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                       Securities And Exchange Commission
                             Washington, D.C. 20549

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

                                    FORM 10-K

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

           JOINT ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

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

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<S>                                                     <C>                                  <C>
               DELAWARE                                 1-5759                               65-0949535
    (State or other jurisdiction of             Commission File Number          (I.R.S. Employer Identification No.)
    incorporation or organization)
</TABLE>

                                    BGLS INC.
             (Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>

<S>                                                    <C>                                   <C>
               DELAWARE                                33-93576                              65-0949536
    (State or other jurisdiction of             Commission File Number          (I.R.S. Employer Identification No.)
    incorporation or organization)
</TABLE>

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

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

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

                                                    NAME OF EACH EXCHANGE ON
             TITLE OF EACH CLASS                        WHICH REGISTERED
  --------------------------------------              -----------------------
 Common Stock, par value $.10 per share              New York Stock Exchange

        SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None

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

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 Regulation S-K is not contained herein, and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statement incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X] Yes [ ] No

         The aggregate market value of the voting stock held by non-affiliates
of Brooke Group Ltd. as of March 24, 2000 was approximately $142,000,000.
Directors and officers and ten percent or greater stockholders of Brooke Group
Ltd. are considered affiliates for purposes of this calculation but should not
necessarily be deemed affiliates for any other purpose.

         At March 24, 2000, Brooke Group Ltd. had 21,989,782 shares of common
stock outstanding, and BGLS Inc. had 100 shares of common stock outstanding, all
of which are held by Brooke Group Ltd.

                      DOCUMENTS INCORPORATED BY REFERENCE:

         Part III (Items 10, 11, 12 and 13) from the definitive Proxy Statement
for the 2000 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission no later than 120 days after the end of the registrant's
fiscal year covered by this report.

+==============================================================================

<PAGE>   2




                                BROOKE GROUP LTD.
                                    BGLS INC.

                                    FORM 10-K

                        T A B L E   O F   C O N T E N T S
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                                                                                                            PAGE
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                                                  PART I

Item 1.   Business.....................................................................................         1

Item 2.   Properties...................................................................................        23

Item 3.   Legal Proceedings............................................................................        23

Item 4.   Submission of Matters to a Vote of Security Holders;
          Executive Officers of the Registrants........................................................        24


                                                 PART II

Item 5.   Market for Registrants' Common Equity and Related Stockholder Matters........................        27

Item 6.   Selected Financial Data......................................................................        28

Item 7.   Management's Discussion and Analysis of Financial Condition and
              Results of Operations....................................................................        30

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk...................................        44

Item 8.   Financial Statements and Supplementary Data..................................................        44

Item 9.   Changes In and Disagreements with Accountants on Accounting and
              Financial Disclosure.....................................................................        45


                                                 PART III

Item 10.  Directors and Executive Officers of the Registrants..........................................        45

Item 11.  Executive Compensation.......................................................................        45

Item 12.  Security Ownership of Certain Beneficial Owners and Management...............................        45

Item 13.  Certain Relationships and Related Transactions...............................................        45


                                                 PART IV

Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K..............................        46

SIGNATURES.............................................................................................        55

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                                     PART I

ITEM 1.    BUSINESS

GENERAL

         Brooke Group Ltd., a Delaware corporation, is a holding company for a
number of businesses. It is engaged principally in the manufacture and sale of
cigarettes in the United States through its subsidiary Liggett Group Inc.; in
the manufacture and sale of cigarettes in Russia through its subsidiary
Liggett-Ducat Ltd.; and in the investment banking and brokerage business in the
United States, real estate operations in Russia and investment in
Internet-related businesses through its majority-owned subsidiary New Valley
Corporation. Brooke holds these businesses through its wholly-owned subsidiary,
BGLS Inc., a Delaware corporation.

         Brooke is controlled by Bennett S. LeBow, the Chairman and Chief
Executive Officer of Brooke, BGLS and New Valley, who beneficially owns
approximately 44% of Brooke's common stock. The principal executive offices of
Brooke and BGLS are located at 100 S.E. Second Street, Miami, Florida, and the
telephone number is (305) 579-8000.

LIGGETT GROUP INC.

         GENERAL. Liggett, which is the operating successor to the Liggett &
Myers Tobacco Company, is the fifth largest manufacturer of cigarettes in the
United States in terms of unit sales. Substantially all of Liggett's
manufacturing facilities are located in or near Durham, North Carolina.

         Liggett is a wholly-owned subsidiary of Brooke Group Holding Inc., the
predecessor of Brooke and a wholly-owned subsidiary of BGLS.

         Liggett manufactures and sells cigarettes primarily in the United
States. Liggett believes, based on published industry sources, that Liggett's
domestic shipments of approximately 5.24 billion cigarettes during 1999
accounted for 1.2% of the total cigarettes shipped in the United States during
such year. This market share percentage represents a decline of 0.1% from 1998
and 1997. Liggett produces both premium cigarettes as well as discount
cigarettes (which include among others, control label, branded discount and
generic cigarettes). Premium cigarettes are generally marketed under
well-recognized brand names at full retail prices to adult smokers with strong
preference for branded products, whereas discount cigarettes are marketed at
lower retail prices to adult smokers who are more cost conscious. Liggett's
cigarettes are produced in approximately 200 combinations of length, style and
packaging.

         Until May 1999, Liggett produced four premium cigarette brands: L&M,
CHESTERFIELD, LARK and EVE. Liggett's premium cigarettes represented
approximately 18.6% in 1999, 30.2% in 1998 and 32.8% in 1997 of Liggett's net
sales (excluding federal excise taxes). Liggett's management believes, based on
published industry sources, that Liggett's share of the premium market segment
was approximately 0.3% for 1999 and 0.5% for 1998 and 1997. As part of the
Philip Morris brand transaction which closed on May 24, 1999, Liggett
transferred the L&M, CHESTERFIELD and LARK brands, which represented
approximately 16.1% in 1998 and 18.1% in 1997 of Liggett's net sales (excluding
federal excise taxes).

         In 1980, Liggett was the first major domestic cigarette manufacturer to
successfully introduce discount cigarettes as an alternative to premium




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cigarettes. In 1989, Liggett established a new price point within the discount
market segment by introducing PYRAMID, a branded discount product which, at that
time, sold for less than most other discount cigarettes. Liggett's management
believes, based on published industry sources, that Liggett held a share of
approximately 3.9% of the discount market segment for 1999 compared to 3.5% for
1998 and 1997.

         In January 1997, Liggett underwent a major restructuring from a
centralized organization to a decentralized enterprise with four regional
Strategic Business Units, each a profit center, and a corporate headquarters.
This restructuring was designed 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. As a
result of this reorganization, Liggett reduced its headcount by a total of 108
positions (18%) over the succeeding twelve months.

         In November 1999, Liggett acquired an industrial facility in Mebane,
North Carolina. Liggett plans to relocate its tobacco manufacturing operations
from its current facility in Durham, North Carolina to the Mebane facility by
the end of 2000. Liggett's management currently estimates that the move will
result in annual cost savings of approximately $6 million per year for Liggett.

         At the present time, Liggett has no foreign operations. Liggett does
not own the international rights to its remaining premium cigarette brand, EVE,
which is marketed by Philip Morris in foreign markets, thereby adversely
affecting Liggett's ability to penetrate those markets. Liggett does, however,
export other cigarette brands primarily to Eastern Europe and the Middle East.
Export sales of approximately 128 million cigarettes accounted for approximately
2.5% of Liggett's 1999 total unit sales volume. Revenues from export sales were
$1.2 million for 1999, compared to $0.6 million for 1998 and $0.8 million for
1997. Operating income attributable to export sales in 1999 amounted to
approximately $0.1 million compared to operating income of $0.07 million in 1998
and an operating loss of $0.1 million in 1997.

         BUSINESS STRATEGY. Liggett's business strategy is to capitalize upon
its cost advantage in the United States cigarette market due to the favorable
treatment Liggett has received under the settlement agreements with the state
attorneys general and the Master Settlement Agreement described below. Liggett's
long-term business strategy is to focus its marketing efforts on the discount
segment of the market. Liggett will seek to increase its profitability by
reorganizing its manufacturing facility at a new site and by better targeting of
marketing and selling costs using market research and analysis. Liggett intends
to reinvest a portion of the price increases and cost savings in marketing to
grow its volume and income in the discount segment. Liggett's strategy in the
premium segment of the market is to maintain or improve the profitability of its
remaining premium brand, EVE, in the face of declining unit sales and market
share through improved operating efficiencies and targeted promotional
strategies.

         SALES, MARKETING AND DISTRIBUTION. Liggett's products are distributed
from a central distribution center in Durham, North Carolina to 26 public
warehouses located throughout the United States. These warehouses serve as local
distribution centers for Liggett's customers. Liggett's products are transported
from the central distribution center to the warehouses via third-party trucking
companies to meet pre-existing contractual obligations to its customers.

         Liggett's customers are primarily candy and tobacco distributors, the
military and large grocery, drug and convenience store chains. Liggett offers
its customers discount payment terms, traditional rebates and promotional
incentives. Customers typically pay for purchased goods within two weeks
following delivery from Liggett. Liggett's largest single customer, Speedway
SuperAmerica LLC, accounted for approximately 30.7% of its net sales in 1999,


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approximately 26.9% of its net sales in 1998, and approximately 19.4% of its net
sales in 1997. Sales to this customer were primarily in the private label
discount segment and constituted approximately 38.2% in 1999, 32.8% in 1998 and
29.1% in 1997 of Liggett's discount segment sales.

         Liggett's marketing and sales functions are performed by approximately
115 direct sales representatives calling on national and regional customer
accounts, together with approximately 80 part-time retail sales consultants who
service retail outlets. Liggett also employs food broker groups in certain
geographic locations to perform these marketing and sales functions.

         TRADEMARKS. All of the major trademarks used by Liggett are federally
registered or are in the process of being registered in the United States and
other markets where Liggett's products are sold. Trademark registrations
typically have a duration of ten years and can be renewed at Liggett's option
prior to their expiration date. In view of the significance of cigarette brand
awareness among consumers, management believes that the protection afforded by
these trademarks is material to the conduct of its business. All of Liggett's
trademarks are owned by its wholly-owned subsidiaries, Eve Holdings Inc. and
Cigarette Exporting Company of America, Ltd.

         MANUFACTURING. Liggett purchases and maintains leaf tobacco inventory
to support its cigarette manufacturing requirements. Liggett believes that there
is a sufficient supply of tobacco within the worldwide tobacco market to satisfy
its current production requirements. Liggett stores its leaf tobacco inventory
in warehouses in North Carolina and Virginia. There are several different types
of tobacco, including flue-cured leaf, burley leaf, Maryland leaf, oriental
leaf, cut stems and reconstituted sheet. Leaf components of cigarettes are
generally the flue-cured and burley tobaccos. While premium and discount brands
use many of the same tobacco products, input ratios of tobacco products account
for the differences between premium and discount products. Domestically grown
tobacco is an agricultural commodity subject to United States government
production controls and price supports which can substantially affect its market
price. Foreign flue-cured and burley tobaccos, some of which are used in the
manufacture of Liggett's cigarettes, are generally 10% to 15% less expensive
than comparable domestic tobaccos. Liggett normally purchases all of its tobacco
requirements from domestic and foreign leaf tobacco dealers, much of it under
long-term purchase commitments. As of December 31, 1999, substantially all of
Liggett's commitments were for the purchase of foreign tobacco.

         Liggett's cigarette manufacturing facilities are designed for the
execution of short production runs in a cost-effective manner, which enables
Liggett to manufacture and market a wide variety of cigarette brand styles.
Liggett's cigarettes are produced in approximately 200 different brand styles
under Eve's and Cigarette Exporting's trademarks and brand names as well as
private labels for other companies, typically retail or wholesale distributors
who supply supermarkets and convenience stores. Liggett believes that its
existing facilities are sufficient to accommodate a substantial increase in
production.

         While Liggett pursues product development, its total expenditures for
research and development on new products have not been financially material over
the past three years.

         COMPETITION. Liggett is the smallest of the five major manufacturers of
cigarettes in the United States. The four largest manufacturers of cigarettes
are Philip Morris Incorporated, R.J. Reynolds Tobacco Company, Brown &
Williamson Tobacco Corporation and Lorillard Tobacco Company, Inc.

         There are substantial barriers to entry into the cigarette business,
including extensive distribution organizations, large capital outlays for
sophisticated production equipment, substantial inventory investment, costly
promotional spending, regulated advertising and for premium brands strong brand
loyalty. In this industry, the major cigarette manufacturers compete among



                                       3
<PAGE>   6


themselves for market share on the basis of brand loyalty, advertising and
promotional activities and trade rebates and incentives. Liggett's four major
competitors all have substantially greater financial resources and most of these
competitors' brands have greater sales and consumer recognition than Liggett's
brands.

         Liggett's management believes, based on published industry sources,
that Philip Morris' and RJR's sales together accounted for approximately 72.6%
of the domestic cigarette market in 1999. Liggett's domestic shipments of
approximately 5.24 billion cigarettes during 1999 accounted for 1.2% of the
approximately 419.3 billion cigarettes shipped in the United States during that
year, compared to 5.91 billion cigarettes (1.3%) during 1998 and 6.45 billion
cigarettes (1.3%) during 1997.

         Industry-wide shipments of cigarettes in the United States have been
declining for a number of years. Consistent with published industry sources that
domestic industry-wide shipments declined by approximately 9.0% in 1999,
Liggett's management believes that industry-wide shipments of cigarettes in the
United States will continue to decline as a result of numerous factors,
including health considerations, diminishing social acceptance of smoking,
legislative limitations on smoking in public places and federal and state excise
tax increases which have contributed to cigarette price increases.

         Historically, because of their dominant market share, Philip Morris and
RJR have been able to determine cigarette prices for the various pricing tiers
within the industry and the other cigarette manufacturers have brought their
prices in line with the levels established by the two industry leaders. Off-list
price discounting by manufacturers, however, has substantially affected the
average price differential at retail, which can be significantly greater than
the manufacturers' list price gap.

         PHILIP MORRIS BRAND TRANSACTION. In November 1998, Brooke and Liggett
granted Philip Morris options to purchase interests in Trademarks LLC which
holds three domestic cigarette brands, L&M, CHESTERFIELD and LARK, formerly held
by Liggett's subsidiary, Eve.

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

         The Class A option entitled Philip Morris to purchase the Class A
interest for $10.1 million. On March 19, 1999, Philip Morris exercised the Class
A option, and the closing occurred on May 24, 1999.

         The Class B option entitles Philip Morris to purchase the Class B
interest for $139.9 million. The Class B option will be exercisable during the
90-day period beginning on December 2, 2008, with Philip Morris being entitled
to extend the 90-day period for up to an additional six months under certain
circumstances. The Class B interest will also be redeemable by Trademarks for
$139.9 million during the same period the Class B option may be exercised.

         On May 24, 1999, Trademarks borrowed $134.9 million from a lending
institution. The loan is guaranteed by Eve and is collateralized by a pledge by
Trademarks of the three brands and Trademarks' interest in the trademark license
agreement (discussed below) and by a pledge by Eve of its Class B interest. In
connection with the closing of the Class A option, Trademarks distributed the



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loan proceeds to Eve as the holder of the Class B interest. The cash exercise
price of the Class B option and Trademarks' redemption price were reduced by the
amount distributed to Eve. Upon Philip Morris' exercise of the Class B option or
Trademarks' exercise of its redemption right, Philip Morris or Trademarks, as
relevant, will be required to obtain Eve's release from its guaranty. The Class
B interest will be entitled to a guaranteed payment of $500,000 each year with
the Class A interest allocated all remaining income or loss of Trademarks. The
proceeds of the loan and the exercise of the Class A option were used to retire
a portion of the BGLS notes.

         Trademarks has granted Philip Morris an exclusive license of the three
brands for an 11-year term expiring May 24, 2010 at an annual royalty based on
sales of cigarettes under the brands, subject to a minimum annual royalty
payment of not less than the annual debt service obligation on the loan plus $1
million.

         If Philip Morris fails to exercise the Class B option, Eve will have an
option to put its Class B interest to Philip Morris, or Philip Morris'
designees, at a put price that is $5 million less than the exercise price of the
Class B option (and includes Philip Morris' obtaining Eve's release from its
loan guaranty). The Eve put option is exercisable at any time during the 90-day
period beginning March 2, 2010.

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

         LEGISLATION, REGULATION AND LITIGATION. Reports with respect to the
alleged harmful physical effects of cigarette smoking have been publicized for
many years and, in the opinion of Liggett's management, have had and may
continue to have an adverse effect on cigarette sales. Since 1964, the Surgeon
General of the United States and the Secretary of Health and Human Services have
released a number of reports which claim that cigarette smoking is a causative
factor with respect to a variety of health hazards, including cancer, heart
disease and lung disease, and have recommended various government actions to
reduce the incidence of smoking. In 1997, Liggett publicly acknowledged that, as
the Surgeon General and respected medical researchers have found, smoking causes
health problems, including lung cancer, heart vascular disease and emphysema.

         Since 1966, federal law has required that cigarettes manufactured,
packaged or imported for sale or distribution in the United States include
specific health warnings on their packaging. Since 1972, Liggett and the other
cigarette manufacturers have included the federally required warning statements
in print advertising, on billboards and on certain categories of point-of-sale
display materials relating to cigarettes. The Comprehensive Smoking Education
Act, which became effective in October 1985, requires that packages of
cigarettes distributed in the United States and cigarette advertisements (other
than billboard advertisements) in the United States bear one of the following
four warning statements on a quarterly rotating basis: "SURGEON GENERAL'S
WARNING: Smoking Causes Lung Cancer, Heart Disease, Emphysema, and May
Complicate Pregnancy"; "SURGEON GENERAL'S WARNING: Quitting Smoking Now Greatly
Reduces Serious Risks to Your Health"; "SURGEON GENERAL'S WARNING: Smoking by
Pregnant Women May Result in Fetal Injury, Premature Birth, and Low Birth
Weight"; and "SURGEON GENERAL'S WARNING: Cigarette Smoke Contains Carbon
Monoxide". By a limited eligibility amendment to the Comprehensive Smoking
Education Act, for which Liggett qualifies, Liggett is allowed to display all
four required package warnings for the majority of its brand packages on a
simultaneous basis (such that the packages at any time may carry any one of the
four required warnings), although it rotates the required warnings for
advertising on a quarterly basis in the same manner as do the other major
cigarette manufacturers. The law also requires that each person who




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manufactures, packages or imports cigarettes annually provide to the Secretary
of Health and Human Services a list of ingredients added to tobacco in the
manufacture of cigarettes. Annual reports to the United States Congress are also
required from the Secretary of Health and Human Services as to current
information on the health consequences of smoking and from the Federal Trade
Commission on the effectiveness of cigarette labeling and current practices and
methods of cigarette advertising and promotion. Both federal agencies are also
required annually to make such recommendations as they deem appropriate with
regard to further legislation. In addition, since 1997, Liggett has included the
warning "Smoking is Addictive" on its cigarette packages.

         In August 1996, the Food and Drug Administration filed in the Federal
Register a Final Rule classifying tobacco as a "drug" or "medical device",
asserting jurisdiction over the manufacture and marketing of tobacco products
and imposing restrictions on the sale, advertising and promotion of tobacco
products. Litigation was initiated by certain tobacco companies challenging the
FDA's authority to assert jurisdiction. In March 2000, the United States Supreme
Court ruled that the FDA does not have the power to regulate tobacco. Liggett
supported the FDA rule and began to phase in compliance with certain of the
proposed FDA regulations.

         In August 1996, Massachusetts enacted legislation requiring tobacco
companies to publish information regarding the ingredients in cigarettes and
other tobacco products sold in that state. In December 1997, the United States
District Court for the District of Massachusetts enjoined this legislation from
going into effect on the grounds that it was preempted by federal law. In
November 1998, the First Circuit affirmed this ruling. However, in December
1997, Liggett began complying with this legislation by providing ingredient
information to the Massachusetts Department of Public Health. Several other
states have enacted, or are considering, legislation similar to that enacted in
Massachusetts.

         In 1993, Congress amended the Agricultural Adjustment Act of 1938 to
require each United States cigarette manufacturer to use at least 75% domestic
tobacco in the aggregate of the cigarettes manufactured by it in the United
States, effective January 1994, on an annualized basis or pay a domestic
marketing assessment based upon price differentials between foreign and domestic
tobacco and, under certain circumstances, make purchases of domestic tobacco
from the tobacco stabilization cooperatives organized by the United States
government. After an audit, the United States Department of Agriculture informed
Liggett that it did not satisfy the 75% domestic tobacco usage requirement in
1994 and assessed Liggett approximately $5.5 million. Liggett has paid this
assessment. Since the levels of domestic tobacco inventories on hand at the
tobacco stabilization organizations were below reserve stock levels, Liggett was
not obligated to make purchases of domestic tobacco from the tobacco
stabilization cooperatives.

         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 should be allocated. Currently,
tobacco imported under the quota is allocated on a "first-come, first-served"
basis, meaning that entry is allowed on an open basis to those first requesting
entry in the quota year. Others in the cigarette industry have suggested an
"end-user licensing" system under which the right to import tobacco under the
quota would be initially assigned on the basis of domestic market share. Such an
approach, if adopted, could have a material adverse effect on Liggett.

         In 1993, the Environmental Protection Agency released a report on the
respiratory effect of secondary smoke which concluded that secondary smoke 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 domestic cigarette
manufacturers, together with other segments of the tobacco and distribution
industries, commenced a lawsuit against the agency seeking a determination that
the agency did not have the statutory authority to regulate secondary smoke and
that given the current body of scientific evidence and the agency's failure to
follow its own guidelines in making the determination, its classification of
secondary smoke was arbitrary and capricious. Whatever the outcome of this



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litigation, issuance of the report may encourage efforts to limit smoking in
public areas. In July 1998, a federal district court vacated those sections of
the report relating to lung cancer, finding that the agency may have reached
different conclusions had it complied with relevant statutory requirements. The
federal government has appealed the court's ruling.

         As part of the 1997 budget agreement approved by Congress, federal
excise taxes on a pack of cigarettes, which are currently 34 cents, were
increased at the beginning of 2000 and will rise 5 cents more in the year 2002.
In general, excise taxes and other taxes on cigarettes have been increasing.
These taxes vary considerably and, when combined with sales taxes and the
current federal excise tax, may be as high as $1.66 per pack in a given locality
in the United States. Congress has been considering significant increases in the
federal excise tax or other payments from tobacco manufacturers, and the Clinton
Administration's fiscal year 2001 budget proposal includes an additional
increase of $.25 per pack in the federal excise tax, as well as a contingent
special assessment related to youth smoking rates. Increases in other
cigarette-related taxes have been proposed at the state and local level.

         There are various other legislative efforts pending on the federal and
state level which seek, among other things, to restrict or prohibit smoking in
public buildings and other areas, increase excise taxes, require additional
warnings on cigarette packaging and advertising, ban vending machine sales,
curtail affirmative defenses of tobacco companies in product liability
litigation, place cigarettes under the regulatory jurisdiction of the FDA and
require that cigarettes meet certain fire safety standards. If adopted, at least
certain of the foregoing legislative proposals could have a material adverse
impact on Liggett and Brooke.

         While attitudes toward cigarette smoking vary around the world, a
number of foreign countries have also taken steps to discourage cigarette
smoking, to restrict or prohibit cigarette advertising and promotion and to
increase taxes on cigarettes. Those restrictions are, in some cases, more
onerous than restrictions imposed in the United States. Due to Liggett's lack of
foreign operations, and minimal export sales to foreign countries, the risks of
foreign limitations or restrictions on the sale of cigarettes are limited to
entry barriers into additional foreign markets and the inability to expand the
existing markets.

         The cigarette industry continues to be challenged on numerous fronts.
The industry is facing increased pressure from anti-smoking groups and an
extraordinary increase in smoking and health litigation, including private class
action litigation and health care cost recovery actions brought by governmental
entities and other third parties, the effects of which, at this time, Brooke is
unable to evaluate. As of December 31, 1999, there were approximately 300
individual suits, approximately 50 purported class actions or actions where
class certification has been sought and approximately 90 governmental and other
third-party payor health care recovery actions pending in the United States in
which Liggett is a named defendant. These cases are referred to herein as though
commenced against Liggett (without regard to whether such cases were actually
commenced against Liggett or against Brooke Group Holding, Brooke's
predecessor). The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for injuries allegedly caused by cigarette smoking are
based on various theories of recovery, including negligence, gross negligence,
breach of special duty, strict liability, fraud, misrepresentation, design
defect, failure to warn, breach of express and implied warranties, conspiracy,
aiding and abetting, concert of action, unjust enrichment, common law public
nuisance, property damage, invasion of privacy, mental anguish, emotional
distress, disability, shock, indemnity and violations of deceptive trade
practice laws, the Federal Racketeer Influenced and Corrupt Organization Act,
state racketeering statutes and antitrust statutes. In many of these cases, in
addition to compensatory damages, plaintiffs also seek other forms of relief
including treble/multiple damages, disgorgement of profits and punitive damages.
Defenses raised by defendants in these cases include lack of proximate cause,
assumption of the risk, comparative fault and/or contributory negligence, lack
of design defect, statutes of limitations, 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



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allegedly attributable to smoking and seek reimbursement of those costs. Other
claims made by some but not all plaintiffs include the equitable claim of
indemnity, common law claims of negligence, strict liability, breach of express
and implied warranty, breach of special duty, fraud, negligent
misrepresentation, conspiracy, public nuisance, claims under state and federal
statutes governing consumer fraud, antitrust, deceptive trade practices and
false advertising, and claims under RICO.

         In September 1999, the United States government commenced litigation
against Liggett and the other tobacco companies in the United States District
Court for the District of Columbia. The action seeks to recover an unspecified
amount of healthcare costs paid for and furnished, and to be paid for and
furnished, by the Federal Government for lung cancer, heart disease, emphysema
and other smoking-related illnesses allegedly caused by the fraudulent and
tortious conduct of defendants, to restrain defendants and co-conspirators from
engaging in fraud and other unlawful conduct in the future, and to compel
defendants to disgorge the proceeds of their unlawful conduct. The complaint
alleges that such costs total more than $20 billion annually. The action asserts
claims under three Federal statutes: the Medical Care Recovery Act, the Medicare
Secondary Payer provisions of the Social Security Act and RICO. In December
1999, Liggett filed a motion to dismiss the lawsuit on numerous grounds,
including that the statutes invoked by the government do not provide a basis for
the relief sought.

         Approximately 20 purported state class action complaints have been
filed on behalf of various consumers of cigarette products against the tobacco
manufacturers. The complaints allege that cigarette manufacturers engaged in
illegal and unethical activities since the 1940's, many conspiratorial in
nature, designed to increase profits at the financial and physical expense of
customers. These alleged activities include knowingly increasing the
addictiveness of cigarettes through crop manipulation; downplaying the
detrimental health effects of cigarette smoking; conspiring to refrain from
researching and introducing "safer" cigarettes; creating false and misleading
scientific research design to combat the growing scientific consensus about the
lethal health effects associated with cigarettes; aggressively marketing
products to children and minors in an effort to addict them to cigarettes at a
young age; and systematically covering up activities to avoid regulation of
products by governmental agencies. The purported class actions are brought
pursuant to various state laws.

         In March 1996, Brooke Group Holding and Liggett entered into an
agreement, subject to court approval, to settle the CASTANO class action tobacco
litigation. The CASTANO class was subsequently decertified by the court. In
1996, 1997 and 1998, Brooke Group Holding and Liggett entered into settlements
of smoking-related litigation with the Attorneys General of 45 states and
territories. The settlements released Brooke Group Holding and Liggett from all
smoking-related claims, including claims for health care cost reimbursement and
claims concerning sales of cigarettes to minors.

         In November 1998, Philip Morris, RJR, Brown & Williamson, Lorillard,
and Liggett entered into the Master Settlement Agreement with 46 states, the
District of Columbia, Puerto Rico, Guam, the United States Virgin Islands,
American Samoa and the Northern Marianas to settle the asserted and unasserted
health care cost recovery and certain other claims of those settling
jurisdictions. As described above, Brooke Group Holding and Liggett had previous
settlements with a number of these settling states.

         The Master Settlement Agreement is subject to final judicial approval
in each of the settling states and territories, which approval has been
obtained, as of December 31, 1999, in 47 jurisdictions.

         Liggett has no payment obligations under the Master Settlement
Agreement unless its market share exceeds a base share of 125% of its 1997
market share or 1.67% of total cigarettes sold in the United States. In the year



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<PAGE>   11


following any year in which Liggett's market share does exceed the base share,
Liggett will pay on each excess unit an amount equal (on a per-unit basis) to
that paid during such following year by the original participating manufacturers
under the annual and strategic contribution payment provisions of the Master
Settlement Agreement, subject to applicable adjustments, offsets and reductions.
Under the annual and strategic contribution payment provisions of the Master
Settlement Agreement, the original participating manufacturers (and Liggett to
the extent its market share exceeds the base share) will pay the following
annual amounts (subject to certain adjustments):

                 YEAR                          AMOUNT
                 ----                          ------

2000                                        $4.5 billion
2001                                        $5.0 billion
2002 - 2003                                 $6.5 billion
2004 - 2007                                 $8.0 billion
2008 - 2017                                 $8.1 billion
2018 and each year thereafter               $9.0 billion

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

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

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

         In May 1994, an action entitled ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO
COMPANY, ET AL., Circuit Court Eleventh Judicial Circuit, Dade County, Florida,
was filed against Liggett and others. The class consists of all Florida
residents and citizens, and their survivors, who have suffered, presently suffer
or have died from diseases and medical conditions caused by their addiction to
cigarettes that contain nicotine. In July 1998, Phase I of the trial in this
action commenced. On July 7, 1999, the jury returned the Phase I verdict. The
Phase I verdict concerned certain issues determined by the trial court to be
"common" to the causes of action of the plaintiff class. Among other things, the
jury found that smoking cigarettes causes 20 diseases or medical conditions,
that cigarettes are addictive or dependence producing, defective and
unreasonably dangerous, that defendants made materially false statements with
the intention of misleading smokers, that defendants concealed or omitted
material information concerning the health effects and/or the addictive nature
of smoking cigarettes and agreed to misrepresent and conceal the health effects
and/or the addictive nature of smoking cigarettes, and that defendants were
negligent and engaged in extreme and outrageous conduct or acted with reckless
disregard with the intent to inflict emotional distress. The jury also found
that defendants' conduct "rose to a level that would permit a potential award or
entitlement to punitive damages." The court decided that Phase II of the trial,
which commenced November 1, 1999, would be a causation and damages trial for
three of the class representatives and a punitive damages trial on a class-wide
basis, before the same jury that returned the verdict in Phase I. Phase III of
the trial will be conducted before separate juries to address absent class
members' claims, including issues of specific causation and other individual
issues regarding entitlement to compensatory damages.



                                       9
<PAGE>   12


         In March 1997, Liggett, Brooke Group Holding and a nationwide class of
individuals that allege smoking-related claims filed a mandatory class
settlement agreement in an action entitled FLETCHER, ET AL. V. BROOKE GROUP
LTD., ET AL., Circuit Court of Mobile County, Alabama, where the court granted
preliminary approval and preliminary certification of the class. In July 1998,
the parties filed an amended class action settlement agreement which was
preliminarily approved by the court in December 1998. In July 1999, the court
denied approval of the settlement. The parties' motion for reconsideration is
still pending.

         Management is not able to predict the outcome of the smoking-related
litigation pending against Brooke Group Holding or Liggett. Management believes,
and has been so advised by counsel handling the cases, that Brooke Group Holding
and Liggett have a number of valid defenses to the claims asserted against them.
Litigation is subject to many uncertainties. An unfavorable verdict has been
returned in the first phase of the ENGLE smoking and health class action trial
pending in Florida. It is possible that additional cases could be decided
unfavorably and that there could be further adverse developments in the ENGLE
case. In a worst case scenario, it is possible that a judgment for punitive
damages could be entered in the ENGLE case in an amount not capable of being
bonded, resulting in an execution of the judgment before it could be set aside
on appeal. An unfavorable outcome of a pending smoking and health case could
encourage the commencement of additional similar litigation. Management is
unable to make a meaningful estimate with respect to the amount of loss that
could result from an unfavorable outcome of many of the cases pending against
Brooke Group Holding or Liggett or the costs of defending such cases. It is
possible that Brooke's consolidated financial position, results of operations or
cash flows could be materially adversely affected by an unfavorable outcome in
any such smoking-related litigation.

         Liggett's management is unaware of any material environmental
conditions affecting its existing facilities. Liggett's management believes that
current operations are conducted in accordance with all environmental laws and
regulations. Compliance with federal, state and local provisions regulating the
discharge of materials into the environment, or otherwise relating to the
protection of the environment, have not had a material effect on the capital
expenditures, earnings or competitive position of Liggett.

         Liggett's management believes that it is in compliance in all material
respects with the laws regulating cigarette manufacturers.

         See Note 22 to Brooke's consolidated financial statements for a
description of legislation, regulation and litigation and of the Master
Settlement Agreement and Brooke Group Holding's and Liggett's other settlements.

LIGGETT-DUCAT LTD.

         LIGGETT-DUCAT LTD. Brooke (Overseas) Ltd., a wholly-owned subsidiary of
BGLS, owns a 99.9% equity interest in Liggett-Ducat Ltd., a Russian joint stock
company, through its subsidiary Western Tobacco Investments LLC. Liggett-Ducat,
one of Russia's leading cigarette producers since 1892, manufactured and
marketed 25.2 billion cigarettes in 1999, an increase of 24% from the 20.3
billion cigarettes manufactured and marketed in 1998. Liggett-Ducat produces or
has rights to produce 26 different brands of cigarettes, including Russian
brands such as PEGAS, PRIMA, NOVOSTI and BELOMORKANAL. In 1999, Liggett-Ducat
launched two new American blend cigarettes under the names "DUKAT" and "LD".

         Liggett-Ducat manufactures three types of cigarettes: filter,
non-filter and papirossi. Papirossi is a traditional type of Russian cigarette
featuring a long paper filter comprising two-thirds of the cigarette with


                                       10
<PAGE>   13


tobacco filling up the balance. In 1999, Liggett-Ducat sold 8.9 billion filter
cigarettes (35% of its total volume), 13.0 billion non-filter cigarettes (52%)
and 3.3 billion papirossi (13%).

         The long-term strategy of Liggett-Ducat is to continue to upgrade the
quality of its traditional Russian cigarette brands to international standards
and to expand the range of cigarettes it offers to include more higher-margin
American blend and international blend cigarettes. The new types of cigarettes
should appeal to the growing segment of the market that prefers American blend
cigarettes over traditional Russian blended cigarettes. Russian blend cigarettes
have a very strong flavored oriental tobacco blend with a heavy pungent odor,
while the American blend is a lighter flavored Virginia tobacco blend. The
international blend will be a mix between Russian and American blends. As
markets have developed in Eastern Europe, consumer preferences have typically
shifted toward international and American blend cigarettes.

         Until March 1999, Liggett-Ducat produced its cigarettes in a 150,000
square foot factory complex located on Gasheka Street in downtown Moscow.
Liggett-Ducat also operates a 150,000 square foot warehouse outside of the city.
In June 1999, Liggett-Ducat completed construction of a new cigarette factory on
the outskirts of Moscow on land it has leased for a term of 49 years. The new
factory, which utilizes Western cigarette making technology and has a capacity
in excess of 40 billion units per year, produces American and international
blend cigarettes, as well as traditional Russian cigarettes. The old factory
closed at the end of March 1999 with production starting in the new factory in
June 1999.

         Liggett-Ducat manufactures its cigarettes on 29 production lines at the
new factory, comprised of both imported and Russian-made machinery.
Liggett-Ducat acquired 14 new high-speed tobacco lines which are being used at
the new factory. In recent years, Liggett-Ducat had upgraded the equipment at
the old factory to improve its operations and all upgraded equipment has been
utilized at the new factory. In 1997, Liggett-Ducat completed installation of an
upgraded primary processing complex manufactured by GBE Tobacco. The upgraded
primary equipment has been moved to and expanded in the new factory, allowing
Liggett-Ducat to produce American blend, international blend and traditional
Russian cigarettes. In addition, Liggett-Ducat acquired four new or rebuilt
filter-making complexes from Hoechst Celanese which allow Liggett-Ducat to
produce Western quality filters, and installed a new cigarette tobacco
reclamation machine to reduce waste.

         The Russian cigarette market is one of the largest and fastest growing
cigarette markets in the world. Annual consumption of cigarettes is estimated at
in excess of 270 billion units in Russia (1999 estimate), making the market the
fourth largest in the world after the United States, China and Japan. The
potential size of the market is estimated by management at up to 350 billion
units per year. Approximately 61% of Russian men and 23% of Russian women are
estimated to smoke cigarettes. The market has been growing rapidly over the past
several years (particularly the female market) as imported cigarettes have
become available to satisfy increasing demand.

         While growth in consumption had been restrained historically by static
domestic cigarette making capacity, domestic production capacity has increased
significantly in the past several years to approximately 230 billion cigarettes
in 1999. Excess demand and demand for Western-style cigarettes are satisfied by
imported cigarettes. Industry estimates indicate that imported product
represented approximately 45% of the total Russian market in 1997 and 1998. This
trend changed substantially in 1999 with only 11% of the market supplied through
imports. This resulted from the continued effects of the August 1998 Russian
financial crisis and the related decline in the value of the ruble. In order to
increase their presence in the Russian market and avoid import duties, several
of the major international cigarette manufacturers have begun to produce
American and international blend cigarettes domestically.

         Russian customs legislation continues to support local producers. The
Russian Government imposes high import duties on imported cigarettes with a
current effective rate of 100% of cost. In the past, many imported cigarettes
were sold illegally without payment of required duties. Recent efforts to




                                       11
<PAGE>   14



improve enforcement of import duties have maintained the differential between
the price of imported and domestic cigarettes. Imported cigarettes currently
range in price at retail from approximately 10 to 29 rubles ($.35 to $1.01) per
pack, while domestically produced cigarettes sell for approximately 2.2 to 9.2
rubles ($.08 to $.32) per pack.

         Liggett-Ducat's Russian brands currently compete primarily against
those of other Russian cigarette makers. Liggett-Ducat as well as other Russian
producers sell their cigarettes at the lowest price points in the market.
Competition in this sector of the market is generally based on price and name
recognition of the producing factory. There is very limited advertising of these
products, typically only in trade publications and wholesale catalogs.
Liggett-Ducat's Russian brands also compete to a lesser extent against lower
priced imported cigarettes from Eastern Europe and Asia. Liggett-Ducat's
recently introduced "DUKAT" and "LD" brands will compete with the brands of the
other major international manufacturers in the mid-priced segment of the market.
Liggett-Ducat will support the introduction of the brand with billboard and
print advertising and other promotional activities.

NEW VALLEY CORPORATION

         GENERAL. New Valley, a Delaware corporation, is engaged in the
investment banking and brokerage business through its ownership of Ladenburg,
Thalmann & Co. Inc., in the real estate development business in Russia through
BrookeMil Ltd., Western Realty Development LLC and Western Realty Repin LLC, and
in investment in Internet-related businesses. New Valley is registered under the
Securities Exchange Act of 1934 and files periodic reports and other information
with the SEC.

         BGLS currently holds, either directly or indirectly through BGLS'
wholly-owned subsidiary, New Valley Holdings, Inc., approximately 55.5% of the
Common Shares of New Valley.

         New Valley was originally organized under the laws of New York in 1851
and operated for many years under the name "Western Union Corporation". In 1991,
bankruptcy proceedings were commenced against New Valley. In January 1995, New
Valley emerged from bankruptcy. As part of the bankruptcy plan, New Valley sold
the Western Union money transfer and messaging services businesses and all
allowed claims in the bankruptcy were paid in full.

         In October 1999, New Valley's Board of Directors authorized the
repurchase of up to 2,000,000 Common Shares from time to time in the open market
or in privately negotiated transactions. As of March 24, 2000, New Valley had
repurchased 75,200 shares for approximately $346,000.

         PLAN OF RECAPITALIZATION. New Valley consummated a plan of
recapitalization on June 4, 1999, following approval by New Valley's
stockholders. Pursuant to the plan of recapitalization:

         o    each $15.00 Class A Increasing Rate Cumulative Senior Preferred
              Share ($100 liquidation), $.01 par value, was reclassified into 20
              Common Shares and one Warrant exercisable for five years,

         o    each $3.00 Class B Cumulative Convertible Preferred Share, $.10
              par value, was reclassified into 1/3 of a Common Share and five
              Warrants, and

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

         The recapitalization had a significant effect on New Valley's financial
position and results of operations. As a result of the exchange of the
outstanding preferred shares for common shares and warrants in the
recapitalization, New Valley's stockholders' equity increased by $343.4 million
from the elimination of the carrying value and dividend arrearages on the




                                       12
<PAGE>   15


redeemable preferred stock. Furthermore, the recapitalization resulted in the
elimination of the on-going dividend accruals on the existing redeemable
preferred shares of New Valley, as well as the redemption obligation for the
Series A Preferred Shares in January 2003. Also as a result of the
recapitalization, the number of outstanding Common Shares more than doubled, and
additional Common Shares were reserved for issuance upon exercise of the
Warrants, which have an initial exercise price of $12.50 per Common Share. In
addition, Brooke increased its ownership of the Common Shares from 42.3% to
55.1%, and its total voting power from 42% to 55.1%. At December 31, 1999,
Brooke owned 55.4% of New Valley's Common Shares. If all outstanding Warrants
were exercised, the percentage of the Common Shares that Brooke owns would
decline to 38.8%.

         LADENBURG, THALMANN & CO. INC. In May 1995, a subsidiary of New Valley
acquired all of the outstanding shares of common stock and other equity
interests of Ladenburg for $25.8 million, net of cash acquired, subject to
adjustment. Ladenburg is a full service broker-dealer, which has been a member
of the New York Stock Exchange since 1876. Ladenburg provides its services
principally for middle market and emerging growth companies and high net worth
individuals through a coordinated effort among corporate finance, research,
capital markets, investment management, brokerage and trading professionals.

         Ladenburg's investment banking area maintains relationships with
businesses and provides them with research, advisory and investor relations
support. Services include merger and acquisition consulting, management of and
participation in underwriting of equity and debt financing, private debt and
equity financing, and rendering appraisals, financial evaluations and fairness
opinions. Ladenburg's listed securities, fixed income and over-the-counter
trading areas trade a variety of financial instruments. Ladenburg's client
services and institutional sales departments serve over 20,000 accounts
worldwide and its asset management area provides investment management and
financial planning services to numerous individuals and institutions.

         On December 23, 1999, New Valley completed the sale of a 19.9% interest
in Ladenburg to Berliner Effektengesellschaft AG, a German public financial
holding company. New Valley received $10.2 million in cash and Berliner shares
valued in accordance with the purchase agreement. Pursuant to the agreement,
Berliner also acquired a three-year option to purchase additional interests in
Ladenburg subject to certain conditions. New Valley recorded a $4.3 million gain
in connection with the transaction for the year ended December 31, 1999.

         BROOKEMIL LTD. In January 1997, New Valley entered into a purchase
agreement with Brooke (Overseas), under which New Valley acquired 10,483 shares
of the BrookeMil common stock. These shares comprise 99.1% of the outstanding
shares of BrookeMil, which is engaged in the real estate development business in
Moscow, Russia. New Valley paid Brooke (Overseas) a purchase price of $55
million for the BrookeMil shares, consisting of $21.5 million in cash and a
$33.5 million 9% note. The note, which was collateralized by the BrookeMil
shares, was paid during 1997.

         BrookeMil is developing a three-phase complex on 2.2 acres of land in
downtown Moscow, for which it has a 49-year lease. In 1993, the first phase of
the project, Ducat Place I, a 46,500 sq. ft. Class-A office building, was
successfully built and leased. In April 1997, BrookeMil sold Ducat Place I to
one of its tenants, Citibank, for approximately $7.5 million. This price had
been reduced to reflect approximately $6.2 million of rent prepayments by
Citibank. In 1997, BrookeMil completed construction of Ducat Place II, a premier
150,000 sq. ft. office building. Ducat Place II has been leased to a number of
leading international companies including Motorola, Conoco and Morgan Stanley.
Ducat Place II is one of the leading modern office buildings in Moscow due to



                                       13
<PAGE>   16


its design and full range of amenities. The third phase, Ducat Place III, has
been planned as a 450,000 sq. ft. office tower. The site of the proposed third
phase of the project was used by Liggett-Ducat as the site for its former
tobacco factory under a use agreement with BrookeMil. Liggett-Ducat, which
completed construction in 1999 of a new factory on the outskirts of Moscow, is
vacating the site.

         Under the BrookeMil purchase agreement, certain liabilities of
BrookeMil aggregating approximately $40 million remained as liabilities of
BrookeMil after the purchase of the BrookeMil shares. These liabilities included
a $20.4 million construction loan from a Russian bank. In addition, the
liabilities of BrookeMil at the time of purchase included approximately $13.8
million of rents and related payments prepaid by tenants in Ducat Place II for
periods generally ranging from 15 to 18 months.

         In August 1997, BrookeMil refinanced all amounts due under the
construction loan with borrowings under a new credit facility with the Russian
bank SBS-Agro. The new credit facility bears interest at 16% per year, matures
no later than August 2002, with principal payments commencing after the first
year, and is collateralized by a mortgage on Ducat Place II and guaranteed by
New Valley. At December 31, 1999, borrowings under the new credit agreement
totaled $14.7 million.

         WESTERN REALTY DEVELOPMENT. In February 1998, New Valley and Apollo
Real Estate Investment Fund III, L.P. organized Western Realty Development to
make real estate and other investments in Russia. New Valley agreed to
contribute the real estate assets of BrookeMil, including Ducat Place II and the
site for Ducat Place III, to Western Realty Development, and Apollo agreed to
contribute up to $65.9 million, including the $25.9 million investment in
Western Realty Repin discussed below.

         The ownership and voting interests in Western Realty Development are
held equally by Apollo and New Valley. Apollo will be entitled to a preference
on distributions of cash from Western Realty Development to the extent of its
investment of $40 million, of which $39.6 million had been funded through
December 31, 1999, together with a 15% annual rate of return. New Valley will
then be entitled to a return of $20 million of BrookeMil-related expenses
incurred and cash invested by New Valley since March 1, 1997, together with a
15% annual rate of return. Subsequent distributions will be made 70% to New
Valley and 30% to Apollo. Western Realty Development is managed by a Board of
Managers consisting of an equal number of representatives chosen by Apollo and
New Valley. Material corporate transactions by Western Realty Development will
generally require the unanimous consent of the Board of Managers. Accordingly,
New Valley accounts for its non-controlling interest in Western Realty
Development on the equity method.

         In March 2000, Apollo and New Valley each agreed to increase its
capital commitment to Western Realty Development by $3.75 million.

         New Valley, Brooke and their affiliates have other business
relationships with affiliates of Apollo. In January 1996, New Valley acquired
from an affiliate of Apollo eight shopping centers for $72.5 million. New
Valley's two remaining shopping centers are subject to second mortgages in favor
of the sellers. New Valley and pension plans sponsored by BGLS have invested in
investment partnerships managed by an affiliate of Apollo. Affiliates of Apollo
have owned a substantial amount of debt securities of BGLS and hold warrants to
purchase common stock of Brooke.

         Western Realty Development may seek additional real estate and other
investments in Russia. Western Realty Development has made a $30 million
participating loan to, and payable out of a 30% profits interest in, Western
Tobacco Investments which holds Brooke (Overseas)'s interest in Liggett-Ducat
and its new factory. Western Realty Development is entitled to receive a 15%
annual rate of return on amounts advanced on the loan under certain
circumstances in the event of a sale or refinancing of Western Tobacco
Investments or the new factory.



                                       14
<PAGE>   17


         New Valley has determined that a permanent impairment occurred in the
value of the site for the proposed Ducat Place III office building and related
goodwill due to the economic difficulties in the Russian economy following the
financial crisis of August 1998. New Valley recognized an impairment charge of
$11.6 million in 1999.

         WESTERN REALTY REPIN. In June 1998, New Valley and Apollo organized
Western Realty Repin to make a loan to BrookeMil. The proceeds of the loan will
be used by BrookeMil for the acquisition and preliminary development of the
Kremlin sites, two adjoining sites totaling 10.25 acres located on the Sofiskaya
Embankment of the Moscow River. The sites are directly across the river from the
Kremlin and have views of the Kremlin walls, towers and nearby church domes.
BrookeMil is planning the development of a hotel, office, retail and residential
complex on the Kremlin sites. BrookeMil owned 95.9% of one site and 100% of the
other site at December 31, 1999. Apollo will be entitled to a preference on
distributions of cash from Western Realty Repin to the extent of its investment
of $25.9 million, together with a 20% annual rate of return, and New Valley will
then be entitled to a return of its investment of $10.5 million, together with a
20% annual rate of return. Subsequent distributions will be made 50% to New
Valley and 50% to Apollo. Western Realty Repin is managed by a board of managers
consisting of an equal number of representatives chosen by Apollo and New
Valley. Material corporate transactions by Western Realty Repin will generally
require the unanimous consent of the board of managers.

         Through December 31, 1999, Western Realty Repin had advanced $36.4
million, of which $25.9 million was funded by Apollo, under the loan. The loan
bears no fixed interest and is payable only out of distributions by the entities
owning the Kremlin sites to BrookeMil. Such distributions must be applied first
to pay the principal of the loan and then as contingent participating interest
on the loan. Any rights of payment on the loan are subordinate to the rights of
all other creditors of BrookeMil. BrookeMil used a portion of the proceeds of
the loan to reimburse New Valley for expenditures on the Kremlin sites
previously incurred. The loan is due and payable upon the dissolution of
BrookeMil and is collateralized by a pledge of New Valley's shares of BrookeMil.

         As of December 31, 1999, BrookeMil had invested $32 million in the
Kremlin sites and held approximately $.93 million in cash and $1.4 million in
receivables from an affiliate, both of which were restricted for future
investment in the Kremlin sites. In acquiring its interest in one of the
Kremlin sites, BrookeMil agreed with the City of Moscow to invest an additional
$22 million by May 2000 in the development of the property. Management believes
that short-term financing alternatives are available to fund the investment.
Failure to make the required investment could result in the forfeiture of a
34.8% interest in the site. New Valley's investment in the Kremlin sites, net
of the participating loan of $32.1 million, was carried in the accompanying
financial statements at $2.3 million at December 31, 1999.

         INTERNET INVESTMENTS. New Valley has invested $8.1 million in various
Internet-related businesses. These investments include an approximate 4%
interest in JFAX.COM, Inc. JFAX is an Internet-based messaging and
communications services provider to individuals and businesses, which completed
an initial public offering in July 1999. New Valley has also invested $4.5
million for a 33.33% interest in Atomic Pop, an online music enterprise founded
by Al Teller, the former head of MCA Music Entertainment and president of CBS
Records, dedicated to leveraging the digital medium to change the way music is
acquired, promoted, sold and distributed. New Valley also owns smaller
interests in other Internet companies.

         NEW VALLEY REALTY DIVISION. In January 1996, New Valley acquired four
office buildings and eight shopping centers for an aggregate purchase price of
$183.9 million, consisting of $23.9 million in cash and $160 million in
non-recourse mortgage financing provided by the sellers. The office buildings
and shopping centers have been operated through its New Valley Realty division.
In September 1998, New Valley sold the office buildings.

         In January 1996, New Valley acquired the shopping centers for an
aggregate purchase price of $72.5 million. Each seller was an affiliate of
Apollo. The shopping centers are located in Marathon and Royal Palm Beach,
Florida; Lincoln, Nebraska; Santa Fe, New Mexico; Milwaukie, Oregon; Richland
and Marysville, Washington; and Kanawha, West Virginia. In August 1999, New
Valley sold five of the shopping centers for an aggregate purchase price of


                                       15
<PAGE>   18



$46.1 million before closing adjustments and expenses. The five shopping centers
were subject to approximately $35 million of mortgage financing which was
assumed by the purchasers at closing. New Valley's two remaining shopping
centers in Royal Palm Beach, Florida and Kanawha, West Virginia are subject to
approximately $19.7 million of underlying mortgages in favor of senior lenders
and second mortgages in favor of the original sellers.

         THINKING MACHINES CORPORATION. Thinking Machines, New Valley's 73%
owned subsidiary, designed, developed, marketed and supported software offering
prediction-based management solutions under the name LoyaltyStream(TM) for
businesses such as financial services and telecommunications providers. This
software was designed to help reduce customer attrition, control costs, more
effectively cross-sell or bundle products or services and manage risks.
Incorporated in LoyaltyStream was Darwin(R), a data mining software tool set
with which a customer can analyze large amounts of its pre-existing data as well
as external demographics data to predict behavior or outcomes. The customer can
then send this information through systems integration to those divisions of the
customer, which can use it to more effectively anticipate and solve business
problems. To date, no material revenues have been recognized by Thinking
Machines from the sale or licensing of such software and services.

         On June 2, 1999, Thinking Machines sold substantially all of its
assets, consisting of its Darwin(R) software and services business, to Oracle
Corporation. The purchase price was $4.7 million in cash at the closing of the
sale and up to an additional $20.3 million, payable in cash on January 31 in
each of the years 2001 through 2003, based on sales by Oracle of Darwin product
above specified sales targets.

         MISCELLANEOUS INVESTMENTS. At December 31, 1999, New Valley owned
approximately 48% of the outstanding shares of CDSI Holdings, Inc. (formerly
known as PC411, Inc.), a development stage company, which completed an initial
public offering in May 1997. CDSI holds a minority interest in a business
engaged in the delivery of an on-line electronic directory information service.

         As of December 31, 1999, long-term investments consisted primarily of
investments in limited partnerships of $8.7 million. New Valley determined that
an other than temporary impairment in the value of an investment had occurred
and wrote down this investment to zero in 1997 with a charge to operations of
$3.8 million.

         New Valley may acquire additional operating businesses through merger,
purchase of assets, stock acquisition or other means, or seek to acquire control
of operating companies through one of such means.

CORPORATE DEVELOPMENTS

         Effective October 1, 1999, Brooke was reorganized into a holding
company form of organizational structure. The new corporate structure was
implemented by the merger of a wholly-owned indirect subsidiary of the former
Brooke Group Ltd., the predecessor of the current Brooke, with the predecessor,
which was the surviving corporation. As a result of this merger, each share of
the common stock of the predecessor issued and outstanding or held in its
treasury was converted into one share of common stock of the current Brooke
(formerly known as BGL Successor Inc.). The current Brooke became the holding
company for the business and operations previously conducted by the predecessor
and its subsidiaries, and the predecessor become an indirect wholly-owned
subsidiary of Brooke. On the effective date of the merger, the name of the
current Brooke was changed to Brooke Group Ltd. and the name of the predecessor
was changed to Brooke Group Holding Inc.

         In connection with the merger, BGLS Inc., a subsidiary of the
predecessor, sold the stock of all of its direct wholly-owned subsidiaries,
other than Liggett, to BGLS Holding Inc., a Delaware corporation which is a




                                       16
<PAGE>   19


wholly-owned subsidiary of Brooke. In consideration for such shares, BGLS
transferred and assigned to BGLS Holding, and BGLS Holding assumed and agreed to
perform and discharge, pursuant to a supplemental indenture, all of BGLS'
obligations under the Indenture for BGLS' 15.75% Series B Senior Secured Notes
due 2001. In addition, BGLS Holding assumed all of BGLS' liability as plan
sponsor of three pension plans. Following these transactions, BGLS merged into
the predecessor and the name of BGLS Holding was changed to BGLS Inc.

         Except as otherwise stated, all references in this report to Brooke and
BGLS include references to their predecessors.

         All information in this report concerning Brooke's common stock has
been adjusted to give effect to the 5% stock dividend paid to stockholders on
September 30, 1999.

EMPLOYEES

         At December 31, 1999, Brooke had approximately 2,200 full-time
employees, of whom approximately 133 were employed by Liggett, approximately
1,392 were employed by Liggett-Ducat and approximately 365 were employed by New
Valley. Approximately 9.1% of Brooke's employees are hourly employees and are
represented by unions. Brooke has not experienced any significant work stoppages
since 1977, and Brooke believes that relations with its employees and their
unions are satisfactory.

                                  RISK FACTORS

BROOKE IS HIGHLY LEVERAGED, HAS NEGATIVE NET WORTH AND HAS SUFFERED
SIGNIFICANT LOSSES

         At December 31, 1999, Brooke had total outstanding indebtedness of $190
million and a net worth deficiency of $133 million. Brooke has substantial debt
service requirements on a consolidated basis, including $108,037 principal
amount and deferred interest of the BGLS senior secured notes which mature on
January 31, 2001. Brooke has experienced significant losses from continuing
operations every year since 1991 except for 1998 and 1999. There is a risk that
Brooke will not be able to generate enough funds to repay its debts. If Brooke
cannot service its fixed charges, it would significantly harm Brooke and the
value of its common stock.

BROOKE IS A HOLDING COMPANY AND DEPENDS ON CASH PAYMENTS FROM SUBSIDIARIES
WHICH ARE SUBJECT TO RESTRICTIONS

         Brooke is a holding company and has no operations of its own. Brooke's
ability to pay dividends on its common stock depends primarily on the ability of
Liggett, Liggett-Ducat and New Valley, in which Brooke indirectly holds an
approximately 55% interest, to generate cash and make it available to Brooke.
Liggett's revolving credit agreement prohibits Liggett from paying cash
dividends to Brooke unless Liggett's adjusted net worth and borrowing
availability exceed specified levels.

         Liggett-Ducat has significant debt service requirements over the next
three years relating to equipment purchased for Liggett-Ducat's new factory and
working capital lines. Brooke anticipates that substantially all of
Liggett-Ducat's cash flow will be required to meet these requirements and will
not be available for distribution to Brooke over this period.

         As the controlling New Valley stockholder, Brooke must deal fairly with
New Valley, which may limit its ability to enter into transactions with New
Valley that result in the receipt of cash from New Valley and to influence New
Valley's dividend policy. In addition, since Brooke owns only approximately 55%
of the common shares of New Valley, a significant portion of any cash and other
assets distributed by New Valley will be received by persons other than Brooke
and its subsidiaries.



                                       17
<PAGE>   20


         Brooke's receipt of cash payments, as dividends or otherwise, from its
subsidiaries is an important source of its liquidity and capital resources. If
Brooke does not receive payments from its subsidiaries in an amount sufficient
to repay its debts, it must obtain additional funds from other sources. There is
a risk that Brooke will not be able to obtain additional funds at all or on
terms acceptable to Brooke. Brooke's inability to service these obligations
would significantly harm BGLS and the value of its common stock.

LIGGETT FACES INTENSE COMPETITION IN THE DOMESTIC TOBACCO INDUSTRY

         Liggett is considerably smaller and has fewer resources than all its
major competitors and has a more limited ability to respond to market
developments. Published industry sources indicate that the three largest
manufacturers control approximately 86% of the United States cigarette market.
Philip Morris Companies Inc. is the largest and most profitable manufacturer in
the market, and its profits are derived principally from its sale of premium
cigarettes. Based on published industry sources, Liggett's management believes
that Philip Morris had more than 59% of the premium segment and more than 49% of
the total domestic market during 1999. Philip Morris and RJR, the two largest
cigarette manufacturers, have historically, because of their dominant market
share, been able to determine cigarette prices for the various pricing tiers
within the industry. The other cigarette manufacturers historically have brought
their prices into line with the levels established by the two major
manufacturers.

LIGGETT'S BUSINESS IS HIGHLY DEPENDENT ON THE DISCOUNT SEGMENT

         Liggett depends more on sales in the discount segment of the market,
relative to the full-price premium segment, than its major competitors. After
giving effect for the entire year to the transfer in May 1999 of three of
Liggett's premium cigarette brands in connection with the Philip Morris brand
transaction, approximately 88% of Liggett's net sales in 1999 were generated in
the discount segment. The discount segment is highly competitive with consumers
having less brand loyalty and placing greater emphasis on price. Since 1993,
Liggett's management believes that Philip Morris' market strategy has been to
minimize the actual price spread between discount and premium products and to
curtail the sales made by the makers of discount products. In part, Philip
Morris sought to minimize that spread by dropping its premium prices in early
1993. In addition, that strategy has also been carried out through wholesale and
retail trade programs. The result has been a greater decline in recent years of
industry-wide sales in the United States of discount cigarettes than of premium
cigarettes. If this decline in the discount segment continues, Liggett's sales
volumes, operating income and cash flows could be negatively affected, which in
turn could negatively affect the value of Brooke's common stock.

LIGGETT'S MARKET SHARE HAS DECLINED IN RECENT PERIODS

         Liggett has suffered a substantial decline in unit sales and associated
market share. This market share erosion results in part from its highly
leveraged capital structure that existed until December 1998 and Liggett's
limited ability to match other competitors' wholesale and retail trade programs,
obtain retail shelf space for its products and advertise its brands. The decline
also resulted from adverse developments in the tobacco industry, intense
competition and changes in consumer preferences. Based on published industry
sources, Liggett's management believes that Liggett's overall market share
during 1999 was 1.2%, down from 1.3% for 1998 and 1997. Based on published
industry sources, Liggett's management believes that Liggett's share of the
premium segment during 1999 was .3%, down from .5% in 1998 and 1997, and its
share of the discount segment during 1999 was 3.9%, up from 3.5% in 1998 and
1997. As adjusted for the Philip Morris brand transaction, Liggett's share of
the premium segment during 1998 and 1997 was .2%. If Liggett's market share
decline continues, Liggett's sales volume, operating income and cash flows could
be negatively affected, which in turn could negatively affect the value of
Brooke's common stock.



                                       18
<PAGE>   21


THE DOMESTIC CIGARETTE INDUSTRY HAS EXPERIENCED DECLINING UNIT SALES IN
RECENT PERIODS

         Industry-wide shipments of cigarettes in the United States have been
steadily declining for a number of years. Published industry sources estimate
that domestic industry-wide shipments decreased by approximately 9.0% in 1999
compared to 1998. Liggett's unit sales volume decreased more significantly
(11.3% in 1999) without giving effect to the Philip Morris transaction.
Liggett's management believes that industry-wide shipments of cigarettes in the
United States will continue to decline as a result of numerous factors. These
factors include health considerations, diminishing social acceptance of smoking
and legislative limitations on smoking in public places, federal and state
excise tax increases and settlement-related expense which have contributed to
large cigarette price increases. If this decline in industry shipments continues
and Liggett is unable to capture market share from its competitors, or if the
industry is unable to offset the decline in unit sales with price increases,
Liggett's sales volume, operating income and cash flows could be negatively
affected, which in turn could negatively affect the value of Brooke's common
stock.

LITIGATION AND REGULATION WILL CONTINUE TO HARM THE TOBACCO INDUSTRY

         The cigarette industry continues to be challenged on numerous fronts.
New court cases continue to be commenced against Liggett and the other cigarette
manufacturers. At December 31, 1999, there were approximately 300 individual law
suits, 50 purported class actions and 90 governmental and other third-party
payor health care cost recovery actions pending in the United States in which
Liggett is a named defendant. As new cases are commenced, the costs associated
with defending them and the risks resulting from the inherent unpredictability
of litigation continue to increase. An unfavorable verdict has been returned in
the first phase of the ENGLE smoking and health class action trial pending in
Florida. It is possible that additional cases could be decided unfavorably and
that there could be further adverse developments in the ENGLE case. In a worst
case scenario, it is possible that a judgment for punitive damages could be
entered in the ENGLE case in an amount not capable of being bonded, resulting in
an execution of the judgment before it could be set aside on appeal. Recently,
there have been a number of restrictive regulatory actions by various Federal
administrative bodies, including the Environmental Protection Agency and the
Food and Drug Administration. There have also been adverse political and legal
decisions and other unfavorable developments concerning cigarette smoking and
the tobacco industry, including the commencement and certification of class
actions and the commencement of third-party payor actions. These developments
generally receive widespread media attention. Brooke is not able to evaluate the
effect of these developing matters on pending litigation or the possible
commencement of additional litigation, but Brooke's consolidated financial
position, results of operations or cash flows could be materially adversely
affected by an ultimate unfavorable outcome in any of such tobacco-related
litigation, which in turn could negatively affect the value of Brooke's common
stock.

LIGGETT-DUCAT'S NEW CIGARETTE BRANDS WILL COMPETE DIRECTLY WITH THOSE OF THE
MAJOR INTERNATIONAL MANUFACTURERS

         Liggett-Ducat's brands currently compete primarily against those of
other Russian cigarette makers. In 1999, Liggett-Ducat launched in Russia two
new American-style blended cigarettes under the names "DUKAT" and "LD". These
brands will compete directly with established products in Russia made by the
major international cigarette manufacturers in the mid-priced segments of the
market. In addition, several of these major international companies have begun
to increase their production in Russia of American and international blend
cigarettes. Such activities by larger, better capitalized companies with well
established international brands will create significant additional competition
for Liggett-Ducat as its seeks to increase its sales of higher margin products.



                                       19
<PAGE>   22


LIGGETT HAS SIGNIFICANT SALES TO A SINGLE CUSTOMER

         In 1999, 30.7% of Liggett's net sales, 38.2% of Liggett's net sales in
the discount segment and 22.9% of Brooke's consolidated revenues were to
Liggett's largest customer. If this customer were to discontinue its
relationship with Liggett or experience financial difficulties, Liggett's
results of operations could be adversely affected.

EXCISE TAX INCREASES MAY ADVERSELY AFFECT CIGARETTE SALES

         As part of the 1997 budget agreement approved by Congress, federal
excise taxes on a pack of cigarettes, which are currently 34 cents, were
increased at the beginning of 2000 and will rise 5 cents more in the year 2002.
In general, excise taxes and other taxes on cigarettes have been increasing.
These taxes vary considerably and, when combined with sales taxes and the
current federal excise tax, may be as high as $1.66 per pack in a given locality
in the United States. Congress has been considering significant increases in the
federal excise tax or other payments from tobacco manufacturers, and the Clinton
Administration's fiscal year 2001 budget proposal includes an additional
increase of $.25 per pack in the federal excise tax, as well as a contingent
special assessment related to youth smoking rates. Increases in other
cigarette-related taxes have been proposed at the state and local level. A
substantial federal or state excise tax increase could accelerate the trend away
from smoking and could have an unfavorable effect on Liggett's sales and
profitability.

OPERATIONS IN RUSSIA ARE SUBJECT TO A HIGH LEVEL OF RISK

         Brooke has significant investments in its cigarette manufacturing
operations in Russia and, through its subsidiary, New Valley, in real estate
development operations in Russia. These operations are subject to a high level
of risk. There is a risk that investments in Russia will harm Brooke's
profitability (if any) or liquidity and cash flow.

         In its on-going transition from a centrally-controlled economy under
communist rule, Russia has experienced dramatic political, social and economic
upheaval. There is a risk that further reforms necessary to complete this
transition will not occur. In August 1998, the economy of the Russian Federation
entered a period of even greater economic instability which has continued since
that time. The country's currency continues to devalue. There is continued
volatility in the debt and equity markets, and hyperinflation persists.
Confidence in the banking sector has yet to be restored, and there continues to
be a general lack of liquidity in the economy. In addition, Brooke and New
Valley may be harmed by regulatory, political and legal developments beyond the
control of companies operating in the Russian Federation, including:

         o    diplomatic developments;

         o    decisions of international lending organizations;

         o    regional tensions;

         o    currency repatriation restrictions;

         o    foreign exchange fluctuations;

         o    an undeveloped system of commercial laws, including laws on real
              estate titles and mortgages, and a relatively untested judicial
              system;

         o    an evolving taxation system subject to constant changes which may
              be applied retroactively and subject to varying interpretations by
              tax authorities which may not coincide with that of management and


                                       20
<PAGE>   23


              can result in assessments of additional taxes, penalties and
              interest, which can be significant; and

         o    other legal developments and, in particular, the risks of
              expropriation, nationalization and confiscation of assets and
              changes in legislation relating to foreign ownership.

CHANGES IN FOREIGN EXCHANGE RATES COULD HAVE ADVERSE EFFECTS ON
LIGGETT-DUCAT'S OPERATIONS

         Liggett-Ducat's revenues are in Russian rubles while its costs and
liabilities are denominated in multiple currencies, particularly the U.S.
dollar, the Russian ruble and the German mark. This exposes Liggett-Ducat to
currency fluctuations, which may affect Brooke's consolidated financial
condition and results of operations as reported in U.S. dollars. The Russian
ruble depreciated against the U.S. dollar 247% in 1998 and 31% in 1999 (based on
average exchange rates for these periods).

NEW VALLEY IS SUBJECT TO RISKS RELATING TO THE INDUSTRIES IN WHICH IT OPERATES

         THE SECURITIES INDUSTRY. As a broker-dealer, Ladenburg is subject to
uncertainties endemic to the securities industry. These uncertainties include
the volatility of domestic and international financial, bond and stock markets,
as demonstrated by recent disruptions in the financial markets, extensive
governmental regulation, litigation, intense competition and substantial
fluctuations in the volume and price level of securities. Ladenburg also depends
on the solvency of various counterparties. As a result, revenues and earnings
may vary significantly from quarter to quarter and from year to year. In periods
of low volume, profitability is impaired because certain expenses remain
relatively fixed. Ladenburg is much smaller and has much less capital than many
competitors in the securities industry.

         RISKS OF REAL ESTATE JOINT VENTURES AND DEVELOPMENT PROJECTS. New
Valley has two significant joint ventures with Apollo to make real estate and
other investments in Russia. New Valley must seek Apollo's approval for
important actions regarding the joint ventures. Since Apollo's interests may
differ from those of New Valley, a deadlock could arise that might impair the
ability of the joint ventures to function. Such a deadlock could significantly
harm the joint ventures. The terms of the joint ventures, which require New
Valley to offer Apollo the first opportunity to participate in new investments
in Russia, may make it more difficult for New Valley to forge alliances in
Russia with other entities.

         New Valley plans to pursue a variety of real estate development
projects. Development projects are subject to special risks including potential
increase in costs, inability to meet deadlines which may delay the timely
completion of projects, reliance on contractors who may be unable to perform and
the need to obtain various governmental and third party consents.

         RISKS RELATING TO RUSSIAN REAL ESTATE OPERATIONS. New Valley has
significant real estate development operations in Russia. These operations are
subject to a high level of risk.

         As a result of the recent economic difficulties in the Russian economy,
New Valley took a charge of $11.6 million in 1999 for a permanent impairment in
the value of the site for the proposed Ducat Place III office building and
related goodwill. The uncertainties in Russia may also impair New Valley's
ability to complete planned financing and investing activities. The development
of certain Russian properties will require significant amounts of debt and other
financing. In acquiring its interest in the Kremlin sites, New Valley agreed
with the City of Moscow to invest an additional $22 million by May 2000 in the
development of the property. Failure to make the required investment could




                                       21
<PAGE>   24


result in the forfeiture of a 34.8% interest in one of the sites. New Valley is
considering potential financing alternatives on behalf of the joint ventures.
However, given the recent economic turmoil in Russia, there is a risk that
financing will not be available on acceptable terms. Failure to obtain
sufficient capital for the projects would force the joint ventures to curtail or
delay their projects.

NEW VALLEY'S POTENTIAL INVESTMENTS ARE UNIDENTIFIED AND MAY NOT SUCCEED

         New Valley currently holds a significant amount of marketable
securities and cash not committed to any specific investments. This subjects you
to increased risk and uncertainty because you will not be able to evaluate how
this cash will be invested and the economic merits of particular investments.
There may be substantial delay in locating suitable investment opportunities. In
addition, New Valley may lack relevant management experience in the areas in
which New Valley may invest. There is a risk that New Valley will fail in
targeting, consummating or effectively managing any of these investments.

BROOKE DEPENDS ON ITS KEY PERSONNEL

         Brooke depends on the efforts of its executive officers and other key
personnel. While Brooke believes that it could find replacements for these key
personnel, the loss of their services could have a significant adverse effect on
Brooke's operations. Brooke does not maintain key-man life insurance for any of
its personnel.

BROOKE AND NEW VALLEY HAVE MANY POTENTIALLY DILUTIVE SECURITIES OUTSTANDING

         In March 1998, in connection with agreements to amend the terms of
BGLS' senior secured notes, Brooke issued five-year warrants to purchase
4,357,500 shares of Brooke's common stock. These warrants are currently
exercisable as to 2,100,000 shares, at a price of $4.76 per share, and as to
2,257,500 additional shares, at a price of $.095 per share. In 1998, Brooke
granted options for 1,312,500 shares of Brooke's common stock, at a price of
$5.71 per share, to a law firm that represents Brooke, Liggett and New Valley,
all of which are currently exercisable. At December 31, 1999, Brooke had
outstanding options granted to employees and a consultant to purchase 7,936,910
shares of its common stock, at prices ranging from $1.90 to $18.00 per share, of
which options for 2,600,284 shares are exercisable during 2000. The issuance of
these shares will cause dilution which may adversely affect the market price of
Brooke's common stock. The availability for sale of significant quantities of
Brooke's common stock could adversely affect the prevailing market price of the
stock.

         As part of New Valley's recapitalization, a total of 17,898,629
warrants to purchase common shares were issued to New Valley's stockholders. The
potential issuance of common shares on exercise of the warrants would increase
the number of New Valley's common shares outstanding by more than 76%.

BROOKE'S STOCK PRICE HAS BEEN VOLATILE

         The trading price of Brooke's common stock has fluctuated widely,
ranging between $10.63 and $25.36 per share over the past 52 weeks. The overall
market and the price of its common stock may continue to fluctuate greatly. The
trading price of its common stock may be significantly affected by various
factors, including:

         o    the depth and liquidity of the trading market for Brooke's common
              stock;

         o    quarterly variations in its actual or anticipated operating
              results;

         o    changes in investors' and analysts' perceptions of the business
              and legal risks facing Brooke and the tobacco industry;



                                       22
<PAGE>   25



         o    changes in estimates of its earnings by investors and analysts;
              and

         o    announcements or activities by its competitors.

ITEM 2.    PROPERTIES

         Brooke's, BGLS' and New Valley's principal executive offices are
located in Miami, Florida. Brooke leases 12,356 square feet of office space from
an unaffiliated company in an office building in Miami, which it shares with
BGLS and New Valley and various of their subsidiaries. New Valley has entered
into an expense-sharing arrangement for use of such office space. The lease
expires in May 2003.

         Substantially all of Liggett's tobacco manufacturing facilities,
consisting principally of factories, distribution and storage facilities, are
located in or near Durham, North Carolina. Such facilities are both owned and
leased. As of December 31, 1999, the principal properties owned or leased by
Liggett are as follows:
<TABLE>
<CAPTION>

                                                        OWNED           APPROXIMATE
                                                          OR           TOTAL SQUARE
TYPE                             LOCATION               LEASED            FOOTAGE
----                             --------               ------            -------
<S>                              <C>                    <C>                <C>
Office and
   Manufacturing Complex         Durham, NC             Owned              836,000
Warehouse                        Durham, NC             Owned              203,000
Storage Facilities               Danville, VA           Owned              578,000

</TABLE>


         Liggett's Durham, North Carolina complex consists of eight major
structures over approximately 13 acres. Included are Liggett's manufacturing
plant, research facility and corporate offices. Liggett's management believes
its property, plant and equipment are well maintained and in good condition and
that its existing facilities are sufficient to accommodate a substantial
increase in production.

         In November 1999, 100 Maple Lane LLC, a newly formed entity owned by
Liggett, purchased for $8.4 million an industrial facility in Mebane, North
Carolina. The Mebane facility is an approximately 240,000 square foot
manufacturing facility located on 42 acres. Liggett plans to relocate its
tobacco manufacturing operations from Durham, North Carolina to the Mebane
facility, which is approximately 30 miles from Durham.

         Liggett-Ducat has a 49-year land lease on a site on the outskirts of
Moscow, Russia where Liggett-Ducat has built its new cigarette factory.

         Ladenburg leases approximately 74,000 square feet of office space under
a lease that expires on June 30, 2015. Effective September 1, 1999, Ladenburg
subleased approximately 13,125 square feet of office space under a 10-year
sublease. New Valley's operating properties are described above.

ITEM 3.    LEGAL PROCEEDINGS

         Liggett (and, in certain cases, Brooke Group Holding) and other United
States cigarette manufacturers have been named as defendants in numerous direct,
third-party and class actions predicated on the theory that they should be
liable for damages from adverse health effects alleged to have been caused by
cigarette smoking or by exposure to secondary smoke from cigarettes. See Item 1.
"Business -- Liggett Group Inc. -- Legislation, Regulation and Litigation."
Reference is made to Note 22 to Brooke's consolidated financial statements,




                                       23
<PAGE>   26


which contains a general description of certain legal proceedings to which
Brooke Group Holding, BGLS, New Valley or their subsidiaries are a party and
certain related matters. Reference is also made to Exhibit 99.1, Material Legal
Proceedings, incorporated herein, for additional information regarding the
pending smoking-related material legal proceedings to which Brooke Group
Holding, BGLS and/or Liggett are party. A copy of Exhibit 99.1 will be furnished
to security holders of Brooke and its subsidiaries without charge upon written
request to Brooke at its principal executive offices, 100 S.E. Second Street,
Miami, Florida 33131, Attn: Investor Relations.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         During the fourth quarter of 1999, Brooke submitted the following
matter to a vote of stockholders at its Annual Meeting of Stockholders held on
November 9, 1999. Proxies for the annual meeting were solicited pursuant to
Regulation 14A under the Securities Exchange Act of 1934.

         The matter voted upon at the annual meeting was the election of four
directors and the following is a tabulation of the results:

         Total shares of Common Stock outstanding as of October 6, 1999 (the
record date) - 21,990,916

         Total shares of Common Stock voted in person or by proxy - 20,345,912

                             Election of Directors:

                                      FOR                    WITHHOLD
                                      ---                    --------

      Robert J. Eide               20,214,773                 131,139
      Bennett S. LeBow             20,214,528                 131,384
      Jeffrey S. Podell            20,214,773                 131,139
      Jean E. Sharpe               20,214,773                 131,139





                                       24
<PAGE>   27


EXECUTIVE OFFICERS OF THE REGISTRANTS

         The table below, together with the accompanying text, presents certain
information regarding all current executive officers of Brooke and of BGLS as of
March 24, 2000. Each of the executive officers of Brooke and of BGLS serves
until the election and qualification of such individual's successor or until
such individual's death, resignation or removal by the Board of Directors of the
respective company.

<TABLE>
<CAPTION>
                                                                                   YEAR INDIVIDUAL
                                                                                      BECAME AN
                       NAME               AGE               POSITION              EXECUTIVE OFFICER
                       ----               ---               --------              -----------------

<S>                                        <C>       <C>                                 <C>
              Bennett S. LeBow             62        Chairman of the Board,              1990
                                                     President and Chief
                                                     Executive Officer of the
                                                     Company and of BGLS

              Richard J. Lampen            46        Executive Vice President            1996
                                                     of the Company and
                                                     of BGLS

              Joselynn D. Van Siclen       59        Vice President, Chief               1996
                                                     Financial Officer and
                                                     Treasurer of the
                                                     Company and of BGLS

              Marc N. Bell                 39        Vice President, General             1998
                                                     Counsel and Secretary
                                                     of the Company and of
                                                     BGLS

              Ronald S. Fulford            66        Chairman of the Board,              1996
                                                     President and Chief
                                                     Executive Officer of
                                                     Liggett

</TABLE>


         BENNETT S. LEBOW has been the Chairman of the Board, President and
Chief Executive Officer of Brooke since June 1990 and has been a director of
Brooke since October 1986. Since November 1990, he has been Chairman of the
Board, President and Chief Executive Officer of BGLS. Mr. LeBow has been a
director of Liggett since June 1990. Mr. LeBow has been Chairman of the Board of
New Valley since January 1988, and Chief Executive Officer since November 1994.

         RICHARD J. LAMPEN has served as the Executive Vice President of Brooke
and of BGLS since July 1996. Since October 1995, Mr. Lampen has been the
Executive Vice President of New Valley. From May 1992 to September 1995, Mr.
Lampen was a partner at Steel Hector & Davis, a law firm located in Miami,
Florida. From January 1991 to April 1992, Mr. Lampen was a Managing Director at
Salomon Brothers Inc, an investment bank, and was an employee at Salomon
Brothers Inc from 1986 to April 1992. Mr. Lampen is a director of New Valley,
Thinking Machines, CDSI Holdings Inc. and PANACO, INC., an independent oil and
gas exploration and production company. Mr. Lampen has served as a director of a
number of other companies, including U.S. Can Corporation, The International
Bank of Miami, N.A. and Spec's Music Inc., as well as a court-appointed
independent director of Trump Plaza Funding, Inc.

         JOSELYNN D. VAN SICLEN has been Vice President, Chief Financial Officer
and Treasurer of Brooke and of BGLS since May 1996, and currently holds various
positions with certain of BGLS' subsidiaries, including Vice President and
Treasurer of Eve since April 1994 and May 1996, respectively. Prior to May 1996,
Ms. Van Siclen served as Director of Finance of Brooke and was employed in
various accounting capacities with subsidiaries of Brooke since 1992.


                                       25
<PAGE>   28


Since before 1990 to November 1992, Ms. Van Siclen was an audit manager for the
accounting firm of Coopers & Lybrand L.L.P.

         MARC N. BELL has been the Vice President of Brooke and of BGLS since
January 1998 and has served as General Counsel and Secretary of Brooke and of
BGLS since May 1994. Since November 1994, Mr. Bell has served as Associate
General Counsel and Secretary of New Valley and since February 1998, as Vice
President. Prior to May 1994, Mr. Bell was with the law firm of Zuckerman,
Spaeder, Taylor & Evans in Miami, Florida and from June 1991 to May 1993, with
the law firm of Fischbein o Badillo o Wagner o Harding in New York, New York.

         RONALD S. FULFORD has served as Chairman of the Board, President and
Chief Executive Officer of Liggett since September 1996. Mr. Fulford has also
served as a consultant to Brooke from March 1996 to March 1997. From June, 1986
until February 1996, Mr. Fulford served as Executive Chairman of Imperial
Tobacco, the British tobacco unit of the British conglomerate Hanson PLC. Before
Imperial, Mr. Fulford was chief executive of three other Hanson companies:
London Brick, British EverReady UK & South Africa and United Gas Industries UK &
Europe.




                                       26
<PAGE>   29


                                     PART II

ITEM 5.    MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         Brooke's common stock is listed and traded on the New York Stock
Exchange under the symbol "BGL". The following table sets forth, for the periods
indicated, high and low sale prices for a share of its common stock on the NYSE,
as reported by the NYSE, and quarterly cash dividends declared on shares of
common stock:

                                                                CASH
           YEAR                  HIGH            LOW          DIVIDENDS
           ----                  ----            ---          ---------
1999:
Fourth Quarter                 $ 18.38        $ 13.56             $.25
Third Quarter                    22.56          16.50              .25
Second Quarter                   25.36          13.09              .07
First Quarter                    23.22          14.83              .07

1998:
Fourth Quarter                 $ 23.57         $ 4.46             $.07
Third Quarter                    11.19           3.63              .07
Second Quarter                   15.83           8.10              .07
First Quarter                    16.43           8.27              .07

         There is no public market for BGLS' common stock, $.01 par value per
share, as all of such common stock is held by Brooke.

         At March 24, 2000, there were approximately 470 holders of record of
Brooke's common stock.

         The declaration of future cash dividends is within the discretion of
the Board of Directors of Brooke and is subject to a variety of contingencies
such as market conditions, earnings and the financial condition of Brooke as
well as the availability of cash. The payment of dividends and other
distributions to Brooke by BGLS are subject to the Indenture for BGLS' senior
secured notes. Liggett's revolving credit agreement prohibits Liggett from
paying cash dividends to Brooke unless Liggett's adjusted net worth and
borrowing availability exceed specified levels.

         Brooke paid a 5% stock dividend on September 30, 1999 to the holders of
Brooke's Common Stock. All information presented above is adjusted for the stock
dividend.

RECENT SALES OF UNREGISTERED SECURITIES

         No securities of Brooke which were not registered under the Securities
Act of 1933 have been issued or sold by Brooke during 1999, except (i) on
November 4, 1999, Brooke granted to six executive officers of Brooke and/or New
Valley stock options to purchase 2,210,000 shares of Brooke's common stock at an
exercise price of $15 7/16 per share, subject to increase under certain
circumstances; (ii) on November 24, 1999, Brooke granted to an executive officer
of Liggett stock options to purchase 250,000 shares of Brooke's common stock at
an exercise price of $18 per share; and (iii) on November 24, 1999, Brooke
granted to 26 officers and employees of Liggett stock options to purchase
670,000 shares of Brooke's common stock at an exercise price of $15 7/16 per
share. The foregoing transactions were effected in reliance on the exemption
from registration afforded by Section 4(2) of the Securities Act of 1933 or did
not involve a "sale" under the Securities Act of 1933.



                                       27
<PAGE>   30



ITEM 6.    SELECTED FINANCIAL DATA

                                BROOKE GROUP LTD.


<TABLE>
<CAPTION>
                                              ----------------------------------------------------------------------
                                                                     Year Ended December 31,
                                              ------------- ------------- -------------- ------------- -------------
                                                  1999          1998          1997           1996          1995
                                              ------------- ------------- -------------- ------------- -------------
                                                        (dollars in thousands, except per share amounts)
<S>                                              <C>           <C>           <C>            <C>           <C>
STATEMENT OF OPERATIONS DATA:

Revenues(1)..............................        $567,045      $444,566      $389,615       $460,356      $461,459
Income (loss) from continuing operations.         236,084        24,219       (51,421)       (65,515)      (45,344)
Income from discontinued operations(2)...           1,249         3,208         1,536          2,982        21,229
Loss from extraordinary items(4).........          (1,660)                                                  (9,810)
Net income (loss)........................         235,673        27,427       (49,885)       (62,533)      (33,925)

Per basic common share:
  Income (loss) from continuing
      operations(3) (5)..................           10.74          1.13         (2.70)         (3.28)        (1.48)
  Income from discontinued operations....            0.06          0.15          0.08           0.15          1.10
  Net loss from extraordinary items......           (0.08)                                                   (0.51)
  Net income (loss) applicable to
      common shares......................           10.72          1.28         (2.62)         (3.13)        (0.89)

Per diluted common share:
  Income (loss) from continuing
      operations.........................            8.81          0.93         (2.70)         (3.28)        (1.48)
  Income from discontinued operations....            0.05          0.12          0.08           0.15          1.10
  Net loss from extraordinary items......           (0.06)                                                   (0.51)
  Net income (loss) applicable to
      common shares......................            8.80          1.05         (2.62)         (3.13)        (0.89)
Cash distributions declared per common
      share..............................            0.63          0.29          0.29           0.29          0.29


BALANCE SHEET DATA:

Current assets...........................        $188,732      $122,560     $  66,759      $  80,552     $  96,615
Total assets ............................         504,448       228,982       125,234        177,677       225,620
Current liabilities......................         226,654       273,441       139,278        204,463       119,177
Notes payable, long-term debt and
  other obligations, less current portion         148,349       262,665       399,835        378,243       406,744
Noncurrent employee benefits, deferred
  credits and other long-term liabilities         262,543        87,051        74,518         49,960        55,803
Stockholders' equity (deficit)...........        (133,098)     (394,175)     (488,397)      (454,989)     (356,104)
</TABLE>

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

(1)  Revenues include federal excise taxes of $66,698, $82,613, $87,683,
     $112,218 and $123,420, respectively.
(2)  In 1998, 1997 and 1996, income from discontinued operations pertains to
     sale of Western Union Data Services Inc. and in 1995 to the sale of Western
     Union, SkyBox International Inc. and the distribution of MAI Systems
     Corporation common stock.
(3)  Per share computations include the impact of New Valley's repurchase of
     Class A Preferred Shares in 1996 and 1995.
(4)  In 1999 and 1995, extraordinary items represent loss resulting from the
     early extinguishment of debt.
(5)  Per share computations include the impact of a 5% stock dividend on
     September 30, 1999.



                                       28
<PAGE>   31


ITEM 6.    SELECTED FINANCIAL DATA

                                    BGLS INC.

<TABLE>
<CAPTION>
                                                       ---------------------------------------------------------------------
                                                                             Year Ended December 31,
                                                       ---------------------------------------------------------------------
                                                           1999          1998          1997          1996          1995
                                                       ------------- ------------- ------------- ------------- -------------
                                                                 (dollars in thousands, except per share amounts)
<S>                                                       <C>           <C>           <C>           <C>           <C>
STATEMENT OF OPERATIONS DATA:
Revenues(1).......................................        $567,045      $444,566      $389,615      $460,356      $461,459
Operating income (loss)...........................          74,214        74,528         8,419        (2,016)        8,311
Interest expense..................................          57,910        84,194        65,581        64,417        61,036
Income (loss) from continuing operations..........         235,933        22,358       (54,411)      (75,201)      (50,502)
Income from discontinued operations...............           1,249         3,208         1,536         2,982        21,229
Loss from extraordinary items(3)..................          (1,660)                                                 (9,810)
Net income (loss).................................         235,522        25,566       (52,875)      (72,219)      (39,083)
Distributions to parent...........................           9,636                                     3,621         5,872

BALANCE SHEET DATA:
Current assets....................................         187,985      $122,186     $  67,366     $  80,197     $  99,643
Total assets .....................................         502,521       227,396       128,916       178,108       229,242
Current liabilities...............................         224,353       304,516       161,475       229,736       142,885
Notes payable, long-term debt and
     other obligations, less current portion......         148,349       262,665       399,835       378,243       420,449
Noncurrent employee benefits and other
     long-term obligations........................         262,275        90,917        80,721        53,214        55,803
Stockholders' equity (deficit)....................        (132,456)     (430,702)     (513,115)     (483,085)     (389,895)
</TABLE>



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

(1)  Revenues include federal excise taxes of $66,698, $82,613, $87,683,
     $112,218 and $123,420, respectively.
(2)  In 1998, 1997 and 1996, income from discontinued operations pertains to
     sale of Western Union and in 1995 to the sale of Western Union, SkyBox and
     distribution of MAI common stock.
(3)  In 1995, extraordinary items represent loss resulting from the early
     extinguishment of debt.



                                       29
<PAGE>   32




ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
           RESULTS OF OPERATIONS

                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

OVERVIEW

         Brooke is a holding company for a number of businesses. It is engaged
principally in:

         o    the manufacture and sale of cigarettes in the United States
              through its subsidiary Liggett Group Inc.;

         o    the manufacture and sale of cigarettes in Russia through its
              subsidiary Liggett-Ducat Ltd.; and

         o    the investment banking and brokerage business in the United
              States, real estate operations in Russia and investment in
              Internet-related businesses through its majority-owned subsidiary
              New Valley Corporation.

         Brooke's domestic cigarette business, Liggett, shipped approximately
5.24 billion cigarettes during 1999 which accounted for 1.2% of the total
cigarettes shipped in the United States during that year. After giving effect
for the entire year to the Philip Morris transaction, Liggett would have shipped
5.71 billion cigarettes, representing 1.4% of the market. In May 1999, Liggett
transferred to Philip Morris the rights to manufacture the L&M, CHESTERFIELD and
LARK brands. Together, these three brands represented approximately 16.1% in
1998 and 18.1% in 1997 of Liggett's net sales excluding federal excise taxes.
After giving effect for the entire year to this transaction, approximately 88%
of Liggett's net sales in 1999 would have been generated in the discount
segment.

         Brooke believes that Liggett has gained a sustainable cost advantage
over its competitors through its various settlement agreements. Under the Master
Settlement Agreement reached in November 1998 with 46 state attorneys general
and various territories, Liggett's four major competitors must make settlement
payments to the states and territories based on how many cigarettes they sell
annually. Liggett, however, is not required to make any payments unless its
market share exceeds 1.67% of the U.S. cigarette market.

         Brooke's Russian tobacco business, Liggett-Ducat, produces some of the
leading discount and value brands in the Russian market. Liggett-Ducat's sales
have increased rapidly from approximately 10.3 billion cigarettes in 1995 to
approximately 25.2 billion cigarettes in 1999, which accounted for approximately
9% of the cigarettes sold in Russia during 1999.

         Brooke's majority - owned subsidiary New Valley is engaged in:

         o    the investment banking and securities brokerage business through
              its subsidiary Ladenburg Thalmann & Co.;

         o    real estate development in Russia through its joint ventures
              Western Realty Development LLC and Western Realty Repin LLC; and

         o    investment in Internet-related investments.

         Ladenburg operates as a full service broker-dealer which provides its
services principally for middle market and emerging growth companies and high



                                       30
<PAGE>   33


net worth individuals through a coordinated effort among corporate finance,
research, capital markets, investment management, brokerage and trading
professionals.

         New Valley has entered into two separate joint venture agreements with
Apollo Real Estate Investment Fund III, L.P. to make real estate and other
investments in Russia. New Valley and Apollo developed and manage a 150,000
square foot class A office building located in downtown Moscow. Its tenants
include Motorola, Conoco and Morgan Stanley Dean Witter. Once economic
conditions improve in Russia, the adjacent site will be developed into
additional commercial office space.

         During 1999, New Valley has made several long-term investments in
Internet-related businesses. New Valley owns a substantial interest in Atomic
Pop, an online music enterprise, and owns smaller interests in other Internet
companies.

         In recent years, the domestic tobacco business has experienced the
following trends:

         o    Declining unit volumes due to health considerations, diminishing
              social acceptance of smoking, legislative limitations on smoking
              in public places, federal and state excise tax increases and
              settlement-related expenses which have augmented cigarette prices;

         o    Narrower price spreads between the premium and discount segments
              and aggressive premium price promotions by larger competitors
              including Philip Morris and RJR; and

         o    Loss of discount market share by generic brand discount cigarettes
              such as those sold by Liggett due to higher distribution
              penetration and vendor promotions by branded discount cigarettes
              sold by Philip Morris and RJR.

         In recent years, the Russian tobacco business has experienced the
following trends:

         o    Strong market growth as consumers gained exposure to Western-style
              cigarettes;

         o    Consumer migration toward lower priced cigarettes following the
              Russian economic turmoil beginning in 1998;

         o    Increased market penetration of domestic producers due to high
              import duties; and

         o    Consumer preference evolving toward lighter tasting international
              and American blend cigarettes away from the traditional stronger
              tasting Russian cigarettes.

         In recent years, the industries in which New Valley operates have
experienced the following trends:

         o    Strong growth in securities trading, merger and acquisition
              activity and corporate bond and equity underwriting due to healthy
              underlying U.S. economic fundamentals; and

         o    A slowdown of new construction and development in Russia since the
              economic turmoil experienced beginning in 1998.

RECENT DEVELOPMENTS

         MASTER SETTLEMENT AGREEMENT. In November 1998, Liggett and the four
largest U.S. cigarette manufacturers, Philip Morris, Brown & Williamson, RJR and
Lorillard, entered into the Master Settlement Agreement with 46 states, the




                                       31
<PAGE>   34


District of Columbia, Puerto Rico and various other territories to settle their
asserted and unasserted health care cost recovery and certain other claims
caused by cigarette smoking.

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

         PHILIP MORRIS BRAND TRANSACTION. In November 1998, Brooke and Liggett
granted Philip Morris options to purchase interests in Trademarks LLC which
holds three domestic cigarette brands, L&M, CHESTERFIELD and LARK, formerly held
by Liggett's subsidiary, Eve Holdings Inc.

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

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

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

         NEW VALLEY SHOPPING CENTERS. On August 30 1999, New Valley sold five of
its shopping centers for an aggregate purchase price of $46,125 (before closing
adjustments and expenses). The shopping centers were subject to $35,023 of
mortgage financing which was assumed by the purchasers at closing. In connection
with the transaction, New Valley recorded a gain of $3,849 on the sale.

         On December 23, 1999, New Valley sold a 19.9% interest in Ladenburg to
a German public financial holding company. New Valley received $10.2 million in
cash and shares of the purchaser valued in accordance with the purchase
agreement. New Valley recognized a gain of $4,256 on the sale.

RECENT DEVELOPMENTS IN LEGISLATION, REGULATION AND LITIGATION

         The cigarette industry continues to be challenged on numerous fronts.
New court cases continue to be commenced against Liggett and other cigarette
manufacturers. As of December 31, 1999, there were approximately 300 individual



                                       32
<PAGE>   35

law suits, 50 purported class actions and 90 governmental and other third-party
payor health care recovery actions pending in the United States in which Liggett
was a named defendant. As new cases are commenced, the costs associated with
defending such cases and the risks attendant to the inherent unpredictability of
litigation continue to increase. An unfavorable verdict has been returned in the
first phase of the ENGLE smoking and health class action trial pending in
Florida. It is possible that additional cases could be decided unfavorably and
that there could be further adverse developments in the ENGLE case. In a worst
case scenario, it is possible that a judgment for punitive damages could be
entered in the ENGLE case in an amount not capable of being bonded, resulting in
an execution of the judgment before it could be set aside on appeal. Recently,
there have been a number of restrictive regulatory actions from various Federal
administrative bodies, including the Environmental Protection Agency and the
Food and Drug Administration. There have also been adverse political decisions
and legal decisions and other unfavorable developments concerning cigarette
smoking and the tobacco industry, including the commencement and certification
of class actions and the commencement of third-party payor actions. These
developments generally receive widespread media attention. Management is not
able to evaluate the effect of these developing matters on pending litigation or
the possible commencement of additional litigation, but Brooke's consolidated
financial position, results of operations or cash flows could be materially
adversely affected by an unfavorable outcome in any of such smoking-related
litigation. See Note 22 to Brooke's consolidated financial statements for a
description of legislation, regulation and litigation.

         In March 1996, March 1997 and March 1998, Brooke's predecessor, Brooke
Group Holding Inc., and Liggett entered into settlements of smoking-related
litigation with the Attorneys General of 45 states and territories. The
settlements released Brooke Group Holding and Liggett from all smoking-related
claims, including claims for health care cost reimbursement and claims
concerning sales of cigarettes to minors. Brooke accrued approximately $16,902
for the present value of the fixed payments under the March 1998 Attorneys
General settlements. As a result of Liggett's treatment under the Master
Settlement Agreement, $14,928 of net charges accrued for the prior settlements
were reversed in 1998 and $1,051 were reversed in 1999. See the discussions of
the tobacco litigation settlements appearing in Note 22 to Brooke's consolidated
financial statements.

RESULTS OF OPERATIONS

         The following discussion provides an assessment of the results of
operations, capital resources and liquidity of Brooke and should be read in
conjunction with Brooke's consolidated financial statements and related notes
included elsewhere in this report. The consolidated financial statements include
the accounts of BGLS, Liggett, Brooke (Overseas), Liggett-Ducat and other less
significant subsidiaries. As of June 1, 1999, New Valley became a consolidated
subsidiary of Brooke as a result of New Valley's recapitalization in which
Brooke's interest in New Valley's common shares increased to 55.1%. New Valley's
stock repurchase program, which began in late 1999, increased Brooke's interest
to 55.4% at December 31, 1999.

         For purposes of this discussion and other consolidated financial
reporting, Brooke's significant business segments for the year ended December
31, 1999 were tobacco sold in the United States and Russia, broker-dealer
transactions and real estate. Brooke's significant business segment for the
years ended December 31, 1998 and 1997 was tobacco sold in the United States and
Russia.



                                       33
<PAGE>   36


1999 COMPARED TO 1998 AND 1998 COMPARED TO 1997
<TABLE>
<CAPTION>

                                                      FOR THE YEARS ENDED DECEMBER 31,
                                                  -----------------------------------------
                                                    1999           1998             1997
                                                  -------        --------          --------
                                                         (Dollars in Thousands)

<S>                                              <C>             <C>               <C>
NET REVENUES:
  Liggett............................            $422,748        $347,129          $312,268
  Liggett-Ducat......................             100,059          97,350            77,115
                                                  -------        --------          --------
    Total tobacco....................             522,807         444,479           389,383

  *Broker-dealer....................              40,852
  *Real estate......................               3,386
  Other..............................                                  87               232
                                                  -------        --------          --------
      Total revenues.................             567,045         444,566           389,615
                                                  =======         =======           =======

OPERATING INCOME:
  Liggett............................              76,700          54,422             3,688
  Liggett-Ducat......................               5,215          13,234             8,642
                                                  -------        --------          --------
      Total tobacco..................              81,915          67,656            12,330

  *Broker-dealer.....................                369
  *Real estate.......................               (776)
  Corporate and other................             (9,505)           3,938            (4,301)
                                                  -------        --------          --------
      Total operating income.........           $  72,003       $  71,594        $    8,029
                                                 ========        ========         =========
</TABLE>

*  New Valley became a consolidated subsidiary of Brooke on June 4, 1999.
   Broker-Dealer, Real Estate and New Valley's portion of Corporate and Other
   are included for the seven months ended December 31, 1999.

1999 COMPARED TO 1998

         REVENUES. Total revenues were $567,045 for the year ended December 31,
1999 compared to $444,566 for the year ended December 31, 1998. This 27.6%
increase in revenues was due to a $75,619 or 21.8% increase in revenues at
Liggett, a $2,709 or 2.8% increase at Liggett-Ducat and the addition of revenues
from New Valley of $44,238.

         TOBACCO REVENUES. In August 1999, the major cigarette manufacturers,
including Liggett, announced a list price increase of $1.50 per carton. During
1998, the major cigarette manufacturers, including Liggett, announced list price
increases of $6.35 per carton. This included an increase of $4.50 per carton
announced by the industry in December 1998 following the signing of the Master
Settlement Agreement. In January 2000, an additional list price increase of
$1.30 per carton was announced.

         Tobacco revenues at Liggett increased for both the premium and discount
segments due to price increases of $129,291 partially offset by a 13.6%
($47,235) decline in unit sales volume (approximately 794.8 million units) and
$6,437 in unfavorable sales mix. The decline in Liggett's unit sales volume was
due to an overall decline in industry volume, the closing of the Philip Morris
brand transaction, certain competitors continuing leveraged rebate programs tied
to their products and increased promotional activity by certain other
manufacturers.

         Premium sales at Liggett for the year ended December 31, 1999 amounted
to $78,182 and represented 18.5% of total Liggett sales, compared to $105,422
and 30.4% of total sales for 1998. In the premium segment, revenues declined by
25.8% ($27,240) in the year ended December 31, 1999 compared to 1998, due to an
unfavorable volume variance of $48,789, reflecting a 46.3% decline in unit sales
volume (approximately 697.2 million units), primarily due to the closing of the



                                       34
<PAGE>   37


Philip Morris brand transaction on May 24, 1999, which was partially offset by
price increases of $21,549. As adjusted for the contribution of the three brands
in the Philip Morris brand transaction, the decline in Liggett's premium segment
from the prior year period was 21.5% (approximately 232.7 million units).
Although this decline compares unfavorably to an overall industry decline in the
premium segment of approximately 8.5% during 1999, Liggett's management believes
that the percentage decline is consistent with other, smaller premium brands.

         Discount sales at Liggett (comprising the brand categories of branded
discount, private label, control label, generic, international and contract
manufacturing) for 1999 amounted to $344,566 and represented 81.5% of total
Liggett sales, compared to $241,707 and 69.6% of total Liggett sales in 1998. In
the discount segment, revenues grew by 42.6% ($102,859) in the year ended
December 31, 1999 compared to 1998, due to price increases of $107,742, and a
favorable product mix among the discount brand categories of $560 partially
offset by a 2.3% decline in unit sales volume (approximately 97.6 million units)
accounting for $5,443 in volume variance.

         For the year ended December 31, 1999, fixed manufacturing costs on a
basis comparable to 1998 at Liggett were $1,073 lower, although costs per
thousand units remained unchanged despite a 6.1% decline in production volume
from the previous year. Payroll expenses increased but were offset by a decline
in non-payroll expense over the prior year.

         The increase in tobacco revenues at Liggett-Ducat is attributable to a
20.9% increase in unit sales volume of $20,387 and a favorable product mix of
$3,672 offset by decreased prices of $21,350. Although volume increased by
approximately 4,265 million units in 1999, Liggett-Ducat's sales volume was
adversely affected by the move to the new factory and price declines in Russia
due to the full impact of the 1998 ruble devaluation.

         TOBACCO GROSS PROFIT. Tobacco consolidated gross profit was $333,179
for the year ended December 31, 1999 compared to $243,570 for the year ended
December 31, 1998, an increase of $89,609 or 36.8% when compared to 1998, due
primarily to price increases at Liggett offset by the price declines at
Liggett-Ducat discussed above. Liggett's premium brands contributed 17.7% to
Brooke's gross profit, the discount segment contributed 75.9% and Liggett-Ducat
contributed 6.4% for the year ended December 31, 1999. In 1998, Liggett's
premium brands contributed 28.8%, the discount segment contributed 60.6% and
Liggett-Ducat contributed 10.3%.

         Liggett's gross profit of $310,964 for the year ended December 31, 1999
increased $93,122 or 42.7% from gross profit of $217,842 in 1998, due primarily
to the price increases discussed above. As a percent of revenues (excluding
federal excise taxes), gross profit at Liggett increased to 85.5% for the year
ended December 31, 1999 compared to 78.4% in 1998, with gross profit for the
premium segment at 85.8% in 1999 and 80.2% in 1998 and gross profit for the
discount segment at 85.4% in 1999 and 77.5% in 1998. This increase is primarily
the result of the 1998 list price increases and, to a lesser degree, list price
increases in August 1999.

         As a percentage of revenues (excluding Russian excise taxes), gross
profit at Liggett-Ducat decreased to 23.5% for the year ended December 31, 1999
compared to 29.9% in 1998, due to declining prices as discussed above.

         BROKER-DEALER AND REAL ESTATE REVENUES. New Valley's broker-dealer
revenues were $40,852 and real estate revenues were $3,386 for the seven months
ended December 31, 1999.



                                       35
<PAGE>   38



         EXPENSES. Operating, selling, general and administrative expenses were
$306,228 for the year ended December 31, 1999 compared to $186,904 in 1998. The
increase of $119,324 is due primarily to a $56,967 increase at Liggett, a $4,371
increase at Brooke (Overseas) and additional expenses of $52,870 as a result of
the consolidation of New Valley. The increase in operating expenses at Liggett
was due primarily to an increase of $61,703 in spending for promotional and
marketing programs partially offset by a reduction in amortization charges and
legal expenses. In 1999, such expenses were offset by the reversal of charges
for the Attorneys General settlements of $1,051 which were previously accrued.
In 1998, operating expenses of $178,348 at Liggett were offset by the reversal
of $14,928 in net charges for the Attorneys General settlements previously
accrued but reversed in the fourth quarter 1998 as a result of the Master
Settlement Agreement.

         The increase at Brooke (Overseas) is largely due to an increase in
depreciation expense of $3,689 due to Liggett-Ducat's new factory being placed
in service in June of 1999 and increased promotional and advertising expense as
Liggett-Ducat introduces new products into the Russian market.

         OTHER INCOME (EXPENSES). For the year ended December 31, 1999, Liggett
recognized a gain of $294,078 in connection with the closing of the Philip
Morris brand transaction. In addition, the Company recognized a gain of $11,883
from the sales by New Valley of five U. S. shopping centers, Thinking Machines'
assets and a 19.9% interest in Ladenburg. Brooke also recognized in March 1999 a
deferred gain of $7,050 relating to the expiration of the put obligation on
Ducat Place III (the site of the old cigarette factory in Russia) in connection
with the 1997 sale of the BrookeMil common shares.

         Interest expense was $54,378 for the year ended December 31, 1999
compared to $79,704 in 1998. The decrease of $25,326 is largely due to a savings
of $19,165 because of the redemption by Liggett of its senior secured notes on
December 28, 1998 and lower interest expense on Liggett's credit facility. In
addition, BGLS realized a savings of $14,185 due to the repurchase of a portion
of BGLS' senior secured notes. This was offset by additional interest expense at
Brooke (Overseas) of $8,753 and interest at New Valley of $5,060.

         Equity in earnings of affiliate was a loss of $11,315 and includes
Brooke's loss in New Valley which was accounted for on the equity method for the
five months ended May 31, 1999 as well as losses at New Valley on its equity
method investees. This is compared to a loss of $28,717 for the year ended
December 31, 1998 which relates to New Valley's net loss applicable to common
shares of $96,553 accounted for on the equity method for the year ended December
31, 1998. The loss in joint venture of $12,082 in 1999 resulted primarily from
an impairment charge of $11,561 associated with Western Realty Development.

         INCOME FROM CONTINUING OPERATIONS. The income from continuing
operations for the year ended December 31, 1999 was $236,084 compared to income
of $24,219 for 1998. Income tax expense for the year ended December 31, 1999 was
$82,458 compared to a benefit of $59,613 for the year ended December 31, 1998.

         OTHER. At December 31, 1999, Brooke and its consolidated group had U.S.
tax operating loss carryforwards for tax purposes of approximately $135,000
which may be subject to certain restrictions and limitations and which will
generally expire in the years 2006 to 2017.

1998 COMPARED TO 1997

         REVENUES. Consolidated revenues were $444,566 for the year ended
December 31, 1998 compared to $389,615 for the year ended December 31, 1997, an
increase of $54,951 or 14.1% due to increases in tobacco revenues at Liggett of
$34,861 and at Liggett-Ducat of $20,235.




                                       36
<PAGE>   39


         During 1998, the major cigarette manufacturers, including Liggett,
announced price increases of $6.35 per carton. This is compared with announced
increases of $1.20 per carton in 1997.

         Revenues at Liggett increased in both the premium and discount segments
by 11.2% due to price increases of $60,384 and a favorable product mix of
$1,214, partially offset by an 8.6% decline in unit sales volume (approximately
547 million units), which accounted for $26,737 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 at Liggett for the 1998 year amounted to $105,422 and
represented 30.4% of Liggett's total revenues, compared to $102,440 and 32.8% of
total sales in 1997. In the premium segment, revenues grew by 2.9% ($2,982) for
the year ended December 31, 1998, compared to the prior year, due to price
increases of $14,604, which were partially offset by an 11.3% decline in unit
sales volume (approximately 192.8 million units), accounting for $11,622 in
volume variance. The brands contributed to Trademarks, L&M, CHESTERFIELD and
LARK, represented 16.1% in 1998 and 18.1% in 1997 of Liggett's net sales
(excluding federal excise taxes).

         Liggett's discount sales for 1998 amounted to $241,707 and represented
69.6% of total revenues, compared to $209,828 and 67.2% of total sales for the
prior year. In the discount segment, revenues grew by 15.2% ($31,879) for the
year ended December 31, 1998 compared to the prior year, due to price increases
of $45,780 and a favorable product mix among the discount brand categories of
$1,949, which were partially offset by a 7.6% decline in unit sales volume
(approximately 354.2 million units), accounting for $15,850 in volume variance.

         For the year ended December 31, 1998, fixed manufacturing costs on a
basis comparable to 1997 were $2,040 lower at Liggett, although costs per
thousand units increased by $0.12 per thousand due to lower volume.

         Revenues at Liggett-Ducat increased 26.2% ($20,235) due to a 5.8
billion increase in unit sales volume ($30,991) offset by a decline in price
($10,634) due to Russian currency fluctuation and slightly unfavorable product
mix ($122). For the year ended 1998, manufacturing costs increased by $8,914,
but costs per thousand units decreased by $0.81 per thousand.

         GROSS PROFIT. Consolidated gross profit of $243,570 for the year ended
December 31, 1998 increased $56,076 (29.9%) from gross profit of $187,494 for
the year ended December 31, 1997 reflecting an increase in gross profit at
Liggett of $44,884 primarily due to price increases discussed above.
Liggett-Ducat's gross profit increased $11,600 (85.7%) primarily due to
increased volume also discussed above. In 1998, Liggett's premium and discount
brands contributed 28.8% and 60.6%, respectively, to Brooke's total gross profit
and Liggett-Ducat contributed 10.3%. In 1997, Liggett's premium and discount
brands contributed 33.8% and 58.5%, respectively, while Liggett-Ducat
contributed 7.2%.

         As a percentage of revenues (excluding federal excise taxes), Liggett's
gross profit increased to 78.4% for the year ended December 31, 1998 compared to
73.0% for the same period in 1997, with gross profit for the premium segment at
80.2% in 1998 and 77.1% in 1997, and gross profit for the discount segment at
77.5% in 1998 and 70.8% in 1997. This increase is the result of Liggett's 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 Liggett from leaf tobacco dealers on tobacco
purchased under prior years' purchase commitments.



                                       37
<PAGE>   40


         As a percentage of revenues (excluding Russian excise taxes),
Liggett-Ducat's gross profit increased to 29.9% for the year ended December 31,
1998 compared to 20.6% for the same period in 1997. The improved gross profit
margin at Liggett-Ducat was due to higher volume and lower manufacturing costs
($3.55 per thousand units in 1998 vs. $4.36 per thousand units in 1997). The 40%
growth in unit sales volume arose, in part, following a move to a four-shift,
24-hour production cycle in the Russian factory.

         EXPENSES. Consolidated operating, selling, general and administrative
expenses were $186,904 for the year ended December 31, 1998 compared with
$162,938 for the year ended December 31, 1997. The increase in expenses of
$23,966 was largely the result of higher spending for promotional and marketing
programs ($20,106) and increased administrative expense ($6,508) at Liggett.
These costs were offset by lower pension expenses and decreases in systems
development costs at Liggett when compared with the prior year. At Brooke
(Overseas), consolidated operating, selling, general and administrative expenses
were $11,894 for the year ended December 31, 1998 compared to $9,293 for the
year ended December 31, 1997, an increase of $2,601 over the prior year due
primarily to timing of employee compensation awards of $2,014, an increase in
employee benefits and in various Russian taxes of $2,782 and increased
depreciation expense of $812. These costs were offset primarily by a decrease in
consulting fees of approximately $2,500.

         In addition, $14,928 of net charges for the Attorneys General
settlements previously accrued in 1997 and in early 1998 were reversed in 1998
as a result of the Master Settlement Agreement.

         OTHER INCOME (EXPENSE). Consolidated other expense was $106,988 for the
twelve months ended December 31, 1998 compared to overall expense of $58,327 in
1997. In 1998, interest expense increased by $17,926 due primarily to non-cash
charges for debt restructuring of approximately $10,560 at BGLS and $2,600 at
Liggett as well as an increase of approximately $3,200 at Brooke (Overseas)
caused by higher interest rates in Russia and the preference requirement on the
net income of Western Tobacco Investments.

         In 1998, sale of assets of $5,975 included $4,246 representing a
portion of the gain on the sale of the BrookeMil shares which had been deferred
due to Brooke's 42% equity ownership of New Valley. With the contribution of the
real estate assets of BrookeMil by New Valley to Western Realty Development, a
joint venture between New Valley and Apollo, Brooke recognized a portion of the
deferred gain to the extent of Apollo's interest in Western Realty Development.
In 1997, the sale of assets included recognition of $21,300 or 58% of the gain
on the sale of the BrookeMil shares.

         Equity in loss of affiliate in 1998 was $28,717 compared to a loss of
$26,646 in 1997 and represents Brooke's proportionate share of losses from
continuing operations at New Valley and a portion of New Valley's dividend
arrearages. This was partially offset by discontinued operations in which Brooke
reflected its portion of New Valley's income from discontinued operations of
$3,208 in 1998 and $1,536 in 1997.

         INCOME FROM CONTINUING OPERATIONS. The income from continuing
operations for the year ended December 31, 1998 was $24,219 compared with a loss
of $51,421 for the same period in the prior year. Brooke recognized a tax
benefit of $59,613 in 1998 as compared to a provision of $1,123 for 1997.

LIQUIDITY AND CAPITAL RESOURCES

         Net cash and cash equivalents increased $12,727 in 1999, $2,642 in 1998
and $2,813 in 1997.



                                       38
<PAGE>   41


         Net cash provided by operations in 1999 was $58,093 compared to net
cash used in operations of $3,289 in 1998 and $25,063 in 1997. The increase of
$61,382 in net cash provided by operating activities in 1999 over the prior year
was due primarily to an increase in operating income at Liggett, a reduction in
debt service resulting from Liggett's bond redemption on December 28, 1998 and
an increase in deferred taxes and non-cash expenses including certain interest
expenses, loss in joint venture and loss in equity of affiliate. In the 1998
period, cash payments included interest payments by BGLS and Liggett of
approximately $50,000. In addition, increases in inventories were partially
offset by decreases in receivables and in payables and in other long-term
liabilities.

         Net cash used in operations in 1998 was $3,289 compared to net cash
used in 1997 of $25,063, a net change of $21,774 due primarily to an increase in
operating income over the prior year, a reduction in cash interest on the BGLS
senior secured notes of $9,806, additional other non-cash interest of $1,991 and
non-cash stock based expense of $9,394 which includes legal expenses of $4,192,
charges for stock issued to the Liggett bondholders of $3,648 and other non-cash
compensation expenses of $1,554. Other non-cash expenses in 1998 include a
foreign currency translation loss of $4,294. These non-cash expenses were offset
by a decrease in deferred taxes, an increase in receivables and net liabilities
which included increasing accruals for interest charges on the BGLS notes.

         Net cash provided by investing activities of $127,968 in 1999 compares
to net cash provided of $131,327 in 1998. In 1999, the majority of the proceeds
were from the purchase of the Class A option by Philip Morris in May 1999, loan
proceeds which Trademarks borrowed and distributed to Eve and the sale of real
estate. In 1999, these proceeds were partially offset by capital expenditures
primarily for machinery and equipment at Liggett of $17,432 and equipment and
construction costs for the new factory of $42,825 at Liggett-Ducat. Other
payments made principally pertained to broker-dealer transactions and the sale
of assets at New Valley. In 1998, net cash provided by investing activities of
$131,327 was due to the payment by Philip Morris of $150,000 for options in
Trademarks, offset by capital expenditures of $21,006, primarily costs for
construction and equipment for the new Liggett-Ducat cigarette factory in
Russia.

         Net cash provided by investing activities in 1998 of $131,327 compares
to net cash provided in 1997 of $36,327 which was due principally to the sale of
the BrookeMil shares by Brooke (Overseas) for $55,000 on January 30, 1997 and
the sale of used equipment by Liggett offset by capital expenditures of $20,142,
principally for construction and equipment costs for the new Liggett-Ducat
factory.

         Net cash used in financing activities was $172,169 in 1999 as compared
with cash used in financing activities in 1998 of $124,024. Cash was used in
1999 primarily to retire the BGLS notes in principal amount of $144,794 and to
retire $35,023 of New Valley mortgage financing relating to the five shopping
centers sold in August 1999. Cash was also used in the 1999 period to decrease
the margin loan at New Valley, to purchase preferred stock in a New Valley
subsidiary and for distributions on common stock. Net borrowings under the
revolving credit facilities were $16,765, of which $19,203 is attributable to
Liggett-Ducat offset by net repayments at Liggett of $2,438. Proceeds included
$4,500 of equipment financing, a $5,000 term loan for the Mebane facility and
the effect of the New Valley recapitalization which was $9,010. Cash used in the
1998 period includes the redemption of Liggett's senior secured notes of
$144,919 and net repayments on revolving credit facilities of $14,728. These
payments were offset by the $30,000 participating loan from Western Realty
Development.

         Net cash used in financing activities in 1998 of $124,024 compares with
net cash used of $8,532 in 1997. Cash used in 1997 included the repurchase of
$7,500 principal amount of the Liggett notes, repayment of credit facilities in
Russia and repayments of Liggett's credit facility partially offset by proceeds
from credit facilities in Russia and proceeds from the credit facility at
Liggett.





                                       39
<PAGE>   42


         LIGGETT. On December 28, 1998, Liggett redeemed the entire outstanding
$144,891 principal amount of its senior secured notes at 100% of the principal
amount together with accrued interest. Proceeds of $150,000 from the purchase by
Philip Morris of two options to purchase interests in Trademarks which acquired
the three brands of Eve were used to fund the redemption.

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

         Liggett has a $35,000 credit facility, under which $0 was outstanding
at December 31, 1999. Availability under the credit facility was approximately
$26,816 based on eligible collateral at December 31, 1999. The facility is
collateralized by all inventories and receivables of Liggett. Borrowings under
the facility, whose interest is calculated at a rate equal to 1.0% above
Philadelphia National Bank's (the indirect parent of Congress Financial
Corporation, the lead lender) prime rate, bore a rate of 9.5% at December 31,
1999. The facility requires Liggett's compliance with certain financial and
other covenants including a restriction on the payment of cash dividends unless
Liggett's borrowing availability under the facility for the 30-day period prior
to the payment of the dividend, and after giving effect to the dividend, is at
least $5,000. In addition, the facility, as amended, imposes requirements with
respect to Liggett's adjusted net worth (not to fall below $8,000 as computed in
accordance with the agreement) and working capital (not to fall below a deficit
of $17,000 as computed in accordance with the agreement). At December 31, 1999,
Liggett was in compliance with all covenants under the credit facility;
Liggett's adjusted net worth was $37,597 and net working capital was $36,157, as
computed in accordance with the agreement. The facility expires on March 8, 2003
subject to automatic renewal for an additional year unless a notice of
termination is given by the lender at least 60 days prior to the anniversary
date.

         In November 1999, 100 Maple Lane LLC, a subsidiary of Liggett,
purchased an industrial facility in Mebane, North Carolina for $8.4 million.
Liggett plans to relocate its tobacco manufacturing operations to the new
facility by the end of 2000. Maple Lane borrowed $5,040 from the lender under
Liggett's credit facility. The loan is payable in 59 monthly installments of $60
including annual interest of 1% above the prime rate with a final payment of
$1,500. Liggett has guaranteed the loan, and a first mortgage on the Mebane
property collateralizes the Maple Lane loan and Liggett's credit facility.

         On March 11, 1997, Liggett sold certain surplus realty in Durham, North
Carolina to Blue Devil Ventures, a North Carolina limited liability partnership,
for a sale price of $2,200. A gain of approximately $1,600 was recognized on
this sale.

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

         Liggett (and, in certain cases, Brooke Group Holding, Brooke's
predecessor and a wholly-owned subsidiary of BGLS) and other United States
cigarette manufacturers have been named as defendants in a number of direct and
third-party actions (and purported class actions) predicated on the theory that
they should be liable for damages from cancer and other adverse health effects
alleged to have been caused by cigarette smoking or by exposure to secondary
smoke from cigarettes. Brooke believes, and has been so advised by counsel
handling the cases, that Brooke Group Holding and Liggett have a number of valid
defenses to the claims asserted against them. Litigation is subject to many
uncertainties. An unfavorable verdict has been returned in the first phase of
the ENGLE smoking and health class action trial pending in Florida. It is
possible that additional cases could be decided unfavorably and that there could
be further adverse developments in the ENGLE case. In a worst case scenario, it




                                       40
<PAGE>   43


is possible that a judgment for punitive damages could be entered in the ENGLE
case in an amount not capable of being bonded, resulting in an execution of the
judgment before it could be set aside on appeal. An unfavorable outcome of a
pending smoking and health case could encourage the commencement of additional
similar litigation. Recently, there have been a number of adverse regulatory,
political and other developments concerning cigarette smoking and the tobacco
industry. These developments generally receive widespread media attention.
Neither Brooke nor Liggett is able to evaluate the effect of these developing
matters on pending litigation or the possible commencement of additional
litigation or regulation. See Note 22 to Brooke's consolidated financial
statements.

         Management is not able to make a meaningful estimate of the amount or
range of loss that could result from an unfavorable outcome of the cases pending
against Brooke Group Holding and Liggett or the costs of defending such cases.
It is possible that Brooke's consolidated financial position, results of
operations or cash flows could be materially adversely affected by an
unfavorable outcome in any such smoking-related litigation.

         BROOKE (OVERSEAS). On January 31, 1997, Brooke (Overseas) sold its
99.1% interest in BrookeMil to New Valley for $55,000. The purchase price paid
was $21,500 in cash and a 9% promissory note of $33,500, which was paid during
1997.

         Liggett-Ducat has recently completed construction of a new cigarette
factory on the outskirts of Moscow which became operational in June 1999. The
new factory, which utilizes Western cigarette making technology and has a
capacity in excess of 40 billion units per year, produces American and
international blend cigarettes, as well as traditional Russian cigarettes.
Western Realty Development has made a $30,000 participating loan to Western
Tobacco Investments, which holds Brooke (Overseas)'s interest in Liggett-Ducat
and the new factory. In addition, Western Tobacco Investments has entered into
note agreements for equipment purchases which have a liability of approximately
$21,800 at December 31, 1999. The remaining costs for construction and equipment
for the new factory have been financed by loans from Russian banks and
approximately $12,900 of loans from Brooke (Overseas) made during the first half
of 1999.

         BGLS. During 1999, BGLS repurchased $144,794 principal amount of the
BGLS senior secured notes, together with accrued interest thereon, for a
discounted purchase price of $164,732. The purchases were made using primarily
proceeds from the Philip Morris brand transaction which closed on May 24, 1999.

         At December 31, 1999, BGLS had outstanding $88,070 principal amount of
its BGLS notes which mature on January 31, 2001. Of this amount, $52,639 carry
deferred interest. On March 2, 1998, BGLS entered into a standstill agreement
with the holders of $97,239 principal amount of its notes, who were affiliated
with Apollo, under which the Apollo holders (and any transferees) agreed to the
deferral of interest payments, commencing with the interest payment due July 31,
1997 through the interest payment due July 31, 2000. BGLS had deferred a total
of $25,435 of interest as of December 31, 1999. Interest on all of the notes for
the six-month period ended January 31, 2000 was paid in cash.

         On January 20, 2000, BGLS repurchased an additional $5,500 principal
amount of the BGLS notes, together with accrued interest, for a purchase price
of $8,456.

         CONSOLIDATED. Brooke has substantial near-term consolidated debt
service requirements, with aggregate required principal payments of
approximately $168,700 due in the years 2000 through 2002. Brooke believes that
it will continue to meet its liquidity requirements through 2000. The Brooke
senior secured notes indenture limits the amount of restricted payments BGLS is
permitted to make to Brooke during the calendar year. At December 31, 1999, the
remaining amount available through December 31, 2000 in the restricted payment
basket related to BGLS' payment of dividends to Brooke (as defined by the BGLS
notes indenture) is $22,829. Brooke expenditures (exclusive of Liggett,
Liggett-Ducat and New Valley) over the next twelve months for current operations
include cash interest expense of approximately $16,650, dividends on Brooke's



                                       41
<PAGE>   44


shares (currently at an annual rate of approximately $21,990) and corporate
expenses. Brooke anticipates funding its expenditures for current operations
with public and/or private debt and equity financing, management fees from
subsidiaries and tax sharing and other payments from Liggett or New Valley. New
Valley may acquire or seek to acquire additional operating businesses through
merger, purchase of assets, stock acquisition or other means, or to make other
investments, which may limit its ability to make such distributions.

MARKET RISK

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

         FOREIGN MARKET RISK

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

         RUSSIA. Liggett-Ducat's, Western Tobacco Investment's, BrookeMil's and
Western Realty Development's operations are conducted in Russia. The Russian
Federation continues to experience economic difficulties following the financial
crisis of August 1998. Consequently, the country's currency continues to
devalue, there is continued volatility in the debt and equity markets,
hyperinflation persists, confidence in the banking sector has yet to be restored
and there continues to be a general lack of liquidity in the economy. In
addition, laws and regulations affecting businesses operating within the Russian
Federation continue to evolve.

         The Russian Federation's return to economic stability is dependent to a
large extent on the effectiveness of the measures taken by the government,
decisions of international lending organizations, and other actions, including
regulatory and political developments, which are beyond Brooke's control.
Brooke's Russian operations of may be significantly affected by these factors
for the foreseeable future.

         DOMESTIC MARKET RISK

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

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

         EQUITY PRICE RISK. Ladenburg maintained inventories of trading
securities at December 31, 1999 with fair values of $15,707 in long positions
and $7,625 in short positions. Ladenburg performed an entity-wide analysis of
its financial instruments and assessed the related risk and materiality. Based
on this analysis, in the opinion of management the market risk associated with
the Ladenburg's financial instruments at December 31, 1999 will not have a
material adverse effect on the consolidated financial position or results of
operations of Brooke.



                                       42
<PAGE>   45


         New Valley held investment securities available for sale totaling
$48,722 at December 31, 1999. Approximately 22% of these securities represent an
investment in RJ Reynolds Tobacco Holdings and Nabisco Group Holdings, which are
defendants in numerous tobacco products-related litigation, claims and
proceedings. An adverse outcome in any of these proceedings against these
companies could have a significant effect on the value of New Valley's
investment.

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

NEW ACCOUNTING PRONOUNCEMENTS

         In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 requires that all derivative
instruments be recorded on the balance sheet at fair value. Changes in the fair
value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. Originally,
the statement had been effective for all quarters of fiscal years beginning
after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities", which postponed the adoption of
SFAS No. 133 until fiscal years beginning after June 15, 2000. Brooke has not
yet determined the impact that the adoption of SFAS 133 will have on its
earnings or statement of financial position.

YEAR 2000 COSTS

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

         BROOKE, NEW VALLEY AND LIGGETT-DUCAT. Brooke, New Valley and
Liggett-Ducat use personal computers for all transactions. All such computers
and related systems and software are less than three years old and are Year 2000
compliant. As a result, Brooke, New Valley and Liggett-Ducat are Year 2000
compliant.

         LIGGETT. Liggett is Year 2000 compliant. The focus of Liggett's Year
2000 compliance and verification efforts were directed at the implementation of
new customer service, inventory control and financial reporting systems at each
of the three regional Strategic Business Units formed as part of Liggett's
reorganization which began in January 1997. Liggett estimates that approximately
$138 of the expenditures for this reengineering effort related to Year 2000
compliance, validation and testing. In November 1998, Liggett completed a major
conversion of factory accounting, materials management and information systems
at its Durham production facility with upgrades that were successfully tested
for Year 2000 compliance. Program upgrades to Liggett's payroll system were
completed in July 1999 with parallel upgrades to the human resources system
software completed in August 1999. Enhancements to Liggett's warehouse
management finished goods inventory tracking systems were completed in October
1999.

         LADENBURG. Ladenburg is Year 2000 compliant. Ladenburg's plan addressed
external interfaces with third party computer systems necessary in the
broker-dealer industry. It also addressed internal operations software necessary
to continue operations on a daily basis. Ladenburg's Year 2000 plan cost
approximately $650. The cost was inclusive of hardware and software upgrades and
replacements as well as consulting.




                                       43
<PAGE>   46


         EXTERNAL SERVICE PROVIDERS. The modifications for Year 2000 compliance
by Brooke and its subsidiaries were completed in 1999. However, the failure of
Brooke's service providers, including Ladenburg's clearing agent, to resolve
their own processing issues in a timely manner could result in a material
financial risk. Published reports have stated that Year 2000 miscalculations
could occur throughout 2000. To date, neither Brooke nor its subsidiaries have
experienced any material disruption to their business operations.

         It is unclear whether the Russian government and other organizations
that provide significant infrastructure services in Russia have addressed the
Year 2000 problem sufficiently to mitigate potential substantial disruption to
these infrastructure services. The substantial disruption to these services
would have an adverse effect on Brooke's operations. Furthermore, the current
financial crises in Russia could affect the ability of the government and other
organizations to fund Year 2000 compliance programs. To date, Brooke is not
aware of any Year 2000 related issues reported in Russia.

         Although Brooke and its subsidiaries have confirmed that their service
providers adequately addressed Year 2000 issues, there can be no complete
assurance of success, or that interaction with other service providers will not
impair Brooke's or its subsidiaries' services.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

         Brooke 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, including any statements that may be contained in
the foregoing discussion in "Management's Discussion and Analysis of Financial
Condition and Results of Operations", in this report and in other filings with
the Securities and Exchange Commission and in its reports to stockholders, which
reflect Brooke's expectations or beliefs 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 Private Securities Reform Act, Brooke has identified under "Risk Factors" in
Item 1 above important factors that could cause actual results to differ
materially from those contained in any forward-looking statement made by or on
behalf of Brooke.

         Results actually achieved may differ materially from expected results
included in these forward-looking statements as a result of these or other
factors. Due to such uncertainties and risks, readers are cautioned not to place
undue reliance on such forward-looking statements, which speak only as of the
date on which such statements are made. Brooke does not undertake to update any
forward-looking statement that may be made from time to time by or on behalf of
Brooke.

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         Brooke's and BGLS' Consolidated Financial Statements and Notes thereto,
together with the report thereon of PricewaterhouseCoopers LLP dated March 30,
2000, are set forth beginning on page F-1 of this report.



                                       44
<PAGE>   47


ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
           AND FINANCIAL DISCLOSURE

         None.

                                    PART III

ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         This information is contained in Brooke's definitive Proxy Statement
for its 2000 Annual Meeting of Stockholders, to be filed with the SEC not later
than 120 days after the end of the registrant's fiscal year covered by this
report pursuant to Regulation 14A under the Securities Exchange Act of 1934, and
incorporated herein by reference.

ITEM 11.   EXECUTIVE COMPENSATION

         This information is contained in the Proxy Statement and incorporated
herein by reference.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         This information is contained in the Proxy Statement and incorporated
herein by reference.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         This information is contained in the Proxy Statement and incorporated
herein by reference.



                                       45
<PAGE>   48



                                     PART IV

ITEM 14.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

         (A)(1)  INDEX TO 1999 CONSOLIDATED FINANCIAL STATEMENTS:

         Brooke's and BGLS' Consolidated Financial Statements and the Notes
thereto, together with the report thereon of PricewaterhouseCoopers LLP dated
March 30, 2000, appear beginning on page F-1 of this report. Financial statement
schedules not included in this report have been omitted because they are not
applicable or the required information is shown in the Consolidated Financial
Statements or the Notes thereto.

         (A)(2)  FINANCIAL STATEMENT SCHEDULES:

Schedule II - Valuation and Qualifying Accounts ....................Page F-53

         (A)(3)  EXHIBITS

(a) The following is a list of exhibits filed herewith as part of this Annual
Report on Form 10-K:

                                INDEX OF EXHIBITS

 EXHIBIT
   NO.                                DESCRIPTION
--------------- --------------------------------------------------------------

  * 2.1         Stock Purchase Agreement dated as of January 31, 1997 among
                BrookeMil Ltd. ("BrookeMil"), Brooke (Overseas) Ltd. ("Brooke
                (Overseas)"), BGLS Inc. ("BGLS") and New Valley Corporation
                ("New Valley") (incorporated by reference to Exhibit 2.1 in New
                Valley's Form 8-K dated January 31, 1997, Commission File No.
                1-2493).

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

  * 3.1         Amended and Restated Certificate of
                Incorporation of Brooke (incorporated by reference
                to Exhibit 3.1 in Brooke's Form 10-Q for the
                quarter ended September 30, 1999).

  * 3.2         By-Laws of Brooke (incorporated by reference to
                Exhibit 3.2 in Brooke's Form 10-Q for the quarter
                ended September 30, 1999).

  * 3.3         Certificate of Incorporation of BGLS
                (incorporated by reference to Exhibit 3.3 in
                Brooke's Form 10-Q for the quarter ended September
                30, 1999).

  * 3.4         By-Laws of BGLS (incorporated by reference to
                Exhibit 3.4 in Brooke's Form 10-Q for the quarter
                ended September 30, 1999).



                                       46
<PAGE>   49
 EXHIBIT
   NO.                                DESCRIPTION
--------------- --------------------------------------------------------------

  * 4.1         Indenture, dated as of January 1, 1996, between BGLS
                and Fleet National Bank of Massachusetts ("Fleet"),
                as Trustee, relating to the "Series A Notes" and the 15.75%
                Series B Senior Secured Notes due 2001 (the "Series B
                Notes"), including the form of Series A Note and the form of
                Series B Note (the "Indenture") (incorporated by reference to
                Exhibit 4.1 in BGLS' Registration Statement on Form S-4 dated
                December 19, 1995).

  * 4.2         First Supplemental Indenture, dated as of
                September 30, 1999, to the Indenture, dated as of
                January 1, 1996, between BGLS, BGLS Holding Inc.
                and State Street Bank and Trust Company, as Trustee
                (incorporated by reference to Exhibit 4.1 in
                Brooke's Report on Form 8-K dated October 1, 1999).

  * 4.3         Pledge and Security Agreement, dated as of
                January 1, 1996, between BGLS and Fleet, as
                Trustee, under the Indenture (incorporated by reference to
                Exhibit 4.2 in BGLS' Registration Statement on Form S-4 dated
                December 19, 1995).

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

  * 4.5         Pledge and Security Agreement, dated as of
                January 1, 1996, between New Valley Holdings, Inc.
                and Fleet, as Trustee, under the Indenture (incorporated by
                reference to Exhibit 4.4 in BGLS' Registration Statement on
                Form S-4 dated December 19, 1995).

  * 4.6         Amended and Restated Standstill Agreement,
                dated as of February 9, 1999, among BGLS and AIF
                II, L.P. ("AIF II") and Artemis America Partnership
                ("AAP" and collectively, with AIF and their future
                transferees, the "Apollo Holders") (incorporated by
                reference to Exhibit 4.6 in Brooke's Form 10-K for
                the year ended December 31, 1998).

  * 4.7         Amended and Restated Limited Recourse Guarantee Agreement, dated
                as of February 9, 1999, made by Brooke (Overseas) for the
                benefit of the Apollo Holders (incorporated by reference to
                Exhibit 4.7 in Brooke's Form 10-K for the year ended December
                31, 1998).

  * 4.8         Amended and Restated Pledge Agreement, dated as of February 9,
                1999, between Brooke (Overseas) and the Apollo Holders
                (incorporated by reference to Exhibit 4.8 in Brooke's Form 10-K
                for the year ended December 31, 1998).

  * 4.9         Collateral Agency Agreement, dated as of February 9, 1999,
                between the Apollo Holders, U.S. Bank Trust National
                Association, as Collateral Agent, and Brooke (Overseas)
                (incorporated by reference to Exhibit 4.9 in Brooke's Form 10-K
                for the year ended December 31, 1998).

                                       47
<PAGE>   50
 EXHIBIT
   NO.                                DESCRIPTION
--------------- --------------------------------------------------------------

 * 4.10         Loan and Security Agreement, dated as of March
                8, 1994, between Liggett and Congress Financial
                Corporation (incorporated by reference to Exhibit
                10(xx) in Brooke's Form 10-K for the year year
                ended December 31, 1993).

 * 10.1         Corporate Services Agreement, dated as of June
                29, 1990, between Brooke and Liggett (incorporated
                by reference to Exhibit 10.10 in Liggett's
                Registration Statement on Form S-1, No. 33-47482).

 * 10.2         Corporate Services Agreement, dated June 29, 1990, between
                Brooke and Liggett (incorporated by reference to Exhibit 10.11
                in Liggett's Registration Statement on Form S-1, No. 33-47482).

 * 10.3         Services Agreement, dated as of February 26, 1991, between
                Brooke Management Inc. ("BMI") and Liggett (the "Liggett
                Services Agreement") (incorporated by reference to Exhibit 10.5
                in BGLS' Registration Statement on Form S-1, No. 33-93576).

 * 10.4         First Amendment to Liggett Services Agreement,
                dated as of November 30, 1993, between Liggett and
                BMI (incorporated by reference to Exhibit 10.6 of
                BGLS' Registration Statement on Form S-1, No.
                33-93576).

 * 10.5         Second Amendment to Liggett Services
                Agreement, dated as of October 1, 1995, between
                BMI, Brooke and Liggett (incorporated by reference
                to Exhibit 10(c) in Brooke's Form 10-Q for the
                quarter ended September 30, 1995).

 * 10.6         Corporate Services Agreement, dated January 1,
                1992, between BGLS and Liggett (incorporated by
                reference to Exhibit 10.13 of Liggett's
                Registration Statement on Form S-1, No. 33-47482).

 * 10.7         Employment Agreement, dated February 21, 1992,
                between Brooke and Bennett S. LeBow (incorporated
                by reference to Exhibit 10(xx) in Brooke's Form
                10-K for the year ended December 31, 1991).

 * 10.8         Amendment to Employment Agreement, dated as of
                July 20, 1998, between Brooke and Bennett S. LeBow
                (incorporated by reference to Exhibit 10.8 in
                Brooke's Form 10-K for the year ended December 31,
                1998).

 * 10.9         Tax-Sharing Agreement, dated June 29, 1990, among Brooke,
                Liggett and certain other entities (incorporated by reference to
                Exhibit 10.12 in Liggett's Registration Statement on Form S-1,
                No. 33-47482).

 * 10.10        Tax Indemnity Agreement, dated as of October 6, 1993, among
                Brooke, Liggett and certain other entities (incorporated by
                reference to Exhibit 10.2 in SkyBox International Inc.'s Form
                10-Q for the quarter ended September 30, 1993).

                                       48
<PAGE>   51
 EXHIBIT
   NO.                                DESCRIPTION
--------------- --------------------------------------------------------------

 * 10.11        Expense Sharing Agreement, dated as of January 18, 1995, between
                Brooke and New Valley (incorporated by reference to Exhibit
                10(d) in Brooke's Form 10-Q for the quarter ended September 30,
                1995).

 * 10.12        Stock Option Agreement, dated January 25, 1995, between Brooke
                and Howard M. Lorber (incorporated by reference to Exhibit 10(g)
                in Brooke's Form 10-K for the year ended December 31, 1994).

 * 10.13        Amended and Restated Consulting Agreement, dated as of January
                1, 1996, between Brooke and Howard M. Lorber (the "Lorber
                Consulting Agreement") (incorporated by reference to Exhibit
                10.25 in Brooke's Form 10-K for the year ended December 31,
                1995).

 * 10.14        Amendment dated January 1, 1998 to the Lorber Consulting
                Agreement (incorporated by reference to Exhibit 10.23 in
                Brooke's Form 10-K for the year ended December 31, 1997).

 * 10.15        Settlement Agreement, dated March 12, 1996, by and between
                Dianne Castano and Ernest Perry, the putative representative
                plaintiffs in Dianne Castano, et al. v. The American Tobacco
                Company, Inc. et al., Civil No. 94-1044, United States District
                Court for the Eastern District of Louisiana, for themselves and
                on behalf of the plaintiff settlement class, and Brooke Group
                Holding and Liggett, as supplemented by the letter agreement
                dated March 14, 1996 (the "Settlement Agreement") (incorporated
                by reference to Exhibit 13 in the Schedule 13D filed by, among
                others, Brooke with the SEC on March 11,1996, as amended, with
                respect to the common stock of RJR Nabisco Holdings Corp. (the
                "Schedule 13D")).

 * 10.16        Addendum to Settlement Agreement (incorporated by reference to
                Exhibit 10.30 in Brooke's Form 10-K/A No. 1 for the year
                ended December 31, 1996).

 * 10.17        Settlement Agreement, dated March 15, 1996, by and among the
                State of West Virginia, State of Florida, State of Mississippi,
                Commonwealth of Massachusetts, and State of Louisiana, Brooke
                Group Holding and Liggett (incorporated by reference to Exhibit
                15 in the Schedule 13D).

 * 10.18        Addendum to Initial States Settlement Agreement (incorporated by
                reference to Exhibit 10.43 in Brooke's Form 10-Q for the
                quarterly period ended March 31, 1997).

 * 10.19        Settlement Agreement, dated March 20, 1997, by and between the
                named and representative plaintiffs in Fletcher, et al. v.
                Brooke Group Ltd., et al., for themselves and on behalf of the
                plaintiff settlement class, and Brooke Group Holding and Liggett
                (incorporated by reference to Exhibit 10.41 in Brooke's Form
                10-K for the year ended December 31, 1996).



                                       49
<PAGE>   52
 EXHIBIT
   NO.                                DESCRIPTION
--------------- --------------------------------------------------------------

 * 10.20        Settlement Agreement, dated March 12, 1998, by and among the
                States listed in Appendix A thereto, Brooke Group Holding and
                Liggett (incorporated by reference to Exhibit 10.35 in Brooke's
                Form 10-K for the year ended December 31, 1997).

 * 10.21        Amended Settlement Agreement, dated July 2, 1998, by and between
                the named representative plaintiffs in Fletcher, et al., v.
                Liggett Group Inc., et al., for themselves and on behalf of the
                plaintiff settlement class, and Brooke Group Holding and Liggett
                (incorporated by reference to Exhibit 10.32 in Brooke's Form
                10-K for the year ended December 31, 1998).

 * 10.22        Master Settlement Agreement made by the Settling States and
                Participating Manufacturers signatories thereto (incorporated by
                reference to Exhibit 10.1 in Philip Morris Companies Inc.'s
                Report on Form 8-K dated November 25, 1998).

 * 10.23        General Liggett Replacement Agreement, dated as of November 23,
                1998, entered into by each of the Settling States under the
                Master Settlement Agreement, and Brooke Group Holding and
                Liggett (incorporated by reference to Exhibit 10.34 in Brooke's
                Form 10-K for the year ended December 31, 1998).

 * 10.24        Class Settlement Agreement, dated January 14, 1999, by and
                between the named representative plaintiffs in Iron Workers
                Union No. 17 Insurance Fund, et al., v. Philip Morris Inc., et
                al., for themselves and on behalf of the plaintiff settlement
                class, and Brooke Group Holding and Liggett (incorporated by
                reference to Exhibit 10.35 in Brooke's Form 10-K for the year
                ended December 31, 1998).

* 10. 25        Stock Option Agreement, dated December 16, 1996, between
                Brooke and Howard M. Lorber (incorporated by reference to
                Exhibit 10.34 in Brooke's Form 10-K for the year ended
                December 31,1996).

 * 10.26        Letter Agreement dated September 5, 1996 between Ronald S.
                Fulford and Liggett (incorporated by reference to Exhibit 10.23
                in Liggett's Form 10-K for the year ended December 31, 1996).

 * 10.27        Stock Option Agreement, dated January 1, 1997, between Brooke
                and Richard J. Lampen (incorporated by reference to Exhibit
                10.35 in Brooke's Form 10-K for the year ended December 31,
                1996).

 * 10.28        Stock Option Agreement, dated January 1, 1997, between
                Brooke and Marc N. Bell (incorporated by reference to
                exhibit 4.3 in the Brooke's Registration Statement on Form S-8,
                No. 333-24217).

 * 10.29        Stock Option Agreement, dated January 1, 1998, between Brooke
                and Joselynn D. Van Siclen (incorporated by reference to Exhibit
                10.43 in Brooke's Form 10-K for the year ended December 31,
                1997).

                                       50
<PAGE>   53
 EXHIBIT
   NO.                                DESCRIPTION
--------------- --------------------------------------------------------------

 * 10.30        Warrant to purchase common stock of Brooke, dated March 2, 1998,
                issued to AIF (incorporated by reference to Exhibit 10.2 in
                Brooke's Form 8-K dated March 2, 1998).

 * 10.31        Warrant to purchase common stock of Brooke, dated March 2, 1998,
                issued to AAP (incorporated by reference to Exhibit 10.3 in
                Brooke's Form 8-K dated March 2, 1998).

 * 10.32        Warrant to purchase common stock of Brooke, dated March 2, 1998,
                issued to AIF (incorporated by reference to Exhibit 10.4 in
                Brooke's Form 8-K dated March 2, 1998).

 * 10.33        Warrant to purchase common stock of Brooke, dated March 2, 1998,
                issued to AAP (incorporated by reference to Exhibit 10.5 in
                Brooke's Form 8-K dated March 2, 1998).

 * 10.34        Registration Rights Agreement, dated as of March 2, 1998, among
                Brooke and the Apollo Holders (incorporated by reference to
                Exhibit 10.6 in Brooke's Form 8-K dated March 2, 1998).

 * 10.35        Registration Rights Agreement, dated as of March 2, 1998, among
                Brooke and the Apollo Holders (incorporated by reference to
                Exhibit 10.7 in Brooke's Form 8-K dated March 2, 1998).

 * 10.36        Amended and Restated Stock Option Agreement, dated as of October
                12, 1998, by and between Brooke and Kasowitz, Benson, Torres &
                Friedman LLP, Marc E. Kasowitz and Daniel R. Benson
                (incorporated by reference to Exhibit 10.4 in Brooke's Form 10-Q
                for the quarter ended September 30, 1998).

 * 10.37        Amended and Restated Limited Liability Company Agreement
                (Second Restatement) dated as of February 20, 1998 by and among
                Western Realty Development LLC, New Valley, BrookeMil
                and Apollo Real Estate Investment Fund III, L.P. ("Apollo")
                 (incorporated by reference to Exhibit 10.1 in New
                Valley's Form 10-Q for the quarter ended June 30,
                1998).

 * 10.38        Limited Liability Company Agreement, dated as of June 18, 1998,
                by and among Western Realty Repin LLC, Apollo and New Valley
                (incorporated by reference to Exhibit 10.3 in New Valley's Form
                10-Q for the quarter ended June 30, 1998).

 * 10.39        Participating Loan Agreement, dated as of April 28, 1998, by and
                among Western Realty Development LLC, Western Tobacco
                Investments LLC and Brooke (Overseas) (incorporated by reference
                to Exhibit 10.2 in New Valley's Form 10-Q for the quarter ended
                June 30, 1998).

 * 10.40        Participating Loan Agreement, dated as of June 18, 1998, by and
                between Western Realty Repin LLC and BrookeMil (incorporated by
                reference to Exhibit 10.4 in New Valley's Form 10-Q for the
                quarter ended June 30, 1998).


                                       51
<PAGE>   54
 EXHIBIT
   NO.                                DESCRIPTION
--------------- --------------------------------------------------------------

 * 10.41        Consulting Agreement, dated as of May 1, 1998, between
                Brooke and J. Sauter Enterprises, Inc. (incorporated by
                reference to Exhibit 4.1 in Brooke's Registration Statement
                on Form S-8, No. 333-59615).

 * 10.42        Brooke Group Ltd. 1998 Long-Term Incentive Plan (incorporated
                by reference to the Appendix to Brooke's Proxy Statement
                dated September 15, 1998).

 * 10.43        Stock Option Agreement, dated July 20, 1998, between Brooke and
                Bennett S. LeBow (incorporated by reference to Exhibit 6 in the
                Amendment No. 5 to the Schedule 13D filed by Bennett S. LeBow on
                October 16, 1998 with respect to the common stock of Brooke).

 * 10.44        Stock Option Agreement, dated July 20, 1998, between Brooke and
                Howard M. Lorber (incorporated by reference to Exhibit 10.3 in
                Brooke's Form 10-Q for the quarter ended September 30, 1998).

 * 10.45        Letter Agreement, dated November 20, 1998, by and among Philip
                Morris Incorporated ("PM"), Brooke, Liggett & Myers Inc. ("L&M")
                and Liggett (incorporated by reference to Exhibit 10.1 in
                Brooke's Report on Form 8-K dated November 25, 1998).

 * 10.46        Amended and Restated Formation and Limited Liability Company
                Agreement of Trademarks LLC, dated as of May 24, 1999, among
                Brooke, L&M, Eve Holdings Inc. ("Eve"), Liggett and PM,
                including the form of Trademark License Agreement (incorporated
                by reference to Exhibit 10.4 in Brooke's Form 10-Q for the
                quarter ended June 30, 1999).

 * 10.47        Class A Option Agreement, dated as of January 12, 1999, among
                Brooke, L&M, Eve, Liggett and PM (incorporated by reference to
                Exhibit 10.61 in Brooke's Form 10-K for the year ended December
                31, 1998).

 * 10.48        Class B Option Agreement, dated as of January 12, 1999, among
                Brooke, L&M, Eve, Liggett and PM (incorporated by reference to
                Exhibit 10.62 in Brooke's Form 10-K for the year ended December
                31, 1998).

 * 10.49        Pledge Agreement dated as of May 24, 1999 from Eve, as grantor,
                in favor of Citibank, N.A., as agent (incorporated by reference
                to Exhibit 10.5 in Brooke's Form 10-Q for the quarter ended June
                30, 1999).

 * 10.50        Guaranty dated as of June 10, 1999 from Eve, as guarantor, in
                favor of Citibank, N.A., as agent (incorporated by reference to
                Exhibit 10.6 in Brooke's Form 10-Q for the quarter ended June
                30, 1999).

 * 10.51        Purchase and Sale Agreement, dated February 17, 1999, between
                BGLS and U.S. Bancorp Investments, Inc. (incorporated by
                reference to Exhibit 10.64 in Brooke's Form 10-K for the
                year ended December 31, 1998).



                                       52
<PAGE>   55

 EXHIBIT
   NO.                                DESCRIPTION
--------------- --------------------------------------------------------------

 * 10.52       Employment Agreement dated as of June 1, 1995, as amended,
                effective as of January 1, 1996, between New Valley and Bennett
                S. LeBow (incorporated by reference to Exhibit 10(b)(i) in New
                Valley's Form 10-K for the year ended December 31, 1995).

 * 10.53        Employment Agreement dated September 22, 1995, between New
                Valley and Richard J. Lampen (incorporated by reference to
                Exhibit 10(a) in New Valley's Form 10-Q for the quarter ended
                September 30, 1995).

 * 10.54        Employment Agreement dated April 15, 1994, between Brooke and
                Marc N. Bell (incorporated by reference to Exhibit 10.67 in
                Brooke's Form 10-K for the year ended December 31, 1998).

 * 10.55        Sale-Purchase Agreement, dated as of September 2, 1998, by and
                between New Valley and PW/MS OP Sub I, LLC (incorporated by
                reference to Exhibit 2.1 in New Valley's on Form 8-K dated
                September 28, 1998).

 * 10.56        Employment Agreement dated as of August 1, 1999, between Brooke
                and Joselynn D. Van Siclen (incorporated by reference to Exhibit
                10.8 in Brooke's Form 10-Q for the quarter ended June 30, 1999).

 * 10.57        Purchase Agreement, dated as of September 30, 1999, between
                BGLS Inc. and BGLS Holding Inc. (incorporated by reference
                to Exhibit 10.1 in Brooke's Form 8-K dated October 1, 1999).

   10.58        Brooke Group Ltd. 1999 Long-Term Incentive Plan.

   10.59        Stock Option Agreement, dated November 4, 1999,
                between Brooke and Bennett S. LeBow.

   10.60        Stock Option Agreement, dated November 4, 1999, between
                Brooke and Richard J. Lampen.

   10.61        Stock Option Agreement, dated November 4, 1999, between
                Brooke and Marc N. Bell.

   10.62        Stock Option Agreement, dated November 4, 1999, between
                Brooke and Joselynn D. Van Siclen.

   10.63        Stock Option Agreement, dated November 4, 1999, between
                Brooke and Howard M. Lorber.

   10.64        Stock Option Agreement, dated November 24, 1999, between
                Brooke and Ronald S. Fulford.

   21           Subsidiaries of Brooke.

   23.1         Consent of PricewaterhouseCoopers LLP relating to Brooke's
                Registration Statements on Form S-8 (No. 333-24217, No.
                333-50189 and No. 333-59615).



                                       53
<PAGE>   56
 EXHIBIT
   NO.                                DESCRIPTION
--------------- --------------------------------------------------------------

    23.2        Consent of Arthur Anderson LLP relating to Brooke's
                Registration Statements on Form S-8 (No. 333-24217, No.
                333-50189 and No. 333-59615).

    27.1        Financial Data Schedule of Brooke.

    27.2        Financial Data Schedule of BGLS.

    99.1        Material Legal Proceedings

    99.2        Liggett Group Inc.'s Consolidated Financial
                Statements for the fiscal year ended December 31,
                1999.

  * 99.3        New Valley Corporation's Consolidated
                Financial Statements for the fiscal year ended
                December 31, 1999 (incorporated by reference to New
                Valley's Form 10-K for the fiscal year ended
                December 31, 1999).

    99.4        Brooke (Overseas) Ltd.'s Consolidated Financial
                Statements for the fiscal year ended December 31,
                1999.

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

         Each management contract or compensatory plan or arrangement required
to be filed as an exhibit to this report pursuant to Item 14(c) is listed in
exhibit nos. 10.7, 10.8, 10.26, 10.27, 10.28, 10.29, 10.42, 10.43, 10.52, 10.53,
10.54, 10.56 and 10.58 through 10.64.

                  (B)     REPORTS ON FORM 8-K:

         Brooke filed the following Report on Form 8-K during the fourth quarter
of 1999:

                                                                   FINANCIAL
           DATE                              ITEMS                 STATEMENTS
           ----                              -----                 ----------

          October 1, 1999                     5, 7                    None




                                       54
<PAGE>   57


                                   SIGNATURES

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

                                  BROOKE GROUP LTD.
                                  (REGISTRANT)

                                   By:   /s/ Bennett S. LeBow
                                      -----------------------------------------
                                         Bennett S. LeBow
                                         Chairman of the Board, Chief
                                         Executive Officer and President

Date:    March 30, 2000

                                   BGLS INC.
                                   (REGISTRANT)

                                   By:   /s/ Bennett S. LeBow
                                      -----------------------------------------
                                         Bennett S. LeBow
                                         Chairman of the Board, Chief
                                         Executive Officer and President

Date:    March 30, 2000



                                       55
<PAGE>   58




                                POWER OF ATTORNEY

         The undersigned directors and officers of Brooke Group Ltd. and BGLS
Inc. hereby constitute and appoint Richard J. Lampen, Joselynn D. Van Siclen and
Marc N. Bell, and each of them, with full power to act without the other and
with full power of substitution and resubstitutions, our true and lawful
attorneys-in-fact with full power to execute in our name and behalf in the
capacities indicated below, this Annual Report on Form 10-K and any and all
amendments thereto and to file the same, with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
and hereby ratify and confirm all that such attorneys-in-fact, or any of them,
or their substitutes shall lawfully do or cause to be done by virtue hereof.

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 30, 2000.
<TABLE>
<CAPTION>

            SIGNATURE                                                TITLE
            ---------                                                -----
<S>                                                    <C>
         /s/  Bennett S. LeBow
         ---------------------------------------
         Bennett S. LeBow                               Chairman of the Board, President
                                                        and Chief Executive Officer
                                                        (Principal Executive Officer)

         /s/  Joselynn D. Van Siclen
         ---------------------------------------
         Joselynn D. Van Siclen                         Vice President and Chief
                                                        Financial Officer
                                                        (Principal Financial Officer and
                                                        Principal Accounting Officer)

         /s/  Robert J. Eide
         ---------------------------------------
         Robert J. Eide                                 Director

         /s/  Jeffrey S. Podell
         ---------------------------------------
         Jeffrey S. Podell                              Director

         /s/  Jean E. Sharpe
         ---------------------------------------
         Jean E. Sharpe                                 Director


</TABLE>

                                       56
<PAGE>   59

                                BROOKE GROUP LTD.
                                    BGLS INC.

                 FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999
                      ITEMS 8, 14(a) (1) AND (2), AND 14(d)

                          INDEX TO FINANCIAL STATEMENTS
                        AND FINANCIAL STATEMENT SCHEDULE

         Financial Statements and Schedule of the Registrant and its
subsidiaries required to be included in Items 8, 14(a) (1) and (2), and 14(d)
are listed below:
<TABLE>
<CAPTION>

                                                                                                   PAGE
                                                                                                   ----
<S>                                                                                                   <C>
   FINANCIAL STATEMENTS:

        BROOKE GROUP LTD./BGLS INC. CONSOLIDATED FINANCIAL STATEMENTS

        Report of Independent Certified Public Accountants.................................         F-2
        Brooke Group Ltd. Consolidated Balance Sheets as of December 31, 1999 and 1998              F-3
        BGLS Inc. Consolidated Balance Sheets as of December 31, 1999 and 1998.............         F-4
        Brooke Group Ltd. Consolidated Statements of Operations for the years ended
            December 31, 1999, 1998 and 1997...............................................         F-5
        BGLS Inc. Consolidated Statements of Operations for the years ended
            December 31, 1999, 1998 and 1997...............................................         F-6
        Brooke Group Ltd. Consolidated Statements of Stockholders' Equity (Deficit) for the
            years ended December 31, 1999, 1998 and 1997...................................         F-7
        BGLS Inc. Consolidated Statements of Stockholder's Equity (Deficit) for the years
            ended December 31, 1999, 1998 and 1997.........................................         F-8
        Brooke Group Ltd. Consolidated Statements of Cash Flows for the years ended
            December 31, 1999, 1998 and 1997...............................................         F-9
        BGLS Inc. Consolidated Statements of Cash Flows for the years ended
            December 31, 1999, 1998 and 1997...............................................        F-10
        Notes to Consolidated Financial Statements.........................................        F-11

   FINANCIAL STATEMENT SCHEDULE:

        Schedule II -- Valuation and Qualifying Accounts...................................        F-52

        Financial Statement Schedules not listed above have been omitted because
        they are not applicable or the required information is contained in
        Brooke's Consolidated Financial Statements or accompanying Notes.

        THINKING MACHINES CORPORATION

        Report of Independent Public Accountants.................................                  F-53

</TABLE>


        LIGGETT GROUP INC.

        The consolidated financial statements of Liggett Group Inc. are filed as
        exhibit 99.2 to this report and are incorporated herein by reference.

        NEW VALLEY CORPORATION

        The consolidated financial statements of New Valley Corporation are
        filed as exhibit 99.3 to this report and are incorporated herein by
        reference.

        BROOKE (OVERSEAS) LTD.

        The consolidated financial statements of Brooke (Overseas) Ltd. are
        filed as exhibit 99.4 to this report and are incorporated herein by
        reference.



                                      F-1
<PAGE>   60






               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders
of Brooke Group Ltd. and BGLS Inc.

In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) of this Form 10-K present fairly, in all material
respects, the financial position of Brooke Group Ltd. and its subsidiaries and
BGLS Inc. and its subsidiaries, (collectively the "Company") at December 31,
1999 and 1998, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States. In addition, in
our opinion, the financial statement schedule listed in the index appearing
under Item 14 (a) (2) of this Form 10-K presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

/s/ PricewaterhouseCoopers LLP

Miami, Florida
March 30, 2000



                                      F-2
<PAGE>   61



                       BROOKE GROUP LTD. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS

                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                                       DECEMBER 31,      DECEMBER 31,
                                                                                           1999              1998
                                                                                      ---------------- -----------------
<S>                                                                                     <C>             <C>
ASSETS:

Current assets:
  Cash and cash equivalents....................................................         $  20,123       $    7,396
  Receivables from clearing brokers............................................            10,903
  Investment securities available for sale.....................................            48,722
  Trading securities owned.....................................................            15,707
  Accounts receivable - trade..................................................            19,658           15,160
  Other receivables............................................................             1,290              924
  Inventories..................................................................            45,205           36,316
  Restricted assets............................................................             3,239
  Deferred income taxes........................................................            21,374           59,613
  Other current assets.........................................................             2,511            3,151
                                                                                        ---------        ---------
    Total current assets.......................................................           188,732          122,560

Property, plant and equipment, net.............................................           154,260           93,504
Investment in real estate, net.................................................            53,353
Long-term investments, net.....................................................             8,731
Investment in joint venture....................................................            38,378
Restricted assets..............................................................             5,195
Deferred income taxes..........................................................            45,631
Other assets...................................................................            10,168           12,918
                                                                                         --------         --------
    Total assets...............................................................          $504,448         $228,982
                                                                                          =======          =======

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):

Current liabilities:
  Current portion of notes payable and long-term debt..........................         $  41,547        $  21,176
  Margin loan payable..........................................................               983
  Accounts payable.............................................................            36,456           13,880
  Cash overdraft...............................................................                                 77
  Securities sold, not yet purchased...........................................             7,625
  Accrued promotional expenses.................................................            22,473           23,760
  Accrued taxes payable........................................................            42,408           14,854
  Deferred income taxes........................................................             2,274
  Accrued interest.............................................................             8,488           17,189
  Proceeds received for options................................................                            150,000
  Prepetition claims and restructuring accruals................................            12,279
  Other accrued liabilities....................................................            52,121           32,505
                                                                                         --------         --------
    Total current liabilities..................................................           226,654          273,441

Notes payable, long-term debt and other obligations, less current portion......           148,349          262,665

Noncurrent employee benefits...................................................            23,264           21,701
Deferred income taxes..........................................................           117,285
Other liabilities..............................................................            76,628           65,350
Minority interests.............................................................            45,366

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

Stockholders' equity (deficit):
  Preferred stock, par value $1.00 per share, authorized 10,000,000 shares.....
  Common stock, par value $0.10 per share, authorized 100,000,000
    shares, issued 27,822,779 shares, outstanding 21,989,782...................             2,199            2,094
  Additional paid-in capital...................................................           196,695          124,120
  Deficit......................................................................          (302,155)        (512,182)
  Accumulated other comprehensive income.......................................             1,379           24,774
  Other........................................................................            (3,743)          (5,508)
  Less:  5,832,997 shares of common stock in treasury, at cost.................           (27,473)         (27,473)
                                                                                         --------         --------
      Total stockholders' equity (deficit).....................................          (133,098)        (394,175)
                                                                                          -------          -------

      Total liabilities and stockholders' equity (deficit).....................          $504,448         $228,982
                                                                                          =======          =======

</TABLE>

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


                                      F-3
<PAGE>   62


                           BGLS INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS

                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>

                                                                                       DECEMBER 31,       DECEMBER 31,
                                                                                           1999               1998
                                                                                      ---------------- -------------------
<S>                                                                                      <C>             <C>
ASSETS:

Current assets:
  Cash and cash equivalents.....................................................         $  19,590       $    7,396
  Receivables from clearing brokers.............................................            10,903
  Investment securities available for sale......................................            48,722
  Trading securities owned......................................................            15,707
  Accounts receivable - trade...................................................            19,658           15,160
  Other receivables.............................................................             1,237              755
  Inventories...................................................................            45,205           36,316
  Restricted assets.............................................................             3,239
  Deferred income taxes.........................................................            21,374           59,613
  Other current assets..........................................................             2,350            2,946
                                                                                         ---------        ---------
      Total current assets......................................................           187,985          122,186

Property, plant and equipment, net..............................................           154,246           93,481
Investment in real estate, net..................................................            53,353
Long-term investments, net......................................................             8,731
Investment in joint venture.....................................................            38,378
Restricted assets...............................................................             5,195
Deferred income taxes...........................................................            45,631
Other assets....................................................................             9,002           11,729
                                                                                          --------         --------
      Total assets..............................................................          $502,521         $227,396
                                                                                           =======          =======

LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT):

Current liabilities:
  Current portion of notes payable and long-term debt...........................         $  41,333      $    20,955
  Margin loan payable...........................................................               983
  Accounts payable..............................................................            36,236           13,746
  Cash overdraft................................................................                                 63
  Securities sold, not yet purchased............................................             7,625
  Due to parent.................................................................                             32,394
  Accrued promotional expenses..................................................            22,473           23,760
  Accrued taxes payable.........................................................            42,408           14,854
  Deferred income taxes.........................................................             2,274
  Accrued interest..............................................................             8,488           17,188
  Proceeds received for options.................................................                            150,000
  Pre-petition claims and restructuring accruals................................            12,279
Other accrued liabilities.......................................................            50,254           31,556
                                                                                          --------         --------
      Total current liabilities.................................................           224,353          304,516

Notes payable, long-term debt and other obligations, less current portion.......           148,349          262,665

Noncurrent employee benefits....................................................            23,264           21,701
Deferred income taxes...........................................................           117,285
Other liabilities...............................................................            76,360           69,216
Minority interests..............................................................            45,366

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

Stockholder's equity (deficit):
  Common stock, par value $0.01 per share; 100 shares authorized, issued and
    outstanding.................................................................

  Additional paid-in capital....................................................           161,800           69,297
  Deficit.......................................................................          (295,635)        (524,773)
  Accumulated other comprehensive income........................................             1,379           24,774
                                                                                           -------          -------
      Total stockholder's equity (deficit)......................................          (132,456)        (430,702)
                                                                                           -------          -------

      Total liabilities and stockholder's equity (deficit)......................          $502,521         $227,396
                                                                                           =======          =======
</TABLE>


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




                                      F-4
<PAGE>   63


                       BROOKE GROUP LTD. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS

                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>

                                                                           YEAR ENDED DECEMBER 31,
                                                               --------------------------------------------------
                                                                   1999              1998             1997
                                                               --------------- ----------------- ----------------
<S>                                                                <C>              <C>               <C>
Revenues:
    Tobacco* ..............................................      $    522,807       $    444,566       $    389,615
    Broker-dealer transactions ............................            40,852
    Real estate leasing ...................................             3,386
                                                                 ------------       ------------       ------------
      Total revenues ......................................           567,045            444,566            389,615

Expenses:

    Cost of goods sold* ...................................           189,865            200,996            202,121
    Operating, selling, administrative and general expenses           306,228            186,904            162,938
    Settlement charges ....................................            (1,051)           (14,928)            16,527
                                                                 ------------       ------------       ------------
      Operating income ....................................            72,003             71,594              8,029

Other income (expenses):
    Interest and dividend income ..........................             2,840              1,169                553
    Interest expense ......................................           (54,378)           (79,704)           (61,778)
    Equity in loss of affiliate ...........................           (11,315)           (28,717)           (26,646)
    Recognition of deferred gain on sale of assets ........             7,050
    Loss in joint venture .................................           (12,082)
    Gain on sale of investments, net ......................               741
    Sale of assets ........................................            12,172              5,975             23,086
    Gain on brand transaction .............................           294,078
    Other, net ............................................             1,966             (5,711)             6,458
                                                                 ------------       ------------       ------------
Income (loss) from continuing operations before provision
      (benefit) for income taxes and minority interests ...           313,075            (35,394)           (50,298)
    Provision (benefit) for income taxes ..................            82,458            (59,613)             1,123
    Minority interests ....................................             5,467
                                                                 ------------       ------------       ------------
Income (loss) from continuing operations ..................           236,084             24,219            (51,421)
                                                                 ------------       ------------       ------------
Gain on disposal of discontinued operations ...............             1,249              3,208              1,536

Loss on extraordinary items.............. .................            (1,660)
                                                                 ------------       ------------       ------------
Net income (loss) .........................................      $    235,673       $     27,427       $    (49,885)
                                                                 ============       ============       ============
Per basic common share:
    Income (loss) from continuing operations ..............      $      10.74       $       1.13       $      (2.70)
                                                                 ============       ============       ============
    Gain from discontinued operations .....................      $       0.06       $       0.15       $       0.08
                                                                 ============       ============       ============
    Loss from extraordinary items .........................      $      (0.08)
                                                                 ============
    Net income (loss) applicable to common shares .........      $      10.72       $       1.28       $      (2.62)
                                                                 ============       ============       ============

Basic weighted average common shares outstanding ..........        21,989,782         21,446,255         19,076,745
                                                                 ============       ============       ============


Per diluted common share:
    Income (loss) from continuing operations ..............      $       8.81       $       0.93       $      (2.70)
                                                                 ============       ============       ============
    Gain from discontinued operations .....................      $       0.05       $       0.12       $       0.08
                                                                 ============       ============       ============
    Loss from extraordinary items .........................      $      (0.06)
                                                                 ============
    Net income (loss) applicable to common shares .........      $       8.80       $       1.05       $      (2.62)
                                                                 ============       ============       ============

Diluted weighted average common shares outstanding ........        26,811,273         26,034,912         19,076,745
                                                                 ============       ============       ============

</TABLE>

-----------
*  Revenues and Cost of goods sold include excise taxes of $66,698, $82,613 and
   $87,683 for ended the years ended December 31, 1999, 1998 and 1997,
   respectively.



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






                                      F-5
<PAGE>   64


                           BGLS INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS

                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>

                                                                 ------------------------------------------------
                                                                             YEAR ENDED DECEMBER 31,
                                                                 ------------- ----------------- ----------------
                                                                      1999              1998             1997
                                                                 ------------- ----------------- ----------------
<S>                                                                   <C>              <C>               <C>
Revenues:
    Tobacco* ......................................................      $ 522,807       $ 444,566       $ 389,615
    Broker dealer transactions ....................................         40,852
    Real estate leasing ...........................................          3,386
                                                                         ---------       ---------       ---------
      Total revenues ..............................................        567,045         444,566         389,615

Expenses:
    Cost of goods sold* ...........................................        189,865         200,996         202,121
    Operating, selling, administrative and general expenses .......        304,017         183,970         162,548
    Settlement charges ............................................         (1,051)        (14,928)         16,527
                                                                         ---------       ---------       ---------
      Operating income ............................................         74,214          74,528           8,419

Other income (expenses):
    Interest and dividend income ..................................          2,840           1,025             543
    Interest expense ..............................................        (57,910)        (84,194)        (65,581)
    Equity in loss of affiliate ...................................        (11,315)        (28,717)        (26,646)
    Recognition of deferred gain on sale of assets ................          8,264
    Loss in joint venture .........................................        (12,082)
    Gain on sale of investments, net ..............................            741
    Sale of assets ................................................         12,172           5,981          27,663
    Gain on brand transaction .....................................        294,078
    Other, net ....................................................          1,922          (5,878)          2,326
                                                                         ---------       ---------       ---------

Income (loss) from continuing operations before provision (benefit)
      for income taxes and minority interests .....................        312,924         (37,255)        (53,276)
    Provision (benefit) for income taxes ..........................         82,458         (59,613)          1,135
    Minority interests ............................................          5,467
                                                                         ---------       ---------       ---------
Income (loss) from continuing operations ..........................        235,933          22,358         (54,411)
                                                                         ---------       ---------       ---------
Gain on disposal of discontinued operations .......................          1,249           3,208           1,536
Loss on extraordinary items........................................         (1,660)
                                                                         ---------       ---------       ---------
Net income (loss) .................................................      $ 235,522       $  25,566       $ (52,875)
                                                                         =========       =========       =========
</TABLE>


-----------------
*  Revenues and Cost of goods sold include excise taxes of $66,698, $82,613 and
   $87,683 for the years ended December 31, 1999, 1998 and 1997, respectively.


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





                                      F-6
<PAGE>   65


                       BROOKE GROUP LTD. AND SUBSIDIARIES
            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>


                                                                                                           ACCUMULATED
                                                                   ADDITIONAL                                 OTHER
                                           COMMON STOCK             PAID-IN          TREASURY             COMPREHENSIVE
                                        SHARES      AMOUNT    CAPITAL    DEFICIT       STOCK       OTHER      INCOME       TOTAL
                                      ----------   -------   --------   ---------    ---------    ------- -------------  ---------

<S>                                   <C>          <C>       <C>         <C>         <C>          <C>        <C>          <C>
Balance, December 31, 1996......      18,497,096   $ 1,850   $ 94,169   $(490,706)   $ (32,339)   $(5,061)   $(22,902)   $(454,989)
                                      ----------   -------   --------   ---------    ---------    -------    --------    ---------
Net loss........................                                          (49,885)                                         (49,885)
  Unrealized holding gain
    on investment in New Valley.                                                                                16,842      16,842
  Effect of New Valley capital
     transactions...............                                                                                 3,190       3,190
  Pension-related minimum
     liability adjustment.......                                                                                 1,013       1,013
                                                                                                                         ---------
    Total other comprehensive
      income....................                                                                                            21,045
                                                                                                                         ---------
Total comprehensive loss........                                                                                           (28,840)
                                                                                                                         ---------
Distributions on common stock...                               (5,504)                                                      (5,504)
Amortization of deferred
  compensation..................                                                                    1,311                    1,311
Stock options granted to
  consultant....................                                 (375)                                                        (375)
Settlement of loan..............        (400,000)                           1,800       (1,800)
                                      ----------   -------   --------   ---------    ---------    -------    --------    ---------
Balance, December 31, 1997......      18,097,096     1,850     88,290    (538,791)     (34,139)    (3,750)     (1,857)    (488,397)
Net income......................                                                        27,427                              27,427
  Unrealized holding gain on
    investment in New Valley....                                                                               30,902       30,902
  Effect of New Valley capital
    transactions................                                                                               (3,383)      (3,383)
  Pension-related minimum
    liability adjustment........                                                                                 (888)        (888)
                                                                                                                         ---------
    Total other comprehensive
     income.....................                                                                                            26,631
                                                                                                                         ---------
Total comprehensive income......                                                                                            54,058
                                                                                                                         ---------
Distributions on common stock...                               (6,123)                                                      (6,123)
Effectiveness fee on debt.......         483,002        48      1,666                    2,391                               4,105
Issuance of options and
  warrants......................                               28,086                              (3,261)                  24,825
Issuance of common stock........       1,500,000       150     11,342                                                       11,492
Issuance of treasury stock......         863,632        46        319        (818)       4,275                               3,822
Amortization of deferred
  compensation..................                                  540                               1,503                    2,043
                                      ----------   -------   --------   ---------    ---------    -------    --------    ---------
Balance, December 31, 1998......      20,943,730     2,094    124,120    (512,182)     (27,473)    (5,508)     24,774     (394,175)
Net income......................                                          235,673                                          235,673
  Unrealized gains on investment
    securities..................                                                                                  565          565
  Other New Valley capital
    transactions................                                                                                  342          342
  Effect of New Valley
    recapitalization on other
    comprehensive loss..........                                                                              (24,647)     (24,647)
  Pension-related minimum
    liability adjustment........                                                                                  345          345
                                                                                                                         ---------
      Total other comprehensive
       loss....................                                                                                            (23,395)
                                                                                                                         ---------
Total comprehensive income.....                                                                                            212,278
                                                                                                                         ---------
Effect of stock dividend.......        1,046,052       105     25,541     (25,646)
Recapitalization of New Valley.                                58,390                                                       58,390
New Valley purchase of
 preferred stock in subsidiary.                                   850                                                          850
Distributions on common stock..                               (13,945)                                                     (13,945)
Amortization of deferred
 compensation..................                                 1,739                               1,765                    3,504
                                      ----------   -------   --------   ---------    ---------    -------    --------    ---------
Balance, December 31, 1999.....       21,989,782   $ 2,199   $196,695   $(302,155)   $ (27,473)   $(3,743)   $  1,379    $(133,098)
                                      ==========   =======   ========   =========    =========    =======    ========    =========
</TABLE>

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




                                      F-7
<PAGE>   66


                           BGLS INC. AND SUBSIDIARIES
            CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)

                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                       ----------------------------------------------------------------------------
                                                                                                         ACCUMULATED
                                                                             ADDITIONAL                     OTHER
                                                           COMMON STOCK        PAID-IN                  COMPREHENSIVE
                                                        SHARES     AMOUNT      CAPITAL       DEFICIT        INCOME          TOTAL
                                                       ----------------------------------------------------------------------------
<S>                                                        <C>   <C>          <C>          <C>            <C>            <C>
Balance, December 31, 1996...........................      100   $            $ 39,081     $(499,264)     $(22,902)      $(483,085)

Net loss.............................................                                        (52,875)                      (52,875)
  Unrealized holding gain on investment in New Valley                                                       16,842          16,842
  Effect of New Valley capital transactions..........                                                        3,190           3,190
  Pension-related minimum liability adjustment.......                                                        1,013           1,013
                                                                                                                         ---------
    Total other comprehensive income.................                                                                       21,045
                                                                                                                         ---------
Total comprehensive loss.............................                                                                      (31,830)
                                                                                                                         ---------
Settlement of loan...................................                                         1,800                         1,800
                                                           ---   ---------    -------      --------       --------       ---------
Balance, December 31, 1997...........................      100                 39,081      (550,339)        (1,857)       (513,115)

Net income...........................................                                        25,566                        25,566
  Unrealized holding gain on investment in New Valley                                                       30,902          30,902
  Effect of New Valley capital transactions..........                                                       (3,383)         (3,383)
  Pension-related minimum liability adjustment.......                                                         (888)           (888)
                                                                                                                         ---------
    Total other comprehensive income.................                                                                       26,631
                                                                                                                         ---------
Total comprehensive income...........................                                                                       52,197
                                                                                                                         ---------
Issuance of options and warrants.....................                           24,825                                      24,825
Effectiveness fee on debt............................                            2,442                                       2,442
Payment of interest by parent........................                            2,531                                       2,531
Amortization of deferred compensation................                              418                                         418
                                                           ---   ---------    --------      --------      --------       ---------
Balance, December 31, 1998...........................      100                  69,297      (524,773)       24,774        (430,702)

Net income...........................................                                        235,522                       235,522
  Unrealized gain on investment securities...........                                                          565             565
  Other New Valley capital transactions..............                                                          342             342
  Effect of New Valley recapitalization on other
    comprehensive loss...............................                                                      (24,647)        (24,647)
  Pension-related minimum liability adjustment.......                                                          345             345
                                                                                                                         ---------
      Total other comprehensive loss.................                                                                      (23,395)
                                                                                                                         ---------
Total comprehensive income...........................                                                                      212,127
                                                                                                                         ---------
Capital contribution.................................                           31,323         3,252                        34,575
Recapitalization of New Valley.......................                           58,390                                      58,390
Distributions to parent..............................                                         (9,636)                       (9,636)
New Valley purchase of preferred stock in subsidiary.                              850                                         850
Amortization of deferred compensation................                            1,940                                       1,940
                                                           ---   ---------    --------     ---------      --------       ---------
Balance, December 31, 1999...........................      100   $            $161,800     $(295,635)     $  1,379       $(132,456)
                                                           ===   =========    ========     =========      ========       =========
</TABLE>

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



                                      F-8
<PAGE>   67


                       BROOKE GROUP LTD. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                             --------------------------------------------------
                                                                                          YEAR ENDED DECEMBER 31,
                                                                             --------------------------------------------------
                                                                                  1999             1998             1997
                                                                             ---------------- ---------------- ----------------
<S>                                                                              <C>             <C>              <C>
Cash flows from operating activities:
  Net income (loss).....................................................         $235,673        $  27,427        $ (49,885)
                                                                                ---------        ---------        ---------
  Adjustments to reconcile net income (loss) to net cash provided by
    (used in) operating activities:
      Depreciation and amortization.....................................            7,672            8,610            8,135
      Non-cash stock-based expense......................................            5,360            9,394            1,311
      Gain on brand transaction........................................          (294,078)
      Gain on sale of assets............................................             (260)          (5,003)         (26,247)
      Deferred income taxes.............................................          102,172          (59,613)
      Currency translation (gain) loss..................................           (1,352)           4,294              (81)
      Gain on sale of securities........................................          (21,103)
      Non-cash interest expense.........................................           21,612           11,797
      Impact of discontinued operations.................................           (1,708)          (3,208)          (1,536)
      Loss in joint venture.............................................           12,082
      Minority interests................................................           (5,467)
      Equity in loss of affiliates......................................            8,981           28,717           26,646
  Changes in assets and liabilities (net of effect of
  recapitalization and dispositions):
      Receivables.......................................................            1,590           (3,782)           8,839
      Due from clearing broker..........................................            5,237
      Inventories.......................................................           (9,589)           2,997           14,379
      Accounts payable and accrued liabilities..........................          (11,905)          (5,496)           7,585
      Securities sold but not yet purchased.............................            4,671
      Deferred gain.....................................................           (5,331)                           (6,459)
      Other assets and liabilities, net.................................            3,836          (19,423)          (7,750)
                                                                                ---------        ---------        ---------
Net cash provided by (used in) operating activities.....................           58,093           (3,289)         (25,063)
                                                                                ---------        ---------        ---------
Cash flows from investing activities:
  Proceeds from sale of businesses and assets, net......................              932            2,333           56,494
  Proceeds from brand transaction.......................................          145,000          150,000
  Sale or maturity of investment securities.............................            5,422
  Purchase of investment securities.....................................           (8,585)                              (25)
  Purchase of long-term investments.....................................           (3,606)
  Proceeds from sale of real estate, net................................           46,867
  Sale of preferred stock in subsidiary, net............................            3,434
  Payment of prepetition claims.........................................              (85)
  Capital expenditures..................................................          (61,411)         (21,006)         (20,142)
                                                                                ---------        ---------        ---------
Net cash provided by investing activities...............................          127,968          131,327           36,327
                                                                                ---------        ---------        ---------
Cash flows from financing activities:
  Proceeds from debt....................................................           16,585            4,425           10,305
  Repayments of debt....................................................         (195,354)        (146,701)         (11,516)
  Borrowings under revolver.............................................          375,394          282,004          278,442
  Repayments on revolver................................................         (358,629)        (296,731)        (279,435)
  Effect of New Valley recapitalization.................................            8,874
  Decrease in margin loan payable.......................................           (5,017)
  (Decrease) increase in cash overdraft.................................              (77)            (868)             938
  Distributions on common stock.........................................          (13,945)          (6,123)          (7,266)
  Proceeds from participating loan......................................                            30,000
  Issuance of common stock..............................................                             9,970
                                                                                ---------        ---------        ---------
Net cash used in financing activities...................................         (172,169)        (124,024)          (8,532)
                                                                                ---------        ---------        ---------
Effect of exchange rate changes on cash and cash equivalents............           (1,165)          (1,372)              81
                                                                                ---------        ---------      -----------
Net increase in cash and cash equivalents...............................           12,727            2,642            2,813
Cash and cash equivalents, beginning of year............................            7,396            4,754            1,941
                                                                                ---------        ---------        ---------
Cash and cash equivalents, end of year..................................        $  20,123       $    7,396       $    4,754
                                                                                =========        =========        =========
</TABLE>
                   The accompanying notes are an integral part
                    of the consolidated financial statements.




                                      F-9
<PAGE>   68


                           BGLS INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>

                                                                             --------------------------------------------------
                                                                                          YEAR ENDED DECEMBER 31,
                                                                             --------------------------------------------------
                                                                                  1999             1998             1997
                                                                             ---------------- ---------------- ----------------
<S>                                                                          <C>              <C>              <C>
Cash flows from operating activities:
  Net income (loss).....................................................     $235,522         $  25,566        $ (52,875)
                                                                             ---------        ---------       ---------
  Adjustments to reconcile net income (loss) to net cash provided by
    (used in) operating activities:
      Depreciation and amortization.....................................        7,663             8,524            7,993
      Non-cash stock-based expense......................................        4,176             8,878
      Gain on brand transaction........................................      (294,078)
      Gain on sale of assets............................................         (260)           (5,733)         (26,247)
      Deferred income taxes.............................................      102,172           (59,613)
      Currency translation (gain) loss..................................       (1,352)            4,294              (81)
      Gain on sale of securities........................................      (21,103)
      Non-cash interest expense.........................................       21,612            11,797
      Impact of discontinued operations.................................       (1,708)           (3,208)          (1,536)
      Loss in joint venture.............................................       12,082
      Minority interests................................................       (5,467)
      Equity in loss of affiliates......................................        8,981            28,717           26,646
  Changes in assets and liabilities (net of effect of recapitalization
  and dispositions):
      Receivables.......................................................         (165)            6,613            8,838
      Due from clearing broker..........................................        5,237
      Inventories.......................................................       (9,589)            2,997           14,379
      Accounts payable and accrued liabilities..........................      (12,122)           (6,017)           1,245
      Securities sold but not yet purchased.............................        4,671
      Deferred gain.....................................................       (6,545)                            (3,511)
      Other assets and liabilities, net.................................        2,986           (21,218)          (8,207)
                                                                             ---------        ---------       ---------
Net cash provided by (used in) operating activities.....................       52,713             1,597          (33,356)
                                                                             ---------        ---------       ---------
Cash flows from investing activities:
  Proceeds from sale of businesses and assets, net......................          932             1,609           56,494
  Proceeds from brand transaction.......................................      145,000           150,000
  Sale or maturity of investment securities.............................        5,422
  Purchase of investment securities.....................................       (8,585)                               (25)
  Purchase of long-term investments.....................................       (3,606)
  Proceeds from sale of real estate, net................................       46,867
  Sale of preferred stock in subsidiary, net............................        3,434
  Payment of prepetition claims.........................................          (85)
  Capital expenditures..................................................      (61,411)          (20,980)         (20,142)
                                                                             ---------        ---------       ---------
Net cash provided by investing activities...............................      127,968           130,629           36,327
                                                                             ---------        ---------       ---------
Cash flows from financing activities:
  Proceeds from debt....................................................       16,642             3,950          10,305
  Repayments of debt....................................................     (194,887)         (146,606)        (10,436)
  Borrowings under revolver.............................................      375,394           282,004         278,442
  Repayments on revolver................................................     (358,629)         (296,732)       (279,434)
  Effect of New Valley recapitalization.................................        8,874
  Decrease in margin loan payable.......................................       (5,017)
  (Decrease) increase in cash overdraft.................................          (63)             (828)            885
  Distributions paid to parent..........................................       (9,636)
  Proceeds from participating loan......................................                         30,000
                                                                             ---------        ---------       ---------
Net cash used in financing activities...................................     (167,322)         (128,212)           (238)
                                                                             ---------        ---------       ---------
Effect of exchange rate changes on cash and cash equivalents............        (1,165)          (1,372)             81
                                                                             ---------        ---------       ---------
Net increase in cash and cash equivalents...............................        12,194            2,642           2,814
Cash and cash equivalents, beginning of year............................         7,396            4,754           1,940
                                                                             ---------        ---------       ---------
Cash and cash equivalents, end of year..................................     $  19,590        $   7,396       $   4,754
                                                                             =========        =========       =========
</TABLE>

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




                                      F-10
<PAGE>   69



                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      (a)  BASIS OF PRESENTATION:

           The consolidated financial statements of Brooke Group Ltd. (the
           "Company" or "Brooke") include the consolidated financial statements
           of its wholly-owned subsidiary, BGLS Inc. ("BGLS"). The consolidated
           financial statements of BGLS include the accounts of Liggett Group
           Inc. ("Liggett"), Brooke (Overseas) Ltd. ("Brooke (Overseas)"),
           Liggett-Ducat Ltd. ("Liggett-Ducat") and other less significant
           subsidiaries. As of June 1, 1999, New Valley Corporation ("New
           Valley") became a consolidated subsidiary of the Company as a result
           of New Valley's recapitalization in which the Company's interest in
           New Valley's common shares increased to 55.1%. (See Note 3.) All
           significant intercompany balances and transactions have been
           eliminated. Certain amounts in prior years' consolidated financial
           statements have been reclassified to conform to the current year's
           presentation.

           Liggett is engaged primarily in the manufacture and sale of
           cigarettes, principally in the United States. Liggett-Ducat is
           engaged in the manufacture and sale of cigarettes in Russia. New
           Valley is engaged primarily in the investment banking and brokerage
           business through its ownership of Ladenburg Thalmann & Co. Inc., in
           the real estate development business in Russia and in investment in
           Internet-related businesses.

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

       (b) LIQUIDITY:

           The Company's anticipated sources of liquidity for 2000 include,
           among other things, additional debt and/or equity financing,
           management fees, tax sharing and other payments from Liggett and
           certain funds available from New Valley subject to limitations
           imposed by BGLS' indenture agreements. Liggett's and New Valley's
           ability to make such payments is subject to risks and uncertainties
           attendant to their businesses. (Refer to Notes 3 and 5.) New Valley
           may also acquire or seek to acquire additional operating businesses
           through merger, purchase of assets, stock acquisition or other
           means, or to make other investments, which may limit its ability to
           make such distributions. In 1999, the Company used proceeds from
           cash received from the Philip Morris brand transaction, primarily to
           repurchase $141,794 principal amount of the BGLS 15.75% Series B
           Senior Secured Notes together with accrued interest thereon. The
           principal amount of the BGLS Notes outstanding is currently $82,570,
           including $50,100 principal amount of the BGLS Notes which were held
           by holders who have agreed to defer payment of interest. The BGLS
           Notes, together with all deferred and accrued interest, mature on
           January 31, 2001. (Refer to Notes 2 and 13.)


       (c) RISKS AND UNCERTAINTIES:

           The Russian Federation continues to experience economic difficulties
           following the financial crisis of August 1998. Consequently, the
           country's currency continues to devalue, there is continued
           volatility in the debt and equity market, hyperinflation persists,
           confidence in the banking sector has yet to be restored and there
           continues to be a general lack of liquidity in the economy. In
           addition, laws and regulations affecting businesses operating within
           the Russian Federation continue to evolve.

           The Russian Federation's return to economic stability is dependent to
           a large extent on the effectiveness of the measures taken by the
           government, decisions of international lending organizations, and
           other actions, including regulatory and political developments, which
           are beyond the Company's control.


                                      F-11
<PAGE>   70
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


           The Company's assets and operations could be at risk if there are any
           further significant adverse changes in the political and business
           environment. Management is unable to predict what effect those
           uncertainties might have on the future financial position of the
           Company. No adjustments related to these uncertainties have been
           included in the accompanying consolidated financial statements.

       (d) 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, 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 deferred tax
           assets, allowance for doubtful accounts, promotional accruals, sales
           returns and allowances, actuarial assumptions of pension plans and
           litigation and defense costs. Actual results could differ from those
           estimates.

      (e)  CASH AND CASH EQUIVALENTS:

           For purposes of the statements of cash flows, cash includes cash on
           hand, cash on deposit in banks and cash equivalents, comprised of
           short-term investments which have an original maturity of 90 days or
           less. Interest on short-term investments is recognized when earned.

      (f)  FINANCIAL INSTRUMENTS:

           Investments in securities and securities sold, not yet purchased
           traded on a national securities exchange or listed on NASDAQ are
           valued at the last reported sales prices of the reporting period.
           Futures contracts are valued at their last reported sales price.
           Investments in securities, principally warrants, which have exercise
           or holding period restrictions, are valued at fair value as
           determined by management based on the intrinsic value of the warrants
           discounted for such restrictions. The carrying value of cash and
           cash equivalents, restricted assets, receivables from clearing
           brokers and short-term loans are reasonable estimates of their
           fair value.

           The estimated fair value of the Company's long-term debt is as
           follows:

                                 DECEMBER 31,1999           DECEMBER 31, 1998
                              --------------------         --------------------
                              CARRYING        FAIR         CARRYING       FAIR
                               AMOUNT         VALUE         AMOUNT        VALUE
                              --------        -----        --------       -----

           Long-term debt    $189,896      $184,494       $283,841      $267,679

           The carrying amounts of short-term debt reported in the Consolidated
           Balance Sheets are a reasonable estimate of fair value. The fair
           value of long-term debt is estimated based on current market
           quotations, where available, or based on an evaluation of the debt in
           relation to market prices of the Company's publicly traded debt.

           The methods and assumptions used by the Company's management in
           estimating fair values for financial instruments presented herein are
           not necessarily indicative of the amounts the



                                      F-12
<PAGE>   71
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      Company could realize in a current market exchange. The use of different
      market assumptions and/or estimation methodologies may have a material
      effect on the estimated fair values.

(g)   INVESTMENT SECURITIES:

      The Company classifies investments in debt and marketable equity
      securities as either trading, available for sale, or held to maturity.
      Trading securities are carried at fair value, with unrealized gains and
      losses included in income. Investments classified as available for sale
      are carried at fair value, with net unrealized gains and losses included
      as a separate component of stockholders' equity (deficit). Debt securities
      classified as held to maturity are carried at amortized cost. The cost of
      securities sold is determined based on average cost.

(h)   SIGNIFICANT CONCENTRATIONS OF CREDIT RISK:

      Financial instruments which potentially subject the Company to
      concentrations of credit risk consist principally of cash and cash
      equivalents and trade receivables. The Company places its temporary cash
      in money market securities (investment grade or better) with what
      management believes are high credit quality financial institutions.

      Liggett's customers are primarily candy and tobacco distributors, the
      military and large grocery, drug and convenience store chains. One
      customer accounted for approximately 30.7% of Liggett's net sales in 1999,
      26.9% of its net sales in 1998 and 19.4% of its net sales in 1997. Sales
      to this customer were primarily in the private label discount segment.
      Concentrations of credit risk with respect to trade receivables are
      limited due to the large number of customers, located primarily throughout
      the United States, comprising Liggett's customer base. Ongoing credit
      evaluations of customers' financial condition are performed and,
      generally, no collateral is required. Liggett maintains reserves for
      potential credit losses and such losses, in the aggregate, have generally
      not exceeded management's expectations.

      Liggett-Ducat sells its products primarily to companies in the wholesale
      distribution and retail industries in the Russian Federation. Four
      distributors accounted for approximately 40% of sales in 1999, three
      distributors accounted for approximately 54% of sales in 1998 and two
      distributors accounted for approximately 47% in 1997. Prepayment for goods
      and services is a customary business practice in Russia, and Liggett-Ducat
      receives payment in advance for the majority of its sales. Although
      Liggett-Ducat does not require collateral and, as a consequence, is
      exposed to credit risk, Liggett-Ducat does perform ongoing credit
      evaluations of its customers and believes that its trade accounts
      receivable risk exposure is limited.

 (i)  ACCOUNTS RECEIVABLE:

      The allowance for doubtful accounts and cash discounts was $1,002 and
      $2,007 at December 31, 1999 and 1998, respectively.

 (j)  INVENTORIES:

      Domestic tobacco inventories, which comprised 60.0% and 71.5% of total
      inventory in 1999 and 1998, respectively, are stated at the lower of cost
      or market and are determined primarily by the last-in, first-out (LIFO)
      method. All other inventories are determined primarily on a first-in,


                                      F-13
<PAGE>   72
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      first-out (FIFO) basis. Although portions of leaf tobacco inventories may
      not be used or sold within one year because of the time required for
      aging, they are included in current assets, which is common practice in
      the industry. It is not practicable to determine the amount that will not
      be used or sold within one year.

(k)   RESTRICTED ASSETS:

      Restricted assets at December 31, 1999 consisted primarily of $5,147
      pledged as collateral for a $5,000 letter of credit which is used as
      collateral for a long-term lease of commercial office space.

(l)   PROPERTY, PLANT AND EQUIPMENT:

      Property, plant and equipment are depreciated using the straight-line
      method over the estimated useful lives of the respective assets, which are
      20 to 25 years for buildings and 3 to 10 years for machinery and
      equipment.

      Interest costs are capitalized in connection with the construction of
      major facilities. Capitalized interest is recorded as part of the asset to
      which it relates and is amortized over the asset's estimated useful life.
      In 1999, 1998 and 1997, interest costs of $3,287, $761 and $693,
      respectively, were capitalized.

      Expenditures for repairs and maintenance are charged to expense as
      incurred. The costs of major renewals and betterments are capitalized. The
      cost and related accumulated depreciation of property, plant and equipment
      are removed from the accounts upon retirement or other disposition and any
      resulting gain or loss is reflected in operations.

 (m)  INTANGIBLE ASSETS:

      Intangible assets, consisting principally of trademarks and goodwill, are
      amortized using the straight-line method over 10-12 years. Amortization
      expense for the years ended December 31, 1999, 1998 and 1997 was $73,
      $2,473 and $1,845, respectively. Management periodically reviews the
      carrying value of such assets to determine whether asset values are
      impaired.

 (n)  IMPAIRMENT OF LONG-LIVED ASSETS:

      Impairment losses on long-lived assets are recognized when expected future
      cash flows are less than the assets' carrying value. Accordingly, when
      indicators of impairment are present, the Company evaluates the carrying
      value of property, plant and equipment and intangibles in relation to the
      operating performance and estimates of future cash flows of the underlying
      business.

 (o)  SECURITIES SOLD, NOT YET PURCHASED:

      Securities sold, not yet purchased represent obligations of the Company to
      deliver a specified security at a contracted price and thereby create a
      liability to repurchase the security in the market at prevailing prices.
      Accordingly, these transactions involve, to varying degrees, elements of
      market risk, as the Company's ultimate obligation to satisfy the sale of
      securities sold, not yet purchased may exceed the amount recognized in the
      consolidated balance sheets.



                                      F-14
<PAGE>   73
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


 (p)  EMPLOYEE BENEFITS:

      Liggett sponsors self-insured health and dental insurance plans for all
      eligible employees. As a result, the expense recorded for such benefits
      involves an estimate of unpaid claims as of December 31, 1999, 1998 and
      1997 which are subject to significant fluctuations in the near term.

 (q) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS:

      The cost of providing retiree health care and life insurance benefits is
      actuarially determined and accrued over the service period of the active
      employee group.

 (r)  STOCK OPTIONS:

      The Company measures compensation expense for stock-based employee
      compensation plans using the intrinsic value method and provides pro forma
      disclosures of net income as if the fair value-based method had been
      applied in measuring compensation expense.

 (s)  INCOME TAXES:

      Deferred taxes reflect the impact of temporary differences between the
      amounts of assets and liabilities recognized for financial reporting
      purposes and the amounts recognized for tax purposes as well as tax credit
      carryforwards and loss carryforwards. These deferred taxes are measured by
      applying currently enacted tax rates. A valuation allowance reduces
      deferred tax assets when it is deemed more likely than not that some
      portion or all of the deferred tax assets will not be realized.

 (t)  REVENUE RECOGNITION:

      SALES: Revenues from sales are recognized upon the shipment of finished
      goods to customers. The Company provides an allowance for expected sales
      returns, net of related inventory cost recoveries. Since the Company's
      primary line of business is tobacco, the Company's financial position and
      its results of operations and cash flows have been and could continue to
      be materially adversely affected by significant unit sales volume
      declines, litigation and defense costs, increased tobacco costs or
      reductions in the selling price of cigarettes in the near term.

      REAL ESTATE LEASING REVENUES: The real estate properties are being leased
      to tenants under operating leases. Base rental revenue is generally
      recognized on a straight-line basis over the term of the lease. The lease
      agreements for certain properties contain provisions which provide for
      reimbursement of real estate taxes and operating expenses over base year
      amounts, and in certain cases as fixed increases in rent. In addition, the
      lease agreements for certain tenants provide additional rentals based upon
      revenues in excess of base amounts, and such amounts are accrued as
      earned.



                                      F-15
<PAGE>   74
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      (u)  ADVERTISING AND PROMOTIONAL COSTS:

           Advertising and promotional costs are expensed as incurred.
           Advertising and promotional expenses were $69,079, $44,540 and
           $40,534 for the years ended December 31, 1999, 1998 and 1997,
           respectively.

      (v)  LEGAL COSTS:

           The Company's policy is to accrue legal and other costs related to
           contingencies as services are performed.

      (w)  EARNINGS PER SHARE:

           Information concerning the Company's common stock has been adjusted
           to give effect to the 5% stock dividend paid to Company stockholders
           on September 30, 1999. The dividend was charged to retained earnings
           in the net amount of $25,646, which was based on the fair value of
           the Company's common stock. In connection with the 5% dividend, the
           Company increased the number of warrants and stock options by 5% and
           reduced the exercise prices accordingly. All share amounts have been
           presented as if the stock dividend had occurred on January 1, 1997.

           Basic net income (loss) per share is computed by dividing net income
           (loss) by the weighted-average number of shares outstanding. Diluted
           net income per share includes the dilutive effect of stock options,
           vested restricted stock grants and warrants. Basic and diluted EPS
           were calculated using the following for the years ended December 31,
           1999, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                    1999             1998             1997
                                                                    ----             ----             ----

       <S>                                                       <C>               <C>              <C>
           Weighted average shares for basic EPS.........        21,989,782        21,446,255       19,076,745

           Plus incremental shares from conversions:

               Stock options and warrants................         4,821,491         4,588,657
                                                                -----------       -----------      -----------

           Weighted average shares for diluted EPS.......        26,811,273        26,034,912       19,076,745
                                                                 ==========        ==========       ==========
</TABLE>

           In 1997, options on 2,018,100 shares of common stock were not
           included in the calculation of weighted average shares for diluted
           EPS because the effects would have been antidilutive.

      (x)  FOREIGN CURRENCY TRANSLATION:

           The Company's Russian subsidiaries operate in a highly inflationary
           economy and use the U.S. dollar as the functional currency.
           Therefore, certain assets of this entity (principally inventories and
           property and equipment) are translated at historical exchange rates
           with all other assets and liabilities translated at year end exchange
           rates and all translation adjustments being reflected in the
           consolidated statements of operations.



                                      F-16
<PAGE>   75
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      (y)  OTHER COMPREHENSIVE INCOME (LOSS):

           Other comprehensive income is a component of stockholders' equity and
           includes such items as the Company's proportionate interest in New
           Valley's capital transactions, unrealized gains and losses on
           investment securities and minimum pension liability adjustments.

2.    PHILIP MORRIS BRAND TRANSACTION

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

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

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

      The Class B option entitles Philip Morris to purchase the Class B interest
      for $139,900. The Class B option will be exercisable during the 90-day
      period beginning on December 2, 2008, with Philip Morris being entitled to
      extend the 90-day period for up to an additional six months under certain
      circumstances. The Class B interest will also be redeemable by Trademarks
      for $139,900 during the same period the Class B option may be exercised.

      On May 24, 1999, Trademarks borrowed $134,900 from a lending institution.
      The loan is guaranteed by Eve and collateralized by a pledge by Trademarks
      of the three brands and Trademarks' interest in the trademark license
      agreement (discussed below) and by a pledge by Eve of its Class B
      interest. In connection with the closing of the Class A option, Trademarks
      distributed the loan proceeds to Eve as the holder of the Class B
      interest. The cash exercise price of the Class B option and Trademarks'
      redemption price were reduced by the amount distributed to Eve. Upon
      Philip Morris' exercise of the Class B option or Trademarks' exercise of
      its redemption right, Philip Morris or Trademarks, as relevant, will be
      required to obtain Eve's release from its guaranty. The Class B interest
      will be entitled to a guaranteed payment of $500 each year with the Class
      A interest allocated all remaining income or loss of Trademarks. The
      proceeds of the loan and the exercise of the Class A option were used to
      retire a portion of BGLS' 15.75% Senior Secured Notes. (Refer to Note 13.)

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

      If Philip Morris fails to exercise the Class B option, Eve will have an
      option to put its Class B interest to Philip Morris, or Philip Morris'



                                      F-17
<PAGE>   76
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      designees, at a put price that is $5,000 less than the exercise price of
      the Class B option (and includes Philip Morris' obtaining Eve's release
      from its loan guarantee). The Eve put option is exercisable at any time
      during the 90-day period beginning March 2, 2010.

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

      The $150,000 in proceeds received from the sale of the Class A and B
      options was presented as a liability on the consolidated balance sheet
      until the closing of the exercise of the Class A option and the
      distribution of the loan proceeds on May 24, 1999. Upon closing, Philip
      Morris obtained control of Trademarks, and the Company recognized a
      pre-tax gain of $294,078 in its consolidated financial statements to the
      extent of the total cash proceeds received from the payment of the option
      fees, the exercise of the Class A option and the distribution of the loan
      proceeds.

3.    NEW VALLEY CORPORATION

      Until May 31, 1999, the Company was an equity investor in New Valley. The
      Class A Senior Preferred Shares and the Class B Preferred Shares of New
      Valley that the Company owned were accounted for as debt and equity
      securities, respectively, pursuant to the requirements of SFAS No. 115,
      "Accounting for Certain Investments in Debt and Equity Securities", and
      were classified as available for sale. The Common Shares were accounted
      for pursuant to APB No. 18, "The Equity Method of Accounting for
      Investments in Common Stock".

      Summarized financial information for New Valley as of and for the periods
      ended May 31, 1999 and December 31, 1998 and 1997 when the Company was an
      equity investor follows:

<TABLE>
<CAPTION>
                                                                  MAY 31,       DECEMBER 31,     DECEMBER 31,
                                                                    1999            1998             1997
                                                                ------------- ----------------- ----------------
<S>                                                                 <C>            <C>               <C>
Current assets, primarily cash and marketable securities..      $   81,625       $  91,451
Noncurrent assets.........................................         183,254         181,271
Current liabilities.......................................          73,847          83,581
Noncurrent liabilities....................................          83,476          78,251
Redeemable preferred stock................................         343,435         316,202
Stockholders' equity (deficit)............................        (235,879)       (205,312)

Revenues..................................................          39,452         102,087          $114,568
Costs and expenses........................................          50,659         127,499           139,989
Loss from continuing operations...........................         (10,668)        (23,329)          (24,260)
Income from discontinued operations.......................           4,100           7,740             3,687
Net loss applicable to Common Shares(A)...................         (44,327)        (96,553)          (89,048)

Company's share of discontinued operations................           1,708           3,208             1,536
</TABLE>

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

      The Company's and BGLS' investment in New Valley at May 31, 1999 and
December 31, 1998 is summarized below:



                                      F-18
<PAGE>   77
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



                                        NUMBER OF       FAIR          CARRYING
      MAY 31, 1999                       SHARES         VALUE          AMOUNT
      ------------                      ---------       -----         --------

       Class A Preferred Shares.......      618,326     $57,504        $ 57,504
       Class B Preferred Shares.......      250,885       1,129           1,129
       Common Shares..................    3,989,710       2,494         (58,633)
                                                        -------          ------
                                                        $61,127        $
                                                        =======          ======

      DECEMBER 31, 1998
      -----------------

       Class A Preferred Shares.......      618,326     $61,833        $ 61,833
       Class B Preferred Shares.......      250,885       1,693           1,693
       Common Shares..................    3,989,710       1,870         (63,526)
                                                        -------          ------
                                                        $65,396         $
                                                        =======          ======

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

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

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

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

      The recapitalization had a significant effect on the Company's financial
      position and results of operations. The recapitalization resulted in the
      elimination of the existing redeemable preferred shares of New Valley and
      the on-going dividend accruals thereon, as well as the redemption
      obligation for the Series A Senior Preferred Shares in January 2003. The
      Company's ownership of the Common Shares of New Valley increased from
      42.3% to 55.1%, and its total voting power increased from 42.3% to 55.1%.
      As a result of the increase in ownership, New Valley became a consolidated
      subsidiary of the Company as of June 1, 1999. In addition, the Company's
      equity in New Valley increased by $59,263 which, presented net of tax, is
      $38,331. At December 31, 1999, the Company owned 55.4% of New Valley's
      Common Shares.

      BROOKEMIL LTD. In connection with the sale by Brooke (Overseas) of the
      common shares of BrookeMil to New Valley in 1997, a portion of the gain
      was deferred in recognition of the fact that the Company retained an
      interest in BrookeMil through its 42% equity ownership of New Valley prior
      to recapitalization and that a portion of the property sold (the site of
      the third phase of the Ducat Place real estate project being developed by
      BrookeMil, which was used by Liggett-Ducat for its cigarette factory
      operation) was subject to a put option held by New Valley. The option
      expired when Liggett-Ducat ceased factory operations at the site in March
      1999. (Refer to Note 6).



                                      F-19
<PAGE>   78
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



4.    PRO FORMA EFFECTS OF BRAND AND NEW VALLEY TRANSACTIONS

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

 <TABLE>
<CAPTION>

                                                 YEAR ENDED            YEAR ENDED
                                               DECEMBER 31, 1999    DECEMBER 31, 1998
                                           ----------------------- -------------------

      <S>                                          <C>                   <C>
      Revenues...........................          $581,490              $462,235
                                                   ========              ========

      Operating income...................          $ 54,466              $ 24,135
                                                   ========              ========

      Income from continuing operations..          $ 15,519              $  7,447
                                                   ========              ========

      Net income.........................          $ 16,189              $ 11,712
                                                   ========              ========

      Net income per common share:
          Basic..........................          $   0.74              $   0.55
                                                   ========              ========
          Diluted........................          $   0.60              $   0.45
                                                   ========              ========
</TABLE>

5.    INVESTMENT IN WESTERN REALTY

      WESTERN REALTY DEVELOPMENT LLC. In February 1998, New Valley and Apollo
      Real Estate Investment Fund III, L.P. ("Apollo") organized Western Realty
      Development LLC ("Western Realty Development") to make real estate and
      other investments in Russia. New Valley agreed to contribute the real
      estate assets of BrookeMil, including Ducat Place II and the site for
      Ducat Place III, to Western Realty Development and Apollo agreed to
      contribute up to $65,900, including the $25,900 investment in Western
      Realty Repin discussed below.

      The ownership and voting interests in Western Realty Development are held
      equally by Apollo and New Valley. Apollo will be entitled to a preference
      on distributions of cash from Western Realty Development to the extent of
      its investment commitment of $40,000, of which $39,606 had been funded
      through December 31, 1999, together with a 15% annual rate of return. New
      Valley will then be entitled to a return of $20,000 of BrookeMil-related
      expenses incurred and cash invested by New Valley since March 1, 1997,
      together with a 15% annual rate of return. Subsequent distributions will
      be made 70% to New Valley and 30% to Apollo. Western Realty Development is
      managed by a Board of Managers consisting of an equal number of
      representatives chosen by Apollo and New Valley. Material corporate
      transactions by Western Realty Development generally require the unanimous
      consent of the Board of Managers. Accordingly, New Valley accounts for its
      non-controlling interest in Western Realty Development using the equity
      method of accounting.

      In March 2000, Apollo and New Valley each agreed to increase its capital
      commitment to Western Realty Development by $3,750. Management believes
      that this additional funding commitment will be sufficient to support
      Western Realty Development's expected cash flow needs over the next 12
      months.



                                      F-20
<PAGE>   79
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



      New Valley recorded its basis in the investment in Western Realty
      Development in the amount of $60,169 based on the carrying value of assets
      less liabilities transferred. There was no difference between the carrying
      value of the investment and New Valley's proportionate interest in the
      underlying value of net assets of Western Realty Development. New Valley
      recognizes losses incurred by Western Realty Development to the extent
      that cumulative earnings of Western Realty Development are not sufficient
      to satisfy Apollo's preferred return.

      Summarized financial information as of December 31, 1999 and for the year
      ended December 31, 1999 for Western Realty Development follows:

                                                    DECEMBER 31, 1999
                                                    -----------------

       Current assets.......................            $  3,557
       Participating loan receivable........              37,849
       Real estate, net.....................              77,988
       Furniture and fixtures, net..........                 249
       Other noncurrent assets..............                 320
       Goodwill, net........................                 722
       Notes payable - current..............               6,445
       Other current liabilities............               7,067
       Notes payable - long-term............               8,211
       Other long-term liabilities..........                 752
       Members' equity......................              98,210

                                                        YEAR ENDED
                                                    DECEMBER 31, 1999
                                                    -----------------

       Revenues.............................             $11,537
       Costs and expenses...................              15,708
       Real estate impairment charge........              11,561
       Other income.........................               5,858
       Net loss.............................              (9,874)

      In 1999, Western Realty Development determined a permanent impairment had
      occurred related to difficulties within the Russian economy following the
      financial crisis of August 1998. Based on an appraisal conducted by an
      independent third party, Western Realty Development recorded an impairment
      charge for the year ended December 31, 1999 of $11,561 associated with its
      investment in the site for the proposed Ducat Place III office building
      and related goodwill. The fair market value was determined based on
      current market conditions and anticipated discounted future cash flows.
      Management has concluded that the site for the proposed Ducat Place III
      office building had a fair value of $16,000 at December 31, 1999.

      In 1998, Western Realty Development made a $30,000 participating loan to,
      and payable out of a 30% profits interest in, Western Tobacco Investments
      LLC ("Western Tobacco Investments"), which holds Brooke (Overseas')
      interests in Liggett-Ducat and its new factory. The loan bears no fixed
      interest and is payable only out of 30% of distributions made by Western
      Tobacco Investments to Brooke (Overseas). After prior payment of debt
      service on loans to finance the construction of the new factory, 30% of
      distributions from Western Tobacco Investments to Brooke (Overseas) will



                                      F-21
<PAGE>   80
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      be applied first to pay the principal of the loan and then as contingent
      participating interest on the loan. In addition, Western Realty
      Development is entitled to receive a 15% annual rate of return on amounts
      advanced on the loan under certain circumstances in the event of a sale or
      refinancing of Western Tobacco Investments or the new factory. Any rights
      of repayment on the loan are subordinate to the rights of all other
      creditors of BrookeMil. Western Tobacco Investments has recognized net
      interest expense of $5,858 in 1999, which represents a 15% cumulative
      adjustment to realizable value on the loan and 30% of any net expense
      applicable to common interests in Western Tobacco Investments. The loan is
      classified in other long-term liabilities on the consolidated balance
      sheet at December 31, 1999.

      WESTERN REALTY REPIN LLC. In June 1998, New Valley and Apollo organized
      Western Realty Repin to make a loan to BrookeMil. The proceeds of the loan
      will be used by BrookeMil for the acquisition and preliminary development
      of the Kremlin sites, two adjoining sites totaling 10.25 acres located in
      Moscow across the Moscow River from the Kremlin. BrookeMil is planning the
      development of a hotel, office, retail and residential complex on the
      Kremlin sites. BrookeMil owned 95.9% of one site and 100% of the other
      site at December 31, 1999. Apollo will be entitled to a preference on
      distributions of cash from Western Realty Repin to the extent of its
      investment of $25,875 together with a 20% annual rate of return, and New
      Valley will then be entitled to a return of its investment of $10,525,
      together with a 20% annual rate of return. Subsequent distributions will
      be made 50% to New Valley and 50% to Apollo. Western Realty Repin is
      managed by a board of managers consisting of an equal number of
      representatives chosen by Apollo and New Valley. Material corporate
      transactions by Western Realty Repin will generally require the unanimous
      consent of the board of managers.

      Through December 31, 1999, Western Realty Repin has advanced $36,400, of
      which $25,875 was funded by Apollo under the loan. The loan bears no fixed
      interest and is payable only out of 100% of the distributions by the
      entities owning the Kremlin sites to BrookeMil. Such distributions will be
      applied first to pay the principal of the loan and then as contingent
      participating interest on the loan. Any rights of payment on the loan are
      subordinate to the rights of all other creditors of BrookeMil. BrookeMil
      used a portion of the proceeds of the loan to repay New Valley for certain
      expenditures on the Kremlin sites previously incurred. The loan is due and
      payable upon the dissolution of BrookeMil and is collateralized by a
      pledge of New Valley's shares of BrookeMil.

      As of December 31, 1999, BrookeMil had invested $32,003 in the Kremlin
      sites and held approximately $929 in cash and $1,418 in receivables from
      an affiliate, both of which were restricted for future investment in the
      Kremlin sites. In acquiring its interest in one of the Kremlin sites,
      BrookeMil agreed with the City of Moscow to invest an additional $22,000
      by May 2000 in the development of the property. Failure to make the
      required investment could result in forfeiture of 34.8% interest in the
      site.

      The development of Ducat Place III and the Kremlin sites will require
      significant amounts of debt and other financing. New Valley is considering
      potential financing alternatives on behalf of Western Realty Development
      and BrookeMil. However, in light of the recent economic turmoil in Russia,
      there is a risk that financing will not be available on acceptable terms.
      Failure to obtain sufficient capital for the projects would force Western
      Realty Development and BrookeMil to curtail or delay the planned
      development of Ducat Place III and the Kremlin sites.



                                      F-22
<PAGE>   81
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


6.    INVESTMENT IN BROOKE (OVERSEAS) LTD.

      At December 31, 1999, Brooke (Overseas) owned approximately 99.9% of the
      stock of Liggett-Ducat through its subsidiary, Western Tobacco
      Investments. (Refer to Note 13 for information concerning pledges of
      interests in Western Tobacco Investments.)

      Liggett-Ducat completed construction of a new cigarette factory on the
      outskirts of Moscow and began production in June 1999. Production at
      Liggett-Ducat's old factory ceased in March 1999.

      On January 31, 1997, Brooke (Overseas) sold all its shares of BrookeMil to
      New Valley for $21,500 in cash and a $33,500 9% note. The note was paid in
      full as of December 31, 1997. The consideration received exceeded the
      carrying value of its investment in BrookeMil by $43,700. The Company
      recognized a gain on the sale in 1997 in the amount of $21,300. The
      remaining $22,400 was deferred in recognition of the fact that the Company
      then retained an interest in BrookeMil through its then 42% equity
      ownership in New Valley and that a portion of the property sold (the site
      of the third phase of the Ducat Place real estate project being developed
      by BrookeMil) was subject to a put option held by New Valley. The option
      expired when Liggett-Ducat operations at the factory ceased in March 1999.
      The Company recognized that portion of the deferred gain, $7,050, in March
      1999.

      During the second quarter 1997, BrookeMil sold one of its office
      buildings, Ducat Place I, to a third party. Accordingly, the Company
      recognized $1,240 of its deferred gain. As discussed in Note 5, in 1998,
      New Valley contributed the BrookeMil real estate assets to Western Realty
      Development and the Company recognized a further portion of the deferred
      gain, $4,246, to the extent of Apollo's interest in Western Realty
      Development.

7.    INVESTMENT SECURITIES AVAILABLE FOR SALE

      Investment securities classified as available for sale are carried at fair
      value, with net unrealized gains or losses included as a component of
      accumulated other comprehensive income. Investment securities available
      for sale totaling $48,722 at December 31, 1999 are comprised of marketable
      equity securities and warrants of $47,659 and notes receivable of $1,063.

8.    INVENTORIES

      Inventories consist of:

                                                            DECEMBER 31,
                                                         1999          1998
                                                         ----          ----

      Leaf tobacco.................................    $13,599       $13,882
      Other raw materials..........................      6,423         4,629
      Work-in-process..............................      3,542         2,001
      Finished goods...............................     20,662        15,446
      Replacement parts and supplies...............      4,795         4,130
                                                       -------       -------
      Inventories at current cost..................     49,021        40,088
      LIFO adjustments.............................     (3,816)       (3,772)
                                                       -------       -------
                                                       $45,205       $36,316
                                                       =======       =======



                                      F-23
<PAGE>   82
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



      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. At December 31, 1999, Liggett and
      Liggett-Ducat had leaf tobacco purchase commitments of approximately
      $3,679 and $45,311, respectively.

9.    PROPERTY, PLANT AND EQUIPMENT

      Property, plant and equipment consist of:

                                                                DECEMBER 31,
                                                             1999          1998
                                                             ----          ----

      Land and improvements........................      $    415    $     412
      Buildings....................................        51,773        5,823
      Machinery and equipment......................       129,693       54,144
      Construction-in-progress.....................        14,605       66,981
                                                         --------       ------
                                                          196,486      127,360

      Less accumulated depreciation................       (42,226)     (33,856)
                                                         --------       ------
                                                         $154,260     $ 93,504
                                                          =======       =======

      Depreciation expense for the years ended December 31, 1999, 1998 and 1997
      was $7,069, $4,123 and $4,513, respectively. Capitalized interest included
      in property, plant and equipment was $3,287 and $761 in 1999 and 1998,
      respectively.

10.   INVESTMENT IN REAL ESTATE

      The components of the Company's investment in real estate at December 31,
      1999 are as follows:
<TABLE>
<CAPTION>

                                                       RUSSIAN
                                                         REAL            SHOPPING
                                                        ESTATE           CENTERS          TOTAL
                                                        ------           ----------       -----

     <S>                                                 <C>              <C>            <C>
     Land                                                $32,003          $  4,542       $36,545
     Buildings...............................                               19,053        19,053
                                                         -------            ------        ------
           Total.............................             32,003            23,595        55,598
     Less accumulated depreciation...........                               (2,245)       (2,245)
                                                         -------           -------       -------
           Net investment in real estate.....            $32,003           $21,350       $53,353
                                                          ======            ======        ======

</TABLE>


11.   SALE OF ASSETS

      On December 23, 1999, New Valley completed the sale of a 19.9% interest in
      its subsidiary Ladenburg, Thalmann & Co. Inc. ("Ladenburg") to Berliner
      Effektengesellschaft AG ("Berliner"). New Valley received $10,200 in cash
      and Berliner shares valued in accordance with the purchase agreement.



                                      F-24
<PAGE>   83
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      Pursuant to the agreement, Berliner also acquired a three-year option to
      purchase additional interests in Ladenburg subject to certain conditions.
      In connection with this transaction, New Valley recorded a gain of $4,256
      for the year ended December 31, 1999.

      On August 30, 1999, New Valley completed the sale of five of its shopping
      centers for an aggregate purchase price of $46,125 before closing
      adjustments and expenses. The shopping centers were subject to
      approximately $35,023 of mortgage financing, which was assumed by the
      purchasers at closing. In connection with the transaction, New Valley
      recorded a gain of $3,849 for the year ended December 31, 1999.

      In June 1999, Thinking Machines, New Valley's 73% owned subsidiary, sold
      substantially all of its assets, consisting of its Darwin(R) software and
      services business, to Oracle Corporation. The purchase price was $4,700 in
      cash at the closing of the sale and up to an additional $20,300, payable
      in cash on January 31 in each of the years 2001 through 2003, based on
      sales by Oracle of Darwin product above specified sales targets. New
      Valley recorded a gain of $3,801 in connection with the sale. The
      operations and related gain associated with Thinking Machines have not
      been classified as discontinued operations based on the fact that
      substantial revenues were not realized from the Darwin(R) product.

      At the closing of the Oracle sale, $4,136 of loans, including interest,
      were repaid by Thinking Machines to New Valley and New Valley offered to
      purchase all of Thinking Machines' outstanding preferred stock for $1,950.
      Approximately 77% of Thinking Machines' preferred stockholders tendered
      their stock to New Valley in the third quarter of 1999.

      On January 31, 1997, Brooke (Overseas) sold BrookeMil to New Valley for
      $21,500 in cash and a promissory note of $33,500 which was paid in 1997.
      (Refer to Note 6.)

      On March 11, 1997, Liggett sold to Blue Devil Ventures, a North Carolina
      limited liability partnership, surplus realty for $2,200. The Company
      recognized a gain of approximately $1,100.

12.   LONG-TERM INVESTMENTS

      At December 31, 1999, long-term investments consisted primarily of
      investments in limited partnerships of $8,730. The Company believes the
      fair value of the limited partnerships exceeds their carrying amount by
      approximately $5,058 based on the indicated market values of the
      underlying investment portfolio provided by the partnerships. The
      Company's investments in limited partnerships are illiquid and the
      ultimate realization of these investments are subject to the performance
      of the underlying partnership and its management by the general partners.
      New Valley is not required to make additional investments in limited
      partnerships as of December 31, 1999.

      Also included in long-term investments are various Internet-related
      businesses which are carried at $5,598 at December 31, 1999. New Valley
      owns a 33.33% interest in AtomicPop, an online music company, and smaller
      interests in other Internet companies.



                                      F-25
<PAGE>   84
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



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

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

<TABLE>
<CAPTION>
                                                                       DECEMBER 31,     DECEMBER 31,
                                                                           1999             1998
                                                                     ---------------    -------------
     <S>                                                             <C>               <C>
     BGLS:
     15.75% Series B Senior Secured Notes due 2001,
           net of unamortized discount of $5,468 and $17,374...      $  82,602         $215,490
     Deferred interest on 15.75% Series B Senior Secured
           Notes due 2001......................................         25,435           24,985

     New Valley:
     Notes payable.............................................         19,813

     Liggett:
     Revolving credit facility.................................                           2,538
     Term loan under credit facility...........................          5,040
     Note payable..............................................          4,232

     Brooke (Overseas):
     Foreign credit facilities.................................          29,470         11,600
     Notes payable.............................................          23,090         28,057

     Other                                                                  214          1,171
                                                                     ----------      ---------
     Total notes payable, long-term debt and other obligations.         189,896        283,841
     Less:
           Current maturities..................................         (41,547)       (21,176)
                                                                     ----------      ---------
     Amount due after one year.................................      $  148,349      $ 262,665
                                                                     ==========      =========

</TABLE>



      15.75% SERIES B SENIOR SECURED NOTES DUE 2001 - BGLS:

      During 1999, BGLS repurchased $144,794 principal amount of its 15.75%
      Senior Secured Notes due 2001 (the "Notes"), together with accrued
      interest thereon. The purchases were funded primarily with proceeds from
      the Philip Morris brand transaction which closed on May 24, 1999. The
      Company recognized an extraordinary loss on early extinguishment of debt
      primarily due to the unamortized imputed interest associated with the
      repurchased Notes. At December 31, 1999, the principal amount of Notes
      outstanding was $88,070, subsequently reduced to $82,570 in January 2000.
      At December 31, 1999, $55,600 principal amount of the Notes were held by
      the holders who have agreed to defer payment of interest as discussed
      below.

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



                                      F-26
<PAGE>   85

                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



      In connection with the March 2, 1998 agreement with the Apollo Holders,
      the Company issued to the Apollo Holders a five-year warrant to purchase
      2,100,000 shares of the Company's common stock at a price of $4.76 per
      share. The Apollo Holders were also issued a second warrant expiring
      October 31, 2004 to purchase an additional 2,257,500 shares of the
      Company's common stock at a price of $0.095 per share. The second warrant
      became exercisable on October 31, 1999.

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

      The Notes outstanding are collateralized by substantially all of BGLS'
      assets, including a pledge of BGLS' equity interests in Liggett, Brooke
      (Overseas) and New Valley. The Notes Indenture contains certain covenants
      which, among other things, limit the ability of BGLS to make distributions
      to the Company to $12,000 per year (which amount increased from $6,000 per
      year in May 1999 when more than 50% of the original principal amount of
      the Notes were retired) plus any unpaid distribution amounts from prior
      years. The Notes also limit additional indebtedness of BGLS to $10,000,
      limit guaranties of subsidiary indebtedness by BGLS to $50,000, and
      restrict certain transactions with affiliates that exceed $2,000 in any
      year subject to certain exceptions which include payments to the Company
      not to exceed $6,500 per year for permitted operating expenses, payment of
      the Chairman's salary and bonus and certain other expenses, fees and
      payments. In addition, the Indenture contains certain restrictions on the
      ability of the Chairman and certain of his affiliates to enter into
      certain transactions with, and receive payments above specified levels
      from, New Valley. The Notes may be redeemed, in whole or in part, at a
      price of 100% of the principal amount plus accrued interest. Interest is
      payable at the rate of 15.75% per annum on January 31 and July 31 of each
      year.

      SENIOR SECURED NOTES DUE 1999 - LIGGETT:

      On December 28, 1998, all of the outstanding $144,891 principal amount of
      the Liggett Senior Secured Notes were redeemed at a price equal to 100% of
      the principal amount together with accrued interest. As discussed in Note
      2, proceeds of $150,000 from the purchase by Philip Morris of two options
      to purchase the Class A Interest and the Class B Interest in the
      Trademarks were used to fund the redemption.

      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, on February 2, 1998,
      the Company issued 507,152 shares of the Company'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 $4,105 during
      the first quarter of 1998 reflecting the fair value of the instruments
      issued. This deferred charge was amortized over a period of eleven months.




                                      F-27
<PAGE>   86


      REVOLVING CREDIT FACILITY - LIGGETT:

      Liggett has a $35,000 credit facility, under which $0 was outstanding at
      December 31, 1999. Availability under the credit facility was
      approximately $26,816 based on eligible collateral at December 31, 1999.
      The facility is collateralized by all inventories and receivables of
      Liggett. Borrowings under the facility, whose interest is calculated at a
      rate equal to 1.0% above Philadelphia National Bank's (the indirect parent
      of Congress Financial Corporation, the lead lender) prime rate, bore a
      rate of 9.5% at December 31, 1999. The facility requires Liggett's
      compliance with certain financial and other covenants including a
      restriction on the payment of cash dividends unless Liggett's borrowing
      availability under the facility for the 30-day period prior to the payment
      of the dividend, and after giving effect to the dividend, is at least
      $5,000. In addition, the facility, as amended, imposes requirements with
      respect to Liggett's adjusted net worth (not to fall below $8,000 as
      computed in accordance with the agreement) and working capital (not to
      fall below a deficit of $17,000 as computed in accordance with the
      agreement). At December 31, 1999, Liggett was in compliance with all
      covenants under the credit facility; Liggett's adjusted net worth was
      $37,597 and net working capital was $36,157, as computed in accordance
      with the agreement. The facility expires on March 8, 2003 subject to
      automatic renewal for an additional year unless a notice of termination is
      given by the lender at least 60 days prior to the anniversary date.

      In November 1999, 100 Maple Lane LLC, a new company formed by Liggett to
      purchase the Mebane facility, borrowed $5,040 from the lender under
      Liggett's credit facility. The loan is payable in 59 monthly installments
      of $60 including annual interest at 1% above the prime rate with a final
      payment of $1,500. Liggett has guaranteed the loan, and a first mortgage
      on the Mebane property collateralizes the Maple Lane loan and Liggett's
      credit facility. Liggett plans to relocate its manufacturing operations to
      this facility in late 2000.

      EQUIPMENT LOAN - LIGGETT:

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

      NOTES PAYABLE - NEW VALLEY:

      During the third quarter 1999, New Valley refinanced its notes payable on
      its two remaining shopping centers in Florida and West Virginia for
      $19,828, in the aggregate. Interest rates range from 7.5% to 9.03% per
      annum. The four notes are due between 2002 and 2024. Two, for $8,459, are
      subject to call in 2001 under certain conditions.

      FOREIGN CREDIT FACILITIES - LIGGETT-DUCAT:

      At December 31, 1999, Liggett-Ducat had various credit facilities with
      Russian banks under which approximately $29,500 was outstanding.
      Facilities denominated in dollars amount to $23,000, bear interest at
      rates of 13.0% to 20.0% per annum and expire within the next twelve
      months. The remaining facilities, denominated in rubles (approximately
      $6,500 at the December 31, 1999 exchange rate), have terms of six to
      twelve months with annual interest rates of 40% to 50%. The facilities are
      collateralized by the new factory building, factory equipment and tobacco
      inventory.



                                      F-28
<PAGE>   87
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



      NOTES PAYABLE - BROOKE (OVERSEAS):

      Western Tobacco Investments has entered into several contracts for the
      purchase of cigarette manufacturing equipment. The equipment is being
      utilized at the new factory, built by Liggett-Ducat, on the outskirts of
      Moscow which began production in June 1999. Approximately 85% of the
      amount of the contracts were financed with promissory notes generally
      payable over a period of five years. The outstanding balance on these
      notes, which are denominated in various European currencies, is $21,787 at
      December 31, 1999. Brooke (Overseas) also has issued a promissory note for
      approximately $1,303 covering deposits for equipment being purchased for
      the new factory. The note is due March 31, 2000.

      SCHEDULED MATURITIES:

      Scheduled maturities of long-term debt are as follows:

      Year ending December 31:

      2000............................          $  41,547
      2001............................            121,697
      2002............................              5,454
      2003............................              5,395
      2004............................              4,912
      Thereafter......................             10,891
                                                 --------
               Total..................           $189,896
                                                  =======


14.   SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED

      The components of trading securities owned and securities sold, not yet
      purchased are as follows:

                                                  DECEMBER 31, 1999
                                             --------------------------
                                              TRADING       SECURITIES
                                             SECURITIES    SOLD, NOT YET
                                               OWNED         PURCHASED
                                             ----------    -------------

      Common stock....................        $13,306            $6,522
      Equity and index options........          1,973             1,087
      Other...........................            428                16
                                             --------           -------
                                              $15,707            $7,625
                                               ======             =====


15.   COMMITMENTS

      Certain of the Company's subsidiaries lease facilities and equipment used
      in operations under both month-to-month and fixed-term agreements. The
      aggregate minimum rentals under operating leases with noncancelable terms
      of one year or more are as follows:



                                      F-29
<PAGE>   88
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



                Year ending December 31:
                2000..........................     $6,513
                2001..........................      5,323
                2002..........................      5,062
                2003..........................      4,529
                2004..........................      4,157
                Thereafter....................     49,531
                                                   ------
                    Total.....................    $75,115
                                                   ======

      Lease commitments for 2004 and thereafter relate primarily to the
      remaining 42 years of a land lease.

      The Company's rental expense for the years ended December 31, 1999, 1998
      and 1997 was $7,369, $3,035 and $3,625, respectively.

      Future minimum rents to be received by New Valley under non-cancelable
      operating leases are $2,067 in 2000, $1,906 in 2001, $1,627 in 2002, $755
      in 2003, $626 in 2004 and $590 thereafter.

16.   EMPLOYEE BENEFIT PLANS

      DEFINED BENEFIT RETIREMENT PLANS:

      The Company sponsors several defined benefit pension plans, covering
      virtually all of Liggett's full-time employees. These plans provide
      pension benefits for eligible employees based primarily on their
      compensation and length of service. Contributions are made to the pension
      plans in amounts necessary to meet the minimum funding requirements of the
      Employee Retirement Income Security Act of 1974.

      In a continuing effort to reduce operating expenses, all defined benefit
      plans were frozen between 1993 and 1995 and several early retirement
      windows were offered between 1995 and 1999. As a result of these actions,
      the Company recorded a curtailment charge (see table below).

      The Company's net pension expense consists of the following components:

<TABLE>
<CAPTION>
                                                                   YEAR ENDED DECEMBER 31,
                                                               -------------------------------
                                                               1999          1998          1997
                                                               ----          ----          ----
     <S>                                                   <C>            <C>            <C>
     Service cost - benefits earned during the period      $    350       $    350       $    350
     Interest cost on projected benefit obligation ..        10,850         11,707         12,255
     Expected return on assets ......................       (15,338)       (16,724)       (14,093)
     Amortization of net gain .......................          (894)        (3,064)          (988)
     Curtailment related to plan restructuring ......         1,302                           484
                                                           --------       --------       --------
     Net pension credit .............................      $ (3,730)      $ (7,731)      $ (1,992)
                                                           ========       ========       ========
</TABLE>

                                      F-30
<PAGE>   89
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)




<TABLE>
<CAPTION>
                                                                             1999             1998
                                                                             ----             ----

<S>                               <C>                                      <C>               <C>
Change in benefit obligation:
    Benefit obligation at January 1..............................          $(170,064)        $(165,474)
    Interest cost................................................            (10,850)          (11,707)
    Benefits paid................................................             16,763            15,861
    Termination, settlements and curtailment.....................             (1,302)
    Actuarial gain (loss)........................................             13,945            (8,744)
                                                                            --------         ---------
    Benefit obligation at December 31............................          $(151,508)        $(170,064)
                                                                             =======           =======

Change in plan assets:
    Fair value of plan assets at January 1.......................           $184,079          $194,732
    Actual return on plan assets.................................             31,130             4,866
    Contributions................................................                341               342
    Benefits paid................................................            (16,763)          (15,861)
                                                                            --------          --------
    Fair value of plan assets at December 31.....................           $198,787          $184,079
                                                                             =======           =======

Excess of plan assets versus benefit
        obligations at December 31...............................          $  47,279         $  14,015
    Unrecognized actuarial gains.................................            (54,921)          (25,729)
    Contributions or SERP benefits...............................                 85                86
                                                                           ---------       -----------
Net pension liability before additional minimum liability
        and purchase accounting valuation adjustments............             (7,557)          (11,628)
Additional minimum liability.....................................             (1,556)           (1,901)
Purchase accounting valuation adjustments relating
        to income taxes..........................................              2,383             2,730
                                                                           ---------           -------
Pension liability included in the December 31
        balance sheet............................................         $   (6,730)        $ (10,799)
                                                                           =========          ========
</TABLE>

      Assumptions used in the determination of net pension expense and the
      actuarial present value of benefit obligations for the years ended
      December 31, 1999 and 1998 follow:

<TABLE>
<CAPTION>
                                                                   1999                  1998
                                                                   ----                  ----

    <S>                                                        <C>                   <C>
      Discount rates..................................         5.50 - 6.75%          5.50 - 7.50%
      Accrued rates of return on invested assets......            8.75%              8.75 - 9.0%
      Salary increase assumptions.....................             N/A                   N/A
</TABLE>

      Plan assets consist of commingled funds, marketable equity securities and
      corporate and government debt securities.

      POSTRETIREMENT MEDICAL AND LIFE INSURANCE PLANS:

      BGLS AND LIGGETT

      Substantially all of Liggett's employees are eligible for certain
      postretirement benefits if they reach retirement age while working for the
      Company. Retirees are required to fund 100% of participant medical
      premiums.



                                      F-31
<PAGE>   90
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      The components of net periodic postretirement benefit cost for the years
      ended December 31, 1999, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>

                                                                        1999         1998         1997
                                                                        ----         ----         ----
<S>                                                                  <C>             <C>          <C>
      Service cost, benefits attributed to employee
           service during the year............................       $    45         $  43        $  24
      Interest cost on accumulated postretirement
           benefit obligation.................................           599           583          703
      Charge for special termination benefits.................           240                         47
      Amortization of net gain (loss).........................           582          (284)        (193)
                                                                      ------           ---          ---
      Net periodic postretirement benefit expense.............        $1,466          $342         $581
                                                                       =====           ===          ===
</TABLE>

      The following sets forth the actuarial present value of the Accumulated
      Postretirement Benefit Obligation ("APBO") at December 31, 1999 and 1998
      applicable to each employee group for benefits:

<TABLE>
<CAPTION>

                                                                1999             1998
                                                                ----             ----

<S>                                                           <C>            <C>
Change in benefit obligation:
     Benefit obligation at January 1 ...................      $ (9,116)      $ (8,178)
     Service cost ......................................           (45)           (43)
     Interest cost .....................................          (599)          (583)
     Benefits paid .....................................           712            934
     Actuarial gain (loss) .............................           192         (1,246)
     Charge for special termination benefits ...........          (240)
                                                              --------       --------
     Benefit obligation at December 31 .................      $ (9,096)      $ (9,116)
                                                              ========       ========

Change in plan assets:

     Contributions .....................................      $    712       $    934
     Benefits paid .....................................          (712)          (934)
                                                              --------       --------
     Fair value of plan assets at December 31 ..........      $              $
                                                              ========       ========
Accumulated postretirement benefit obligation (in excess
         of plan assets) ...............................      $ (9,096)      $ (9,116)
     Unrecognized net gain .............................        (3,236)        (2,462)
Purchase accounting valuation adjustments relating
         to income taxes ...............................           745            854
                                                              --------       --------
Postretirement liability included in the December 31
         balance sheet .................................      $(11,587)      $(10,724)
                                                              --------       ========
</TABLE>

      The APBO at December 31, 1999 and 1998 was determined using discount rates
      of 6.75% and 7.5%, respectively, and a health care cost trend rate of 4%
      in 1999 and 1998. A 1% increase in the trend rate for health care costs
      would have increased the APBO and net periodic postretirement benefit cost
      by $353 and $26, respectively, for the year ended December 31, 1999. The
      Company does not hold any assets reserved for use in the plan.




                                      F-32
<PAGE>   91
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



      PROFIT SHARING PLAN:

      The Company maintains 401(k) plans for substantially all U.S. employees
      which allow eligible employees to invest a percentage of their pre-tax
      compensation.

      LIGGETT

      The 401(k) plans at Liggett match up to a 3% employee contribution, plus
      additional Liggett contributions of up to 6% of salary based on the
      achievement of Liggett's profit objectives. Liggett contributed and
      expensed $527, $469 and $497 to the 401(k) plans for the years ended
      December 31, 1999, 1998 and 1997, respectively.

      NEW VALLEY:

      Ladenburg has a profit sharing plan for substantially all its employees.
      The plan includes two features: profit sharing and a deferred compensation
      vehicle. Contributions to the profit sharing portion of the plan are made
      by Ladenburg on a discretionary basis. The deferred compensation feature
      of the plan enables non-salaried employees to invest up to 15% of their
      pre-tax annual compensation. The plan was inactive in 1999.

17.   INCOME TAXES

      The Company files a consolidated U.S. income tax return that includes its
      more than 80%-owned United States subsidiaries. The amounts provided for
      income taxes are as follows:

<TABLE>
<CAPTION>
                                                                          YEAR ENDED DECEMBER 31,
                                                                      1999          1998          1997
                                                                      ----          ----          ----
      <S>                                                         <C>           <C>           <C>
      Current:

            U.S. Federal...................................      $ 1,208       $
            Foreign........................................          429                      $1,134
            State..........................................        5,076                         (11)
                                                                 -------        --------      ------
                                                                   6,713                       1,123
                                                                 -------        --------     -------
      Deferred:

            U.S. Federal...................................      $66,688        $(59,158)     $
            Foreign........................................          455            (455)
            State..........................................        8,612
                                                                 -------        --------     -------

      Total (benefit) provision............................       75,745         (59,613)      1,123
                                                                 -------        --------     -------
                                                                 $82,458        $(59,613)      1,123
                                                                 =======        ========     =======

</TABLE>

      The tax effect of temporary differences which give rise to a significant
      portion of deferred tax assets and liabilities are as follows:



                                      F-33
<PAGE>   92
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



<TABLE>
<CAPTION>

                                                         DECEMBER 31, 1999              DECEMBER 31, 1998
                                                    ---------------------------    ----------------------------
                                                    DEFERRED TAX   DEFERRED TAX    DEFERRED TAX    DEFERRED TAX
                                                       ASSETS       LIABILITIES       ASSETS       LIABILITIES
                                                    ------------   ------------    ------------    ------------
<S>                                                 <C>             <C>              <C>            <C>

  Sales and product allowances..............      $  2,057          $                $  3,468
  Inventory.................................           957             2,274              660         $ 1,220
  Coupon accruals...........................           859                              1,004
  Property, plant and equipment.............                           4,712                            4,791
  Employee benefit plan accruals............        10,555                              8,429
  Debt restructuring........................         3,110                             17,159
  Excess of tax basis over book basis-
    non-consolidated entities...............        23,204             9,227            9,969
    Legal Settlements.......................         1,165                              2,036
  Difference in basis of investments........         8,021
  Deferral on brand transaction.............
  Restructuring accruals....................         4,936           103,346
  Russian tax loss carryforwards............         6,632                              3,354
  U.S. tax loss carryforwards-BGL...........        48,007                             62,714
  U.S. tax loss carryforwards-New Valley....        65,911
  Valuation allowance.......................      (108,409)                           (43,169)
  Reclassifications.........................                                           (6,011)         (6,011)
                                                  --------          --------         --------           -----
                                                  $ 67,005          $119,559         $ 59,613         $
                                                                                       ======           =====
</TABLE>



      The Company provides a valuation allowance against deferred tax assets if,
      based on the weight of available evidence, it is more likely than not that
      some or all of the deferred tax assets will not be realized. The Company
      has established a valuation allowance against deferred tax assets of
      $108,409 at December 31, 1999.

      The valuation allowance of $108,409 at December 31, 1999 consisted
      primarily of New Valley's net operating loss carryforwards of $65,911 and
      Russian tax loss carryforwards of $6,632. In addition, a valuation
      allowance was established against New Valley's additional deferred tax
      assets of $35,737 primarily related to differences between book and tax
      accounting purposes for basis in investments and subsidiaries and
      restructuring accruals.

      At December 31, 1999, the Company and its consolidated group had U.S. tax
      loss carryforwards of $135,000 which may be subject to certain
      restrictions and limitations and which will expire in the years 2006 to
      2017.

      Differences between the amounts provided for income taxes and amounts
      computed at the federal statutory tax rate are summarized as follows:

<TABLE>
<CAPTION>
                                                                          YEAR ENDED DECEMBER 31,
                                                                      1999          1998          1997
                                                                      ----          ----          ----
      <S>                                                            <C>           <C>           <C>
      Income (loss) from continuing operations before
          income taxes......................................         $318,542      $(35,394)     $(50,298)
                                                                     --------      --------      --------
      Federal income tax provision (benefit) at
          statutory rate....................................          111,490       (12,387)      (17,604)

      Increases (decreases) resulting from:
          State income taxes, net of federal income tax
            benefits........................................            8,897                          (8)
          Foreign taxes.....................................              873          (455)        1,134
          Other, net........................................              822         9,921         8,386
          Changes in valuation allowance....................          (39,624)      (56,692)        9,215
                                                                     --------      --------     ---------
          Provision (benefit) for income tax................         $ 82,458      $(59,613)    $   1,123
                                                                     ========      ========     =========
</TABLE>
      Both the Company's and New Valley's 1996 and 1997 tax years are presently
      under audit with the IRS. The Company believes it has adequately reserved
      for any potential adjustments which may occur.


                                      F-34
<PAGE>   93
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)

18.   EQUITY

      On December 10, 1999, each outside director of the Company was granted an
      option to purchase 10,000 shares of common stock at $16.75 per share, the
      fair market value on the date of grant. The options vest and become
      exercisable in three equal annual installments commencing on January 1,
      2001, but are subject to earlier vesting upon a change of control.

      During April and May 1998, the Company granted 10,500 shares of common
      stock to each of its three outside directors. Of these shares, 7,875
      vested immediately and the remaining 23,625 shares vest in three equal
      annual installments. At December 31, 1999, $200 had been expensed and the
      remaining amount of $103 will be recognized over the remaining vesting
      period.

      On January 16, 1998, the Company sold to High River Limited Partnership
      1,575,000 shares of common stock for $9,000.

      In connection with the March 2, 1998 agreement with the Apollo Holders,
      the Company issued warrants to purchase common stock. (Refer to Note 13.)

      On March 12, 1998, the Company granted an option for 1,312,500 shares of
      common stock to a law firm that represents the Company and Liggett
      originally exerciseable at $16.67 per share. The fair value of the equity
      instruments was estimated based on the Black-Scholes option pricing model
      and the following assumptions: volatility 77.6%, risk-free interest rate
      of 5.47%, expected life of two years and dividend rate of 0%. The Company
      recognized expense of $1,495 in the second quarter of 1998. On October 12,
      1998, the Company amended the option to reduce the exercise price from
      $16.67 per share to $5.71 per share. The initial exercise date on all
      1,312,500 shares was extended to April 1, 2000, subject to earlier
      exercise under certain circumstances which were satisfied resulting in the
      option becoming exercisable in full. The expense at the initial grant date
      was $3,063, and the incremental expense incurred due to the modifications
      of the grant was $2,050. At December 31, 1999, all such amounts had been
      expensed.

      On August 28, 1998, the Company granted 493,500 shares of common stock as
      part of a performance fee to members of a law firm which represents the
      Company and Liggett. The Company expensed $1,687 for the year ended
      December 31, 1998.

      On March 7, 1997, a partnership controlled by the Company's Chairman,
      President and Chief Executive Officer and controlling stockholder (the
      "Chairman"), transferred 420,000 shares of common stock to the Company in
      satisfaction of an obligation. (Refer to Note 23.)

19.   STOCK PLANS

      On November 4, 1999, the Company adopted its 1999 Long-Term Incentive Plan
      (the "1999 Plan") subject to approval by the stockholders of the Company
      at the 2000 annual meeting. The 1999 Plan authorizes the granting of up to
      5,000,000 shares of common stock through awards of stock options (which
      may include incentive stock options and/or nonqualified stock options),
      stock appreciation rights and shares of restricted Company common stock.
      All officers, employees and consultants of the Company and its
      subsidiaries are eligible to receive awards under the 1999 Plan.




                                      F-35
<PAGE>   94
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


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

      On October 15, 1998, stockholders of the Company approved the adoption of
      the 1998 Long-Term Incentive Plan (the "1998 Plan"). The 1998 Plan,
      adopted on May 8, 1998, authorizes the granting of up to 5,250,000 shares
      of common stock through awards of stock options (which may include
      incentive stock options and/or nonqualified stock options), stock
      appreciation rights and shares of restricted Company common stock. All
      officers, employees and consultants of the Company and its subsidiaries
      are eligible to receive awards under the 1998 Plan.

      On July 20, 1998, the Company granted a non-qualified stock option to each
      of the Chairman and a consultant to the Company who serves as President
      and a director of New Valley (the "Consultant"), pursuant to the 1998
      Plan. Under the options, the Chairman and the Consultant have the right to
      purchase 2,625,000 shares and 525,000 shares, respectively, of common
      stock at an exercise price of $9.29 per share (the fair market value of a
      share of common stock on the date of grant). The options have a ten-year
      term and become exercisable as to one-fourth of the shares on each of the
      first four anniversaries of the date of grant. However, any then
      unexercisable portion of the option will immediately vest and become
      exercisable upon (i) the occurrence of a "Change in Control," or (ii) the
      termination of the option holder's employment or consulting arrangement
      with the Company due to death or disability.

      The fair value of the equity instruments issued to the Consultant was
      estimated based on the Black-Scholes option pricing model and the
      following assumptions: volatility of 82.18%, risk-free interest rate of
      5.47%, expected option life of 10 years and dividend rate of 0%. The
      Company is recognizing $3,260 over the vesting period.

      On November 24, 1999, the Company granted non-qualified stock options to
      purchase 920,000 shares of common stock to key employees of Liggett under
      the 1998 Plan. Under the options, the 27 Liggett option holders have the
      right to purchase shares at $15 7/16 per share except for the grant of
      250,000 options to the chairman of Liggett whose options have an exercise
      price of $18.00 per share, the fair market value on the date of grant. The
      options become exercisable as to 25% of the shares on December 31, 2001
      and as to an additional 37.5% of the shares on each of December 31, 2002
      and December 31, 2003, assuming the continued employment of the option
      holder. Vesting is accelerated upon death or disability. The Company will
      recognize compensation expense of $1,717 over the vesting period.

      As of January 1, 1998 and 1997, the Company granted to employees of the
      Company non-qualified stock options to purchase 45,150 and 443,100,
      respectively, shares of the Company's common stock


                                      F-36
<PAGE>   95
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      at an exercise price of $4.76 per share. The options have a ten-year term
      and vest in six equal annual installments. The Company will recognize
      compensation expense of $154 over the vesting period.

      A summary of stock options granted to employees follows:

<TABLE>
<CAPTION>
                                                                                                WEIGHTED
                                                            NUMBER OF         EXERCISE          AVERAGE
                                                             SHARES            PRICE           FAIR VALUE
                                                             ------            -----           ----------
      <S>                                                     <C>              <C>               <C>
      Outstanding on December 31, 1996..............                0
           Granted..................................          443,100          $4.76             $4.10
           Exercised................................                0
           Cancelled................................                0
      Outstanding on December 31, 1997..............          443,100          $4.76             $4.10
           Granted..................................        2,670,150       $4.76-$9.29          $7.28
           Exercised................................           98,838          $4.76
           Cancelled................................                0
      Outstanding on December 31, 1998..............        3,014,412       $4.76-$9.29          $7.38
           Granted..................................          950,000      $15.44-$18.00          7.61
           Exercised................................                0
           Cancelled................................                0
      Outstanding on December 31, 1999..............        3,964,412       $4.76-$18.00         $7.64

      Options exercisable at:
           December 31, 1997........................           93,623
           December 31, 1998........................           73,884
           December 31, 1999........................          737,659

</TABLE>


      The Company will continue to account for stock options granted employees
      at their intrinsic value. Had the fair value method of accounting been
      applied to the Company's stock options granted to employees, the pro forma
      effect would be as follows:

<TABLE>
<CAPTION>
                                                                         1999         1998         1997
                                                                         ----         ----         ----
      <S>                                                                               <C>         <C>
      Net income (loss) as reported............................       $235,673      $27,427     $(49,885)
      Estimated fair value of the year's option grants.........          5,605        2,549          383
      Net income (loss) adjusted...............................        230,068       24,878      (50,268)
      Adjusted net income (loss) per share - basic.............          10.46         1.16        (2.64)
      Adjusted net income (loss) per share - diluted...........           8.58         0.96        (2.64)
</TABLE>

      The fair value of option grants to employees is estimated on the date of
      grant using the Black-Scholes option pricing model with the following
      assumptions for options granted. The dividend yield ranges from 0%-5%.



                                      F-37
<PAGE>   96
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


<TABLE>
<CAPTION>

                                      RISK-FREE         EXPECTED         EXPECTED        WEIGHTED AVERAGE
                 DATE               INTEREST RATE    LIFE IN YEARS      VOLATILITY          FAIR VALUE
                 ----               -------------    -------------      ----------          ----------
      <S>                               <C>                <C>            <C>                  <C>
      December 10, 1999                 6.07%              10             47.36%               $5.08
      November 24, 1999                 6.08%              10             68.27%               $7.75
      July 20, 1998                     5.54%              10             79.14%               $8.21
      January 1, 1998                   5.74%              10             76.56%               $7.58
      January 1, 1997                   6.44%              10             81.46%               $4.30
</TABLE>

      On December 16, 1996, the Company entered into a stock option agreement
      with the Consultant. The agreement granted the Consultant non-qualified
      stock options to purchase 1,050,000 shares of the Company's common stock
      at an exercise price of $0.95 per share. The options, which have a
      ten-year term, vest and become exercisable in six equal annual
      installments beginning on July 1, 1997. Under the agreement, common stock
      dividend equivalents are paid on each vested and unexercised option. The
      Company estimated the fair value of such grant on the date of grant using
      the Black-Scholes option pricing model with the following assumptions: a
      risk-free interest rate of 6.4%, expected option life of 10 years,
      volatility of 81.4% and no expected dividends or forfeiture. Under this
      model, the fair value of stock options granted in 1996 was $4,750. The
      Company recognized expense of $792, $792 and $1,127 in 1999, 1998 and
      1997, respectively. In 1999, 1998 and 1997, the Company also recorded
      charges to income of $444, $330 and $149, respectively, for dividend
      equivalent rights.

      As of January 1, 1994, the Company had granted 525,000 shares of
      restricted common stock to the Consultant. Of the total number of shares
      granted, 262,500 were immediately vested and issued during the third
      quarter. The remaining 262,500 shares were issued in 1995 and vested in
      1997. In addition, on January 25, 1995, the Company entered into a
      non-qualified stock option agreement with the Consultant. Under the
      agreement, options to purchase 525,000 shares were granted at $1.90 per
      share. The options are exercisable over a ten-year period and were fully
      vested in January 1999. The grant provides for dividend equivalent rights
      on all the shares underlying the unexercised options. During 1999, 1998
      and 1997, the Company recorded charges to income of $16, $188 and $205,
      respectively, for compensation based on estimates of the fair market value
      for the shares and options granted. In 1999, 1998 and 1997, the Company
      also recorded charges to income of $166, $155 and $188, respectively, for
      the dividend equivalent rights.



                                      F-38
<PAGE>   97
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


20.   OTHER LONG-TERM LIABILITIES

      Other long-term liabilities consist of the following:

                                                           DECEMBER 31,
                                                      1999             1998
                                                      ----             ----

       Western Realty Repin
            participating loan..............          $32,091         $

       Western Realty Development
            participating loan..............           37,849          31,991

       Deferred gain........................                           20,392

       Other long-term liabilities..........            6,688          12,967
                                                       ------          ------

                  Total.....................          $76,628         $65,350
                                                       ======          ======


21.   SUPPLEMENTAL CASH FLOW INFORMATION


<TABLE>
<CAPTION>
                                                                        Year Ended December 31,
                                                                  1999             1998            1997
                                                                  ----             ----            ----

<S>                                                             <C>               <C>              <C>
     I.  Cash paid during the period for:
           Interest........................................     $48,030           $62,339          $43,028
           Income taxes, net of refunds....................       2,942             2,751              462

    II. Non-cash investing and financing activities:
           Issuance of stock to Liggett noteholders........                        4,105
           Issuance of stock to consultants and law firms..                        3,705
           Issuance of warrants............................                       22,421
           Promissory note from New Valley.................                                        33,500
           Issuance of stock dividend......................     25,646

</TABLE>

22.   CONTINGENCIES

      SMOKING-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 alleged to have been caused by cigarette
      smoking or by exposure to secondary smoke from cigarettes. These cases are
      reported here as though having been commenced against Liggett (without
      regard to whether such cases were actually commenced against Brooke Group
      Holding, the Company's predecessor and a wholly-owned subsidiary of BGLS,
      or Liggett). There has been a noteworthy increase in the number of cases
      commenced against Liggett and the other cigarette manufacturers in recent




                                      F-39
<PAGE>   98
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)



      years. The cases generally fall into the following categories: (i) smoking
      and health cases alleging injury brought on behalf of individual
      plaintiffs ("Individual Actions"); (ii) smoking and health cases alleging
      injury and purporting to be brought on behalf of a class of individual
      plaintiffs ("Class Actions"); (iii) health care cost recovery actions
      brought by various governmental entities ("Governmental Actions"); and
      (iv) health care cost recovery actions brought by third-party payors
      including insurance companies, union health and welfare trust funds,
      asbestos manufacturers and others ("Third-Party Payor Actions"). As new
      cases are commenced, defense costs and the risks attendant to the inherent
      unpredictability of litigation continue to increase. The future financial
      impact of the risks and expenses of litigation and the effects of the
      tobacco litigation settlements discussed below is not quantifiable at this
      time. In 1999, Liggett incurred counsel fees and costs totaling
      approximately $5,733 compared to $7,828 in 1998.

      INDIVIDUAL ACTIONS. As of December 31, 1999, there were approximately 300
      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 secondary
      smoke and seek compensatory and, in some cases, punitive damages. Of
      these, 85 were pending in Florida, 91 in New York, 30 in Massachusetts and
      17 in Texas. The balance of the individual cases were pending in 22
      states. There are five individual cases pending where Liggett is the only
      named defendant.

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

      In February 1999, a California jury awarded $51,500 in damages to a woman
      who claimed lung cancer from smoking Marlboro cigarettes made by Philip
      Morris. The award includes $1,500 in compensatory damages and $50,000 in
      punitive damages. The court subsequently reduced the punitive damages
      award to $25,000. In March 1999, an Oregon jury awarded $80,311 in damages
      to the family of a deceased smoker who smoked Marlboro cigarettes made by
      Philip Morris. The award includes $79,500 in punitive damages. The court
      subsequently reduced the punitive damages award to $32,000. Philip Morris
      has appealed both the verdict and damage awards.

      CLASS ACTIONS. As of December 31, 1999, there were approximately 50
      actions pending, for which either a class has been certified or plaintiffs
      are seeking class certification, where Liggett, among others, was a named
      defendant. Many of these actions purport to constitute statewide class
      actions and were filed after May 1996 when the Fifth Circuit Court of
      Appeals, in the CASTANO case (discussed below), reversed a Federal
      district court's certification of a purported nationwide class action on
      behalf of persons who were allegedly "addicted" to tobacco products.

      In March 1994, an action entitled CASTANO, ET AL. V. THE AMERICAN TOBACCO
      COMPANY INC., ET AL., United States District Court, Eastern District of
      Louisiana, was filed against Liggett and others. The class action
      complaint sought relief for a nationwide class of smokers based on their
      alleged addiction to nicotine. In February 1995, the District Court
      granted plaintiffs' motion for class certification (the "Class
      Certification Order").



                                      F-40
<PAGE>   99
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


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

      The extent of the impact of the CASTANO decision on smoking-related class
      action litigation is still uncertain, although the decertification of the
      CASTANO class by the Fifth Circuit may preclude other federal courts from
      certifying a nationwide class action for trial purposes with respect to
      smoking-related claims. The CASTANO decision has had to date, however,
      only limited effect with respect to courts' decisions regarding narrower
      smoking-related classes or class actions brought in state rather than
      federal court. For example, since the Fifth Circuit's ruling, courts in
      Louisiana (Liggett is not a defendant in this proceeding) and Maryland
      have certified "addiction-as-injury" class actions that covered only
      citizens in those states. Two class actions, BROIN and ENGLE, were
      certified in state court in Florida prior to the Fifth Circuit's decision.
      The CASTANO decision has had no measurable impact on litigation brought by
      or on behalf of single individual claimants.

      In May 1994, an action entitled ENGLE, ET AL. V. R.J. REYNOLDS TOBACCO
      COMPANY, ET AL., Circuit Court Eleventh Judicial Circuit, Dade County,
      Florida, was filed against Liggett and others. The class consists of all
      Florida residents and citizens, and their survivors, who have suffered,
      presently suffer or have died from diseases and medical conditions caused
      by their addiction to cigarettes that contain nicotine. In July 1998,
      Phase I of the trial in this action commenced. On July 7, 1999, the jury
      returned the Phase I verdict. The Phase I verdict concerned certain issues
      determined by the trial court to be "common" to the causes of action of
      the plaintiff class. Among other things, the jury found that smoking
      cigarettes causes 20 diseases or medical conditions, that cigarettes are
      addictive or dependence producing, defective and unreasonably dangerous,
      that defendants made materially false statements with the intention of
      misleading smokers, that defendants concealed or omitted material
      information concerning the health effects and/or the addictive nature of
      smoking cigarettes and agreed to misrepresent and conceal the health
      effects and/or the addictive nature of smoking cigarettes, and that
      defendants were negligent and engaged in extreme and outrageous conduct or
      acted with reckless disregard with the intent to inflict emotional
      distress. The jury also found that defendants' conduct "rose to a level
      that would permit a potential award or entitlement to punitive damages."
      The court has decided that Phase II of the trial, which commenced November
      1, 1999, will be a causation and damages trial for three of the class
      representatives and a punitive damages trial on a class-wide basis, before
      the same jury that returned the verdict in Phase I. Phase III of the trial
      will be conducted before separate juries to address absent class members'
      claims, including issues of specific causation and other individual issues
      regarding entitlement to compensatory damages. The defendants' motion to
      order the trial court to assess punitive damages on an individual basis
      was denied and the petition for review was also denied, without prejudice
      to raise the same issue on subsequent appeals.


                                      F-41
<PAGE>   100
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      It is unclear how the trial court's order will be implemented. The order
      provides that the punitive damage amount, if any, should be standard as to
      each class member and acknowledges that the actual size of the class will
      not be known until the last case has withstood appeal. The order does not
      address whether defendants would be required to pay the punitive damage
      award, if any, prior to a determination of claims of all class members, a
      process that could take years to conclude. In a worst case scenario, it is
      possible that a judgment for punitive damages could be entered in the
      ENGLE case in an amount not capable of being bonded, resulting in an
      execution of the judgment before it could be set aside on appeal. The
      Company believes that such a result would be unconstitutional and would
      also violate Florida laws.

      Class certification motions are pending in a number of putative class
      actions. Classes remain certified against Liggett in Florida (ENGLE) and
      Maryland (RICHARDSON). A number of class certification denials are on
      appeal.

      GOVERNMENTAL ACTIONS. As of December 31, 1999, there were approximately 20
      Governmental Actions pending against Liggett. In these proceedings, both
      foreign and domestic governmental entities seek reimbursement for Medicaid
      and other health care expenditures. The claims asserted in these health
      care cost recovery actions vary. In most of these cases, plaintiffs assert
      the equitable claim that the tobacco industry was "unjustly enriched" by
      plaintiffs' payment of health care costs allegedly attributable to smoking
      and seek reimbursement of those costs. Other claims made by some but not
      all plaintiffs include the equitable claim of indemnity, common law claims
      of negligence, strict liability, breach of express and implied warranty,
      breach of special duty, fraud, negligent misrepresentation, conspiracy,
      public nuisance, claims under state and federal statutes governing
      consumer fraud, antitrust, deceptive trade practices and false
      advertising, and claims under RICO.

      THIRD-PARTY PAYOR ACTIONS. As of December 31, 1999, there were
      approximately 70 Third-Party Payor Actions pending against Liggett. The
      claims in these cases are similar to those in the Governmental Actions but
      have been commenced by insurance companies, union health and welfare trust
      funds, asbestos manufacturers and others. As of December 31, 1999, five
      United States. Circuit Courts of Appeal had ruled that Third-Party Payors
      did not have standing to bring lawsuits against the tobacco companies. The
      United States Supreme Court recently denied a petition for writ of
      certiorari filed by several of the union health and welfare trust funds.
      However, a number of Third-Party Payor Actions, including an action
      brought by 24 Blue Cross/Blue Shield Plans, remain pending.

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

      FEDERAL GOVERNMENT ACTION. In September 1999, the United States government
      commenced litigation against Liggett and the other tobacco companies in
      the United States District Court for the District of Columbia. The action
      seeks to recover an unspecified amount of healthcare costs paid for and
      furnished, and to be paid for and furnished, by the Federal Government for
      lung cancer, heart disease, emphysema and other smoking-related illnesses
      allegedly caused by the fraudulent and tortious conduct of defendants, and
      to restrain defendants and co-conspirators from engaging in fraud and




                                      F-42
<PAGE>   101
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      other unlawful conduct in the future, and to compel defendants to disgorge
      the proceeds of their unlawful conduct. The complaint alleges that such
      costs total more than $20,000,000 annually. The action asserts claims
      under three federal statutes, the Medical Care Recovery Act, the Medicare
      Secondary Payer provisions of the Social Security Act and RICO. In
      December 1999, Liggett filed a motion to dismiss the lawsuit on numerous
      grounds, including that the statutes invoked by the government do not
      provide the basis for the relief sought.

      SETTLEMENTS. In March 1996, Brooke Group Holding and Liggett entered into
      an agreement, subject to court approval, to settle the CASTANO class
      action tobacco litigation. The CASTANO class was subsequently decertified
      by the court.

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

      In November 1998, Philip Morris, Brown & Williamson Tobacco Corporation,
      R.J. Reynolds Tobacco Company and Lorillard Tobacco Company (collectively,
      the "Original Participating Manufacturers" or "OPMs") and Liggett
      (together with the OPMs and any other tobacco product manufacturer that
      becomes a signatory, the "Participating Manufacturers") entered into the
      Master Settlement Agreement (the "MSA") with 46 states, the District of
      Columbia, Puerto Rico, Guam, the United States Virgin Islands, American
      Samoa and the Northern Marianas (collectively, the "Settling States") to
      settle the asserted and unasserted health care cost recovery and certain
      other claims of those Settling States.

      The MSA has been initially approved by trial courts in all Settling
      States. The MSA is subject to final judicial approval in each of the
      Settling States, which approval has been obtained, as of December 31,
      1999, in 47 jurisdictions. If final judicial approval is not obtained in a
      jurisdiction by December 31, 2001, then, unless the settling defendants
      and the relevant jurisdiction agree otherwise, the MSA will be terminated
      with respect to such jurisdiction.



                                      F-43
<PAGE>   102
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)

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

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

      Liggett has no payment obligations under the MSA unless its market share
      exceeds a base share of 125% of its 1997 market share, or 1.67% of total
      cigarettes sold in the United States. Liggett believes, based on published
      industry services, that its domestic shipments accounted for 1.2% of the
      total cigarettes shipped in the United States during 1999. In the year
      following any year in which Liggett's market share does exceed the base
      share, Liggett will pay on each excess unit an amount equal (on a per-unit
      basis) to that paid during such following year by the OPMs under the
      annual and strategic contribution payment provisions of the MSA, subject
      to applicable adjustments, offsets and reductions. Under the annual and
      strategic contribution payment provisions of the MSA, the OPMs (and
      Liggett to the extent its market share exceeds the base share) will pay
      the following annual amounts (subject to certain adjustments):

              YEAR                     AMOUNT
              ----                     ------

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

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

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

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

      In April 1999, a putative class action was filed on behalf of all firms
      that directly buy cigarettes in the United States from defendant tobacco
      manufacturers. The complaint alleges violation of antitrust law, based in
      part on the MSA. Plaintiffs seek treble damages computed as three times
      the difference between current prices and the price plaintiffs would have
      paid for cigarettes in the absence of an alleged conspiracy to restrain
      and monopolize trade in the domestic cigarette market, together with
      attorneys' fees. Plaintiffs also seek injunctive relief against certain
      aspects of the MSA.

      In March 1997, Liggett, Brooke Group Holding and a nationwide class of
      individuals that allege smoking-related claims filed a mandatory class
      settlement agreement in an action entitled FLETCHER, ET AL. V. BROOKE
      GROUP LTD., ET AL., Circuit Court of Mobile County, Alabama, where the

                                      F-44
<PAGE>   103
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


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

      The Company accrued $16,902 for the present value of the fixed payments
      under the March 1998 Attorneys General settlements. As a result of the
      Company's treatment under the MSA, $14,928 of net charges accrued for the
      prior settlements were reversed in 1998 and $1,051 were reversed in 1999.

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

      TRIALS. In addition to the ENGLE case, cases currently scheduled for trial
      in 2000 include Third-Party Payor Actions brought by several Blue
      Cross/Blue Shield plans in federal court in New York (June), asbestos
      companies in Mississippi (September) and New York (April) and certain
      unions in New York (July). Also, two Individual Actions and an adequacy of
      warning case are currently scheduled for trial during the first six months
      of 2000. Trial dates, however, are subject to change.

      Management is not able to predict the outcome of the litigation pending
      against Brooke Group Holding or Liggett. Litigation is subject to many
      uncertainties. An unfavorable verdict has been returned in the first phase
      of the ENGLE smoking and health class action trial pending in Florida. It
      is possible that additional cases could be decided unfavorably and that
      there could be further adverse developments in the ENGLE case. An
      unfavorable outcome of a pending smoking and health case could encourage
      the commencement of additional similar litigation. Management is unable to
      make a meaningful estimate with respect to the amount of loss that could
      result from an unfavorable outcome of many of the cases pending against
      Brooke Group Holding or Liggett, because the complaints filed in these
      cases rarely detail alleged damages. Typically, the claims set forth in an
      individual's complaint against the tobacco industry pray for money damages
      in an amount to be determined by a jury, plus punitive damages and costs.
      These damage claims are typically stated as being for the minimum
      necessary to invoke the jurisdiction of the court.

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

      Liggett's management is unaware of any material environmental conditions
      affecting its existing facilities. Liggett's management believes that
      current operations are conducted in material compliance with all
      environmental laws and regulations and other laws and regulations
      governing cigarette manufacturers. Compliance with federal, state and
      local provisions regulating the discharge of materials into the
      environment, or otherwise relating to the protection of the environment,
      has not had a material effect on the capital expenditures, earnings or
      competitive position of Liggett.

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



                                      F-45
<PAGE>   104
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      LEGISLATION AND REGULATION:

      In 1993, the Environmental Protection Agency ("EPA") released a report on
      the respiratory effect of secondary smoke which concludes that secondary
      smoke 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 secondary smoke, 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 secondary smoke was
      arbitrary and capricious. Whatever the outcome of this litigation,
      issuance of the report may encourage efforts to limit smoking in public
      areas. In July 1998, a federal district court vacated those sections of
      the report relating to lung cancer, finding that the EPA may have reached
      different conclusions had it complied with relevant statutory
      requirements. The federal government has appealed the court's ruling.

      In February 1996, the United States Trade representative issued an
      "advance notice of rule making" concerning how tobaccos imported under a
      previously established tobacco rate quota ("TRQ") should be allocated.
      Currently, tobacco imported under the TRQ is allocated on a "first-come,
      first-served" basis, meaning that entry is allowed on an open basis to
      those first requesting entry in the quota year. Others in the cigarette
      industry have suggested an "end-user licensing" system under which the
      right to import tobacco under the quota would be initially assigned based
      on domestic market share. Such an approach, if adopted, could have a
      material adverse effect on the Company and Liggett.

      In August 1996, the Food and Drug Administration (the "FDA") filed in the
      Federal Register a Final Rule classifying tobacco as a "drug" or "medical
      device", asserting jurisdiction over the manufacture and marketing of
      tobacco products and imposing restrictions on the sale, advertising and
      promotion of tobacco products. Litigation was commenced in the United
      States District Court for the Middle District of North Carolina
      challenging the legal authority of the FDA to assert such jurisdiction, as
      well as challenging the constitutionality of the rules. The court, after
      argument, granted plaintiffs' motion for summary judgment prohibiting the
      FDA from regulating or restricting the promotion and advertising of
      tobacco products and denied plaintiffs' motion for summary judgment on the
      issue of whether the FDA has the authority to regulate access to, and
      labeling of, tobacco products. The Fourth Circuit reversed the district
      court on appeal and in August 1998 held that the FDA cannot regulate
      tobacco products because Congress had not given them the authority to do
      so. Liggett supported the FDA Rule and began to phase in compliance with
      certain of the proposed FDA regulations. (See Subsequent Events.)

      In August 1996, Massachusetts enacted legislation requiring tobacco
      companies to publish information regarding the ingredients in cigarettes
      and other tobacco products sold in that state. In December 1997, the
      United States District Court for the District of Massachusetts enjoined
      this legislation from going into effect on the grounds that it is
      preempted by federal law. in November 1999, the first Circuit affirmed
      this ruling. Notwithstanding the foregoing, in December 1997, Liggett
      began complying with this legislation by providing ingredient information
      to the Massachusetts Department of Public Health. Several other states
      have enacted, or are considering, legislation similar to that enacted in
      Massachusetts.




                                      F-46
<PAGE>   105
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      As part of the 1997 budget agreement approved by Congress, federal excise
      taxes on a pack of cigarettes, which are currently 34 cents, were
      increased at the beginning of 2000 and will rise 5 cents more in the year
      2002. In general, excise taxes and other taxes on cigarettes have been
      increasing. These taxes vary considerably and, when combined with sales
      taxes and the current federal excise tax, may be as high as $1.66 per pack
      in a given locality in the United States. Congress has been considering
      significant increases in the federal excise tax or other payments from
      tobacco manufacturers, and the Clinton Administration's fiscal year 2001
      budget proposal includes an additional increase of $.25 per pack in the
      federal excise tax, as well as a contingent special assessment related to
      youth smoking rates. Increases in other cigarette-related taxes have been
      proposed at the state and local level.

      In addition to the foregoing, there have been a number of other
      restrictive regulatory actions, adverse legislative and political
      decisions and other unfavorable developments concerning cigarette smoking
      and the tobacco industry, the effects of which, at this time, management
      is not able to evaluate. These developments may negatively affect the
      perception of potential triers of fact with respect to the tobacco
      industry, possibly to the detriment of certain pending litigation, and may
      prompt the commencement of additional similar litigation.

      OTHER MATTERS:

      In March 1997, a stockholder derivative suit was filed in Delaware
      Chancery Court against New Valley, as a nominal defendant, its directors
      and Brooke Group Holding by a stockholder of New Valley. The suit alleges
      that New Valley's purchase in January 1997 of the BrookeMil shares from
      Brooke (Overseas) constituted a self-dealing transaction which involved
      the payment of excessive consideration by New Valley. The plaintiff seeks
      (i) a declaration that New Valley's directors breached their fiduciary
      duties, Brooke Group Holding aided and abetted such breaches and such
      parties are therefore liable to New Valley, and (ii) unspecified damages
      to be awarded to New Valley. In December 1999, another stockholder of New
      Valley commenced an action in Delaware Chancery Court substantially
      similar to the March 1997 action. This stockholder alleges, among other
      things, that the consideration paid by New Valley for the BrookeMil shares
      was excessive, unfair and wasteful, that the special committee of New
      Valley's board lacked independence, and that the appraisal by the
      independent appraisal firm and the fairness opinion by the independent
      investment bank were flawed. Brooke Group Holding and New Valley believe
      that the allegations in both cases are without merit. By order of the
      court, both actions were consolidated. Brooke Group Holding and New Valley
      recently filed a motion to dismiss the consolidated action. Although there
      can be no assurances, Brooke Group Holding and New Valley believe, after
      consultation with counsel, that the ultimate resolution of this matter
      will not have a material adverse effect on the Company's or New Valley's
      consolidated financial position, results of operations or cash flows.

      In July 1999, a purported class action was commenced on behalf of New
      Valley's former Class B preferred shareholders against New Valley, Brooke
      Group Holding and certain directors and officers of New Valley in Delaware
      Chancery Court. The complaint alleges that the recapitalization, approved
      by a majority of each class of New Valley's stockholders in May 1999, was
      fundamentally unfair to the Class B preferred shareholders, the proxy
      statement relating to the recapitalization was materially deficient and
      the defendants breached their fiduciary duties to the Class B preferred
      shareholders in approving the transaction. The plaintiffs seek class
      certification of the action and an award of unspecified compensatory




                                      F-47
<PAGE>   106
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      damages as well as all costs and fees. Brooke Group Holding and New Valley
      believe that the allegations are without merit. Although there can be no
      assurances, Brooke Group Holding and New Valley believe, after
      consultation with counsel, that the ultimate resolution of this matter
      will not have a material adverse effect on the Company's or New Valley's
      consolidated financial position, results of operations or cash flows.

      On October 18, 1999, an action was commenced against a subsidiary of
      Brooke Group Holding. in the Supreme Court of the State of New York,
      County of New York. The complaint alleges that under the terms of a 1993
      Put Agreement, Brooke Group Holding's subsidiary was obligated to purchase
      certain shares of plaintiff's stock for $7,500. In addition, the complaint
      seeks prejudgment interest in the amount of approximately $3,000. Brooke
      Group Holding believes, and has been so advised by counsel, that it has a
      number of valid defenses to this matter.

      As of December 31, 1999, New Valley had $12,279 of prepetition claims and
      restructuring accruals. The remaining prepetition claims may be subject to
      future adjustments depending on pending discussions with the various
      parties and the decisions of the bankruptcy court.

      New Valley is a defendant in various lawsuits and may be subject to
      unasserted claims primarily concerning its activities as a securities
      broker-dealer and its participation in public underwritings. These
      lawsuits involve claims for substantial or indeterminate amounts and are
      in varying stages of legal proceedings. In the opinion of management,
      after consultation with counsel, the ultimate resolution of these matters
      will not have a material adverse effect on the Company's or New Valley's
      consolidated financial position, results of operations or cash flows.

      RECENT DEVELOPMENTS:

      Approximately 20 purported state class action complaints have been filed
      on behalf of various consumers of cigarette products against the tobacco
      manufacturers. The complaints allege that cigarette manufacturers engaged
      in illegal and unethical activities since the 1940's, many conspiratorial
      in nature, designed to increase profits at the financial and physical
      expense of customers. These alleged activities include knowingly
      increasing the addictiveness of cigarettes through crop manipulation;
      downplaying the detrimental health effects of cigarette smoking;
      conspiring to refrain from researching and introducing "safer" cigarettes;
      creating false and misleading scientific research design to combat the
      growing scientific consensus about the lethal health effects associated
      with cigarettes; aggressively marketing products to children and minors in
      an effort to addict them to cigarettes at a young age; and systematically
      covering up activities to avoid regulation of products by governmental
      agencies. The purported class actions are brought pursuant to various
      state laws.

      In February 2000, Liggett and plaintiffs sent correspondence to the court,
      in SIMON V. PHILIP MORRIS, ET al., a putative nationwide smokers class
      action, indicating that Liggett and the plaintiffs are engaged in
      preliminary settlement discussions. There are no assurances that any
      settlement will be reached or that the class will ultimately be certified.

      In March 2000, a California jury awarded $1,700 in compensatory damages
      and $20,000 in Punitive damages to a former smoker and her husband. The
      jury found Philip Morris and R.J. Reynolds Tobacco misrepresented the
      health dangers of cigarettes and that they acted with malice. The
      defendents have stated that they intend to appeal the verdict and the
      damage awards.




                                      F-48
<PAGE>   107
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


      On March 21, 2000, the United States Supreme Court ruled that the FDA does
      not have the power to regulate tobacco.

23.   RELATED PARTY TRANSACTIONS

      The Company and New Valley have an expense sharing agreement whereby
      certain lease, legal and administrative expenses are allocated to the
      entity incurring the expense. Expense reimbursements amounted to $307,
      $502 and $375 for the years ended December 31, 1999, 1998 and 1997,
      respectively.

      An outside director of the Company is a stockholder of and serves as the
      chairman and treasurer of a registered broker-dealer that has performed
      services for the Company and its affiliates since before December 31,
      1997. The broker-dealer received brokerage commissions and other income of
      approximately $59, $128 and $522 from the Company and/or its affiliates
      during 1999, 1998 and 1997, respectively. The broker-dealer, in the
      ordinary course of its business, engages in brokerage activities with New
      Valley's broker-dealer subsidiary on customary terms.

      Effective May 1, 1998, a former officer of the Company entered into a
      consulting agreement in which the Company will pay him a total of $2,254
      in stock or cash in quarterly installments over a period of six years. The
      Company recognized the expense during the second quarter of 1998.

      In September 1998, New Valley made a one-year, $950 loan to BGLS which
      bore interest at 14% per annum. The loan and accrued interest thereon were
      repaid on September 30, 1999.

      On March 7, 1997, a partnership controlled by the Chairman transferred to
      the Company the remaining 420,000 pledged shares of the Company's common
      stock with a market value of $1,800 in final satisfaction of an obligation
      to make certain payments to the Company on account of a former executive's
      outstanding indebtedness of $5,477 (deducted from equity).

      On December 16, 1996, the Company entered into a stock option agreement
      relating to 1,050,000 shares of the Company's common stock with the
      Consultant. In addition, the Company granted the Consultant options to
      purchase 525,000 shares in 1998 and 500,000 in 1999. (Refer to Notes 18
      and 19.) During 1999, 1998 and 1997, the Consultant received consulting
      fees of $480 per year from the Company and a subsidiary.



                                      F-49
<PAGE>   108
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


24.   SEGMENT INFORMATION

      Financial information for the Company's continuing operations before taxes
      and minority interest for the years ended December 31, 1999, 1998 and 1997
      follows:

<TABLE>
<CAPTION>
                                    UNITED
                                    STATES      RUSSIA       BROKER-         REAL         CORPORATE
                                    TOBACCO    TOBACCO       DEALER         ESTATE        AND OTHER        TOTAL
                                    -------    -------       ------         ------        ---------        -----
<S>                                   <C>       <C>          <C>          <C>                     <C>
1999

Net sales......................       $422,748  $100,059     $40,852      $   3,386      $                 $567,045
Operating income...............         76,700     5,215         369           (776)         (9,505)         72,003
Identifiable assets............        112,900   160,526      47,480         57,920         125,622         504,448
Depreciation and amortization..          2,878     3,323         269            888             312           7,670
Capital expenditures...........         17,432    43,875         104                                         61,411

1998

Net sales......................       $347,129 $  97,437                                 $                 $444,566
Operating income...............         54,422    13,234                                      3,938          71,594
Identifiable assets............         74,743   104,090                                     50,149         228,982
Depreciation and amortization..          6,678     1,708                                        224           8,610
Capital expenditures...........          1,859    17,784                                      1,363          21,006

1997

Net sales......................       $312,268 $  77,347                                                   $389,615
Operating income...............          3,688     8,642                                 $   (4,301)          8,029
Identifiable assets............         68,475    46,222                                     11,760         126,457
Depreciation and amortization..          7,025       783                                        327           8,135
Capital expenditures...........          2,462    17,680                                                     20,142


</TABLE>


*  New Valley became a consolidated subsidiary of Brooke on June 4, 1999.
   Broker-Dealer, Real Estate and New Valley's portion of Corporate and Other
   are included for the seven months ended December 31, 1999.



                                      F-50
<PAGE>   109
                                BROOKE GROUP LTD.
                                    BGLS INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - (CONTINUED)


25.   QUARTERLY FINANCIAL RESULTS (UNAUDITED)

      Quarterly data for the year ended December 31, 1999 are as follows:

<TABLE>
<CAPTION>
                                            DECEMBER 31,     SEPTEMBER 30,     JUNE 30,     MARCH 31,
                                                1999             1999            1999          1999
                                          ----------------- ---------------- ------------- -------------

<S>                                            <C>               <C>           <C>            <C>
Revenues............................           $192,522          $150,219      $115,895       $108,409
Operating income....................             16,898            19,362        13,598         22,145
Income from continuing operations...              6,486             6,230       215,814          7,554
Income from discontinued
  operations........................                                                             1,249
Loss from extraordinary items.......               (250)             (354)       (1,056)
                                             ----------        ----------      --------     ----------
Net income applicable to
  common shares.....................         $    6,236        $    5,876      $214,758     $    8,803
                                             ==========        ==========      ========     ==========

*Per basic common share:

Income from continuing
  operations........................              $0.29            $ 0.28        $ 9.81         $0.34
Income from discontinued
  operations........................                                                             0.06
Loss from extraordinary items.......              (0.01)            (0.02)        (0.05)
                                             ----------        ----------      --------     ----------
Net income applicable to
  common shares.....................              $0.28            $ 0.26        $ 9.76         $0.40
                                             ==========        ==========      ========     ==========

*Per diluted common share:

Income from continuing
  operations........................              $0.24            $ 0.23        $ 8.01         $0.28
Income from discontinued
  operations........................

Loss from extraordinary items.......              (0.01)            (0.01)        (0.04)         0.05
                                             ----------        ----------      --------     ----------
Net income applicable to
  common shares.....................              $0.23            $ 0.22        $ 7.97         $0.33
                                             ==========        ==========      ========     ==========
</TABLE>

*  Per share computations include the impact of a 5% stock dividend on September
   30, 1999. Quarterly basic and diluted net income or loss per common share
   were computed independently for each quarter and do not necessarily total to
   the year to date basic and diluted net income (loss) per common share.



                                      F-51
<PAGE>   110



                                BROOKE GROUP LTD.
                                    BGLS INC.

                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                        ADDITIONS
                                              --------------- ------------------------------- --------------- --------------
                                                BALANCE AT      CHARGED TO      CHARGED TO                       BALANCE
                                                BEGINNING       COSTS AND         OTHER                          AT END
                DESCRIPTION                     OF PERIOD        EXPENSES        ACCOUNTS       DEDUCTIONS      OF PERIOD
--------------------------------------------- --------------- --------------- --------------- --------------- --------------

<S>                                                <C>          <C>             <C>             <C>               <C>
YEAR ENDED DECEMBER 31, 1999

Allowances for:
      Doubtful accounts..................          $1,096       $     217                       $     622         $   691
      Cash discounts.....................             911          14,957                          15,557             311
      Sales returns......................           7,100                                           2,910           4,190
                                                    -----        --------                         -------           -----
         Total...........................          $9,107         $15,174                         $19,089          $5,192
                                                    =====        ========                         =======           =====
Provision for inventory obsolescence.....          $1,965        $  1,124                         $   679          $2,410
                                                    =====         =======                         =======           =====

YEAR ENDED DECEMBER 31, 1998

Allowances for:
      Doubtful accounts..................         $   820       $     613                       $     337          $1,096
      Cash discounts.....................             563          12,583                          12,235             911
      Sales returns......................           4,750                          $2,350                           7,100
                                                    -----        --------      ----------         -------           -----
         Total...........................          $6,133         $13,196          $2,350         $12,572          $9,107
                                                    =====        ========      ==========         =======           =====
Provision for inventory obsolescence.....          $1,157        $  1,303     $                 $     495          $1,965
                                                    =====        ========      ==========         =======           =====
YEAR ENDED DECEMBER 31, 1997

Allowances for:
      Doubtful accounts..................         $   750       $     226                       $     156         $   820
      Cash discounts.....................             530          11,319                          11,286             563
      Sales returns......................           5,000                                             250           4,750
                                                    -----        --------      ----------         -------           -----
         Total...........................          $6,280         $11,545     $                   $11,692          $6,133
                                                    =====        ========      ==========         =======           =====
Provision for inventory obsolescence.....          $3,218       $     221     $                  $  2,282          $1,157
                                                    =====        ========      ==========         =======           =====
</TABLE>



(a) Charged  to net sales.

(b) Amounts include impact of consolidating Liggett-Ducat.



                                      F-52
<PAGE>   111


                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors of
Thinking Machines Corporation:

         We have audited the consolidated statements of operations,
stockholders' investment and cash flows of Thinking Machines Corporation and
subsidiaries for the year ended December 31, 1997. These financial statements
are the responsibility of Thinking Machines Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the result of operations and cash
flows of Thinking Machines Corporation and subsidiaries for the year ended
December 31, 1997 in conformity with generally accepted accounting principles.

         The accompanying financial statements have been prepared assuming that
Thinking Machines Corporation will continue as a going concern. As discussed in
Note 1 to the financial statements, Thinking Machines Corporation has been
unable to generate significant revenue and has incurred recurring losses from
its operations. These factors, among others, as described in Note 1, create
substantial doubt about Thinking Machines Corporation's ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

ARTHUR ANDERSEN LLP

Boston, Massachusetts
January 23, 1998


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