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International Place 100 S.E. Second Street 32nd Floor Miami, Florida 33131 305/579-8000 BROOKE GROUP Bennett S. LeBow Chairman LTD. Dear Fellow Stockholder: I am pleased to report that the hard work at Brooke Group over the last several years began paying off in 1994 and in early 1995. Brooke Group has never shied away from complex transactions in out-of-favor industries in our quest for value. As we look to 1995 and beyond, we will continue to focus on maximizing the value of our existing operations while exploring a wide range of additional opportunities in various industries in the United States and overseas in order to generate long-term value for our stockholders. For the year, Brooke Group reported consolidated revenues of $479 million, with net income of $110 million, or $6.25 per share, which includes gains from discontinued operations. Most significantly since our last report, New Valley Corporation, of which we are approximately 42 percent stockholders, successfully emerged from Chapter 11 bankruptcy proceedings in January 1995. We were particularly pleased with this outcome. With the sale of New Valley's money transfer business in November, to First Financial Management Corporation, New Valley was able to pay all of its creditor claims in full and retain over $300 million in unrestricted cash. In February 1995, New Valley acquired, for $12.6 million, a stake in Empresa Brasileira de Aeronautica, S.A., a recently privatized Brazilian commuter and military airplane manufacturer. In April, New Valley announced a definitive agreement to acquire Ladenburg Thalmann & Co., a privately held investment banking firm, for approximately $26.8 million in cash. This transaction is expected to close in June 1995. As 1995 unfolds, New Valley will continue to pursue an opportunis- tic acquisition program in various industries. We were also pleased that during 1994, Liggett Group Inc., the fifth largest manufacturer of cigarettes in the United States, continued to improve its operations in what proved to be an unfavorable operating environment. Liggett continued to focus on maximizing profitability in both the price/value and full-price branded tobacco segments. Reduced operating expenses, including a 16 percent reduction in selling, general and administrative expenses, and an increase in unit cigarette sales to approximately 11.3 billion cigarettes in 1994 from 11.2 billion in 1993, led to net income of $15.4 million for 1994, compared to a loss of $31.4 million for 1993. Liggett was the first major domestic cigarette manufacturer to successfully introduce price/value cigarettes as an alternative to full-price branded cigarettes. While the overall market for price/value cigarettes, which represented 67 percent of Liggett's 1994 net sales, declined in 1994, Liggett improved its market share in this segment to 5.4 percent from 4.7 percent in 1993, according to industry surveys. We intend to maintain or increase our market share and increase profitability in this category by providing consistently high quality products and services at competitive prices. Liggett also produces four full-price cigarette brands, including L&M, Chesterfield, Lark and Eve, which represent the remaining percentage of Liggett's cigarette sales. As we entered 1995, we simplified our operating structure through the spin off, in the form of a special dividend to our stockholders, of our 65 percent interest in MAI Systems Corporation and the

BROOKE GROUP LTD. sale of our remaining interest in SkyBox International Inc. SkyBox, the majority of which was distributed to Brooke Group stockholders in October 1993 as a special dividend, has entered into a definitive agreement to be acquired by Marvel Entertainment Group Inc. for $150 million, or $16 per share of common stock. That price represents a positive return to Brooke Group stockholders who received the stock in 1993, validating the accuracy of the independent appraisal of SkyBox done earlier that year. We also announced that we are resuming payment of a regular quarterly cash dividend on Brooke Group common stock for the first time since 1992, at $0.075 per share, beginning February 1995. The positive developments of the past year will not go unnoticed to Brooke Group's long-term stockholders. An investor who originally purchased Liggett common stock, Brooke Group's prede- cessor, at the initial public offering price of $12 per share in 1987, has to date received cash and stock dividends in excess of $20 per share. Looking ahead, we are optimistic about the future and are continuing to work hard to create long-term value for all Brooke Group stockholders. Sincerely, Bennett S. LeBow Chairman, President and Chief Executive Officer

III IIII II II I i i iiil ill ill ,, UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1994 Commission File Number : 1-5759 BROOKE GROUP LTD. (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 100 S.E. Second Street, Miami, Florida (Address of principal executive offices) 51-0255124 (I.R.S. Employer Identification Number) 33131 (Zip Code) Registrant's telephone number, including area code: (305) 579-8000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which re~_istered Common Stock, Par Value $.10 New York Stock Exchange Securities registered pursuant to Section 12(g)of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [ X ] Yes [ ] No Indicate by check mark if disclosure of delinquent fliers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant~s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ ]. l~e aggregate market value of the voting stock held by non-affiliates of the registrant as of Apdl 11, 1995 was approximately $21,916,569. Dlrectore and officare and ten percent or greater stockholders are considered affiliates for purposes of this calculation but should not necessarily be deemed affiliates for any other purpose. As of April tl, 1995, 18,247,096 shares of the registmnt's Common Stock were outstanding. Documents Incorporated by Reference: Part III (Items 10, 11, 12 and 13) from the definitive Proxy Statement for the 1995 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days after the end of the registrant~s fiscal year covered by this Report.

Item 1. Item 2. Item 3. Item 4. Item 5. Item 6. Item 7. Item 8. Item 9. ~tem 10. Item 1 1. Item 1 2. Item 1 3. Item 14. INDEX PART I Page Business .................................................................................................... .............. 2 Properties .................................................................................................... ............ 8 Legal Proceedings .................................................................................................... . 9 Submission of Matters to a Vote of Security Holders .................................................... 9 Executive Officers of the Registrant ............................................................................. 9 PART II Market for the Registrant's Common Equity and Related Stockholder Matters .................................................................................................. 1 1 Selected Financial Data ............................................................................................. 1 1 Management's Discussion and Analysis of Financial Condition and Results of Operations ........................................................................... 12 Financial Statements and Supplementary Data ............................................................. 12 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ............................................................................................ 12 PART ill Directors and Executive Officers of the Registrant ........................................................ 13 Executive Compensation ........................................................................................... 13 Security Ownership of Certain Beneficial Owners and Management ................................ 13 Certain Relationships and Related Transactions ............................................................ 13 PART IV Exhibits, Financial Statement Schedules, and Reports on Form 8-K ................................. 14 Signatures .................................................................................................... ........... 16 3.

PART I Item 1. Business Brooke Group Ltd. (the "Company" or "BGL"), a Delaware corporation founded in 1980, is principally engaged in the manufacture and sale of cigarettes, the acquisition of operating companies through a controlled subsidiary, and, through December 31, 1994, the sale of information processing systems. See "Business-Recent Developments". The Company also has investments in a number of additional companies engaged in a diverse group of businesses. Described below are the operations of the Company's core businesses. Tobacco General. The Company's tobacco business is conducted principally through its wholly- owned subsidiary, Liggett Group Inc. ("Liggett"), a Delaware corporation, which is the ultimate operating successor to the Liggett & Myers Tobacco Company formed in 1873. Liggett is engaged primarily in the manufacture and sale of cigarettes. Liggett is the fifth largest manufacturer of cigaret"tes in the United States in terms of unit sales with approximately 2.3% of the total domestic cigarette market for the year ended December 31, 1994. Liggett is headquartered in Durham, North Carolina. Liggett produces both full-price branded cigarettes as well as price/value cigarettes. Full- price branded cigarettes are generally marketed under well-recognized brand names at full retail prices to adult smokers with strong preference for branded products, whereas price/value cigarettes (which include, among others, branded discount and generic cigarettes), are marketed at lower retail prices to adult smokers who are more cost conscious. Liggett's full-price branded and price/value cigarettes are produced in over approximately 300 combinations of lengths, styles and packaging. Liggett produces four (4) full-price cigarette brands: L&M, Chesterfield, Lark and Eve. Liggett's full-price branded cigarettes represented approximately 33%, 42% and 50% of net sales (excluding federal excise taxes) in the years ended December 31, 1994, 1993 and 1992, respectively, and contributed substantially to Liggett's operating profits. Liggett's share of the full-price branded market was approximately 0.9% for the 12 months ended December 31, 1994, compared to 1.1% for the comparable period in 1993 and 1.4% for the comparable period in 1992, according to The Maxwell Consumer Report, a recognized industry publication (the "Maxwell Report"). In 1980, Liggett was the first major domestic cigarette manufacturer to successfully introduce price/value cigarettes as an alternative to full-price branded cigarettes. In 1989, Liggett established a new price point within the price/value segment by introducing Pyramid, a branded product which at that time sold for less than most other price/value cigarettes. Liggett's share of the price/value market was approximately 5.4% for the twelve months ended December 31, 1994 according to the Maxwell Report. This represents an increase from 4.7% for the comparable period in 1993, and a decrease from 6.9% for the comparable period in 1992. Liggett has attempted to regain market share in this segment by launching new price/value cigarette brands. As discussed herein, shifts in consumer preferences among different product tiers (for example, switches to premium brands resulting from the narrowing of the price differential between such brands and discount brands) have affected and could further affect Liggett's sales in the future, which .are predominantly in the price/value segment. At the present time, Liggett sells its full-price branded and price/value cigarettes principally in the United States. Liggett does not own the international rights to its L&M, Chesterfield, Lark and Eve brands. However, Liggett has introduced an international brand and sold more than 750 million cigarettes (in excess of 6% of Liggett's unit volume) in Eastern Europe and the Middle East in 1994. Liggett anticipates increased emphasis in its international segment in the future. 2

Business Strategy. Liggett's near-term business strategy is to further reduce certain of its operating and selling costs so as to maintain or increase the profitability of both its full-price and price/value products at their current unit sales volume and, further, to reduce its investment in working capital. As part of this strategy, Liggett restructured its headquarters and manufacturing operations in early 1993 and reorganized its sales force in early 1994, reducing its field sales force by 150 permanent positions and adding approximately 300 part-time positions. These changes have significantly reduced operating costs and enabled Liggett to nearly double its retail base coverage. Liggett has further reduced costs in both the administrative and manufacturing functions by making additional modifications to its manufacturing operations and significantly curtailing employee benefit programs. In March 1995, Liggett continued its efforts towards reducing costs by, among other things, offering voluntary retirement programs to eligible employees. Thus far, Liggett's cost reduction programs have reduced its headcount by approximately 14% of its total hourly employees. Liggett anticipates further cost reduction programs during 1995. Liggett's long-term business strategy in the full-price branded segment of the market is to maintain its share of that segment of the market by consistently offering promotional programs with the objective of maximizing the profitability of its full-price brands. Liggett's long-term business strategy in the price/value segment of the market is to maintain its market share and increase its profitability by providing consistently high quality products and services at prices and terms comparable to those available elsewhere in the market. Sales, Marketing and Distribution. The majority of Liggett's products are distributed from a central distribution center in Durham, North Carolina to approximately 28 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 manufactures and markets the third largest selling brand family of price/value cigarettes to the U.S. military. 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. None of Liggett's customers accounted for more than 10% of revenues in 1994. Liggett's marketing and sales functions are now performed by approximately 110 direct sales representatives calling on national and regional customer accounts, together with approximately 385 part-time retail sales consultants who service retail outlets. In addition, Liggett employs food broker groups in certain geographic locations to perform these marketing and sales functions. Manufacturing. Liggett purchases and maintains leaf tobacco inventory to support cigarette manufacturing requirements. Tobacco is an agricultural commodity subject to United States government production controls and price supports which can substantially affect its market price. Liggett normally purchases all of its tobacco requirements from domestic and foreign leaf tobacco dealers, much of it under long-term purchase commitments, and 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. Recent federal legislation imposes domestic tobacco content requirements on domestic manufacturers. See "Business- Tobacco-Government Regulation". 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 full-price branded and price/value cigarettes are produced in approximately 300 different brand styles of cigarettes under its own 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 during the past three years. Trademarks. All of the major trademarks used by Liggett are federally registered or are in the process of being registered in the United States. In view of the significance of cigarette brand awareness among consumers, management of Liggett believes that the protection afforded by its trademarks is material to the conduct of Liggett's business. Competition. Liggett is the fifth largest manufacturer of cigarettes in the United States. The four largest manufacturers of cigarettes are Philip Morris Incorporated ("Philip Morris"), R JR Nabisco Inc. ("R JR Nabisco"), Brown & Williamson Tobacco Corporation (which recently acquired American Tobacco Company; See "Management's Discussion and Analysis of Financial Condition and Results of Operation-Recent Developments in the Cigarette Industry-Competitive Activity") and Lorillard Inc. According to the Maxwell Report, Liggett's domestic shipments of approximately 11.3 billion cigarettes in 1994 accounted for 2.3% of the approximately 489.6 billion cigarettes shipped in the United States during such year, and Liggett's domestic shipments of approximately 11.2 billion cigarettes in 1993 accounted for 2.4% of the approximately 461.2 billion cigarettes shipped in the United States during such year. Although Liggett experienced an increase in its unit cigarette sales in 1994, its market share decreased. The Company believes that this was primarily ascribable to decreases in volume and market share for the price/value segment of the market. Recent pricing changes described below have caused Liggett to become more reliant upon sales in the price/value segment of the market, relative to the full-price branded segment, than certain of its competitors. The United States cigarette industry had three (3) price tiers from 1989 to 1993: full price, branded discount and generic. The cigarette industry has not historically competed on the basis of list price within a given price tier. In recent years, there have been substantial regular price increases by all manufacturers culminating in full-price branded list prices in excess of $14.00 per carton. These increases widened the gap between prices of this segment and prices in the generic segment of the market, culminating in a price gap of approximately $7.00 (50%) per carton in July 1993. In July 1993, the two (2) largest cigarette manufacturers reduced the price of their full-price branded cigarettes to 1989-1990 levels, forcing other manufacturers, including Liggett, to do likewise. This price decrease also narrowed the gap between prices of full-price brands and prices in the price/value segment (reducing the price gap from 43% to approximately 25%), which has resulted in a substantial reduction in volumes in the latter segment. Since that price decrease, list prices at all tiers have again increased and the relative volume and market share of full-price cigarettes have been increasing. According to the Maxwell Report, the price/value segment accounted for 32.5% of the 489.6 billion cigarettes shipped in the United States during 1994, compared to 36.8% of the 461.2 billion ciqarettes shipped in the United States during 1993. Consequently, Liggett's market share, which is predominantly in the price/value segment, declined in 1994. Prior to 1994, industry-wide consumer purchases of cigarettes in the United States have steadily declined at an average annual rate of 2% to 3%. The Maxwell Report, however, estimates that domestic industry-wide consumer purchases increased by approximately 6.2% in 1994, Liggett's management does not believe that this increase in 1994 is indicative of a trend. Liggett's management believes that future shipments in the United States will return to historical decline rates 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 augmented cigarette price increases. Historically, because of their dominant market share, Philip Morris and R JR Nabisco have been able to determine cigarette prices for the various pricing tiers within the industry, and the other manufacturers have been compelled, in order to remain competitive, to bring their prices into line with the levels established by the two major manufacturers. 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 strong brand loyalty..In

II I this industry, the major cigarette manufacturers compete among 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 than Liggett, and most of these competitors' brands have greater saies and consumer recognition than Liggett's brands. Government Regulation. Reports with respect to the alleged harmful physical effects associated with 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. 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 October 12, 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, in lieu of the prier warning notice, 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." Shortened versions of these statements are also required, on a rotating basis, on billboard advertisements. 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 manufacturers. The law also requires that each person who manufactures, packages or imports cigarettes annually provide to the Secretary of Health and Human Services a list of the ingredients added to tobacco in the manufacture of cigarettes. Annual reports to the United States Congress also are 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. The Omnibus Budget Reconciliation Act of 1993 ("OBRA") requires that domestic tobacco comprise at least 75% of the tobacco content of cigarettes manufactured in the United States effective January 1, 1994. Liggett uses both foreign and domestic tobacco in its cigarettes. The foreign tobacco used in Liggett's cigarettes is less expensive than comparable domestic tobacco. However, the Company took certain steps, including modifying its agreements with tobacco vendors, in an effort to reduce the potentially unfavorable effects of this legislation on its business. A General Agreement on Tariffs and Trade ("GATT"} tribunal ruled that this legislation violates GATT. Legislation has been enacted which will repeal retroactively the domestic content legislation as of December 31, 1994 upon the declaration of tariffs on imported tobacco in excess of certain quotas pursuant to a Presidential proclamation. Management believes that such a proclamation will be issued during 1995. The Company is exploring avenues which might be available to it to realize relief from the imposition of these sanctions under OBRA. While Liggett is of the opinion that there is a realistic potential for the Company realizing relief, no assurance can be given at this time that Liggett will be successful in realizing such relief, either in whole or in part.

In March 1994, the Food and Drug Administration ("FDA") began an investigation of whether cigarettes should be regulated by that agency in response to certain accusations made on a tabloid television program. These accusations have been denied by the Company and others in the industry. All radio and television advertising of cigarettes has been prohibited by federal statute since 1971 and federal law prohibits smoking aboard aircraft for domestic flights of six hours or less. Both the State of Florida and the Commonwealth of Massachusetts have enacted legislation allowing recovery of certain payments made on behalf of Medicaid recipients as a result of diseases allegedly caused by third parties. The United States Interstate Commerce Commission has banned smoking on buses transporting passengers inter-state. In addition, the United States Congress and a number of states and local government units have enacted or are considering legislation which is intended to discourage smoking through education efforts or which imposes various restrictions or requirements relating to smoking including restrictions on public smoking. Certain employers have initiated programs restricting or eliminating smoking in the workplace. Other proposals previously presented to or currently before Congress and certain states and local government units include, but are not limited to, legislative efforts to further restrict or ban the advertising and promotion of cigarettes, to eliminate the income tax deductibility of expenses incurred for such advertising and promotion, to restrict or prohibit smoking in public buildings and other areas, to increase excise taxes, to require additional warnings on cigarette packaging and advertising, to ban vending machine sales, to eliminate the federal preemption defense in product liability actions, to place cigarettes under the regulatory jurisdiction of the FDA and to require that cigarettes meet certain fire safety hazards. If adopted, at least certain of the foregoing legislative proposals might have a materially adverse impact on Liggett's business. 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. The price of cigarettes includes federal excise taxes at the rate of $12.00 per 1,000 cigarettes. This tax, which was levied as of January 1, 1993, increased the previous federal excise tax of $10.00 per 1,000 cigarettes. In the prior session of Congress, health care legislation was introduced which would have substantially increased excise taxes on cigarettes. While that legislation was not enacted, and no proposals to increase federal excise taxes are pending before Congress currently, there remains a possibility that proposals to increase excise taxes may be put forward. A substantial excise tax increase could accelerate the trend away from smoking. Excise and similar taxes on cigarettes, which are levied upon and typically paid by the distributors, are also in effect in the 50 states, the District of Columbia and many municipalities. These state and local taxes range from approximately $1.25 to $37.50 per 1,000 cigarettes. Management believes that, with the exception of certain provisions of the federal domestic content requirements described above, Liggett is in compliance in all material respects with the laws regulating 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, have no material effect on the capital expenditures, earnings or competitive position of Liggett. Acquisition of Operating Companies The Company holds an approximately 42% voting interest in New Valley Corporation ("New Valley"), a company predominantly engaged in the acquisition of operating companies. On or about November 15, 1991, an involuntary petition seeking an order for relief under Chapter 11 of Title 11 of the United States Code was commenced against New Valley by certain of its bondholders. On or about November 1, 1994, the United States Bankruptcy Court for the District of New Jersey entered an order confirming the First Amended Joint Chapter 11 Plan of Reorganization, as amended (the "Joint Plan"). Pursuant to the Joint Plan, on November 15, 1994, New Valley sold the assets and operations with which it provided domestic and international money transfer services, bill payment services, telephone cards, money orders and bank card services (collectively the "Money Transfer 6

Business") which included the capital stock of its subsidiary, Western Union Financial Services, Inc. ("FSI"}, and certain related assets, to First Financial Management Corporation ("FFMC"} and, on January 13, 1995, it sold to FFMC all of the trademarks and tradenames used in the Money Transfer Business and constituting the Western Union name and trademark, for an aggregate purchase price of approximately $1,193 million, including $893 million in cash and $300 million representing the assumption by FFMC of substantially all of New Valley's obligations under its pension plan. New Valley plans to acquire operating businesses through merger, purchase of assets, stock acquisition or other means, or to acquire control of operating companies through one of such means, with the purpose of being primarily engaged in a business or businesses other than that of investing, reinvesting, owning, holding or trading in securities. New Valley is also engaged, subject to the Option (as defined below), in the business of operating its messaging services business, which includes the Mailgram~, Telegram, Priority LettersM, HotlineTM, Automated Voice TelegramTM, Commercial Teleservices, Customer LetterTM, Cablegram, OpiniongramsM, and Datagram® messaging businesses (the "Messaging Services Business"). New Valley conducts its messaging operations through its wholly-owned subsidiary, Western Union Data Services Company, Inc., a Delaware corporation ("DSI"), which provides such messaging services to individual consumers and high-volume commercial users. New Valley has a put option to sell DSI to FFMC, and FFMC has a call option to purchase DSl from New Valley, in either case at a price of $20 million, exercisable from January 1, 1996 to March 31, 1996 (together, the "Option"). New Valley currently intends to exercise the Option, and therefore, currently reports its Messaging Services Business as a discontinued operation. On February 1, 1995, New Valley acquired, for $12.8 million , a 28.2% equity interest in a holding company that owns a 16.5% voting interest in Empresa Brasileira de Aeronautica, S.A., a Brazilian airplane manufacturer. New Valley is exploring a further investment in this venture. In addition, New Valley recently executed a definitive purchase agreement to acquire all of the outstanding shares of common stock and other equity interests of Ladenburg, Thalmann & Co. Inc., a registered broker-dealer and an investment bank, for $26.75 million in cash, subject to adjustment. The acquisition is subject to satisfaction of certain conditions, including regulatory approvals. See Note 3 to the Consolidated Financial Statements for a discussion of the Company's investment in New Valley. The information describing the business of New Valley set forth in Item 1 of New Valley's Annual Report on Form 10-K for the year ended December 31, 1994 is incorporated herein by reference. Other Businesses In addition to the above, the Company is involved in the sale of computer output microfiche products through a wholly-owned subsidiary. The Company is also involved in cigarette manufacturing and real estate development businesses in the Commonwealth of Independent States (the "CIS", formerly known as the Soviet Union). The Company's interests in the CIS have not, to date, generated a material amount of net income and has not been consolidated. The Company is contemplating further investment in the ClSo Recent Developments Through 1994, the Company conducted its information processing systems business through its majority owned subsidiary, MAI Systems Corporation, a Delaware corporation ("MAI"). MAI is engaged in the development, sale and service of a variety of computer and software products. On January 25, 1995, the Company declared a pro rata distribution of its entire 65.2% equity interest in MAI (the "MAI Distribution"), in the form of a special dividend payable on February 13, 1995 to holders of record of the Company's common stock as of February 6, 1995 (the "Eligible Shareholders"). Pursuant to the MAI Distribution, the Eligible Shareholders received: (1) one share of

MAI Common Stock for each six shares of the Company's common stock outstanding on said record date; ana (2) through an independent agent, a pro rata cash distribution for fractional shares of the MAI Shares. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Recent Events". As a result of the distribution, certain information previously reflected in consolidation in the Company's financial statements for the years ended 1992 and 1993 has been reclassified to reflect MAI's operations as discontinued operations. See Note 2 to the Consolidated Financial Statements for a further description of the MAI Distribution. The information describing the business of MAI set forth in Item 1 of MAI's Annual Report on Form 10-K for the year ended December 31, 1994 is incorporated herein by reference. At December 31, 1 994, the Company held an approximately 15% voting interest in SkyBox International Inc. ('SkyBox"), its former indirect wholly-owned subsidiary of which approximately 81.5% of the outstanding shares of common stock were distributed to the Company's shareholders in the form of a special dividend on or about October 6, 1993. On March 27, 1995, the Company divested its remaining shares of SkyBox common stock through open market sales. On or about March 29, 1995, SkyBox redeemed the Company's remaining holdings of its preferred stock. SkyBox is a producer, marketer and distributor of collectible sports and trading cards and related products. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Recent Events'. As a result of the Company's sale of its SkyBox common stock and the redemption of its SkyBox preferred holdings, certain information previously reflected in consolidation in the Company's financial statements for the year ended 1992 and for the nine month period ended September 30, 1993 has been reclassified to reflect SkyBox's operations as discontinued operations. See Note 2 to the Consolidated Financial Statements for a further description of the Company's divestiture of its equity interest in SkyBox. The information describing the business of SkyBox set forth in Item 1 of SkyBox's Annual Report on Form 10-K for the year ended December 31, 1994 is incorporated herein by reference. Employees At December 31, 1994, without giving effect to the MAI Distribution, the Company and its consolidated subsidiaries, other than those located in the CIS, had approximately 1,850 employees of which approximately 1,150 were employed by Liggett and approximately 647 were employed by MAI. Approximately 26% of the Company's employees are hourly employees and are represented by unions. The Company and its consolidated subsidiaries have not experienced any significant work stoppages since 1977, and the Company considers its relationship with its employees and their unions to be satisfactory. Item 2. Properties The Company's principal executive offices are located in Miami, Florida. The Company subleases 12,356 square feet of office space in an office building in Miami (the "Premises"). The term of the sublease is until February 28, 1999. New Valley recently relocated its principal executive office to Miami and currently shares office space with the Company at the Premises. The Company intends to enter into an expense sharing agreement with New Valley regarding its use and occupation of the Premises. 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. The principal properties owned or leased by Liggett are as follows:

Owned or Location Leased Approximate Total Square Footage Corporate Office/ Manufacturing Complex Durham, NC Owned Warehouse Durham, NC Owned Storage Facilities Danville, VA Owned Distribution Center Durham, NC Leased 1,350,000 203,000 578,000 40,000 Liggett's Durham, North Carolina facility consists of 16 major structures located on approximately 25 acres. Included are Liggett's manufacturing complex, research facility and corporate offices. In or about June 1993, the Company leased on terms consistent with those available in the general marketplace a substantial portion of one of its Durham headquarters buildings to SkyBox. The Company recently completed leasing the remainder of the building to an unrelated party. Liggett leases the Durham, North Carolina distribution center pursuant to a lease which expires May 31, 1999. Liggett utilizes approximately 40% of the distribution center and subleases the remaining 60% to a third party. Liggett has an option to purchase the leased property at any time during the term of the lease. Item 3. Legal Proceedings Reference is made to Note 14 to the Consolidated Financial Statements which embodies a description of certain legal proceedings to which the Company is or has been a party. Item 4. Submission of Matters to a Vote of Secudty Holders During the fourth quarter of fiscal 1994, the Company submitted certain matters to a vote of security holders at its Annual Meeting of Shareholders held on December 15, 1994, as proxies for said meeting were solicited pursuant to Regulation 14A under the Securities Exchange Act of 1934. The following constitutes a brief description of the matters voted upon at the meeting and a tabulation of the results: Total shares outstanding as of November 15, 1994 (the record date) - 18,260,844 Total shares voted in person or by proxy - 17,178,214 Election of directors: For Withheld Bennett S. LeBow 17,121,724 56,490 Robert J. Eide 17,122,624 55,590 Jeffrey S. Podell 17,122,624 55,590 the Company for the year ending December 31, 1994. For ~ 17,152,354 12,700 To approve the appointment of Coopers & Lybrand L.L.P. as independent accountants for Abstain 13,160 Executive Officers of the Registrant The executive officers of the Company, their respective ages, and the positions held with the Company, are listed below. I~ach of the executive officers of the Company serves until the election and qualification of his successor or until his death, resignation or removal by the Board of 9

Directors of the Company. The Company's executive officers devote substantially all of their business efforts to the affairs of the Company. Name ~ Position Bennett S. LeBow 57 Chairman of the Board, President, Chief Execu- tive Officer and Treasurer Gerald E. Sauter 51 Vice President, Chief Financial Officer and Secretary Bennett S. LeBow (the "Chairman") has been Chairman of the Board, President and Chief Executive Officer of the Company since June 1990 and has been a director of the Company since October 1986. For the past five years, the Chairman's principal occupation has been as an officer and/or director of, and a private investor in, privately and publicly held companies. Since November 1990, he has been Chairman of the Board, President and Chief Executive Officer of BGLS Inc. ("BGLS"), a wholly-owned subsidiary of the Company which is in the business of acquiring other companies and which holds (either directly or indirectly) the Company's equity interests in several private and public companies. Each of the publicly held companies have been, directly or indirectly, operating companies. The Chairman has been a director of Liggett since June 1990 and Chairman of the Board of Directors of Liggett from July 1990 to May 1993. He served as one of three interim Co-Chief Executive Officers of Liggett from March 1993 to May 1993. He has been Chairman of the Board of New Valley, in which the Company holds an indirect interest of approximately 42%, since January 1988 and Chief Executive Officer thereof since November 1994. In or about November 1991, an involuntary petition seeking an order for relief under Chapter 11 of Title 11 of the United States Code was commenced against New Valley by certain of its bondholders. New Valley emerged from bankruptcy reorganization proceedings in or about January 1995 subsequent to the United States Bankruptcy Court for the District of New Jersey's confirmation of New Valley's First Amended Joint Chapter 11 Plan of Reorganization, as amended, on or about November 1, 1994. He has been a director of MAI since 1984 and has been Chairman of the Board thereof since November 1990. He was Chief Executive Officer of MAI from November 1990 to April 1993. In or about April 1993, MAI filed for protection under Chapter 11 of Title 11 of the United States Code. MAI emerged from bankruptcy reorganization proceedings in or about November 1993 upon the United States Bankruptcy Court for the District of Delaware's confirmation of MAI's First Amended Joint Chapter 11 Plan of Reorganization. From June 1990 until August 1994, he was Chairman of the Board and/or a director of SkyBox. Gerald E. Sauter has been Vice President and Chief Financial Officer of the Company since April 1993 and Secretary since December 1993. Mr. Sauter has been Vice President, Secretary and Chief Financial Officer of BGL$ since April 1993. He has been a director and Vice President, Chief Financial Officer and Treasurer of New Valley since November 1994. Mr. Sauter has been employed by Brooke Management Inc. ("BMI"), a subsidiary of the Company, in various capacities since before 1989. l0

PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters Market Information The Company's common stock, $.10 par value per share (the "Common Stock"), is listed and traded on the New York Stock Exchange ("NYSE") under the symbol "BGL". ]-he high, low and closing sale prices for a share of Common Stock on the NYSE, as reported by the NYSE Quarterly Market Statistics, for each fiscal quarter of 1994 and 1993 were as follows (in dollars): 1994 High Low (;lose Fourth Quarter 4 1/2 2 5/8 3 3/4 Third Quarter 5 3/8 1 3/8 4 3/8 Second Quarter 2 1 1/4 1 1/2 First Quarter 2 1/4 1 1/2 1 5/8 1993 High Low Close Fourth Quarter 6 1 1/4 1 7/8 Third Quarter 6 1/8 2 5/8 4 1/2 Second Quarter 3 1/4 1 3/4 2 5/8 First Quarter 3 1 3/8 2 3/8 Holders As of April 11, 1995, there were approximately 300 record owners of the Company's 18,247,096 outstanding shares of Common Stock. Dividends No cash dividends were paid on the shares of Common Stock during fiscal years 1993 and 1994. On January 25, 1995, the Board of Directors of the Company declared that it would resume a quarterly cash dividend of $.075 per share on the Common Stock. The declaration of future cash dividends is within the discretion of the Board of Directors of the Company and is subject to a variety of contingencies such as market conditions, earnings and the financial condition of the Company. The Company currently has loan agreements that embody certain financial covenants that restrict the payment of dividends and the Company may enter into future loan agreements with similar limitations. Item 6. Selected Financial Data Selected financial data for the Company for each of its last five (5) fiscal years is set forth under the caption "Selected FinancialData" on page A-1 of this report on Form IO-K.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations A discussion of the Company's financial condition and results of operations is set forth under the caption "Managernent's Discussion and Analysis of Financial Condition and Results of Operations" on pages B-1 through B-1 1 of this report on Form IO-K. Item 8. Financial Statements and Supplementary Data Financial statements of the Corporation and specific supplementary financial information is set forth on pages C-1 through C-38 of this report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. 12

PART III Item 10, Directors and Executive Officers of the Registrant Information required by this Item 10 is contained in the Company's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders (the "Proxy Statement"), to be filed with the Securities and Exchange Commission within 120 days after the end of the registrant's fiscal year covered by this Repor~ pursuant to Regulation 14A under the Securities Exchange Act of 1934, is incorporated herein by reference. Item 1 1. Executive Compensation Information required by this incorporated herein by reference. Item 11 is contained in the Proxy Statement which is Item 12. Security Ownership of Certain Beneficial Owners and Management Information required by this Item 12 is contained in the Proxy Statement which incorDorated herein by reference. is Item 13, Certain Relationships and Related Transactions Information required by this Item 13 is contained incorporated herein by reference. in the Proxy Statement which is

PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8oK (a)(1) Index to 1994 Financial Statements: The Financial Statements listed in the accompanying Index to Selected Financial Information, Management's Discussion and Analysis of Financial Condition and Results of Operations, Financial Statements and Financial Statement Schedules on page 15 are filed as part of this report on Form IO-K. (a)(2) Financial Statement Schedules: The Financial Statement Schedules listed in the accompanying Index to Selected Financial Information, Management's Discussion and Analysis of Financial Condition and Results of Operations, Financial Statements and Financial Statement Schedules on page 15 are filed as part of this report on Form IO-K. (a|(31 Exhibits: The Exhibits listed in the accompanying Index of Exhibits on page E-1 are filed as part of this report on Form IO-K. (b) Reports on Form 8-K: Inapplicable. (c| Exhibits See Index of Exhibits on page E-I. (d| Financial Statement Schedules The Financial Statement Schedules listed in the accompanying Index to Selected Financial Information, Management's Discussion and Analysis of Financial Condition and Results of Operations, Financial Statements and Financial Statement Schedules on page 15 are filed as part of this report on Form IO-K.

BROOKE GROUP LTD, Form IO-K for the Year Ended December 31, 1994 Items 6, 7, 8, 14(a) (1) and (2), and 14(d) Index to Selected Financial Information, Management's Discussion and Analysis of Financial Condition and Results of Operations, Financial Statements and Financial Statement Schedules Selected Financial Information, Management's Discussion and Analysis of Financial Condition and Results of Operations, Financial Statements and Schedules of the Registrant and its subsidiaries, required to be included in Items 6, 7, 8, 14(a) (1) and (2), and 14(d) are listed below: Page SELECTED FINANCIAL DATA .................................................................... MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ..................................................... B-1 FINANCIAL STATEMENTS: Report of Independent Accountants ................................................. C-1 Consolidated Balance Sheets as of December 31, 1994 and 1993 ....... C-3 Consolidated Statements of Operations for the years ended December 31, 1994, 1993 and 1992 .................................................................. C-5 Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1994, 1993 and 1992 .................................... C-6 Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993, and 1992 ................................................................. C-7 Notes to Consolidated Financial Statements ...................................... C-9 Report of Independent Accountants-MAI Systems Corporation ............. C-39 Report of Independent Accountants-New Valley Corporation ................ C-40 FINANCIAL STATEMENT SCHEDULES: Report of Independent Accountants ................................................. D-1 Schedule II -- Valuation and Qualifying Accounts ............................. D-2 Financial Statement Schedules not listed above have been omitted because they are not app!icable or the required information is contained in the Consolidated Financial Statements or accompanying Notes. 15

SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Rel3ort to be signed on its behalf by the undersigned thereunto duly authorized. BROOKE GROUP LTD, (Registrant) Date: April 12, 1995 By: /s/Bennett S. LeBow Bennett S. LeBow Chairman of the Board, President, Chief Executive Officer and Treasurer

POWER OF ATTORNEY The undersigned directors and officer of Brooke Group Ltd. hereby constitute and appoint Bennett S. LeBow and Gerald E. Sauter, and each of them, with full power to act without the other and with full power of substitution and resubstitution, our true and lawful attorneys-in-fact with full power to execute in our name and behalf in the Cal3acities indicated below, this Annual Report on Form I O-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 April 12, 1995. Signature Title /s/Bennett S. LeBow Bennett S. LeBow Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Is/Robert J. Eide Robert J. Eide Director /sl Jeffrey S. Podell Jeffrey S. Podell Director /s/Gerald E. Sauter Gerald E. Sauter Vice President, Chief Financial Officer and Secretary (Principal Financial Officer and Principal Accounting Officer)

SELECTED FINANCIAL DATA The folrowing selected financial data should be read in conjunction with the Consolidated Financial Statements and the notes thereto included elsewhere in this Report. Year Ended December 31, 1994 I 1993 I 1992 I 1991 1 1990 (dollars in thousands, except per share amounts) Statement of Operations Information Revenues{1) Restructuring charges{2) Gain on reversal of New Valley losses{3) (Loss) income from continuing operations Gain (loss) from discontinued operations(z) (Loss) income from extraordinary items Net income (toss) Income (loss) from continuing operations per share(6) Gain (loss) from discontinued operations per share (Loss) income from extraordinary items per share Net income (loss) per share(6) Cash dividends declared per common share{4) $479,343 $493,041 $632,791 $632,151 $553,002 (11,913) (2,200) - 433,380 (17,991 ) (69,228) (7,724) (36,381 ) 413,881 174,683 62,001 (232,397) (113,245) (38,002) (46,597) 153,741 7,994 20,439 110,095 106,780 (232,127) (149,626) 396,318 (1.02) (4.19) (1.10) (1.98) 17.28 9.92 3.45 (11.01) (4.93) (1.59) (2.65) 8.55 0.38 0.85 6.25 5.60 (11.73) (6.91 ) 16.54 0.42 0.70 0.56 Balance Sheet Information (At Period End): Current assets Total assets CVR liability, short-term(x) Current liabilities Notes payable, long-term debt and other obligations, less current portion Noncurrent employee benefits, deferred credits and other long-term liabilities CVR liability, long term(5) Minority interest PreferTed stock of subsidiary Stockholders' equity (deficit) $ 87,504 $114,411 $256,160 $299,552 $420,684 229,425 164,819 366,206 581,252 732,904 - - 44,943 - 144,351 220,207 493,631 467,019 357,160 405,798 389,671 452,188 329,845 439,403 54,128 69,623 65,332 89,328 68,366 23,971 14,814 2,150 10,508 7,288 - (374,852) (514,682) (644,945) (338,349) (157,347) Revenues include federal excise taxes of $131,877, $127,341, $147,701, $171,029 and $39,464, respectively. See Note 7 to the Consolidated Financial Statements for information regarding the restructuring charges. Represents losses previously recognized in consolidation and subsequently reversed due to the Company no longer owning a majority of the voting interest in New Valley. See Note 1 to the Consolidated Financial Statements. Cash dividends declared per common share exclude other distributions. See Consolidated Statements of Stockholders' Equity (Deficit). See Notes 11 and 14 to the Consolidated Financial Statements for information regarding Contingent Value Rights ("CVRs'). Per share computations included the impact of the CVR liability as described in Note l(n) to the Consolidated Financial Statements. See Note 2 to the Consolidated Financial Statements, "Discontinued Operations". A-1

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in Thousands, Except Per Share Amounts! Introduction The following discussion provides an assessment of Brooke Group Ltd.'s (the "Company") results of operations, capital resources and liquidity which should be read in conjunction with the Consolidated Financial Statements and notes thereto included elsewhere in this report. The operating results of the periods presented were not significantly affected by inflation. The consolidated financial statements include the accounts of Liggett Group Inc. ("Liggett") and other less significant subsidiaries. Further, the Company holds an equity interest in New Valley Corporation ("New Valley") which sold its money transfer business in November 1994. (Refer to Notes 1, 2 and 3 to the Consolidated Financial Statements). Accordingly, the Company's earnings of discontinued operations reflects its portion of the gain ($139,935) on disposal of that operation. Going forward, the Company will account for its share of earnings based on its ownership of New Valley common and preferred stock, which at December 31, 1994 was approximately 42% and 41%, respectively° Recent Events. On February 13, 1995, the Company distributed to stockholders one share of common stock of MAI Systems Corporation ("MAI") for every six shares of common stock of the Company in the form of a special dividend. On March 27, 1995, the Company sold its remaining common shares (593,572) of SkyBox International Inc. ("SkyBox") for $9,284. In addition, on March 29, 1995 SkyBox redeemed the remaining preferred stock held by the Company in the amount of $4,000 plus accrued dividends. Accordingly, the results of discontinued operations are pdmadly those of SkyBox and MAI. Results of these entities have been reclassified as discontinued operations for the years ended December 31, 1994, 1993 and 1992. (Refer to Note 2). The Company believes it will have sufficient liquidity for 1995. This is based on, among other things, the redemption/sale of the SkyBox preferred and common stock and certain funds available from New Valley as described in the Company's indenture agreements and New Valley's First Amended Joint Chapter 11 Plan of Reorganization (the "Joint Plan"). Forecasts of cash flow for the principal operating companies indicate that they will be self-sufficient; however, due to Liggett's high degree of leverage, if Liggett were to experience significant losses due to further change in conditions in the tobacco industry or otherwise, it is possible that Liggett could be in violation of certain debt covenants. If its lenders were to exercise acceleration rights or refuse to advance under the revolving credit facility, Liggett would not be able to satisfy such demands. For purposes of this discussion and other consolidated financial reporting, the Company's significant business segment is Tobacco, Recent Develo_Dments in the Cigarette Industry_ Proposed Excise Tax Increases. Both net sales and cost of sales include federal excise taxes. The rate was $12.00 per 1,000 cigarettes (24 cents per pack) beginning January 1, 1993, and $10.00 per 1,000 cigarettes (20 cents per pack) in 1992. In the prior session of Congress, health care legislation was introduced which would have substantially increased excise taxes on cigarettes. While that legislation was not enacted, and no proposals to increase federal excise taxes are pending before Congress currently, there remains a possibility that proposals to increase excise taxes may be put forward. Substantial excise tax increases, if enacted, could accelerate the trend away from smoking and have an unfavorable effect on Liggett's future sales. B-1

R en D v I n i h Ci are Indus (continued) Competitive Activity. The United States cigarette industry had three or more list price tiers from 1989 to 1993, and as of 1993 had three list price tiers - full-price branded, branded discount and generic. Cigarette prices in all tiers were raised several times annually, with the price differentials between the tiers increasing. Between March 1991 and November 1992, the price gap between full-price branded cigarettes and generics increased from $24.40 to $37.90 per 1,000 cigarettes (from 49 cents to 76 cents per pack). As a result, during 1992 and continuing into the first half of 1993, the price/value (branded discount and generic) tiers increased market share from 24.9% to 35.8%. In July 1993, the two largest cigarette manufacturers announced significant changes in their list pricing structure and reduced the price of full-price branded cigarettes by 40 cents a pack to 1989- 1990 levels. They further announced that certain retail and trade discounts offered on certain discount cigarettes would be discontinued, resulting in a net price increase for those brands. Subsequently, the remaining cigarette manufacturers announced price changes identical to those of the two largest cigarette manufacturers. These changes consolidated the lower two price tiers into one list price tier and significantly reduced the list price gap between the full-price tier and the discount tier from 43% to approximately 24.5%. Other cigarette manufacturers and Liggett had a general list price increase in November 1993. In April 1994, BAT Industries ("BAT") announced that it had reached an agreement to purchase American Brands' American Tobacco Company subsidiary for $1 billion cash. BAT is the parent of Brown & Williamson Tobacco Corporation. The acquisition is conditioned on approval by United States government antitrust authorities. In December 1994, the Federal Trade Commission gave its approval of the proposed purchase, subject to certain conditions not thought to be unacceptable to BAT. Management is unable to state what effect this acquisition might have, if any, on the Company or the industry. Recent Legislation. In 1993, federal legislation was enacted which required United States cigarette manufacturers to use at least 75% domestic tobacco in cigarettes manufactured in the United States. The foreign tobacco used in Liggett's cigarettes is less expensive than comparable domestic tobacco. Liggett has taken certain steps, including modifying its agreements with tobacco vendors, in an effort to reduce the potentially unfavorable effects of this legislation on its business. A General Agreement on Tariffs and Trade ("GAFF") tribunal ruled that this legislation violates GAFF. Legislation has been enacted which will repeal retroactively the domestic content legislation as of December 31, 1994 upon the declaration of tariffs on imported tobacco in excess of certain quotas pursuant to a Presidential proclamation. Management believes that such a proclamation will be issued during 1995. Liggett is exploring avenues which might be available to it to realize relief from the imposition of sanctions under the 1993 legislation. VVhile management is of the opinion that there is a realistic potential for Liggett realizing relief, no assurance can be given at this time that Liggett will be successful in realizing such relief, either in whole or in part. No amount has been accrued° Further, the proposed tariff structure may have the effect of limiting Liggett's access to imported tobacco, driving Liggett's cost of goods higher. Due to existing inventories of foreign tobacco, management believes the tariffs will have not have any short-term effects but is unable to state at this time what long-term effects, if any, the tariffs will have on Liggett. B-2

Recent Develo_oments in the Cicjarette Industry (continued) Possible FDA Action. The Food and Drug Administration ("FDA") has announced that it is considering classifying tobacco as a drug, and an FDA advisory panel has stated that it believes nicotine is addictive. Management is unable to predict whether such a classification will be made. Management is also unable to predict the effects of such a classification, were it to occur, on its business and profitability, but such a classification could have an unfavorable impact on Liggett's operations. Results of Operations The year 1994 comoared to the year 1993 Revenues. Net revenues for the year ended December 31, 1994 were $479,343 as compared with $493,041 for the year ended December 31, 1993. Of the approximately $13,700 decline, $7,700 is attributable to declines in revenues at Liggett, and $6,000 reflects declines at other, less significant subsidiaries. Liggett's net sales were $465,676 for the year ended December 31, 1994 versus $473,393 last year. This 1.6% decrease in revenues was primarily due to a 5.9% increase in unit sales, offset by a 7.1% decline in selling prices and the effects of the change in sales mix. See "Recent Developments in the Cigarette Industry - Competitive Activity" for a discussion on the decrease in selling prices in mid 1993. The increase in unit sales volume was comprised of an increase in the price/value cigarette segment (8.5%), partially offset by a decline in the full-price branded segment (8.0%). The increase in price/value cigarette volume was comprised of increases in control label brands partially offset by decreases in generic and branded discount volume. The decrease in generic volume was primarily due to the loss of significant accounts to other cigarette manufacturers who used their greater resources by leveraging rebate programs tied to their full- price products and by providing large up-front payments which Liggett was unable to match. The increase in price/value cigarette volume is a reflection of Liggett's renewed emphasis on the price/value segment. The historical decline in full-price branded and branded discount unit sales volume was slowed during the current year due to expanded retail base coverage, reduced selling prices and more effective promotional programs. Gross Profit. Consolidated gross profit was $249,536 for the year ended December 31, 1994 compared to $259,655 for the same period last year. This $10.1 million decrease is largely due to a decrease of $13.2 million at Liggett offset by improved margins at less significant subsidiaries. Gross profit at Liggett was $242,902 for the year ended December 31, 1994, a decrease of $13,243 from $256,145 last year. Gross profit as a percentage of revenues (excluding federal excise taxes) for the year decreased to 72.8% compared to 74.0% for 1993, due primarily to sales mix and reduced selling prices, partially offset by lower per unit cost of sales. There were no list price changes in 1994. Expenses. Consolidated operating, selling, general and administrative expenses were $235,374 compared to $256,902 for the years ended December 31, 1994 and 1993, respectively. This decrease of $21.5 million from the prior year reflects reductions made at the corporate level and at Liggett in 1993, in which the Company took restructuring charges totaling $11.9 million. At Liggett, the reduction primarily results from lower marketing costs which include product price decreases and reorganization of the sales force. These 1994 decreases at Liggett were offset B-3

Results of O_~erations (continued) by corporate charges for debt restructuring of $7,500, stock compensation expense of $7,682 and pension curtailment of $691. Other Income (Expense). Consolidated interest expense was $55,952 and $54,915 for the years ended December 31, 1994 and 1993, respectively. The increase in interest expense was primarily due to the issuance of Series C Notes at Liggett partially offset by lower outstanding revolver balances. Loss from Continuing Operations. Loss from continuing operations in the year ended December 31, 1994 was $17,991 as compared to a loss of $69,228 in 1993. A tax benefit of $24,200 which relates to the completion of an audit by the Internal Revenue Service through December 31, 1991 mitigated 1994 losses. There was no tax benefit for 1993 as operating losses were required to be carried forward and realization is not assured due to historical losses. Other. At December 31, 1994, the Company and its consolidated group had net operating loss carryforwards for tax purposes of approximately $120,000 which may be subject to certain restrictions and limitations and which will generally expire in 2007 and 2008. The year 1993 com_~ared to the year 1992 Revenues. Consolidated revenues were $493,041 for the year ended December 31, 1993 compared to $632,791 for the year ended December 31, 1992, a decrease of $139,750. This decrease reflects decreases in revenues at Liggett, as discussed below. Net sales at Liggett were $473,393 for the year ended December 31, 1993 compared to $605,819 for the same period last year. This 21.9% decrease in revenues was primarily due to a 25.0% decline in unit sales volume and a 5.8% decline in revenues due to the effects of changes in sales mix which were partially offset by price decreases in the full-price branded and branded discount products in the third and fourth quarters of 1993. The decrease in unit sales volume was comprised of declines in full-price branded, generic and branded discount cigarette unit sales of approximately 34%, 17% and 44%, respectively. These declines were partially offset by an increase in volume in Liggett's less significant international market. The decrease in full-price branded unit sales is a result of Liggett's renewed emphasis on the discount segment as well as current industry trends, which showed a 21.4% decrease in this segment's shipments for the year ended December 31, 1993. For a discussion of pricing changes for the premium and discount segments and the resulting consolidation of product tiers in the cigarette industry in the third and fourth quarters of 1993, see "Recent Developments in the Cigarette Industry - Competitive Activity". The decrease in price/value cigarette volume, which includes generic and branded discount cigarettes, was primarily due to increased unit sales by certain other manufacturers as a result of expanded promotional efforts and the effects of other cigarette manufacturers competing in this segment. Liggett believes certain other cigarette manufacturers used their greater resources by requiring purchases by distributors of discount brands as a condition to participation in rebate programs tied to their full-price products ("leveraging") and by providing large up-front payments to distributors in the third and fourth quarters of 1992. Liggett believes that at least one of these other cigarette manufacturers continued to offer large up-front payments in the first half of 1993 and that the B-4

Results of Operations (continued) leveraging programs are continuing. In addition, Liggett believes that the decrease in branded discount volume was caused by the effects of the proliferation of price/value products offered by other manufacturers and Liggett's lower promotional spending for branded discount products in 1993. Liggett believes that, to the extent that prices and margins increase, the effects of these promotional activities by competitors will become less severe. Gross Profit. Consolidated gross profit for the Company was $259,655 for the year ended December 31, 1993, compared to $329,412 for the similar period in 1992. This $69,757 decrease is attributable to a decrease in gross profit at Liggett. Gross profit for Liggett was $256,145 for the year ended December 31, 1993, a decrease of $69,605 from $325,750 in 1992. This decrease was primarily the result of a 25% reduction in unit volume mentioned above. Gross profit as a percentage of revenues (excluding federal excise taxes) increased to 74.0% for the year ended December 31, 1993 compared to 71.1% for the same period in 1992, due primarily to an increase in selling prices and reduction in cost of sales, due to lower material costs. There can be no prediction as to the frequency or extent of future price changes and their effect on net sales while there were significant list price decreases in July 1993, other cigarette manufacturers and Liggett had a general list price increase in November 1993. Expenses. Consolidated operating, selling, administrative and general expenses were $256,902 for the year ended December 31, 1993 compared to $311,506 for the year ended December 31, 1992. This decrease of $54,604 reflects reductions at the corporate level and at Liggett. At corporate, the disposal of former international investments in December 1992 reduced expenses $22,400 in 1993. Operating, selling, administrative and general expenses for Liggett were $249,900 for the year ended December 31, 1993 compared to $273,062 for the year ended December 31, 1992, a decrease of $23,162. In order to reduce operating costs to levels more consistent with reduced revenues, Liggett reduced its overall headcount by 235 headquarters and manufacturing employees in April and May 1993. This resulted in a $5,565 charge ($2,531 of which is included in cost of sales) to operating income in the second quarter. Furthermore, Liggett restructured its field sales force in January 1994 by eliminating 150 permanent field sales positions and adding approximately 300 part-time positions and recorded a $3,000 severance charge against operating income in the fourth quarter of 1993. In 1993, Liggett revised its advertising and promotional programs to reflect its increased emphasis on the discount market segment. Liggett believes these steps significantly reduced operating costs and enabled it to reduce selling, general and administrative expenses as percentage of revenues in future periods. Other Income (Expenses). Consolidated interest expense was $54,915 for the year ended December 31, 1993 compared to $59,223 for the year ended December 31, 1992, a decrease of $4,308. Corporate interest expense was $35,527 for the year ended December 31, 1993 as compared with $41,154 for the year ended December 31, 1992, a decrease of $5,627 due to debt repurchases (see below). This was offset by slightly higher expense at Liggett due to incurring a full year's interest expense in 1993 associated with the issuance of the Liggett Series B Senior Notes in 1992. In the first quarter of 1993, the Company repurchased $48,560 of its 15.501% Junior Subordinated Secured Notes for $10,198. Additionally, in the second quarter of 1993 the Company purchased B-5

Results of Operations (continued) $5,200 face value of its Debt Securities (as defined below) for $574 (see Note 6 to the Consolidated Financial Statements). These repurchases reduced the Company's interest expense by $6,287 and also resulted in an extraordinary gain on extinguishment of indebtedness of $42,849. During the fourth quarter of 1992, the Company recorded income of $36,918 as a result of a legal settlement agreement providing for the payment to the Company of $25,000 in cash, waiver of payment of all accrued interest on $48,560 of Junior Subordinated Secured Notes ($11,918) and dismissal of all claims. Other. There is no tax benefit for 1993 or 1992 as operating losses were carried forward for tax purposes and realization is not assured due to historical losses. Capital Resources and Li~.uidity Net cash used in operations was $44,060 for the year ended December 31, 1994. Net income of $110,095 was due principally to equity in earnings of New Valley and SkyBox of $113,515. Other non cash income included a tax benefit of $24,487 in which the Company adjusted its reserves upon completion of an audit by the Internal Revenue Service. This non cash income was offset by cash interest payments of $39,429. For the year ended December 31, 1993, net cash provided by operations was $21,950. Net income of $106,780 was generated primarily by MAI, now a discontinued operation. With regard to MAI, non cash extraordinary items amounted to $110,892 of its income. In addition, other non cash income relates to the Company's extraordinary gain on early extinguishment of debt principally resulting from the repurchase of its 15.501% Junior Subordinated Secured Notes from Liberty Service Corporation. These non cash income items were offset by interest paid of $56,217. Losses in 1992 of $232,127 resulted from losses of discontinued operations of $224,627 including a write-off of goodwill relating to MAI of $145,690. Other items contributing to a reduction of cash included a decrease in accounts payable and accrued liabilities primarily related to a reduction of accrued promotional expenses at Liggett and an increase in receivables due to a legal settlement at Corporate. The decrease in cash in 1994 when compared to 1993 was further caused by increased trade receivables resulting from timing of December sales, increased inventories resulting from increased customer demands in 1994 as compared with a decrease in other receivables in 1993 principally due to a legal settlement. Further, there were increased payments to vendors in 1994 as compared with slowing of trade payments in 1993. Cash provided by investing activities in 1994 was $23,861 and primarily relates to the sale/redemption of SkyBox common and preferred stock. In 1993, cash provided of $5,222 included proceeds from the redemption of SkyBox preferred and the sale of other assets which were offset by the impact of discontinued operations including the effect of changing to the equity method of accounting for SkyBox ($16,078). Cash used in investing activities in 1992 was $25,060 and relates to acquisitions of $9,600, investment in discontinued operations, principally MAI of $16,468 and capital expenditures of $7,009 offset by proceeds from the sale of marketable securities and other assets. Capital expenditures in 1994, 1993 and 1992 were principally to maintain production facilities and for operational efficiencies at Liggett. Management believes capital expenditures have declined B-6

Capital Resources and Liquidity (continued) because of significant equipment modernization occurring in 1980s and early 1990s, and the effects of lower unit sales and does not anticipate that the Company's future operations will be adversely affected by this decline. Capital expenditures of approximately $3,700, primarily for maintenance of production facilities and further equipment modernization, are projected for the year ending December 31, 1995. These expenditures are expected to be funded with cash flow from operations and borrowings under Liggett's revolving credit facility. Cash flows provided by financing activities in 1994 was $8,765 as compared with cash used in 1993 of $30,022. Proceeds from financing activities in 1994 included proceeds from issuance of the Series C Notes at Liggett, stockholder loan repayments with interest offset principally by decreases in cash overdrafts and payment of Series G dividends. Cash was used in financing activities in 1993 to repurchase bonds, repay debt, pay Series G preferred dividends, purchase treasury stock and discontinued operations. This was offset by the return of the CVR collateral and an increase in cash overdraft. In 1992, cash provided through financing activities was principally through Liggett's issuance of the Senior Secured Notes (the "Series B Notes") offset by repayments of debt, treasury stock repurchases, dividends on common stock a deposit of the CVR collateral and the impact of discontinued operations. At December 31, 1994, corporate long term debt was approximately $247,000 compared with $222,000 on December 31, 1993. The outstanding debt at year end 1993 included $6,851 which had been advanced by certain holders ("Participating Holders") of the Company's 16.125% Senior Subordinated Reset Notes due 1997 ("Reset Notes") and the 14.50% Subordinated Debentures due 1998 ("Subordinated Debentures"), together known as the Debt Securities. Subsequently on March 31, 1994, these same Participating Holders advanced an additional $6,850 under the original agreement as amended. An Exchange and Termination Agreement ("Exchange Agreement") was entered into on September 30, 1994 pursuant to which the prior agreements among the Company and the Participating Holders were terminated. Under the Exchange Agreement, on October 3, 1994 the Company exchanged an aggregate of $49,900 of new 13.75% Series 2 Senior Secured Notes due 1997 ("Series 2 Notes") for an equal principal amount of Reset Notes. The Company also agreed, subject to applicable securities laws, to offer to other holders of the Reset Notes the opportunity to exchange the Reset Notes for Series 2 Notes. That offer commenced October 21, 1994 and closed on December 12, 1994. An additional $33,675 of Reset Notes were exchanged for Series 2 Notes. Only $5,670 of Reset Notes now remain. In addition, a net amount of $183 Series 2 Notes were issued for interest accrued to December 12, 1994 to those participating in the exchange offer. In related transactions with the same Participating Holders, BGLS Inc. ("BGLS"), a subsidiary of the Company, issued (i) an aggregate of $18,958 of its 13.75% Series 1 Senior Secured Notes due 1995 ("Series 1 Notes") to Participating Holders in consideration of the transfer to BGLS by the Participating Holders of certain Revised Senior Secured Notes and Senior Secured Notes of BGLS due October 3, 1994 plus interest accrued thereon, (ii) an aggregate of $2,936 of Series 1 Notes to certain of the Participating Holders on account of new loans extended by them to BGLS in respect of interest payable on October 3, 1994 on the Subordinated Debentures held by such Participating holders, and (iii) an aggregate of $7,536 of Series 2 Notes to the Participating Holders in satisfaction of other obligations to the Participating Holders. In addition, pursuant to the Exchange Agreement certain expenses of certain of the Participating Holders relating to the prior agreements, the Exchange Agreement and the New Valley bankruptcy proceeding, were reimbursed to them by B-7

Ca_Dital Resources and Liauidity (continued) BGLS paying them $500 cash and issuing to them an aggregate $1,700 of Series 1 Notes. In total, additional expense to the Company resulting from these transactions was $9,700. Under certain circumstances some or all of the $500 cash and $1,700 of Series 1 Notes transferred to such Participating Holders may be required to be reimbursed by them to BGLS at a later date. To date, $242 of such amount has been reimbursed. The Series 1 and Series 2 Notes are senior to the Debt Securities and are collateralized by the Company's equity interests in Liggett and New Valley Holdings, Inc. ("NVH") with respect to Sedes 1, and by NVH with respect to Series 2. The Series 1 and Series 2 Indentures also require that the Company use its reasonable best efforts to prepare and file with the Securities and Exchange Commission a Registration Statement and to have the Registration Statement declared effective as soon as practicable following the date that the Series 1 and Series 2 Notes were originally issued (i.e., October 3, 1994). If the Registration Statement was not declared effective by February 1, 1995, the interest rate would increase 0.50% per annum. Thereafter, and until the Registration Statement is effective, the interest rate on the Series 1 and Series 2 Notes would increase an additional 0.25% per annum 90 days following the immediately preceding increase. The Company is in the process of preparing the Registration Statement. The interest rate has increased under the conditions described above to 14.25% effective February 1, 1995; however, it will immediately revert on a prospective basis to its original rate of 13.75% as soon as the Registration Statement is declared effective. The Series 1 Indenture provides that so long as Series 1 Notes are outstanding, if BGLS receives payments from NVH, those payments in most cases must be applied to pay accrued and unpaid interest on, and then to redeem, Series 1 Notes. The Series 2 Indenture also places certain restrictions on the application of payments from NVH, including the redemption of the Series 2 Notes before the Debt Securities are redeemed. In the third quarter 1994 and with respect to the Debt Securities, an agreement was entered into among Participating Holders, the Company and BGLS pursuant to which BGLS agreed that, upon the effective date of the Joint Plan, BGLS would effect certain amendments to the indentures applicable to the Debt Securities (the "Indenture Amendments"). On January 18, 1995, the Indenture Amendments were effected. Generally, the Indenture Amendments, require BGLS to apply any amounts received by it with respect to the New Valley preferred stock or New Valley common stock which it holds ("New Valley Distributions") in excess of $10,000 but not in excess of $30,000, first to the payment of interest and then to principal of Series 1 Notes, Series 2 Notes, Reset Notes and Subordinated Debentures. To the extent that New Valley Distributions exceed $30,000, BGLS is required to apply such amounts first to interest on, and then to the payment of principal of Series 2 Notes, Reset Notes and Subordinated Debentures. The $10,000 and $30,000 thresholds are revised upwards under certain circumstances. At April 3, 1995, the $10,000 threshold has been revised to approximately $22,700. New Valley distributions in excess of this amount are restricted as to their uses. On April 3, 1995 a Notice of Redemption was sent to holders of the Series 1 Notes in which the Company announced its intention to redeem the Series 1 Notes on May 3, 1995. Accordingly, on April 3, 1995 the Company deposited with the trustee an amount sufficient to redeem all of the Series 1 Notes including interest thereon accruing from April 1, 1995 to May 3, 1995. B-8

Capital R~sources and Li0uidity (continued) Under certain circumstances, the Company may be required to purchase an equity interest of up to $7,500 in the holding company of MAI's former European subsidiaries. This amount has been recorded as a liability at December 31, 1994. On June 12, 1991, Liggett entered into a secured revolving credit facility for $50,000 with a syndicate of commercial banks (the "revolver" or the "facility"). The facility was collateralized by all inventories and receivables of Liggett, and was to expire on April 30, 1995. Borrowings under the revolver amounted to $28,436 at December 31, 1993, and bore interest at a rate equal to 1% above the lending bank's prime rate. The facility required Liggett's compliance with financial and other covenants. The facility also limited the amount of dividends and distributions by Liggett. This facility was replaced by a new facility in 1994 discussed below. On March 8, 1994, Liggett entered into a new revolving credit facility for $40,000 with a syndicate of commercial banks (the "new facility") that replaced the facility due April 30, 1995. The new facility is collateralized by all inventories and receivables of Liggett. Borrowings under the new facility bear interest at a rate equal to 1.5% above the Philadelphia National Bank's prime rate which was 8.5% at December 31, 1994. The new facility requires Liggett's compliance with certain financial and other covenants. The new facility also limits the amount of dividends and distributions by Liggett. The new facility expires on March 8, 1997. The refinancing of the revolver resulted in an extraordinary charge of $843 for loss on early extinguishment of debt. Liggett believes that the new facility will adequately address its liquidity requirements during 1995. On February 14, 1992, Liggett issued $150,000 in Senior Secured Notes (the "Notes" or "Sedes B Notes"). From the proceeds of $148,244, net of an original issue discount, $144,054 was dividended to BGLS and $4,190 was paid as financing fees. Interest on the Notes is payable semiannually on February 1 and August at an annual rate of 11.5%. The Notes require mandatory principal redemptions of $7,500 on February 1 in each of the years 1993 through 1997 and $37,500 on February 1, 1998 with the balance of the Notes due on February 1, 1999. The Notes are collateralized by substantially all of the assets of Liggett, excluding accounts receivable and inventory. The Notes may be redeemed, in whole or in part, at a price equal to 104%, 102% and 100% of the principal amount in the years 1996, 1997 and 1998, respectively, at the option of Liggett at any time on or after February 1, 1996. The Notes contain restrictions on Liggett's ability to pay dividends, incur additional debt, grant liens and enter into any new agreements with affiliates, among others. On January 31, 1994, Liggett issued $22,500 of Variable Rate Series C Senior Secured Notes (the "Series C Notes") due February 1, 1999. Liggett received $15,000 from the issuance in cash and received $7,500 in Series B Notes which were credited against the mandatory redemption requirements of Series B Notes required under the indenture for February 1, 1994. Liggett used the cash proceeds to satisfy working capital needs, which included payment of interest related to Sedes B Notes of $8,172. The Series C Notes have the same terms (other than interest rate) and stated maturity as the Series B Notes. The Series C Notes bear a 16.5% interest rate, which was reset on February 1, 1995 to 19.75%. Liggett had received the necessary consents from the required percentage of holders of its Series B Notes allowing for an aggregate principal amount up to but not exceeding $32,850 of Notes to be issued under the Series C Indenture. In connection with the consents, holders of Series B Notes received Series C Notes totaling two percent of their current Series B Notes holdings. The total principal amount of such Series C Notes issued was $2,842. On November 20, 1994, Liggett issued the remaining $7,508 of Series C Notes in exchange for an equal amount of Series B Notes and cash of $375. The Series B Notes were credited against the mandatory redemption requirements for February 1, 1995. B-9

Capital Resources and Liauidity (continued) As part of an inventory management program, Liggett has entered into tobacco purchase agreements under which Liggett's commitments amounted to approximately $41,000 at December 31, 1994, of which approximately 90% is foreign tobacco. The United State Congress, through the Omnibus Budget Reconciliation Act ("OBRA") of 1993, has required that domestic tobacco comprise at least 75% of the content of cigarettes manufactured in the United States effective January 1, 1994. A GATT tribunal has ruled that this legislation violates GATT. Legislation has been enacted which will repeal retroactively the domestic content legislation upon the declaration of tariffs on imported tobacco in excess of certain quotas pursuant to a Presidential proclamation. Management believes that such a proclamation will be issued during 1995. Liggett is exploring avenues which might be available to it to realize relief from the imposition of sanctions under OBRA. While the Company is of the opinion that there is a realistic potential for Liggett realizing relief, no assurance can be given at this time that Liggett will be successful in realizing such relief either in whole or in part. No amount has been accrued. Liggett's accounting i3olicy is to accrue legal and other costs in defending against product liability contingencies as services in respect thereto are performed. Such costs have not been and are not expected to be a material selling, general and administrative expense. In November 1993, the Company announced a restructuring of its pension and postretirement medical plans. BGLS, the plan's sponsor, announced it would freeze its pension plan obligation related to salaried Liggett employees effective December 31, 1993 and accordingly does not expect significant pension expense in the future. Further, retirees will be required to fund 60% of participant medical premiums in 1994 and 100% of premiums on going-forward basis, effective January 1, 1995. Also, effective December 31, 1993, BGLS terminated its postretirement medical, Medicare Part B and life insurance plans. Liggett subsequently modified its postretirement medical plans to include funding responsibility for persons either retired on eligible to retire at June 29, 1990, the eligibility date of the terminated BGLS plan. The Plan's Accumulated Postretirement Benefit Obligation (as defined in SFAS 106) increased by $4,500 from January 1, 1993 to December 31, 1993 as a result of the change. A pension curtailment charge of $691 was incurred in 1994. As a result of the financial conditions discussed above, Liggett has made efforts to reduce certain of its operating and selling costs and will continue to examine opportunities for cost reduction. The reductions in workforce that occurred in April and May 1993 have allowed Liggett to lease, on terms available in the general marketplace, a substantial portion of one of its Durham headquarters buildings to a former affiliated company. Liggett recently completed leasing the majority of the building to unrelated parties. In addition, Liggett announced a further workforce reduction of 63 manufacturing employees on March 31, 1995. Currently, these charges are estimated at approximately $750 and will be recorded in the first quarter of 1995. The Company and its subsidiaries expect to finance their long-term growth, working capital requirements, capital expenditures and debt service requirements through a combination of cash provided from operations, negotiation of secured bank credit lines, additional public or private debt financing and distributions from New Valley. In January 1995, a special $50 per share dividend was granted to holders of New Valley $15,00 Class A Increasing Rate Cumulative Senior Preferred Shares. The Company's subsidiary, NVH realized $30,916 in the transaction. New Valley plans to use the cash from the sale of its money transfer business to First Financial Management Corporation to acquire operating businesses through merger, purchase of assets, stock acquisition or other means, or to acquire control of operating companies through one of such means, with the purpose of being primarily engaged in a business or businesses other than that of investing, reinvesting, owning, holding or trading in securities. B-10

Ca.~ital Resources and Liquidity_ (continued) The Investment Company Act of 1940, as amended (the "Investment Company Act"), and the rules and regulations thereunder, require the registration of, and impose various substantive restrictions on, companies that (I) engage primarily in the business of investing, reinvesting, or trading in securities or (ii) engage in the business of investing, reinvesting, owning, holding or trading in securities and own or propose to acquire "investment securities" having a value exceeding 40% of a company's "total assets" (excluding United States government securities and cash items). For purposes of the Investment Company Act, "investment securities" include stocks, bonds and other securities, but exclude United States government securities and securities issued by majority- owned subsidiaries that are not investment companies. New Valley is relying on the temporary exemption from registration provided by Rule 3a-2 under the Investment Company Act. Pursuant to that Rule, the Executive Committee of the Board of Directors of New Valley has adopted a resolution that New Valley shall use reasonable efforts to become engaged, as soon as reasonably possible, and, in any event, within the one-year period prescribed by Rule 3a-2, primarily in a business or businesses other than that of investing, reinvesting, owning, holding or trading in securities, and that, if said reasonable efforts do not result in New Valley's becoming engaged in such business or businesses on or prior to the end of such one-year period, New Valley will seek to obtain an extension of such date or an exemption from the Securities and Exchange Commission (the "SEC") or no-action position from the SEC staff with respect to registration under the Investment Company Act. New Valley plans to become engaged in such business or businesses (by acquisitions or otherwise) within a time frame and in a manner such that it will not be required to register under the Investment Company Act. On January 25, 1995, the Company announced that it would resume payment of regular quarterly cash dividends on its common stock. A quarterly cash dividend of $0.075 per share was distributed on February 13, 1995 to Company shareholders of record as of February 6, 1995. In December 1991, the Company announced a program to repurchase up to 1,000,000 shares, or approximately 4% of its issued common stock. Through December 31, 1992, 701,800 shares had been acquired at an average cost of $5.30 per share. The Company completed the repurchase program as of April 30, 1993 through the purchase of 298,200 shares in 1993 at an average cost of $2.14 per share. In the second quarter of 1993, the Company announced an extension of its program to repurchase additional shares of its issued common stock in amounts which could approach or possibly exceed the amount of common stock acquired in previous repurchase programs. Under the extension, the Company has repurchased 951,000 shares at an average cost of $2.88 per share through December 31, 1993. B-11

Coopers &Lybrand Coopers & Lybrand L.L.R a professional serwces firm REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Brooke Group Ltd.: We have audited the accompanying consolidated balance sheets of Brooke Group Ltd. and Subsidiaries (the "Company") as of December 31, 1994 and 1993 and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 3 I, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of MAI Systems Corporation ("MAI"), a discontinued subsidiary (Note 2), which statements reflect total (liabilities) assets comprising (5)% and 13 % of consolidated total (liabilities) assets at December 31, 1994 and 1993, respectively, and net income comprising 4%, 114% and (78)% of consolidated net income (losses) for the years ended December 31, 1994, 1993 and 1992, respectively. Further, we did not audit the f'mancial statements of New Valley Corporation ("New Valley"), the investment which is being accounted for by the Company using the equity method of accounting (Note 3). The Company's investment in New Valley represents 43 % of consolidated total assets at December 31, 1994 and the equity in the net income of New Valley represents 85% of consolidated net income for the year ended December 31, 1994. Those statements were audited by other auditors whose reports have been furnished to us and our opinion on the consolidated f'mancial statements, insofar as it relates to the amounts included for MAI and New Valley, are based solely upon the reports of the other auditors. 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 f'mancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the f'mancial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall f'mancial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports of other auditors, the consolidated f'mancial statements referred to above present fairly, in all material respects, the consolidated financial position of Brooke Group Ltd. and Subsidiaries at December 31, 1994 and 1993 and the consolidated results of their operations and their cash flows for each of three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. (2-1 Coopers & Lybrand LL.P.. a registered hmited liability partnership, is a member firm of Coopers & Lybrand (international),

As discussed in Note 14 to the consolidated financial statements, there is litigation pending against the Company and its wholly owned subsidiary Liggett Group Inc. The ultimate outcome of the litigation cannot presently be determined. Accordingly, no provision for any liability that may result upon adjudication has been made in the accompanying financial statements. As discussed in Note 1 to the consolidated financial statements, in 1993 the Company changed its method of accounting for postretirement benefits other than pensions to conform with Statement of Financial Accounting Standards No. 106. COOPERS & LYBRAND L.L.P. Miami, Florida April 3, 1995 C-2

BROOKE GROUP LTD. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (.Dollars in Thousands. Exce.~t Per Share Amounts) ASSETS: Current assets: Cash and cash equivalents Accounts receivable - trade Other receivables Inventories Income taxes receivable Other current assets Total current assets Property, plant and equipment, at cost, less accumulated depreciation Intangible assets, at cost, less accumulated amortization of $13.936 and $12,214 Investment in affiliate Other assets Total assets December 31, 994 1993 4.276 31,325 1,558 47,098 87,504 $ 15,773 35,462 17,704 41,463 1,161 2.848 114,411 25,806 6,728 97,520 11.867 $ 229.425 27.521 8,427 14.460 $164.819 The accompanying notes are an integral part of the consolidated financial statements C-3

BROOKE GROUP LTD. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, Continued !Dollars in Thousands. Exce_~t Per Share Amounts) LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT): Current liabilities: Notes payable and current portion of long-term debt Accounts payable Cash overdraft Accrued promotional expenses Unearned revenue Dividends payable Net current liabilities of business held for disposition Other accrued liabilities Total current liabilities Notes payable, long-term debt and other obligations, less current portion Noncurrent employee benefits Net long term liabilities of business held for disposition Other liabilities Commitments and contingencies Stockholders' equity (deficit): Preferred Stock, par value $1.00 per share, authorized 10,000,000 shares Series G Preferred Stock, 2,184.834 shares, convertible, participating, cumulative, each share convertible to 1,000 shares of common stock and cash or stock distribution, liquidation preference of $1.00 per share ($2 at December 31, 1993). Common stock, par value $0.10 per share, authorized 40,000,000 shares, issued 24,998,043 shares, outstanding 18,260,844 and 15,259,762 shares, respectively Additional paid-in capital Deficit Other Less: 6,737,199 and 7,553,447 shares of common stock in treasury, at cost Total stockholders' equity (deficit) Total liabilities and stockholders' equity (deficit) December 31, 994 I 1993 $ 26,491 12,415 4,860 29,853 2,056 131 4,974 63.571 144,351 $16,097 16,619 19,333 38,768 7,172 15,136 107.082 220,207 405,798 31,119 23,009 389,671 35,957 33,666 1,826 66,245 (420,746) 11,365 (33.542) (374.852) $229.425 1,526 60,578 (540,942) (35.846) (514.682) $164.819 The accompanying notes are an integral part of the consolidated financial statements C-4

BROOKE GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands, ExceDt Per Share Amounts) Revenues" Cost of goods Sold* Gross profit Operating, selling, administrative and general expenses Restructuring charges Operating income (loss) Other income (expenses): Interest income Interest expense Income from legal settlement Other, net (Loss) income from continuing operations before income taxes (Benefit) provision for income taxes (Loss) from continuing operations Discontinued operations: Income (loss) from discontinued operations, net of income taxes of $63, $107 and $5,797 in 1994, 1993 and 1992, respectively. Gain on disposal Income (loss) from discontinued operations Income (loss) before extraordinary items and accounting changes Extraordinary items: (Loss) gain resulting from the early extinguishment of debt Gain on foreclosure of MAI Gain on reorganization of MAI (Loss) income from extraordinary items Income (loss) before cumulative effect of accounting changes Cumulative effect of accounting changes: Retiree health and life insurance benefits Cumulative effect of change in fiscal year end of MAI Net income (loss) Per common share: December 31. 1994 Year Ended December 31, December 31, 1993 1992 $479,343 $493,041 $632,791 229.807 233,386 303.379 249,538 259,655 329,412 235,374 256,902 311,506 ,11,913 14.16i (9,160) 17,906 533 2,292 5,118 (55,952) (54,915) (59,223) 36,918 (1.221) (2.252) (325) (42,478) (64,035) 394 (24,487) 5.193 8,118 (17,991) (69,228) (7,724) 23,693 62,001 150.990 174.583 62.001 (232.397) 156.692 (7.227) (240.121) (47,513) 42,849 7,994 64,452 91~ 46,440 (46.597) 1~,741 7,994 110.095 146.514 (232.127) (232,397) (16,167) (23.567) $110 ,09~ $106.780 $~232.127) (Loss) from continuing operations Income (loss) from discontinued operations Extraordinary items Cumulative effect of accounting changes Net income (loss) Weighted average common shares and common stock equivalents outstanding $(1.02) $(4.19) $ (1,10) $9--32 $ 3.45 $(11.01) $(2.65~ $ 8.,55 $ 0.38 - $(2.21) - $ 6.25 $ 5.60 $(11.73~ 17.610.898 17.977.487 21.109.231 * Revenues and cost of goods sold include federal excise taxes of $131,877, $127,341 and $147,701 for the years ended December 31, 1994, 1993 and 1992, respectively. The accompanying notes are an integral part of the consolidated financial statements C-5

Balance, December 31, 1991 Dividends on common StOck of BGL ($.42 per share) Other, net (principally impact of acquisition of companies under common control) Stock issued under 1991 Incentive Plan Contingent Value Rights settlement Accretion of Contingent Value Rights liability Net (loss) Treasury stock, at cost Balance, December 31, 1992 Common stock exchanged for Preferred stock Senes E Series F and G Dividends on Series G preferred Stock issued to officer and employee Stock surrendered by former officers and employees Reduction of Contingent Value Rights liability SERP minimum liability adjustment Preferred stock exchanged for common stock Repayment of Chairman's loans Net income Treasury stock, at cost Balance. December 31. 1993 Foreign Currency Adjustment Preferred stock exchanged for common Reclassification of former Vice Chairman's loan to other receivables Contingent Value Rights Settlement Repayment by Chairman of interest Waiver of dividends, shareholder settlement Transfer of pension liability to SkyBox Stock grant pursuant to consulting agreement Contract settlement Exemise of warrant Net income Unrealized gain on investment in New Valley Treasury stock, at cost Balance, December 31, 1994 BROOKE GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (Dollars in Thousands, Except Per Share Amounts) Preferred Stock I Series E, F and G Shares Amount Common Stock Retained Shares Amount (Deficit) 22.942,008 $ 2.295 $ 58,806 $ (390.683) Additional Paid-In Capital (8,301) Treasury Stock 8,929338 $ 9 2,194.834 2 (8,939.338) (9) 2,184,834 $ 2 $ (8,767) (2.184834) ($ 2) (21.975) 1.103,343 110 1,215 (435) 1,146 (5,455) (15,519) (232,127) {~,398.613J (540) _5_4_0 1,_~_7_2 (2__6._9_2_7} 18,646.738 $ 1.865 $ 6o,561 $ (672,823) $ (34.548) (8,929.338) (893) 884 (2.194.834) (220) 218 (3o.831) 375.000 38 (358) (1.345) (225.oo0) (23) 23 (863) 44.140 (1.695) 8,939,338 894 (885) 15,695 106,780 ( !.:L5-2.1~_2} (13_~) _13_~ 15,259.762 $ 1.526 $ 60,578 $ (540,942) 2.184.834 $ 218 $ (216) $1.500 1.875 1,163 6,250 3,200 4.305 250.000 25 (739) (371) 607.889 61 (2,875) 110,095 (41.641 ) (4) 4 1.672 ~,26~0 84__~ $1,_8_2__~6 $66.2___4__5 $(4____2__0,7___46__) 2,040 459 $ (35,846) 1,182 2,875 (1,753) $(3_33.54__2) Other $201 11,164 Total $ (338.349 (8,301) (21,975) 2,036 (5.456) (15,519) (232.127) _{25_.2~_5_5) $ (644,945) 0 0 (30,831) 375 (404) 44,140 (1,695) 0 15,695 106,780 {_3.797) $ (514,682) 201 0 1,500 1,875 1.163 9.450 4,305 468 (371) 61 110,095 11,164 (81) The accompanying notes are an integral part of the consolidated financial statements.

BROOKE GROUP LTD; AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands, Exce_~t Per Share Amounts) Cash flows from operating activities: Net income (toss) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization Income on legal settlement Noncash compensation expense tncome taxes Gain on sale of assets Gain on early extinguishment of debt Impact of discontinued operations Equity in earnings of affiliates Other, net Changes in assets and liabilities: Receivables I nvento des Accounts payable and accrued liabilities Other assets and liabilities, net Net cash (used in) provided by operating activities Cash flows from investing activities: Proceeds from sale of business and assets Impact of discontinued operations Payments for acquisitions, net of cash acquired Capital expenditures Other, net Net cash provided by (used in) investing activities Year Ended December31, December31, December31, 1994 1993 1992 $110,095 $106,780 $(232,127) 6,821 11,041 9,772 (11,918) 8,463 2,433 (24,487) 9,287 9,049 (11,925) (1,855) (42,849) (7,994) (3,760) (106,574) 224,627 (113,515) 6,265 89 2,293 (4,002) 42,585 (20,346) (9,574) 14,686 7,347 (8,576) (25,282) (25,099) 1:~ 12.187 (564~ $ (44.060) $ 21.950 $ (~14~382) $29,542 $21,372 $ 8,439 (4,555) (16,078) (16,468) (9,600) (3,023) (443) (7,009) 1.897 :~71 (422) 23.861 5.222 (25.060) The accompanying notes are an integral part of the consolidated financial statements C-7

BROOKE GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued (Dollars in Thousands. Except Per Rhare A~) Cash flows from financing activities: Proceeds from debt Deferred financing costs Purchase of bonds Repayments of debt Increase (decrease) in cash overdraft Series G preferred dividend Dividends paid on common stock CVR Redemption/or settlement Treasury stoc~ purchases Return (deposit) of CVR collateral Stockl~older loan and interest repayments Impact of discontinued operations Other, net I Year Ended December 31, December 31. 1994 1993 12,523 6,498 (2,705) (520) (10,772) (2,027) (26,059) (12,669) 19,217 (5,923) (15,695) December 31, 1992 160,149 (7,014) (29,149) (11,522) 1,875 (1,122) (21) (3,797) (25,255) 12,000 (12,000) 17,774 (437) (8,297) (18,824) ~75 (1.475) (2.119) Net cash provided by (used in) financing activities 8.765 (30.022~ 54.2(~i Effect of exchange rate changes on cash and cash equivalents (63) 795 (634) Net (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of period (11,497) (2,055) (15,810) 15.773 17.828 33.638 Cash and cash equivalents, end of period $ 4,276 $15.773 $17.828 The accompanying notes are an integral part of the consolidated financial statements C-8

BROOKE GROUP LTD. AND SUBSIDIARIES 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 include the accounts of Liggett Group Inc. ("Liggett") and other less significant subsidiaries. On October 6, 1993 the Company distributed (hereinafter referred to as the "Distribution") to holders of record of its common stock at September 20, 1993 one share of common stock of its subsidiary, SkyBox International Inc. ("SkyBox") for each of the 6,522,929 shares of Brooke common stock then outstanding, representing 81.5% of the SkyBox common stock and 46.6% of its direct voting power. Further, on October 28, 1993, SkyBox redeemed 80 shares of its cumulative preferred stock from the Company at the stated redemption price of $100,000 per share for a total of $8,000. This resulted in a 7.1% reduction of the Company's direct voting power in SkyBox from 53.4% to 46.3%. After October 1, 1993, SkyBox was no longer consolidated and is accounted for on the equity method. During 1994, SkyBox paid the Company dividends of $1,897 on the Series A Preferred Stock the Company held and redeemed 180 shares of preferred stock held by the Company at the stated redemption price above for $18,000. In addition, during 1994 the Company sold 833,500 shares of SkyBox common stock for $11,055. This resulted in a further reduction in direct voting power from 46.3% to 15.3% (See Note 2, "Discontinued Operations"). At December 31, 1994, the Company's voting interest in New Valley Corporation ("New Valley" or "NVC") was 41.6%. Prior to December 31, 1994, under the equity method of accounting, the Company's investment was carried at 0 since the Company had no intention or committment to fund New Valley's losses. As of December 31, 1994, the Company's investment in New Valley was $97,520, principally as a result of recording its share of New Valley's fourth quarter 1994 income (Refer to Note 3). On October 1, 1993, the Company transferred the stock of its subsidiary, BrookeMil Ltd., to Liggett-Ducat Ltd., a Russian joint stock company ("LDJSC") in exchange for 58% of the stock of LDJSC and a promissory note from BrookeMil Ltd. Also on October 1, 1993, BrookeMil Ltd. entered into a long-term lease, as lessor, of a western style office building in Moscow. As a result of this transaction on October 5, 1993, the Company received $5,313 as partial payment on the promissory note. This income has been deferred and is being recognized over the lease term. The Company's consolidation policy with respect to foreign subsidiaries is based on consideration of potential economic, political and currency restrictions which may effect its foreign operations. Therefore, with the exception of BrookeMil Ltd., the Company's majority owned subsidiary, LDJSC, located in the Commonwealth of Independent States ("CIS") is presently not included in consolidation. The amounts invested in Russian ventures of $5,723, $6,368 and $21,900 in 1994, 1993 and 1992, respectively, have been expensed. All significant intercompany accounts and transactions have been eliminated. C-9

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Except Per Share Amounts - (.Continued) (b) Li~3uidity: The Company believes it will have sufficient liquidity for 1995. This is based on, among other things, forecasts of cash flow for the principal operating companies which indicate that they will be self-sufficient, satisfactory resolution of the Contingent Value Rights ("CVR") suit (refer to Notes 11 and 14), the redemption/sale of the SkyBox preferred and common stock for $13,284 in March 1995 and certain funds available from New Valley as described in the Company's indenture agreements and New Valley's First Amended Joint Chapter 11 Plan of Reorganization ("Joint Plan"). (Refer to Note 2). (c) Cash and Cash Equivalents Cash equivalents are stated at cost, which approximates market value. 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. (d) Finan¢iel Instrumeni;~;: The estimated fair value of the Company's long-term debt is as follows: At December 31, Long-term debt 1994 Carrying I Fair Amount Value $432,289 $347,912 Carrying Amount $405,768 1993 Fair Value $229,608 Short-term debt- The carrying amounts reported in the Consolidated Balance Sheets approximate fair value because of the variable interest rates and the short maturity of these instruments. Long-term debt - Fair value 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. (e) 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 high credit quality financial institutions. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers, primarily throughout the United States, comprising the Company's customer base. Ongoing credit evaluations of customers' financial condition are performed and, generally, no collateral is required. The Company maintains reserves for potential credit losses and such losses, in the aggregate, have not exceeded management's expectations. C-10

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Ex(;ept; Per Share A.,mounts - !Continued) (f) Accounts Receivable: The allowance for doubtful accounts and cash discounts was $969 and $980 December 31, 1994 and 1993, respectively. (g) Inventories: at Inventories are stated at the lower of cost or market and were determined primarily by the last- in, first-out method (LIFO). 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. (h) Property. Plant and Eaui~ment: Property, plant and equipment are depreciated using the straight-line method over the estimated useful lives of the respective assets, which are 20 years for buildings and 3 to 10 years for machinery and equipment. 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. (i) ~nt6ngible Assets: intangible assets, consisting of trademarks and covenants not to compete, are amortized using the straight-line method over 2 to 12 years. Amortization expense for the years ended December 31, 1994, 1993 and 1992 was $1,722, $1,971 and $2,083, respectively. (j) Postretirement Benefits other than Pensions: Effective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" ("SFAS 106"). Under SFAS 106, 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. Prior to 1993, the Company had recorded liabilities associated only with those former employees who were receiving postretirement benefits and current employees eligible to retire. As permitted by SFAS 106, the Company has elected to fully recognize the transition obligation (the excess of the accumulated postretirement benefit obligation as of January 1, 1993 over the accrued cost). This resulted in a one-time charge for the Company of $16,167, net of taxes, reccrded in the first quarter of 1993. (k) Postemployment Benefits: In November 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits", ("SFAS 112") which is effective for fiscal years beginning after December 15, 1993, with earlier adoption permitted. SFAS 112 establishes standards of financial accounting and reporting for the C-11

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Exce_ot Per Share Amounts - (Continued) estimated cost of benefits provided by an employer to former or inactive employees after employment but before retirement. No expense was associated with the adoption since the Company's previous policies accounted for all items required by SFAS No. 112. (I) Income Taxes: Effective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" ("SFAS 109"). Prior to the adoption of SFAS 109, the Company had accounted for income taxes under the deferral method. Under the provisions of SFAS 109, the Company adjusted previously recorded deferred taxes to reflect currently enacted income tax rates. The Company has not retroactively adjusted for business combinations as it is impracticable. The cumulative effect of the change in the method of accounting for income taxes was immaterial. (m) Revenue Recognition: 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. (n) Earnings Per Share: Per share calculations are based on the equivalent shares of common stock outstanding and include the impact of the CVR liability decretion/accretion for the years ended December 31, 1993, and 1992 (Note 11). The decretion/accretion increased (decreased) earnings by $1.37 and $(0.74) for the years ended December 31, 1993 and 1992, respectively. The Series G Preferred Stock are common stock equivalents; however, in making per-share calculations for 1993, they have been treated as preferred stock since treating them as common stock would be anti-dilutive (Note 12). The net income per share calculation for December 31, 1993 assumed conversion of the outstanding warrant (Note 15). (o) Reclassifications: Certain amounts in prior years' financial statements have been reclassified to conform to the current years presentation. C-12

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Except Per Share Amounts - JContin~ed) 2. DISCONTINUED OPERATIONS A summary of discontinued operations follows: 1994 1993 1992 Income (loss) from discontinued operations: MAI $ 3,628 $28,177 $(199,049) SkyBox 20,065 33,824 (24,553) Other (8.795) 23.693 62.001 Gain from disposal of operations: SkyBox New ValleytA) Income (loss) from discontinued operations 11,055 139,935 150.990 $174.683 0 O $62,001 $(232.397) Represents equity in earnings of discontinued operations of New Valley Corporation. Net revenues of MAI for the years ended December 31, 1994, 1993 and 1992 were $66,095, $115,291 and $341,531, respectively. Net revenues of SkyBox were $65,119 for the nine months ended September 30, 1993 and $87,287 for the year ended December 31, 1992. MA.I: On January 25, 1995, the Board of Directors of the Company approved the spin-off of the 65.2% equity interest in MAI Systems Corporation ("MAI") through a distribution to its stockholders of one share of MAI for every six shares of the Company's common stock. The distribution occurred on February 13, 1995. As a result, MAI has been treated as a discontinued operation in the financial statements for all periods presented. The assets and liabilities of MAI at December 31, 1994 are included in the captions net current liabilities of businesses held for disposition and net long-term liabilities of businesses held for disposition. The distribution will reduce the stockholder deficit by approximately $28,000 in the first quarter of 1995. On December 21, 1992, the Company determined to dispose of MAI. At that time, in addition to an equity interest of 87.2%, the Company was owed $37,600 by MAI and was their largest single creditor. On April 12, 1993, MAI filed a voluntary petition under Chapter 11 of the Bankruptcy Code and emerged from bankruptcy on November 18, 1993. Under the plan of reorganization, the Company received zero for its original equity ownership and a 44.9% common ownership interest for the MAI debt it held. Further, on February 1, 1994, the Company renegotiated a December 21, 1992 agreement with an unrelated third party which enabled the Company to purchase additional MAI equity for $3,565 in the reorganized entity. When combined with the interest originally received in the reorganization, total equity held by the Company at December 31, 1994 was approximately 65.2%. The terms of the Plan of Reorganization provided for the issuance of new MAI common stock having an estimated fair market value of $50,000 in exchange for the cancellation of unsecured debt. In connection with the issuance of the new common stock, the Company recorded an extraordinary gain C-13

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Except Per Share Amounts - (Continued) of $46,440 for the difference between the debt being forgiven and the fair market value of the new MAI common stock issued. On March 22, 1993, a syndicate of banks (the "Banks") foreclosed on all of the outstanding capital stock of certain of MAI's European subsidiaries, on certain intellectual property of MAI and on amounts due to MAI from certain of its European subsidiaries (the "Foreclosure"), in satisfaction of all amounts due under MAI's term loan facilities and revolving facilities with the Banks (the "Credit Agreements"). Because management's estimated fair market value of assets surrendered was less than the amount of the debt satisfied, the Foreclosure was accounted for as a troubled debt restructuring. As a result, the difference between the book value and management's estimated fair market value of the assets surrendered of $22,187 is included in the loss from discontinued operations and the difference between the carrying amount of the debt satisfied and the fair market value of the assets surrendered of $64,452 is classified as an extraordinary gain on foreclosure. In addition, in connection with a transaction wherein MAI's U.S. and Canadian bank lenders took title to the stock of MAI's European subsidiaries in satisfaction of a total of approximately $84,000 of indebtedness owed by MAI to such bank lenders, the Company may be required, under certain circumstances, to purchase an equity interest of up to $7,500 in the holding company of MAI's former European subsidiaries which is controlled by such bank lenders. The $7,500 is recorded as a liability at December 31, 1994. In the fourth quarter of 1992, the Company recorded non-recurring charges of $145,690 associated with the write-off of goodwill related to MAI and $7,009 for additional costs of implementing the restructuring program begun in 1991. The write-off of goodwill was due to declining results in 1992 and a forecasted decline in subsequent years of the businesses associated with such goodwill. MAI is consolidated for 1992 on a three month lag since MAI's year end as reported at that time was September 30. Further, in 1993 MAI changed its year end to December 31 and, therefore, in 1993 MAI was no longer consolidated on a three month lag. This change, amounting to $23,567, is reported as a change in accounting in the first quarter of 1993. The condensed statement of operations for this three month period ending December 31, 1992 follows: Total revenue $59,183 Direct costs 37.442 Gross profit 21,741 Selling, general and administrative expenses Non-recurring charges Operating (loss) 22,792 15.340 (16,391) Interest, net (4,675) Loss before taxes (21,066) Income taxes 2.501 Net loss $(23.567) SkyBox: On March 27, 1995, the Company sold all of its remaining shares (593,572) of SkyBox common stock for approximately $9,284. On March 29, 1995, SkyBox redeemed the remaining 40 shares of Series A Preferred Stock for $4,000 plus accrued dividends. These amounts will be recognized in 1995. C-14

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands. Exce_~t Per Share Amounts - (Continued) New Valley: During the fourth quarter of 1994, New Valley sold or was in the process of selling virtually all of its current operations. In connection with the implementation of the provisions of the Joint Plan, New Valley completed the sale of Western Union Financial Services Inc. and certain other assets to First Financial Management Corporation (See Note 3). Accordingly, the financial statements of the Company reflect its portion of the gain, $139,935, in gain on disposal of discontinued operations. Other:. The Company completed the sale of Edwards Holdings Inc. on April 5, 1993. The selling price exceeded the book value of net assets sold. In November 1992 after review of the long-term business prospects of its luxury yacht manufacturing subsidiary, the Company concluded it would no longer fund the operations. In the third quarter 1992, the Company wrote off its investment in the luxury yacht manufacturing subsidiary and in November 1992, a receiver was appointed by certain creditors of the subsidiary. 3. INVESTMENT IN NEW VALLEY CORPORATION At December 31, 1994, the Company's investment in New Valley consisted of a 41.6% voting interest. The Company's investment is represented by 618,326 Class A Increasing Rate Cumulative Senior Preferred Shares ("Class A Shares") with an aggregate fair value of $145,963 and 79,399,254 common shares (42.1%) with a quoted market value of $13,498 at December 31, 1994. In addition, the Company holds an irrevocable proxy to vote an additional 32,543 Class A Shares. These shares had been transferred to a third party in December 1994 resulting in compensation expense of $7,682. This proxy expires on the earlier of December 31, 1995 or the sale of the shares now owned by the third party. Options to purchase up to an aggregate of 9,000,000 common shares owned by the Company for $2,250 are held by third parties. Summarized financial information for NVC as of and for the year ended December 31, 1994 follows: Current assets, primarily cash and cash equivalents ................................. Noncurrent assets ....................................... Current liabilities ......................................... Noncurrent liabilities ................................... Redeemable preferred stock ....................... Common shareholder deficit ....................... Cumulative, undeclared Class B dividends. Loss from continuing operations ............. Earnings of discontinued operations*. ......... Extraordinary item ...................................... Net income ................................................. Company's share of equity in net income .... $1,039,209 30,682 754,360 36,177 317,798 (38,444) (76,700) (15,265) 1,135,706 (110,500) 929,904 93,450 *Includes gain on sale of NVC's money transfer business of $1,056,081, net of income taxes of $52,000 C-15

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Exce_~t Per Share Amounts - (Continued) The Class A Shares are accounted for as debt securities pursuant to the requirements of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities", and are classified as available-for-sale. The net unrealized holding gain on these securities, in the amount of $11,164, is accounted for as a separate component of stockholders' equity. Because the preferred shares are thinly traded, their fair value has been estimated with reference to both their quoted market price as well as to the securities' preference features, including dividend and liquidation preferences, and the composition and nature of the underlying net assets of New Valley. The common shares are accounted for pursuant to APB 18, "The Equity Method of Accounting for Investments in Common Stock", and have a negative carrying value of approximately $48,443 at December 31, 1994. The Company's share of net income was determined after accounting for losses and undeclared Class B preferred stock dividends not recognized in prior years. In addition, the Company's share of the extraordinary item related to extinguishment of debt was $46,487. The Class A Shares of New Valley are required to be redeemed on January 1, 2003 for $100 per share plus dividends accrued to the redemption date. The shares are redeemable, at any time, at the option of New Valley. At December 31, 1994, the accrued and unpaid dividends arrearage was $117.69 per share after giving effect to a cash dividend (the "Special Cash Dividend"), of $50.00 per share which was paid on January 18, 1995. The Company's wholly-owned subsidiary, New Valley Holdings, Inc. ("NVH"), received $30,916 in the dividend distribution. 4. INVENTORIES Inventories at December 31 consist of: 1994 I 1993 Finished goods $18,374 $15,282 Work in process 2,952 2,130 Raw matedals 20,609 17,485 Replacement parts and supplies 3.754 6.837 Inventories at current cost 45,689 41,734 LIFO adjustments 1.409 (271) $47.098 $41.463 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. The commitments cover pedods ranging from twelve to twenty-fourmonths at December 31, 1994. At December 31, 1994, the Company had leaf tobacco purchase commitments of approximately $41,000. C-16

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Thousands. Exce_ot Per Share Amounts - (Col~tinued) 5. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at December 31 consist of: Land and improvements Buildings Machinery and equipment Leasehold improvements Asset under capital lease Less accumulated depreciation 1994 I 1993 $ 716 $ 716 8,703 7,059 35,069 37,531 82 5 5.696 2.235 50,266 47,546 24,469 20.025 $25,806 $27.521 The amounts provided for depreciation for the years ended December 31, 1994, 1993 and 1992 were $4,609, $4,675, and $5,148 respectively. The amounts provided for amortization of assets under capital lease for the years ended December 31, 1994 and 1993 were $551 and $202, respectively. 6. NOTES PAYABLE. LONG-TERM DEBT AND OTHER OBLIGATIONS Notes payable, long-term debt and other obligations at December 31 consist of: 1994 I 1993 13.75% Series 1 Senior Secured Notes due 1995 13.75% Series 2 Senior Secured Notes due 1997 16.125% Senior Subordinated Reset Notes due 1997 14.500% Subordinated Debentures due 1998 Obligation to Exchange Holders Other, includes MAI in 1993 23,594 91,294 5,670 126,295 4,940 $ 89,245 126,295 6,851 14,044 Liggett: 11.500% Senior Secured Notes due 1993 - 1999 Vadable rate Series C Senior Secured Notes due 1999 Revolving credit facility 126,234 140,897 29,415 24.847 28.436 Total notes payable and long-term debt 432,289 405,768 Less: Current maturities 26.491 16.097 Amount due after one year $405.798 $389.671 13.75% Series 1 Senior Secured Notes due 1995 13.75% Sedes 2 Senior Secured Notes due 1997 An Exchange and Termination Agreement ("Exchange Agreement") was entered into as of September 30, 1994 among the Company, its subsidiary, BGLS Inc. ("BGLS"), and certain holders ("Participating Holders") of the 16.125% Senior Subordinated Reset Notes due 1997 ("Reset Notes") and the 14.500% Subordinated Debentures due 1998 ("Subordinated Debentures") pursuant to which certain pdor agreements among the parties were terminated. The Participating Holders had advanced $13,702 to the Company under the prior agreements. C-17

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Except Per Share Amounts - (.Continued) Under the Exchange Agreement, on October 3, 1994 the Company exchanged an aggregate of $49,900 of new BGLS 13.75% Series 2 Senior Secured Notes due 1997 ("Series 2 Notes") for an equal principal amount of Reset Notes. The Company and BGLS also agreed, subject to applicable securities laws, to offer the other holders of the Reset Notes the opportunity to exchange the Reset Notes for Series 2 Notes. That offer commenced October 21, 1994 and was closed December 12, 1994. An additional $33,675 of the Reset Notes were exchanged. In related transactions with the same Participating Holders, BGLS issued (i) an aggregate of $18,958 of its 13.75% Series 1 Senior Secured Notes due 1995 ("Series 1 Notes") to the Participating Holders in consideration of the transfer to BGLS by the Participating Holders of certain Revised Senior Secured Notes and Senior Secured Notes of BGLS due October 3, 1994 plus interest accrued thereon, (ii) an aggregate of $2,936 of Series 1 Notes to certain of the Participating Holders on account of new loans extended by them to BGLS in respect of interest payable on October 3, 1994 on the Subordinated Debentures held by such Participating Holders, and (iii) an aggregate of $7,536 of Series 2 Notes to the Participating Holders in satisfaction of other obligations to the Participating Holders. In addition, pursuant to the Exchange Agreement certain expenses of certain of the Participating Holders relating to the prior agreements, the Exchange Agreement and the New Valley bankruptcy proceeding, were reimbursed to them by BGLS paying them $500 cash and issuing to them an aggregate $1,700 of Series 1 Notes. In total, additional expense to the Company resulting from these transactions was $9,700. Under certain circumstances some or all of the $500 cash and $1,700 of Series 1 Notes transferred to such Participating Holders is reimbursable by them to BGLS at a later date. At December 31, 1994, $242 had been repaid. The Series 1 Notes are senior obligations of BGLS, collateralized by BGLS' equity interests in Liggett and in NVH. The Series 2 Notes are collateralized only by a junior lien on BGLS' interest in NVH and, except for maturity, are otherwise similar to the Series 1 Notes. The Series 1 Indenture provides that so long as Series 1 Notes are outstanding, if BGLS receives payments from NVH, those payments in most cases must be applied to pay accrued and unpaid interest on, and then to redeem, Series 1 Notes. The Series 2 Indenture also places certain restrictions on the application of payments from NVH, including the redemption of the Series 2 Notes before Debt Securities (as defined below) are redeemed. The Series 1 and Series 2 Indentures also require that the Company use its reasonable best efforts to prepare and file with the Securities and Exchange Commission a Registration Statement and to have the Registration Statement declared effective as soon as practicable following the date that the Series 1 and Series 2 Notes were originally issued (i.e., October 3, 1994). If the Registration Statement has not been declared effective by February 1, 1995, the interest rate will increase 0.50% per annum. Thereafter, and until the Registration Statement is effective, the interest rate on the Series 1 and Series 2 Notes will increase an additional 0.25% per annum 90 days following the immediately preceding increase. The Company is in the process of preparing the Registration Statement. The interest rate has increased under the conditions described above to 14.25% effective February 1, 1995; however, it will immediately revert on a prospective basis to its original rate of 13.75% as soon as the Registration Statement is declared effective. Also in the third quarter 1994, an agreement was entered into among certain holders, the Company and BGLS pursuant to which BGLS agreed that, upon the effective date of Joint Plan BGLS, would effect certain amendments to the indentures applicable to the Reset Notes and the Subordinated Debentures (the "Indenture Amendments"). C-18

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands. Exce.ot Per Share Amounts - (Continued) Subsequent Events: On January 18, 1995, the Indenture Amendments were effected. Generally, the Indenture Amendments, require BGLS to apply any amounts received by it with respect to the New Valley preferred stock or New Valley common stock which it holds ("New Valley Distributions") in excess of $10,000 but not in excess of $30,000, first to the payment of interest and then to principal of Series 1 Notes, Series 2 Notes, Reset Notes and Subordinated Debentures. To the extent that New Valley Distributions exceed $30,000, BGLS is required to apply such amounts first to interest on, and then to the payment of principal of Series 2 Notes, Reset Notes and Subordinated Debentures. The $10,000 and $30,000 thresholds are revised upwards under certain circumstances. At April 3, 1995, the $10,000 threshold has been revised to approximately $22,700. New Valley distributions in excess of this amount are restricted as to their uses. On April 3, 1995 a Notice of Redemption was sent to holders of the Series 1 Notes in which the Company announced its intention to redeem the Series 1 Notes on May 3, 1995. Accordingly, on April 3, 1995 the Company deposited with the trustee an amount sufficient to redeem all of the Series 1 Notes including interest thereon accruing from April 1, 1995 to May 3, 1995. 16,125% Senior Subordinated Reset Notes due 1997 14.500% Subordinated Debentures due 1998 The Senior Subordinated Reset Notes and the Subordinated Debentures are collectively referred to as the "Debt Securities." In the year ended December 31, 1993, the Company repurchased $48,560 of the Junior Secured Notes for $10,198 (see below) and $5,200 of its Debt Securities for $574. In the year ended December 31, 1992, the Company repurchased $33,955 face value of its Debt Securities for $25,215 plus accrued interest. As a result of these transactions, the Company recorded extraordinary gains on extinguishment of indebtedness of $42,849 and $7,994 in the years ended December 31, 1993 and 1992. 1~5,501% Junior Subordinated Secured Notes due 2008 Pursuant to an agreement (the "Purchase Agreement") dated February 23, 1989 among the Company, Liberty Service Corporation ("Liberty") and its parent, Columbia Savings & Loan Association ("Columbia"), Liberty purchased from the Company $48,560 of the Company's 15.501% Junior Subordinated Secured Notes due 2008 (the "Junior Secured Notes") which was utilized to purchase New Valley securities. Under the Purchase Agreement, Liberty had committed to purchase up to $100,000 of Junior Secured Notes. Liberty subsequently reneged on such commitment and the Company, in response, reserved its rights under the Purchase Agreement to require Liberty to fulfill its aforementioned commitment. In December 1992, Liberty and the Company signed a settlement agreement providing for the payment to the Company of $25,000 in cash, waiver of payment of all accrued interest on the Junior Secured Notes ($11,918) and dismissal of all claims in the litigation. The Company recorded income of $36,918 in the fourth quarter 1992 as a result of the settlement. Dudng the first quarter 1993, the Company repurchased the Junior Secured Notes as discussed above. Restrictive Covenants The Debt Securities Indentures and the Series 1 and Series 2 Indentures contain certain covenants, which among other things, limit the ability of the Company to make distributions to its shareholders, limit additional indebtedness senior to, or on parity with, the Series 1 and Series 2 Notes and the Debt Securities and prevent certain transactions with affiliates. C-19

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thogsands. Except Per Share Amounts - (Continued) The Company will be required to make an offer to repurchase 20% of the principal amount of each class of Series 1 and Series 2 Notes and the Debt Securities originally issued at the principal amount thereof, plus accrued interest, if the Net Worth (as defined) of L Holdings Inc. ("Holdings"), a wholly- owned subsidiary, at the end of two consecutive fiscal quarters is $15,000 or less. Also, if the controlling person of the Company ceases to control the Company other than as a result of death or incapacity, then each of the holders of the Series 1 and Series 2 Notes and the Debt Securities will have the option to cause the Company to repurchase all, but not less than all, o~f the Series 1 and Series 2 Notes and the Debt Securities held by such holders at the principal amount thereof, plus accrued interest. Interest on the Series 1 an~ Series 2 Notes and the Debt Securities is payable semiannually, on April 1 and October 1 with a thirty day grace period. Liggett 11.500% Senior Secured Series B Notes due 1993 - 1999 During the first quarter 1992, Liggett issued $150,000 in Senior Secured Notes (the "Series B Notes"). Interest on the Series B Notes is payable semiannually on February 1 and August 1 at an annual rate of 11.5%. The Series B Notes require mandatory principal redemptions of $7,500 on February 1 in each of the years 1993 through 1997 and $37,500 on February 1, 1998 with the balance of the Series B Notes due on February 1, 1999. The Series B Notes are collateralized by substantially all of the assets of Liggett, excluding accounts receivable and inventory. The Sedes B Notes may be redeemed, in whole or in part, at a price equal to 104%, 102% and 100% of the principal amount in the years 1996, 1997 and 1998, respectively, at the option of Liggett at any time on or after February 1, 1996. The Series B Notes contain restrictions on Liggett's ability to pay dividends, incur additional debt, grant liens and enter into any new agreements with affiliates. I_ssuance of Series C Vadable Rate Notes On January 31, 1994, Liggett issued $22,500 of Variable Rate Series C Senior Secured Notes Due 1999 (the "Series C Notes"). Liggett received $15,000 from the issuance in cash and received $7,500 in Series B Notes which were credited against the mandatory redemption requirements of Series B Notes required under the indenture for February 1, 1994. Liggett had received the necessary consents from the required percentage of holders of its Series B Notes allowing for an aggregate principal amount up to but not exceeding $32,850 of Series C Notes to be issued under the Series B Indenture. The Series C Notes have the same terms (other than interest rate) and stated maturity as the Series B Notes. In connection with the consents, holders of Series B Notes received Series C Notes totaling $2,842 of their current Series B Notes holdings. Liggett issued the remaining $7,508 of Series C Notes in November 1994. The Series C Notes bear a 16.5% interest rate, which was reset on February 1, 1995 to 19.75%, the maximum reset rate. Subsequent Event. On January 26, 1995, the Company sold the Series C Notes it held in face amount of $2,935. Issuance of Revolving Credit Facility. - Liggett On June 12, 1991, Liggett entered into a revolving credit facility for $50,000 with a syndicate of commercial banks. This facility was replaced in March 1994 (See below). The facility in existence at December 31, 1993 was collateralized by all eligible inventories and receivables of Liggett. Borrowings under the facility bore interest at a rate equal to 1.0% above the lead lending bank's (NationsBank) prime rate. At December 31, 1993, $28,436 was outstanding under this credit facility. C-20

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Except Per Share Amounts - (Continued) On March 8, 1994, Liggett entered into a new revolving credit facility for $40,000 with a syndicate of commercial banks that replaced the Revolving Credit facility due April 30, 1995. The facility is collateralized by all inventories and receivables of Liggett. Borrowings under the facility bear interest at a rate equal to 1.5% above the Philadelphia National Bank's prime rate. The facility requires Liggett's compliance with certain financial and other covenants. The facility also limits the amount of dividends and distributions by Liggett. At December 31, 1994, the Company was not in compliance with certain non-financial covenants under the revolver. These covenants relate to obtaining prior approval from its lender for certain transactions that occurred during 1994. On March 29, 1995, the Company's lender waived these events of non-compliance with subsequent approval of the foregoing transactions. The refinancing of the revolver resulted in a $843 extraordinary charge for loss on early extinguishment of debt. The facility expires on March 8, 1997. Scheduled Maturities: Regularly scheduled maturities of long-term debt for each of the next five years are as follows: 1995 $ 26,491 1996 7,985 1997 129,814 1998 163,990 1999 104,009 Thereafter 0 $432,289 7. RESTRUCTURING CHARGES Liaaett: In early 1993, Liggett restructured its headquarters operations to reduce operating costs. In connection with the restructuring, Liggett has recorded a non-recurring net charge to operating income of $5,565 ($2,531 is included in cost of sales). In January 1994, Liggett reduced its field sales force and recorded a charge of $3,000 against operating income in the fourth quarter of 1993. Headauarters: In 1993, the Company restructured its domestic and foreign operations including reduction in personnel and subleasing of certain office spaces to reduce operating costs. In connection with the restructuring, the Company recorded non-recurring charges of approximately $2,425, $1,500 and $1,954 in the second, third and fourth quarters of 1993, respectively. C-21

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Except; per Share Amounts - (Continued) 8. EMPLOYEE BENEFIT PLANS Defined Benefit Retirement Plans: Certain subsidiaries sponsor several defined benefit pension plans, covering virtually all of their 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 ("ERISA")= On November 11, 1993, Liggett restructured its defined benefit retirement plans by freezing its pension plan obligation related to Liggett salaried employees effective December 31, 1993. As a result of this, the Company recorded a $4,766 curtailment charge in 1993. As a result of Liggett's contract with the Tobacco Workers Union, effective January 1, 1995, the portion of Liggett's Hourly Defined Benefit Plan related to these workers was frozen effective December 31, 1994. As a result, the Company recorded a $691 curtailment charge in 1994. The Company's net pension expense consists of the following components: Service cost - benefits earned during the period Interest cost on projected benefit obligation Actual return on assets Curtailment related to plan restructuring Net amortization and deferral Year Ended December31,1994 December31'11993 December31,1992 $ 1,140 $ 2,065 $ 2,039 12,363 13,746 13,872 (5,144) (23,925) (26,043) 691 4,766 (8,337~ 8.727 13.077 $ 713 $ 5.379 $ 2.945 An analysis of the funded status of the Company's defined benefit pension plans and amounts recognized in the balance sheets at December 31, 1994 and 1993 for the pension plans are as follows: December 31, 1994 Assets Exceed Accumulated Benefits Actuarial present value of benefit obligations: Vested benefit obligation $77.521 Accumulated benefit obligation $77.521 Projected benefit obligation $77,521 Plan assets at fair value 78.239 Projected benefit obligation (less than) in excess of plan assets (718) Unrecognized net gain 7,232 Unrecognized prior service cost Adjustment required to recognize minimum liability Pension liability before purchase accounting valuation adjustments 6,514 Purchase accounting valuation adjustments related to income taxes (2.061~ Net pension liability included in the balance sheets $ 4.453 Accumulated Benefits Exceed Assets $81.472 $83.471 $83,622 December31, 1993 $189.012 $194.874 $196,038 78.475 5,147 11,143 (229) 8O3 16,864 (2.060~ $14.80~. $171.609 24,429 5,348 (I ,878) 1.630 29,529 (4.469'1 $ 25.060 C-22

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Exce_~t Per Share Amounts - (Continued) Assumptions used in the determination of net pension expense and the actuarial present value of benefit obligations were as follows: Discount rates Accrued rates of return on invested assets Salary increase assumptions 5.75% - 8.0% 8.0% - 10.0% 3.0% per annum Plan assets consist of commingled funds, marketable equity securities and corporate and government debt securities. Postretirement Medical and Life Insurance Plans: Substantially all of the Company's employees were eligible for certain postretirement benefits if they reach retirement age while working for the Company; however, there were several modifications made to the Company's Plans in 1993. Prior to 1994, the Plans had reimbursed 80 percent of retirees' medical claims. However, the Company announced on November 11, 1993 that retirees would be required to fund 60 percent of participant medical premiums in 1994 and 100 percent of premiums on a going-forward basis, effective January 1, 1995. As a result of the above modifications, the Plan's Accumulated Postretirement Benefit Obligation was decreased from $39,029 at January 1, 1993 to $15,137 at December 31, 1993. The components of net periodic postretirement (benefit) cost for the year ended December 31, 1994 and 1993 are as follows: Service cost, benefits attributed to employee service during the year Interest cost on accumulated postretirement benefit obligation Curtailment credits related to restructuring expense 1994 1993 $ 63 $ 587 1,037 3,133 - (623) Immediate recognition of transition obligation 16,853 Curtailment credits related to modification of Medical Plans Amortization of net loss -- (26,172) 33- Net periodic postretirement cost (benefit) $1,133 s C-23

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands. ExceDt Per Share Amounts - (Continued) The following sets forth the actuarial present value of the Accumulated Postretirement Benefit Obligation ("APBO") at December 31, 1994 and 1993 applicable to each employee group: 1994 1993 Retired employees Active employees - fully eligible Active employees - not fully eligible APBO Unrecognized net gain (loss) Purchase accounting valuation adjustments related to income taxes Postretirement liability $ 9,292 $12,695 1,170 1,286 1,143 1.156 $11,605 $15,137 1,277 (2,006) !1.291) (1.000) $11,591 $12.131 The APBO was determined using a discount rate of 8.5% and a health-care cost trend rate ranging from 13% in the near term, declining to 10% in the fifth year, 7% in the tenth year, and ultimately to a rate of 5.5%. A 1% increase in the trend rate for health care costs would have increased the APBO and postretirement benefit costs by $814 and $2,462 and $69 and $283, respectively for the years ended December 31, 1994 and 1993. The Company does not hold any assets in the plans. Postretirement benefits expense for the years ended December 31, 1992 amounted to $3,578. Profit Sharing Plan: As of January 1, 1992, Liggett terminated its profit sharing plan for all salaried employees and instituted a 401(k) plan. Liggett's contract with the Tobacco Workers Union also terminated their profit sharing plan and initiated the 401(k) plan as of January 1, 1992. The 401(k) plans originally called for Liggett contributions matching 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. Effective January 1, 1994, Liggett suspended the 3% match for the Salaried Employees' 401(k) Plan. Liggett contributed $420, $1,787 and $2,710 to the 401(k) plans for the years ended December 31, 1994, 1993 and 1992, respectively. The Company files a consolidated federal income tax return that includes its more than 80% controlled subsidiaries. The amounts provided for income taxes are as follows: December1994 31, I Year Ended December 31, I December 31, 1993I 1992 Current: U.S, Federal $(24,714) $1,000 State 227 $ 791 Deferred: U.S. Federal 2,141 5,557 State 2.052 1.770 Total provision for continuing operations $(24,487) $5.193 $8,118 C-24

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands. Exce_Dt Per Share Amounts - (.Continued) The tax effect of temporary differences which give rise to a significant portion of deferred tax assets and liabilities are as follows: December 31. 1994 December 31. 1993 Deferred Tax Deferred Tax Deferred Tax Deferred Tax Assets Liabilities Assets Liabilities Sales and product allowances $ 2,721 $ 1,447 Inventory 550 $ 2,397 570 Coupon accruals 4,645 5,581 Property plant and equipment 6,554 Employee benefit accruals 12,502 12,279 Debt restructuring charges 3,403 Excess of tax basis over book basis- non-consolidated entities 17,508 44,490 Excess of book basis over tax basis- non-consolidated entities 21,306 Other 1,289 1,105 Net operating loss carryforwards 48,501 44,971 Valuation allowance (60,862) (101,240) Reclassifications (30.257) (30.257) (9.20:~) $ 2,454 6,749 (9.2O3) Differences between the amounts provided for income taxes and amounts computed at the federal statutory tax rate are summarized as follows: (Loss) income from continuing operations before income taxes Federal income tax (benefit) at statutory rate Year Ended December 31, / December 31, | December 31, 1994[ 1993~ 1992 $(42.478) $(64.035) $ 394 (14,867) (22,412) 133 Increases (decreases) resulting from: State income taxes, net of federal income tax benefits 148 Change in valuation allowance, net of discontinued operations 14,432 Intangible amortization, net deductible Reduction of reserves (24,200) Recognition of utilization of NOL carryforwards, net (Benefit) provision for income tax $(24.487) 1,333 1,690 26,272 595 5.700 $ 5.193 $ 8.118 The Company favorably settled an audit with the Internal Revenue Service in the third quarter of 1994 and has adjusted its reserves accordingly. At December 31, 1994, the Company and its consolidated group had net operating loss carryforwards for tax purposes of approximately $120,000 which may be subject to certain restrictions and limitations and which will expire in the years 2006 to 2008. 10. COMMITMENTS Certain of the Company's subsidiaries lease certain facilities and equipment used in its operations under both month-to-month and fixed-term agreements. The aggregate minimum rentals under operating leases with noncancelable terms for one year or more are as follows: C-25

~ III II II I II IIIIIIIIII I Ill Ilia,,,,,, _ , ,,, . ,, ~ .............. BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Exce_ot Per Share Amounts - (Continued) Yearending December31: 1995 $ 3,342 1996 3,633 1997 1,996 1998 1,666 1999 838 2000 andthereaffer 18,763 $30,238 Lease commitments for 2000 and thereafter relate primarily to the remaining 42 years of a land lease in the Commonwealth of Independent States. The total of minimum rentals to be received in the future by certain of the Company's subsidiaries under noncancelable subleases are as follows: Yearending December31: 1995 $ 669 1996 642 1997 126 $1,437 The Company's rental expense for the years ended December31, 1994, 1993 and 1992 was, $4,808, $7,286 and $8,122 respectively. 11. CONTINGENT VALUE RIGHTS The CVR entitled the holder (3,117,400 CVRs outstanding at December 31, 1992) to receive on November 15, 1993 a cash payment equal to the amount, if any, by which the then current market value of the Company's common stock for a period of 20 trading days ending five days before such date was less than $19.45 per share, reduced as provided in the CVR agreement for dividends and distributions, if any, paid on shares of common stock up to the time of maturity. The Company may have redeemed the CVRs in whole or in part, at any time after May 15, 1991, for a price equal to $13.75 per share increased from November 1990 at a 15% compound annual rate as adjusted for dividends paid (the "Target Price") minus the then market price of the common stock as of a date 60 days before the redemption date. The CVR obligation, initially recorded at fair market value which was de minimis, was adjusted to the calculated redemption value through October 15, 1993, with the change reflected directly in stockholders' equity. The CVR's were senior collateralized obligations of the Company and were freely transferable separately from the common stock. They were collateralized by assets ($12,000 in cash and certain securities of the Company) deposited with a trustee. The Company satisfied the major portion of its liability with respect to the CVR obligation on October 6, 1993 through the distribution of SkyBox common stock which removed $44,813 of the obligation. The remaining portion of the obligation was satisfied pursuant to a Notice of Redemption given on October 15, 1993 whereby the Company redeemed each CVR for $0.36 (a total of $1,122) on December 9, 1993 or thereafter when such CVR was surrendered to the Trustee. Accordingly, all collateral (except for the $1,122, above) which included cash and certain securities of the Company C-26

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands. Exce.~t Per Share Amounts - (Continued) was released to the Company. (See also Note 14 "Contingencies" regarding a complaint filed by a group of CVR holders). 12. Preferred Stock Series E. F and G: On September 14, 1993, certain officers and an employee of the Company exchanged 11,124,172 common shares for 8,929.338 shares of Series E and 2,194.834 of Series F redeemable preferred stock. Each share of Series E Preferred Stock is convertible beginning 30 days after initial issuance into 1,000 shares of the Company's common stock. At October 31, 1993, all Series E Preferred Stock had been converted into the Company's common stock. The terms of the Series F Preferred Stock are identical to those of the Series E Preferred Stock, except that the Series F Preferred Stock are entitled to receive, in addition to dividends payable on the Series E Preferred Stock, a special dividend per share in an amount equal to the appraised value per share of the SkyBox common stock ($14.375) dividended in the Distribution times the number of shares into which it is convertible, payable one year from the date of the Distribution, in cash, or at the option of the Company, in the Company's common stock valued at its average closing price over the 20 trading days prior to payment. Following payment of this dividend, each share of Series F Preferred Stock will convert automatically into Company common stock. On December 30, 1993, certain present and a former officer of the Company were offered an exchange for all shares remaining (a total of 2,184.834) of Series F redeemable preferred stock for 2,184.834 shares of Series G redeemable preferred stock. The terms of the Series G Preferred Stock are identical to those of the Series F Stock, except that the special dividend on Series G stock was accelerated and paid in two parts. To the extent that dividends were utilized to facilitate the repayment or defrayal of certain debt obligations to the Company, cash dividends were disbursed or dividends were waived to satisfy such obligations. The remaining portion of the special dividend was payable in four installments on January 1, April 1, July 1 and October 1, 1994 payable in cash or shares of common stock at the option of the Company using the prime rate announced by Citibank, N.A. discounted by the number of days between the installment payment date and October 6, 1994, the date the Special dividend on the Series F preferred stock was to have been paid out. (Refer to Note 14 "Contingencies" and Note 15 "Related Party Transactions"). At December 31, 1994, all Series G Preferred Stock had been converted into Company common stock. Treasury_ Stock: For the years ended December 31, 1993 and 1992, the Company purchased at market prices 1,224,200 and 4,125,800 shares, respectively, of common stock in the open market for a total amount of $33,679. In 1994, pursuant to a Stock Grant Agreement, the Company purchased 41,641 shares of common stock from two former employees at market price. Through December 31, 1993, 225,000 unvested shares were surrendered by a former officer and two employees. In addition, 127,939 vested shares were transferred to the Company by two former officers and an employee in satisfaction of certain liabilities. Through December 31, 1992 the Company also repurchased from its Chairman of the Board (the "Chairman") at prices less than market and from certain officers and key employees at market prices 664,924 shares of common stock ($3,581) (Note 15). C-27

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dqllars In Thousands. Exce_~t Per Share Amounts - (Continued) 13. STOCK PLANS The Company's Stock Option Plan (the "Plan") provides that options and stock appreciation rights ("SAR's") for up to 400,000 shares of common stock may be granted to officers and other key employees of the Company. All options must be granted on or before the tenth anniversary of the effective date of the Plan (September 1, 1997) and at prices not less than the fair market value of the stock on the date of grant. The exercise price may be paid in cash or in shares of the Company's common stock having a fair market value equal to the cash amount for which it was substituted. Shares received upon exercise of a portion of an option may be applied automatically at their fair market value to purchase additional portions of the option. Shares relating to options that expire or are canceled are added back to shares authorized for future grants. At December 31, 1994 and 1993, no options were outstanding; however, there were 212,400 shares available to be granted under this Plan. On August 7, 1991, the Company's Board of Directors adopted the 1991 Stock Incentive Plan (the "1991 Incentive Plan") for officers and other key employees of the Company and its subsidiaries and authorized the grant of up to 1,213,343 shares of common stock under the 1991 Incentive Plan. The 1991 Incentive Plan was approved by stockholders on September 12, 1991, and all shares were granted during 1991. Of the awards made under the 1991 Incentive Plan, 110,000 shares are unrestricted shares and the remainder are shares whose transferability are restricted for a specified period of time and vest over a four-year period (the "Restricted Shares"). Restricted Shares have full voting rights and, subject to certain escrow arrangements, are entitled to all dividends. Holders of unrestricted shares have all dghts of a stockholder. In connection with the Company's 1991 Incentive Plan described above, the Company issued an additional 998,043 shares of common stock. During the first quarter of 1993, the Company granted an additional 375,000 shares of common stock to an officer and an employee, under terms substantially similar to the Restricted Shares described above. During the fourth quarter of 1993, the officer surrendered the equivalent of 150,000 unvested shares received earlier in the year. Pursuant to an agreement dated as of January 1, 1994, the Company granted 500,000 shares of restricted common stock to a consultant who also serves as the Chairman of SkyBox and a member of the Board of Directors and President of New Valley. Of the total number of shares granted, 250,000 were immediately vested and issued during the third quarter. The remaining 250,000 shares will vest and be issued in 1995. In addition, on January 25, 1995 the Company entered into a nonqualified stock option agreement. Under the agreement, options to purchase 500,000 shares were granted at $2.00 per share. The options are exercisable over a ten-year period, beginning with 20% on the grant date and 20% on each of the four anniversaries of the grant date. Unexercised options do not provide any rights of a stockholder; however, the grant does provide for dividend equivalent rights on the unexercised shares. During 1994, 1993 and 1992 the Company recorded charges to income of $781, $790 and $2,433 for compensation equal to the excess of the fair market value for the shares granted over the price paid for them. In 1993, 75,000 restricted shares were cancelled and all other shares were deemed unrestricted as a result of certain officers' termination of employment. C-28

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Exce.ot Per Share Amounts - (Continued) 14. CONTINGENCIES Since 1954, the Company and other United States cigarette manufacturers have been named as defendants in a number of direct and third-party 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 exposures to so-called secondary smoke (environmental tobacco smoke, "ETS") from cigarettes. These cases are reported hereinafter as though having been commenced against Liggett (without regard to whether such actually were commenced against Brooke Group Ltd. in its former name or in its present name or against Liggett), since all involve the tobacco manufacturing and marketing activities currently performed by Liggett. The number of such cases pending against the Company and the other cigarette manufacturers has decreased generally since early 1987, after several years of increases, but new cases continue to be commenced against Liggett and other cigarette manufacturers with the number of cases now pending against Liggett being somewhat greater than in 1993. As new cases are commenced, the costs associated with defending such cases and the risks attendant on the inherent unpredictability of litigation continue. To date a number of such actions, including several against Liggett, have been disposed of favorably to the defendants; no plaintiff has ultimately prevailed on the merits of any such action; and no payment in settlement of any such claim has been made by the Company nor, to the Company's knowledge, any other cigarette manufacturer. In the action entitled Y.vonne Rogers v. Liggett Grou.o Inc.. et al., Superior Court, Marion County, Indiana, trial commenced on January 31, 1995 and ended on February 22, 1995 when the trial court declared a mistrial due to the jury's inability to reach a verdict. In one such action entitled Cipollone v. Liggett Grou.~ Inc.. et al., the United States Supreme Court on June 24, 1992, issued an opinion respecting federal preemption of state law damage actions. The Supreme Court in Cipollone concluded that The Federal Cigarette Labeling and Advertising Act (the "1965 Act") did not preempt any state common law damage claims. The decision permits plaintiff to assert common law claims for damages for failure to warn adequately, fraudulent misrepresentation, concealment, conspiracy and breach of express warranty in the period from 1966 to 1969. Relying on an amendment to Section 5(b) of the 1965 Act by The Public Health Cigarette Smoking Act of 1969 (the "1969 Act"), however, the Supreme Court concluded that the 1969 Act preempted certain, but not all, common law damage claims. Accordingly, the decision bars plaintiff from asserting claims that, after the effective date of the 1969 Act, the tobacco companies either failed to warn adequately of the claimed health risks of cigarette smoking or sought to neutralize those claimed risks in their advertising or promotion of cigarettes, It does permit, however, claims for fraudulent misrepresentation (other than a claim of fraudulently neutralizing the warning), concealment (other than in advertising and promotion of cigarettes), conspiracy and breach of express warranty after 1969. The Court expressed no opinion on whether any of these claims are viable under state law, but assumed arguendo that they are viable. The application of the principles enunciated in the decision to the particular theories of recovery asserted in each case will await further proceedings. On May 11, 1993, in the case entitled Wilks v. The American Tobacco Com.~any, No. 91-12,355, Circuit Court of Washington County, State of Mississippi (a case in which Liggett is not a defendant), the trial court granted plaintiffs' motion to impose absolute liability on defendants for the manufacture and sale of cigarettes and struck defendants' affirmative defenses of assumption of risk and comparative fault/contributory negligence. The trial court ruled that the only issues to be tded in the case were causation and damages. No other court has ever imposed absolute liability on a manufacturer of cigarettes. After trial, the jury returned a verdict for defendants, finding no liability. C-29

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands. Except Per Share Amounts - (Continued) The Company is or has been a defendant in other cases in Mississippi and it cannot be stated that other courts will not apply the Wilks ruling as to absolute liability. On May 12, 1992, an action entitled Cordova v. Liggett Grou~ Inc.. et al., Superior Court of the State of California, City of San Diego, was filed against Liggett, five other cigarette manufacturing companies, the Tobacco Institute, Inc., the Council for Tobacco Research and Hill & Knowlton. In her complaint, plaintiff, purportedly on behalf of the general public, alleges that defendants have been engaged in unlawful, unfair and fraudulent business practices by allegedly misrepresenting and concealing from the public scientific studies pertaining to smoking and health funded by, and misrepresenting the independence of, the Council for Tobacco Research and its predecessor. The Complaint seeks equitable relief against the defendants, including the imposition of a corrective advertising campaign, restitution of funds fraudulently obtained by defendants, disgorgement of revenues and profits acquired as a result of the alleged fraud, the imposition of a constructive trust and an asset freeze on alleged ill-gotten gains, an injunction precluding defendants from pursuing the alleged wrongful acts, and reasonable attorneys' fees and costs. The case is presently in discovery. On March 15, 1994, in an action entitled Broin et al v. Phili.~ Morris Com.~anies. Inc.. et al., Dade County Circuit Court, State of Florida, the District court of Appeals for the Third District reversed the Dade County Circuit Court's dismissal of plaintiffs' class action allegations and a motion to invoke the discretionary jurisdiction of the Florida Supreme Court is pending. This case was the first class action commenced against the industry, and has been brought by plaintiffs on behalf of all flight attendants that have worked or are presently working for airlines based in the United States and who have never regularly smoked cigarettes but allege that have been damaged by an involuntary exposure to ETS. On December 12, 1994, plaintiffs' motion to certify the action as a class action was granted. Defendants have appealed this ruling. On March 25, 1994, an action entitled Castano. et al y. The American Tobacco ComDany. et al., United States District Court, Eastern District of Louisiana, was filed against Liggett and four other cigarette companies (and since has been amended to add an additional cigarette company as a defendant). The class action complaint was brought on behalf of plaintiffs and residents of the United States who claim to be addicted to tobacco products of defendants, including Liggett, and survivors who claim their decedents were addicted to such tobacco products. The complaint is based upon the claim that defendants manipulated the nicotine levels in their tobacco products with the intent to addict plaintiffs and the class members and, inter alia, fraud, deceit, negligent misrepresentation, breach of express and implied warranty, strict liability and violation of consumer protection statutes. Plaintiffs seek compensatory and punitive damages, equitable relief including disgorgement of profits from the sale of cigarettes and creation of a fund to monitor the health of class members and to pay for medical expenses allegedly caused by defendants, attorneys' fees and costs. On December 14, 1994, plaintiffs' motion to certify the action as a class action was orally argued before the Court. On February 17, 1995, the Court issued an Order that granted in part Plaintiffs' motion for class certification, for the specific claims of fraud, breach of express warranty, breach of implied warranty, intentional tort, negligence, strict liability and consumer protection, together with punitive damages to the end of establishing a multiplier to compute punitive damage awards. The court denied class certification as to issues of injury and fact, proximate cause, reliance and affirmative defenses. The Court defined Plaintiffs' class as being comprised of all nicotine-dependent persons (and their representatives) in the U.S. and its territories and possessions and Puerto Rico who have purchased and smoked cigarettes manufactured by the Defendants. The trial court Order defines "nicotine- dependent" as (a) all cigarette smokers who have been diagnosed by a medical practitioner as nicotine-dependent; and/or (b) all regular cigarette smokers who were or have been advised by a medical practitioner that smoking has had or will have adverse health consequences who thereafter do not or have not quit smoking. Defendants will make application to the trial court that it certify the C-30

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands. ExceDt Per Share Amounts - (_Continued) class certification Order for interlocutory appeal, but if such is not granted, Defendants will seek appellate review by mandamus. On May 5, 1994, an action entitled Engle, et al v. R. J. Reynolds Tobacco ComDany. et al., Circuit Court of the 11th Judicial District in and for Dade County, Florida, was filed against Liggett, five other cigarette companies, The Council for Tobacco Research - USA, Inc., the Tobacco Institute, Inc. and others. The class action complaint was brought on behalf of plaintiffs and all persons in the United States who allegedly have become addicted to cigarette products of defendants, including those of Liggett, and allegedly have suffered personal injury as a result thereof, with such claims predicated on theories of strict liability in tort, fraud and misrepresentation, conspiracy to misrepresent and commit fraud, breach of implied warranty of merchantability and fitness, breach of express warranty, intentional infliction of emotional distress and negligence. Plaintiffs seeks compensatory and punitive damages, equitable relief including but not limited to a medical fund for future health care costs, attorneys' fees and costs. On October 31, 1994, plaintiffs' motion to certify the action as a class action was granted. On November 29, 1994, defendants filed notice of appeal to the Third District of the Florida Court of Appeal. On May 23, 1994, an action entitled Mike Moore. Attorney General. ex rel State of Mississi_o_oi vs. The American Tobacco Company. et ~1., Chancery Court for the County of Jackson, State of Mississippi, was filed against Liggett and five other cigarette companies, the Tobacco Institute, Inc., the Council for Tobacco Research - USA, Hill & Knowlton and others. In this action, the State of Mississippi seeks restitution and indemnity for medical payments and expenses made or incurred by the State of Mississippi on behalf of welfare patients for tobacco related illnesses. Similar actions (although not identical) have been filed recently by the State of Minnesota (together with Minnesota Blue Cross- Blue Shield) and by the State of West Virginia. The State of Florida has enacted legislation effective July 1, 1994 allowing certain state authorities or entities to commence a lawsuit to seek recovery of Medicaid payments made on behalf of Medicaid recipients as a result of diseases allegedly caused by liable third parties. Though not limited to the tobacco industry, the statutory scheme includes the industry with ultimate liability based upon market share and would include disease allegedly caused by the smoking of cigarettes. The statute abrogates comparative negligence, assumption of risk and other defenses normally available to liable third parties and, by its stated language, permits the use of statistical evidence to prove causation. A suit has been commenced to challenge the constitutionality of the legislation. On February 22, 1995, suit was commenced by the State of Florida, together with others, against the five domestic cigarette manufacturers and their respective parent companies, as well as others, seeking restitution of monies expended in the past and which may be expended in the future by the State of Florida to provide health care to Medicaid recipients by the State of Florida for injuries and ailments allegedly caused by the use of cigarettes and other tobacco products° Plaintiffs also seek a variety of other forms of relief including a disgorgement of all profits from the sales of cigarettes in Florida. The Commonwealth of Massachusetts has enacted legislation authorizing lawsuits similar to the suits filed by the State of Mississippi, the State of Minnesota, the State of West Virginia and the State of Flodda as described above. Currently in addition to Cordova, approximately 23 product liability lawsuits are pending and active in which Liggett is a defendant. In most of these lawsuits, plaintiffs seek punitive as well as compensatory damages. The states in which suits are presently pending and active against Liggett are California, Florida, Indiana, Louisiana, Minnesota, Mississippi, Nevada, New Hampshire, New Jersey, New York, Ohio, Oklahoma, Pennsylvania, Texas and West Virginia. C-31

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands. Exce_ot Per Share Amounts - (.Continued) In addition, bills have been introduced in Congress on occasion to eliminate the federal preemption defense. Enactment of any federal legislation with such an effect could result in a significant increase in claims, liabilities and litigation costs. A Grand Jury investigation presently is being conducted by the office of the United~States Attorney for the Eastern District of New York regarding possible violations of criminal law relating to the activities of The Council for Tobacco Research - USA, Inc. The Company was a sponsor of The Council for Tobacco Research - USA, Inc. at one time. The Company is unable, at this time, to predict the outcome of the investigation. Liggett has received a Civil Investigative Demand from the Antitrust Division of the United States Department of Justice, requesting information from Liggett. The request appears to focus on United States tobacco industry activities in connection with product development efforts respecting, in particular, "fire-safe" or self-extinguishing cigarettes. It also requests certain general information concerning contacts with competitors. Liggett is unable to predict the outcome of this investigation. In March and April 1994, the Health and the Environmental Subcommittee of the Energy and Commerce Committee of the House of Representatives held hearings regarding nicotine in cigarettes. On March 25, 1994, Commissioner David A. Kessler of the Food and Drug Administration gave testimony as to the potential regulation of nicotine under the Food, Drug and Cosmetic Act, and the potential for jurisdiction over the regulation of cigarettes to be accorded to the FDA. In response to commissioner Kessler's allegations about manipulation of nicotine by cigarette manufacturers, including Liggett, the chief executive of each of the major cigarette manufacturers, including Liggett, testified before the subcommittee on April 14, 1994, denying Commissioner Kessle(s claims. The United States Congress, through the Omnibus Budget Reconciliation Act ("OBRA") of 1993, has required that domestic tobacco comprise at least 75% of the content of cigarettes manufactured in the United States effective January 1, 1994. A GA'I-i" tribunal has ruled that this legislation violates GAFF. Legislation has been enacted which will repeal retroactively the domestic content legislation upon the declaration of tariffs on imported tobacco in excess of certain quotas pursuant to a Presidential proclamation. Management believes that such a proclamation will be issued during 1995. The Company is exploring avenues which might be available to it to realize relief from the imposition of sanctions under OBRA. While the Company is of the opinion that there is a realistic potential for the Company realizing relief, no assurance can be given at this time that the Company will be successful in realizing such relief, either in whole or in part. No amount has been .accrued. With regard to each of the cases referred to above which is pending against the Company, the Company believes, and has been so advised by counsel handling the respective cases, that the Company has a number of valid defenses to the claim or claims asserted against the Company. All cases are, and will continue to be, vigorously defended. Litigation is subject to many uncertainties, and it is possible that some of these actions could be decided unfavorably. An unfavorable outcome of a pending smoking and health case could encourage the commencement of additional similar litigation. Recently, there have been a number of restrictive regulatory, adverse political and other developments concerning cigarette smoking and the tobacco industry, including the commencement of the purported class actions referred to above. These developments generally receive widespread media attention. The Company is not able to evaluate the effect of these developing matters on pending litigation and the possible commencement of additional litigation. The Company is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of the cases pending against the Company° It is possible that the Company's financial position, results of operations or cash flows could be materially affected by an ultimate unfavorable outcome of certain pending litigation. C-32

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands. Exce.ot Per Share Amounts - (Continued) There are several other proceedings, lawsuits and claims pending against Liggett unrelated to product liability. Management is of the opinion that the liabilities, if any, ultimately resulting from such proceedings, lawsuits and claims should not materially affect Liggett's consolidated financial position, results of operations or cash flows. On September 20, 1993, a group of CVR holders and the CVR trustee filed an action in the Delaware Chancery court, New Castle County, against the Company and certain of its present and former directors, challenging and seeking to enjoin or rescind the Distribution. Pursuant to notice given on October 15, 1993, the Company redeemed its CVRs on December 9, 1993 for a payment of $.36 per CVR. On June 2, 1994, the Company entered into a Stipulation and Agreement of Compromise and Settlement (the "Stipulation") pursuant to which a class of CVR holders, which includes all persons who held CVRs at any time between September 20, 1993 and June 2, 1994, were to receive a total of $4,000 plus an award of attorneys' and experts' fees and expenses not to exceed $900. The $4,000 settlement fund has been deposited into an escrow account for eventual disbursement to all eligible CVR holders. By order dated June 10, 1994, the Court of Chancery scheduled a settlement hearing to be held on August 16, 1994 to determine, inter alia, whether the Stipulation is fair, reasonable and adequate. That settlement hearing was adjourned at the named plaintiff CVR holders' request because of issues arising from filing of a motion for leave to amend the Company's complaint in a separate lawsuit pending against the CVR trustee. The named plaintiff CVR holders subsequently asked the court to rescind the Stipulation, stating, in substance, that they had mistakenly entered into it in the erroneous belief that the Company would be unable to assert claims against the trustee which those CVR holders might have to indemnify. On December 28, 1994, the court rescinded the Stipulation, finding that such a mistake had been made; however, the named plaintiff CVR holders and the defendants continued settlement discussions, seeking to address the named plaintiff CVR holders' concerns over their obligation to indemnify the trustee. On March 3, 1995, these parties advised the court that they had reached an agreement in principle to settle the case on a class basis, subject to the final resolution of certain remaining issues. At December 31, 1994, there were several other proceedings, lawsuits and claims pending against subsidiaries of the Company. The Company is of the opinion that the liabilities, if any, ultimately resulting from the CVR action and other proceedings, lawsuits and claims should not materially affect its consolidated financial position, results of operations or cash flows. 15. RELATED PARTY TRANSACTIONS Effective June 1993, $14,692 of principal indebtedness (the "Consolidated Indebtedness") of the Chairman and certain of his affiliates to the Company were consolidated and the terms of such indebtedness were amended. On January 5, 1994, the Chairman repaid his principal indebtedness of $14,692 and that of certain of his affiliates in the total amount of $15,695 with the use of dividends paid on December 31, 1993 on Series G stock. (Refer to Footnote 13 "Equity"). On March 21, 1994, the Chairman repaid all interest due on the various debts in the amount of $1,163 and accordingly, the stock collateralizing the loans was released. Certain of the various debts under the Consolidated Indebtedness that were satisfied are discussed below: C-33

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands. ExceDt Per Share Amounts - (Continued) In September 1992, the Chairman became indebted to the Company for a shortfall of $1,640 under a note assigned to the Company in prior years. In March 1993, a shortfall in the amount of $3,573 arose with respect to a second note and as a result he became obligated to pay such shortfall amount (plus interest at prime plus 1%) to the Company. These shortfalls were a portion of the Consolidated Indebtedness which was repaid in January 1994. A corporation owned by the Chairman, and subsequently a subsidiary of BGLS, had an outstanding payable for approximately $994 at December 5, 1993. This payable had been assigned to BGLS, in September 1992, in exchange for the cancellation by BGLS of a like amount of debt owed to it by the subsidiary. Prior to the assignment to BGLS, no interest had been charged in respect of this receivable. The Chairman had agreed to guarantee payment of this receivable to BGLS, plus interest at prime rate plus one percent. This loan was repaid as part of the Consolidated Indebtedness and was repaid in January 1994. In December 1991, the Company acquired an option to purchase rights in an aircraft from a company controlled by the Chairman. The appraised value of the plane exceeded the purchase price at that time. The option expired unexercised on January 15, 1993, after which time the aircraft was sold to a third party. The Chairman's company was obligated to repay the option price ($2,895) as well as an amount of approximately $300 related to unreimbursed medical payments from another company owned by the Chairman. Both of the above repayments were a portion of the Consolidated Indebtedness which was repaid in January 1994. As of January 1, 1993, the Chairman had approximately $1,650 of other personal unsecured indebtedness to the Company. In addition, the Chairman was indebted to the Company in 1993 for approximately $2,049 collateralized by 6,234,837 shares of common stock and 1,754.657 shares of Series G Preferred to the Company owned directly or indirectly by the Chairman. On January 11, 1993, the Company approved a $1,475 line of credit for the Chairman on the same terms as the unsecured loans described above, of which $1,475 was outstanding. These loans bore interest at the prime rate plus 1% and were due on June 30, 1993. All of these amounts were repaid in January 1994 as part of the Consolidated Indebtedness. Other related party transactions follow: Effective July 1, 1990, a former executive transferred all of his equity in the Company to the Chairman and resigned from substantially all of his positions with the Company and its affiliates. In consideration for this transfer, a partnership (the "Partnership") controlled by the Chairman agreed, among other things, to make certain payments to the Company on account of the former executive's outstanding indebtedness of $8,677 (deducted from equity). In connection with this transaction, the Partnership had pledged 1,681,713 of the shares it held of the Company's common stock to secure its obligation. In May 1994, the Partnership paid $3,200 in partial satisfaction of the obligation. In consideration thereof, the Company released 1,281,713 of the pledged shares. In July 1991, the Company acquired an option for $2,500 to purchase 80% of the stock of Brooke Management Inc. ("BMI") from the Chairman. On February 21, 1992, the Company acquired the BMI Shares for total consideration of $9,600, the Chairman having repaid the option price (plus accrued interest) in December 1991 through the assignment of notes to the Company discussed above. In August 1992, the Company acquired the remaining 20% for approximately $2,400, payable principally in Liggett Series B Notes held by the Company. The acquisition was recorded at carryover value and decreased equity $16,186.

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In .Thousands, Exce.ot Per Share Amounts - (Continued) The Company and companies in which it has an interest also paid aircraft-related charges of approximately $376 and $594 to affiliated companies during the years ended December 31, 1993 and 1992. Prior to 1990, The Company advanced funds to the former Vice Chairman ($5,126 outstanding as of December 31, 1991, plus accrued interest, and deducted from equity at December 31, 1991). The loans bore interest at either the prime rate or federal short-term interest rate and were payable semiannually or annually. The loans were scheduled to mature in 1995 and 1997, were collateralized by 607,889 shares of the former Vice Chairman's common stock in the Company and, with the exception of loans in the principal amount of $1,500, were nonrecourse to him. Effective December 30, 1992, the former Vice Chairman transferred the 607,889 shares of common stock in the Company which were the collateral for the nonrecourse loan (approximately $4,600 including accrued interest) in connection with the termination of such loans. The Company recorded a $2,654 charge to income as a result of this transfer. In conjunction with the transfer of shares, the former Vice Chairman was granted a warrant (the "Warrant") to purchase 607,889 shares of the Company's common stock for an exercise price of $7.60 per share. This price was subsequently reduced to $0.10 per share as a result of the SkyBox Distribution. The Warrant was exercised in November 1994. The remaining loans in principal amount of $1,500 were to mature in 1995, bore interest at the federal short-term rate, are payable semiannually and are recourse to the former Vice Chairman. On December 31, 1993, the former Vice Chairman repaid $900 of the loan out of certain dividend proceeds. Effective January 1, 1994, the former Vice Chairman resigned waiving all rights in respect of a lump sum severance payment of $1,500 which was part of an employment agreement in effect since January 1, 1991. The Company waived all rights to the remaining $600 balance on the loan. The agreement provides that the former Vice Chairman remains as a consultant to the Company. The former Vice Chairman has served on the Board of Directors of New Valley since 1990. During the fourth quarter of 1994, he was elected President and Chief Executive Officer of MAI. In February 1991, the Company made a loan to a former executive vice president of the Company in the amount of $250, bearing interest at the prime rate plus one percent and due March 1, 1994. On July 26, 1993, the former officer transferred 50,000 shares of the Company's common stock with a fair market value of $275 to the Company in satisfaction of the loan and interest thereon. In connection with the Company's divestiture of its holdings in SkyBox common stock, an affiliate of the Company's outside directors, acting as a broker-dealer, received customary commissions of approximately $121. 16. CHANGE IN ACCOUNTING ESTIMATE Liggett revised its liability for its Long-Term Incentive Plan (the "Plan") in both the second quarters ended June 30, 1992 and 1993 to reflect the current status of the Plan in both years. Upon approval of the Plan in June 1992 by Liggett's Board, Liggett revised its estimated liability for the Plan. The revised liability reflected the amount due to eligible participants at September 30, 1992. The effect of the change in accounting estimate resulted in an increase in the Company's operating income by approximately $3,445 for year ended December 31, 1992. In June 1993, Liggett determined that Liggett's achievement targets under the Plan would not be met; therefore, no distributions would be made under the Plan. As a result, the Company has reversed its liability for the Plan. The effect of the change in accounting estimate resulted in an increase in operating income of approximately $2,450 for the year ended December 31, 1993. C-35

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Except Per Share Amounts - (Continued) 17. SUPPLEMENTAL CASH FLOW INFORMATION In accordance with the requirements of Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows," supplemental cash flow information is disclosed below: Cash paid during the period for: Interest Income taxes, net of refunds Year Ended December31, December31, December31, 1994 1993 1992 $39,429 $56,217 $44,682 605 2.110 3.430 $40.034 $58.327 $48.112 II. Noncash investing and financing activities: Contingent Value Rights liability Dividends payable Issuance and exchange of long-term debt Acquisition of 20% of BMI for Liggett Series B Notes Common stock received in connection with debt repayment Financing of equipment purchases Sedes G dividend Shareholder settlement Transfer of pension liability to SkyBox 131 114,888 3,200 6,250 4,305 $43,821 $20,972 15,136 18,530 2,400 275 1,672 3,500 3,700 18. SUPPLEMENTAL INFORMATION Supplemental balance sheetinformation at December 31 is as follows: 1994 1993 Other assets: Deferred financing costs, net of accumulated amortization $ 9,933 Other 1.934 Total other assets $11.867 $10,053 4.407 $14.460 Otheraccrued liabilities: Interest Compensation and related items Debt guarantee Restructuring Estimated allowance for future sales returns Legal and professional fees Taxes currently payable Other, miscellaneous Total other accrued liabilities $17,201 3,913 7,500 1,306 5,800 1,510 21,849 4.492 $63.5~ $15,525 7,909 13,076 6,300 7,404 45,547 $107.082 C-36

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Exce_~t Per Share Amounts - (ContirlUed) 19. QUARTERLY FINANCIAL RESULTS (UNAUDITED) Quarterly data for the years ended December 31, 1994 and 1993 (reclassified) are as follows{A): Revenues Gross profit (Loss) income from continuing operations, as reported (Loss) income from continuing operations, as adjusted(;) Income of discontinued operations Extraordinary items Net income Per share data: Loss (income) from continuing operations, as reported (Loss) income from continuing operations, as adjusted Income of discontinued operations Extraordinary items Net income Share ~rices: High Low December 31 September 30, I 1994 1994 I June 30, March 31, 1994 1994 $121,715 $124,446 $119,077 $114,105 64,999 66,599 61,129 56,809 18,918 (1,417) (1,406) (14,017) 9,113 (6,377) (6,710) 158,012 10,459 3,381 4,296 (46,943) (1,118) 95,118 18,918 (1,417) (2,524) $. - $1.07 $(0.08.) $(0.08) $(0.79) $0.52 $(0.37) $(0.39) $ 6,75 $0.59 $ 0.19 $0.25 $(2.60) $ - $ " $(0.06) $ 5.27 $1,07 $(0.08) $(0.14) 4 1/2 5 3/8 2 2 1/4 2 5/8 1 3/8 1 1/4 1 1/2 Revenues Gross profit (Loss) income from continuing operations, as reported (Loss) income from continuing operations, as adjusted Income of discontinued operations Extraordinary items Net income Per share data:(8) Income (loss) from continuing operations, as reported (Loss) income from continuing operations, as adjusted Income of discontinued operations Extraordinary items Net income Share pdces: High Low December 31, September 30, I June 30, March 31, 1993 1993I 1993 1993 $129,252 $117,859 $124,238 $121,692 73,086 62,214 62,507 61,848 12,171 (11,624) (13,889) (3,832) (1,065) (21,036) (23,886) (23,241) 13,236 9,461 12,231 27,073 53,940 4,487 95,314 66,100 (11,575) (7,157) 59,412 $ 2,17 $(0.52) $(0,71) $(0.04) $(1,41) $(1.05) $(1.25) $(1.49) $ 0.75 $ 0.54 $ 0.66 $1.45 $3,07 $~ $ 0.24 $ 5.11 $ 5.24 $(0.52) $(0.34) $ 2.94 2 7/8 3 118 5 5/8 5 3/4 • 1 3/8 1 3/4 2 7/8 1 3/8 C-37

BROOKE GROUP LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, ExceDt Per Share Amounts - (Continued) Results of operations have been reclassified for discontinued operations in 1994 and 1993 (Note 2). After consideration of decretion/accretion of Contingent Value Rights liability in 1993. Quarterly income, as adjusted for September 30, 1994, reflects tax benefit of $24,557. 20. SUBSEQUENT EVENT On January 25, 1995, the Company announced that it would resume payment of regular quarterly cash dividends on its common stock. A quarterly cash dividend of $0.075 per share was distributed on February 13, 1995 to Company shareholders of record as of February 6, 1995. C-38

Indet~endent Auditors' Report The Board of Directors and Shareholders MAI Systems Corporation: We have audited the accompanying consolidated balance sheets of MAI Systems Corporation and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, shareholders' deficiency and cash flows for the years ended December 31, 1994 and 1993, the three-month period ended December 31, 1992 and the year ended September 30, 1992. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. 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 f'mancial 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 financial position of MAI Systems Corporation and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for the years ended December 31, 1994 and 1993, the three-month period ended December 31, 1992 and the year ended September 30, 1992, in conformity with generally accepted accounting principles. KPMG Peat Marwick I_l_P Orange County, California March 9, 1995 C-39

REPORT OF INDEPENDENT ACCOUNTANTS TO the Board of Directors and the Shareholders of New Valley Corporation In our opinion, the consolidated financial statements, together with the pro forma consolidated balance sheet data as of December 31, 1994, appearing under Item 14(a) (i) and (2) on page 19 present fairly, in all material respects, the financial position of New Valley Corporation and iss subsidiaries (the "Company") at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards, 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. As described in Note A to the consolidated financial statements, on November I0 1994, the Bankruptcy Court confirmed the Joint Chapter ii Plan of Reorganization (the "Joint Plan"). On January 18, 1995, the Joint Plan became effective and the Company emerged from Bankruptcy. The pro forma consolidated balance sheet data reflects the impact of the Joint Plan on the Company's financial condition at December 31, 1994 had the Joint Plan been in effect at that date. PRICE WATERHOUSE LLP Morristown, New Jersey March 24, 1995 C-40

NEW VALLEY CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS Year Ended D~emher 31, 1994 1993 (Thousazld.s. except per share amoua~ts) Interest and other income Costs and expenses: General and administrative Interest expense Total costs and expenses Income (loss) before income taxes, reorganization, discontinued operations and extraordinary items Reversal of restructuring accruals Financial restructuring costs Income tax benefit Loss before discontinued operations and extraordinary items Discontinued operations (Note B): Income from discontinued operations, net of income taxes of $5,500, $1,325, and $ I, 140, respectively 1992 $10,381 $ 3,844 $ 10,908 2,769 3,247 10,710 643 2,752 61,052 3,412 5,999 71,762 6,969 (2,155) (60,854) 318 2,117 17,724 (23,052) (I l, 152) (t0,968) 500 225 -- ( 15,265) (10,965) (54,098) Gain on disposal of the money transfer business, net of income taxes of $52,000 Earnings of discontinued operations Income (loss) before extraordinary items Extraordinary items: Loss on extinguishment of debt, net of income taxes of $3,475 (Note N') Gain on extinguishment of lease obligation (Note E) 79,625 38,368 34,173 1,056,081 -- -- 1,135,706 38,368 34,173 1,120,441 27,403 (19,925) Net income (loss) Dividends on preferred shares - undeclared (110,500) -- -- 8,417 Net income (loss) applicable to Common Shares 1,009,941 35,820 (19,925) (80,037) (68,706) (60,086) $ 929,900 $ (32,886) Income (loss) per common and equivalent share: Before discontinued operations ~d extraordinary items $ (.50) $ (.42) Discontinued operations 6.03 .20 Before extraordinary items 5.53 622) Extraordinary items (.59) .04 Net income 0oss) $ 4.94 $ (.18) Income (loss) per common share assuming fall dilution: Before discontinued operations and extraordinary items $ (.37) $ (.42) Discontinued operations 5.36 .20 Before extraordinary items 4.99 (.22) Extraordinary items (.52) .04 Net income (loss) $ 4.47 $ (.18) See accompanying Notes to Consolidated Financial Statements. $ (80,01 I) $ (.61) .18 643) $ (.43) $ (.61) .18 643) C-41

NEW VALLEY CORPORATION CONSOLIDATED BALANCE SHEET ASSETS Current assets: Cash in banks and in transit Temporary cash investments (Note C) Contract receivable Accounts receivable, net Restricted assets (Note C) Other current assets Total current assets Proforma December 31. December 3 I. 1994 1994 1993 (Thou~aadx. except par valueJ $ 560 $ 560 $ 64,983 381,210 375,610 111,383 -- 300,000 -- -- -- 10,92I 20,000 354,639 17,091 8,400 8,400 I0,012 410,170 1,039,209 214,390 Property and equipment, net Assets of discontinued operations held for sale Restricted assets Other assets Total assets -- -- 34,295 5,400 5,400 -- 25,000 25,000 12,261 282 282 8,537 $ 440,852 $ 1,069,891 $ 269,483 LIABILITIES AND CAPITAL (DEFICIT) Current liabilities: Current portion of long-term debt and other obligations $ 16,619 $ 16,619 Accounts payable and accrued liabilities 10,931 10,931 Prepetition cIaims and restructuring accruals (Note N) 70,221 619,833 Dividend payable -- 75,070 Income taxes payable 31,907 31,907 Total current liabilities 129,678 754,360 Deferred income taxes payable 19,572 19,572 Note payable and other obligations 16,605 16,605 Prepetition claims and restructuring accruals _ m Redeemable preferred shares (Note H) 306,274 317,798 Non-redeemable preferred shares, Common Shares, and other capital (deficit): Cumulative preferred shares (aggregate involuntary liquidation value $69,769 and $69,779) 279 279 Common Shares. $.01 par value; 850,000,000 shares authorized; 188,725,550 and 188,113,706 shares outstanding 1,887 1,887 Capital surplus 699,168 692,001 Pension plan liability adjustment -- -- Retained earnings (deficit) (732,61 I) (732,611) Total non-redeemable preferred shares, Common Shares and other capital (deficit) (31,277) (38,444) Contlngeaeies and commitments (Note M) Total liabilities and capital (deficit) $ 440,852 $ 1,069,89I See accompanying Notes to Consolidated Financial Statements. $ 7,501 142,194 149,695 19,318 791,893 329,233 279 1,881 755,521 (35,785) (1,742,552) (1,020,656) $ 269,483 C-42

NEW VALLEY CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS Cash provided from (used for) operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided from (used for) operating activities: Gain on disposal of business Income from discontinued operations Extraordinary loss (gain) Reversal of restructuring accruals Financial restructuring costs Decrease (increase) in other assets Increase (decrease) in accounts payable and accrued liabilities Net cash used for operating activities Cash provided from investing activities: Net proceeds from disposal of business Increase in restricted assets Net cash provided from investing activities Year Faded December 31, 1994 1992 1,009,941 $ 35,820 $ (19,925) (1,056,081) (79,625) 110,500 (318) 23,052 (7,571) (16,896) (16,998) (38,368) (8,417) (2,117) 11,152 160 (12,635) (14,405) (I 1,152) (34,173) (17,724) 10,968 30,194 (30,660) 467,822 (367,378) 100,444 (23,052) 60,394 139,410 199,804 176,366 Expenses of financial restructuring Net cash provided from (used for) continuing operations Net cash provided from discontinued operations Net increase in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and ca.sb equivalents, end of year Supplemental cash flow information: Cash paid during the year for:. Interest (including capital leases) State income taxes Non-cash investing and financing activities: Contract receivable Pension liability discharge Capital leases $ 376,170 $ 476 882 300,000 245,000 (25.557) 71,417 45,860 130,506 $ 176,366 $ 2,915 834 4,982 (10,968) (41,628) 4g,72g 7,100 123,406 $130,506 $ 3,259 1,006 2,983 See accompanying Notes to Consolidated Financial Statements. C-43

I I III IIII II I II ii III -- ;-- NEW VALLEY CORPORATION CONSOLIDATED STATEMENT OF CHANGES U~/NON-REDEEMABLE PREFERRED SHARES, COMMON SHARES AND OTHER CAPITAL (DEFICIT} Balance December 3 I, 1991 Net loss Undeclared dividends on redeemable preferred shares Conversion of preferred shares Accrued compensation associated with stock options granted Exercise of stock options Balance December 31, I992 Net income Undeclared dividends on redeemable preferred shares Conversion of preferred shares Accrued compensation associated with stock options granted Balance December 31, 1993 Net income Undeclared dividends on redeemable preferred shares Conversion of preferred shares Exercise of stock options Balance December 31, 1994 3,166 317 184,757 1,848 854,726 (46,083) (141) (14) 1,172 12 2 525 234 2 45 3,025 303 186,163 1,862 809,215 (54,149) (234) (24) 1,951 19 5 (1,758,447) (19,925) (1,778,372) 35,820 450 2,791 279 188,114 1,881 755,521 (63,635) 3 609 6 115 2,791 $ 279 188,726 $ 1,887 $ 692,001 (I,742,552) 1,009,941 Sfr32,6tl) accompanying Notes to Consolidated Financial Statements. C-44

NEW VALLEY CORPORATION NOTES TO CONSOLIDATED FENANCIAL STATEMENTS Note A--Basis of Presentation of Financial Statements Principles of Consolidation. The consolidated financial statements include the accounts of New Valley Corporation (the "Company') and its subsidiaries (collectively, "New Valley'). All significant intercompany transactions are eliminated in consolidation. Certain amounts in the 1992 and 1993 f'mancial statements have been reclassified to conform to the 1994 presentation. Reorganization. On November 15, 1991, a petition was filed in the United States Bankruptcy Court for the District of New Jersey ('Bankruptcy Court') seeking an order of involuntary bankruptcy against the Company. On March 31, 1993, the Company consented to the entry of an order for relief placing it under the protection of Chapter 11 of the United States Bankruptcy Code ('Chapter 11"). Western Union Financial Services, Inc. ("FSI'), Western Union Data Services Company, Inc. ('DSI') and other wholly-owned subsidiaries of the Company did not seek protection under the Bankruptcy Code and continued to operate in the ordinary course. On November 1, 1994, the Bankruptcy Court entered an order confirming the First Amended Joint Chapter 11 Plan of Reorganization, as amended (the "Joint Plan'). The terms of the Joint Plan provided for the sale of FSI and certain other Company assets related to the money transfer business, payment in cash of all allowed claims, payment of postpetition interest of $178 million to certain creditors, a $50 per share cash dividend to the Class A Preferred shareholders, a tender offer by the Company for up to 150,000 shares of its Class A Preferred Shares at a price of $g0 per share, and the reinstatement of all equity interests. On November 15, 1994, First Financial Management Company ('FFMC') purchased all of the common stock of FSI and other Company assets relating to the money transfer business for $1,193 million. The purchase price consisted of $593 million in cash, $300 million representing the assumption of the Western Union Pension Plan, and $300 million paid on January I3, 1995 for certain intangible assets of FSI. The pur.h,x~ agreement with FFMC contained various terms and provisions, including the escrow of $45 million of the purchase price, a put option by the Company to sell to FFMC and a call option by FFMC to purchase DSI for $20 million exercisable during the first quarter of 1996, and various services agreements. On January 18, 1995, the effective date of the Joint Plan, the Company paid approximately $549.6 million to holders of allowed prepetition claims. At~er emerging from bankruptcy, the Company had approximately $70.2 million in unsettled prepetition clairm and restructuring accruals which are expected to be settled and paid in 1995. Pursuant to the Joint Plan, the Company made an $80 per share tender offer for a maximum of 150,000 Class A Senior Preferred Shares. This tender offer expired February 17, 1995 and resulted in a payment of $4,355,600 for 54,445 shares tendered. The historical financial statements do not include adjustments and reclassifications to Prepetitioa Claims that have been made to reflect payment of such liabilities which were settled on January 18, 1995 as part of the Joint Plan. Pro Forma Consolidated Balance Sheet Data. On January 18, 1995 (the effective date of the Joint Plan), following the receipt of $300 million in collection of the contract receivable from FFMC in connection with the sale of certain intangible assets, the Company paid $549.6 million in settlement of allowed prepetition claims. Approximately $70.2 million of prepetition claims and accruals remain which are expected to be paid in 1995. C-45

NEW VALLEY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) In addition, pursuant to the Joint Plan the Company made an $80 per share tender offer for a maximum of 150,000 Class A Senior Preferred Shares. This tender offer expired on February 18, 1995 and resulted in a payment of $4.4 million for 54,445 shares tendered. Because the Joint Plan was approved prior to the year end and has resulted in a number of material settlement transactions being consummated shortly after year end but prior to release of the Company's consolidated financial statements, the Pro Forma Consolidated Balance Sheet Data as of December 31, 1994 has been presented to assist readers i~ understanding the impact of such transactions on the Company's financial position as if they had been implemented as of that date. Note B---Discontinued Operations The Company sold, during the fourth quarter of 1994, or is in the process of selling virtually all of its current operations. As noted above, in connection with the implementation of the provisions of the Joint Plan, the Company completed the sale of FSI and certain other assets to FFMC for $1,193 million. As part of the related purchase agreement between the Company and FFMC, the Company received a put option to sell DSI to FFMC and FFMC received a call option to purchase DSI, for $20 million, exercisable between January 1, 1996 and March 31, 1996. Management intends to exercise its option to sell DSI to FFMC. Accordingly, the financial statements reflect the financial position and the results of operations of the discontinued operations of FSI and DSI separately from the continuing operations. Operating results of the discontinued operations were as follows: Year ~udecl December 31, 1994 1993 1992 CThous'-,ds) Revenues $ 489,916 $ 477,349 $ 449,084 Operating Income $ 85,125 $ 39,693 $ 35,313 Income before income taxes $ 85,125 $ 39,693 $ 35,313 Provision for income taxes 5,500 1,325 I, 140 Net income $ 79,625 $ 38,368 $ 34,173 resulted a gain. The gain on disposal of the money transfer business of $I,056 million (net of $52 million of income taxes) from the sale of FSI to FFMC. The exercise of the option to sell DSI to FFMC is expected to result in Net assets of the discontinued business held for sale at December 31, 1994 consists of current assets of $7.0 miLlion, noncurrent assets of $2.1 million and total liabilities of $3.7 million. Note C--Summary of Significant Accounting Policies Statement of Cash Flows. New Valley defines "cash and cash equivalents" in the Consolidated Statement of Cash Flows as cash in b~dcs, cash in transit and temporary cash investments in highly liquid marketable securities. C-46

Temporary Cash Investment. Temporary cash investments consist primarily of U.S. Treasury obligations and commercial paper with maturities of three months or less and money market funds. An order of the Bankruptcy Court contains provisions which restrict cash investments of the Company to short-term high grade marketable securities. On Januar), 18, 1995, the Company was released from the restrictions imposed by the order. Restricted Assets. At December 3 I, 1994, the current and noncurrent portions of restricted assets consisted of the $45 million held in escrow related to the sale of FSI to FFMC, which have been classified based on the terms of the purchase agreement, and $334.6 million held in escrow for certain debenture holders which was released on January 18, 1995. At December 3 I, 1993, the current portion of restricted assets consisted mainly of deposits held by insurance companies or the banking authorities of various states in connection with the operation of the money transfer business. The noncurrent portion included cash from asset sales, cash from the collection of certain accounts receivable, and certain other assets, which were unavailable to the Company. Accounts Receivable. At December 31, 1993, New Valley's accounts receivable balance is net of an allowance for uncollectible accounts of $8.8 million. Property a~zl Equipment. New Valley's property and equipment at December 31, 1993 was comprised as follows (in thousands) : Office equipment and computers Buildings and improvements Accumulated depreciation Property and equipment $ 72,675 7,046 79,721 (45,426) $ 34,295 Depreciation. Property and equipment (including equipment subject to capital leases) is depreciated over the estimated useful lives, using the straight-line method. As property and equipment is retired, its cost and the related accumulated depreciation are eliminated. The principal lives (in years) used in determining depreciation rates of various assets are as follows: buildings and improvements (I0); and office equipment and computers (5-10). Depreciation expense was $9.0, $12.4, and $12.1 million in 1994, 1993, and 1992, respectively. Income (Loss) Per Common atut Equivalent Share. Net income (loss) per common and equivalent share, after dividends on preferred shares (undeclared), is based on the weighted average number of Common Shares, $.01 par value (the "Common Shares'), outstanding (188,298,000 in 1994, 187,723,000 in 1993 and 185,545,000 in 1992). Common Share equivalents for 1994, 1993 and 1992 are not included because their inclusion would be anti- dilutive~ Net income (loss) per common share assuming full dilution is based on the weighted average number of Common Shares outstanding plus the additional common shares resulting from the conversion of convertible preferred shares if such conversion was dilutive. The weighted average number of Common Shares assuming full dilution was 211,558,000 in 1994, 187,723,000 in 1993 and 185,545,000 in 1992. Note D--Pensions and Retiree Benefits New Valley maintained a suspended defined benefit plan and two defined contribution plans through November 15, 1994 which covered virtually all full-time employees. Total pension costs accrued under all plans was $18.9, $25.1 and $25.9 million in 1994, 1993 and 1992, respectively. Contributions were made to the pension plans in amounts n~_~ry to meet the minimum funding requirements of the Employee Retirement Income Security Act of 1974 ('ERISA'). As discussed in Note B, the liabilities related to these pension plans were assumed by FFMC on November 15, 1994. These liabilities aggregated approximately $245 million at the date of sale. Net pension cost accrued under defined benefit plans for 1994, 1993 and 1992 was: C-47

Year Euded December 1994 1993 1992 Cl-h~usa~ds) Service cost $ 1,250 $ 1,500 $ 1,500 Interest cost 35,490 43,928 44,918 Return on assets (21,448) (55,046) (33,230) Net amortization and deferral -- 30,406 7,737 Net pension cost $15,292 $ 20,788 $ 20,925 An analysis of funded status of the defined benefit plan at December 31, 1993 is as follows: Accumulated benefit obligation (all vested) $ 575,304 Projected benefit obligation Fair market value of plan assets Projected benefit obligation in excess of plan assets Unrecognized net loss ~finimum liability adjustment Accrued pension liability at December 31, 1993 $ 575,304 288,349 (286,955) 35,785 (35,785) $ (286,955) Actuarial assumptions underlying the above data for financial statement purposes were as follows: 1994 !993 1992 Discount rates Assumed rates of return on invested assets 7.5 %-8.5 % 7.5 % 8.5 % 10.0% 10.0% 10.0% The change in discount rates from 7.5% to 8.5% as of March 31, 1994 resulted in a $29.2 million decrease in the minimum pension liability. The change in discount rates from 8.5% as of December 31, 1992 to 7.5% in 1993 resulted in a $44.5 million increase in the projected benefit obligations. New Valley made contributions to its suspended defined benefit pension plans in amounts necessary to meet minimum funding requirements under EKISA. Cash contributions to such suspended plan were $20.3, $24.7 and $16.9 million in 1994, 1993 and 1992, respectively. Effective January 1, 1993, sponsorship of four plans was assumed by an unaffiliated company. Therefore, New Valley's responsibility for the obligations associated with each of these plans ended as of December 31, 1992. In 1992, New Valley recorded a gain of $2.8 million from settlement of these pension obligations. Under the provisions of the defined contribution plans, New Valley contributes 4 % of eligible employec compensation. It also provides for matching contributions up to 1.2% and 4.2% of such compensation for union and non-union employees, respectively, who made voluntary contributions to the plans. Pension expens~ for defined contribution plans was $3.1, $3.5 and $3.5 million in 1994, 1993 and 1992, respectively. Effective November 15, 1994, sponsorship of these defined contribution plans were assumed by FFMC. New Valley also provides certain health care and life insurance benefits for retired employees. Substantially all employees as of December 31, 1989 may qualify for those benefits upon attainment of certain retirement criteria and by paying the full expense associated with these benefits. Employees hired after January 1, 1990 are not eligible for such benefits. The cost of retiree health care and life insurance benefits, net of retiree C-48

contributions, was recognized when the expenses were paid in 1992 and 1991. Effective January 1, 1993, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions'. Such adoption did not have a material effect on the Company's financial position. Such costs were $1.5, $1.7 and $4.0 million in 1994, 1993 and 1992, respectively. Note E--Leases New Valley leased certain real properties for use as customer service centers, corporate headquarters and sales offices. It also leased certain data communications terminals, electronic data processing equipment and automobiles. Effective November 15. 1994, virtually all of these leases were assumed by FFMC as part of the sale of FSL In addition, FFMC a~sumed all of the capital leases of the Company. The property held under these leases had a net book value of $11 million and a related lease li.ability of $12 million at December 31, 1993. Rental expense for operating leases for the years ended 1994, 1993 and 1992 was $3.6, $1.2, and $1.0 million, respectively. In December 1993, an $8.4 million extraordinary gain was recorded as a result of the extinguishment of a capital lease obligation associated with the Company's former corporate headquarters. Note F--Federal Income Tax In January 1993, New Valley prospectively adopted Statement of Financial Accounting Standards No. 109 (FAS 109), Accounting for Income Taxes which changes the Company's method of accounting for income taxes from the deferred method (APB 11) to an asset and liability approach. New Valley files a consolidated Federal income tax return. The 1994 and 1993 Federal income tax provision were based on Alternative Minimum Tax rates. No provision for Federal income tax was recorded in 1992 as a result of losses incurred in that year. The provision for income taxes on continuing operations differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to pretax income from continuing operations as a result of the following differences: Provision (credit) for statutory U.S. tax rates (35% for 1994 and 1993 and 34% for 1992) Increase (decrease) in taxes resulting from: Nondeductible items Temporary items Partially owned and foreign subsidiaries State taxes, net of Federal benefit ~crease in valuation reserve for net operating loss carryforwards 1994 1993 1992 (5,518) $ (3,916) $ (18,393) 2,100 (2,664) 178 -- -- (2,099) -- -- 264 (122) -- -- 3,1MO 6,355 20,050 Income tax provision (benefit) $ (500) $ (225) $ 0 As described in Note B, during 1994 the Company sold FSI, and intends to sell DSI, to FFMC and has thea-~fom reflected these operations as discontinued. In addition, th~ Company recognized an extraordinary loss on the extinguishment of debt in 1994. Income taxes associated with discontinued operations and extraordinary items have been shown net of the utilization of the net operating loss carryforward and the change in other deferred tax assets. C-49

Federal deferred tax amounts are comprised of the following at December 31: 1994 Deferred Tax Assets: Net operating loss carryforward Restricted Net Operating Loss Unrestricted Net Operating Loss Pension liability accrued Accrued interest Other Total Deferred Tax Assets Deferred Tax Liabilities: Deferred gain on sale Total Deferred Tax Liabilities Net Deferred Tax Assets Valuation Allowance Deferred Federal Tax Liability (Thousands) 1993 21,666 $ 29,499 120,336 256,385 0 100,434 0 20,064 8,750 36,138 150,752 442,520 (I05,000) 0 (105,000) o 45,752 442,520 (5 I, 812) (442,520) $ (6,060) $ 0 The Company has recorded approximately $13.5 million of deferred state tax liabilities as of December 3 I, 1994. As of December 31, 1994, virtually all of the Company's current and deferred income taxes payable of $31.9 million and $19.6 million, respectively, resulted from incomes taxes on discontinued operations. There were no deferred tax liabilities at December 31, 1993. In December 1987, New Valley consummated certain restructuring transactions that included certain changes in the ownership of New Valley's stock. The Internal Revenue Code restricts the amount of future income that may be offset by losses and credits incurred prior to an ownership change. New Valley's annual limitation on the use of its net operating losses is computed by multiplying the "long-terra tax exempt rate" at the time of change of ov~aership (which rate was 8.04% as of December 30, 1987) by the fair market value of the company's outstanding stock immediately before the ownership change. The limitation is cumulative; any unused limitation from one year may be added to the limitation of a following year. Operating losses incurred subsequent to an ownership change are generally not subject to such restrictions. As of December 3 I, 1994, New Valley had consolidated net operating loss earryforwards of approximately $406 million for tax purposes, which expire at various dates through 2007. Approximately $62 million of net operating loss carryforwards coustitute pre-change losses and $349 million of net operating losses were ume~tdcted. Approximately $275 million of the net operating loss earryforwards will be utilized in 1995 to offset taxable income related to the sale of FSI which was deferred for tax purposes. New Valley's Federal income tax returns have been examined and settled through 1980. In addition, the Federal income tax returns for 1981 through 1991 have been preliminarily surveyed by the IRS and no changes have been proposed. In addition, all years through 1990 are closed for audit by virtue of the statute of limitations except to the extent of net operating loss carryfonvards. Note C--Note Payable and Other Obligations C-50

9% Note payable due 7/14/9T"~ Amount payable to FFMC pursuant to the purchase contract Deferred credits Other obligations Total note payable and other obligations Dt~etuber 3 I, 1994~* 1993a* Loug-te~m Current Loug-term Current portion portion po~ou portion (Thousands) $ -- $ 5,400 $ -- S 5,400 10,967 10,167 364 8,820 5,274 1,052 10,498 2,101 $ 16,605 $ 16,619 $ 19,318 $ 7,501 The 9% Note that was due 7/14/92 was paid in February 1995. See Note N for details of Prepetition Claims. The maturity of the long-term portion at December 31, 1994 is as follows: 1996 - $8.9 million, 1997 - $4.5 million, 1998 - $I.1 million, and $2.1 million thereafter. Note H--Redeemable Preferred Shares At both December 31, 1994 and 1993, the Company had authorized and outstanding 2,000,000 and 1,501,411, respectively, of its $15.00 Class A Increasing Rate Cumulative Senior Preferred Shares ($100 Liquidation Value), $.01 par value, which are redeemable at the option of the Company (the "Class A Senior Preferred Shares'). At December 31, 1994 and 1993, respectively, the carrying value of such shares amounted to $318 million and $329 million, including undeclared dividends of $177 million and $193 million, or $117.73 and $128.57 per share. The holders of Class A Senior Preferred Shares are entitled to receive a quarterly dividend, as declared by the Board of Directors, payable at the rate of $16.00 per annum through December 31, 1994. On 1anuary 1, 1995, the rate increased to $19.00 per annum. The Class A Senior Preferred Shares are required to be redeemed on January 1, 2003 at $100 per share plus accrued dividends. The Class A Senior Preferred Shares were recorded at their market value ($80 per share) at December 30, 1987, the date of issuance. The discount of $30 million from the liquidation value is aeereted, utilizing the interest method, as a charge to capital surplus and an increase to the recorded value of the preferred shares, through the redemption date. As of December 3 I, 1994, $20.9 million was so accrued on the Class A Senior Preferred Shares. In the event a required dividend or redemption is not made on the Class A Senior Preferred Shares, no dividends shall be paid or declared and no distribution made on any junior stock other than a dividend payable ha junior stock. If at any time six quarterly dividends payable on the Class A Senior Preferred Shares shall be ha arrears or such shares are not redeemed when required, the number of directors will be increased by two and the holders of the Class A Senior Preferred Shares, voting as a class, will have the right to elect two directors until full cumulative dividends shall have been paid or declared and set aside for payment. Such directors were designated pursuant to the Joint Plan ha November 1994. Pursuant to the Joint Plan, the Company declared a dividend in December 1994 on the Class A Senior Preferred Shares of $50 per share which was paid in January 1995. Dividends may be declared by the Company C-51

when and as determined by the Board of Directors of the Company in light of the financial condition, cash position, results of operations, legal dividend capacity of the Company and other factors. Undeclared dividends are accrued quarterly and such accrued and unpaid dividends shall accrue additional dividends in respect thereof compounded monthly at the then applicable dividend rate per armum, both of which are included in the carrying amount of redeemable preferred shares, offset by a charge to capital surplus. For information on Class A Senior Preferred Shares owned by Brooke Group Ltd. ('Brooke Group'), see Note J. Note I--Preferred Shares Not Subject to Redemption Requirements At December 31, 1994, the Company had authorized and outstanding 12,000,000 and 2,790,776, respectively, $3.00 Class B Cumulative Convertible Preferred Shares ($25 Liquidation Value), $. I0 par value (the "Class B Preferred Shares'). The holders of the Class B Preferred Shares are entitled to receive a quarterly dividend, as declared by the Board of Directors, at a rate of $3.00 per armum: Undeclared dividends are accrued quarterly at a rate of 12% per armum, and such accrued and unpaid dividends shall accrue additional dividends in respect thereof, compounded monthly at the rate of 12% per annum. Each Class B Preferred Share is convertible at the option of the holder into 8.3333 Common Shares based on a $25 liquidation value and a conversion price of $3.00 per Common Share. At the option of the Company, the Class B Preferred Shares are redeemable in the event that the closing price of the Common Shares equals or exceeds 140% of the conversion price at a specified time prior to the redemption. If redeemed by New Valley, the redemption price would equal $25 per share plus accrued dividends. In the event a required dividend is not paid on the Class B Preferred Shares, no dividends shall be paid. or declared and no distribution made on any junior stock other than a dividend payable in junior stock. If at any time six quarterly dividends on the Class B Preferred Shares are in arrears, the number of directors will be increased by two, and the holders of Class B Preferred Shares and any other classes of preferred shares similarly entitled to vote for the election of two additional directors, voting together as a class, will have the right to elect two directors to serve until full cumulative dividends shall have been paid or declared and set aside for payment. Such two directors were designated pursuant to the Joint Plan in November 1994. During 1994, 1993 and 1992, 3,094; 1,951,155 and I, 171,657 Common Shares, respectively, were issued upon conversion of 372; 234,141 and 140,603 Class B Preferred Shares, respectively. No dividends on the Class B Preferred Shares have been declared since the fourth quarter of 1988 and the Company does not anticipate paying dividends thereon in the foreseeable future. The undeclared dividends, as adjusted for conversions of Class B Preferred Shares into Common Shares, cumulatively amounted to $76.7 million, $60.2 million and $45.7 million at December 31, 1994, 1993 and 1992, respectively. These undeclared dividends represent $27.46, .$21.58 and $I6.37 per share as of the end of each year. No accrual was recorded for such undeclared dividends as the Class B Preferred Shares are not mandatorily redeemable. Note J--Common Share~ Class B Common Share. In 1987, the Company issued one Class B Common Share, $.01 par value (the "Class B Common Share'), to a company under the control of Bennett S. LeBow, Chairman of the Company's Board of Directors. The Class B Common Share had voting rights equivalent to 79,399,254 Common Shares and liquidation and dividend rights equivalent to 793,993 Common Shares. In May 1991, the Class B Common Share was converted into Common Shares. Through the ownership of 79,399,254 Common Shares and 650,869 Class A Senior Preferred Shares as of December 31, 1994 Brooke Group had 41.6% of all voting power. C-52

Stock Warrants. I.n 1994, 1993 and 1992, no warrants were exercised..Stock warrants outstanding at December 31, 1994 are as follows: Coul~uou Sha l'es Subject to Exercise ]3ate Issued Warrants Price Expiratiou Date February 1, 1985 516,300 $7.67 January 31, 1995 May 1, 1985 258,100 $7.65 April 30, 1995 September 30, 1987 220,000 $2.50 November 13, 1997 October 30, 1987 220,000 $2.50 November 13, 1997 Total 1,214,400 Stock Option Plans. Under the 1987 Stock Option Plan (the ".1987 Plan'), options to purchase up to 30,000,000 Common Shares may be offered to key employees, including officers, az~d non-employee directors. Options may be issued at an exercise price of not less than 35 % of the fair market value of the Common Shares at date of grant. Common Shares available for future grant under the 1987 Plan amounted to 13,014,000 at December 31o 1994. A summary of transactions during 1994 with respect to options is as follows: Outstanding at January 1, 1994~'~ Exercised Canceled, expired or terminated Outstanding at December 31, 1994c*~ Number of Shares Optioued Price Range 19,270,000 $.20- $.48 (608,750) $.20 (1,675,300) $.20 16,985,950 $.20- $.48 13,055,420 shares exercisable. 14,401,230 shares exercisable. Note KwJoint Venture Joint Venture. In 1991, FSI entered into a joint venture to develop and operate a check-cashing services business. At December 3I, 1993, FSI had invested $5.1 million in the joint venture's operations and capital expenditures. In 1993, FSI had determined to end its commitment to fund this joint venture and accordingly wrom off its remaining investment of $3~3 million. C-53

Note L--Accounts Payable and Accrued Liabilities The composition of accounts payable and accrued liabilities is as follows: Accounts payable and accrued liabilities: Accounts payable and accruals, principally trade Payable to banks (funded with cash in transit) Money transfer payable Payable to utilities Taxes (property and miscellaneous) Payable to international agents Interest Wages Excise tax payableI') Other, miscellaneous Total December 1994 1993 (Thous~ucLs) 2,078 $ 58,851 -- 39,988 -- 16,958 -- 10,301 2,755 6,484 -- 5,310 -- 2,170 95 1,739 6,000 -- -- 393 $ I0,931 $ 142,194 The Excise tax payable relates to an excise tax imposed on annual contributions to retirement plans tha) exceed a certain percentage of armual payroll. The Company intends to vigorously contest this tax liability. Note M--Contingencies New Valley is a party to other actions and proceedings incidental to its business. In the event of final adverse determinations, the liability in any of these matters is covered by insurance and/or established reserves or, in the opinion of management, after consultation with counsel, should not, in the aggregate, have a material adverse effect on New Valley's consolidated financial position, liquidity or results of operations. Note N--Prepetition Claims Under Chapter 11 and Restructuring Accruals Those liabilities that are expected to be settled as a part of the Joint Plan are classified in the Consolidated Balance Sheet as prepetition claims. On January 18, 1995, approximately $550 million of prepetition claims were settled pursuant to the Joint Plan. Remaining amounts may be subject to future adjustments depending on: actions of the Bankruptcy Court and further developments with respect to disputed claims. December 3 I, Pro Forma llistorical 1994 1994 1993 frbo,,saads) Debentures and Notes~): 19¼ % due 12/15/92 -- $171,443 $171,443 16% due 6/15/91 -- 23,805 23,805 5% due 311/92 -- 7,958 7,958 8.45% due 3115196 -- 8,058 8,058 7.90% due 5/15/97 -- 5,021 5,021 9¼% due 12/1/97 -- 1,408 1,408 8.10% due 8115198 -- 7,698 7,698 13¼ % due 10/1/08 -- 30,310 30,310 C-54

13 5/8% due 3/15/94 5'A % convertible subordinated due 8/1/97 I0 3/4% subordinated due 8/1/97 Accrued interest - prepetition Accrued interest - postpetitionc*~ Pension liabilitiesc°~ Restructuring accruals Capital leases and installment purchases Long-term tax accrual Payable to connecting carriers Money transfer payableca~ Other, miscellaneous -- 6,330 6,330 -- 27,687 27.687 -- 14,454 14,454 -- 44,512 44,512 3,792 178,000 64,025 -- -- 286,955 53,208 74,166 46,926 -- -- 3,820 168 168 13,030 4,408 7,648 14,725 8,645 8,645 8,579 -- 2,522 5,149 Total $ 70,221 $619,833 $791,893 The Company's Debentures and Notes listed above were paid in full on January 18, 1995. Prior to the Joint Plan being confirmed on November I, 1994, no interest expense was accrued since December 31, 1992. The terms of the Joint Plan provided for postpetition interest of $178 million to be paid to settle the Company's Debentures and Notes. An extraordinary loss of $110.5 million was recorded for the extinguishment of this debt. ~'~ On November 15, 1994, the pension obligation under the Company's Pension Plan was assumed by FFMC. Represents money transfers issued by the Company prior to January 1, 1990 which have not yet been claimed by the customer or escheated to the respective states. The Company is currently in litigation in Bankruptcy Court seeking a determination that these monies are an asset of the Company. There can be no assurance as to the outcome of the litigation. Note O--Restructuring Charges In 1994, 1993 and 1992, New Valley reversed $.3, $2.1 and $17.7 million, respectively, of prior year restructuring accruals as a result of settlements on certain of its vacant real estate lease obligations. The 1994, 1993 and 1992 financial restructuring costs of $23.1, $11.2 and $11.0 million, respectively, consisted of professional fees related to its financial restructuring. C-55

1993('~: Revenues Expenses°~ tN~W VALLEY CORPORATION QUARTERLY FLNANCIAL DATA (UNAUDITED) (Thousands, except per share amout:ts) Quar~e~ 1st 2ad 3rd 4th Income (loss) before discontinued operations and extraordinary item Discontinued operations Income before extraordinary item Extraordinary item Net income Income (loss) per Common Share: Loss before disconEinued operations and extraordinary item Discontinued operations Extraordinary item Net income (loss)(¢' $ 345 5,528 467 $ 918 $ 8,651 13,420 7,497 t (799) (5,183) (12,953) (6,579) 9,450 17,587 29,226 26,071 1,062,822 12,404 16,273 19,492 1,072,272 -- -- -- (I ~0,500) 12,404 $ 16,273 1;19,492 $ 961,772 $ (.12) .09 s (.03) (.18) $ (.15) S (.06) .16 .14 5.64 -- -- (.59) (.02) $ (.01) $ 4.99 Revenues Expensese*~ Loss before discontinued operations and extraordinary item Discontinued operations Income before extraordinary item Extraordinary item Net income Income (loss) per Common Share: Loss before discontinued operations and extraordinary item Discontinued operations Extraordinary item Net loss('~ $ 801 3,077 (2,276) 7,095 4,819 4,819 886 1; 1,082 $ 1,075 ,393 4,675 5,664 (507) (3,593) (4,589) 9,367 15,940 5,966 8,860 12,347 1,377 -- -- 8,417 $ 8,860 $ I2,347 $ 9,794 $ (.io) $ (.oo) $ (.li) $ (.n) .04 .05 .08 .03 $ 606) $ (.o4)$ (.o3) $ 6o4) The quarterly financial data has been restated to reflect the discontinued operations of FSI and DSI. Includes provision for Federal and state income taxes. The sum of quarterly income (loss) per share may not equal income (loss) per share for the year, because the per share da'h for each quarter and for the year is independently computed. Fully diluted earnings per share is anti-dilutive for all periods of 1994 and 1993. See Note C. C-56

Coopers &Lybrand Coopers & Lybrand L.L.P. a orotesslonal services firm RI~.PORT OF IN-DEP~~ ACCOUNTANTS To the Board of Directors and Stockholders of Brooke Group Ltd. Our report on the consolidated f'mancial statements of Brooke Group Ltd. and Subsidiaries is included on Pages C-1 and C-2 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related f'mancial statement schedule on page D-2 of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic fmancial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. Miami, Florida April 3, 1995 D-1 CooDers & Lybrand L.L.P., a registered limited liability partnership, ~s a member firm of Coooers & Lybrand (International).

BROOKE GROUP LTD. SCHEDULE II o- VALUATION AND QUALIFYING ACCOUNTS (In Thousands) Description Balance at Beginning of Period Additions Charges to I Charged to Costs and I Other Expenses Accounts~a) Year ended December 31, 1994 Allowances for: Doubtful accounts .............................$ 235 $ 21 -- Cash discounts ................................. 745 12,337 -- Sales returns ..................................... 6.300 -- 2.800 Total ............................................ $ 7,280 $12.358 $2.800 Provision for inventory obsolescence ........ $ 1,418 $ 520 $ -- Deferred tax valuation account $101,240 $. -- $ -- Year ended December 31, 1993 Allowances for: Doubtful accounts .............................$ 300 $ 240 -- Cash discounts ................................. 1,191 13,018 -- Sales returns ..................................... 10,700 -- $3,800 Pdce increase credits ........................ 919 .... Total ............................................ $ 13.110 $ 13.258 $3.800 Provision for inventory obsolescence ........ $ 1.090 $ 350 Deferred tax valuation account $. -- $ -- $101.240(c) Year ended December 31, 1992 Allowances for: Doubtful accounts ............................. $ 561 Cash discounts .................................797 Sales returns ..................................... 9,400 Price increase credits ........................ -- Total ............................................ $10.758 $ 26 -- 17,615 -- -- $ 1,300(a) .. 4.428(a) $17,641 $ 5,728 Provision for inventory obsolescence ........ $ 2.260 $ 465 (a) Charged to net sales. Includes pdce increase credits. This amount did not impact net income in 1993. Deductions $ 7 12,362 3.300 $15.669 $ 569 $ 40,378 $ 305 13,464 8,200 919 $ 22.888 $ 22 $ -- $ 287 17,221 3.509 $ 21.017 $ 1.635 Balance at End of Period $ 249 720 5.800 $ 6,769 $ 1.369 $ 60.682 $ 235 745(b) 6,300 $ 7.280 $ 1,418 $101.240 $ 300 1,191 10,700 919 $13.110 $ 1.090 D-2

INDEX OF EXHIBITS* Exhibit No. 4. (a) (b) (c) (d) (e) 10. (a) (b) (c) (d) Description Sequentially Numbered Page Indenture, dated as of September 30, 1994, between BGLS Inc. and Shawmut Bank, N.A. relating to the 13.75% Series 1 Senior Secured Notes due 1995. Incorporated by reference to the Issuer's Form 8-K dated September 2, 1994. Indenture, dated as of September 30, 1994, between BGLS Inc. and Shawmut Bank, N.A. relating to the 13.75% Series 2 Senior Secured Notes due 1997. Incorporated by reference to the Issuer's Form 8-K dated September 2, 1994. Shelf Registration Agreement, dated as of September 30, 1994, among BGLS Inc., Brooke Group Ltd., AIF II, L.P., Artemis America LLC and Mainstay High Yield Corporate Bond Fund. Incorporated by reference to the Issuer's Form 8-K dated September 2, 1994. Fifth Supplemental Indenture, dated as of January 18, 1995, to the Indenture, dated as of April 1, 1988, among Brooke Partners, L.P., Brooke Capital Corp., L Holdings Inc. and Shawmut Bank, N.A. Fifth Supplemental Indenture, dated as of January 18, 1995, to the Indenture, dated as of April 1, 1988, among Brooke Partners, L.P., Brooke Capital Corp., L Holdings Inc. and First Trust National Association. Consulting Agreement, dated as of January 1, 1994, by and between Brooke Group Ltd. and Howard M. Lorber. Incorporated by reference to the Issuer's Form 10-Q for the quarter ended September 30, 1994. Agreement, dated September 2, 1994, by and between Icahn Holding Corporation, BGLS Inc. and Brooke Group Ltd. Incorporated by reference to the Issuer's Form 8-K dated September 2, 1994. Amendment No. I, dated September 27, 1994, to Agreement, dated September 2, 1994, by and between Icahn Holding Corporation, BGLS Inc. and Brooke Group Ltd. Incorporated by reference to the Issuer's Form 8-K dated September 2, 1994. Exchange and Termination Agreement, dated as of September 30, 1994, among BGLS Inc., Brooke Group Ltd., AIF II, L.P., Artemis America LLC and Mainstay High Yield Corporate Bond Fund. Incorporated by reference to the Issuer's Form 8-K dated September 2, 1994. E-3 E-18 E-1

(e) (f) (g) Pledge Agreement, dated as of September 30, 1994, between BGLS Inc. and Shawmut Bank, N.A., as Trustee, relating to the 13.75% Series 1 Senior Secured Notes due 1995. Incorporated by reference to the Issuer's Form 8-K dated September 2, 1994. Pledge Agreement, dated as of September 30, 1994, between BGLS Inc. and Shawmut Bank, N.A., as Trustee, relating to the 13.75% Series 2 Senior Secured Notes due 1997. Incorporated by reference to the Issuer's Form 8-K dated September 2, 1994 Stock Option Agreement, dated January 25, 1995, by and between Brooke Group Ltd. and Howard M. Lorber. E-31 11. Statement of Calculation of Per Share Earnings. E-42 21. Subsidiaries of Brooke Group Ltd. E-44 Stipulation and Agreement of Compromise and Settlement in connection with an action in the Court of Chancery of the State of Delaware in and for New Castle County entitled Gvetvan v. Bennett S. LeBow et al., Civil Action No. 12998. Incorporated by reference to the Issuer's Form 8-K dated June 2, 1994. 99. (a) (b) Items 1, 2 and 3 of the Annual Report on Form 10-K for the fiscal E-46 year ended December 31, 1994 of SkyBox International Inc. (c) Items 1, 2 and 3 of the Annual Report on Form IO-K for the fiscal E-109 year ended December 31, 1994 of MAI Systems Corporation. E-167 Items 1, 2 and 3 of the Annual Report on Form 10-K for the fiscal year ended December 31, 1994 of New Valley Corporation. (d) *The Company incorporates by reference all Exhibits of its Annual Report on Form 10-K for the fiscal year ended December 31, 1993. E-2

Independent Accountants: Coopers & Lybrand 1301 Avenue of the Americas New York, New York 10019 Corporate Headquarters: Brooke Group Ltd. 100 S.E. Second Street Miami, Florida 33131 Additional Information: Requests for general information should be directed to corporate head- quarters. Attention: Investor Relations (305) 579-8000 Requests for exhibits not attached to the Annual Report must be in writing, and should be sent to corporate head- quarters: Attention Investor Relations. Please specify the exhibits requested. Company Stock: Brooke Group Ltd. common stock is listed on the New York Stock Exchange (ticker symbol BGL) Transfer Agent and Registrar: American Stock Transfer & Trust Company 40 Wall Street New York, New York 10005 Telephone: (718) 921-8200 Board of Directors: Bennett S. LeBow Chairman of the Board, President and Chief Executive Officer Robert J. Eide Secretary and Treasurer, Aegis Capital Corporation Jeffrey S. Podell President, Newsote, Inc. Executive Officers: Bennett S. LeBow Chairman of the Board, President and Chief Executive Officer Gerald E. Sauter Vice President, Chief Financial Officer and Secretary