1999 under which $22,678 was
outstanding at June 30, 1998. If the Company is unable to refinance or
restructure the terms of the Liggett Notes or otherwise make all payments
thereon, substantially all of the Company's long-term debt and the Facility
would be in default and holders of such debt could accelerate the maturity of
such debt. In such event, Liggett may be forced to seek protection from
creditors under applicable laws. These matters raise substantial doubt about the
Company meeting its liquidity needs and its ability to continue as a going
concern.

RECENT DEVELOPMENTS IN THE CIGARETTE INDUSTRY

         PRICING ACTIVITY. As of August 14, 1998, list price increases during
1998 amount to $1.85 per carton. On January 23, 1998, Philip Morris and RJR
announced a list price increase of $.25 per carton. This action was matched by
Liggett and the other manufacturers during the following 



                                       29
<PAGE>   30

week. On April 3, 1998, Philip Morris announced a second list price increase of
$.50 per carton. This action was matched by Liggett and the other manufacturers.
On May 11, 1998, Philip Morris and RJR announced a third list price increase of
$.50 per carton on all brands. This action was matched by Liggett and the other
manufacturers during the following week. On July 31, 1998, Philip Morris
announced a fourth list price increase of $.60 per carton on all brands. This
action was matched by Liggett and the other manufacturers during the following
week.

         LEGISLATION, REGULATION AND LITIGATION. The cigarette industry
continues to be challenged on numerous fronts. New cases continue to be
commenced against Liggett and BGL and other cigarette manufacturers. As of June
30, 1998, there were approximately 245 individual suits, 40 purported class
actions and 60 state, municipality and other third-party payor health care
reimbursement actions pending in the United States in which Liggett is a named
defendant. As new cases are commenced, the costs associated with defending such
cases and the risks attendant to the inherent unpredictability of litigation
continue to increase. Recently, there have been a number of restrictive
regulatory actions from various Federal administrative bodies, including the
United States Environmental Protection Agency ("EPA") and the Food and Drug
Administration ("FDA"), adverse political decisions and other unfavorable
developments concerning cigarette smoking and the tobacco industry, including
the commencement and certification of class actions and the commencement of
Medicaid reimbursement suits by various states' Attorneys General. These
developments generally receive widespread media attention. Liggett is not able
to evaluate the effect of these developing matters on pending litigation or the
possible commencement of additional litigation, but it is possible that
Liggett's financial position, results of operations and cash flows could be
materially adversely affected by an ultimate unfavorable outcome in any of such
pending litigation. (See Note 8 to the Company's consolidated financial
statements for a description of legislation, regulation and litigation.)

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

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

         SETTLEMENTS. In March 1996, Liggett and BGL entered into an agreement
to settle the CASTANO class action tobacco litigation and an agreement with the
Attorneys General of West Virginia, Florida, Mississippi, Massachusetts and
Louisiana to settle certain actions brought against Liggett and BGL by such
states (the "March 1996 Settlements"). Liggett and BGL, while neither consenting
to FDA jurisdiction nor waiving their objections thereto, agreed to withdraw
their objections and opposition to the proposed FDA regulations and to phase in
compliance with certain of the proposed interim FDA regulations.

         Under the CASTANO settlement agreement, upon final court approval of
the settlement, the CASTANO class would be entitled to receive up to 5% of
Liggett's pretax income (income before income taxes) each year (up to a maximum
of $50,000 per year) for the next twenty-five years, subject to certain
reductions provided for in the agreement, and a $5,000 payment from Liggett if
Liggett or BGL fail to consummate a 





                                       30
<PAGE>   31

merger or similar transaction with another non-settling tobacco company
defendant within three years of the date of the settlement. Liggett and BGL have
the right to terminate the CASTANO settlement under certain circumstances. On
May 11, 1996, the CASTANO Plaintiffs Legal Committee filed a motion with the
United States District Court for the Eastern District of Louisiana seeking
preliminary approval of the CASTANO settlement. On May 23, 1996, the Court of
Appeals for the Fifth Circuit reversed the February 17, 1995 order of the
District Court certifying the CASTANO suit as a nationwide class action and
instructed the District Court to dismiss the class complaint. For additional
information concerning the Fifth Circuit's decision, see Note 8 to the Company's
consolidated financial statements. In September 1996, the CASTANO plaintiffs
withdrew the motion for approval of the CASTANO settlement.

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

         Under the Attorneys General settlement, the five states would share an
initial payment by Liggett of $5,000 ($1,000 of which was paid in March 1996,
with the balance payable over nine years and indexed and adjusted for
inflation), provided that any unpaid amount will be due 60 days after either a
default by Liggett in its payment obligations under the settlement or a merger
or other similar transaction by Liggett or BGL with another defendant in the
lawsuits. In addition, Liggett will be required to pay the states a percentage
of Liggett's pretax income (income before income taxes) each year from the
second through the twenty-fifth year. This annual percentage is 2.5% of
Liggett's pretax income, subject to increase to 7.5% depending on the number of
additional states joining the settlement. No additional states have joined this
settlement to date. All of Liggett's payments are subject to certain reductions
provided for in the agreement. Liggett has also agreed to pay to the states
$5,000 if Liggett or BGL fails to consummate a merger or other similar
transaction with another defendant in the lawsuits within three years of the
date of the settlement.

         In 1997, Liggett and BGL entered into a comprehensive settlement of
tobacco litigation through parallel agreements with the Attorneys General of 21
states and with a nationwide class of individuals and entities that allege
smoking-related claims (collectively, the "March 1997 Settlements"). The
settlements cover all smoking-related claims, including both addiction-based and
tobacco injury claims against Liggett and BGL brought by the states and, upon
court approval, the nationwide class. In March 1998, Liggett and BGL entered
into additional settlements with the Attorneys General of 15 states, the
District of Columbia, Guam, the Northern Mariana Islands and the U. S. Virgin
Islands (the "March 1998 Settlements").

         As mentioned above, in March 1997, Liggett, BGL and plaintiffs filed
the mandatory class settlement agreement in an action entitled FLETCHER, ET AL.
V. BROOKE GROUP LTD., ET AL., Circuit Court of Mobile County, Alabama, where the
court granted preliminary approval and preliminary certification of the class,
and in May 1997, a similar mandatory class settlement agreement was filed in an
action entitled WALKER, ET AL. V. LIGGETT GROUP INC., ET AL., United States
District Court, Southern District of West Virginia. On July 2, 1998, the Company
and plaintiffs filed an amended class action settlement agreement in FLETCHER.
Pursuant to the amended agreement, Liggett is required to pay to the class 7.5%
of Liggett's pre-tax income each year for 25 years, with a minimum annual
payment guarantee of $1,000 over the term of the agreement. The amended
agreement does not set forth a formula with respect to the distribution of







                                       31

<PAGE>   32

settlement proceeds to the class. The WALKER court also granted preliminary
approval and preliminary certification of the nationwide class; however, on
August 5, 1997, the court vacated its preliminary certification of the
settlement class, which decision is currently on appeal.

         In the FLETCHER action, it is anticipated that class members will be
notified of the settlement and will have an opportunity to appear at a later
court hearing. Effectiveness of the mandatory settlement is conditioned on final
court approval of the settlement after a fairness hearing. There can be no
assurance as to whether or when court approval will be obtained. For additional
information concerning the FLETCHER action, see Note 8 to the Company's
consolidated financial statements.

         Under the March 1998 Settlements, Liggett is required to pay each of
the settling states and territories their relative share (based on the Medicaid
population of each state over the total Medicaid population of the United
States) of between 27.5% and 30% of Liggett's pre-tax income each year for 25
years, with a minimum payment guarantee of $1,000 per state over the first nine
years of the agreement. The annual percentage is subject to increase, pro rata
from 27.5% up to 30%, depending on the number of additional states joining the
settlement. Pursuant to the "most favored nation" provisions under the March
1996 and March 1997 Settlements, each of the states settling under those
settlements could benefit from the economic terms of the March 1998 Settlements.

         Liggett accrued approximately $4,000 for the present value of the fixed
payments under the March 1996 Settlements and $18,301 for the present value of
the fixed payments under the March 1998 Settlements. No additional amounts have
been accrued because the Company cannot quantify the future costs of the
settlements as the amounts Liggett must pay are based, in part, on future
operating results. Possible future payments based on a percentage of pretax
income, and other contingent payments based on the occurrence of a business
combination, will be expensed when considered probable. (See the discussions of
the tobacco litigation settlements appearing in Note 8 to the Company's
consolidated financial statements.

         Separately, the other tobacco companies negotiated settlements of the
Attorney General Actions in Mississippi, Florida, Texas and Minnesota and it has
been widely publicized that the other companies have engaged in negotiations to
settle with the Attorneys General of the remaining states.

         OTHER MATTERS. On June 20, 1997, Philip Morris, RJR, B&W, Lorillard and
the United States Tobacco Company, along with the Attorneys General for the
States of Arizona, Connecticut, Florida, Mississippi, New York and Washington
and the CASTANO Plaintiffs' Litigation Committee executed a Memorandum of
Understanding (the "Resolution") to support the adoption of federal legislation
and necessary ancillary undertakings, incorporating the features described in a
proposed resolution. The proposed Resolution mandates a total reformation and
restructuring of how tobacco products are manufactured, marketed and distributed
in the United States. (For additional information concerning the proposed
Resolution, see Note 8 of the Company's consolidated financial statements.) The
White House, Congress and various public interest groups are currently reviewing
the proposed Resolution along with other proposed federal tobacco legislation.
Management is unable to predict the ultimate effect, if any, of the enactment of
legislation adopting the proposed Resolution. Management is also unable to
predict the ultimate content of any such legislation. However, adoption of any
such legislation could have a material adverse effect on the business of
Liggett.

         In a speech in September 1997, President Clinton called for federal
legislation that, among other things, would raise cigarette prices by up to
$1.50 per pack. Since then, several bills have been introduced in the Senate
that purport to propose legislation along these lines. Management is unable to
predict the ultimate content of any such legislation; however, adoption of any
such legislation could have a material adverse effect on the business of
Liggett.












                                       32

<PAGE>   33

RESULTS OF OPERATIONS

1997 RESTRUCTURING

         In January 1997, Liggett underwent a major restructuring from a
centralized organization to a decentralized enterprise with four Strategic
Business Units, each a profit center, and a corporate headquarters. This
restructuring was intended to more closely align sales and marketing strategies
with the unique requirements of regional markets as well as reduce working
capital by improved production planning and inventory control.

         During 1997, the Company reduced its headcount by approximately 108
full-time positions and recorded a $1,964 restructuring charge to operations
($407 of which is included in cost of sales) for severance programs, primarily
salary continuation and related benefits for terminated employees. The
anticipated savings of the restructuring relate primarily to reduced payroll and
benefits expenses in future periods. Of the total restructuring recorded during
1997, $1,671 was funded during 1997, leaving $293 remaining to be funded in
1998.

         For the six months ending June 30, 1998, restructuring charges of
approximately $241 were funded, leaving $52 to be funded in the remainder of
1998.

THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997

         REVENUES. For the three months ended June 30, 1998, net sales totaled
$83,398, compared to $78,142 for the same period in 1997. Revenues increased in
both the premium and discount segments by 6.7% ($5,256) due to price increases
of $10,754 (see "Recent Developments in the Cigarette Industry - Pricing
Activity") and improved product mix of $290, partially offset by 7.4% decline in
unit sales volume (approximately 119.5 million units) accounting for $5,788 in
volume variance. The decline in Liggett's sales volume was due to certain
competitors' continuing leveraged rebate programs tied to their products and
increased promotional activity by certain other manufacturers.

         Premium sales over this period amounted to $26,951 and represented
32.3% of total revenues, compared to $25,309 and 32.4% of total sales for the
same period in 1997. In the premium segment, revenues grew by 6.5% ($1,642) over
the three months ended June 30, 1998, compared to the same period in 1997, due
to price increases of $3,015, which were partially offset by a 5.4% decline in
unit sales volume (approximately 23.0 million units) accounting for $1,373 in
volume variance.

         Discount sales (comprising the brand categories of branded discount,
private label, control label, generic, international and contract manufacturing)
over this period amounted to $56,447 and represented 67.7% of total revenues,
compared to $52,833 and 67.6% of total sales for the same period in 1997. In the
discount segment, revenues grew by 6.8% ($3,614) over the three months ended
June 30, 1998 compared to the same period in 1997, due to price increases of
$7,738 and improved product mix among the brand categories of $162, which were
partially offset by an 8.1% decline in unit sales volume (approximately 96.5
million units) accounting for $4,286 in volume variance. For the three months
ended June 30, 1998, fixed manufacturing costs on a basis comparable to the same
period in 1997 were $1,062 lower, along with a decline in costs per thousand
units of $0.87 per thousand due to the absence of severance payments in the
second quarter of 1998 compared to the prior year period.

             GROSS PROFIT. Gross profit of $50,316 for the three months ended
June 30, 1998 increased $8,388 from gross profit of $41,928 for the same period
in 1997, due primarily to the price increases discussed above. In 1998,
Liggett's premium and discount brands contributed 34.9% and 65.1% ,
respectively, to the Company's overall gross profit. Over the same period in
1997, Liggett's premium and discount brands contributed 36.5% and 63.5%,
respectively, to total gross profit. As a percent of revenues (excluding federal
excise taxes), gross profit at Liggett increased to 76.5% for the three months
ended June 30, 1998 compared to 71.1% for the same period in 1997, with gross
profit for the premium segment at 79.4% and 75.7% in the second quarter of 1998
and 1997, respectively, and gross profit for the discount segment at 75.1% and
68.7% in 1998 and 1997, respectively. This increase is the result of the
September 1997, January 1998, April 1998 and May 1998 list price increases and
improved production variances. 













                                       33

<PAGE>   34

These increases were partially offset by increased tobacco costs at Liggett due
to a reduction in the average discount available to the Company from leaf
tobacco dealers on tobacco purchased under prior years' purchase commitments.

         EXPENSES. Operating, selling, general and administrative expenses were
$40,022 for the three months ended June 30, 1998 compared to $37,430 for the
same period for the prior year, an increase of $2,592. This increase in
operating expense was due primarily to $3,459 in higher spending for promotional
and marketing programs and higher legal expenses of $743. Such increases were
partially offset by reductions in management fees of $586 and decreases in
systems development costs of approximately $868 over the same prior year period.

         OPERATING INCOME. Operating income increased to $8,895 for the three
months ended June 30, 1998 from $4,428 for the same prior year period due
primarily to an increase in gross profits discussed above, partially offset by
increased selling and legal expenses and settlement charges of $1,399, along
with the decline in unit sales volume discussed above.

         OTHER INCOME (EXPENSE). Interest expense was $7,352 for the three
months ended June 30, 1998 compared to $5,930 for the same period in 1997. This
increase in interest expense resulted from the Company recording a deferred
charge of approximately $4,100 during the first quarter of 1998. This deferred
charge is being amortized over a period of one year. (Refer to Note 7 to the
Company's consolidated financial statements.)

         NET INCOME. Net income amounted to $2,011 for the three months ended
June 30, 1998 compared to net income of $1,122 for the same period in the prior
year. The increase in net income was primarily the result of the factors
discussed above which resulted in higher operating income, offset by the
non-cash interest charge discussed above, by a gain of $2,402 in the 1997 period
on the sales of assets and by equity in income from an affiliate of
approximately $218 in the prior year period.

SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997

         REVENUES. For the six months ended June 30, 1998, net sales totaled
$149,024, compared to $144,443 for the same period in 1997. Revenues increased
in the premium and discount segments by 3.2% ($4,581) due to price increases of
$18,064 (see "Recent Developments in the Cigarette Industry - Pricing Activity")
and improved product mix of $667 which were partially offset by a 9.8% decline
in unit sales volume (approximately 298.1 million units) accounting for $14,150
in volume variance. The decline in Liggett's sales volume was due to certain
competitors' continuing leveraged rebate programs tied to their products and
increased promotional activity by certain other manufacturers.

         Premium sales over this period amounted to $49,925 and represented
33.5% of total revenues, compared to $47,914 and 33.2% of total sales for the
same period in 1997. In the premium segment, revenues grew by 4.2% ($2,011) over
the six months ended June 30, 1998, compared to the same period in 1997, due to
price increases of $5,212, which were partially offset by a 6.7% decline in unit
sales volume (approximately 54.5 million units) accounting for $3,201 in volume
variance.

         Discount sales (comprising the brand categories of branded discount,
private label, control label, generic, international and contract manufacturing)
over this period amounted to $99,099 and represented 66.5% of total revenues,
compared to $96,529 and 66.8% of total sales for the same period in 1997. In the
discount segment, revenues grew by 2.7% ($2,570) over the six months ended June
30, 1998, compared to the same period in 1997, due to price increases of $12,851
and improved product mix among the discount brand categories of $276, partially
offset by a 10.9% decline in unit sales volume (approximately 243.6 million
units) accounting for $10,557 in volume variance. For the six months ended June
30, 1998, fixed manufacturing costs on a basis comparable to the same period in
1997 were $1,314 lower, along with a 













                                       34

<PAGE>   35

decline in costs per thousand units of $0.34 per thousand due to the absence of
severance payments in the second quarter of 1998 compared to the prior year
period.

              GROSS PROFIT. Gross profit of $89,754 for the six months ended
June 30, 1998 increased $11,784 from gross profit of $77,970 for the same period
in 1997, due primarily to the price increases discussed above. In 1998,
Liggett's premium and discount brands contributed 36.1% and 63.9%, respectively,
to the Company's overall gross profit. Over the same period in 1997, Liggett's
premium and discount brands contributed 37.4% and 62.6%, respectively, to total
gross profit. As a percent of revenues (excluding federal excise taxes), gross
profit at Liggett increased to 77.0% for the six months ended June 30, 1998
compared to 71.5% for the same period in 1997, with gross profit for the premium
segment at 79.6% and 76.1% in the six months ended June 30 of 1998 and 1997,
respectively, and gross profit for the discount segment at 75.6% and 69.0% in
1998 and 1997, respectively. This increase is the result of the March 1997,
September 1997, January 1998, April 1998 and May 1998 list price increases and
improved production variances. These increases were partially offset by
increased tobacco costs at Liggett due to a reduction in the average discount
available to the Company from leaf tobacco dealers on tobacco purchased under
prior years' purchase commitments.

         EXPENSES. Operating, selling, general and administrative expenses were
$72,728 for the six months ended June 30, 1998 compared to $71,353 for the same
period for the prior year, an increase of $1,375. This increase in operating
expense was due primarily to $4,066 in higher spending for promotional and
marketing programs and higher legal expenses of $1,385. Such increases were
partially offset by reductions in management fees of $741 and decreases in
systems development costs of approximately $2,893 over the same prior year
period.

         OPERATING INCOME. Operating income increased to $15,145 for the six
months ended June 30, 1998 from $4,786 in the same period for the prior year due
primarily to an increase in gross profits discussed above and the absence of
approximately $1,831 in reduced administrative charges resulting from the 1997
restructuring, partially offset by increased selling and legal expenses and
settlement charges of $1,881, along with the decline in unit sales volume
discussed above.

         OTHER INCOME (EXPENSE). Interest expense was $14,434 for the six months
ended June 30, 1998 compared to $11,970 for the same period in 1997. This
increase in interest expense resulted from the Company recording a deferred
charge of approximately $4,100 during the first quarter of 1998, partially
offset by lower outstanding revolver balances. This deferred charge is being
amortized over a period of one year. (Refer to Note 7 to the Company's
consolidated financial statements.)

         NET INCOME. Net income amounted to $1,547 for the six months ended June
30, 1998 compared to net income of $18 for the same period in the prior year.
The increase in net income was primarily the result of the factors discussed
above which resulted in higher operating income, offset by the non-cash interest
charge discussed above, by a gain of $3,994 in the 1997 period on the sales of
assets, a gain of $2,963 on the retirement of debt and by equity in income from
an affiliate of approximately $185 in the prior year period.

CAPITAL RESOURCES AND LIQUIDITY

         Cash provided by operating activities was $2,213 for the six months
ended June 30, 1998 compared to cash used in operating activities of $1,035 for
the same period in 1997. The net increase in cash in the first half of 1998 when
compared to the corresponding period in 1997 was due primarily to a decrease in
inventories and an increase in revenues.

         Cash provided by investing activities amounted to $477 for the six
months ending June 30, 1998, primarily due to proceeds from the sale of
equipment of approximately $1,171, which were partially offset by expenditures
for capital equipment of $694. This compares to cash provided by














                                       35

<PAGE>   36
investing activities of $1,457 for the six months of 1997, primarily due to
proceeds from the sale of assets of approximately $4,743, which were partially
offset by investments in affiliates of $2,200 and expenditures for capital
equipment of $1,086.

         Cash used in financing activities for the six months of 1998 totaled
$2,108, in contrast to cash provided by financing activities of $84 in the prior
year, resulting primarily from net repayments under the Facility and a decrease
in cash overdraft. In 1997, repayments of long-term debt totaling approximately
$4,664 were offset by net borrowings under the Facility of $4,754.

         On March 8, 1994, Liggett entered into the Facility under which it can
borrow up to $40,000 (depending on the amount of eligible inventory and
receivables as determined by the lenders) from a syndicate of commercial
lenders. Availability under the Facility was approximately $5,946 based upon
eligible collateral at June 30, 1998. The Facility is collateralized by all
inventories and receivables of the Company. Borrowings under the Facility are
charged interest 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. Liggett's interest rate is currently 10.0%. The Facility contains
certain financial covenants similar to those contained in the Liggett Notes
indenture, including restrictions on Liggett's ability to declare or pay cash
dividends, incur additional debt, grant liens and enter into any new agreements
with affiliates, among others. In addition, the Facility, as amended April 8,
1998, imposes requirements with respect to the Company's adjusted net worth (not
to fall below a deficit of $195,000 as computed in accordance with the
agreement, this computation was $185,051 at June 30, 1998) and working capital
(not to fall below a deficit of $17,000 as computed in accordance with the
agreement, this computation was $6,005 at June 30, 1998). The Facility, as
amended, also provides that a default by Liggett or its subsidiaries under the
March 1996 Settlements, March 1997 Settlements and March 1998 Settlements (all
as defined below in Note 8) shall constitute an event of default under the
Facility.

         In November 1997, the Facility was extended until March 8, 1999. At
June 30, 1998 the closing balance on the Facility stood at $22,678.

         In 1992, Liggett issued $150,000 in Senior Secured Notes (the "Series B
Notes") and in 1994, the Company issued $32,850 of Variable Rate Series C Senior
Secured Notes (the "Series C Notes"). Interest on the Series B Notes and the
Senior C Notes is payable semiannually on February 1 and August 1 at an annual
rate of 11.5% and 19.75%, respectively. The Series B Notes and Series C Notes
(collectively, the "Liggett Notes") required mandatory principal redemptions of
$7,500 on February 1 in each of the years 1993 through 1997 and $37,500 on
February 1, 1998 with the balance of the Liggett Notes due on February 1, 1999.
In February 1997, $7,500 of Liggett B Notes were purchased using the Facility
and credited against the mandatory redemption requirements. The Liggett Notes
are collateralized by substantially all of the assets of the Company, excluding
accounts receivable and inventory. Eve is a guarantor for the Liggett Notes. The
Liggett Notes may be redeemed, in whole or in part, at a price equal to 100% of
the principal amount at the option of the Company. The Liggett Notes contain
restrictions on Liggett's ability to declare or pay cash dividends, incur
additional debt, grant liens and enter into any new agreements with affiliates,
among others. BGLS or its affiliates, including Liggett, may, from time to time,
based on current market conditions, purchase Liggett Notes in the open market or
in privately negotiated transactions.

         On January 30, 1998, with the consent of the required majority of the
holders of the Liggett Notes, Liggett entered into various amendments to the
Indenture governing the Liggett Notes, which provided, among other things, for a
deferral of the February 1, 1998 mandatory redemption payment of $37,500 to the
date of final maturity of the Liggett Notes on February 1, 1999. In connection
with the deferral, BGL agreed to issue 483,002 shares of BGL's common stock to
the holders of record on January 15, 1998 of the Liggett Notes. As a result of
this transaction, the Company recorded a deferred charge of approximately $4,100
during the first quarter of 1998 reflecting the fair value of the instruments
issued. This deferred charge is being amortized as an adjustment to interest
expense over a period of one year. The Indenture under which the Liggett Notes
are outstanding was also amended to prohibit, with limited exceptions,












                                       36


<PAGE>   37

payments of dividends and incurrence of new debt by Liggett and to tighten
restrictions on the disposition of proceeds of asset sales. (Refer to Note 7 to
the Company's consolidated financial statements.)

         The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. Liggett had a net
capital deficiency of $188,372 as of June 30, 1998, is highly leveraged and has
substantial near-term debt service requirements. Due to the many risks and
uncertainties associated with the cigarette industry and the impact of tobacco
litigation (see Note 8 to the Company's consolidated financial statements),
there can be no assurance that the Company will be able to meet its future
earnings or cash flow goals. Consequently, the Company could be in violation of
its debt covenants, including covenants limiting the maximum permitted net worth
and working capital deficiencies, and if its lenders were to exercise
acceleration rights under the Facility or the indenture for the Liggett Notes or
refuse to lend under the Facility, the Company would not be able to satisfy such
demands or its working capital requirements.

         As discussed above, the Liggett Notes require payments at maturity on
February 1, 1999 of $144,891. Liggett does not anticipate it will be able to
generate sufficient cash from operations to make such payments. If Liggett is
unable to refinance or restructure the terms of the Liggett Notes or otherwise
make all payments thereon, the Liggett Notes and the Facility would be in
default and holders of such debt could accelerate the maturity of such debt. In
such event, the Company may be forced to seek protection from creditors under
applicable laws. The Company's independent accountants have issued a report
covering the Company's December 31, 1997 consolidated financial statements
containing an explanatory paragraph that states that these facts raise
substantial doubt about the Company's ability to continue as a going concern.
The accompanying consolidated financial statements of the Company do not include
any adjustments that might arise from the outcome of this uncertainty. (Refer to
Note 1 to the Company's consolidated financial statements.)

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", and elsewhere in
this report and in other filings with the Securities and Exchange Commission and
in its reports to securityholders 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. The Company 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, legislation, including tax increases, governmental regulation,
privately imposed smoking restrictions, decline in consumption, governmental and
grand jury investigations and litigation. Furthermore, the Company is subject to
intense competition, changes in consumer preferences, the effects of changing
prices for its raw materials and local economic conditions. In addition, the
Company has a high degree of leverage and substantial near-term debt service
requirements, a payment at maturity of the Liggett Notes of $144,891 on February
1, 1999, as well as a significant net worth deficiency and working capital
deficiency and recent net losses, and is highly dependent upon its revolving
credit facility which currently expires in March 1999. See "Capital Resources
and Liquidity" for a discussion of certain matters which raise substantial doubt
about Liggett meeting its liquidity needs and its ability to continue as a going
concern. The Liggett Notes and the Facility contain restrictions on the
Company's ability to incur additional debt, grant liens, enter into any new
agreements with affiliates and declare or pay cash dividends, among others. Due
to such uncertainties and risks, investors are cautioned not to place undue
reliance on such forward-looking statements, which speak only as of the date
such 





                                       37

<PAGE>   38

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.















































                                       38

<PAGE>   39


PART II  - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         Reference is made to Note 8, incorporated herein by reference, to the
Company's consolidated financial statements included elsewhere in this Report on
Form 10-Q, which contains a general description of certain legal proceedings to
which Liggett and/or BGL or their subsidiaries are a party and certain related
matters. Reference is also made to Exhibit 99.1, Material Legal Proceedings
incorporated herein by reference, for additional information regarding the
pending material legal proceedings to which Liggett and/or BGL are party. A copy
of Exhibit 99.1 will be provided to security holders of Liggett without charge
upon written request to BGL at its principal executive offices, 100 S. E. Second
Street, Miami, Florida 33131, Attn. Investor Relations.

ITEM 6.  EXHIBITS

  (a).   EXHIBITS

          27.1     Liggett Group Inc.'s Financial Data Schedule (for SEC use
                   only)

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

          99.1     Material legal proceedings (incorporated by reference to
                   Exhibit 99.1 in BGL's Form 10-Q for the quarter ended June
                   30, 1998, Commission File No. 1-5759).

  (b)    REPORTS ON FORM 8-K

         None




























                                       39

<PAGE>   40


                                   SIGNATURES

         Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized on August 14, 1998.

                           LIGGETT GROUP INC.



                           By: /s/ Samuel M. Veasey
                               -------------------------------------
                               Samuel M. Veasey
                               Senior Vice President, Chief
                               Financial Officer and Treasurer
                               (Principal Financial and Principal
                               Accounting Officer)


                           EVE HOLDINGS INC.


                           By: /s/ Joselynn D. Van Siclen
                               -------------------------------------
                               Joselynn D. Van Siclen
                               Vice President, Treasurer and Assistant Secretary
                               (Principal Financial and Principal
                               Accounting Officer)




























                                       40