LIGGETT GROUP INC /DE/, 10-K/A, 1997-04-11

LIGGETT GROUP INC /DE/
10-K/A, 1997-04-11
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<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K/A No. 1

[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996].

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996

Commission File Number 33-75224

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

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

700 WEST MAIN STREET, DURHAM, NORTH CAROLINA 27702
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (919) 683-9000

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

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

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

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

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act: NONE

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

Explanatory Note: The Registrants are required to file all reports required by
Section 13 or 15(d) of the Exchange Act in connection with Liggett Group Inc.'s
Senior Secured Notes due 1999.

Item 405 of Regulation S-K is inapplicable to the registrants because neither
has a class of equity securities registered pursuant to Section 12 of the
Exchange Act.

Aggregate market value of voting stock held by non-affiliates: (Not
applicable; all voting stock of Liggett Group Inc. is owned by its indirect
parent Brooke Group Ltd. and all voting stock of Eve Holdings Inc. is owned by
its direct parent Liggett Group Inc.)

As of March 31, 1997, there were outstanding 1,000 shares of common stock, par
value $0.10 per share, of Liggett Group Inc. and 100 shares of common stock,
par value $1.00 per share, of Eve Holdings Inc.

Documents incorporated by reference: NONE

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INDEX

PART I

<TABLE>
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Page
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<S> <C> <C>
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . . 11

PART II

Item 5. Market for the Registrants' Common Stock and Related
Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

PART III

Item 10. Directors and Executive Officers of the Registrants . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . . . . . . 13
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . 14
</TABLE>

SIGNATURES

<PAGE> 3

PART I

ITEM 1. BUSINESS

GENERAL

Liggett Group Inc. ("Liggett" or the "Company"), a Delaware corporation,
is the operating successor to the Liggett & Myers Tobacco Company formed in
1873. Liggett is the fifth largest manufacturer of cigarettes in the United
States in terms of unit sales. Liggett is headquartered in Durham, North
Carolina.

Liggett is an indirect wholly-owned subsidiary of Brooke Group Ltd.
("BGL"). BGL (then called Liggett Group Inc.) was acquired by L Holdings
Inc., a company controlled by Bennett S. LeBow, in October 1986. In June 1990,
BGL reorganized its operations by contributing its existing businesses to
separate subsidiaries. BGL formed Liggett & Myers Tobacco Company ("L&M") as
an indirect wholly-owned subsidiary to conduct its cigarette manufacturing
business. In July 1990, L&M was renamed Liggett Group Inc. BGL is controlled
by Mr. LeBow, who owns directly or indirectly approximately 53% of its stock.
BGL, a New York Stock Exchange-listed company, and BGLS Inc. ("BGLS"), a
wholly-owned subsidiary of BGL and the direct parent of Liggett, file reports
and other information with the Securities and Exchange Commission.

Eve Holdings Inc. ("Eve"), a Delaware corporation, is a wholly-owned
subsidiary of Liggett. Eve is located in Miami, Florida. Eve's predecessor,
Chesterfield Assets Inc. ("Chesterfield"), was organized in March 1987. In
June 1990, Eve was formed as a subsidiary of Liggett, which was a subsidiary of
Chesterfield. Chesterfield contributed its trademarks to Eve via Liggett. In
February 1992, Chesterfield was merged into Liggett. Eve's sole business is to
hold certain federal trademark registrations used by, and to license them on an
exclusive basis to, Liggett and to hold a certain note receivable from Liggett.

Liggett is engaged in the manufacture and sale of cigarettes, primarily in
the United States. According to The Maxwell Consumer Report, a recognized
industry publication (the "Maxwell Report"), Liggett's domestic shipments of
approximately 8.95 billion cigarettes during 1996 accounted for 1.9% of the
total cigarettes shipped in the United States during such year. This
represents a market share decline of 0.3% from 1995 and 0.4% from 1994.
Liggett produces both premium cigarettes as well as discount cigarettes (which
include among others, control label, branded discount and generic cigarettes).
Premium cigarettes are generally marketed under well-recognized brand names at
full retail prices to adult smokers with strong preference for branded
products, whereas discount cigarettes are marketed at lower retail prices to
adult smokers who are more cost conscious. Liggett's cigarettes are produced
in over 325 combinations of length, style and packaging.

Liggett produces four premium cigarette brands: L&M, Chesterfield, Lark
and Eve. Liggett's premium cigarettes represented approximately 33%, 32% and
33% of net sales (excluding federal excise taxes) in 1996, 1995 and 1994,
respectively, and contributed a substantial portion of Liggett's operating
profits for the respective periods. Liggett's share of the premium market
segment was approximately 0.7% for 1996, compared to 0.8% and 0.9% for 1995
and 1994, respectively, according to the Maxwell Report.

In 1980, Liggett was the first major domestic cigarette manufacturer to
successfully introduce discount cigarettes as an alternative to premium
cigarettes. In 1989, Liggett established a new price point within the discount
market segment by introducing Pyramid, a branded discount product which, at
that time, sold for less than most other discount cigarettes. Liggett continues
to produce discount cigarettes with a share of approximately 4.9% of the
discount market segment for 1996, according to the Maxwell Report, compared to
5.5% and 5.4% for 1995 and 1994, respectively.

<PAGE> 4

At the present time, Liggett has no foreign operations other than through
its investment in Liggett-Ducat Ltd.("Liggett-Ducat") which is engaged in the
manufacture and sale of cigarettes in Russia. Liggett does not own the
international rights to its premium cigarette brands. The Company does,
however, export cigarettes which are sold primarily in Eastern Europe and the
Middle East. Export sales of approximately 473 million units accounted for
approximately 5% of Liggett's 1996 total units sales volume. Revenues from
export sales were $3.3 million for 1996, compared to $5.4 million and $4.7
million for 1995 and 1994, respectively. Operating loss attributable to export
sales for each of the years 1996, 1995 and 1994 were $1.8 million, $2.1 million
and $1.1 million, respectively. Management's strategy is to increase volume in
its foreign markets only where it can sell its brands at a profit.

On July 5, 1996, Liggett purchased 140,000 shares (19.97%) of
Liggett-Ducat's tobacco operations from Brooke (Overseas) Ltd. ("BOL)"), an
indirect subsidiary of BGL, for $2.1 million. Liggett-Ducat, which produces
cigarettes in Russia, manufactured and marketed 11.4 billion cigarettes in
1996. Liggett also acquired on that date for $3.4 million a ten-year option,
exercisable by Liggett in whole or in part, to purchase from BOL at the same
per share price, up to 292,407 additional shares of Liggett-Ducat, thereby
entitling Liggett to increase its interest in Liggett-Ducat to approximately
62%. The option fee would be credited against the purchase price. In addition,
as part of the same transaction, Liggett had the right on or before June 30,
1997 to acquire from BOL for $2.2 million another ten-year option on the same
terms to purchase the remaining shares of Liggett-Ducat (currently
approximately an additional 33%) owned by BOL. On March 13, 1997, Liggett
acquired this option and paid BOL $2.0 million, and recorded a payable to BOL
for the remaining $0.2 million.

BUSINESS STRATEGY

Liggett's near-term business strategy is to further reduce certain
operating and selling costs in order to increase the profitability of both its
premium and discount products, and to reduce its investment in working
capital. As part of this strategy, the Company reorganized its sales force in
early 1994, reducing its field sales force by 150 permanent positions and
adding approximately 300 part-time positions. Liggett has also reduced costs
in both administrative and manufacturing functions by making additional
modifications to its manufacturing operations and significantly curtailing
employee benefit programs. During 1995, Liggett continued its efforts towards
reducing costs by, among other things, offering voluntary retirement programs
to eligible employees and reduced headcount by an additional 120 positions.

In January 1997, Liggett underwent a major restructuring from a
centralized organization to a decentralized enterprise with four Strategic
Business Units, each a profit center, and a corporate headquarters. This
restructuring is intended to more closely align sales and marketing strategies
with the unique requirements of regional markets as well as reduce working
capital by improved production planning and inventory control. As a result of
this reorganization, Liggett will further reduce its salaried, hourly and
part-time headcount by a total of 273 positions (35%) over an eight-month
transition period.

Liggett's long-term business strategy in the premium segment of the market
is to maintain or improve its profit margins in the face of declining unit
sales and market share by improving operating efficiencies and implementing
further cost reduction programs. Liggett's long-term business strategy in the
discount segment of the market is to maintain or improve its profit margins by
consistently providing high-quality products and services at prices and on
terms comparable to those available elsewhere in the market.

SALES, MARKETING AND DISTRIBUTION

Liggett's products are distributed from a central distribution center in
Durham, North Carolina to 27 public warehouses located throughout the United
States. These warehouses serve as local distribution

<PAGE> 5

centers for Liggett's customers. Liggett's products are transported from the
central distribution center to the warehouses via third-party trucking
companies to meet pre-existing contractual obligations to its customers.

Liggett's customers are primarily candy and tobacco distributors, the
military and large grocery, drug and convenience store chains. Liggett offers
its customers discount payment terms, traditional rebates and promotional
incentives. Customers typically pay for purchased goods within two weeks
following delivery from Liggett. Liggett's largest single customer accounted
for approximately 13.7% of net sales in 1996 and approximately 11.6% of net
sales in 1995, the majority of which were in the private label discount
segment. No single customer accounted for more than 10% of Liggett's net sales
in 1994.

Following the January 1997 restructuring, Liggett's marketing and sales
functions will be performed by approximately 100 direct sales representatives
calling on national and regional customer accounts, together with approximately
145 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.

TRADEMARKS

All of the major trademarks used by Liggett are federally registered or
are in the process of being registered in the United States and other markets
where the Company's products are sold. Trademarks typically have a duration of
ten years and can be renewed at the Company's option prior to their expiration
date. In view of the significance of cigarette brand awareness among
consumers, management believes that the protection afforded by these trademarks
is material to the conduct of its business. All of Liggett's trademarks are
owned by its wholly-owned subsidiaries, Eve Holdings Inc. ("Eve") and Cigarette
Exporting Company of America, Ltd. ("CECOA"). The Company does not own the
international rights to its premium cigarette brands.

MANUFACTURING

Liggett purchases and maintains leaf tobacco inventory to support its
cigarette manufacturing requirements. The Company believes that there is a
sufficient supply of tobacco within the worldwide tobacco market to satisfy its
current production requirements. Liggett stores its leaf tobacco inventory in
warehouses in North Carolina and Virginia. There are several different
types of tobacco, including flue-cured leaf, burley leaf, Maryland leaf,
oriental leaf, cut stems and reconstituted sheet. Leaf components of
cigarettes are generally the flue-cured and burley tobaccos. While premium and
discount brands use many of the same tobacco products, input ratios of tobacco
products account for the differences between premium and discount products.
Domestically grown tobacco is an agricultural commodity subject to United
States government production controls and price supports which can
substantially affect its market price. Foreign flue-cured and burley tobaccos,
some of which are used in the manufacture of Liggett's cigarettes, are
generally 10% to 15% less expensive than comparable domestic tobaccos. Liggett
normally purchases all of its tobacco requirements from domestic and foreign
leaf tobacco dealers, much of it under long-term purchase commitments. As of
December 31, 1996, approximately 73% of Liggett's commitments were for the
purchase of foreign tobacco. Increasing tobacco costs due to reduced worldwide
supply of tobacco and a reduction in the average discount available to Liggett
from leaf tobacco dealers on tobacco purchased under prior years' purchase
commitments will have an unfavorable impact on Liggett's operations during
1997.

Liggett's cigarette manufacturing facilities are designed for the
execution of short production runs in a cost-effective manner, which enables
Liggett to manufacture and market a wide variety of cigarette brand styles.
Liggett's cigarettes are produced in over 325 different brand styles under
Eve's and CECOA's trademarks and brand names as well as private labels for
other companies, typically retail

<PAGE> 6

or wholesale distributors who supply supermarkets and convenience stores.
Liggett believes that its existing facilities are sufficient to accommodate a
substantial increase in production.

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

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

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 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 sales and consumer recognition than Liggett's
brands.

According to the Maxwell Report, Philip Morris' and RJR's sales together
accounted for approximately 72.4% of the domestic cigarette market in 1996.
Liggett's domestic shipments of approximately 8.95 billion cigarettes during
1996 accounted for 1.9% of the approximately 483 billion cigarettes shipped in
the United States during such year, compared to 10.52 billion cigarettes (2.2%)
and 11.32 billion cigarettes (2.3%) during 1995 and 1994, respectively.

Industry-wide shipments of cigarettes in the United States have been
steadily declining for a number of years, although this trend reversed itself
in 1996. While the Maxwell Report estimates that domestic industry-wide
shipments increased by approximately 0.5% in 1996, Liggett's management
believes that industry-wide shipments of cigarettes in the United States will
continue to decline as a result of numerous factors, including health
considerations, diminishing social acceptance of smoking, legislative
limitations on smoking in public places and federal and state excise tax
increases which have augmented cigarette price increases.

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

LEGISLATION, REGULATION AND LITIGATION

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

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,

<PAGE> 7

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 ("CSEA"), 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 prior 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 CSEA for which Liggett qualifies, Liggett is
allowed to display all four required package warnings for the majority of its
brand packages on a simultaneous basis (such that the packages at any time may
carry any one of the four required warnings), although it rotates the required
warnings for advertising on a quarterly basis in the same manner as do the
other major cigarette manufacturers. The law also requires that each person
who manufactures, packages or imports cigarettes annually provide to the
Secretary of Health and Human Services a list of ingredients added to tobacco
in the manufacture of cigarettes. Annual reports to the United States Congress
are also required from the Secretary of Health and Human Services as to
current information on the health consequences of smoking and from the
Federal Trade Commission on the effectiveness of cigarette labeling and current
practices and methods of cigarette advertising and promotion. Both federal
agencies are also required annually to make such recommendations as they deem
appropriate with regard to further legislation.

On August 28, 1996, the Food and Drug Administration ("FDA") filed in the
Federal Register a Final Rule classifying tobacco as a drug, asserting
jurisdiction by the FDA over the manufacture and marketing of tobacco products
and imposing restrictions on the sale, advertising and promotion of tobacco
products. The FDA's stated objective and focus for its initiative is to limit
access to cigarettes by minors by measures beyond the restrictions either
mandated by existing federal, state and local laws or voluntarily implemented
by major manufacturers in the industry. Litigation has been commenced in the
United States District Court for the Middle District of North Carolina
challenging the legal authority of the FDA to assert such jurisdiction, as well
as challenging the constitutionality of the rules. A hearing on the tobacco
industry's motion for summary judgment in that case was held on February 10,
1997 and a decision by the court is expected soon. The FDA's proposed
restrictions, some of which became effective as early as February 28, 1997,
purport to: (i) limit access to tobacco products and (ii) limit advertising
and marketing. Management is unable to predict whether the Final Rule will be
upheld as enforceable against the industry. Management is also unable to
predict the effects of the proposed restrictions, if implemented, on Liggett's
operations, but such actions could have an unfavorable impact thereon.

Liggett and BGL, while neither consenting to FDA jurisdiction nor waiving
their objections thereto, agreed to withdraw their objections and opposition
to the proposed rule making and to phase in compliance with certain of the
proposed interim FDA regulations. See discussion of the tobacco litigation
settlements in Note 12 to the Company's consolidated financial statements,
included elsewhere in this Report on Form 10-K.

In August 1996, the Commonwealth of Massachusetts enacted legislation
requiring tobacco companies to publish information regarding the ingredients in
cigarettes and other tobacco products sold in that state. Regulations adopted
pursuant to this legislation are scheduled to become effective on July 1, 1997.
On February 7, 1997, the United States District Court for the District of
Massachusetts denied an attempt to block the new legislation on the ground that
it is preempted by federal law.

<PAGE> 8

In 1993, the United States Congress amended the Agricultural Adjustment
Act of 1938 to require each United States cigarette manufacturer to use at
least 75% domestic tobacco in the aggregate of the cigarettes manufactured by
it in the United States, effective January 1, 1994, on an annualized basis or
pay a domestic marketing assessment ("DMA") based upon price differentials
between foreign and domestic tobacco and, under certain circumstances, make
purchases of domestic tobacco from the tobacco stabilization cooperatives
organized by the United States government.

After an audit, the United States Department of Agriculture ("USDA")
informed Liggett that it did not satisfy the 75% domestic tobacco usage
requirement for 1994 and was subject to a DMA of approximately $5.5 million.
Liggett has agreed to pay this assessment in quarterly installments, with
interest, over a five-year period. Since the levels of domestic tobacco
inventories on hand at the tobacco stabilization organizations are below
reserve stock levels, the Company was not obligated to make purchases of
domestic tobacco from the tobacco stabilization cooperatives.

On September 13, 1995, the President of the United States issued
Presidential Proclamation 6821, which established a tariff rate quota ("TRQ")
on certain imported tobacco, imposing extremely high tariffs on imports of
flue-cured and burley tobacco in excess of certain levels which vary from
country to country. Oriental tobacco is exempt from the quota as well as all
tobacco originating from Canada, Mexico or Israel. Management believes that
the TRQ levels are sufficiently high to allow Liggett to operate without
material disruption to its business. In addition, the Presidential
Proclamation served to limit the application of the legislation establishing
the DMA to only those activities occurring in calendar year 1994.

On February 20, 1996, the United States Trade Representative issued an
"advance notice of rule making" concerning how tobaccos imported under the TRQ
should be allocated. Currently, tobacco imported under the TRQ is allocated on
a "first-come, first-served" basis, meaning that entry is allowed on an open
basis to those first requesting entry in the quota year. Others in the
cigarette industry have suggested an "end-user licensing" system under which
the right to import tobacco under the quota would be initially assigned on the
basis of domestic market share. Such an approach, if adopted, could have a
material adverse effect on the Company.

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

In January 1993, the United States Environmental Protection Agency ("EPA")
released a report on the respiratory effect of environmental tobacco smoke
("ETS") which concluded that ETS is a known human lung carcinogen in adults
and, in children, causes increased respiratory tract disease and middle ear
disorders and increases the severity and frequency of asthma. In June 1993,
the two largest major domestic cigarette manufacturers, together with other
segments of the tobacco and distribution industries, commenced a lawsuit
against the EPA seeking a determination that the EPA did not have the statutory
authority to regulate ETS, and that given the current body of scientific
evidence and the EPA's failure to follow its own guidelines in making the
determination, the EPA's classification of ETS was arbitrary and capricious.
Whatever the outcome of this litigation, issuance of the report may encourage
efforts to limit smoking in public areas.

The State of Florida enacted legislation, effective July 1, 1994, allowing
certain state authorities or entities to commence litigation seeking recovery
of certain Medicaid payments made on behalf of Medicaid recipients as a result
of diseases (including, but not limited to, diseases allegedly caused by
cigarette smoking) allegedly caused by liable third parties (including, but not
limited to, the tobacco industry). This statute purportedly abrogates certain
defenses typically available to defendants. This legislation would impose on
the tobacco industry, if ultimate liability of the industry is established in
litigation, liability based upon market share for such payments made by the
state as a result of such

<PAGE> 9
smoking-related diseases. On February 22, 1995, suit was commenced by the
State of Florida, acting through the Agency for Health Care Administration,
against Liggett and 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 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 sale of cigarettes in Florida. The Florida action is scheduled for trial
in August 1997. In addition to Florida, 21 states (and several municipalities)
have brought actions against Liggett and other cigarette manufacturers seeking
restitution and indemnity for medical payments and expenses allegedly made or
incurred for tobacco related illnesses. Other states are contemplating
initiating similar litigation. See Note 12 to the Company's consolidated
financial statements included elsewhere in this Report on Form 10-K for a
discussion of such legislation and related litigation, and of the Company's and
BGL's recent Attorneys General settlements.

All radio and television advertising of cigarettes has been prohibited by
federal statute since 1971 and federal law now prohibits smoking aboard
aircraft for domestic flights of six hours or less. The United States
Interstate Commerce Commission has banned smoking on buses transporting
passengers interstate. 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 educational 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 standards. If adopted, at least certain of
the foregoing legislative proposals could have a material adverse impact on
Liggett's operations.

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. Such restrictions are, in some cases, more onerous than
restrictions imposed in the United States. Due to the Company's lack of
foreign operations, with the exception of its investment in Liggett-Ducat, and
minimal export sales to foreign countries, the risks of foreign limitations or
restrictions on the sale of cigarettes are limited to entry barriers into
additional foreign markets and the inability to grow the existing markets.

The price of cigarettes includes federal excise taxes at the rate of
$12.00 per 1,000 cigarettes. A substantial excise tax increase could accelerate
the trend away from smoking.

The cigarette industry continues to be challenged on numerous fronts. New
cases continue to be commenced against Liggett and other cigarette
manufacturers. As of March 14, 1997, there were 108 individual suits, 12
purported class actions and 22 state (and several municipality) Medicaid
reimbursement actions pending in the United States in which Liggett is a named
defendant. The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for personal injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence, gross
negligence, strict liability, fraud, misrepresentation, design defect, failure
to warn, breach of express and implied warranties, conspiracy, concert of
action, unjust enrichment, common law public nuisance, indemnity, market share
liability, and violations of deceptive trade practices laws and antitrust
statutes. Plaintiffs also seek punitive damages in many of these cases. The
claims asserted in the Medicaid recovery actions vary. All plaintiffs assert
the equitable claim that the tobacco industry was "unjustly enriched" by
plaintiffs' payment of health care costs allegedly attributable to smoking and
seek reimbursement of those costs. Other claims made by some but not all
plaintiffs include the equitable

<PAGE> 10

claim of indemnity, common law claims of negligence, strict liability, breach
of express and implied warranty, violation of a voluntary undertaking or
special duty, fraud, negligent misrepresentation, conspiracy, public nuisance,
claims under state and federal statutes governing consumer fraud, antitrust,
deceptive trade practices and false advertising, and claims under the Federal
Racketeer Influenced and Corrupt Organization Act.

On March 12, 1996, Liggett, together with BGL, entered into an agreement
to settle the Castano class action tobacco litigation, and on March 15, 1996,
Liggett, together with BGL, entered into an agreement with the Attorneys
General of West Virginia, Florida, Mississippi, Massachusetts and Louisiana to
settle certain actions brought against Liggett and the Company by such states.
On March 20, 1997, Liggett, together with BGL, entered into comprehensive
settlements with each of the remaining 17 states which have filed Medicaid
actions and with a nationwide class of individuals and entities that allege
smoking-related claims. See the discussion of the settlements in Note 12 to
the Company's consolidated financial statements.

The Company has been involved in certain environmental proceedings, none
of which, either individually or in the aggregate, rise to the level of
materiality. The Company's current operations are conducted in accordance with
all environmental laws and regulations. Management is unaware of any material
environmental conditions affecting its existing facilities. Compliance with
federal, state and local provisions regulating the discharge of materials into
the environment, or otherwise relating to the protection of the environment,
have not had a material effect on the capital expenditures, earnings or
competitive position of Liggett.

Management believes that Liggett is currently in compliance in all
material respects with the laws regulating cigarette manufacturers.

See Note 12 to the Company's consolidated financial statements for a
description of legislation, regulation and litigation.

EMPLOYEES

Liggett had 584 full-time employees at December 31, 1996 with 330 hourly
employees represented by three unions and 254 non-union salaried employees.
The majority (261) of the union employees are represented by the Bakery,
Confectionery and Tobacco Workers International Union whose three-year contract
expires December 31, 1997. Liggett has not experienced any work stoppages
since 1977 and considers its relationship with its employees and their unions
to be good.

ITEM 2. PROPERTIES

Liggett's principal executive office and manufacturing plant are located
in Durham, North Carolina. Eve's principal executive office is located in
Miami, Florida. As of December 31, 1996, the principal properties owned or
leased by Liggett were as follows:

<TABLE>
<CAPTION>
APPROXIMATE
OWNED OR TOTAL
TYPE LOCATION LEASED SQUARE FOOTAGE
- -------------------------------- ------------ ----------------- -----------------
<S> <C> <C> <C>
Office and Manufacturing Complex Durham, NC Owned 1,231,000
Warehouse Durham, NC Owned 203,000
Storage Facilities Danville, VA Owned 578,000
Distribution Center Durham, NC Leased 240,000
</TABLE>

<PAGE> 11

Liggett's Durham, North Carolina complex consists of 15 major structures
over approximately 20 acres. Included are Liggett's manufacturing plant,
research facility and corporate offices. Liggett's management believes its
property, plant and equipment are well maintained and in good condition and
that its existing facilities are sufficient to accommodate a substantial
increase in production.

Liggett leases the Durham, North Carolina distribution center pursuant to
a lease which expires in May 1999. Liggett has an option to purchase the
leased property at any time during the term of the lease. Liggett utilizes
approximately 40% of the distribution center. Liggett leases excess space in
its research facility to third parties.

On May 14, 1996, Liggett sold certain surplus realty in Durham, North
Carolina to the County of Durham for a sale price of $4.3 million. A gain of
approximately $3.6 million was recognized on this sale.

On March 11, 1997, Liggett sold to Blue Devil Ventures, a North
Carolina limited liability partnership, certain surplus realty in Durham,
North Carolina, for a sale price of $2.2 million. A gain of approximately $1.6
million was recognized on the sale.

ITEM 3. LEGAL PROCEEDINGS

A description of certain legal proceedings to which Liggett is or has been
a party is set forth in Note 12 to the Company's consolidated financial
statements included elsewhere in this Report on Form 10-K.

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

No matters were submitted to a vote of security holders during the fourth
quarter of 1996.

<PAGE> 12

PART II

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

All common stock of Liggett is held indirectly by BGL and all common
stock of Eve is held directly by Liggett.

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth for the periods and dates indicated,
summary consolidated financial information for Ligggett.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF
- ------------
OPERATIONS DATA:
- ---------------
Net sales(1) $401.1 $455.7 $465.7 $473.4 $605.8
Gross profit 213.3 243.4 242.9 256.1 325.8
Operating income 6.8 24.6 33.6 0.2 52.7
Interest expense 23.9 23.4 21.7 19.4 18.1
Income (loss) before income taxes, extra-
ordinary item and accounting changes (14.6) 2.3 11.4 (18.9) 35.2
Income (loss) before extraordinary item
and accounting changes (18.4) 0.6 16.4 (24.1) 20.5
Income (loss) before cumulative effect
of accounting changes (18.4) 0.6 15.4 (24.1) 20.5
Net income (loss) (18.4) 0.6 15.4 (31.4) 20.5
Net income (loss) per common share (18,372) 555 15,406 (31,383) 20,499
Weighted average common shares
outstanding 1,000 1,000 1,000 1,000 1,000
Depreciation and amortization 8.0 8.0 8.3 8.4 7.8

BALANCE SHEET DATA:
- ------------------
Current assets 71.4 84.6 87.7 67.9 96.1
Total assets 97.7 113.3 124.0 111.1 143.9
Current liabilities 112.1 75.6 82.5 101.6 79.0
Long-term debt, less current maturities 144.7 173.3 184.2 167.3 185.0
Other long-term obligations 17.4 19.2 11.9 12.1 7.0
Stockholder's (deficit) equity (176.5) (154.7) (154.5) (169.9) (127.1)
Dividends declared and paid - - - - 167.9
</TABLE>

1) Net sales include federal excise taxes of $104.5, $123.4, $131.9, $127.3
and $147.7, respectively.

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

This information is set forth under the caption "Management's Discussion
and Analysis of Financial Condition and Results of Operations" beginning on
page 18 of this Report on Form 10-K.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

This information is contained in the Financial Statements, Notes to
Financial Statements and Reports of Independent Accountants for both Liggett
and Eve beginning on page 27 of this Report on Form 10-K.

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

None.

<PAGE> 13

PART III

ITEMS 10, 11, 12 AND 13.

This information will be contained in an amendment to this report to be filed
with the Securities and Exchange Commission not later than 120 days after the
end of the registrants' fiscal year covered by this report.
13

<PAGE> 14

PART IV

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

(a)
1. The financial statements listed in the accompanying
Index to 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 10-K.

2. The financial statement schedules listed in the
accompanying Index to 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 10-K.

3. The exhibits listed in the accompanying Index to
Exhibits beginning on page 59 are filed as part of this Report
on Form 10-K.

(b) Reports on Form 8-K

No reports were filed on Form 8-K during the fourth quarter of the
year ended December 31, 1996.

See Index to Exhibits beginning on page 59.

(d) Financial Statement Schedules

The financial statement schedules listed in the accompanying Index
to 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 10-K.

<PAGE> 15

INDEX TO
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS,
FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

<TABLE>
<CAPTION>
Page
-------
<S> <C>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS . . . . . . . . . . . . . . . . . . . . . 18

FINANCIAL STATEMENTS - LIGGETT GROUP INC.:
Report of Independent Accountants . . . . . . . . . . . . . . . . . . . . . . 27
Consolidated Balance Sheets as of December 31, 1996 and 1995 . . . . . . . . 28
Consolidated Statements of Operations for the years ended December 31,
1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Consolidated Statements of Stockholder's Equity (Deficit) for the years
ended December 31, 1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . 31
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . 33

FINANCIAL STATEMENTS - EVE HOLDINGS INC.:
Report of Independent Accountants . . . . . . . . . . . . . . . . . . . . . . 51
Balance Sheets as of December 31, 1996 and 1995 . . . . . . . . . . . . . . . 52
Statements of Operations for the years ended December 31, 1996,
1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
Statements of Stockholder's Equity (Deficit) for the years ended
December 31, 1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . 54
Statements of Cash Flows for the years ended December 31, 1996,
1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Notes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . 56

FINANCIAL STATEMENT SCHEDULES:
Schedule II - Valuation and Qualifying Accounts . . . . . . . . . . . . . . . 58
</TABLE>

Schedules other than those listed above have been omitted because the
required information is contained in the notes to financial statements
or because such schedules are not required or are not applicable.

15
<PAGE> 16

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrants have duly caused this report to be signed
on their behalf by the undersigned thereunto duly authorized on April 11, 1997.

LIGGETT GROUP INC.

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

EVE HOLDINGS INC.

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

16
<PAGE> 17

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

(DOLLARS IN THOUSANDS, EXCEPT SELLING PRICES)

INTRODUCTION

Liggett is the operating successor to the Liggett & Myers Tobacco Company
formed in 1873. Liggett is the fifth largest manufacturer of cigarettes in the
United States in terms of unit sales.

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

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

The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. Liggett had a net
capital deficiency of $176,478 and a working capital deficiency of $40,694 as
of December 31, 1996, is highly leveraged and has substantial near-term debt
service requirements. Due to the many risks and uncertainties associated
with the cigarette industry, the impact of recent tobacco litigation
settlements and anticipated increased tobacco costs, there can be no assurance
that the Company will be able to meet its future earnings goals. Consequently,
the Company could be in violation of certain debt covenants and if the lenders
were to exercise acceleration rights under the revolving credit facility or
senior secured notes indentures or refuse to lend under the revolving credit
facility, the Company would not be able to satisfy such demands or its working
capital requirements. Further, the Company's Senior Secured Notes require a
mandatory principal redemption of $37,500 on February 1, 1998 and a payment at
maturity one year later of $107,400, and its revolving credit facility expires
on March 8, 1998 unless extended by its lenders. While management currently
intends to seek to refinance and/or restructure with the Company's note holders
the redemption and maturity requirements on the Senior Secured Notes and to
extend the revolving credit facility, there are no refinancing or restructuring
arrangements for the notes or commitments to extend the facility at this
time, and no assurances can be given in this regard. These circumstances raise
substantial doubt about the Company meeting its liquidity needs and continuing
as a going concern. (See "Capital Resources and Liquidity" below).

RECENT DEVELOPMENTS IN THE CIGARETTE INDUSTRY

Pricing Activity

On May 5, 1995, RJR initiated a list price increase on all brands of 30
cents per carton. Philip Morris and B & W, which together with RJR comprise
approximately 90% of the market, matched the price increase on the same day.
Liggett followed on May 9, 1995.

On April 8, 1996, Philip Morris announced a list price increase on all
brands of 40 cents per carton. The other manufacturers, including Liggett,
matched the price increase.

On March 7, 1997, RJR initiated another list price increase on all brands
of 40 cents per carton (approximately 4%). B & W, Lorillard and Liggett have
matched this increase, and, on March 21, 1997, Philip Morris announced a price
increase of 50 cents per carton.

<PAGE> 18

Legislation, Regulation and Litigation

The cigarette industry continues to be challenged on numerous fronts. New
cases continue to be commenced against Liggett and other cigarette
manufacturers. As of March 14, 1997, there were 108 individual suits, 12
purported class actions and 22 state (and several municipality) Medicaid
reimbursement actions pending in the United States in which Liggett is a named
defendant. As new cases are commenced, the costs associated with defending
such cases and the risks attendant to the inherent unpredictability of
litigation continue to increase. Recently, there have been a number of
restrictive regulatory actions from various Federal administrative bodies,
including EPA and FDA, adverse political decisions and other unfavorable
developments concerning cigarette smoking and the tobacco industry, including
the commencement and certification of class actions and the commencement of
Medicaid reimbursement suits by various states' Attorneys General. These
developments generally receive widespread media attention. Management is not
able to evaluate the effect of these developing matters on pending litigation
or the possible commencement of additional litigation, but it is possible that
Liggett's financial position, results of operations and cash flows could be
materially adversely affected by an ultimate unfavorable outcome in any of such
pending litigation. See Note 12 to the Company's consolidated financial
statements for a description of legislation, regulation and litigation.

The plaintiffs' allegations of liability in those cases in which
individuals seek recovery for personal injuries allegedly caused by cigarette
smoking are based on various theories of recovery, including negligence, gross
negligence, strict liability, fraud, misrepresentation, design defect, failure
to warn, breach of express and implied warranties, conspiracy, concert of
action, unjust enrichment, common law public nuisance, indemnity, market share
liability, and violations of deceptive trade practices laws and antitrust
statutes. Plaintiffs also seek punitive damages in many of these cases.
Defenses raised by defendants in these cases include lack of proximate cause,
assumption of the risk, comparative fault and/or contributory negligence, lack
of design defect, statutes of limitations or response, equitable defenses such
as "unclean hands" and lack of benefit, failure to state a claim and preemption
by the Federal Cigarette Labeling and Advertising Act, as amended.

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

On March 12, 1996, Liggett, together with BGL, entered into an agreement
to settle the Castano class action tobacco litigation, and on March 15, 1996,
Liggett, together with BGL, entered into an agreement with the Attorneys
General of West Virginia, Florida, Mississippi, Massachusetts and Louisiana to
settle certain actions brought against Liggett and the Company by such states.
Liggett and BGL, while neither consenting to FDA jurisdiction nor waiving their
objections thereto, agreed to withdraw their objections and opposition to the
proposed FDA regulations and to phase in compliance with certain of the
proposed interim FDA regulations.

Under the Castano settlement agreement, upon final court approval of
the settlement, the Castano class would be entitled to receive up to 5% of
Liggett's pretax income (income before income taxes) each year (up to a maximum
of $50,000 per year) for the next twenty-five years, subject to certain
reductions provided for in the agreement, and a $5,000 payment from Liggett if
BGL or Liggett fails to consummate a merger or similar transaction with another
non-setting tobacco company defendant within three years of the date of the
settlement. BGL and Liggett have the right to terminate the Castano settlement
under certain circumstances. On May 11, 1996, the Castano Plaintiffs Legal
Committee filed a motion with the United States District Court for the Eastern
District of Louisiana seeking preliminary approval of the Castano settlement.
On May 23, 1996, the Court of Appeals for the Fifth Circuit reversed the
February 17, 1995 order of the District Court certifying the Castano suit as a
nationwide class action and instructed the District Court to dismiss the class
complaint. On September 6, 1996, the Castano plaintiffs withdrew the motion for
approval of the Castano settlement.

On March 14, 1996, BGL, the Castano Plaintiffs Legal Committee and the
Castano plaintiffs entered into a letter agreement. According to the terms of
the letter agreement, for the period ending nine months from the date of Final
Approval (if granted) of the Castano settlement or, if earlier, the completion
by BGL or Liggett of a combination with any defendant in Castano, except Philip
Morris, the Castano plaintiffs and their counsel agree not to enter into any
more favorable settlement agreement with any Castano defendant which would
reduce the terms of the Castano settlement agreement. If the Castano
plaintiffs or their counsel enter into any such settlement during this period,
they shall pay BGL $250,000 within thirty days of the more favorable agreement
and offer BGL and Liggett the option to enter into a settlement on terms at
least as favorable as those included in such other settlement. The letter
agreement further provides that during the same time period, and if the Castano
settlement agreement has not been earlier terminated by BGL in accordance with
its terms, BGL and its affiliates will not enter into any business transaction
with any third party which would cause the termination of the Castano
settlement agreement. IF BGL or its affiliates enter into any such
transaction, then the Castano plaintiffs will be entitled to receive $250,000
within thirty days from the transacting party.

Under the Attorneys General settlement, the five states would share an
initial $5,000 ($1,000 of which was paid on March 22, 1996, with the balance
payable over nine years and indexed and adjusted for inflation). In addition,
Liggett will be required to pay the states a percentage of Liggett's pretax
income (income before income taxes) each year from the second through the
twenty-fifth year. This annual percentage is 2-1/2% of Liggett's pretax
income, subject to increase to 7-1/2% depending on the number of additional
states joining the settlement. No additional states have joined this
settlement to date. All of Liggett's payments are subject to certain
reductions provided for in the agreement. Liggett has also agreed to pay to
the states $5,000 if BGL or Liggett fails

<PAGE> 19

to consummate a merger or other similar transaction with another defendant in
the lawsuits within three years of the date of the settlement.

Recent Settlements. On March 20, 1997, Liggett, together with BGL,
entered into a comprehensive settlement of tobacco litigation through parallel
agreements with the Attorneys General of 17 states and with a nationwide class
of individuals and entities that allege smoking-related claims. Liggett and
BGL have now obtained settlements with each of the 22 states that have
commenced suit against them. The settlements cover all smoking-related claims,
including both addiction-based and tobacco injury claims against Liggett and
BGL, brought by the 22 states, and upon court approval, the nationwide class.

The settlement with the Attorneys General, which does not require court
approval, includes the states of Arizona, Connecticut, Hawaii, Illinois,
Indiana, Iowa, Kansas, Maryland, Michigan, Minnesota, New Jersey, New York,
Oklahoma, Texas, Utah, Washington and Wisconsin. Liggett and BGL's previous
settlements on March 15, 1996, with the Attorneys General of Florida, Louisiana,
Massachusetts, Mississippi and West Virginia remain in full force and effect.

The settlement with the nationwide class covers all smoking-related
claims. On March 20, 1997, Liggett, BGL and plaintiffs filed the mandatory class
settlement agreement in an action entitled Fletcher, et al. v. Brooke Group
Ltd., et al., Circuit Court of Mobile County Alabama, where the court granted
preliminary approval and preliminary certification of the class. Class members
will be notified of the settlement and will have an opportunity to appear at a
later court hearing. Effectiveness of the mandatory settlement is conditioned
on final court approval of the settlement after a fairness hearing. There can
be no assurance as to whether or when court approval will be obtained. There are
no opt out provisions in this settlement, except for Medicaid claims by states
that are not party to the Attorneys General settlements.

Pursuant to the settlements, Liggett and BGL have agreed to cooperate
fully with the Attorneys General and the nationwide class in their lawsuits
against the tobacco industry. Liggett and BGL have agreed to provide to these
parties all relevant tobacco documents in their possession, other than those
subject to claims of joint defense privilege, and to waive, subject to court
order, certain attorney-client privileges and work product protections regarding
Liggett's smoking-related documents to the extent Liggett and BGL can so waive
these privileges and protections. The Attorneys General and the nationwide
class have agreed to keep Liggett's documents under protective order and,
subject to final court approval, to limit their use to those actions brought by
parties to the settlement agreements. Those documents that may be subject to
a joint defense privilege with other tobacco companies will not be produced to
the Attorneys General or the nationwide class, but will be, pursuant to court
order, submitted to the appropriate court and placed under seal for possible
in camera review. Additionally, under similar protective conditions, Liggett
and BGL have agreed to offer their employees for witness interviews and
testimony at deposition and trial. Pursuant to both settlement agreements,
Liggett has also agreed to place an additional warning on its cigarette
packaging stating that "smoking is addictive" and to issue a public statement,
as requested by the Attorneys General.

Under the terms of the new settlement agreements, Liggett will pay on an
annual basis 25% of its pretax income for the next 25 years into a settlement
fund, commencing with the first full fiscal year starting after the date of the
agreements. Monies collected in the settlement fund will be overseen by a
court-appointed committee and utilized to compensate state health care programs
and settlement class members and to provide counter-market advertising.
Liggett has also agreed to phase-in compliance with certain proposed FDA
regulations regarding smoking by children and adolescents, including a
prohibition on the use of cartoon characters in tobacco advertising and
limitations on the use of promotional materials and distribution of sample
packages where minors are present.

<PAGE> 20
appeal any further adverse judgment. In addition, within 120 days following
such a combination, Liggett would be required to pay the settlement fund $25
million. Both the Attorneys General and the nationwide class have also agreed
not to seek an injunction preventing a defendant tobacco company combining with
Liggett or BGL from spinning off any of its affiliates which are not engaged in
the domestic tobacco business.

Liggett and BGL are also entitled to certain "most favored nation"
benefits not available to the other defendant tobacco companies. In addition,
in the event of a "global" tobacco settlement enacted through federal
legislation or otherwise, the Attorneys General and tobacco plaintiffs have
agreed to use their "best efforts" to ensure that Liggett's and BGL's liability
under such a plan should be no more onerous than under these new settlements.

On March 20, 1997, RJR, Philip Morris, B & W and Lorillard obtained a
temporary restraining order from a North Carolina state court preventing
Liggett and BGL and their agents, employees, directors, officers and lawyers
from turning over documents allegedly subject to the joint defense privilege in
connection with the settlements. On March 24, 1997, the United States District
Court for the Eastern District of Texas and state courts in Mississippi and
Illinois each issued orders enjoining these four companies from interfering
with Liggett's filing with the courts, under seal, those documents.

At December 31, 1995, the Company had accrued approximately $4,000 for the
present value of the fixed payments under the March 1996 Attorneys General
settlement and no additional amounts have been accrued with respect to the
recent settlements discussed above. The Company cannot quantify the future
costs of the settlements at this time as the amount Liggett must pay is based,
in part, on future operating results. Possible future payments based on a
percentage of pretax income, and other contingent payments based on occurrence
of a business combination, will be expensed when considered probable. See the
discussion of the tobacco litigation settlements appearing in Note 12 to the
Company's consolidated financial statements.

RESULTS OF OPERATIONS

1996 Restructuring

During 1996, the Company reduced its headcount by 38 positions and
recorded a $3,428 restructuring charge to operations ($132 of which is
included in cost of sales) for severance programs, primarily salary
continuation and related benefits for terminated employees. The anticipated
savings of the restructuring relate primarily to reduced payroll and benefits
expenses in future periods. Of the total restructuring expense recorded during
1996, $1,416 was funded during 1996, leaving $2,012 remaining to be funded in
subsequent years.

1995 Restructuring

During 1995, the Company reduced its headcount by approximately 120
positions and recorded a $2,548 restructuring charge to operations ($621 of
which is included in cost of sales) for severance programs, primarily salary
continuation and related benefits for terminated employees. The anticipated
savings of the restructuring relate primarily to reduced payroll and benefits
expenses in future periods. Of the total restructuring charge recorded during
1995, $2,311 was funded during 1995 and $237 during 1996.

1996 Compared to 1995

Net sales were $401,062 for 1996 compared to $455,666 for 1995. The 12%
decrease in revenues was due primarily to a 15.3% decline in domestic unit
sales volume, partially offset by the effects of the April 1996 list price
increase (see "- Recent Developments in the Cigarette Industry - Pricing
Activity"). This change in unit sales volume was comprised of declines within
the premium and discount market segments of 13.7% and 16.2%, respectively.
The decline in premium and discount unit sales volume was due to certain
competitors continuing leveraging rebate programs tied to their products and
increased promotional activity by certain other manufacturers. The Company
experienced a significant increase in volume at the end of the fourth quarter of
1996, in part due to ongoing trade programs based

<PAGE> 21

on quarterly volume targets for its customers and to consumer promotional
programs consisting of coupons and variable price reductions. The effects of
these trade programs may have a negative impact on sales in future periods.

Gross profit of $213,263 for 1996 decreased $30,089 from $243,352 for
1995, due primarily to the decline in unit sales volume discussed above. As a
percent of revenues (excluding federal excise taxes), gross profit decreased to
72.0% for 1996 compared to 73.2% for 1995. This decrease is the result of
increased tobacco costs due to reduced worldwide supply of tobacco, and a
reduction in the average discount available to Liggett from leaf tobacco
dealers on tobacco purchased under prior years' purchase commitments, partially
offset by the April 1996 list price increase. Gross profit for 1995 was
reduced by an accrual of approximately $4,900 for the USDA marketing
assessment. See Note 12 to the Company's consolidated financial statements.

Operating income decreased to $6,753 for 1996 from $24,619 for 1995 due
primarily to the decrease in gross profit discussed above and 1996
restructuring charges. The negative effects on operating income were partially
offset by reduced spending on promotional programs. Operating income for 1995
was reduced by the accrual of approximately $4,000 for the settlement of
certain tobacco litigation with the Attorneys General of certain states.

Net interest expense was $23,878 for 1996 compared to $23,446 for 1995.
This increase was due to interest accrued on the USDA marketing assessment and
Attorneys General settlement, partially offset by the redemption of $7,000
Series B Senior Secured Notes in December 1995.

Net loss amounted to $18,372 for 1996 compared to net income of $555 for
1995. This decrease was primarily the result of the same factors affecting
operating income as discussed above, along with Liggett's equity in the net
loss of Liggett-Ducat of $1,116 and recording of $3,800 tax expense to increase
the valuation allowance for deferred tax assets based on management's
determination that it is more likely than not that such future tax benefits
will not be realized. The decrease was offset in part by a $3,669 gain on the
sale of surplus realty in 1996.

1995 Compared to 1994

Net sales were $455,666 for 1995 compared to $465,676 for 1994. The 2.1%
decrease in revenue was primarily due to a 5.6% decrease in unit sales volume,
partially offset by the effects of the May 9, 1995 list price increase. See
"Recent Developments in the Cigarette Industry - Pricing Activity" for a
discussion on the May 1995 increase in selling prices. The decrease in unit
sales volume was comprised of decreases in the premium, discount and military
categories, partially offset by an increase in the international category.
Both premium and discount products suffered a temporary decline in volume as a
result of the implementation of a new distribution and marketing program in one
of Liggett's sales zones and national accounts during 1995. Also, heavy
discounting of a competitor's product within the premium segment contributed to
the premium volume decline. The decrease in discount volume was due to
decreases in generic and branded discount brands as a result of leveraged
rebate programs tied to the premium products of other cigarette manufacturers
and trade and promotional programs for new brands offered by competitors on
branded discount products. The decrease in discount volume was partially
offset by the continued growth of Liggett's control label brands since their
introduction in 1993. The decrease in the military volume is primarily due to
heavy discounting of a competitor's product within this category. The overall
decline in unit sales volume would have been much greater except for aggressive
trade programs offered near the end of the fourth quarter of 1995.

Gross profit of $243,352 for 1995 increased $450 from $242,902 for 1994.
As a percentage of revenues (excluding federal excise taxes), gross profit
increased to 73.2% for 1995 from 72.8% for 1994. The increase is the result of
the May 9, 1995 list price increase and lower per unit cost of sales resulting
from the 1995 restructuring discussed above, partially offset by the accrual of
approximately $4,900 for the USDA marketing assessment.

<PAGE> 22

Operating income decreased to $24,619 for 1995 from $33,596 for 1995. The
decline in operating income was primarily caused by increased spending on trade
and promotional programs to combat other cigarette manufacturers' programs for
unit sales volume along with the accrual of approximately $4,000 for the
settlement of certain tobacco litigation with the Attorneys General of certain
states. These expenses were only partially offset by the net effects of the
1995 restructuring discussed above.

Net interest expense was $23,446 for 1995 compared to $21,704 for 1994.
The increase was due to the additional Series C Notes issued in November 1994
and the higher interest rate on the Series C Notes which was reset from 16.5%
to 19.75% on February 1, 1995. In addition, the Series C Notes were
outstanding for a full year in 1995.

Net income amounted to $555 for 1995 compared to $15,406 for 1994.
Additional factors affecting net income other than the items previously
mentioned include the recording of $1,751 tax expense to reduce deferred tax
assets by a valuation allowance based on management's belief that it is more
likely than not the full amount of such deferred tax assets will not be
realized. This compared to a $5,000 tax benefit for the reduction of the
valuation allowance on deferred tax assets in 1994 based upon the circumstances
existing at the end of 1994. In addition, a $1,114 gain on the redemption of
Senior Secured Notes was recorded in 1995. An extraordinary loss of $1,028 on
the refinancing of the revolving credit facility was recorded in 1994.

CAPITAL RESOURCES AND LIQUIDITY

Cash provided by operations was $6,168 for 1996 compared with $13,587 for
1995. The decrease was due primarily to the decline in net sales (see "-
Results of Operations"). The decrease in cash provided by operating activity
was partially offset by decreases in trade receivables and inventories, and by
increases in accrued promotional expense.

The Company had been receiving certain financial assistance from others in
the industry in defraying the costs incurred in the defense of smoking and
health litigation and related proceedings, but these benefits have recently
ended. Certain joint defense arrangements, and the financial benefits incident
thereto, have also ended. The future financial impact on the Company of the
termination of this assistance and the effects of the tobacco litigation
settlements discussed above is not quantifiable at this time.

Cash provided by operations was $13,587 for 1995 compared with cash used
in operations of $3,767 for 1994. The increase was primarily the result of
increased selling prices, more favorable trade payment terms, accelerated
collection of trade receivables due to increased customer participation in
Electronic Funds Transfer ("EFT") programs and reduced legal fees.

23
<PAGE> 23

Cash used in investing activities for 1996, 1995 and 1994 related
primarily to capital expenditures (including non-cash investing activities)
which amounted to approximately $4,300, $1,100 and $1,000 for the respective
years. The expenditures were principally to maintain production facilities and
for operational efficiencies. Capital expenditures of approximately $3,520,
primarily for maintenance of production facilities and further equipment
modernization, are projected for 1997. These expenditures are expected to be
funded with cash flow from operations, borrowings under the Facility, and
proceeds from the sale of surplus equipment.

On May 14, 1996, Liggett sold certain surplus realty in Durham, North
Carolina to the County of Durham for a sale price of $4,300. A gain of
approximately $3,600 was recognized on this sale.

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

On July 5, 1996, Liggett purchased 140,000 shares (19.97%) of
Liggett-Ducat's tobacco operations from BOL, an indirect subsidiary of BGL, for
$2,100. Liggett-Ducat, which produces cigarettes in Russia, manufactured and
marketed 11.4 billion cigarettes in 1996. Liggett also acquired on that date
for $3,400 a ten-year option, exercisable by Liggett in whole or in part, to
purchase from BOL at the same per share price up to 292,407 additional shares
of Liggett-Ducat, thereby entitling Liggett to increase its interest in
Liggett-Ducat to approximately 62%. The option fee would be credited against
the purchase price. In addition, as part of the same transaction, Liggett had
the right on or before June 30, 1997 to acquire from BOL for $2,000 another
ten-year option on the same terms to purchase the remaining shares of
Liggett-Ducat (currently approximately an additional 33%) owned by BOL. On
March 13, 1997, Liggett acquired this option and paid BOL $2,000, and recorded
a payable to BOL for the remaining $0.2 million. The transactions did not
impact Liggett's cash flows from operations as the Company used the proceeds
from the May 1996 and March 1997 sales of surplus realty of $6,500 (see Item 2,
"Properties") and the payment in July 1996 of a receivable from New Valley
Corporation, also an affiliate, of $1,200 to fund the transactions.

Cash used in financing activities for 1996 of $772 included redemptions
and repayments of long-term debt of $254, net borrowings under the Facility of
$3,255 and a decrease in cash overdraft of $3,755.

Cash used in financing activities for 1995 of $12,253 included redemptions
and repayments of long-term debt of $8,208 and net repayments under the
revolving credit facility of $3,830.

Cash provided by financing activities for 1994 of $4,725 included the
issuance of the Series C Notes of $15,000, partially offset by deferred finance
charges associated with the issuance of the Series C Notes and refinancing of
the revolving credit facility of $2,705 along with the satisfaction of $4,000
of Liggett liabilities assumed by BGLS in 1993. Cash of $28,436 was also used
to repay the former revolving credit facility which was offset by net
borrowings of $24,847 under the Facility.

On March 8, 1994, Liggett entered into the Facility under which it can
borrow up to $40,000 (depending on the amount of eligible inventory and
receivables as determined by the lenders) from a syndicate of commercial
lenders. Availability under the Facility was approximately $13,098 based upon
eligible collateral at December 31, 1996. The Facility is collateralized by all
inventories and receivables of the Company. Borrowings under the Facility,
whose interest is calculated at a rate equal to 1.5% above Philadelphia
National Bank's (the indirect parent of Congress Financial Corporation, the
lead lender) prime rate of 8.25%, bore a rate of 9.75% on December 31, 1996.
The Facility contains certain financial

<PAGE> 24
covenants similar to those contained in the Note indenture, including
restrictions on Liggett's ability to declare or pay cash dividends, incur
additional debt, grant liens and enter into any new agreements with affiliates,
among others. In addition, the Facility imposes requirements with respect to
the Company's adjusted net worth (not to fall below a deficit of $175,000 as
computed in accordance with the agreement) and working capital (not to fall
below a deficit of $35,000 as computed in accordance with the agreement). At
December 31, 1996, the Company was in compliance with all covenants under the
Facility. On January 7, 1997 the Facility was extended for a one-year period
ending March 8, 1998. No assurances can be given that the Facility will be
further extended.

During the first quarter of 1997, the Company violated the working capital
covenant contained in the Facility as a result of the 1998 mandatory redemption
payment on the Senior Secured Notes becoming due within one year. On March 19,
1997, the lead lender agreed to waive this covenant default, and the Facility
was amended as follows: (i) the working capital definition was changed to
exclude the Senior Secured Notes; (ii) the maximum permitted working capital
deficit was reduced to $12,000; (iii) the maximum permitted adjusted net worth
deficit was increased to $180,000; and (iv) the permitted advance rates under
the Facility for eligible inventory were reduced by five percent.

On February 14, 1992, Liggett issued $150,000 in Senior Secured Notes (the
"Series B Notes"). From the proceeds of $148,244, net of an original issue
discount, $144,054 was dividended to BGLS (which reduced stockholder's equity)
and $4,190 was paid as financing fees. Interest on the Series B Notes is
payable semiannually on February 1 and August 1 at an annual rate of 11.5%.
The Series B Notes and Series C Notes referred to below (collectively, the
"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 the Company, excluding accounts receivable
and inventory. Eve is a guarantor for the Notes. The Notes may be redeemed,
in whole or in part, at a price equal to 102% and 100% of the principal amount
in the years 1997 and 1998, respectively, at the option of the Company. The
Notes contain restrictions on Liggett's ability to declare or pay cash
dividends, incur additional debt, grant liens and enter into any new agreements
with affiliates, among others. At December 31, 1996, the Company was in
compliance with all covenants under the Note indenture.

On January 31, 1994, the Company issued $22,500 of Variable Rate Series C
Senior Secured Notes (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 for February 1, 1994. The Series
C Notes have the same terms (other than interest rate) and stated maturity as
the Series B Notes. The Series C Notes bore a 16.5% interest rate, which was
reset on February 1, 1995 to 19.75%. The Company 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 indenture. In connection with the consents,
holders of Series B Notes received Series C Notes totaling two percent of
their current Series B Note holdings. The total principal amount of such
Series C Notes issued for this purpose was $2,842. On November 20, 1994, the
Company 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 so exchanged
were credited against the mandatory redemption requirements for February 1,
1995.

In December 1995, $7,000 of Series B Notes were purchased using revolver
availability and credited against the mandatory redemption requirements for
February 1, 1996. The transaction resulted in a net gain of $1,114. The
remaining $500 mandatory redemption requirement for February 1, 1996 was met by
retiring the $500 Series C Notes held in treasury. In February 1997, $7,500
of Series B Notes were purchased using revolver availability and credited
against the mandatory redemption requirements. The transaction resulted in a
net gain of $2,963.

While management currently intends to seek to refinance and/or restructure
with the Company's note holders the mandatory principal redemption on the Notes
of $37,500 due on February 1, 1998 and the payment at maturity, on February 1,
1999, of $107,400 and to extend the Facility, there are no refinancing or
restructuring arrangements for the Notes or commitments to extend the Facility
at this time, and no assurances can be given in this regard. Based on the
Company's net loss for 1996 and anticipated 1997 operating results, the Company
does not anticipate it will be able to generate sufficient cash from operations
to make such payments. If the Company is unable to refinance or restructure
such obligations, renegotiate the payment terms of the Notes, extend the
Facility or otherwise make such payments, substantially all of its long-term
debt would be in default and holders of such debt could accelerate the maturity
of such debt. In such event, the Company may be forced to seek protection from
creditors under

<PAGE> 25

applicable laws. The Company's independent accountants have issued a report
covering the Company's December 31, 1996 consolidated financial statements
containing an explanatory paragraph that states that these facts raise
substantial doubt about the Company's ability to continue as a going concern.
The accompanying consolidated financial statements of the Company do not
include any adjustments that might arise from the outcome of this uncertainty.
See "Report of Independent Accountants" and Note 2 to the Company's
consolidated financial statements.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

The Company and its representatives may from time to time make oral or
written "forward-looking statements" within the meaning of the Private
Securities Reform Act of 1995 (the "Reform Act"), including any statements that
may be contained in the foregoing discussion in "Management's Discussion and
Analysis of Financial Condition and Results of Operations", and elsewhere in
this report and in other filings with the Securities and Exchange Commission
and in its reports to securityholders which reflect management's current views
with respect to future events and financial performance. These forward-looking
statements are subject to certain risks and uncertainties and, in connection
with the "safe-harbor" provisions of the Reform Act, the Company is hereby
identifying important factors that could cause actual results to differ
materially from those contained in any forward-looking statement made by or on
behalf of the Company. The Company continues to be subject to risk factors
endemic to the domestic tobacco industry including, without limitation, health
concerns relating to the use of tobacco products and exposure to environmental
tobacco smoke, legislation, including tax increases, governmental regulation,
privately imposed smoking restrictions, decline in consumption, governmental
and grand jury investigations and litigation. Furthermore, the Company is
subject to intense competition, changes in consumer preferences, the effects of
changing prices for its raw materials and local economic conditions. In
addition, the Company has a high degree of leverage and substantial near-term
debt service requirements, including a mandatory principal redemption of
$37,500 on its Notes due February 1, 1998 and a payment at maturity of $107,400
on February 1, 1999, as well as a net worth and a working capital deficiency
and recent net losses, and is highly dependent upon its revolving credit
facility which expires in March 1998, unless extended by its lenders. The
Notes and the Facility contain restrictions on the Company's ability to incur
additional debt, grant liens, enter into any new agreements with affiliates and
declare or pay cash dividends, among others. Due to such uncertainties and
risks, investors are cautioned not to place undue reliance on such
forward-looking statements, which speak only as of the date such statements are
made. The Company does not undertake to update any forward-looking statement
that may be made from time to time by or on behalf of the Company.

<PAGE> 26

REPORT OF INDEPENDENT ACCOUNTANTS

Board of Directors
Liggett Group, Inc.

We have audited the consolidated financial statements and the financial
statement schedule of Liggett Group Inc. listed in the index on page 15 of this
Form 10-K. These financial statements and the financial statement schedule are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and the financial statement
schedule 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 financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Liggett Group,
Inc. as of December 31, 1996 and 1995 and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
In addition, in our opinion, the financial statement schedule referred to
above, when considered in relation to the basic financial statements taken as a
whole, present fairly, in all material respects, the information required to be
included therein.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2a to the
financial statements, the Company suffered a loss of $18,372,000 for the year
ended December 31, 1996 and had net capital and working capital deficiencies of
$176,478,000 and $40,694,000, respectively, at December 31, 1996. The Company
also has a $37,500,000 principal payment due on its Senior Secured Notes on
February 1, 1998 and payment due at maturity of the Senior Secured Notes on
February 1, 1999 of $107,400,000 and the Company's revolving credit facility
(the "Facility"), which had a balance of $24,272,000 at December 31, 1996, is
due on March 8, 1998. The Company's financial resources are not sufficient to
repay the Senior Secured Notes when they become due, nor will the Company be
able to repay the Facility when it becomes due. These facts raise substantial
doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 2a.
The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.

COOPERS & LYBRAND L.L.P.
Miami, Florida
March 20, 1997

<PAGE> 27

LIGGETT GROUP INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share amounts)

ASSETS

<TABLE>
<CAPTION>
December 31,
---------------------------
1996 1995
------- --------
<S> <C> <C>
Current assets:
Accounts receivable:
Trade, less allowances of $1,280 and $815, respectively. . . $19,316 $ 22,279
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 644 1,367
Affiliates . . . . . . . . . . . . . . . . . . . . . . . . 100 1,105

Inventories . . . . . . . . . . . . . . . . . . . . . . . . . 50,122 54,342

Deferred income taxes . . . . . . . . . . . . . . . . . . . . . - 3,800

Other current assets (Note 6) . . . . . . . . . . . . . . . . 1,205 1,703
------- --------
Total current assets . . . . . . . . . . . . . . . . . . 71,387 84,596

Property, plant and equipment, at cost, less accumulated
depreciation of $29,511 and $26,545, respectively . . . . . . . 18,705 18,352

Intangible assets, at cost, less accumulated amortization
of $17,388 and $15,661, respectively . . . . . . . . . . . . . 3,327 5,036

Other assets and deferred charges, at cost, less accumulated
amortization of $7,410 and $5,440, respectively . . . . . . . 4,258 5,330
------- --------

Total assets . . . . . . . . . . . . . . . . . . . . . $97,677 $113,314
======= ========
</TABLE>

(continued)

<PAGE> 28

LIGGETT GROUP INC.

CONSOLIDATED BALANCE SHEETS (Continued)

(Dollars in thousands, except per share amounts)

LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)

<TABLE>
<CAPTION>
December 31,
-----------------------
1996 1995
--------- ---------
<S> <C> <C>
Current liabilities:
Current maturities of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . $ 31,807 $ 50
Cash overdraft . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 3,761
Accounts payable, principally trade . . . . . . . . . . . . . . . . . . . . . . . . . . 18,949 18,921
Accrued expenses:
Promotional . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,257 25,519
Compensation and related items . . . . . . . . . . . . . . . . . . . . . . . . . . . 682 1,175
Taxes, principally excise taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,565 7,006
Estimated allowance for sales returns . . . . . . . . . . . . . . . . . . . . . . . . 5,000 5,000
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,435 8,412
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,380 5,728
--------- -----------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 112,081 75,572

Long-term debt, less current maturities . . . . . . . . . . . . . . . . . . . . . . . . . 144,698 173,251

Non-current employee benefits and other long-term liabilities . . . . . . . . . . . . . . 17,376 19,197

Commitments and contingencies (Notes 5 and 12)

Stockholder's equity (deficit):
Redeemable preferred stock (par value $1.00 per share;
authorized 1,000 shares; no shares issued and out-
standing)(Note 14)
Common stock (par value $0.10 per share; authorized
2,000 shares; issued and outstanding 1,000 shares)
and contributed capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49,840 53,240
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (226,318) (207,946)
--------- -----------
Total stockholder's deficit . . . . . . . . . . . . . . . . . . . . . . . . . (176,478) (154,706)
--------- -----------
Total liabilities and stockholder's equity (deficit) . . . . . . . . . . . . $ 97,677 $ 113,314
========= ===========
</TABLE>
The accompanying notes are an integral part
of these financial statements.

<PAGE> 29

LIGGETT GROUP INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands)

Year Ended December 31,
-------------------------------
1996 1995 1994
-------- -------- --------

<S> <C> <C> <C>
Net sales* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $401,062 $455,666 $465,676
Cost of sales* . . . . . . . . . . . . . . . . . . . . . . . . . . . 187,799 212,314 222,774
-------- -------- --------
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . 213,263 243,352 242,902
Selling, general and administrative expenses . . . . . . . . . . . . 203,214 216,806 209,306
Restructuring . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,296 1,927 -
-------- -------- --------
Operating income . . . . . . . . . . . . . . . . . . . . . . 6,753 24,619 33,596
Other income (expense):
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . 23 3 -
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . (23,901) (23,449) (21,704)
Equity in loss of affiliate . . . . . . . . . . . . . . . . . . . (1,116) - -
Sale of assets . . . . . . . . . . . . . . . . . . . . . . . . . . 3,669 - -
Miscellaneous, net . . . . . . . . . . . . . . . . . . . . . . . - 1,133 (458)
-------- -------- --------
Income (loss) before income taxes and extra-
ordinary item . . . . . . . . . . . . . . . . . . . . . . . (14,572) 2,306 11,434
Income tax provision (benefit) . . . . . . . . . . . . . . . . . . . 3,800 1,751 (5,000)
-------- -------- --------
Income (loss) before extraordinary item . . . . . . . . . . . (18,372) 555 16,434

Extraordinary loss from the early
extinguishment of debt . . . . . . . . . . . . . . . . . . . . . . - - (1,028)
-------- -------- --------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . $(18,372) $ 555 $ 15,406
======== ======== ========
</TABLE>

*Net sales and cost of sales include federal excise taxes of $104,518, $123,420
and $131,877 respectively.

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

<PAGE> 30

LIGGETT GROUP INC.

STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)

(Dollars in thousands)

<TABLE>
<CAPTION>
Common Retained Total
Stock and Earnings Stockholder's
Contributed (Accumulated Translation Equity
Capital Deficit) Adjustments (Deficit)
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Balance at December 31, 1993 . . . . . . . . . . . . . . . . . . . $53,240 $(223,109) $ (3) $(169,872)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . - 15,406 - 15,406
Translation adjustments . . . . . . . . . . . . . . . . . . . . - - 3 3
------- --------- --------- ---------
Balance at December 31, 1994 . . . . . . . . . . . . . . . . . . . 53,240 (207,703) - (154,463)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . - 555 - 555
Excess of investment over cost basis of
net assets acquired from indirect parent . . . . . . . . . . . - (798) - (798)
------- --------- --------- ---------
Balance at December 31, 1995 . . . . . . . . . . . . . . . . . . . 53,240 (207,946) - (154,706)
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (18,372) - (18,372)
Consideration for option to acquire affiliate
stock in excess of its net assets (Note 13) . . . . . . . . . . (3,400) - - (3,400)
------- --------- --------- ---------
Balance at December 31, 1996 . . . . . . . . . . . . . . . . . . . $49,840 $(226,318) $ - $(176,478)
======= ========= ========= =========
</TABLE>

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

<PAGE> 31

LIGGETT GROUP INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

Year Ended December 31,
---------------------------------------------
1996 1995 1994
---------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (18,372) $ 555 $ 15,406
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . 7,969 7,972 8,310
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,800 1,259 (5,781)
(Gain) loss on sale of property, plant and equipment . . . . . . . . . . . . . (3,669) (375) 114
(Gain) on retirement of notes . . . . . . . . . . . . . . . . . . . . . . . . - (1,273) (375)
Deferred finance charges and debt discount written off . . . . . . . . . . . - 160 1,404
Equity in loss of affiliate . . . . . . . . . . . . . . . . . . . . . . . . . 1,116 - -
Changes in assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,691 7,060 (3,381)
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,220 (7,658) (9,712)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (330) 7,671 (480)
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,479 (10,638) (10,474)
Non-current employee benefits . . . . . . . . . . . . . . . . . . . . . . . . (276) (225) (290)
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,461) 9,079 1,492
--------- --------- ---------
Net cash provided by (used in) operating activities . . . . . . . . . . . . 6,167 13,587 (3,767)
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sale of property, plant and equipment . . . . . . . . . . . . . . 4,424 570 78
Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,319) (1,104) (1,036)
Investment in affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,500) (800) -
--------- --------- ---------
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . (5,395) (1,334) (958)
--------- --------- ---------
Cash flows from financing activities:
Repayments of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . (254) (8,208) (1,690)
Issuance of Senior Secured Notes . . . . . . . . . . . . . . . . . . . . . . . - - 15,000
Borrowings under revolving credit facility . . . . . . . . . . . . . . . . . . 351,428 397,873 362,955
Repayments under revolving credit facility. . . . . . . . . . . . . . . . . . . (348,173) (401,703) (366,544)
Proceeds from retirement of notes . . . . . . . . . . . . . . . . . . . . . . - - 375
Deferred finance charges . . . . . . . . . . . . . . . . . . . . . . . . . . . (18) - (2,705)
Cumulative translation adjustment . . . . . . . . . . . . . . . . . . . . . . . - - 3
Changes in advances to affiliate . . . . . . . . . . . . . . . . . . . . . . . - - (4,000)
Increase (decrease) in cash overdraft . . . . . . . . . . . . . . . . . . . . . (3,755) (215) 1,331
--------- --------- ---------
Net cash provided by (used in) financing activities . . . . . . . . . . . . (772) (12,253) 4,725
--------- --------- ---------
Net change in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . - - -
Cash and cash equivalents:
Beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - - -
--------- --------- ---------
End of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ - $ -
========= ========= =========
Supplemental cash flow information:
Cash payments during the period for:

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 23,228 $ 23,196 $ 20,287
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 189 $ 130 $ 123
</TABLE>

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

<PAGE> 32

LIGGETT GROUP INC.

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

1. Basis of Presentation

Liggett Group Inc. ("Liggett" or the "Company") is a wholly-owned
subsidiary of BGLS Inc. ("BGLS"), a wholly-owned subsidiary of Brooke Group
Ltd. ("BGL"). Liggett is engaged primarily in the manufacture and sale of
cigarettes, principally in the United States. Certain management and
administrative functions are performed by affiliates (see Note 13).

2. Summary of Significant Accounting Policies

a. Going Concern

Further, the Company's senior secured notes require a mandatory principal
redemption of $37,500 on February 1, 1998 and a payment at maturity on February
1, 1999, of $107,400, and its revolving credit facility expires on March 8,
1998 unless extended by its lenders. The revolving credit facility is
classified as a short-term debt thereby creating a working capital deficit of
approximately $40,694 at December 31, 1996.

While management currently intends to seek to refinance and/or restructure
with the Company's note holders the redemption and maturity requirements on the
Senior Secured Notes and to extend the revolving credit facility, there are no
refinancing or restructuring arrangements for the notes or commitments to extend
the facility at this time, and no assurances can be given in this regard. Based
on the Company's net loss for 1996 and anticipated 1997 operating results, the
Company does not anticipate it will be able to generate sufficient cash from
operations to make such payments. If the Company is unable to refinance or
restructure such obligations, renegotiate the payment terms of the senior
secured notes, extend the revolving credit facility or otherwise make such
payments, substantially all of its long-term debt and revolving credit facility
would be in default and holders of such debt could accelerate the maturity of
such debt. In such event, the Company may be forced to seek protection from
creditors under applicable laws. These matters raise substantial doubt about
the Company meeting its liquidity needs and its ability to continue as a going
concern.

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

b. Principles of Consolidation

<PAGE> 33

The consolidated financial statements include the accounts of Liggett and
its wholly-owned subsidiaries, Eve Holdings Inc. ("Eve"), Cigarette Exporting
Company of America Ltd. ("CECOA") and Carolina Tobacco Express Company
("CTEC"). Intercompany accounts and transactions have been eliminated.

c. Estimates and Assumptions

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at December 31, 1996 and 1995
and the reported amounts of revenues and expenses during the three year period
ended December 31, 1996. Significant estimates subject to material changes in
the near term include deferred tax assets, allowance for doubtful accounts,
sales returns and allowances, actuarial assumptions of pension plans and
litigation and defense costs. Actual results could differ from those estimates.

d. Per Share Data

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

e. Inventories

Inventories are valued at the lower of cost (LIFO) or market. 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.

f. Property, Plant and Equipment

Property, plant and equipment are depreciated using the straight-line
method over the estimated useful lives of the respective assets which are
twenty years for buildings and four to ten 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.

The Company is required to review long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable, in accordance with the provisions of
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
("SFAS 121"). Accordingly, when indicators of impairment are present, the
Company evaluates the carrying value of property, plant and equipment and
intangibles in relation to the operating performance and estimates of future
discounted cash flows of the underlying business.

g. Trademarks

Trademarks are amortized using the straight-line method over twelve years.
Amortization expense for the years ended December 31, 1996, 1995 and 1994
amounted to $1,727, $1,725 and $1,722, respectively. Management periodically
reviews the carrying value of trademarks to determine whether asset values are
impaired.

<PAGE> 34

h. Sales and Sales Returns

Revenue from sales is recognized upon the shipment of finished goods to
customers. The Company provides for expected sales returns, net of related
inventory cost recoveries. As Liggett does not have any other lines of
business, the Company's financial position and its results of operations could
be materially adversely affected by significant unit sales volume declines,
increased tobacco costs or reductions in the selling price of cigarettes.

i. Employee Benefits

The Company sponsors self-insured health and dental insurance plans for
all eligible employees. As a result, the expense recorded for such benefits
involves an estimate of unpaid claims as of December 31, 1996 and 1995 which
are subject to significant fluctuations in the near term.

BGLS maintains defined benefit retirement plans for substantially all of
the Company's employees. The Company records as an expense the portion of
BGLS' annual funding requirements applicable to the Company.

The Company sponsors a postretirement benefit plan and, in accordance with
Statement of Financial Accounting Standards No. 106, "Employers Accounting for
Postretirement Benefits Other than Pensions" ("SFAS 106"), records an
actuarially determined liability and charges operations for the estimated cost
of postretirement benefits for current employees and retirees.

j. Income Taxes

Under SFAS No. 109, "Accounting for Income Taxes", deferred taxes reflect
the impact of temporary differences between the amounts of assets and
liabilities recognized for financial reporting purposes and the amounts
recognized for tax purposes as well as tax credit carryforwards and loss
carryforwards. These deferred taxes are measured by applying currently enacted
tax rates. A valuation allowance reduces deferred tax assets when it is deemed
more likely than not that future taxable income will be insufficient to realize
some portion or all of the deferred tax assets.

k. Legal Costs

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

l. Fair Value of Financial Instruments

The fair values of the Company's Senior Secured Notes have been based upon
market quotations (see Note 10). The carrying amount of borrowings outstanding
under the revolving credit facility and other long-term debt is a reasonable
estimate of fair value, based upon estimated current borrowing rates for loans
with similar terms and maturities. The estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair values.

3. Changes in Accounting Estimates

In September 1995, the Company adjusted an accrual estimate recorded in
prior years which had the effect of increasing operating income by
approximately $1,214 for the year ended December 31, 1995.

As a consequence of certain litigation settlements and marketing
assessment contingencies (see Note 12), Liggett charged approximately $8,846
to operations in the fourth quarter of 1995. Possible

<PAGE> 35

future payments under the litigation settlements which are based on a
percentage of Liggett's pretax income, if any, will be charged to operations
in the period that the Company's operating results are known. Liggett increased
its valuation allowance for deferred tax assets by $443 in the fourth quarter
of 1995.

Liggett increased its valuation allowance for deferred tax assets by
$3,800 in the third quarter of 1996. In December 1996, Liggett increased its
estimate of coupon promotions which resulted in a decrease in the Company's
operating income of $1,800 for the year ended December 31, 1996.

4. Concentrations of Credit Risk

Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of trade receivables.

Liggett's customers are primarily candy and tobacco distributors, the
military and large grocery, drug and convenience store chains. Liggett's
largest single customer accounted for approximately 13.7% of net sales in 1996,
and approximately 11.6% of net sales in 1995, the majority of which were in the
private label discount market segment. No single customer accounted for more
than 10% of the Company's net sales in 1994. Concentrations of credit risk with
respect to trade receivables are limited due to the large number of customers
comprising the remainder of 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
estimates.

5. Inventories

Inventories consist of:

<TABLE>
<CAPTION>
December 31,
------------------
1996 1995
------ -------
<S> <C> <C>

Finished goods . . . . . . . . . . . . . . . . . . . . . . $15,304 $18,240
Work-in-process . . . . . . . . . . . . . . . . . . . . . . 4,382 3,331
Raw materials . . . . . . . . . . . . . . . . . . . . . . . 31,338 24,946
Replacement parts and supplies . . . . . . . . . . . . . . 3,554 3,926
------- -------
Inventories at current cost . . . . . . . . . . . . . . . 54,578 50,443

LIFO adjustment . . . . . . . . . . . . . . . . . . . . . (4,456) 3,899
------- -------
Inventories at LIFO cost . . . . . . . . . . . . . . . . $50,122 $54,342
======= =======
</TABLE>

The Company has a leaf inventory management program whereby, among other
things, it is committed to purchase certain quantities of leaf tobacco. The
purchase commitments are for quantities not in excess of anticipated
requirements and are at prices, including carrying costs, established at the
date of the commitment. Liggett had leaf tobacco purchase commitments of
approximately $20,116 at December 31, 1996.

<PAGE> 36

6. Assets Under Agreement for Sale

On April 9, 1996, Liggett executed a definitive agreement with the County
of Durham for the sale by Liggett to the County of Durham of certain surplus
realty in Durham, North Carolina, for a sale price of $4,300. The net book
value of those assets ($713) for which the agreement was signed is classified
as current assets on the Company's Consolidated Balance Sheet as of December
31, 1995. The transaction closed on May 14, 1996, at which time a gain of
approximately $3,600 was recognized.

On April 29, 1996, Liggett executed a definitive agreement (as amended)
with Blue Devil Ventures, a North Carolina limited liability partnership, for
the sale by Liggett to Blue Devil Ventures of certain surplus realty in Durham,
North Carolina, for a sale price of $2,200. The net book value of those assets
($309) for which the agreement was signed is classified as current assets on
the Company's Consolidated Balance Sheet as of December 31, 1996. The
transaction closed on March 11, 1997. A gain of approximately $1,600 is
expected to be recognized in 1997.

7. Property, Plant and Equipment

Property, plant and equipment consists of the following:

<TABLE>
<CAPTION>
December 31,
------------------
1996 1995
------- -------
<S> <C> <C>
Land and improvements ....................................... $ 455 $ 542
Buildings ................................................... 5,848 6,011
Machinery and equipment ..................................... 41,913 38,344
------- -------

Property, plant and equipment ............................... 48,216 44,897

Less accumulated depreciation ............................... (29,511) (26,545)
------- -------

Property, plant and equipment, net .......................... $18,705 $18,352
======= =======
</TABLE>

8. Employee Benefits Plans

Defined Benefit Retirement Plans

Prior to 1994, substantially all of Liggett's employees participated in
two noncontributory defined benefit retirement plans sponsored by BGLS. The
Company records as an expense the portion of BGLS' annual funding requirements
applicable to the Company. There was no pension expense recorded in 1996, 1995
or 1994.

<PAGE> 37

Future Pension Benefits to be Funded by BGLS

Actuarial estimates of the total future minimum pension benefits to be
funded by BGLS, prior to the effect of unamortized purchase accounting
adjustments, are as follows:

<TABLE>
<S> <C>
1997 ...................... $ 350
1998 ...................... 350
1999 ...................... 350
2000 ...................... 250
2001 ...................... 150
Thereafter ................. 1,500
------

Total ................... $2,950
======
</TABLE>

Postretirement Medical and Life Insurance Plans

The components of net periodic postretirement benefit cost are as follows:

<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Service cost, benefits attributed to employee
service during the year .................... $ 68 $ 68 $ 63
Interest cost on accumulated postretirement
benefit obligation ......................... 829 970 1,037
Charge for special termination benefits ...... -- 489 --
Amortization of net (gain) loss .............. (92) (26) 33
----- ------- ------
Net periodic postretirement benefit expense .. $ 805 $ 1,501 $1,133
===== ======= ======
</TABLE>

The following sets forth the actuarial present value of the Accumulated
Postretirement Benefit Obligation ("APBO") applicable to each employee group
for benefits:

<TABLE>
<CAPTION>
December 31,
--------------
1996 1995
---- ----
<S> <C> <C>
Retired employees ........................................... $ 7,899 $ 8,673
Active employees - fully eligible ........................... 674 1,707
Active employees - not fully eligible ....................... 515 1,078
------- -------
APBO ........................................................ 9,088 11,458
Unrecognized net gain ....................................... 3,324 1,339
Purchase accounting valuation adjustment
related to income taxes ..................................... (1,072) (1,181)
------- -------
Postretirement liability .................................... $11,340 $11,616
======= =======
</TABLE>

<PAGE> 38

The APBO at December 31, 1996 was determined using a discount rate of 8%
and health care cost trend rates of 4%. A 1% increase in the trend rate for
health care costs would have increased the APBO and net periodic postretirement
benefit cost by $419 and $32, respectively, for the year ended December 31,
1996. The Company does not hold any assets reserved for use in the plan.

Profit Sharing Plans

Liggett's 401(k) plans originally called for Company contributions
matching up to a 3% employee contribution, plus additional Company
contributions of up to 6% of salary based on the achievement of Company profit
objectives. Effective January 1, 1994, the Company suspended the 3% match for
the salaried employees' 401(k) Plan, but reinstated it on April 1, 1996. The
Company contributed and expensed $2,712, $900 and $420 to the 401(k) plans for
the years ended December 31, 1996, 1995 and 1994, respectively.

9. Income Taxes

Liggett's operations are included in the consolidated federal income tax
return of its indirect parent, BGL. Pursuant to a tax allocation agreement,
the Company's federal income tax provision is calculated as if the Company
filed a separate federal income tax return except that the tax sharing
agreement with BGL effectively limits the ability of the Company to carry back
losses for refunds.

The amounts provided for income taxes are as follows:

<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Current:
Federal ...................................... $ -- $ (233) $ 341
State ........................................ -- 216 227

Deferred:
Federal ...................................... 3,800 1,768 (5,568)
State ........................................ -- -- --
------- ------ -------
Total tax provision (benefit) ................ $ 3,800 $ 1,751 $(5,000)
======= ======= =======
</TABLE>

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

<TABLE>
<CAPTION>
1996 1995
---------------------- ----------------------
Deferred Tax Deferred Tax
Asset Liability Asset Liability
-------- --------- ------- ---------
<S> <C> <C> <C> <C>
Sales and product allowances ........ $ 2,504 $ -- $ 2,293 $ --
Inventory ........................... 1,269 683 816 1,256
Coupon accruals ..................... 4,492 -- 3,138 --
Property, plant and equipment ....... -- 4,890 -- 5,778
Employee benefit plan accruals ...... 5,303 -- 4,886 --
USDA marketing assessment ........... 1,681 -- 1,920 --
Tobacco litigation settlements ...... 1,229 -- 1,568 --
Difference in basis in investment ... 1,864 -- -- --
Net operating loss carryforward ..... 7,244 -- 5,022 --
Valuation allowance ................. (20,013) -- (8,809) --
Reclassifications ................... (5,573) (5,573) (7,034) (7,034)
-------- ------- ------- ---------
Total deferred taxes................. $ -- $ -- $ 3,800 $ ----
======== ======= ======= =========
</TABLE>

<PAGE> 39

The $20,013 net valuation allowance at December 31, 1996 is composed of
$18,590 for net deferred assets arising from items which have been reflected in
book income or loss and $1,423 for deferred assets arising for basis
differences in the investments which were reflected as direct entries to
equity.

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

<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Income before taxes .......................... $ (14,572) $ 2,306 $ 11,434
========= ========= =========
Federal income tax at statutory rates ........ $ (5,100) $ 807 $ 4,002
Increases (decreases) resulting from:
State income tax expense (benefit) net of
federal income tax benefit (expense) ..... (634) 216 743
Other, net ................................. (247) 285 516
Change in valuation allowance .............. 9,781 443 (10,261)
--------- --------- ---------

Total tax provision (benefit) ................ $ 3,800 $ 1,751 $ (5,000)
========= ========= =========
</TABLE>

As of December 31, 1996, the Company's net operating loss ("NOL")
carryforward pursuant to its tax sharing agreement with BGL is approximately
$18,250 which expires from 2008 to 2011. However, if the Company were
deconsolidated from BGL, its allocable share of NOL could be significantly
different. In 1993 a valuation allowance was established for the net deferred
tax assets because of the lack of recoverability of NOLs against prior years'
taxable income and the Company's 1993 loss. The Company has adjusted its
valuation allowance in subsequent years based upon its assessment of whether it
is more likely than not that taxable income will be sufficient to realize the
deferred tax assets.

10. Long-Term Debt

Long-term debt consists of the following:

<TABLE>
<CAPTION>
December 31,
------------
1996 1995
----------------------- ------
Estimated Carrying Carrying
Fair Value Value Value
---------- -------- --------
<S> <C> <C> <C>
11.5% Senior Secured Notes due February 1, 1999
net of unamortized discount of $0, $424 and $627,
respectively .................................... $ 74,805 $ 119,688 $ 119,485
Variable Rate Series C Senior Secured Notes due
February 1, 1999 ................................ 23,402 32,279 32,279
Borrowings outstanding under revolving credit
facility ........................................ 24,272 24,272 21,017
Other ............................................ 266 266 520
--------- --------- ---------
122,745 176,505 173,301
Current portion .................................. (31,807) (31,807) (50)
--------- --------- ---------
</TABLE>

<PAGE> 40

<TABLE>
<S> <C> <C> <C>
Amount due after one year ....................... $ 90,938 $ 144,698 $ 173,251
========= ========= =========
</TABLE>

Maturities of long-term debt, net of discount, at December 31, 1996 are as
follows:

<TABLE>
<S> <C>
1997 ................................. $ 31,807
1998 ................................. 37,324
1999 ................................. 107,374
--------
Total .............................. $176,505
========
</TABLE>

Senior Secured Notes

On February 14, 1992, Liggett issued $150,000 in Senior Secured Notes (the
"Series B Notes"). Interest on the Series B Notes is payable semiannually on
February 1 and August 1 at an annual rate of 11.5%. The Series B Notes and
Series C Notes referred to below (collectively, the "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. In February 1997, $7,500 of Series B Notes were purchased
using revolver availability and credited against the mandatory redemption
requirements. The transaction resulted in a net gain of $2,963. The Notes are
collateralized by substantially all of the assets of the Company, excluding
inventories and receivables. Eve is a guarantor for the Notes. The Notes may
be redeemed, in whole or in part, at a price equal to 102% and 100% of the
principal amount in the years 1997 and 1998, respectively, at the option of
the Company. The Notes contain restrictions on Liggett's ability to declare or
pay cash dividends, incur additional debt, grant liens and enter into any new
agreements with affiliates, among others.

On January 31, 1994, the Company issued $22,500 of Variable Rate Series C
Senior Secured Notes (the "Series C Notes"). The Series C Notes have the same
terms (other than interest rate) and stated maturity as the Series B Notes.
The Series C Notes bore a 16.5% interest rate, which was reset on February 1,
1995 to 19.75%. The Company 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 C Notes 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, the Company 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 so exchanged were credited against the
mandatory redemption requirements for February 1, 1995.

BGLS purchased $4,500 of the Series C Notes which were subsequently sold.

Revolving Credit Facility

On March 8, 1994, Liggett entered into a revolving credit facility (the
"Facility") under which it can borrow up to $40,000 (depending on the amount of
eligible inventory and receivables as determined by the lenders) from a
syndicate of commercial lenders. Availability under the Facility was
approximately $13,098 based upon eligible collateral at December 31, 1996. The
Facility is collateralized by all inventories and receivables of the Company.
Borrowings under the Facility, whose interest is calculated at a rate equal to
1.5% above Philadelphia National Bank's (the indirect parent of Congress
Financial Corporation, the lead lender) prime rate of 8.25%, bore a rate of
9.75% on December 31, 1996. The Facility contains certain financial covenants
similar to those contained in the Note indenture, including restrictions on
Liggett's ability to declare or pay cash dividends, incur additional debt,
grant liens and enter into any new agreements with affiliates, among others.
In addition, the Facility imposes

<PAGE> 41

requirements with respect to the Company's adjusted net worth (not to fall
below a deficit of $175,000 as computed in accordance with the agreement) and
working capital (not to fall below a deficit of $35,000 as computed in
accordance with the agreement). The Facility is classified as short-term debt
as of December 31, 1996, as it was due on March 8, 1997. On January 7, 1997,
the Facility was extended for a one-year period ending March 8, 1998.

11. Operating Leases

At December 31, 1996, the Company has operating leases for building space
and computer equipment. The future minimum lease payments are as follows:

<TABLE>
<S> <C>
1997 .......................... $ 1,672
1998 .......................... 1,118
1999 .......................... 361
2000 .......................... 6
--------
Total ....................... $ 3,157
========
</TABLE>

Rental expense for the years ended December 31, 1996, 1995 and 1994
amounted to approximately $3,121, $3,112 and $2,854, respectively.

12. Commitments and Contingencies

Litigation

Since 1954, Liggett and other United States cigarette manufacturers have
been named as defendants smoking or by exposure to secondary smoke
(environmental tobacco smoke, "ETS") from cigarettes. These cases are reported
hereinafter as though having been commenced against Liggett (without regard to
whether such actually were commenced against Brooke Group Ltd. in its former
name or in its present name or against Liggett). New cases continue to be
commenced against Liggett and other cigarette manufacturers. As new cases are
commenced, the costs associated with defending such cases and the risks
attendant to the inherent unpredictability of litigation continue to increase.
Liggett had been receiving certain financial and other assistance from others
in the industry in defraying the costs and other burdens incurred in the
defense of smoking and health litigation and related proceedings, but these
benefits have recently ended. Certain joint defense arrangements, and the
financial benefits incident thereto, have also ended. The future financial
impact on the Company of the termination of this assistance and the effects of
the tobacco litigation settlements discussed below is not quantifiable at this
time.

As of March 14, 1997, there were 108 cases pending against Liggett where
individual plaintiffs allege injury resulting from cigarette smoking, addiction
to cigarette smoking or exposure to ETS and seek compensatory and, in some
cases, punitive damages. Of these, 58 are pending in the State of Florida and
19 are pending in the State of New York. The balance of individual cases are
pending in 13 different states. The next individual case scheduled for trial
where Liggett is a defendant is Chutz-Reymers v. Liggett Group Inc., et al.
United States District Court, Middle District of Florida, Tampa Division, which
is scheduled for trial in June 1997. In light of the settlements discussed
below, this case will not proceed against Liggett on that date. In addition to
the foregoing, there are four individual cases scheduled for trial in 1997
where Liggett is a defendant, although trial dates are subject to change.

<PAGE> 42

warn, breach of express and implied warranties, conspiracy, concert of action,
unjust enrichment, common law public nuisance, indemnity, market share
liability, and violations of deceptive trade practices laws and antitrust
statutes. Plaintiffs also seek punitive damages in many of these cases.
Defenses raised by defendants in these cases include lack of proximate cause,
assumption of the risk, comparative fault and/or contributory negligence, lack
of design defect, statute of limitations, equitable defenses such as "unclean
hands" and lack of benefit, failure to state a claim and preemption by the
Federal Cigarette Labeling and Advertising Act, as amended (the "Act").
Several representative cases are described below.

On June 24, 1992, in the action entitled Cipollone v. Liggett Group Inc.,
et al., the United States Supreme Court issued an opinion concluding that The
Federal Cigarette Labeling and Advertising Act did not preempt state common law
damage claims but that The Public Health Cigarette Smoking Act of 1969 (the
"1969 Act"), did preempt certain, but not all, state common law damage claims.
The decision bars plaintiffs from asserting claims that, after the effective
date of the 1969 Act, the tobacco companies either failed to warn adequately of
the claimed health risks of cigarette smoking or sought to neutralize those
claimed risks in their advertising or promotion of cigarettes. Bills have been
introduced in Congress on occasion to eliminate the federal preemption defense.
Enactment of any federal legislation with such an effect could result in a
significant increase in claims, liabilities and litigation costs.

On March 27, 1987, an action entitled Yvonne Rogers v. Liggett Group Inc.
et al., Superior Court, Marion County, Indiana, was filed against Liggett and
others. The plaintiff sought compensatory and punitive damages for cancer
alleged to have been caused by cigarette smoking. Trial commenced on January
31, 1995. The trial ended on February 22, 1995 when the trial court declared a
mistrial due to the jury's inability to reach a verdict. The Court directed a
verdict in favor of the defendants as to the issue of punitive damages during
the trial of this action. A second trial commenced on August 5, 1996 and, on
August 23, 1996, the jury returned a verdict in favor of the defendants. A
Notice of Appeal has been filed by the plaintiff.

On October 31, 1991, an action entitled Broin et al. v. Philip Morris
Incorporated, et al., Circuit Court of the Eleventh Judicial District in and
for Dade County, Florida, was filed against Liggett and others. This case was
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 they have been damaged by involuntary
exposure to ETS. Plaintiffs' motion to certify the action as a class action
was granted. The suit is scheduled to go to trial on June 2, 1997. In
addition to Broin, as of March 25, 1997 there were 12 other actions which have
either been certified as a class or are seeking class certification. One of
these actions, Engle, et al. v. R. J. Reynolds Tobacco Company, et al.,
Circuit Court of the Eleventh Judicial Circuit in and for Dade County, Florida,
involving a certified class of smokers in the State of Florida, is scheduled to
commence trial on September 8, 1997.

On May 12, 1992, an action entitled Cordova v. Liggett Group Inc., et al.,
Superior Court of the State of California, City of San Diego, was filed against
Liggett and others. 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 on Tobacco Research
("CTR") and its predecessor. The complaint seeks equitable relief against the
defendants, including the imposition of a corrective advertising campaign,
restitution of funds, disgorgement of revenues and profits and the imposition
of a constructive trust. The case is presently in the discovery phase. This
action is scheduled for trial on December 12, 1997. A similar action has been
filed in the Superior Court for the State of California, City of San Francisco.

On September 10, 1993, an action entitled Sackman v. Liggett Group Inc.,
United States District Court, Eastern District of New York, was filed against
Liggett alleging as injury lung cancer. On May 25, 1996, the District Court
granted Liggett summary judgment on plaintiffs' fraud and breach of warranty

<PAGE> 43

claims. In addition, the District Court vacated the Magistrate's March 19,
1996 order compelling Liggett to produce certain CTR documents with respect to
which Liggett had asserted various privilege claims, and allowed the other
cigarette manufacturers and the CTR to intervene in order to assert their
interests and privileges with respect to those same documents. The Magistrate
Judge is presently reconsidering plaintiffs' motion to compel production of
documents. No trial date has been set.

On March 25, 1994, an action entitled Castano, et al. v. The American
Tobacco Company Inc., et al., United States District Court, Eastern District of
Louisiana, was filed against Liggett and others. The class action complaint
sought relief for a nationwide class of smokers based on their alleged
addiction to nicotine. The District Court granted plaintiffs' motion for class
certification. On May 23, 1996, the Fifth Circuit Court of Appeals decertified
the class and instructed the District Court to dismiss the class complaint.
On March 12, 1996, Liggett and BGL entered into an agreement, subject to court
approval, to settle the Castano class action tobacco litigation.

Under the Castano settlement agreement, upon final court approval of the
settlement, the Castano class would be entitled to receive up to 5% of
Liggett's pretax income (income before income taxes) each year (up to a maximum
of $50,000 per year) for the next twenty-five years, subject to certain
reductions provided for in the agreement, and a $5,000 payment from Liggett if
BGL or Liggett fails to consummate a merger or similar transaction with another
non-settling tobacco company defendant within three years of the date of the
settlement. BGL and Liggett have the right to terminate the Castano settlement
under certain circumstances. On May 11, 1996, the Castano Plaintiffs Legal
Committee filed a motion with the District Court seeking preliminary approval
of the Castano settlement. On September 6, 1996, the Castano plaintiffs
withdrew the motion for approval of the Castano settlement.

On March 14, 1996, BGL, the Castano Plaintiffs Legal Committee and the
Castano plaintiffs entered into a letter agreement. According to the terms of
the letter agreement, for the period ending nine months from the date of Final
Approval (if granted) of the Castano settlement or, if earlier, the completion
by BGL or Liggett of a combination with any defendant in Castano, exept Philip
Morris, the Castano plaintiffs and their counsel agree not to enter into any
more favorable settlement agreement with any Castano defendant which would
reduce the terms of the Castano settlement agreement. If the Castano
plaintiffs or their counsel enter into any such settlement during this period,
they shall pay BGL $250,000 within thirty days of the more favorable agreement
and offer BGL and Liggett the option to enter into a settlement on terms at
least as favorable as those included in such other settlement. The letter
agreement further provides that during the same time period, and if the Castano
settlement agreement has not been earlier terminated by BGL in accordance
with its terms, BGL and its affiliates will not enter into any business
transaction with any third party which would cause the termination of the
Castano settlement agreement. If BGL or its affiliates enter into any such
transaction, then the Castano plaintiffs will be entitled to receive $250,000
within thirty days from the transacting party.

In February 1995, an action entitled Grady Carter, et al. v. The American
Tobacco Company, et al., Superior Court for the State of Florida, Duval County,
was filed against Liggett and others. Plaintiff sought compensatory damages,
including, but not limited to, reimbursement for medical costs. Both American
Tobacco and Liggett were subsequently dismissed from this action. On August 9,
1996, a jury returned a verdict against the remaining defendant, Brown &
Williamson Tobacco Corp., in the amount of $750. Brown & Williamson has filed
a Notice of Appeal.

On May 23, 1994, an action entitled Moore, Attorney General, ex rel State
of Mississippi v. The American Tobacco Company, et al., Chancery Court of
Jackson County, Mississippi, was commenced against Liggett and others seeking
restitution and indemnity for medical payments and expenses allegedly made or
incurred for tobacco related illnesses. In May 1994, the State of Florida
enacted legislation, effective July 1, 1994, allowing certain state authorities
or entities to commence litigation seeking recovery of certain Medicaid
payments made on behalf of Medicaid recipients as a result of diseases
(including, but not limited to, diseases allegedly caused by cigarette smoking)
allegedly caused by liable third parties (including, but not limited to, the
tobacco industry). On February 21, 1995, the State of Florida commenced an
action pursuant to this statutory scheme. In addition to the foregoing,
similar actions have been filed on behalf of 20 states and several
municipalities. The Mississippi, Florida and Texas Medicaid recovery actions
are scheduled for trial in 1997. Legislation similar to that enacted in Florida
has been introduced in the Massachusetts and New Jersey legislatures.

In certain of the pending proceedings, state and local government entities
and others seek reimbursement for Medicaid and other health care expenditures
allegedly caused by tobacco products. The claims asserted in these Medicaid
recovery actions vary. All plaintiffs assert the equitable claim that the
tobacco industry was "unjustly enriched" by plaintiffs' payment of health care
costs allegedly attributable to smoking and seek reimbursement of those costs.
Other claims made by some but not all plaintiffs include the equitable claim of
indemnity, common law claims of negligence, strict liability, breach of express
and implied warranty, violation of a voluntary undertaking or special duty,
fraud, negligent misrepresentation, conspiracy, public nuisance, claims under
state and federal statutes governing consumer fraud, antitrust, deceptive trade
practices and false advertising, and claims under the Federal Racketeer
Influenced and Corrupt Organization Act.

On March 15, 1996, Liggett and BGL entered into a settlement of
tobacco-related litigation with the Attorneys General of Florida, Louisiana,
Mississippi, West Virginia and Massachusetts. The settlement with the
Attorneys General releases Liggett and BGL from all tobacco-related claims by
these states including claims for Medicaid reimbursement and concerning sales
of cigarettes to minors. The settlement provides that additional states which
commence similar Attorney General actions may agree to be bound by the
settlement prior to six months from the date thereof (subject to extension of
such period by the settling defendants). Certain of the terms of the
settlement are summarized below.

<PAGE> 44
Under the settlement, the states would share an initial payment by Liggett
of $5,000 ($1,000 of which was paid on March 22, 1996, with the balance payable
over nine years and indexed and adjusted for inflation), provided that any
unpaid amount will be due sixty days after either a default by Liggett in its
payment obligations under the settlement or a merger or other similar
transaction by Liggett or BGL with another defendant in the lawsuits. In
addition, Liggett will be required to pay the states a percentage of Liggett's
pretax income (income before income taxes) each year from the second through
the twenty-fifth year. This annual percentage is 2-1/2% of Liggett's
pretax income, subject to increase to 7-1/2% depending on the number of
additional states joining the settlement. No additional states have joined
this settlement to date. All of Liggett's payments are subject to certain
reductions provided for in the agreement. Liggett has also agreed to pay to
the states $5,000 if Liggett or BGL fails to consummate a merger or other
similar transaction with another defendant in the lawsuits with in three years
of the date of the settlement.

Settlement funds received by the Attorneys General will be used to
reimburse the states' smoking-related healthcare costs. While neither
consenting to FDA jurisdiction nor waiving their objections thereto, Liggett
and BGL also have agreed to phase in compliance with certain of the proposed
interim FDA regulations on the same basis as provided in the Castano
settlement.

Liggett and BGL have the right to terminate the settlement with respect to
any state participating in the settlement if any of the remaining defendants in
the litigation succeed on the merits in that state's Attorney General action.
Liggett and BGL may also terminate the settlement if they conclude that too
many states have filed Attorney General actions and have not resolved such
cases as to the settling defendants by joining in the settlement.

At December 31, 1995, the Company had accrued approximately $4,000 for the
present value of the fixed payments under the March 1996 Attorneys General
settlement, and no additional amounts have been accrued with respect to the
recent settlements discussed above. The Company cannot quantify the future
costs of the settlements at this time as the amount Liggett must pay is based,
in part, on future operating results. Possible future payments based on a
percentage of pretax income, and other contingent payments, based on occurrence
of a business combination, will be expensed when considered probable.

The Company understands that a grand jury investigation 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 this investigation.

In March 1996, Liggett received a subpoena from a Federal grand jury
sitting in the Southern District of New York. Documents have been produced in
response to the subpoena. The Company understands that this investigation has
been transferred to the main office of the United States Department of Justice.
In addition, in May 1996, Liggett was served with a subpoena by a grand jury
sitting in the District of Columbia. Liggett is in the process of responding
to that subpoena. Liggett and BGL are unable, at this time, to predict the
outcome of these investigations.

The Antitrust Division of the United States Department of Justice
investigation into the United States tobacco industry activities in connection
with product development efforts regarding "fire-safe" or self-extinguishing
cigarettes has been concluded. No action by the Department of Justice was
taken.

On March 15, 1996, an action entitled Spencer J. Volk v. Liggett Group
Inc. was filed in the United States District court for the Southern District of
New York, Case No. 96-CIV-1921, wherein the plaintiff, who was formerly
employed as Liggett's President and Chief Executive Officer, seeks recovery of
certain monies allegedly owing by Liggett to him for long-term incentive
compensation. At a September 19, 1996 hearing, the court dismissed the
plaintiff's alternate claim for recovery under a fraud theory and by order
dated March 10, 1997, the court dismissed the balance of plaintiff's claims. A
notice of appeal has been filed by the plaintiff.

Litigation is subject to many uncertainties, and it is possible that some
of aforementioned actions could be decided unfavorably against the Company.
An unfavorable outcome of a pending smoking and health case could encourage the
commencement of additional similar litigation. The Company is not able to
evaluate the effect of these developing matters on pending litigation or the
possible commencement of additional litigation.

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

<PAGE> 45

other proceedings, lawsuits and claims should not materially affect Liggett's
financial position, results of operations or cash flows.

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 Liggett and BGL. It is possible that the Company's consolidated
financial position, results of operations and cash flows could be materially
adversely affected by an ultimate unfavorable outcome in any of such pending
litigation.

Subsequent Events:

On March 20, 1997, Liggett, together with BGL, entered into a
comprehensive settlement of tobacco litigation through parallel agreements with
the Attorneys General of 17 states and with a nationwide class of individuals
and entities that allege smoking-related claims. Liggett and BGL have now
obtained settlements with each of the 22 states have commenced suit against
them. The settlements cover all smoking-related claims, including both
addiction-based and tobacco injury claims against Liggett and BGL, brought by
the 22 states, and upon court approval, the nationwide class.

The settlement with the Attorneys General, which does not require court
approval, includes the states of Arizona, Connecticut, Hawaii, Illinois,
Indiana, Iowa, Kansas, Maryland, Michigan, Minnesota, New Jersey, New York,
Oklahoma, Texas, Utah, Washington and Wisconsin. Liggett and BGL's previous
settlements on March 15, 1996, with the Attorneys General of Florida,
Louisiana, Massachusetts, Mississippi and West Virginia remain in full force
and effect.

The settlement with the nationwide class covers all smoking-related
claims. On March 20, 1997, Liggett, BGL and plaintiffs filed the mandatory
class settlement agreement in an action entitled Fletcher, et al, v. Brooke
Group Ltd., et al., Circuit Court of Mobile County Alabama, where the court
granted preliminary approval and preliminary certification of the class. Class
members will be notified of the settlement and will have an opportunity to
appear at a later court hearing. Effectiveness of the mandatory settlement is
conditioned on final court approval of the settlement after a fairness hearing.
There can be no assurance as to whether or when court approval will be
obtained. There are no opt out provisions in this settlement, except for
Medicaid claims by states that are not party to the Attorneys General
settlements.

Pursuant to the settlements, Liggett and BGL have agreed to cooperate
fully with the Attorneys General and the nationwide class in their lawsuits
against the tobacco industry. Liggett and BGL have agreed to provide to these
parties all relevant tobacco documents in their possession, other than those
subject to claims of joint defense privilege, and to waive, subject to court
order, certain attorney-client privileges and work product protections regarding
Liggett's smoking-related documents to the extent Liggett and BGL can so waive
these privileges and protections. The Attorneys General and the nationwide
class have agreed to keep Liggett's documents under protective order and,
subject to final court approval, to limit their use to those actions brought by
parties to the settlement agreements. Those documents that may be subject to a
joint defense privilege with other tobacco companies will not be produced to the
Attorneys General or the nationwide class, but will be, pursuant to court order,
submitted to the appropriate court and placed under seal for possible in camera
review. Additionally, under similar protective conditions, Liggett and BGL have
agreed to offer their employees for witness interviews and testimony at
deposition and trial. Pursuant to both settlement agreements, Liggett has also
agreed to place an additional warning on its cigarette packaging stating that
"smoking is addictive" and to issue a public statement, as requested by the
Attorneys General.

Under the terms of the new settlement agreements, Liggett will pay on a
annual basis 25% of its pretax income for the next 25 years into a settlement
fund, commencing with the first full fiscal year starting after the date of the
agreements. Monies collected in the settlement fund will be overseen by a
court-appointed committee and utilized to compensate state health care programs
and settlement class members and to provide counter-market advertising. Liggett
has also agreed to phase-in-compliance with certain proposed FDA regulations
regarding smoking by children and adolescents, including a prohibition on the
use of cartoon characters in tobacco advertising and limitations on the use of
promotional materials and distribution of sample packages where minors are
present.

Under both settlement agreements, any other tobacco company defendant,
except Philip Morris, merging or combining with Liggett or BGL, prior to the
fourth anniversary of the settlement agreements, would receive certain
settlement benefits, including limitations on potential liability and not
having to post a bond to appeal any further adverse judgment. In addition,
within 120 days following such a combination, Liggett would be required to pay
the settlement fund of $25 million. Both the Attorneys General and the
nationwide class have also agreed not to seek an injunction preventing a
defendant tobacco company combining with Liggett or BGL from spinning off any
of its affiliates which are not engaged in the domestic tobacco business.

Liggett and BGL are also entitled to certain "most favored nation"
benefits not available to the other defendant tobacco companies. In addition,
in the event of a "global" tobacco settlement enacted through Federal
legislation or otherwise, the Attorneys General and tobacco plaintiffs have
agreed to use their "best efforts" to ensure that Liggett's and BGL's liability
under such a plan should be no more onerous than under these new settlements.

<PAGE> 46
Legislation and Regulation

On August 28, 1996, the Food and Drug Administration ("FDA") filed in
the Federal Register a Final Rule classifying tobacco as a drug, asserting
jurisdiction by the FDA over the manufacture and marketing of tobacco products
and imposing restrictions on the sale, advertising and promotion of tobacco
products. The FDA's stated objective and focus for its initiative is to limit
access to cigarettes by minors by measures beyond the restrictions either
mandated by existing federal, state and local laws or voluntarily implemented by
major manufacturers in the industry. Litigation has been commenced in the United
States District Court for the Middle District of North Carolina challenging the
legal authority of the FDA to assert such jurisdiction, as well as challenging
the constitutionality of the rules. A hearing on the tobacco industry's motion
for summary judgment in that case was held on February 10, 1997 and a decision
by the Court is expected soon. The FDA's proposed restrictions, some of which
became effective as early as February 28, 1997, purport to: (i) limit access to
tobacco products and (ii) limit advertising and marketing. Management is unable
to predict whether the Final Rule will be upheld as enforceable against the
industry. Management is also unable to predict the effects of the proposed
restrictions, if implemented, on Liggett's operations, but such actions could
have an unfavorable impact thereon.

Liggett and BGL, while neither consenting to FDA jurisdiction nor
waiving their objections thereto, agreed to withdraw their objections and
opposition to the proposed rule making and to phase in compliance with certain
of the proposed interim FDA regulations. See discussions of the Castano and
Attorneys General settlements above.

In 1993, the United States Congress amended the Agricultural Adjustment
Act of 1938 to require each United States cigarette manufacturer to use at least
75% domestic tobacco in the aggregate of the

47
<PAGE> 47

cigarettes manufactured by it in the United States, effective January 1, 1994,
on an annualized basis or pay a domestic marketing assessment ("DMA") based
upon price differentials between foreign and domestic tobacco and, under
certain circumstances, make purchases of domestic tobacco from the tobacco
stabilization cooperatives organized by the United States government.

After an audit, the United States Department of Agriculture ("USDA")
informed Liggett that it did not satisfy the 75% domestic tobacco usage
requirement for 1994 and was subject to a DMA (the "USDA marketing assessment")
of approximately $5,500. Liggett has agreed to pay this assessment in
quarterly installments, with interest, over a five-year period, and $4,900 was
accrued for the assessment in 1995. Since the levels of domestic tobacco
inventories on hand at the tobacco stabilization organizations are below
reserve stock levels, the Company was not obligated to make purchases of
domestic tobacco from the tobacco stabilization cooperatives.

On February 20, 1996, the United States Trade representative issued an
"advance notice of rule making" concerning how tobaccos imported under the TRQ
should be allocated. Currently, tobacco imported under the TRQ is allocated on
a "first-come, first-served" basis, meaning that entry is allowed on an open
basis to those first requesting entry in the quota year. Others in the
cigarette industry have suggested an "end-user licensing" system under which
the right to import tobacco under the quota would be initially assigned on the
basis of domestic market share. Such an approach, if adopted, could have a
material adverse effect on the Company.

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

<PAGE> 48

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

13. Related Party Transactions

On July 5, 1996, Liggett purchased 140,000 shares (19.97%) of
Liggett-Ducat Ltd.'s ("Liggett-Ducat") tobacco operations from Brooke
(Overseas) Ltd. ("BOL"), an indirect subsidiary of BGL, for $2,100.
Liggett-Ducat, which produces cigarettes in Russia, manufactured and marketed
11.4 billion cigarettes in 1996. Liggett also acquired on that date for $3,400
a ten-year option, exercisable by Liggett in whole or in part, to purchase from
BOL at the same per share price up to 292,407 additional shares of
Liggett-Ducat, thereby entitling Liggett to increase its interest in
Liggett-Ducat to approximately 62%. The option fee is to be credited against
the purchase price. In addition, as part of the same transaction, Liggett had
the right on or before June 30, 1997 to acquire from BOL for $2,200 another
ten-year option on the same terms to purchase the remaining shares of
Liggett-Ducat (an additional 33%). On March 13, 1997, Liggett acquired this
option and paid BOL $2,000, and recorded a payable to BOL for the remaining
$0.2 million. Liggett accounts for its investment in Liggett-Ducat under the
equity method of accounting. Liggett's equity in the net loss of Liggett-Ducat
amounted to $1,116 for the year ended December 31, 1996. The excess of the
cost of the option over carrying amount of net assets to be acquired under the
option has been charged to stockholder's deficit.

Since October 1990, Liggett has provided certain administrative and
technical support to Liggett-Ducat in exchange for which Liggett-Ducat provides
assistance to Liggett in its pursuit of selling cigarettes in the Russian
Republic. The expenses associated with Liggett's activities amounted to $76,
$229 and $230 for the years ended December 31, 1996, 1995 and 1994,
respectively.

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

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

Liggett has entered into an annually renewable Corporate Services
Agreement with BGLS wherein BGLS agreed to provide corporate services to the
Company at an annual fee paid in monthly installments. Corporate services
provided by BGLS under this agreement include the provision of administrative
services related to Liggett's participation in its parent company's
multi-employer benefit plan, external publication of financial results,
preparation of consolidated financial statements and tax returns and such other
administrative and managerial services as may be reasonably requested by
Liggett. The charges for services rendered under the agreement amounted to
$3,160 in 1996, $3,010 in 1995 and $2,866 in 1994. This fee is in addition to
the management fee and overhead reimbursements described above.

In prior years, BGLS assumed specified Liggett liabilities from time to
time and Liggett repaid these amounts from time to time. During 1994, Liggett
satisfied all amounts due ($8,000) in full.

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

The Company acquired CTEC from its indirect parent during 1995 for $800.
The excess of cost over the carrying amount of the net assets acquired has
been charged to stockholder's equity (deficit). The

<PAGE> 49

effect of the accounting treatment presents the investment in CTEC at
carryover basis. Accounts receivable from affiliates relate principally to
advances for expenses paid by the Company on behalf of its affiliates.

14. Supplemental Disclosure of Non-Cash Financing and Investing Activities

During 1994, the Company issued $17,850 in Series C Notes in exchange for
Series B Notes and in connection with indenture consent of which $15,008 were
credited against the mandatory redemption of Series B Notes for February 1,
1994 and 1995, and $2,842 were recorded as deferred finance charges.

During 1994, the Company transferred equipment with a net book value of
$2,161 to BGLS in return for assumption of Liggett's note payable of $1,988.

15. Restructuring Charges

During 1996, the Company reduced its headcount by 38 positions and
recorded a $3,428 restructuring charge to operations ($132 of which was
included in cost of sales) for severance programs, primarily salary
continuation and related benefits for terminated employees. Of the total
restructuring recorded during 1996, $1,416 was funded during 1996, leaving
$2,012 remaining to be funded in subsequent years. The Company expects to
continue its cost reduction programs.

During 1995, Liggett continued its efforts towards reducing costs by,
among other things, offering voluntary retirement programs to eligible
employees. The Company's 1995 cost reduction programs reduced the Company's
headcount by approximately 120 positions. In connection therewith, the Company
recorded charges totaling $2,548 to operating income including $621 relating to
manufacturing operations which has been charged to cost of sales.

<PAGE> 50
REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholder
of Eve Holdings Inc.

We have audited the accompanying balance sheets of Eve Holdings Inc. (the
"Company") as of December 31, 1996 and 1995 and the related statements of
operations, stockholder's equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1996. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Eve Holdings Inc. at December
31, 1996 and 1995 and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 1996 in conformity with
generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2a to the
financial statements, the Company's revenues are comprised solely of royalties
and interest income from Liggett Group Inc. ("Liggett"). Liggett had a working
capital deficit of $40,694,000 and a net capital deficiency of $176,478,000 as
of December 31, 1996, is highly leveraged and has substantial near-term debt
service requirements. These matters raise substantial doubt about the
Company's ability to continue as a going concern. The financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.

COOPERS & LYBRAND L.L.P.

Miami, Florida
March 27, 1997

<PAGE> 51

EVE HOLDINGS INC.

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

<TABLE>
December 31,
1996 1995
---- ----
ASSETS
<S> <C> <C>
Cash ............................................................ $ -- $ 8
Office equipment ................................................ 2 2
Trademarks, at cost, less accumulated amortization of
$17,294 and $15,593, respectively ............................ 3,119 4,820
--------- ---------
Total assets .......................................... $ 3,121 $ 4,830
========= =========

LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)

Federal income taxes currently payable to parent ................ $ -- $ 164

Dividends payable ............................................... 4,623 2,536

Cash overdraft .................................................. 92 --

Other current liabilities ....................................... 19 --

Deferred income taxes ........................................... 1,092 1,687
--------- ---------
Total liabilities ..................................... 5,826 4,387
--------- ---------
Stockholder's equity (deficit):
Common stock (par value $1 00 per share; authorized,
issued and outstanding 100 shares) and contributed
capital .................................................... 46,548 47,653
Receivables from parent:
Note receivable - interest at 14%, due no sooner
than February 1, 1999 .................................... (44,520) (44,520)
Other ...................................................... (4,733) (2,690)
--------- ---------
Total stockholder's equity (deficit) ..................... (2,705) 443
--------- ---------
Total liabilities and stockholder's equity (deficit) ..... $ 3,121 $ 4,830
========= =========
</TABLE>

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

<PAGE> 52

EVE HOLDINGS INC.

STATEMENTS OF OPERATIONS

(Dollars in thousands)

<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Revenues:
Royalties - parent ............................ $ 8,608 $ 10,452 $ 10,647
Interest - parent ............................. 6,306 6,306 6,306
--------- --------- ---------
14,914 16,758 16,953
Expenses:
Amortization of trademarks .................... 1,701 1,702 1,701
Miscellaneous ................................. 129 93 70
--------- --------- ---------
Operating income .............................. 13,084 14,963 15,182
Interest expense ................................ 49 -- --
--------- --------- ---------
Income before income taxes .................... 13,035 14,963 15,182
Income tax provision ............................ 2,480 5,237 5,314
--------- --------- ---------
Net income .................................... $ 10,555 $ 9,726 $ 9,868
========= ========= =========
</TABLE>

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

<PAGE> 53

EVE HOLDINGS INC.

STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)

(Dollars in thousands)

<TABLE>
<CAPTION>
Common
Stock and Receivables Total
Capital in Retained From Stockholder's
Excess of Par Earnings Parent Equity
------------- -------- ------ ------------
<S> <C> <C> <C> <C>
Balance at December 31, 1993 ............ $ 49,866 $ -- $ (45,219) $ 4,647

Net income ............................ -- 9,868 -- 9,868
Dividends/capital distributions ....... (1,107) (9,868) -- (10,975)
Net change in receivable from Parent .. -- -- (2,053) (2,053)
--------- --------- --------- ---------
Balance at December 31, 1994 ............ 48,759 -- (47,272) 1,487
Net income ............................ -- 9,726 -- 9,726
Dividends/capital distributions ....... (1,106) (9,726) -- (10,832)
Net change in receivable from Parent .. -- -- 62 62
--------- --------- --------- ---------
Balance at December 31, 1995 ............ 47,653 -- (47,210) 443
Net income ............................ -- 10,555 -- 10,555
Dividends/capital distributions ....... (1,105) (10,555) -- (11,660)
Net change in receivable from Parent .. -- -- (2 043) (2,043)
--------- --------- --------- ---------
Balance at December 31, 1996 ............ $ 46,548 $ -- $ (49,253) $ (2,705)
========= ========= ========= =========
</TABLE>

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

<PAGE> 54

EVE HOLDINGS INC.

STATEMENTS OF CASH FLOWS

(Dollars in thousands)

<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net income .................................................. $ 10,555 $ 9,726 $ 9,868
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ............................. 1,701 1,703 1,701
Deferred income taxes ..................................... (595) (596) (595)
Changes in assets and liabilities:
Federal income taxes currently payable to parent ......... (164) 157 (691)
Other current liabilities ................................. 19 -- --
--------- --------- ---------
Net cash provided by operating activities ............... 11,516 10,990 10,283
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures ........................................ -- -- (3)
--------- --------- ---------
Net cash used in investing activities ................... -- -- (3)
--------- --------- ---------
Cash flows from financing activities:
Increase in cash overdraft .................................. 92 -- --
Dividends/capital distributions ............................. (9,573) (11,046) (8,225)
Increase (decrease) in due from parent ...................... (2,043) 62 (2,053)
--------- --------- ---------
Net cash used in financing activities ................... (11,524) (10,984) (10,278)
--------- --------- ---------
Net (decrease) increase in cash ............................... (8) 6 2

Cash:
Beginning of period ......................................... 8 2 --
--------- --------- ---------
End of period ............................................... $ 0 $ 8 $ 2
========= ========= =========
Supplemental cash flow information:
Payments of income taxes through receivable from parent ..... $ 5,159 $ 5,676 $ 6,600
========= ========= =========
Dividends/capital distributions declared but not paid ....... $ 4,623 $ 2,536 $ 2,750
========= ========= =========
</TABLE>
The accompanying notes are an integral part
of these financial statements.

<PAGE> 55

EVE HOLDINGS INC.

Notes to Financial Statements

(Dollars in thousands, except per share amounts)

1. The Company
Eve Holdings Inc. ("Eve" or the "Company") is a wholly-owned subsidiary of
Liggett Group Inc. ("Liggett"). Eve's predecessor, Chesterfield Assets Inc.,
was organized in March 1987. Eve, formed in June 1990, is the proprietor of,
and has all right, title and interest in, certain federal trademark
registrations (the "Trademarks"). Eve has entered into an exclusive licensing
agreement with Liggett (effective until 2010) whereby Eve grants the use of the
Trademarks to Liggett in exchange for royalties, computed based upon Liggett's
annual net sales, excluding excise taxes of $296, 544, $332,246 and $333,799
for the years ended December 31, 1996, 1995 and 1994, respectively. Generally,
royalties are earned based on a rate of either 2% of sales for generic product
trademarks and 5% of sales for branded product trademarks. In recent fiscal
years, Liggett has experienced greater growth in the sales of generic rather
than branded products resulting in a lower overall royalty rate. The
Trademarks are pledged as collateral for borrowings under the Liggett notes
(see Note 3).

2. Summary of Significant Accounting Policies

a. Going Concern

The accompanying financial statements have been prepared assuming that
Eve will continue as a going concern. Eve's revenues are comprised solely of
royalties and interest income from Liggett. In addition, Eve holds a note
receivable from Liggett for $44,520 due no sooner than February 1, 1999.
Liggett had a working capital deficiency of $40,694 and a net capital
deficiency of $176,478 as of December 31, 1996, is highly leveraged and has
substantial near-term debt service requirements. These matters raise
substantial doubt about Eve and Liggett meeting their liquidity needs and their
ability to continue as going concerns.

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

b. Basis of Presentation

On February 11, 1992, Eve consummated an Agreement and Plan of Merger (the
"Merger Agreement") with LGC Corp. (a wholly-owned subsidiary of Liggett)
whereby the operations of LGC Corp., consisting primarily of holding an
unsecured $44,250 note receivable (bearing interest at 14%, due November 2,
1996) from Liggett and related interest thereon, were merged into those of
Eve. The merger was accounted for at historical cost similar to that in
pooling of interests accounting. On March 7, 1994, Liggett and Eve agreed to
extend the due date of the note to no sooner than February 1, 1999 from
November 2, 1996. All other terms of the note remained the same.

c. Per Share Data

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

d. Trademarks

Trademarks are amortized using the straight-line method over 12 years.
Management periodically reviews the carrying value of trademarks to determine
whether asset values are impaired.

e. Estimates and Assumptions

<PAGE> 56

3. Guarantee of Liggett Notes

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

4. Income Taxes

Eve's operations are included in the consolidated federal income tax
return of its indirect parent, Brooke Group Ltd. ("Brooke"). Eve's federal
income tax provisions are calculated as if it filed a separate federal income
tax return. Statement of Financial Accounting Standards No. 109 "Accounting for
Income Taxes" ("SFAS 109") requires that deferred taxes be recorded under the
liability method.

The amounts provided for income taxes are as follows:

<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Current:
U.S. Federal ........................ $2,883 $5,832 $5,909
State ............................... 192 -- --
------ ------ ------
Deferred:
U.S. Federal......................... (595) (595) (595)
State................................ - - -
------ ------ ------
Total provision for continuing operations $2,480 $5,237 $5,314
====== ====== ======
</TABLE>

Eve's deferred tax liability relates entirely to the difference in
the basis of the Trademarks for book and tax purposes. As permitted in SFAS 109,
Eve has not adjusted the basis of the Trademarks that were previously adjusted
to net of tax amounts to be consistent with the accounting treatment adopted by
Liggett.

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

<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Income from continuing operations
before income taxes ...................... $ 13,035 $ 14,963 $ 15,182
-------- -------- --------

Federal income tax (benefit) at statutory rate 4,563 5,237 5,314

Decreases resulting from:
Exclusion of interest income
between related parties................. (2,207) -- --
State income taxes, net of federal ....... 124 -- --
-------- -------- --------
Total ........................................ $ 2,480 $ 5,237 $ 5,314
======== ======== ========
</TABLE>

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

57
<PAGE> 57

LIGGETT GROUP INC.

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

(Dollars in thousands)
<TABLE>
<CAPTION>
Additions
---------
Balance at Charged to Charged to Balance
Beginning Costs and Net at End
of Period Expenses Sales Deductions of Period
--------- -------- ----- ---------- ---------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996
Allowances for:
Doubtful accounts ................. $ 200 $ 903 $ -- $ 353 (a) $ 750
Cash discounts .................... 615 13,929 -- 14,014 (b) 530
-------- -------- -------- -------- --------
Total ........................... $ 815 $ 14,832 -- $ 14,367 $ 1,280
======== ======== ======== ======== ========
Sales returns allowance ............ $ 5,000 $ -- $ -- $ -- (c) $ 5,000
======== ======== ======== ======== ========
Provision for inventory obsolescence $ 2,069 $ 1,341 $ -- $ 192 (d) $ 3,218
======== ======== ======== ======== ========
Year ended December 31, 1995

Allowances for:
Doubtful accounts ................. $ 249 $ 231 $ -- $ 280 (a) $ 200
Cash discounts .................... 720 14,579 -- 14,684 (b) 615
-------- -------- -------- -------- --------
Total ........................... $ 969 $ 14,810 -- $ 14,964 $ 815
======== ======== ======== ======== ========
Sales returns allowance ............ $ 5,800 $ 1,030 $ (800) $ 1,030 (c) $ 5,000
======== ======== ======== ======== ========
Provision for inventory obsolescence $ 1,369 $ 911 $ -- $ 211 (d) $ 2,069
======== ======== ======== ======== ========
Year ended December 31, 1994

Allowances for:
Doubtful accounts ................. $ 235 $ 21 $ -- $ 7 (a) $ 249
Cash discounts .................... 745 12,337 -- 12,362 (b) 720
-------- -------- -------- -------- --------
Total ........................... $ 980 $ 12,358 $ 12,369 $ 969
======== ======== ======== ======== ========
Sales returns allowance ............ $ 6,300 $ -- $ 2,800 $ 3,300 (c) $ 5,800
======== ======== ======== ======== ========
Provision for inventory obsolescence $ 1,418 $ 520 $ -- $ 569 (d) $ 1,369
======== ======== ======== ======== ========
</TABLE>

(a) Represents uncollectible accounts written off.
(b) Represents cash discounts taken.
(c) Represents adjustments to lower the allowance based on revised estimates of
sales returns by management.
(d) Represents inventory written off, disposed of, or written down to
lower of cost or market value.

<PAGE> 58

INDEX OF EXHIBITS

EXHIBIT NO. DESCRIPTION
- --------- -----------
<S> <C>
*3(i).1 Restated Certificate of Incorporation of Liggett (incorporated by
reference to exhibit 3 in Liggett's Form 10-Q for the quarter ended
June 30, 1992, Commission File No. 33-47482).

*3(i).2 Certificate of Amendment to Restated Certificate of Incorporation of
Liggett, as amended, dated September 28, 1993 (incorporated by
reference to exhibit 3(i).2 in Liggett's Registration Statement on
Form S-1, Amendment No. 4, Commission File No. 33-75224).

*3(i).3 Certificate of Incorporation of Eve (incorporated by reference to
exhibit 3.3 in Liggett's Registration Statement on Form S-1,
Commission File No. 33-47482).

*3(ii).1 Bylaws of Liggett (incorporated by reference to exhibit 3.2 in
Liggett's Registration Statement on Form S-1, Commission File No.
33-47482).

*3(ii).2 Bylaws of Eve (incorporated by reference to exhibit 3.4 in Liggett's
Registration Statement on Form S-1, Commission File No. 33-47482).

*4.1 Indenture, dated February 14, 1992 among Liggett, Eve and Bankers
Trust Company as Trustee including the Forms of Series A Notes and
Series B Notes and the Guaranty thereon (the "Indenture")
(incorporated by reference to exhibit 4 (m) in BGL's Form 10-K for the
year ended December 31, 1991, Commission File No. 1-5759).

*4.2 First Supplemental Indenture, dated January 26, 1994, including the
Form of Series C Variable Rate Senior Secured Note and the Guaranty
thereon (incorporated by reference to exhibit 4.2 in Liggett's
Registration Statement on Form S-1, Amendment No. 4, Commission File
No. 33-75224).

*4.3 Security Agreement, dated February 14, 1992 among Liggett, Eve and
Bankers Trust Company (the "Security Agreement") (incorporated by
reference to exhibit 4 (n) in BGL's Form 10-K for the year ended
December 31, 1991, Commission File No. 1-5759).

*4.4 Amendment No. 1 to the Security Agreement, dated January 26, 1994
(incorporated by reference to exhibit 4.4 in Liggett's Registration
Statement on Form S-1, Amendment No. 4, Commission File No. 33-75224).
</TABLE>

59
<PAGE> 59

EXHIBIT NO. DESCRIPTION
- --------- -----------
<S> <C>
*4.5 Deed of Trust and Assignment of Rents, Leases and Leasehold Interests
dated February 14, 1992 by Liggett to Bankers Trust company relating
to each of the Virginia and North Carolina properties, (the "Deed of
Trust") (incorporated by reference to exhibit 4(o) in BGL's Form 10-K
for the year ended December 31, 1991, Commission File No. 1-5759).

*4.6 Amendment No. 1 to the Deed of Trust (North Carolina), dated January
26, 1994 (incorporated by reference to exhibit 4.6 in Liggett's
Registration Statement on Form S-1, Amendment No. 4, Commission File
No. 33-75224).

*4.7 Amendment No. 1 to the Deed of Trust (Virginia), dated January 26,
1994 (incorporated by reference to exhibit 4.7 in Liggett's
Registration Statement on Form S-1, Amendment No. 4, Commission File
No. 33-75224).

*4.8 Loan and Security Agreement, dated March 8, 1994 in the amount of
$40,000,000 between Liggett and Congress Financial Corporation
(incorporated by reference to exhibit 10(xx) in BGL's Form 10-K for
the year ended December 31, 1993, Commission File No. 1-5759).

*10.1 Retirement Plan of BGLS for Salaried Non-Bargaining Unit Employees
(incorporated by reference to exhibit 10(s) in BGL's Registration
Statement on Form S-1, Commission File No. 33-16499).

*10.2 Profit Sharing Plan for Salaried Non-Bargaining Unit Employees of
Liggett (incorporated by reference to exhibit 10(t) in BGL's
Registration Statement on Form S-1, Commission File No. 33-16499).

*10.3 Resolution of the Board of Directors of Liggett, dated January 7,
1992, relating to Profit Sharing Plan for Salaried Non-Bargaining Unit
Employees of Liggett (incorporated by reference to exhibit 10.4 in
Liggett's Registration Statement on Form S-1, Amendment No. 4,
Commission File No. 33-75224).

*10.4 Resolution of the Board of Directors of Liggett, dated December 21,
1993, amending the Company's Profit Sharing Plan for Salaried
Non-Bargaining Unit Employees (incorporated by reference to exhibit
10.5 in Liggett's Registration Statement on Form S-1, Amendment No. 4,
Commission File No. 33-75224).
</TABLE>

<PAGE> 60

EXHIBIT NO. DESCRIPTION
- --------- -----------
<S> <C>
*10.5 Services Agreement, dated February 26, 1991 between Liggett and BMI
(incorporated by reference to exhibit 10.8 in Liggett's Registration
Statement on Form S-1, Commission File No. 33-47482)

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

*10.7 Second Amendment to Services Agreement, dated October 1, 1995, by and
between BMI, BGL and Liggett (incorporated by reference to exhibit 10
in Liggett's Form 10-Q for the quarter ended September 30, 1995,
Commission File No. 33-75224).

*10.8 Corporate Services Agreement, dated June 29, 1990 between Liggett and
BGL (incorporated by reference to exhibit 10.10 in Liggett's
Registration Statement on Form S-1, Commission File No. 33-47482).

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

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

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

*10.12 Employment Agreement, dated June 1, 1994, between Liggett and Rouben
V. Chakalian (incorporated by reference to exhibit 10.14 in Liggett's
Registration Statement on Form S-1, Amendment No. 4, Commission File
No. 33-75224).
</TABLE>

<PAGE> 61

EXHIBIT NO. DESCRIPTION
- --------- -----------
<S> <C>
*10.13 Termination Agreement, dated April 3, 1995, between Liggett and Ronald
J. Bernstein (incorporated by reference to exhibit 10.21 in Liggett's
Registration Statement on Form S-1, Post Effective Amendment No. 1,
Commission File No. 33-75224).

*10.14 Lease with respect to Liggett's distribution center in Durham, North
Carolina, including letter agreement extending term of Lease
(incorporated by reference to exhibit 10.15 in Liggett's Registration
Statement on Form S-1, Commission File No. 33-47482).

*10.15 License Agreement, dated June 1993, between Liggett and Eve
(incorporated by reference to exhibit 10.16 in Liggett's Registration
Statement on Form S-1, Commission File No. 33-47482).

*10.16 Tax Indemnity Agreement, dated October 6, 1993, among BGL, Liggett and
certain other entities (incorporated by reference to exhibit 10.2 in
SkyBox's Form 10-Q for the quarter ended September 30, 1993,
Commission File No. 0-22126).

*10.17 Letter Agreement, dated June 15, 1993, between Liggett and Rouben V.
Chakalian, relating to consultancy and director compensation
arrangements (incorporated by reference to exhibit 10.19 in Liggett's
Registration Statement on Form S-1, Amendment No. 4, Commission File
No. 33-75224).

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

*10.19 Addendum to the Settlement Agreement (incorporated by reference to
exhibit 10.30 to BGL's Form 10-K for the year ended December 31,
1996, as amended).
</TABLE>

<PAGE> 62

<TABLE>
<CAPTION>
SUBSEQUENTLY
EXHIBIT NO. DESCRIPTION NUMBERED PAGE
- --------- ----------- -------------
<S> <C> <C>

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

*10.21 Amended Employment Agreement, dated January 9, 1996, between
Liggett and Rouben V. Chakalian (incorporated by reference to
exhibit 10.25 in Liggett's Form 10-K for the year ended
December 31, 1995, Commission File No. 33-75224).

*10.22 Employment Agreement, dated February 1, 1996, between Liggett and
Douglas A. Cummins (incorporated by reference to exhibit 10.26 in
Liggett's Form 10-K for the year ended December 31, 1995, Commissioon
File No. 33-75224).

*10.23 General Policies and Practices of Liggett. Executive Termination
Policy No. 2503, effective February 1, 1996 (incorporated by reference
to exhibit 10.27 in Liggett's Form 10-K for the year ended December 31,
1995, Commission File No. 33-75224).

*10.24 Letter Agreement, dated September 5, 1996, between Liggett and Ronald
S. Fulford (incorporated by reference to exhibit 10.23 in
Liggett's Form 10-K for the year ended December 31, 1996, Commission
File No. 33-75224 (the "1996 Form 10-K")).

*10.25 Settlement Agreement, dated March 20, 1997, by and among the State
listed in Appendix A thereto, BGL and Liggett (incorporated by
reference to exhibit 10.40 in BGL's Form 10-K for the year ended
December 31, 1996).

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

*21.1 Subsidiaries of Liggett (incorporated by reference to exhibit 21.1 in the
1996 Form 10-K).

*21.2 Subsidiaries of Eve (incorporated by reference to exhibit 21.2 in the 1996
Form 10-K).

*27.1 Financial Data Schedule of Liggett (incorporated by reference to exhibit 27.1
in the 1996 Form 10-K).

*27.2 Financial Data Schedule of Eve (incorporated by reference to exhibit 27.2
in the 1996 Form 10-K).
</TABLE>

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

* Incorporated by reference